Audit Workbook

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CA Final Advanced Auditing & Professional Ethics
Workbook
Advanced Auditing and Professional Ethics (CA Final) Compiled by: Pankaj Garg
Complied by: Pankaj Garg (CA, CS, CWA(I) All India Topper, Gold Medalist)
Upcoming Batches: F2F@ SmartteachCA (IMA ITO, Delhi) w.e.f. 30 May (MWF, 5.30 p.m.- 08.30 p.m.); Satellite@ETENCA w.e.f. 28 May (SS, 2 p.m 5 p.m.)
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Must Read - Preface to Workbook

This workbook contains topics which are not covered in main notes but important to study as questions on these concepts are regularly asked in the exams. Such Topics are Guidance Notes, Accounting Standards,
Companies (AS) Rules, 2006, Schedule VI etc.

As these topics, in itself are very much detailed and the part of IPCC Account / Final Financial Reporting, only the portion that is relevant for Auditing paper is covered here. Most of the practical illustrations covered in these notes are taken from Chartered Accountant Journal, RTP, Suggested answers, Practice Manuals and Compiler. On analysis of past year question papers, it can be concluded that around one question covering 16-20 marks is from the areas mentioned above and generally that question is compulsory one. I hope that readers will be satisfied with the contents of these notes. Still, there always remains scope for improvement. I will be grateful to the readers for their valuable feedback for improvement of these notes. Wishing every success to the readers. CA. Pankaj Garg e-mail: ca.gargpankaj@sify.com
Best of Luck.
Schedule of Upcoming Batches

IPCC - Audit F2F F2F Satellite IPCC - Law Final - Audit F2F F2F Satellite 31-May 31-May 21-May 30-May 30-May 28-May TT TT SS MWF MWF SS 10.30 a.m. - 01.30 p.m. 05.30 p.m. - 08.30 p.m. 10.30 a.m. - 01.30 p.m. 10.30 a.m. - 01.30 p.m. 05.30 p.m. - 08.30 p.m. 02.00 p.m. - 05.00 p.m. SmartteachCA, IMA - ITO, New Delhi SmartteachCA , Pitampura, New delhi ETEN Centers - Across India SmartteachCA , Pitampura, New delhi SmartteachCA , IMA - ITO, New Delhi ETEN Centers - Across India
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CA Final Advanced Auditing & Professional Ethics CONTENTS S. No. Name of Topic Page No. No. of Illustrations/Questions Preface Contents 1 2 3 4 5 Guidance Notes Questions on Standards on Auditing AS and Companies (AS) Rules Company Audit and Schedule VI Additional Illustrations / Questions Professional Ethics Bank audit Tax Audit Misc. Total Illustrations/Questions 36 36 37 38 39 40 41 - 42 3 3 4 4 110 02 03 04 07 08 13 14 30 31 35 7 36 40 13
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GUIDANCE NOTES
Statements Issued with a view to securing compliance by members on matters which in the opinion of the council of the institute are critical for the proper discharge of their functions. Compliance is Mandatory in Nature Examples Statement on Reporting u/s 227(1A) of the Companies Act, 1956 Statement on the CARO, 2003. Framework for the Preparation and Presentation of Financial Statements. Duties of members to examine whether Statements relating to accounting matters are complied with in the presentation of F.S. In the event of any deviation from such Statements, to make adequate disclosures in their audit reports so that the users of F.S. may be aware of such deviations to ensure that the Statements relating to auditing matters, are followed in the audit of financial information covered by their audit reports. If, for any reason, a member, has not been able to perform an audit in accordance with such Statements his report should draw attention to the material departures there from. Guidance Notes Designed to provide guidance to members on matters which may arise in the course of their professional work and on which they may desire assistance. Compliance is recommendatory in nature Example Accounting Guidance Note on Accounting Treatment for Excise Duty. Guidance Note on Accounting for Depreciation in Companies. Guidance Note on Accounting Treatment for CENVAT. Guidance Note on Accounting for Corporate Dividend Tax Auditing Guidance Note on Independence of Auditors. Guidance Note on Audit of Fixed Assets. Guidance Note on Audit u/s 44AB of the Income -tax Act. Guidance Note on Audit of Abridged Financial Statements. Duties of member Accounting Examine whether the recommendations in a guidance note relating to an accounting matter have been followed or not. If the same have not been followed, consider whether keeping in view the circumstances of the case, a disclosure in his report is necessary. Auditing Follow recommendations in a guidance note except where he is satisfied that in the circumstances of the case, it may not be necessary to do so. Expected Question Q. No. 1: The Institute has, from time to time, issued Statements and Guidance Notes on a number of matters. Discuss the level of authority attached to these documents and the degree of compliance required in respect thereof.
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GUIDANCE NOTES Accounting and Auditing Practical Illustrations

Treatment of Reserve created on Revaluation of Fixed Assets Q. No. 1 As a statutory auditor of a Public Limited Company, how would you deal with the following situation: As at the beginning of the year, the company has a capital of `.2.50 crores, free reserves of ` 0.50 crores and Revaluation Reserve of ` 4.50 crores. In the relevant year under audit the company has incurred a loss of ` 4 crores. The company proposes to adjust the loss with the Revaluation Reserve. Answer: Adjustment of Loss against Revaluation Reserve: Relevant Provisions: Guidance Note on Treatment of Reserve created on Revaluation of Fixed Assets states that where the value of fixed assets is written up in the books of account of a company, the corresponding credit appearing as revaluation reserve does not represent a realised gain and is, therefore, not available for distribution as dividend. Therefore any accumulated losses / depreciation (including arrears) should not be adjusted against revaluation reserve since this would amount to setting off actual losses against unrealized gains. Conclusion: The auditor should explain to the management that accumulated losses cannot be adjusted against the revaluation reserve created on revaluation of the fixed assets. In case the company in question does so, the balance sheet of the company will not reflect a true and fair view of the state of affairs of the company, keeping in view the magnitude of the amounts involved, i.e., accumulated losses amount to ` 4 crores and share capital and reserves amount to `3 crores (excluding revaluation reserve). If the management does not agree with the opinion of the auditor, the auditor may even issue an adverse report. As a Statutory auditor, how would you deal with following: While finalizing its accounts, a company does not provide for Income-tax payable under the provisions of the Income-tax Act, 1961. A note is however given that since adequate tax has been deducted at source, no additional tax is payable. [Nov. 08 Old (5 Marks)] Answer: No provisions for Income Tax Payable: Guidance Note on provision for liability for taxation, provides that the provision for anticipated tax liability in respect of profits of the company has to be made while finalizing its accounts. According to it, non-provision for taxation would amount to contravention of the provisions of Sec. 209 and 211 of the Companies Act i.e. maintenance of proper books of account and disclosures of true and fair view of the state of affairs of the company. Conclusion: Auditor is required to quality his report and such qualification should bring out in what manner the accounts do not disclose "True and Fair view of the state of affairs of the Company and its Profit or loss. However, the qualification should also mention clearly that TDS is in excess of the estimated tax liability for the year. Comment on the following: S Ltd. issued Bonds to the tune of `100 lacs and provided security to the tune of `80 lacs for the same. It insists that it will disclose the Bonds as Secured in the Balance Sheet of the Company. [May 10 New (5 Marks)] Answer: Prima facie, the Bonds issued to the tune of `100 lacs are provided with security to the tune of `80 lacs i.e. neither fully secured nor unsecured. Guidance Note on the Terms used in Financial Statements issued by ICAI, states Secured Loans as loan secured wholly or partly against an asset. Conclusion: Bonds should be classified under Secured Loans for the purpose of disclosure in the Balance Sheet. However the nature of security should be clearly specified.
Guidance Note on provision for liability for taxation
Q. No. 2
Terms used in F.S.
Q. No. 3
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Accounting for Credit available in respect of MAT under the IT Act 1961 Q. No. 4 As a Statutory Auditor, how would you deal with the following: For the year ended 31st March, 2011, a company has paid Minimum Alternative tax under section 115 JB of the Income Tax Act, 1961. The company wants to disclose the same as an Asset since the company is eligible to claim credit for the same. [Nov. 09 New (5 Marks)] Answer: Disclosure of MAT paid as an Asset: As per Guidance Note on Accounting for Credit available in respect of MAT under the IT Act 1961, although MAT credit is not a deferred tax asset under AS 22 , yet it give rise to expected future economic benefit in the form of adjustment of future income tax liability arising within the specified period. The Framework for the Preparation and Presentation of Financial Statements, issued by the ICAI, defines the term asset as follows: An asset is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise. MAT paid in a year in respect of which the credit is allowed during the specified period under the Income Tax Act is a resource controlled by the company as a result of past event, namely the payment of MAT. MAT credit has expected future economic benefits in the form of its adjustment against the discharge of the normal tax liability if the same arises during the specified period. Accordingly, MAT credit is an asset. Conclusion: If the auditor is satisfied that the probability of the company to claim the said credit is high, it could recognize the same as an asset. In Balance sheet it should be shown under the head Loans & Advances as MAT credit entitlement. Revised Accounts of Companies Before Circulation to Shareholders Q. No. 5 Comment on the following: The statutory audit of Fortune Limited for the year ended on 31.03.2009 was completed and auditor also submitted his report with the audited Financial Statements to the management of the company. Thereafter, the management of the company approached the auditor to revise certain items in the Financial Statements. [Nov. 09 New (5 Marks)] Or 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 audit should adopt in such a situation. Answer: Revision of F.S.: As per the Guidance Note on Revised Accounts of Companies Before Circulation to Shareholders, Mngt. 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 share-holders. If not, he can issue a revised report on the amended F.S. 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 F.S. with reasons should be incorporated in the Directors Report. If it is neither included nor found adequately disclosed in the Directors 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.
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Audit of Payment of Dividend Q. No. 6 State your views as an auditor on the following: During the year under audit Z Ltd. credited to the P & L Account, the entire profit of `20 lakhs on the sale of land not required for its use. You are informed that the directors would like to propose dividend out of the above profit. Answer: Payment of dividend out of Capital profits: Profit of Rs. 20 lakhs on the sale of land is a capital profit. It represents the excess of sale value over the original cost of the asset, i.e capital profits. As per Guidance Note on Audit of payment of Dividend the capital profits can be distributed by a company only if all the following conditions are fulfilled: 1. The articles of association should permit distribution of capital profits. 2. The capital profit which is sought to be distributed should have actually been realised. 3. The capital profit should remain after a proper valuation has been fairly taken of the whole of the assets and liabilities. Conclusion: The profit arise on sale of land is realized in cash and hence subject to satisfaction of other conditions can be distributed as dividend. distributable. Accounting for Derivatives Q. No. 7 As an auditor, how would you deal with the following: XY Ltd. had entered into derivative transactions in foreign currency which were based on probable export orders. As at the year end on 31st March, 2011, the mark-to-market (MTM) loss on the said derivatives was `250 lakhs. The company contends that since the MTM loss is notional and likely to be recouped in the next year, the same need not be provided for. [Nov. 09 Old (5 Marks)] Answer: Derivative transactions (MTM) Loss: As per ICAI announcement on Accounting for Derivatives the entity is required to provide for losses in respect of all outstanding derivative contracts at the balance sheet date by marking them to market, keeping in view the principle of prudence as enunciated in AS 1 Disclosure of Accounting Policies. Conclusion: In the given case, XY Ltd. should provide for mark to-market (MTM) losses amounting `250 Lakhs. Auditors, should consider for making appropriate disclosures in their reports if the aforesaid accounting treatment and disclosures are not made by the company.
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STANDARDS ON AUDITING AND RELATED SERVICES

