Chapter 1- Nature, Objective and Scope of Audit

Category A
1. The auditor’s report shall include a section with a heading “Responsibilities of
Management for the Financial Statements.” SA 200 explains the premise, relating to the
responsibilities of management and, where appropriate, those charged with governance,
on which an audit in accordance with SAs is conducted. Explain (MTP April 19)

Ans. Responsibilities for the Financial Statements: The auditor’s report shall include a section
with a heading “Responsibilities of Management for the Financial Statements.”
SA 200 explains the premise, relating to the responsibilities of management and, where
appropriate, those charged with governance, on which an audit in accordance with SAs is
conducted. Management and, where appropriate, those charged with governance accept
responsibility for the preparation of the financial statements. Management also accepts
responsibility for such internal control as it determines is necessary to enable the preparation
of financial statements that are free from material misstatement, whether due to fraud or error.
The description of management’s responsibilities in the auditor’s report includes reference to both
responsibilities as it helps to explain to users the premise on which an audit is conducted.

2. The auditor shall evaluate whether the financial statements are prepared in
accordance with the requirements of the applicable financial reporting framework.
This evaluation shall include consideration of the qualitative aspects of the entity’s
accounting practices, including indicators of possible bias in management’s judgments.
Advise about qualitative aspects of the entity’s accounting practices, including
indicators of possible bias in management’s judgments. (MTP Oct. 19)

Ans. Evaluations by the Auditor: The auditor shall evaluate whether the financial statements
are prepared in accordance with the requirements of the applicable financial reporting framework.
This evaluation shall include consideration of the qualitative aspects of the entity’s
accounting practices, including indicators of possible bias in management’s judgments.
Qualitative Aspects of the Entity’s Accounting Practices
a) Management makes a number of judgments about the amounts and disclosures in the
financial statements.
b) SA 260 (Revised) contains a discussion of the qualitative aspects of accounting practices.
c) In considering the qualitative aspects of the entity’s accounting practices, the auditor may
become aware of possible bias in management’s judgments. The auditor may conclude that
lack of neutrality together with uncorrected misstatements causes the financial statements
to be materially misstated.
Indicators of a lack of neutrality include the following:
 The selective correction of misstatements brought to management’s attention during the
audit
 Possible management bias in the making of accounting estimates.
d) SA 540 addresses possible management bias in making accounting estimates.

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Indicators of possible management bias do not constitute misstatements for purposes of drawing
conclusions on the reasonableness of individual accounting estimates. They may, however, affect
the auditor’s evaluation of whether the financial statements as a whole are free from material
misstatement.

3. The Code of Ethics for Professional Accountants, prepared by the International

Federation of Accountants (IFAC) identifies five types of threats. Explain. (SM)
OR

The auditor should be straightforward, honest and sincere in his approach to his
professional work. He must be fair and must not allow prejudice or bias to override his
objectivity. He should maintain an impartial attitude and both be and appear to be free
of any interest which might be regarded as being incompatible with integrity and
objectivity. Many different circumstances, or combination of circumstances, may be
relevant and accordingly it is impossible to define every situation that creates threats to
independence and specify the appropriate mitigating action that should be taken. In
addition, the nature of assurance engagements may differ and consequently different
threats may exist requiring the application of different safeguards. Explain stating clearly
the five types of threats as contained in Code of Ethics for Professional Accountants,
prepared by the International Federation of Accountants (IFAC)
OR

Write a note on “Self-review threats” (RTP Nov. 19)

OR

Familiarity threats are self-evident, and occur when auditors form relationships with the
client where they end up being too sympathetic to the client’s interests. Explain. (MTP
April 19)

