1 nature, objective and scope of audit

6.1

Star RatingOn the basis of Maximum marks from a chapter NilOn the basis of Questions included every year from a chapter NilOn the basis of Compulsory questions from a chapter

CHAPTER

Nature, Objective andScope of Audit1

THIS CHAPTER COMPRISES OF

Meaning and Definition of Auditing Objectives of Audit Scope ofAudit Types of Audit Inherent Limitations of Audit Relationship ofAuditing with other disciplines Standard Setting Process Elementsof a System of Quality ControlPreconditions for an Audit Agreementof Audit Engagement Terms.

Marks of Objective, Short Notes, Distinguish Between, Descriptive & Practical Questions

6.2 O Solved Scanner CA Inter Gr. II Paper - 6 (New

Bloom’s Taxonomy (BT)Keeps You Ahead During Learning

Basis On WhichQuestions AreAsked In YourExam.SoLearn In a Proper,Systematic &Scientific Way.

Low LevelThinking Skills

Level 1: KnowledgeLevel 2: Comprehension

High LevelThinking Skills

Level 3: ApplicationLevel 4: AnalysisLevel 5: SynthesisLevel 6: Evaluation

Focus:

Analysis of this chapter on the basis of Bloom’s Taxonomy

Objective and Descriptive Questions asked in your exam are based onLow Level Thinking Skill alongwith Application Skill, but DistinguishBetween Questions requires High Level Thinking Skills Specially Analysis.

OBJECTIVE QUESTIONS

2008 - May [1] Based on BT’s Level 1State with reasons (in short) whether the following: statement is True orFalse:

(i) Procedural error arises as a result of transactions having beenrecorded in a fundamentally incorrect manner. (2 marks)

Answer:False : When transactions are recorded in fundamentally incorrect mannerit is known as Error of Principle. For e.g. a distinction not being madebetween capital and revenue income or expenditure.Procedural errors arise due to adoption of wrong accounting procedures.

[Chapter 1] Nature, Objective and Scope of Audit O 6.3

2008 - Nov [1] Based on BT’s Level 2State with reasons (in short) whether the following statement is True orFalse:(xi) “Auditor is not an Insurer”. (2 marks)

Answer:True : SA 200 i.e. “Overall objectives of the independent Auditor andthe Conduct of an audit in accordance with standards of Auditing,”states that auditor’s opinion is not an assurance as to the future viability ofthe enterprise or the efficiency or effectiveness with which the managementhas conducted the affairs of the enterprise. The auditor does not insuresthe interest of users of accounts but only states his opinion after taking allreasonable care and skill, that the statements show a true and fair picture.The ultimate responsibility is of the management. The audit of financialstatements does not relieve management of its responsibilities.According to Companies Act 2013:The financial statements shall give a true and fair view of the state of affairsof the company or companies as at the end of the financial year [Sec. 129(1)of 2013 Act].The auditor’s report shall state that:to the best of his information and knowledge, the said accounts, financialstatements give a true and fair view of the state of the company’s affairs asat the end of its financial year and the profit or loss and cash flow for the yearand such other matters as may be prescribed [Sec. 143(2) of the 2013 Act].The aforesaid definition is very authoritative. It makes clear that the basicobjective of auditing, i.e., expression of opinion on financial statements doesnot change with reference to nature, size or form of an entity. The definitiongiven above is restrictive since it covers financial information aspect only.However, the scope of auditing is not restricted to financial information only,but, today it extends to variety of non-financial areas as well. That is howvarious expressions like marketing audit, personnel audit, efficiency audit,production audit, etc. came into existence. But here we should study onlyfinancial audit unless and until otherwise specified.


2009 - May [1] Based on BT’s Level 1&2State with reasons (in short) whether the following statement is True orFalse:

(i) The principle of confidentiality precludes auditor to disclose theinformation about the client to third party at all circumstances withoutany exception. (2 marks)

Answer:False: The principle of confidentiality is one of the basic principles ofauditing. Auditor is generally not expected to disclose the information of hisclient to others. He can disclose the information to others only when (a)permitted by his client, or (b) as per any statutory obligation dictated by anylaw.

2009 - Nov [1] Based on BT’s Level 1&2State with reasons (in short) whether the following statement is true or false.(iv) The auditor, in the interest of the users, while explaining the nature of

his reservation, can describe the work of the expert with his name inthe audit report without obtaining prior consent of the expert.

(2 marks)Answer:False : According to SA 620, “Using the work of an Auditor’s Expert,”if the auditor, in the interest of the users includes the name of the expert inhis audit report, he can do so only after obtaining the prior consent of expert.

2010 - May [1] Based on BT’s Level 1&2State with reasons (in short) whether the following statements are True orFalse:

(ii) The auditor compares entries in the books of accounts with vouchersand if two agrees, his work is done. (2 marks)

Answer:False : The totaling of entries in the books with vouchers shows fairness offinancials statements. But auditor has to determine reliability of annualstatement of accounts alongwith the truth and fairness.


2014 - May [2] Based on BT’s Level 1State with reasons (in short) whether the following statement is correct orincorrect.

(ii) Specific disclosure is required of the fundamental accountingassumptions followed in the financial statements. (2 marks)

(v) ‘Errors of commission’ is where a transaction has been omitted eitherwholly or partially. (2 marks)

Answer:(ii) Incorrect: If the company or firm does not follow the fundamental

accounting assumptions viz., going concern, accrual, consistency thendisclosures in the financial statements are required. If they follow thefundamental accounting assumptions then disclosures are notrequired.