SA 210 SA 230 Q. No. 1 Q. No. 2 What is an audit engagement letter? What are the principal contents of audit engagement letters? As an auditor, how would you deal with the following: 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. [Nov. 09 Old (4 Marks)] Answer: Demand of working papers: As per SA 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. SA 600 Using the Work of Another 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. As per ICAI Guidelines, statutory auditor of an enterprise do 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 can not have access to audit working papers of the subsidiary companys auditor. He can however, ask the auditor to answer certain questions about the manner in which the audit is conducted and certain other clarifications regarding audit. SA 240 Q. No. 3 As a Statutory Auditor, how would you deal with the following cases: In the books of accounts of M/s OPQ Ltd. huge differences are noticed between the control accounts and subsidiary records. The Chief Accountant 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 M/s OPQ Ltd. indicate that there may be material misstatements requiring detailed examination by the auditor to ascertain the cause. The contention of Chief Accountant 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 fails to capture all transactions in time. 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. According to SA 240 The Auditors responsibilities relating to Fraud in an audit of F.S., when the auditor comes across such circumstances indicating the possible misstatements resulting from entitys procedure, the auditor shall evaluate whether such a misstatement is indicative of fraud. In this case, the circumstances indicate the possibility of material misstatements (that might be due to fraud) and accordingly, the auditor must investigate further to consider effect on F.S. Q. No. 4 Explain briefly duties and responsibilities of an auditor in case of material misstatement resulting from Management Fraud. [Nov. 09 New (6 Marks)]
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SA - 240 Q. No. 5 Comment on the following: While conducting statutory Audit of ABC Ltd., you come across IOUs amounting to Rs. 2 crores as against a cash balance shown in books of `2.10 crores. You also observe that despite similar high balances throughout the year, small amounts of `50,000 are withdrawn from the bank to meet day-to-day expenses. [May 09 New (5 Marks)] Answer: According to SA 240 The Auditors responsibilities relating to Fraud in an audit of F.S., when the auditor comes across such circumstances indicating the possible misstatements resulting from entitys procedure, the auditor shall evaluate whether such a misstatement is indicative of fraud. In this case, the circumstances indicate the possibility of fraud and accordingly, the auditor must investigate further to consider effect on F.S. The Guidance Note on Audit of Cash and Bank balances also mentions that if the entity is maintaining an unduly large balance of cash, auditor should carry out surprise verification of cash more frequently to ascertain whether it agrees. If cash in hand is not in agreement with the book balance, he should seek explanations and if the same are not satisfactory, he should state this fact appropriately in his Audit Report. State briefly the Communication/Reporting requirements as per SA 250 on NonCompliance in an audit of F.S.: (i) To the management (ii) To the users of the auditor's report on the financial statements. (iii) To the regulatory and enforcement authorities. [May 09 Old (8 Marks)] What are the points to be considered while evaluating the Knowledge of the Business in the conduct of an audit? [May 09 New (8 Marks)] Write short note on: Assessing the reliability of Audit Evidence. [May 09 Old (4 Marks)] As a Statutory Auditor, how would you deal with the following case: M/s LNKs group gratuity schemes valuation by actuary shows wide variation compared to the previous years figures. Answer: Using the work of Management Expert as an audit evidence: SA 500 (Revised), Audit Evidence states that the auditor has to evaluate the work of management expert, say, actuary, before adopting the same. This becomes more crucial since M/s LNKs group gratuity schemes valuation by actuary shows wide variation compared to previous year figures. There is no doubt that appropriateness, reasonableness of assumptions and methods used are the responsibility of the expert, but the auditor has to determine whether they are reasonable based on the auditors knowledge of the clients business and result of his audit procedures.
SA 250
Q. No. 6
SA 315 SA 500
Q. No. 7 Q. No. 8 Q. No. 9
Q. No. 10
SA 505
Q. No. 11 Q. No. 12
In the present case, the auditor must verify the reasonableness of assumptions made and methods adopted by the actuary in the evaluation particularly with reference to factors such as rate of return on investments, retirement age, number and salary of employees, etc. Accordingly, the auditor has to satisfy himself whether valuation done by the actuary can be adopted, otherwise he may report on his findings for wide variation. Comment on the following: Z Ltd. had appointed an outside expert to assess accrued gratuity liability of the company. Based on the said report, the company provides Rs. 80 lakhs as gratuity in the financial statements. [May 09 New (4 Marks)] Write short note on: Situations where external confirmations can be used. As a Statutory Auditor, how would you deal with the following: 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.
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SA 510 Q. No. 14 Comment on the following: You have been appointed as the auditor of Good Health Ltd. for 2010-11 which was audited by CA Trustworthy in 2009-10. As the Auditor of the company state the steps you would take to ensure that the Closing Balances of 2009-10 have been brought to account in 2010-11 as Opening Balances and the Opening Balances do not contain misstatements. Q. No. 15 [Nov. 08 New (5 Marks)] What are the procedures to be followed by a Statutory Auditor in the audit of opening balances if the financial statements for the preceding year were audited by another auditor? [Nov. 09 Old (8 Marks)] SA 520 SA 530 SA 550 Q. No. 16 Q. No. 17 Q. No. 18 As an auditor to what extent you can rely on Analytical Procedures. An auditor while analyzing the errors in a sample need not consider the qualitative aspects of errors detected. Comment. As a Statutory Auditor, how do you verify the existence of Related Parties and disclosure of Related Party Transactions? [Nov. 09 Old (8 Marks)] Answer: Verification of Existence of related parties and disclosures: SA 550 (Revised) Related Parties requires that during the audit, 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. In particular, the auditor shall inspect the following for indications of the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor: (a) Bank, legal and third party confirmations obtained during the audit; (b) Minutes of meetings of shareholders and of TCWG; and (c) Such other records or documents as the auditor considers necessary. Records or Documents that auditor may inspect: Entity income tax returns. Information supplied by the entity to regulatory authorities. Shareholder registers to identify the entitys principal shareholders. Statements of conflicts of interest from management and TCWG. Records of the entitys investments and those of its pension plans. Contracts and agreements with key management or TCWG. Significant contracts and agreements not in the entitys ordinary course of business. Specific invoices and correspondence from the entitys professional advisors. Life insurance policies acquired by the entity. Significant contracts re-negotiated by the entity during the period. Internal auditors reports. Documents associated with the entitys filings with a securities regulator (Prospectus).
Examinations of arrangements that may indicate the existence of related party relationships or transactions: Participation in unincorporated partnerships with other parties. Agreements for the provision of services to certain parties under terms and conditions that are outside the entitys normal course of business. Guarantees and guarantor relationships.
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SA 560 Q. No. 19 Q. No. 20 Briefly explain: Audit procedures on subsequent events. [Nov. 09 New (4 Marks)] Comment on the following: A Co. Ltd. has not included in the Balance Sheet as on 31-032011 a sum of `1.50 crores being amount in the arrears of salaries and wages payable to the staff for the last 2 years as a result of successful negotiations which were going on during the last 18 months and concluded on 30-04-2011. The auditor wants to sign the said Balance Sheet and give the audit report on 31-05-2011. The auditor came to know the result of the negotiations on 15-05-2011. [Nov. 10 New (5 Marks)] Answer: Treatment of subsequent Events: SA 560 Subsequent Events requires that in respect of events occurring between the date of F.S. and date of the AR, the auditor shall perform audit procedures to obtain sufficient & appropriate audit evidence to ensure that events which require adjustments or disclosure in the F.S. have been identified. If auditor identifies events that require adjustment or disclosure in the F.S., the auditor should determined whether each such event is appropriately reflected in the F.S. The auditor shall request the management to provide a Written Representation that all events occurring subsequent to the date of the F.S. and requires adjustment or disclosure have been adjusted or disclosed. Conclusion: The facts of the case indicates the event as of adjusting nature as per AS 4 Contingencies and Events Occurring after the Balance Sheet date and requires adjustment in assets and liabilities, which has not been made by the management. Auditor should request mngt. to adjust the sum of `1.50 crores by making provision for expenses. If the mngt. does not accept the request the auditor should qualify the AR. What are the Financial indications to be considered by an auditor for evolution of the going Concern assumption? [Nov. 08 Old (4 Marks)] Comment on the following: A Company's net worth is eroded and creditors are unpaid due to liquidity constraints. The management represents to the statutory auditor that the promoter's wife is expected to give an unsecured loan to meet the liquidity constraints and that negotiations are underway to secure large export orders. [May 09 New (4 Marks)] Answer: Appropriateness of Going Concern Assumption: In this case, it is subjective, but prima-facie a mere expectation of future cash flows from the promoters wife without any firm commitment and the possibility of an export order being negotiated, may not that be sufficient appropriate audit evidence of mitigating factors for resolving the going concerns question under SA 570 Going Concern. What is meant by Written Representations and indicate to what extent an auditor can place reliance on such representations. An 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? Answer: Validity of Management Representation: 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 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.
SA 570
Q. No. 21 Q. No. 22
SA 580
Q. No. 23 Q. No. 24
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SA 580 As per SA 580 Written Representation the representations received from management are recognised as audit evidence, but they do not constitutes 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. SA 600 Q. No. 25 There should be sufficient liaison between a principal auditor and other auditors. Discuss the above statement and state in this context the reporting considerations, when the auditor uses the work performed by other auditor. Enumerate, in brief, the important aspects to be evaluated by the external auditor in determining the efficiency and extent of reliance to be placed on the work and function of an Internal Auditor. You are appointed as statutory auditor of X Ltd. X Ltd. has an internal audit system and reports for the same are given to you. Mention the factors you will consider to ensure that the said system of internal audit of X Ltd. is commensurate with the size of the company and nature of its business. [May 09 New (8 Marks)] Briefly explain how an auditor can use the work of an expert. Write short note on: Auditors responsibilities regarding comparatives. The audit report of P Ltd. for the year 2009-10 contained a qualification regarding non provision of doubtful debts. As the statutory auditor of the company for the year 2010-11, how would you report, if: (i) The company does not make provision for doubtful debts in 2010-11? (ii) The company makes adequate provision for doubtful debts in 2010-11? [June 09 New (8 Marks)] Answer: As per SA 710, when the Audit Report on the prior period intended a qualified opinion and the said matter is: (i) Unresolved and results in an modification of the AR regarding current years figures, his report should be modified regarding corresponding figures. (ii) Resolved and properly dealt with in the F.S., the current report need not refer to such modification. In the instant Case, if P Ltd. does not make provision for doubtful debts the auditor will have to modify his report for both current and previous years figures. If however, the provision is made, the auditor need not refer to the earlier years modification. SRE 2400 Q. No. 31 The directors of C Ltd. are concerned about the reliability and usefulness of the monthly financial management information that they receive. As a result, the companys auditors have been engaged to review the system and the information it generates, and to report their conclusions. What an ordinary procedure includes for the review of financial statements?