Answer:(v) Incorrect: When wrong amount is entered either in the subsidiary

books or in ledger accounts or when totals are wrongly made or whena wrong account is involved or when amount is posted on the wrongside, it is a case of error of commission.

2015 - May [2] Based on BT’s Level 1State with reasons (in short) whether the following statement is correct orincorrect:(viii) The basic objective of audit does not change with reference to nature,

size or form of an entity. (2 marks)Answer:Correct: The meaning and nature of audit does not change with the natureor size of entity, audit is examination of true and fair view of statement of anyentity irrespective of its size and legal structure as defined in definition ofaudit.

SHORT NOTES

2007 - Nov [8] Based on BT’s Level 1Write short note on the following.(b) Quality control for audit work at firm level. (5 marks)


Answer:Under SA 220, Quality Control for an audit of Financial Statement, anaudit firm should implement quality control policies and procedures designedto ensure that all audits are conducted in accordance with Standard of Audit.

Following are the objectives of the quality control policies andprocedure to be adopted by an audit firm :

1 . Professionalrequirements

Personnel in the firm are to adhere to the principlesof independence, integrity, objectivity, confidentialityand professional behaviour.

2 . Skills andcompetence

The firm is to be staffed by the personnel who haveattained and maintained the technical standardsand professional competence required to enablethem to fulfill their responsibility with due care.

3 . Assignment Audit work is to be assigned to personnel who havethe required degree of technical, training, andproficiency required in the circumstances.

4 . Delegation There should be sufficient direction, supervision andreview of the work at all levels to provide reasonableassurance that the work performed keepsappropriate standards of quality.

5 . Consultation Consultation with person of appropriate expertise,within or outside the firm is to be made wheneverrequired.

6 . Acceptance andr e t e n t i o n o fclients

An evaluation of prospective clients and a review onan ongoing basis of existing clients is to beconducted. In making a decision to accept or retaina client, the firm’s independence and ability to servethe client properly are to be considered.

7 . Monitoring The continued adequacy and operationaleffectiveness of quality control policies andprocedures are to be monitored.


8 . Communicationof quality controlpolicies

The firm’s general quality control policies &procedures should be communicated in such amanner that provides reasonable assurance thatthey are understood and implemented.

2010 - Nov [4] Based on BT’s Level 1Write short note on the following :(d) Factors governing modes of communication of auditor with those

charged with governance. (4 marks)Answer:Factors governing modes of communication of auditor with thosecharged with governance :According to SA 260, “Communication with Those Charged withGovernance” the auditor may decide whether to communicate orally or inwriting, the extent of detail or summarisation in the communication, andwhether to communicate in a structured or unstructured manner may beaffected by such factors as:• The size, operating structure, control environment, and legal structure of

the entity.• Legal requirements. In some jurisdictions, a written communication with

those charged with governance is required in a prescribed form by locallaw.

• In the case of an audit of special purpose financial statements, whetherthe auditor also audits the entity’s general purpose financial statements.

• The amount of ongoing contact and dialogue the auditor has with thosecharged with governance.

• The expectations of those charged with governance, includingarrangements made for periodic meetings or communications with theauditor.

• Whether there have been significant changes in the membership of agoverning body.

2014 - Nov [7] Based on BT’s Level 1&3Write short note on the following:(b) Self-revealing errors and four illustrations thereof. (4 marks)


Answer:Self revealing errors : These are such errors the existence of whichbecomes apparent in the process of compilation of accounts.A few illustrations of such errors are given hereunder, showing how theybecome apparent.

1. Omission to post a part of ajournal entry to the ledger.

Trial balance does not tally.

2. Wrong totaling of the PurchaseRegister.

Control Account (e.g., the SundryCreditors Account) balances andthe aggregate of the balances in thepersonal ledger will disagree.

3. A failure to record in the cashbook amounts paid into orwithdrawn from the bank.

Bank reconciliation statement willshow up error.

4. A mistake in recording amountreceived from X in the accountof Y.

Statements of account of parties willreveal mistake.

From the above, it is clear that certain apparent errors balance almostautomatically by double entry accounting procedure and by followingestablished practices that lie within the accounting system but not beinggenerally considered to be a part of it, like bank reconciliation or sendingmonthly statements of account for confirmation.

2015 - May [7] Based on BT’s Level 1&2Write short note on the following:(a) Fundamental Accounting Assumptions. (4 marks)


Answer:There are three fundamental accounting assumptions as per AS 1 onDisclosure of Accounting Policies.1. Going concern : The enterprise is normally viewed as a going concern,

i.e., continuity in operation for the foreseeable future. It is assumed thatthe enterprise has neither the intention nor the necessity of liquidationor of curtailing materially the scale of its operations.

2. Consistency : It is assumed that the accounting policies are consistentfrom one period to another.

3. Accrual : Revenues and costs are accrued i.e., recognized as they areearned or incurred in the financial statements of the period to which theyrelate.

Disclosure requirement as per AS-1: There is no need of specificdisclosure of these assumptions in the financial statements, since it ispresumed that these assumptions have been followed in the preparation andpresentation of financial statements. If a fundamental accounting assumptionis not followed, the fact should be disclosed. Thus disclosure is needed onlyin case of non compliance with the fundamental Accounting Assumptions.

2016 - May [7] Based on BT’s Level 1Write short note on the following:(d) Changes in accounting policies. (4 marks)Answer:Changes in Accounting Policies:! Accounting policies refers to accounting principles and methods of

applying those principles in preparation and presentation of the financialstatement of the client.

! Accounting policies need to be followed consistently by clients, from timeto time and years to year. If there is any change in accounting policies,the auditor shall check following disclosure made by organisation.


! The fact that there is an change in accounting policies shall bedisclosed in financial statements.

! The reason for such change in financial statement.! The impact of such change in financial statements. If the impact is

not ascertainable today but may be ascertainable in future, thansuch effect of change in future shall be disclosed.

DISTINGUISH BETWEEN

2012 - Nov [4] (b) Based on BT’s Level 4Distinguish between Auditing and Investigation. (8 marks)Answer:Both involve a systematic and critical examination of the available evidence,yet these are quite distinct from each other which is as follows:

S. No. Basis ofDifference

Auditing Investigation

1. Meaning Auditing relates to theindependent examinationof financial information ofany entity, when such anexamination is conductedwith a view to express anopinion.

Investigation relates tosystematic, critical andspecial examination ofthe records of thebusiness for a specificpurpose.

2. Scope Audit covers all factualassertions in the financialstatements to ascertaintheir truth and fairness.

Scope is limited asregards the period orarea to be covered.

3. Object The object of an audit isto critically examine thefinancial statements andreport on the truth &fairness of assertions.

Investigation aims atascertaining certain factssuch as fraud, taxliability, value of sharesetc.


4. Coverage Auditing is a routineexercise for generally anaccounting year.

Investigation may spreadover a period longer thanone year.

5. Purpose To enhance the degree ofconfidence of intendedusers in the financialstatements.

To establish a fact orassessing a particularsituation.

6. Appointment Auditor may be appointedby the owners orshareholders.

Investigator may beappointed by the ownersor management or eventhird parties.

7. Procedure The audit is conducted inaccordance with theGeneral ly AcceptedAuditing Procedure.

Investigation involves anex tended au d i t i ngprocedure.

8. Approach Auditor is skeptical andnot suspicious.

Investigator starts hiswork with suspicion &collects evidence toeither confirm or dispelthat suspicion.

9. Evidence Aud i t ev idence ispersuasive.

Investigator relies onconclusive.

10. Extent ofchecking

Test checking or samplechecking is allowed.

In investigation parti-cularly to detect frauds,test checking may not beadvisable. It may benecessary to check100%.

11. Report Auditor reports to theowners e.g. shareholders.

Investigator reports tothe person on whoseb e h a l f h e h a su n d e r t a k e n t h einvestigation.


KZ - 1 Knowledge Zone

Distinguish between Auditing, Accounting and Investigation

Basis Accounting Auditing Investigation

1 Meaning Accounting is theart of recording,classifying ands u m m a r i s i n gfinancial informa-tions transac-tions and eventsand preparationof reports thereon.

An Audit is ani n d e p e n d e n texamination offinancial inform-ation of any entitywhen such anexamination isconducted with aview to expressingan opinion thereon.

I n v e s t i g a t i o nimplies syste-matic critical andspecial exami-nation of therecords of thebusiness for aspecific purpose.

2 Objective Recording oftransaction fromvoucher andp r e p a r i n gfinancial state-ments.

T o c r i t i c a l l ye x a m i n e t h efinancial state-ment and report ontruth and fairness.

To asce r ta incertain facts suchas fraud, taxliability, value ofshare etc.

3 Conductedby

Managementsprimary respon-sibility to main-tain and imple-ment effectiveaccounting state-ment.

A C h a r t e r e dAccountant withinthe meaning of theChartered Account-ants Act, 1949.

Any person asappointed by themanagement.

4 Coverage Do n e on aregular basis fora period of oneaccounting year.

It is a routineexercise generallyfor one accountingyear.

It may spreadover a periodlonger than anyear.


5 Aspect I t i n v o l v e srecording aspecto f f i n a n c i a lstatements.

It covers exami-nation aspect offinancial state-ments.

It covers investi-gation aspect offinancial state-ment.

DESCRIPTIVE QUESTIONS

2007 - Nov [6] (b) Based on BT’s Level 1State any ten areas in which different accounting policies may beencountered. (5 marks)Answer:As per AS - 1, Disclosure of Accounting Policies, area in which differentaccounting policies may be encountered are as follows:1. Valuation of fixed asset2. Valuation of inventory3. Valuation of investment4. Conversion of foreign currency5. Method of depreciation6. Accounting for retirement benefit7. Treatment of goodwill8. Treatment of contingent liability9. Recognition of profit on long term contract10. Treatment of expenditure during construction

2008 - May [5] (b) Based on BT’s Level 1&2What is the importance of having the accounts audited by an independentauditor? (5 marks)Answer:

Independent Audit

1. Meaning Independence implies that the judgement of a personis not subordinate to the wishes or directions of anotherperson who might have engaged him or to his ownself-interest.


2. Nature Independence is a condition of mind and personalcharacter and should not be confused with thesuperficial and visible standards of independence,which are imposed by law.

3. Visibility Independence of the auditor should not only exist, butshould also appear to so exist to all reasonablepersons. The relationship maintained by the auditorshall be such that no reasonable man can doubt hisobjectivity and integrity. There is a collective aspect ofindependence that is important to the accountingprofessional as a whole.

The advantages of an Independent Audit are :1. Protection of interest It safeguards the financial interest of persons

who are not associated with the managementof the organization whether they are partnersor shareholders.