SA 610
Q. No. 26
Q. No. 27
SA 620 SA 710
Q. No. 28 Q. No. 29 Q. No. 30
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SRS 4400 SRS 4410 Q. No. 32 Q. No. 33 What is engagement to perform agreed upon procedures. What are the general principles governing an agreed upon procedures engagement. You have been asked by a company to compile financial statements for the purpose of obtaining loan from a Bank. Draft a report to be given to the Management for the same. [Nov. 08 Old (8 Marks)] Draft an illustrative engagement letter for an engagement to compile financial statements of DEF Ltd. [Nov. 09 Old (8 Marks)] 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 procedure you will follow in the above. Answer: Compilation of Financial Information: 1. As per SA 4410 Engagements to Compile Financial Information, an accountant would normally have to rely upon the management for information to compile the F. S. 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 accountant should perform following procedures: 3. 4. Make any enquiries of management to assess the reliability and completeness of the information provided; Assess internal controls prevailing in the entity; and
Q. No. 34 Q. No. 35
2.
5.
Verify any matters or explanations. The accountant 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 accountant should withdraw from the engagement, informing the entity of the reasons for such withdrawal. If one or more ASs 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 accountant should include the same in notes to the accounts and the compilation report to the management.
Q. No. 36
Comment on the following: You are appointed to compile financial statements of Y & Co. for tax purposes. During the course of work, you learn that the inventory is grossly understated. On pointing the same, the partners of Y & Co. tell you that since you are not conducting an audit, the said figures duly certified by the firm should be accepted. [May 09 New (5 Marks)] Answer: As per SRS 4410 Engagement to Compile Financial Information if an accountant becomes aware of material misstatements, the accountant should persuade the management to carry out necessary amendments in the F.S. or other compiled financial information. If such amendments are not made and the F.S. are still considered to be misleading the accountant should withdraw from the engagement.
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ACCOUNTING STANDARDS
Applicability of AS The Preface to the Statements of AS clarifies that the ASs are issued "for use in the presentation of G.P.F.S. issued to the public by such commercial, industrial or business enterprises, as may be specified by the Institute from time to time and subject to the attest function of its members. The term 'G.P.F.S. includes balance sheet, statement of profit and loss and other statements and explanatory notes which form part thereof, issued for use of shareholders/ members, creditors, employees and public at large". As far as companies, whether limited or unlimited incorporated under the Companies Act, 1956 are concerned, all such companies are expected to adhere to specified AS in terms of section 211(3A) of the said Act. The compliance with AS has to be examined by the auditors while auditing general purpose F. S. which are statutorily required to be audited under any law. Thus, compliance with AS is required to be examined by an auditor in an audit of F. S. of individuals and non-corporate enterprises (for example: Partnership firms, Societies, trusts, HUF, AOP) only where the F.S. are statutorily required to be audited under any law. The AS are also applicable to commercial, industrial or business activities of even charitable or religious organisations. Accounting Standards do not apply to those organisations whose entire activities are not of commercial, industrial or business nature, e.g., an organisation collecting donations to finance education of poor children. However, even if a very small proportion of the activities of an entity is commercial, industrial or business in nature, the accounting standards will apply to all its activities. Q. No. 1 Q. No. 2 Comment: The AS issued by the ICAI need to be followed only by limited companies and not by partnership firms or proprietorships. As an auditor, how would you deal with the following: In the audit of an organization whose objects are charitable or religious, the organization holds that the Accounting Standards are not applicable to it since only a very small proportion of its activities are business in nature. [May 09 Old (5 Marks)] (i) Whose equity or debt securities are not listed or are not in the process of listing on any stock exchange, whether in India or outside India; (ii) Which is not a bank, financial institution or an insurance company; (iii) Whose turnover (excluding other income) does not exceed `50 Cr. in the immediately preceding accounting year, (iv) Which does not have borrowings (including public deposits) in excess of `10 Cr. at any time during the immediately preceding accounting year; and (v) which is not a holding or subsidiary company of a company which is not a small and medium-sized company. Explanation: For this purpose, a company shall qualify as a Small and Medium Sized Company, if the conditions mentioned therein are satisfied as at the end of the relevant accounting period. Comment whether the following Companies can be classified as a Small and Medium Sized Company (SMC) as per the Companies (Accounting standards) Rules, 2006: (i) A Pvt. Ltd., a subsidiary of a multinational company listed on London Stock Exchange. It has a turnover of `12 crores and borrowings of `5 crores. (ii) B Pvt. Ltd. has a turnover of `45 crores, other income of `7 crores and bank borrowings of Rs.9 crores. (iii) C Ltd. has appointed Merchant bankers to prepare a Red-herring prospectus for the purpose of filing the same with SEBI. [Nov. 08 Old (12 Marks)]
Companies (AS) Rules 2006
Small and Medium Size Company
Q. No. 3
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Companies (AS) Rules 2006 Answer: Determination of Small and medium Sized Company: (i) Since A Pvt. Ltd. is a subsidiary of MNC which is listed, on London Stock Exchange (and is therefore not a SMC), A Pvt. Ltd. cannot be a SMC. The turnover and borrowings are not relevant in this case. (ii) Since B Pvt. Ltd. has a turnover of `45 corers and borrowing of `9 corers, it will be classified as SMC. Note: Other incomes are not considered (iii) Since C Pvt. Ltd. has appointed merchant bankers to prepare a Red Herring Prospectus for the purpose of filling the same with SEBI, it is in the process of listing on a Stock Exchange, therefore C Ltd. cannot be classified as a SMC. Q. No. 4 As a Statutory auditor, how would you deal with following: A company which satisfies the conditions of a Small and Medium sized Company (SMC) as per Companies (AS) Rules, 2006 has represented that it does not require to give disclosures required by AS-3 Cash Flow Statements and AS-18 Related Party Disclosures in its F.S. [Nov. 08 Old (4 marks)] Answer: Compliance of AS-3 and AS-18 by SMC: As per the Companies (AS) Rules, 2006, Compliance of Certain ASs is not mandatory, but optional. AS-3, as per the above Rules is not mandatory for SMC. However, AS-18 is required to be complied with mandatorily. Conclusion: T company, even if it is a SMC, will have to give disclosures for: (i) related party relationships, and (ii) transactions between a reporting enterprise and its related parties. Q. No. 5 Comment: The management tells you that there is no need for them to follow AS specified by the ICAI as these are for the auditor to follow. Answer: Observance of AS: In terms of Companies (AS) Rules, 2006 prescribed by the C.G. u/s 211(3)(c) of the Companies Act, 1956, it is mandatory for a Company to follow all the prescribed AS while preparing and presenting its F.S. If a Company does not follow AS, the auditor is required to give a qualification in his report in terms of section 227(3) of the Companies Act, 1956.
Infact directors of the companies are also required to give a written statement as part of Director Responsibility Statement u/s 217 of the Companies Act that all the AS prescribed has been followed and there are no discrepancies. Conclusion: The contention of the company is not correct. Q. No. 6 LMN Pvt. Ltd. is a dealer in government securities. The turnover on account of sale of securities for the year ended 31st March, 2011 is `85 crores whereas the net profit is `0.10 Cr. While finalizing the accounts the company did not prepare the Cash Flow Statement. [May 10 Old (5 Marks)] Answer: Exemption for applicability of AS 3, preparing Cash Flow Statement is available only to Small and Medium Size Companies) preparation of Cash Flow Statement, as per AS 3 is now made mandatory in respect of the following enterprises: (i) Enterprises whose equity of debt securities are listed on a recognized Stock Exchange in India and Enterprises that are in the process of issuing equity or debt securities that will be listed on a recognized Stock Exchange in India. (ii) All other Commercial, industrial and business reporting enterprises, whose turnover for the accounting period exceeds Rs. 50 crores.
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In the instant case, LMN Pvt. Ltd. did not prepare the Cash Flow Statement, even its turn over exceeded Rs. 50 crores. It is not considered as a small and medium size company as per Companies (AS) Rules, 2006 (AS-3) as discussed earlier, hereinabove. Therefore, if LMN Pvt. Ltd. does not prepare cash flow statement it is a violation of AS-3 and section 211(3C) of the Companies Act, 1956. The auditor will have to accordingly qualify his report that 211(3C) is not complied with, the profit & loss account would give a True & Fair View. A company was engaged in the business of buying IMFL (Indian Made Foreign Liquor) and beer and selling same through retail vending shops and bars run by it. The company sold beer to some of the customers who consumed them in bars run by it and left the bottles behind. (Technically, these bottles were the property of the customers.) These bottles were later on disposed off by the company. Answer the followings: 1. Are these bottles left behind by the customers assets of the company? 2. Are they inventories? 3. If they are inventories, how they should be valued? 4. Can the bottles be valued at net realisable value and treated as income? Answer: 1. An asset is a resource controlled (not necessarily owned) by an enterprise as a result of past events from which future economic benefits to the enterprise are expected. In assessing whether an item meets the above definition of assets, the consideration should be given to economic reality and substance and not merely legal form. Accordingly, the bottles can be considered as assets of the company. 2. The stock of empty bottles is inventory as the company holds them for sale in the ordinary course of its business of running the bars. 3. These bottles should be valued at the lower of cost and NRV. However, the cost of purchase and selling price of beer / IMFL are both inclusive of cost of bottles as beer / IMFL cannot be sold without bottles the primary packing. Practically, the empty bottles do not appear to cost anything to the company (i.e. zero cost), if that be the case, the bottles should be reflected at nominal value of Re.1. 4. It would not be correct to value the bottles at NRV with credit being given to income as the bottles have not been sold at the balance sheet date. As an auditor state your views on the following: Included under Current Assets of XYZ Ltd. is inventory aggregating to `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 `20 crores. Answer: Valuation of Damaged Inventory: Auditor is required to examine what part of the inventory is included in the inventory valued at `20 crores. He will also have to satisfy himself that whether such part left with the company has also been damaged on account of moisture content.
AS-2
Q. No. 7
Q. No. 8
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 AS 2 Valuation of Inventories have been followed. The standard requires that the inventories should be valued at the lower of cost or NRV. Conclusion: In the present case the auditor shall satisfy himself whether the balance inventory lying with the company is carrying the same quality issue. If yes, than value of inventory will be revised based on its NRV(if lower than cost).
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Q. No. 9 The management tells you that WIP is not valued since it is difficult to know the same in view of multiple processes involved and in any case opening and closing WIP would be more or less the same. Answer: Valuation of WIP: As per AS-2, Valuation of inventories inventories includes any item held in the process of production. This is known as WIP. Company is required to find out the stage of completion of products and value of the same. In certain cases, due to nature of the product and the manufacturing process involved, physical verification of WIP may be impracticable. But in such cases, the advice of an expert can be taken. The value of such WIP is normally done by taking the basic raw material cost and adding thereto the proportionate factory overhead cost incurred up to the stage of completion. Valuation of WIP is important due to following: WIP is an item of Manufacturing, Trading & Profit & Loss A/c and also forming part of current assets, is relevant and can not be ignored. Omitting WIP will result in under or over statement of profit and current assets.