2. Moral check It acts as a moral check on the employeesfrom committing defalcations.

3. Tax liability Audited statements of account are helpful insetting liability for taxes.

4. Credit negotiation Financers and bankers use audited financialstatements in evaluating the creditworthiness of individuals in negotiating loans.

5. Trade disputesettlement

Audited statements are useful in settling thetrade disputes for higher wages, or bonus,etc.

6. Control overinefficiency

It helps in detection of wastages and lossesand also helps in recommending ways tocorrect it.

7. Funds-in-trust It is an agency, which ensures that personsacting for others have properly accounted forthe amounts collected by them.


8. Arbitration It is helpful in settling disputes by arbitration.

9. Appraisal Audit reviews the existence and operations ofvarious controls in the organization andreports in adequacies, weaknesses, etc inthem. Management can take suitable actionbased on the reports.

10. Assistance togovernment

Government may require audited andcertified statements before it gives assistanceor issues a license for a particular trade.

2008 - Nov [3] (a) Based on BT’s Level 1What are the basic principles which govern the Auditor’s professionalresponsibilities while doing Audit? (5 marks)Answer:Basic Principles Governing an AuditSA 200 Overall Objectives of the Independent Auditor and the Conductof Audit in accordance with standards of auditing discusses the basicprinciples that govern an audit. Though the standard has been developedin the context of independent audit of financial information, the principleslisted therein are also applicable to a large extent to other types of audit.The standard lays down the following basic principles:1. Integrity, objectivity

and independenceThe auditor should be straight forward, honestand sincere in his approach to his professionalwork.He must be fair and must not allow prejudice orbias to override his objectivity. He shouldmaintain an impartial attitude and both be andappear to be free of any interest which might beregarded, whatever its actual effect, as beingincompatible with integrity and objectivity.


2. Confidentiality The auditor should respect the confidentially ofinformation acquired in the course of his workand should not disclose any such information toa third party without specific authority or unlessthere is a legal or professional duty to disclose.

3. Skills and compe-tence

(i) The audit should be performed and thereport prepared with due professional careby persons who have adequate training,experience and competence in auditing.

(ii) The auditor requires specialised skills andcompetence which are acquired through acombination of general education,technical knowledge obtained throughstudy and formal courses concluded by aqualifying examination recognised for thispurpose and practical experience underproper supervision. In addition, the auditorrequires a continuing awareness ofdevelopments, including pronouncementsof ICAI on accounting and auditing matters,and relevant regulations and statutoryrequirements.

4. Work performed byothers

(i) When the auditor delegates work toassistants or uses work performed by otherauditors and experts, he will continue to beresponsible for forming and expressing hisopinion on the financial information.However, he will be entitled to rely on workperformed by others, provided heexercises adequate skill and care and isnot aware of any reason to believe that heshould not have so relied. In the case ofany independent statutory appointment toperform the work on which the auditor has


to rely in forming his opinion, such as in thecase of the work of branch auditorsappointed under the Companies Act, 2013,the auditor’s report should expressly statethe fact of such reliance.

(ii) The auditor should carefully direct,supervise and review work delegate toassistants. The auditor should obtainreasonable assurance that work performedby other auditors or experts is adequate forhis purpose.

5. Documentation The auditor should document matters which areimportant providing evidence that the audit wascarried out in accordance with the basicprinciples.

6. Planning (i) The auditor should plan his work to enablehim to conduct an effective audit in anefficient and timely manner. Plans shouldbe based on knowledge of the client’sbusiness.

(ii) Plans should be made to cover, amongother things:(a) acquiring knowledge of the client’s

accounting system, policies andinternal control procedures;

(b) establishing the expected degree ofreliance to be placed on internal control;

(c) determining and programming thenature, timing, and extent of the auditprocedures to be performed and

(d) co-ordinating the work to be performed.(iii) Plans should be further developed and

revised as necessary during the course ofthe audit.


7. Audit evidence (i) The auditor should obtain sufficientappropriate audit evidence through theperformance of compliance andsubstantive procedures to enable him todraw reasonable conclusions therefrom onwhich to base his opinion on the financialinformation.

(ii) Compliance procedures are tests designedto obtain reasonable assurance that thoseinternal controls on which audit reliance isto be placed are in effect.

(iii) Substantive procedures are test designedto obtain evidence as to the completeness,accuracy and validity of the data producedby the accounting system.

They are of two types:(i) tests of details of transactions and

balances:(ii) analysis of significant ratios and

trends including the resulting enquiryof unusual fluctuations and items.

8. Accounting systemand internal control

(i) Management is responsible formaintaining an adequate accountingsystem incorporating various internalcontrols to the extent appropriate to thesize and nature of the business. Theauditor should reasonably assurehimself that the accounting system isadequate and that all the accountinginformation which should be recordedhas in fact been recorded. Internalcontrols normally contribute to suchassurance.


(ii) The auditor should gain an understandingof the accounting system and relatedinternal controls and should study andevaluate the operation of those internalcontrols upon which he wishes to rely indetermining the nature, timing and extentof other audit procedures.

(iii) Where the auditor concludes that he canrely on certain internal controls hissubstantive procedures would normally beless extensive than would otherwise berequired and may also differ as to theirnature and timing.

9. Audit conclusionand reporting

(i) The auditor should review and assess theconclusions drawn from the audit evidenceobtained and from his knowledge of thebusiness of the entity as the basis for theexpression of his opinion on the financialinformation. This review and assessmentinvolves forming an overall conclusion asto whether:(a) the financial information has been

prepared using acceptable accountingpolicies, which have been consistentlyapplied.

(b) the financial information complies withrelevant regulations and statutoryrequirements.

(c) there is adequate disclosure of allmaterial matters relevant to the properpresentation of the financialinformation, subject to statutoryrequirements, where applicable.


2009 - May [3] Based on BT’s Level 6In auditing, the auditor checks the specific assertions of the items appearingin the financial statements and opines about the overall assertions theysignify. Explain specific assertions and overall assertions in this context.

(10 marks)Answer:Auditor checks specific assertions that the items of financial statementsmisleaded and also gives his opinion in the form of overall assertion inrespect of financial statements taken as a whole.The specific assertions are -

1. Existence An asset or liability exists at a given date.

2. Rights andobligations

An asset is a right of an entity and a liability is anobligation of the entity at a given date.

3. Occurrence A transaction or event took place which pertains tothe entity.

4. Completeness There are no unrecorded assets, liabilities ortransactions.

5. Valuation An assets or liability is recorded at an appropriatecarrying value.

6. Measurement A transaction is recorded in the proper amount andrevenue or expense is allocated to proper period.

7. Presentationand Disclosure

An item is disclosed, classified and described inaccordance with the acceptable accounting policiesand, when applicable, legal requirements.

The overall assertion opined by the auditor about the financialstatements are:

(i) The profit and loss account gives a true and fair view of the results -profit or loss for the period ended on the last date of the accountingperiod.

(ii) The balance sheet gives a true and fair view of the financial status orfinancial position of the entity as on the last date of the accountingperiod.


2009 - Nov [3] Based on BT’s Level 1Discuss the basic principles governing an audit. (10 marks)Answer:Please refer 2008 - Nov [3] (a) on page no. 35

2009 - Nov [4] (b) Based on BT’s Level 1&2Describe a set of instructions, which an auditor has to give to his clientbefore the start of actual audit. (4 marks)Answer:Set of instructions, which an auditor has to give to his client before the audit,known as letter of engagement.Letter of Engagement :

Meaning A letter of engagement refers to a letter written bythe auditor to his client in order to avoid anymisunderstanding between them.

Purpose of the SA 210, Agreeing theterms of AuditEngagements

Normally the objective and scope of an audit andauditor’s duty and obligations are laid down in theapplicable statute like Companies Act, 2013; RBIregulation for bank; or regulations andpronouncements of the Institute of CharteredAccountants of India (ICAI). In such a case to explainthe terms of audit engagement by a letter by theauditor to the client is only informative.The purpose mentioned in SA - 210 is to establishstandard on:1. Agreeing with the terms of engagement with the

client, and2. How the auditor should respond if the client

requests for changes in terms of engagement.

Contents of AuditEngagement Letters

This letter should be sent before starting the audit. Itshould mention the following:1. Objective of the audit of financial statements.2. Responsibility of management regarding the

following:


(i) Financial statements are proposed on goingconcern basis.

(ii) Selection of accounting policies.(iii) Consistently following the accounting policies.(iv) Maintenance of adequate accounting

records.(v) Written representation by the management.(vi) Arrangement concerning the involvement of

internal auditors and the other staff of theclient.

3. The scope of the audit including reference toapplicable laws and regulations andpronouncements of ICAI.

4. Test nature of audit, frauds & errors may remainundetected.

5. Unrestricted access to records.6. The fact that audit process may be subjected to

a peer review under the Chartered AccountantsAct, 1949.

Followinginstructions aregiven by the auditorto the client beforethe start of audit

1. The accounts should be totaled up and trialbalance and final accounts be kept ready.

2. Vouchers should be serially arranged.3. Schedule of trade receivables and trade

payables should be prepared.4. Schedule of outstanding expenses, prepaid

expenses and accrued income to be kept ready.5. A list of bad and doubtful debts should be

prepared.6. Schedule of investments should be prepared.7. Certified list of goods returned to be prepared.8. Statement of permanent capital expenditure to

be prepared.


9. Schedule of deferred revenue expenditures to beprepared.

10. Names and addresses of managers and otherofficers should be kept ready.

2009 - Nov [8] (a) Based on BT’s Level 5&6X, a Chartered Accountant was engaged by PQR & Co. Ltd. for auditing theiraccounts. He sent his letter of engagement to the Board of Directors, whichwas accepted by the Company. In the course of audit of the company, theauditor was unable to obtain appropriate sufficient audit evidence regardingreceivables. The client requested for a change in the terms of engagement.Offer your comments in this regard. (5 marks)Answer:A letter of engagement refers to a letter written by the auditor to his clientin order to avoid any misunderstanding between them as to the scope andobjective of an audit.Change in terms of engagement.In the following circumstances the auditor may think it appropriate to send anew engagement letter to client.1. Any indication that the client misunderstood the objective and scope of

audit.2. Any revised and special terms of engagement.3. Any recent change in board of directors and senior management.4. New legal requirements or pronouncement of ICAI.5. Significant change in clients businessIt should be kept in mind that1. When the terms of engagement change both the auditor and the client

should agree an new terms.2. The auditor should not agree to change in terms where there is no

reasonable justification for doing so.Thus, as per the case in question, the auditor should not agree to change theterms of engagement as the auditor was unable to obtain sufficient evidenceregarding receivable.