Part II of Schedule VI to the Companies Act also prescribes that the figures of opening and closing balances of stock and WIP be disclosed in the profit & loss account. Part I of the same schedule requires that the mode of valuation of stock be shown in the Balance Sheet. Conclusion: The argument of the management that the opening and closing WIP would be more or less the same is not justified because the cost incurred for raw materials and overheads would be different and would give different value of opening and closing WIP. Taking into consideration all the above aspects, management is wrong and if WIP is not valued or taken into consideration, auditor should qualify his report. AS - 4 Q. No. 10 During the course of audit of D Co. Ltd. you as an auditor have observed that Inter corporate deposit of ` 50 lakhs has been over due. The D Co. Ltd. has disclosed this in the notes to accounts note No. 15 in schedule no. 21 stating that ` 50 lakhs is over due from XYZ Co. Ltd. and the said company is in the process of liquidation. The management is taking steps to appoint the liquidator. [Nov. 10 New (5 Marks)] Answer: As per AS 4 Contingencies and Events occurring 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. In the instant case, it appears from the note no 15 that the overdue of outstanding inter corporate deposit may not be realisable in full. The company is in the process of liquidation, makes it clear that on the balance sheet date, the amount of deposit is not safe and is not likely to be realised. Conclusion: As per AS 4 provision for the loss was required in the accounts. Accordingly, auditor should qualify the Audit Report. State your views as an auditor on the following: V Ltd. had announced a voluntary retirement plan for its employees on January 1, 2010. The scheme is scheduled to close on June 30, 2010. 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 March 31, 2010. 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 March 31, 2010. Nor the company made any provision in its accounts towards any liability under the scheme.
Q. No. 11
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AS - 4 Answer: Event occurring after the B/S Date: Relevant Provision: As per AS- 4 on 'Contingencies and Events Occurring After the Balance Sheet Date', 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 is not appropriate. Facts of the case: A condition existed on the balance sheet date (31st March, 2010) regarding the liability towards the Voluntary Retirement Plan since the management started the scheme in the month of January, 2010 and 200 employees opted for the scheme as on March 31, 2010. Conclusion: Since it was probable that future events will confirm that a liability has been incurred on the balance sheet date and that the amount could be estimated on reasonable basis, a provision for payments under the scheme would be required to be made for an appropriate amount for the aforesaid number of employees. Q. No. 12 Arya Ltd. was under audit for the year ended 31.03.2010. An appeal filed by Arya Ltd. against the demand of Excise Duty of `26 crores was pending before the Supreme Court for which neither provision was made nor was disclosed in the notes to the financial statements. On 12th July, 2010, the auditor came to know through paper reports that the point involved in the appeal of Arya Ltd. was adjudicated by the Supreme Court in the case of some other assessee, which is in favour of the department of Excise Duty. The auditor insisted that provisions be made of `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? Answer: Subsequent Events: Relevant Provisions: As per AS- 4 on 'Contingencies and Events Occurring After the Balance Sheet Date', 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 is not appropriate.
SA 560 on Subsequent Events lays down that the auditor should consider the effect of subsequent events on the F.S. and on the auditors report. Explanation: The issue involved in the appeal of Arya 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 favour of the Excise Department, it is necessary for Arya Ltd. to make a provision of Rs. 26 crores. Conclusion: The view of the management that its own appeal is undecided or that it has no effect on the financial position as on 31.03.2006 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. As a statutory auditor, how would you deal when PQ Ltd., as part of overall cost cutting measure announced voluntary retirement scheme (VRS) to its employees, to reduce the employee strength. During the first half year ended 30.9.2010 the company paid a compensation of `72 lakhs to those who availed the scheme. The Chief Accountant has reflected this payment as part of regular salaries and wages paid by the company. Is this correct?
AS - 5
Q. No. 13
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AS - 5 Answer: Treatment of Ordinary activity with large amount: As per AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies the payment made to its employees on account of VRS as an overall cost cutting measure is an ordinary activity. AS 5 requires that when items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.
Though this is not an extraordinary item, but the nature and amount of this expenses is such that its separate disclosure is required to allow the users to understand the financial position and performance of the company. Conclusion: Compensation of `72 Lakhs paid towards VRS availed by employees should be shown separately in the profit and loss account of PQ Ltd. Q. No. 14 State your views as an auditor on the following: Y Ltd. provided `25 lakhs for inventory obsolescence in 2009-2010. 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. Answer: Prior Period Adjustment: As per AS 5 on "Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies", 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 F.S. 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. 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. Conclusion: Revision of the estimate does not bring the resulting amount of `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, adjustment in the value of the inventory through prior period item would not be proper. AS - 7 Q. No. 15 Comment: B Co. Ltd. is engaged in the business of developing mass scale housing projects including development of small commercial complexes. The flats/commercial spaces are booked by the public and are allotted by way of allotments letter to each allottee. Major construction activities pertaining to buildings are undertaken of flats/commercial spaces is given to allottees by executing legal document. The CEO of the B Co. says that AS 7 is not applicable to the company. [Nov. 09 New (5 Marks)] Answer: Applicability of AS-7: AS 7 (Revised) Accounting for Construction contracts states that, "This Statement should be applied in accounting for construction contracts in the F.S. of contractors. The revised AS 7 is silent about its applicability to construction activities undertaken by enterprises on their own account and not as contractors. The matter was considered by Expert Advisory committee of the Institute and they are of the view that the revised AS 7 is not applicable to such enterprises.
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Conclusion: The activity of developing housing projects on its own account can be considered as a commercial venture by the company in the nature of production activity and, therefore, should be construed as such. Accordingly, the flats/commercial spaces should be identified as inventories in accordance with AS 2 and revenue should be recognition in accordance with AS 9. AS - 9 Q. No. 16 A Ltd. prepared an invoice for an export consignment on FOB basis on 30th March, 2010. The goods were dispatched from the factory on 30th March, 2010 and the Bill of Lading was made on 3rd April, 2010. A Ltd. had booked the invoice in the Sales Register for March, 2010. Answer: Revenue recognition in case of export sale: As per AS-9 Revenue Recognition revenue involving sale of goods is to be recognized on transfer of significant risk and reward of ownership to the buyer. In the instant case, A Ltd. has invoiced the goods and they have left the factory on 30th March, 2011. However the same is for export and the bill of landing is dated 3rd April 2011. Conclusion: The sale should be therefore, recognized in April 2011. The auditor will therefore have to qualify his report stating that revenues are overstated to that extent. Q. No. 17 State your views as an auditor on the following: T Ltd. purchased goods on credit for `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: Treatment of discount subsequent to sale: ABC Ltd. had sold goods on credit worth `5 crores to T Ltd. and, therefore, the sale was complete in all respects. 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. 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. Conclusion: Discount should be charged to the P & L A/c separately and not shown as deduction from the sales figure. Q. No. 18 Comment: 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 margins. 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 then Notes to Accounts. [May 10 Old (5 Marks)]
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AS - 9 Answer: Revenue recognition in case of inter division transfers: The recognition of inter-divisional transfers as sales is an inappropriate accounting treatment and is inconsistent with AS 9. 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 has not been fulfilled in respect of inter-divisional transfers. Conclusion: In the instant case, LM Ltd cannot recognise inter-division transfers from L to M as sales and the same will have to be eliminated during finalisation. If not so done, the statutory auditor will have to qualify his report. Q. No. 19 As an auditor, state your view on the following: (a) 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: Recognition of Revenue: AS 9 on Revenue Recognition, states that revenue from sale of goods should be recognised 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 recognised 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 realise. In the absence of the above, the auditor will have to qualify his report. AS - 10 Q. No. 20 Comment: In the notes to accounts of C Co. Ltd. as on 31-03-2011 Note no. 11 states that Certain machinery items are lying at customs warehouses and company has paid ` 900 lakhs up to 30-06-2010 as detention charges, out of which a sum of `580 lakhs is written back during the year 2010-11 based on settlement with the concerned authorities in respect of a major spares of machinery. For the remaining machinery item negotiations are pending and a provision of `44 lakhs is made. As such total amount of `364 lakhs 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 expenses are directly attributable to the acquisition of the related Fixed Asset. [Nov. 10 New (5 Marks)]
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AS - 10 Answer: Capitalisation of Detention Charges: As per AS 10 Accounting for Fixed Assets the cost of an item of fixed assets comprises its 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; any trade discounts and rebates are deducted in arriving at the purchase price. Examples of directly attributable costs are: 1. site preparation ; 2. initial delivery and handling costs ; 3. installation cost, such as special foundations for plant ; and 4. professional fees, for example fees of architects and engineers. Conclusion: Detention charges, being in the nature of penalty levied by Customs for not removing the articles within specified period from custom port can not be considered as directly attributable cost. Treatment done by the company is incorrect. The auditor should qualify the report appropriately mentioning the effect on Balance sheet and Profit and Loss Account. Q. No. 21 F Limited includes in the Schedule of Inventory, those items of Fixed Assets which have not been in active use and held for disposal, as inventory item. [May 10 New (5 Marks)] Answer: Treatment of assets held for Disposal AS-10 Accounting for Fixed Assets requires that the items of fixed assets that have been retired from active use and are held for disposal be stated at the lower of their net book value and NRV and are shown separately in the financial statements. As per AS-2 Valuation of Inventories, inventories are assets held for sale in the ordinary course of business, in the process of production for such sale; or in the form of materials or supplies to be consumed in the production process or in the rendering of service. Conclusion: Inclusion of fixed assets, not in active use and held for disposal, as inventory item in the schedule of inventory is not in line with the requirements of AS10 and AS-2. Such fixed assets should be stated at lower of net book value and NRV and are shown separately in F.S. Q. No. 22 Comment: An old car of a company having a nominal book value has found a buyer, who is willing to pay `1 lakh for it. The company proposes not to sell the car, but to neglect its valuation in its accounts at `1 lakh. Should the auditor permit the company to do so? Answer: Valuation of Fixed Assets: Relevant provisions: The old car formed part of the fixed assets of the company and ordinarily the same should be valued at actual cost less depreciation written off. The market price of any of such assets is not relevant for balance sheet valuation of a going concern. There is no prohibition in law for revaluation of fixed assets. But when all other assets are presumably shown at historical cost, revaluation only of one motorcar seems illogical and has the effect of distorting the overall view of the accounts. AS- 10, Accounting for Fixed Assets also clarifies, when a fixed asset is revalued in F.S., an entire class of assets should be revalued, or the selection of assets for revaluation should be made on a systematic basis and the basis should be disclosed.