2011 - May [3] (a) Based on BT’s Level 1Discuss limitations of audit. (8 marks)Answer:Inherent limitations of AuditAs per SA-200, Overall Objectives of the Independent Auditor and theconduct of Audit in accordance with standards of auditing, the purposeof an audit is to enhance the degree of confidence of intended users in thefinancial statements. This is achieved by the expression of an opinion by theauditor on whether the financial statements are prepared, in all materialrespects, in accordance with an applicable financial reporting framework. Inthe case of most general purpose frameworks, that opinion is on whether thefinancial statements are presented fairly, in all material respects, or give atrue and fair view in accordance with the framework. An audit conducted inaccordance with SAs and relevant ethical requirements enables the auditorto form that opinion.The auditor is not expected to, and cannot, reduce audit risk to zero andcannot therefore obtain absolute assurance that the financial statements arefree from material misstatement due to fraud or error. This is because thereare inherent limitations of an audit, which result in most of the audit evidenceon which the auditor draws conclusions and bases the auditor’s opinionbeing persuasive rather than conclusive.

The inherent limitations of an audit arise from :

1. The Nature ofFinancialReporting

The preparation of financial statements involvesjudgment by management in applying therequirements of the entity’s applicable financialreporting framework to the facts and circumstancesof the entity. In addition, many financial statementitems involve subjective decisions or assessments ora degree of uncertainty, and there may be a range ofacceptable interpretations or judgments that may bemade. Consequently, some financial statement itemsare subject to an inherent level of variability whichcannot be eliminated by the application of additionalauditing procedures.


2. Non co-operation byManagement

There is the possibility that management or othersmay not provide, intentionally or unintentionally, thecomplete information that is relevant to thepreparation and presentation of the financialstatements or that has been requested by theauditor. Accordingly, the auditor cannot be certain ofthe completeness of information, even though theauditor has performed audit procedures to obtainassurance that all relevant information has beenobtained.

3. Fraud mayinvolvesophisticatedand carefullyorganisedschemesdesigned toconceal it

Therefore, audit procedures used to gather auditevidence may be ineffective for detecting anintentional misstatement that involves, for example,collusion to falsify documentation which may causethe auditor to believe that audit evidence is validwhen it is not. The auditor is neither trained as norexpected to be an expert in the authentication ofdocuments.

4. Timeliness ofFinancialReporting andthe BalancebetweenBenefit andCost

The matter of difficulty, time, or cost involved is notin itself a valid basis for the auditor to omit an auditprocedure for which there is no alternative or to besatisfied with audit evidence that is less thanpersuasive. Appropriate planning assists in makingsufficient time and resources available for theconduct of the audit, Notwithstanding this, therelevance of information, and thereby its value, tendsto diminish over time, and there is a balance to bestruck between the reliability of information and itscost. There is an expectation by users of financialstatements that the auditor will form an opinion onthe financial statements within a reasonable periodof time and at a reasonable cost, recognising that itis impracticable to address all information that may


exist or to pursue every matter exhaustively on theassumption that information is in error or fraudulentuntil proved otherwise.

5. Risk of failureof internalcontrol

Any system of internal check/control may becomeineffective due to collusion among employees fordoing fraud and fraud committed by top managementitself.

6. Management’sFraud

Risk of auditor not detecting a material misstatementresulting from management’s fraud is greater thanthat of an employee’s fraud because those chargedwith governance and management are often in aposition that assumes their integrity and enablesthem to override the internal control procedures. Forexample- if a director of a company orders verballythe assistant not to record the sales made toparticular party and to show the goods, sold asinventory, he is overriding the internally establishedprocedure (internal control).

2011 - May [3] (b) Based on BT’s Level 1Discuss prerequisites and fundamental principles to be possessed by anauditor. (8 marks)Answer:Please refer 2008 - Nov [3] (a) on page no. 35

2011 - Nov [1] {C} Based on BT’s Level 2&5Comment on the following :(a) “It is not mandatory to send a new engagement letter in recurring audit,

but sometimes it becomes mandatory to send new letter.” Explain thosesituations where new engagement letter is to be sent. (5 marks)


Answer:As per SA - 210 i.e. “Agreeing the terms of audit engagement, In caseof recurring audit, the auditor should consider:1. Whether circumstances require the terms of engagement to be revised,

and2. Whether there is a need to remind the check of the existing terms of

engagement.In following circumstances the auditor may think it appropriate to senda new engagement letter to client:1. Any indication that the client misunderstood the objective and scope of

audit2. Any revised and special terms of the engagement3. Any recent change in board of directors, and senior managements.4. New legal requirements, or pronouncements of the Institute of Chartered

Accountants of India (ICAI)5. Significant change in client’s business.Change in terms of engagement :1. If a change is related to information that is incorrect or otherwise

unsatisfactory the auditor should not agree to changed terms ofengagement.

2. If the auditor is unable to agree to change the engagement then heshould withdraw from it.

2011 - Nov [6] Based on BT’s Level 1(a) Discuss the areas in which different accounting policies may be adopted.

(6 marks)Answer:(a) Please refer 2007 - Nov [6] (b) on page no. 33

2011 - Nov [6] Based on BT’s Level 1(b) Discuss the types of audits required under law. (5 marks)Answer:(b) Legally audit is not compulsory for all the types of business organisation

or institution. Thus it may be divided in two broad categories :1. Statutory/Mandatory Audit2. Voluntary/Independent Audit


1. Statutory Audit: It is an audit which is conducted under the controlof law as under:

Enterprise Governing Statute

CompaniesCooperative SocietiesBanking Co's

Insurance Co'sElectricity Co'sPublic Charitable Trust

Companies Act, 2013Multi state Cooperative Societies ActBanking Regulation Act, 1949, BankingLaws (Amendment), Act, 2012Insurance Act & Companies ActThe Electricity Act, 2003Indian Trust Act and also state enactments

2. Voluntary Audit : It is a purely optional audit and at the discretionof the governing body. Examples of enterprises of voluntarynatures are individuals, private trust, partnership firm etc which arenot governed by any provisions of the Income Tax Act, 1961.

2012 - May [6] (b) Based on BT’s Level 1What are the advantages of an independent audit? (8 marks)Answer:Please refer 2008 - May [5] (b) on page no. 33

2012 - Nov [2] (b) Based on BT’s Level 1Mention the areas in which differing accounting policies are encountered andhow that would be disclosed? (10 marks)Answer:AS-1 Disclosure of Accounting Policies states the areas in which differentaccounting policies may be adopted by different enterprises. The areas areas follows:1. Method of depreciation, amortisation and depletion2. Treatment of goodwill3. Conversion of foreign currency items4. Valuation of inventories5. Treatment of retirement benefits6. Valuation of investment7. Treatment of contingent liabilities


8 Recognition of profit on long-term contracts9. Valuation of fixed assets10. Treatment of expenditure during construction.

Meaning ofAccountingPolicies

As per AS-1, Accounting Policies refer, “to the specificaccounting principles and the methods of applying thoseprinciples adopted by the enterprise in the preparation andpresentation of financial statements.”There is no such specific list of accounting policies, but itschoice depend upon the circumstances of each case andhence calls for judgement of the management.

DisclosureofAccountingPolicies

As the profit and loss account is affected by the accountingpolicies adopted, so its disclosure is necessary. AS-1requires that, “all the significant accounting policies adoptedin the preparation and presentation of financial statementsshould be disclosed.”

Manner ofDisclosure

The disclosure of accounting policies:(i) Should form part of the financial statements and(ii) Should be disclosed at one place.

Change inAccountingPolicies

Any change in accounting policies :(i) Which affects materially, in current period or in some

future period, should be disclosed.(ii) If the affected amount is:

(a) ascertainable – then, it should be disclosed to theextent ascertainable.

(b) not ascertainable – then, wholly or in part, the factshould be indicated.

Disclosurenot required

(i) If the fundamental accounting assumptions, which are,going concern, consistency and accrual are followedin the preparation and presentation of the financialstatements then no separate disclosure is required.

(ii) If the fundamental accounting assumptions are notfollowed – then the fact should be disclosed.


2013 - May [1] {C} (a) Based on BT’s Level 1&2Discuss with reference to SAs:

(i) The auditor shall communicate all significant findings with thosecharged with Governance. (5 marks)

Answer:Please refer 2010 - Nov [4] (d) on page no. 27

2013 - May [3] (b) Based on BT’s Level 1Explain the basic principles governing audit. (8 marks)Answer:Please refer 2008 - Nov [3] (a) on page no. 35

2013 - Nov [1] {C} Based on BT’s Level 1&2Discuss the following:(b) The discipline of behavioural science is closely linked with the subject of

auditing. (5 marks)Answer:Auditing is very much a discipline which involves review of various assertionsboth financial as well as non financial as regards his truthfulness. So auditcan be performed in a better way only if the person also possesses a goodknowledge about other disciplines.The discipline of behavioural science is closely linked with subject ofauditing. While carrying out audit activity an auditor is required to obtaininformation and explanations from the client’s staff and he has also tointeract with the client’s staff in analysing the financial figures. So, theknowledge of human behaviour is very essential for an auditor. Thusknowledge of dealing with human being is indeed very essential for anauditor in order to discharge his duties.

2014 - Nov [1] {C} Based on BT’s Level 1&2Discuss the following:(c) Indicate the factors which make it appropriate for an auditor to send a

new Engagement Letter for a recurring audit. (5 marks)


Answer:Factors what make it appropriate for an auditor to send a newEngagement Letter for a recurring audit. Any indication that entity misunderstands the objective and scope of the

audit. Any revised or special terms of the audit engagement. A recent change of senior management. A significant change in ownership. A significant change in nature or size of the Entity’s business. A change in legal or regulatory requirements. A change in the financial reporting framework adopted in the preparation

of the financial statements. A change in other reporting requirements.

2015 - May [1] {C} Based on BT’s Level 1Discuss the following:(a) Advantages of independent audit. (5 marks)Answer:Please refer 2008 - May [5] (b) on page no. 33

2015 - Nov [1] {C} Based on BT’s Level 1&3Discuss the following:(c) ‘P’ an auditor decides not to send a new audit engagement letter to G

Ltd. every year. Whether he is right in his approach? State thecircumstances where sending new engagement letter, would beappropriate. (5 marks)

Answer:As per SA-210, Agreeing the terms of Audit Engagements, the auditorshall assess whether circumstances require the terms of audit engagementto be revised and whether there is a need to remind the entity of the existingterms. It is not necessary to issue audit engagement letter each year for

repetitive audit. Here ‘P’ an auditor decides not to send a newengagement letter to G Ltd. every year. So, the approach of the auditoris correct and appropriate.


The following are the circumstances where issue of the freshengagement letter becomes mandatory:(i) When it appears that the client has misunderstood the objective and

scope of audit. In such case issue of engagement letter becomesnecessary.