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AS - 10 Facts of the case: In the present case, there is no proper appraisal and a revaluation based on one stray bid is not proper to establish a proper replacement value of an item of asset. The willingness of a buyer to pay the particular price is not logical basis to work out the value of the asset. The company though proposes not to sell the car at Rs. One lakh yet it has decided to neglect its value in the accounts. Conclusion: In view of the fact that the company has been taking proper step, the auditor should permit the company to neglect the valuation of car in the accounts because it is in accordance with the relevant requirements of the AS. As a statutory auditor of a Public Limited Company, how would you deal with the following: The company has sold some old machinery for Rs. one crore. The details of the cost of such machinery are not available since the entire records relating to fixed assets have been destroyed in an earthquake. Answer: Profit/Loss on Sale of Machinery: As per AS 10 "Accounting for Fixed Assets", gains or losses arising on disposal are generally recognised in the profit and loss statement. In the instant case, since the entire records of fixed assets have been destroyed, the WDV of the machinery sold should be determined by company on some estimated and reasonable basis. Such calculation may be done by obtaining old copies of annual reports, annual accounts filed with ROC, IT Returns etc. A note to that effect would also have to be given by the management in the accounts. Under this situation, the auditor will have to see whether the estimate of cost and WDV arrived at in the above manner by the company is reasonable and whether the profit/loss is determined accordingly. If the auditor is of the opinion that the said estimates are satisfactory based on available records and the note given by management explains the said fact, he may not qualify his report. If he is not so satisfied, he would have to give disclaimer in the audit report that in the absence of proper records, the said profit/loss has been arrived on an estimated basis and in that view he has been unable to form an opinion. As far as the report under the CARO, 2003 order is concerned, the auditor would have to point out that proper records of fixed assets showing full particulars as required by that clause are not available.
Q. No. 23
Q. No. 24
As a statutory auditor of a Public Limited Company, how would you deal with the following situation: As at the beginning of the year, the company has a capital of `2.50 crores, free reserves of `0.50 crore and Revaluation Reserve of `4.50 crores. In the relevant year under audit the company has incurred a loss of `4 crores. The company proposes to adjust the loss with the Revaluation Reserve. Answer: Adjustment of Losses against Revaluation Reserve: Accumulated losses cannot be adjusted against the revaluation reserve created on revaluation of the fixed assets. In case the company in question does so, the balance sheet of the company will not reflect a true and fair view of the state of affairs of the company keeping in view the magnitude of the amounts involved, i.e., accumulated losses amount to Rs.4 crores and share capital and reserves amount to Rs.3 crores (excluding revaluation reserve). If the management does not agree with the opinion of the auditor, the auditor may even issue an adverse report.
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AS - 12 Q. No. 25 As a Statutory auditor, how would you deal with following: A company receives a grant from the State Govt. as compensation for loss of stocks due to unseasonal floods. Entire grant received is credited to Capital Reserve. [Nov. 08 Old (5 Marks)] Answer: Accounting of Government Grants: As per AS-12 Accounting for Government Grants grants related to revenue should be recognized on a systematic basis in the profit and loss Account over, the periods necessary to match them with the related costs which they are intended to compensate. Such Grants should either be shown separately under 'Other Income in the profit & loss account or should be deducted in reporting the related expenses or losses, if such Grant is received in the same year in which loss is sustained. Conclusion: Accounting Treatment is wrong. In no case, it can be credited to 'CAPITAL RESERVE'. The Auditor should give qualified report. Comment on the following: XYZ Limited received a grant of Rs. 25 lakhs under the Government's Subsidy Scheme, for acquiring an imported machinery for setting up new plant. The entire grant received is credited to Profit and Loss Account. [Nov. 09 New (5 Marks)] Answer: Treatment of Capital Grant: As per AS 12, Accounting for Government Grants grants received for acquisition of specific fixed asset maybe treated in following ways: (a) Deduction from the gross value of the asset; or (b) Treating it as deferred income which should be recognised in the P & L account on a systematic and rational basis over the useful life of the asset. By crediting the entire amount of grant to P & L account, the company has treated it as a revenue income which is not in accordance with the requirements of the AS 12. Conclusion: Auditor needs to qualify the report stating the fact that the income has been overstated to the extent of the amount of grant net of proportionate credit that would have been worked out. As a statutory auditor of a Public Limited Company, how would you deal with the following situation: The company had subscribed to shares of associate companies amounting to ` 5 crores. These associate companies have incurred substantial losses and have been referred to BIFR for being declared as sick companies. The company does not want to make any provision for the fall in the value of the investments. Answer: Valuation of Investments: Relevant Provision: AS 13 on "Accounting for Investments" requires that long-term investments should be carried in the F.S. at cost. However, provision for diminution shall be made to recognise a decline, other than temporary, in the value of the investments, such reduction being determined and made for each investment individually". Facts of the case: In the present case, the investments made in associate companies can be classified as long term investments. These associate companies have incurred substantial losses and have been referred to BIFR for being declared as sick companies. The net worth of these companies would have been wiped out resulting in a fall in the value of the investments. Conclusion: Such fall in value of investments cannot be merely temporary as the companies could take a long time to turn around and again have a positive net worth. The auditor would therefore have to qualify his report by saying that no provision for diminution for fall in the value of investments as required by AS 13 has been made and to that extent the profits and reserves have been overstated.
Q. No. 26
AS - 13
Q. No. 27
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AS - 16 Q. No. 28 As a statutory auditor for the year ended 31st March 2011, how would you deal with the Following: X Ltd., has borrowed ` 25 crores from financial institutions during the financial year 2010-11. These borrowings are used to invest in shares of Y Ltd., a subsidiary company which is implementing a new project estimated to cost ` 50 crores. As on 31st March 2011, since the said project was not yet complete, the directors of X Ltd. resolved to capitalize the interest on the borrowings amounting to ` 3 crores and add it to the cost of investments. Answer: Capitalisation of Interest on Borrowings in respect of Investments Relevant Provisions: AS-16 Borrowing Costs does not consider investment in shares as qualifying assets that can enable a company to add the borrowing costs to investments. In the instant case, X Ltd. has used borrowed funds for making investment in shares of a subsidiary company. For acquiring shares of a subsidiary company, apart from any fees, duties etc., there are no cost incurred for investing in shares. Any borrowing costs incurred cannot be treated as part of cost of investments and cannot be added to the cost of investments. Conclusion: The statutory auditor is required to qualify his report by stating that the borrowing costs have been wrongly added to the cost of investments. It is required to Charge the borrowing cost to the profit and loss account. The effect of the same on the Profit for the year would also have to be mentioned in the audit report. Q. No. 29 As a Statutory Auditor, how would you deal with: ABC Ltd. commenced construction of a flyover in Mumbai in January, 2010 under BOLT scheme. The same was completed in February, 2011. Due to seasonal heavy rains in July, 2010 in the area, the work on the flyover had to be suspended for 1 month. The company accordingly suspended borrowing costs of `12.50 lakhs for that month from capitalisation. Answer: Capitalization of borrowing costs: As per AS 16, Borrowing Costs, capitalization of borrowing costs should be suspended in respect of periods in which active development is interrupted, except for the situation when 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 being regular feature. Conclusion: Borrowing cost of `12.50 lakhs incurred by ABC Ltd. should be capitalized. Suspension of capitalization by the company is not a correct treatment and statutory auditor should report accordingly. AS - 17 Q. No. 30 Following is the data regarding six segments of Z Ltd.: Particulars Segment Revenue (Rs.) Segment Result (Rs.) Segment Assets (Rs.) reported. Advise A 150 25 20 B 310 (95) 40 C 40 5 15 D 30 5 10 E 40 (5) 10 F 30 15 5 (` in 000s)
The Finance Director is of the view that it is sufficient that segments A and B alone be
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Answer: Identification of Reportable Segments: As per AS 17 on Segment Reporting, a business segment or geographical segment should be identified as a reportable segment if: (i) its revenue from sales to external customers and inter segment transfer is 10% or more of the total revenue, external and internal of all segments, or (ii) its segment result, whether profit or loss, is 10% or more of: a. the combined result of all segments in profit; or b. the combined result of all segments in loss, whichever is greater in absolute amount; or (iii) its segment assets are 10% or more of the total assets of all segments. AS 17 also requires that if total external revenues attributable to reporting segments constitute less than 75% of the total enterprise revenue, additional segments should be identified even if they do not meet 10% criteria. Conclusion: On the basis of the above the following conclusions emerge: Segmental Revenue A and B will be reportable segments since both these segments 10% or more of total revenue i.e., `6,00,000. Segmental Results A, B & F will be reportable segments since the result of these segments is 10% or more than (`1,00,000) the combined results of segments in loss. Segment assets A,B,C, D and E will be the reportable segments since there are 10% or more if total segmental assets i.e. `1,00,000. Hence all the segments have to be reported. AS - 18 Q. No. 31 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 31.03.07. 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: Related party Disclosures: AS 18 Related Party Disclosures requires disclosure of related party relationship and transactions between a reporting enterprise and its related parties. 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 constitutes a substantial holding in the firm. And hence the transaction is covered by AS 18. Conclusion: 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. AS - 19 Q. No. 32 Y Ltd. wishes to obtain a machine tool costing `20 lakhs by way of lease. Effective life of the machine tool is 12 years but the company requires it only for the first five years. It enters into an agreement with R Ltd. for a lease rental of `2 lakhs p.a. The Finance Director of Y Ltd. is not sure about the treatment of these lease rentals and hence requests your assistance in proper disclosure of the same. For calculation purposes, the implicit rate of interest may be taken at 15%. Discount factors: 0.87, 0.76, 0.66, 0.57 and 0.50.
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Answer: Accounting Treatment of Lease Rental: The fair value of asset is `20 lacs and the present value of lease rentals is `6.72 lacs. The machine is required for 5 years only which is less than 50% of the economic life. As per AS 19, having regard to substance of the transaction, the lease will be classified as an operating lease. As per AS 19, the following may be disclosed: Future minimum lease payments Not later than 1 year Future minimum lease payments Later than 1 year and not later than 5 years AS 20 Q. No. 33 `2 lacs `4.98 lacs
As a statutory auditor for the year ended 31st March 2011, how would you deal with the following: As on 31/3/2010, the equity share capital of X Ltd. is `10 crores divided into shares of `10 each. During the financial year 20010-11, it has issued bonus shares in the ratio of 1:1. The net profit after tax for the years 2009-10 and 2010-11 is ` 8.50 crores and ` 11.50 crores respectively. The EPS disclosed in the accounts for two years is ` 8.50 and ` 5.75 respectively. Answer: Disclosure of Earnings Per Share: Relevant Provision: As per AS 20, in the case of a bonus issue, the number of equity shares outstanding before the event of a bonus issue have 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. In view of the above, the EPS for both the years will have to be calculated taking the equity share capital after the bonus issue as the denominator. If the same is done the EPS for 31/3/2010 will be ` 4.25 and that for 31/3/2010 will be ` 5.75. Since the above figures of EPS have not been disclosed, the company has not complied with the provisions of the AS 20. Conclusion: As EPS reported is not in compliance with AS 20, auditor is required to qualify his report in terms of Sec. 227(3)(d) of the Companies Act, 1956.
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T Pvt. Ltd. is an unlisted closely held company with turnover less than `50 crores. While finalizing the accounts, Mr. M the Director (finance) disputed the applicability of AS 20 to the company. Answer: Applicability of AS - 20: AS 20 Earning Per Share, is mandatory in respect of enterprises whose equity shares or potential equity shares are listed on a recognised stock exchange in India. However, every company is required under Part IV, Schedule VI to the Companies Act 1956, to disclose EPS. Accordingly, every company, which is required to give information under Part IV of Schedule VI to the Companies Act, 1956, should calculate and disclose EPS in accordance with AS 20, whether or not its equity shares or potential equity shares are listed on a recognised stock exchange in India. Conclusion: The contention of Director (Finance) is incorrect. The auditor will have to ensure that EPS is disclosed as per AS 20 or else the auditor should appropriately modify the audit report.
AS -22
Q. No. 35
As a statutory auditor for the year ended 31st March 2011, how would you deal with the following: 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 finalising the accounts for the year ended 31st March 2010, 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 years losses that had remained unabsorbed in Income tax.
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AS -22 Or Do you approve of the following: Shakti Pan Masala (P) Ltd. was incurring heavy losses in the last several years since it could not withstand the competition in the market. The State in which the company had its registered office and also its major sales had moved a bill in the State Assembly to ban manufacture and sale of all kinds of Pan Masalas in the State. While finalizing the accounts for the year ended 31-032011, the CFO of the company created a Deferred Tax Asset for the tax benefits that would arise in future years from the earlier years losses that had remained unabsorbed in Income Tax. Answer: Recognition of Deferred Tax Assets: Relevant Provision: AS 22 on Accounting for Taxes on Income, requires that deferred tax should be recognised 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 recognised 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 realised. This implies that there is a reasonable certainty that the carry forward losses would be recouped in the future years. Facts of the case: 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. Q. No. 36 Comment: T Ltd. an Indian company, subject to Income tax Act, 1961, discloses advance Income-tax paid (Current tax asset) and provision for Income-tax (Current tax liability), separately in Balance Sheet for the year ended 31.3.2011, i.e., it does not offset the amount. [May 10 New (5 Marks)] Answer: As per AS 22 Accounting for Taxes in Income, an enterprise should offset assets and liabilities representing current tax if the enterprise: (i) has a legally enforceable right to set off the recognized amounts and (ii) intends to settle the asset and liability on a net basis. An enterprise will normally have a legally enforceable right to set off an asset and liability representing current tax when they relate to income taxes levied under the same governing taxation laws and the taxation laws permit the enterprise to make or receive a single net payment. Conclusion: T Ltd. is entitled to set off the advance tax against provision for tax, and can show only the net amount in the balance sheet.
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AS - 25 Q. No. 37 As a Statutory auditor, how would you deal with following: A company which has presented its quarterly results for a limited review report, has represented that expenditure incurred on heavy repairs carried in that quarter are being spread over the entire year, since it would otherwise, distort the quarterly results. [Nov. 08 Old (4 marks)] Answer: Presentation of Quarterly Results (AS-25): As per AS-25, "Interim Financial Reporting" (which is mandatory for all entities preparing Interim Financial Report), uniform accounting policies are to be applied in interim and annual F.S. It further says that uneven costs can also be anticipated or deferred only if appropriate to do so at the end of the year. Conclusion: In the instant case, in view of the above, as stated in AS-25, heavy repairs can not be deferred to other quarters. If so done by the company, the limited review report will have to contain a qualification for the same. AS 26 Q. No. 38 As an auditor, how would you deal with the following: PQR Ltd. had acquired a Brand from another company for `100 lakhs. PQR Ltd. contends that since the said brand is a very popular and famous brand, no depreciation or amortisation needs to be provided. [Nov. 09 Old (4 Marks)] Answer: Amortization or Depreciation of Brand: AS 26 Intangible Assets provides that an intangible asset should be measured initially at cost. After initial recognition, an intangible asset should be carried at cost less any accumulated amortization and any accumulated impairment losses. The depreciable amount of an intangible asset should be allocated on a systematic basis over the best estimate of its useful life. There is a rebuttable presumption that the useful life of an intangible asset will not exceed ten years from the date when the asset is available for use. The auditor should satisfy himself that the value of brand is amortized in accordance with AS 26, as brand is considered to be an intangible asset. Conclusion: The contention of PQR Ltd., that Brand is very popular and famous, no depreciation or amortization needs to be provided, is wrong and hence, the auditor will have to qualify this matter in his report and quantify the amount of non-amortisation. AS 29 Q. No. 39 Comment: There is a sales-tax demand of Rs. 3 crores against X Ltd. relating to prior years against which the company has gone into an appeal. [May 10 Old (5 Marks)] Answer: As per AS 29 Provisions, contingent Liabilities and Contingent Assets, contingent liability is: (a) a possible obligation that arises from past events and the existence of which 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; or (b) 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) a reliable estimate of the amount of the obligation cannot be made. Accordingly in this case, when there is sales tax demand of Rs. 3 crores and the company has gone in an appeal, it needs considerations as to whether the entire demand is disputed, because it is difficult to presume that the demand by sales tax authority is without any basis.
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AS -29 Conclusion: Therefore, to the extent the company considered that the demand is based on some logical basis, that amount may be provided for and the remaining may be disclosed as the contingent liability. Note: The answer may also covers the requirement of reporting under CARO, Para No. 4(ix)(b)- In case dues of Income Tax/ Sales Tax/ Service Tax/ Customs Duty/ Wealth Tax/ Excise Duty/ Cess have not been deposited on account of any dispute, then the amounts involved and the forum where dispute is pending shall be mentioned. Q. No. 40 As on 31-3-2010, 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 finalisation of accounts for the year ended 31-3-2010 (the accounts were finalised on 14th June, 2010), 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 31-3-2010, which it says, will be reversed in the next year. Answer: Accounting treatment of Contingent Liabilities: As per AS-29 Provisions, Contingent Liabilities and Contingent Assets 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 companys accounting treatment making provision for a contingent liability violates (AS) 29. Impact of post balance sheet development The company won the case and had no liability. This development has occurred after 31-3-2010 but before the date of finalisation of accounts (i.e. 14-6-2010). It should be taken into account for finalisation of accounts as it pertains to the conditions existing at the balance sheet date. The impact of this development is that even disclosures are not required as it is no longer a continent liability. If this development had not taken place, the company would be required to make disclosures of the contingent liability. Conclusion: Auditor should ask the company to rectify the accounts and reverse the provision made as on 31-3-2010 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 and also quality his remarks regarding compliance with AS which he is required to make pursuant to Section 227(3)(d) of the Companies Act, 1956.
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Company Audit
Issue of prospectus Section 62 of the Companies Act, 1956 deals with civil liability for mis-statements in the prospectus. An Action in this case can be brought by a person who has sustained a loss or damage as a result of subscription to the shares or debentures, on the faith of the prospectus containing an untrue statement. The liability would arise if the written consent of the auditor to the issue of the prospectus, including the report purporting to have been made by him as an expert has been obtained. However, auditor will not liable to third parties if he can prove that: (a) The prospectus was issued without his knowledge or consent and that on becoming aware of its issue, he forthwith gave reasonable public notice that it was issued without his knowledge or consent. He would withdraw his consent by writing to the company, to the ROC, to the stock exchange and through suitable press publicity. (b) He withdrew his consent in writing before delivery of the prospectus for registration, or (c) After the delivery of prospectus for registration but before allotment of shares or debentures, on becoming aware of the untrue misleading statement, he withdrew his consent in writing and gave reasonable public notice of his withdrawal and of the reasons thereof, or (d) He was competent to make the statement and that he had reasonable grounds to believe up to the time of allotment of the shares or debentures that the statement was true. Q. No. 1 Comment: Auditors liability to third parties in relation to issue of prospectus. [Nov. 08 Old (8 Marks)] Or Explain the liability of the auditor u/s 62 of the Companies Act, 1956, for making an untrue statement in the report (as an expert forming a part of the prospectus). [May 10 New (5 Marks)] Payment controlled by Co. law Q. No. 2 As an Auditor, comment on the following: BOD of PQ Ltd. has given donations of `50,000 each to a charitable school and a trust for blinds, during the year ended 31-32011. The average net profit of the company during last three financial years amounts to `12 lacs. Answer: Donation to Charitable Trust: Sec. 293(1)(e) of Companies Act, 1956, provides that the BOD of a Public Ltd. Co. can not contribute to charitable and other funds (not directly relating to the business of the company or the welfare of its employees), any amounts the aggregate of which will, in any FY, exceed `50,000 or 5% of average net profits of the 3 preceding FYs, whichever is greater, (except with the consent of the company). In the given case, the donations given by the company are not directly relating to business of the company or the welfare of its employees, hence in this case, the BOD can contribute either (i) `50,000 or (ii) 5% of average net profit of least 3 FYs i.e. `60,000 which ever is greater. Conclusion: BOD has violated Section 293(1)(e) of the Companies Act, and this matter should be reported in the auditors report.
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Branch Audit Q. No. 3 XLW has a branch office in Malaysia. The company has appointed Mr. X, who is qualified to audit accounts as per Malaysian laws. Mr. Z, the statutory auditor objects to the same, contending that he alone can audit the branch office accounts. Discuss. Can Mr. Z visit the branch? Answer: Eligibility criteria for appointment as Branch Auditor As per Sec. 228 of the Companies Act, 1956, a company can appoint as auditor of a foreign branch an accountant duly qualified to act as an auditor in accordance with the laws of the foreign country. Further, if the accounts of any branch office are audited by a person other than the companys auditor, the companys auditor shall have the following rights: to visit the branch office if he considers necessary; and access at all times to books and vouchers maintained at the branch office. Conclusion: Mr. Z contention that he alone can audit the branch office accounts is not valid, however he has a right to visit the branch office if he so desires. Q. No. 4 Mr. P is the statutory auditor of S Ltd. which has a branch in Pune. The company in general meeting decided to have the accounts of Pune Branch audited by Mr. Q who was appointed without Mr. Ps knowledge and consent. State your comments on the above with reasons. Answer: Appointment of Branch auditor: As per Sec. 228(3)(a), where a company in general meeting decides to have the accounts of a branch audited otherwise than by the companys auditor, the company in that meeting shall do either of the following two things: (a) appoint an eligible person as branch auditor, or (b) authorise the BOD to appoint such a person in consultation with the companys auditor. Conclusion: So, it is clear that if the company itself appoints the branch auditor in general meeting there is no need for consultation with the statutory auditor. The need for consultation with companys auditor arises only when the BOD appoint the branch auditor. Appointment of Mr. Q as branch auditor without Ps consent is Valid. Q. No. 5 A company has a branch office, which recorded a turnover of `1,90,000 in the financial year 2004-05. No audit of the branch has been carried out. The statutory auditor of the company has made no reference of the above branch in his report. The total turnover of the company is Rs.10 crores for the year 2004-05. Comment. Answer: Reference of Branch audit exemption in audit Report: Companies (Branch Audit Exemptions) Rules, 1961 provides for the exemption of a branch office of a company carrying on manufacturing, processing or trading activity from the provisions of section 228, if the average quantum of activity of the branch does not exceed the higher of `2 lakh or 2% of the average of the total turnover (Including other incomes). As the turnover of the branch is less than the limit prescribed above, hence audit of concerned branch is not required. However, as per Rule 7 of above said rules, auditor is required to refer the exemption in his report. Conclusion: Auditor fails to comply with the requirements of Rule 7.