(ii) Where there has been change in management, board or ownership,so that it is felt that it is pertinent to remind them of the engagementterms again.

(iii) Where any revision by way of addition, deletion or modifications hadbeen contemplated in the engagement letter originally issued.

(iv) Where significant changes had occurred in nature, volume of thebusiness transactions of the client which warrant the scope andterms of engagement to be altered to be in tune with them.

(v) Where there has been necessity to modify audit approach to be inline with the pronouncements of ICAI, the Companies Act and thelike.

PRACTICAL QUESTIONS

2010 - Nov [7] (c) Based on BT’s Level 4&5R & M Company, a firm of Chartered Accountants, was appointed asstatutory auditors of XYZ Company Ltd. Draft an engagement letteraccepting the appointment as auditors. (8 marks)Answer:Engagement Letter for accepting the appointment as an Auditor : As perthe SA 210, “Agreeing the Terms of Audit Engagements”.Draft of Engagement Letter :To the Board of Directors of ABC LimitedYou have requested that we audit the financial statements of ABC CompanyLimited, which comprise the Balance Sheet as at March 31, 2011, and theStatement of Profit & Loss, and Cash Flow Statement for the year thenended, and a summary of significant accounting policies and otherexplanatory information.

We are pleased to confirm our acceptance and our understanding of thisaudit engagement by means of this letter. Our audit will be conducted with


the objective of our expressing an opinion on the financial statements.We will conduct our audit in accordance with Standards on Auditing

(SAs), issued by the Institute of Chartered Accountants of India (ICAI). ThoseStandards require that we comply with ethical requirements and plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free from material misstatement. An audit involves performingprocedures to obtain audit evidence about the amounts and disclosures inthe financial statements. The procedures selected depend on the auditor’sjudgment, including the assessment of the risks of material misstatement ofthe financial statements, whether due to fraud or error. An audit also includesevaluating the appropriateness of accounting policies used and thereasonableness of accounting estimates made by management, as well asevaluating the overall presentation of the financial statements.

Because of the inherent limitations of an audit, together with the inherentlimitations of internal control, there is an unavoidable risk that some materialmisstatements may not be detected, even though the audit is properlyplanned and performed in accordance with SAS.

In making our risk assessments, we consider internal control relevant tothe entity’s preparation of the financial statements in order to design auditprocedures that are appropriate in the circumstances, but not for the purposeof expressing an opinion on the effectiveness of the entity’s internal control.However, we will communicate to you in writing concerning any significantdeficiencies in internal control relevant to the audit of the financial statementsthat we have identified during the audit.

Our audit will be conducted on the basis of acknowledgment provided bymanagement or appropriate governance body.1. For the preparation of financial statements that give a true and fair view

in accordance with the Financial Reporting Standards. This includes: the responsibility for the preparation of financial statements on a

going concern basis.

the responsibility for selection and consistent application ofappropriate accounting policies, including implementation of


applicable accounting standards along with proper explanationrelating to any material departures from those accounting standards.

the responsibility for making judgements and estimates that arereasonable and prudent so as to give a true and fair view of thestate of affairs of the entity at the end of the financial year and of theprofit or loss of the entity for that period.

2. For such internal control as management determines, it is necessary toenable the preparation of financial statements that are free from materialmisstatement, whether due to fraud or error; and

3. To provide us with : (i) Access, at all times, to all information, including the books, accounts,

vouchers and other records and documentation, of the Company,whether kept at the head office of the company or elsewhere, ofwhich management is aware that is relevant to the preparation of thefinancial statements such as records, documentation and othermatters;

(ii) Additional information that we may request from management for thepurpose of the audit; and

(iii) Unrestricted access to persons within the entity from whom wedetermine it necessary to obtain audit evidence. This includes ourentitlement to require from the officers of the Company suchinformation and explanations as we may think necessary for theperformance of our duties as auditor.

As part of our audit process, we will request from management and,where appropriate, those charged with governance, written confirmationconcerning representations made to us in connection with the audit.

We also wish to invite your attention to the fact that our auditprocess is subject to 'peer review' under the Chartered Accountants Act,1949 to be conducted by an Independent reviewer. The reviewer mayinspect, examine or take abstract of our working papers during thecourse of the peer review. We look forward to full cooperation from yourstaff during our audit.

The form and content of our report may need to be amended in thelight of our audit findings.


* This table contains the Similarly Asked Questions. Please pay moreattention to such question.

Please sign and return the attached copy of this letter to indicateyour acknowledgment of, and agreement with, the arrangements for ouraudit of the financial statements including our respective responsibilities.

XYZ & Co.Chartered AccountantsFirm’s Registration No.…………………………

(Signature)Date : (Name of the Member)Place :Acknowledged on behalf of ABC Ltd. by (Partner or Proprietor)……………………..(Signature)Name and DesignationDate

Similarly Asked Questions*

No. Category Question Marks Frequency

1 Descriptive What are the basic principles whichgovern the Auditor’s professionalresponsibilities while doing Audit?

08 - Nov [3] (a), 09 - Nov [3] 5, 10 2 Times

2 Descriptive Advantages of independent audit.08 - May [5] (b), 12 - May [6] (b),

15 - May [1] (a) 5, 8, 5 3 Times

Table Showing Marks of Compulsory Questions


Year12N

13M

13N

14M

14N

15M

15N

16M

16N

17M

Descriptive 5 5 5 5 5

Total 5 5 5 5 5

1 nature, objective and scope of audit

Documents