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Schedule VI Q. No. 6 Comment on the following: X Ltd., paid `25 lakhs as advance to Y Ltd. towards the purchase of a printing machinery on 15.1.11 with delivery instructions to deliver the same in the last week of June, 11. Further on 2.2.11 X Ltd. purchased two diesel generator sets from Y Ltd. for `30 lakhs on 90 days Credit term. In the accounts for 2010-11, X Ltd. intends to adjust the advance paid against Credit purchase and show the net amount of `5 lakhs as due from them. As the statutory auditor, how would you deal with this? [Nov. 08 New (5 Marks)] Answer: Adjustment of advance paid against the Personal Account: X Ltd. has paid advance amount to the supplier of machinery to be used in the project, such advance amount is required to be shown under the head Capital Work in Progress, in terms of requirement of Schedule VI to the Companies Act, 1956 and the existing accounting practice. If the advance is for purchase of other machinery, it should be grouped under a separate head Advance Payment for Capital Expenditure and should be disclosed as next item to Fixed Assets in the Balance Sheet. Conclusion: Proposal of X Ltd., to show the net balance in the personal account of Y Ltd., is not correct. Such proposal will conceal two material items in the B/S one, expenditure towards capital asset and the other current liability for purchase of the generator set. Auditor should advise X Ltd., to show these two items separately. If X Ltd., does not accept the advice, the auditor should qualify his report with suitable quantification of amount involved. Q.No.7 Comment on the following as auditor: Interest paid or payable to the managing director or manager has not been shown separately in profit and loss account on the ground that it is not even 0.1% of total interest paid / payable. Answer: Clause 3(v) of Part II of Schedule VI to the Companies Act, 1956 requires that the profit and loss account shall disclose interest paid or payable to the managing director or manager. In view of this specific statutory requirement, interest paid or payable to the managing director or manager are material irrespective of their quantum and should be disclosed separately. If not disclosed, auditor will have to qualify his audit report. Audit of Dividends Q. No. 8 State your views as an auditor on the following: During the year under audit, Ram Ltd. credited to the Profit and Loss Account, the entire profit of ` 20 lakhs on the sale of land not required for its use. You are informed that the directors would like to propose dividend out of the above profit. Answer: Distribution of Capital Profits as Dividend: Profit of ` 20 lakhs on the sale of land is a capital profit. It represents the excess of sale value over the original cost of the asset, i.e capital profits. The capital profits can be distributed by a company only if all the following conditions are fulfilled: 4. 5. 6. The articles of association should permit distribution of capital profits. The capital profit which is sought to be distributed should have actually been realised. The capital profit should remain after a proper valuation has been fairly taken of the whole of the assets and liabilities. Conclusion: The profit arise on sale of land is realized in cash and hence subject to satisfaction of other conditions can be distributed as dividend.
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Audit of Dividends Q. No. 9 Give your views on the following: The rates of equity dividend declared and paid by a company are as follows: 2008-2009 15% 2007-2008 12% 2006-2007 12% The company has earned sufficient profit after tax in 2009-10 and wishes to propose a dividend on equity shares at 11% of the current profits and transfer to Reserve 20%. The company has not issued any bonus shares during the last few years. The post-tax profit in 2009-10 is higher than the corresponding profit of each of the previous three years. (a) Will it make any difference if the company proposed a rate of equity dividend @ 20%? (b) Will it make any difference if the amounts of net profits after tax of the company are as follows: 2009-2010 10,00,000 2008-2009 17,00,000 2007-2008 15,00,000 2006-2007 18,00,000
Answer The proposal is not legally sustainable. Transfer to reserves at a %age higher than 10% can be made only when the company complies with the requirements laid down by the Companies (Transfer of Profits to Reserve) Rules. Ensure minimum distribution of dividend i.e average rate of dividend for the immediately preceding three years. In the present case the average rate of dividend works out to 13%. The dividend proposed in 2009-10, viz. 11% is less than this rate and, therefore the company cannot transfer higher than 10%. Further companys post-tax profit is not less than the average post-tax profit for the last two years and no bonus shares have been issued by the company during 2009-10 or in the preceding three years, therefore transfer higher than 10% will not be allowed. (a) Dividend @20%: As the company ensures minimum distribution of dividend i.e. average rate of last three years, the companys proposal to transfer to reserves @ 20% would be in order. (b) In this case also, the company can pay dividend @11% without ensuring minimum distribution as the current year profit is less by more than 20% of average profits of last two years. The post-tax profit for the current year is `10,00,000 whereas the average post tax profit, taking 2008-2009 and 2007-2008 figure into account is `16,00,000; the former is less than the latter by about 37.5%. CARO Q. No. 10 As an Auditor, comment on the following situation: JKT Ltd. having `40 lacs paid up capital, `9.50 lacs reserves and turnover of last three consecutive financial years immediately preceding the financial year under audit, being `4.90 crores, `4.50 crores and `6 crores, but does not have any internal audit system. In view of the management, internal audit system is not mandatory. Or Comment: The company has a turnover exceeding `5 crores for a period of three consecutive financial years immediately preceding the financial year concerned, but does not have any internal audit system. Answer: As average annual turnover of preceding three years exceeds `5 Crores, auditor is required to report on non-existence of internal audit system by virtue of requirement of Para 4(vii) of CARO.
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CARO Q. No. 11 As an auditor, state your view on the following: A Public Company defaulted in the repayment of deposits together with interest on the due date for more than a year and the Chief Accountant contends that the auditor need not report on the default committed by the company. Answer: Reporting required under Para 4(vi) of CARO and under Sec, 227(3)(f). Misc. Q. No. 12 As a statutory auditor for the year ended 31st March 2010, how would you deal with the following: P Ltd. has filed a petition in the High Court for adjustment of product development expenses of `50 crores against the balance in Securities Premium account. While finalizing the accounts, the directors carried out the said adjustment since they were certain that the High Court approval would be received. The said petition has not come up for hearing till the date of signing of the accounts by the auditor. Answer: Adjustment of Product Development Expenses against Balance in the Securities Premium Account: Product development expenses are normally classified as revenue expenditure. In Adjustment of such expenses against Securities Premium Account is violation of generally accepted accounting principles. However, any adjustment that is approved by the High Court will override the generally acceptable accounting principles. In the instant case, though the company has filed a petition in the HC for such adjustment, and though the directors are certain that the HC would approve the adjustment, the petition has not been finalised till the date of signing of accounts. Conclusion: The company cannot carry out the said adjustment. The statutory auditor, therefore, will have to qualify his report by stating that the product development expenses have been adjusted against the Securities Premium Account rather than treating them as the revenue expenditure and writing it off to the P & L A/c. The statutory auditor would also have to mention the amount by which the profit for the year has been overstated. Q. No. 13 Y Ltd. has accumulated losses of `12 crores. The Reserves and Surplus of the said company also include Securities Premium Account of `15 crores. The company intends to adjust the accumulated losses against the Securities Premium Account. Is the company permitted to do so under the provisions of the Companies Act, 1956? Answer: Not permitted by virtue of Sec. 78.
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PROFESSIONAL ETHICS
Q. No. 1 X, a practicing chartered accountant paid 25% of the audit fees received by him to his employee Y, who was an M.Com., under the nomenclature of office allowance and such an arrangement continued for a number of years. Comment. Answer: Sharing fees with Employees: As per clause (2) of Part I of the First Schedule to the Chartered Accountants Act, 1949 , a CA in practice is deemed to be guilty of professional misconduct if he 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, or a member of any other professional body or with such other persons having such qualification as may be prescribed, for the purpose of rendering such professional services to time in or outside India. Conclusion: In the given case in substance the CA has shared his profit and therefore, is guilty of professional misconduct under the clause. It is not the nomenclature to a transaction that is material but it is the substance of the transaction, which has to be looked into. Q. No. 2 T, a practicing CA uses the designation, Municipal Councillor apart from the expression FCA on his visiting card. Comment. Answer: Using designated other than CA: As per clause (7) of Part I of the First Schedule to the CA Act, 1949 , a CA in practice is deemed to be guilty of professional misconduct if he Advertises his professional attainments or services, or uses any designation or expressions other than the CA on professional documents, visiting cards, letter heads or sign boards. However, an recognized degree of university or title indicating membership of ICAI or other recognized institution may be used. It also restrains a member from using any designation or expression other than that of a CA in documents through which the professional attainments of the member would come to the notice of the public. Conclusion: A member is not permitted to use the designation such as Member of Parliament, Municipal Councillor or any other functionary in addition to that of CA. Therefore under this clause T is guilty of professional misconduct. Professional Negligence Q. No. 3 Write short note on: Professional Negligence. Answer: Professional negligence: Negligence, which is culpable, generally consists of under mentioned three elements: (a) Existence of duty or responsibility owed by one party to another to perform some act with certain degree of care and competence. (b) Occurrence of a breach of such duty and (c) Loss or detriment, being suffered by the party to whom the duty was owed as a result of negligence. In this context, professional negligence would constitute failure to perform duties according to "accepted professional standards", resulting in some damage to a party to whom duty is owed. [May 09 Old (4 marks)]
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Bank Audit
Q. No. 1 Mr. X, a practicing CA, has been issued a credit card by State Bank of India. He used the credit card for buying clothes for him for Rs. 1200. Is he eligible for appointment as one of the auditors of the Bank? Answer: Disqualification for appointment as an auditor: Relevant Provisions: Sec. 30 of the Banking Regulation Act, 1949 requires that the Balance Sheet and Profit and Loss Account of a banking company should be audited by a person duly qualified under any law for the time being in force to be an auditor of companies. According to section 226(3)(d) of the Companies Act, 1956, a person who is indebted to the company for an amount exceeding `1,000, or who has given any guarantee or provided any security in connection with the indebtedness of any third person to the company for an amount exceeding `1,000, can not be appointed as an auditor. It is to be noted that the disqualification is not confined to appointment as auditor of the particular branch to which the debt is owed, but to any branch. In the context of banks, the expression indebtedness would cover, inter alia, the amounts outstanding in respect of credit cards issued by a bank. Conclusion: Thus, where the credit card outstanding exceed the prescribed limit of `1,000, the CA in whose name the card is issued as well as the firm of which he is a partner would be disqualified for appointment as auditor of the issuing bank. X is not eligible for appointment as an auditor of the Bank. Your firm has been appointed as Central Statutory Auditors of a Nationalised Bank. The Bank follows financial year as accounting year. State your views on the following issues which were brought to your notice by your Audit Manager: (a) The bank has recognised on accrual basis income from dividends on securities and Units of Mutual Funds held by it as at the end of financial year. The dividends on securities and Units of Mutual Funds were declared after the end of financial year. (b) The bank is a consortium member of Cash Credit Facilities of ` 50 crores to X Ltd Bank's own share is ` 10 crores only. During the last two quarters against a debit of ` 1.75 crores towards interest the credits in X Ltd's account are to the tune of ` 1.25 crores only. Based on the certificate of lead bank, the bank has classified the account of X Ltd as performing. Answer: (a) Income Recognition: Income from dividend on shares of corporate bodies and units of mutual funds should be booked on cash basis. In respect of income from government securities and bonds and debentures of corporate bodies, where interest rates on these instruments are pre-determined, income could be booked on accrual basis, provided interest is serviced regularly and as such is not in arrears. Banks may book income from dividend on shares of corporate bodies on accrual basis, provided dividend on the shares has been declared by the corporate body in its AGM and the owner's right to receive payment is established. This is also in accordance with AS-9 as well. In the instant case, the recognition of income by the bank on accrual basis is not in order (b) NPA Classification in Consortium advances: In consortium advances, each bank may classify the advance given by it according to its own experience of recovery and other factors. Since in the last two quarters, the amount remains outstanding and, thus, interest amount should be reversed. Despite the certificate of lead bank to classify the account as performing, the advance need to be classified as non-performing asset.
Q. No. 2
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Q. No. 3 Write a short note on: Corporate Debt Restructuring. Answer: Corporate Debt Restructuring (CDR) CDR system has been evolved for restructuring of the corporate debts of viable entities facing problems, which are out side the purview of BIFR, DRT and other legal proceedings. All the banks have been advised by RBI to follow the CDR mechanism which would be a non-statutory voluntary system based on debtor creditor agreement and inter creditor agreement. The mechanism will apply only to the multiple banking account/syndicate/consortium with an outstanding exposure of `20 crore and above by bank and financial institutions. CDR would generally affect the operations both at Branch level as well as the Head Office level, although, in most of the cases the effects of provisioning as envisaged in the RBI circular due to sacrifice in the interest would be made at the Head Office level. In case of restructuring of the principal amount, auditors should verify that adequate security coverage of the loan/credit account is available.
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TAX AUDIT
Q. No. 1 A public charitable trust earns income of Rs.10 lakhs from Unit Trust of India, which is not taxable under Section 10(33) of Income-tax Act, 1961. It spends Rs.7 lakhs on its activities. The entire expenditure is vouched and is in accordance with the trust objects and is fully allowable as application. As Auditor of the Trust, would you require the trust to make any provision for tax in its accounts? Answer: Tax audit of Public Trusts: Section 10(33) of the Income-tax Act, 1961 provides exemption in respect of income received in respect of units from UTI to all assessees including a public charitable trust. Hence, `10 lakhs received from UTI is not taxable income of the trust. The Income-tax Act, 1961 requires that for claiming full exemption by the trust, it is required to apply at least 85% of such income during the previous year for charitable or religious purposes. As per the facts given, the trust has applied only ` 7 lakhs i.e. 70% of its total income towards the trust objects and, thus, contravened the requirements of the Act. Yet the trust shall not be required to pay tax on its income because the income has been received on account of units, which in any case is fully exempt. Accordingly, the trust is not required to make any provisions for tax in the accounts. The fact that not spending `3 lakhs out of `10 lakhs, though contravening the requirement of spending at least 85% of "income" would, therefore, not attract tax. Hence, no tax provision is necessary. Q. No. 2 Mr. P carries on the business of dealing and export of diamonds. For the year ended 31st March, 2011, you as the tax auditor, find that the entire exports are to another firm in U.S.A., which is owned by Mr. Ps brother. Answer: Export Payments to a Relative: Clause 18 of Form 3CD, requires the tax auditor to specify particulars of payments made to persons specified u/s 40(A)(2)(b) of the Income Tax Act, 1961. Persons specified in the said section are relatives of an assessee and sister concerns, etc. In the instant case, however, Mr. P has not made any payments to his brother. On the contrary, he must have received payments from him against exports made and, thus, this clause would not be applicable to him. Mr. P will nonetheless be still as a part of his normal audit planning would be required to verify whether the exports are genuine, i.e., whether the diamonds have been delivered by verifying the necessary delivery documents, relevant invoices, etc., the reasonableness of the price and whether the export realisations have been received. Q. No. 3 Mr. X deals in a commodity and purchase and sales of that commodity is ultimately settled otherwise than by the actual delivery. During the financial year 2010-11 he purchased the commodity worth ` 55 Lacs and sold the same commodity for ` 64 Lacs and the contract was settled otherwise than by the actual delivery. X seeks your advice whether he is liable for tax audit u/s 44AB of the Income Tax Act. Answer: Liability for Tax Audit in case of Speculative Transactions: Mr. X deals in commodity as a speculator. A speculative transaction means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery. As such, in such transaction the difference amount is turnover. In the given case the difference of ` 64 lacs and ` 55 lakhs i.e, `. 9 Lakhs is the turnover. In such transactions though the contract notes are issued for full value of the purchases or sales, but the entries in the books of account are made only for the differences. Conclusion: Mr. X is not liable for Tax audit under section 44AB of the Income Tax Act, 1961.
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Q. No. 4 A leading jewellery merchant used to value his inventory at cost on LIFO basis. However, for the current year, in view of requirements of AS-2, he changed over to FIFO method of valuation. The difference in value of stock amounted to `55 lakhs which is higher than that under the previous method. In such a situation, what are the reporting responsibilities of a Tax Audit u/s 44AB of Income Tax Act, 1961. Answer: Reporting Requirement in case of change in valuation of stock: Change in the method of valuation of stock is not a change in method of accounting, as it is only a change in accounting policy. However in the Income Tax Act, 1961 this is considered under method of accounting. Under the Income-Tax Act, 1961 if the change in method of valuation is bonafide, and is regularly and consistently adopted in the subsequent years as well, such change would be permitted to be made for tax purposes. In the instant case, the change in the valuation of stock from LIFO basis to FIFO basis is pursuant to mandatory requirements of the AS-2 Valuation of Inventories and therefore should be viewed as bonafide change. This apart, the tax auditor in his report has to specifically refer to the method of valuation of stock under Clause 12 in Form 3CD. Method of valuation of closing stock employed in the previous year. Details of deviation, if any, from the method of valuation prescribed u/s 145A and the effect thereof on profit or loss.
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MISCELLANEOUS
SEBI Guidelines Q. No. 1 As the auditor of LMN Ltd. you notice certain differences in the figures between the books of account and offer document. The company explains that it is due to certain adjustments made as per SEBI (Disclosure and Investor Protection) Guideline, 2000. State such disclosure and adjustments which are to be incorporated in the Financial Statement of the offer document. [Nov. 08 New (8 Marks)] Answer: SEBI (Disclosure and Investor Protection) Guidelines, 2000 require following disclosure and adjustment in the F.S. to be incorporated in the offer document: (a) All significant accounting policies and standards followed in the preparation of the F.S. shall be disclosed. (b) Statement of assets and liabilities and P & L or any other financial information shall be incorporated after making the following adjustments: (i) Incorrect accounting policies or failures to make provisions or other adjustments which resulted in audit qualifications. (ii) Where there has been change in accounting policy, the profits or losses of the earlier years and of the year in which the change has taken place shall be recomputed to reflect what the profits or losses would have been if a uniform accounting policy was followed in each of these years. (iii) Statement of profit or loss shall disclose both the profit and loss before and after considering the profit or loss from extraordinary items. (iv) The statement of assets and liabilities shall be prepared after deducting the balance outstanding on revaluation reserve account from both fixed assets and reserve and the net worth arrived at after such deduction. Flowchart techniques for evaluation of IC System Q. No. 2 Explain briefly the Flow Chart technique for evaluation of the Internal Control system. [Nov. 09 New (4 Marks)] Answer: Flow-Chart Technique for evaluation of Internal Control: 1. It is a graphic presentation of internal controls in the organisation and is normally drawn up to show the controls in each section or sub-section. 2. It provides the most concise and comprehensive way for reviewing the internal controls and the evaluators findings. 3. A flow chart is a diagram full with lines and symbols and if judicious use of them can be made, it is probably an effective way of presenting the state of internal controls in the clients organisation. 4. A properly drawn up flow chart can provide a neat visual picture of the whole activities of the section or department involving flow of documents and activities. More specifically it can show at what point a document is raised internally or received from external sources; the number of copies in which a document is raised or received; the intermediate stages set sequentially through which the document and the activity pass; distribution of the documents to various sections, department or operations; checking authorisation and matching at relevant stages; filing of the documents; and final disposal by sending out or destruction.
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Investigation Q. No. 3 A state government has appointed you as an investigator to investigate into the affairs of the sick company. Investigation in such a case involves detailed examination of records for several years, collection of information from different sources and analysis of facts and figures. Briefly discuss the major steps involved in such an investigation. Write short notes on: Usefulness of careful and adequate audit planning. [May 09 Old (4 marks)] Answer: Usefulness of careful and adequate Audit Planning The auditor should plan his work to enable him to conduct an effective audit in an efficient and timely manner. Careful and adequate audit planning helps him to: (i) Ensure that appropriate attention is devoted to important areas of the audit (ii) Ensure that potential problems are promptly identified (iii) Ensure that the work is completed expeditiously (iv) Utilize the assistants properly and (v) Co-ordinate the work done by other auditors and experts
Audit Planning
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Audit Workbook

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Page |1

CA Final Advanced Auditing & Professional Ethics

Must Read - Preface to Workbook

Companies (AS) Rules, 2006, Schedule VI etc.

Schedule of Upcoming Batches

GUIDANCE NOTES Accounting and Auditing Practical Illustrations

Guidance Note on provision for liability for taxation

Terms used in F.S.

STANDARDS ON AUDITING AND RELATED SERVICES

Q. No. 7 Q. No. 8 Q. No. 9

Q. No. 28 Q. No. 29 Q. No. 30

Companies (AS) Rules 2006

Small and Medium Size Company

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