Ans. The auditor should be straightforward, honest and sincere in his approach to his
professional work. He must be fair and must not allow prejudice or bias to override his objectivity.
He should maintain an impartial attitude and both be and appear to be free of any interest which
might be regarded as being incompatible with integrity and objectivity.
Many different circumstances, or combination of circumstances, may be relevant and accordingly
it is impossible to define every situation that creates threats to independence and specify the
appropriate mitigating action that should be taken. In addition, the nature of assurance
engagements may differ and consequently different threats may exist requiring the application of
different safeguards.
The Code of Ethics for Professional Accountants, prepared by the International Federation
of Accountants (IFAC) identifies five types of threats. These are as follows
1.Self-interest threats: which occur when an auditing firm, its partner or associate could benefit
from a financial interest in an audit client. Examples include (i) direct financial interest or
materially significant indirect financial interest in a client, (ii) loan or guarantee to or from the
concerned client, (iii) undue dependence on a client's fees and, hence, concerns about losing the
engagement, (iv) close business relationship with an audit client, (v) potential employment with
the client, and (vi) contingent fees for the audit engagement.
2.Self-review threat: which occur when during a review of any judgement or conclusion
reached in a previous audit or non-audit engagement (Non audit services include any
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professional services provided to an entity by an auditor, other than audit or review of the
financial statements. These include management services, internal audit, investment advisory
service, design and implementation of information technology systems etc.), or when a member
of the audit team was previously a director or senior employee of the client. Instances where such
threats come into play are (i) when an auditor having recently been a director or senior officer of
the company, and (ii) when auditors perform services that are themselves subject matters of
audit.
3. Advocacy threats: which occur when the auditor promotes, or is perceived to promote, a
client’s opinion to a point where people may believe that objectivity is getting
compromised, eg. When an auditor deals with shares or securities of the audited company, or
becomes the client’s advocate in litigation and third-party disputes.
4. Familiarity threats: are self-evident, and occur when auditors form relationships with the
client where they end up being too sympathetic to the client’s interests. This can occur in many
ways:
(i) Close relative of the audit team working in a senior position in the client company,
(ii) Former partner of the audit firm being a director or senior employee of the client,
(iii) Long association between specific auditors and their specific client counterparts, and
(iv) Acceptance of significant gifts or hospitality from the client company, its directors or
employees.
5. Intimidation threats: which occur when auditors are deterred from acting objectively with
an adequate degree of professional skepticism. Basically, these could happen because of threat
of replacement over disagreements with the application of accounting principles, or pressure to
disproportionately reduce work in response to reduced audit fees.

4. The chief utility of audit lies in reliable financial statements on the basis of which the
state of affairs may be easy to understand. Apart from this obvious utility, there are other
advantages of audit. Some or all of these are of considerable value even to those
enterprises and organizations where audit is not compulsory. Explain. (RTP NOV. 18)
OR

PACE is proprietorship firm of Mr. Abhinav engaged in the manufacturing of textile and
handloom products. It sells its finished products both in the domestic as well as in the
international market. The company is making total turnover of Rs. 50 crores. It has also
availed cash credit limit of Rs. 5 crores from Axis Bank. In the year 2017-18, proprietor
of the firm is worried about the financial position of the company and is under the
impression that since he is out of India, therefore firm might run into losses. He
approaches CA Mahesh about advantages of getting his accounts audited throughout the
year so that he may not suffer due to accounting weaknesses. Advice regarding
advantages of getting accounts audited.

Ans. The chief utility of audit lies in reliable financial statements on the basis of which the state
of affairs may be easy to understand. Apart from this obvious utility, there are other advantages
of audit. Some or all of these are of considerable value even to those enterprises and organization’s
where audit is not compulsory,

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 These advantages are given below:
(a) It safeguards the financial interest of persons who are not associated with the management
of the entity, whether they are partners or shareholders, bankers, Fl’s, public at large etc.
(b) It acts as a moral check on the employees from committing defalcations or embezzlement.
(c) Audited statements of account are helpful in settling liability for taxes, negotiating loans and
for determining the purchase consideration for a business.
(d) These are also useful for settling trade disputes for higher wages or bonus as well as claims
in respect of damage suffered by property, by fire or some other calamity.
(e) An audit can also help in the detection of wastages and losses to show the different ways by
which these might be checked, especially those that occur due to the absence of inadequacy of
internal checks or internal control measures.
(f) Audit ascertains whether the necessary books of account and allied records have been
properly kept and helps the client in making good deficiencies or inadequacies in this respect.
(g) As an appraisal function, audit reviews the existence and operations of various controls in
the organizations’ and reports weaknesses, inadequacies, etc, in them.
(h)Audited accounts are of great help in the settlement of accounts at the time of admission
or death of partner.
(i) Government may require audited and certified statement before it gives assistance or issues a
license for a particular trade.

5. “An auditor who before the completion of the engagement is requested to change the
engagement to one which provides a lower level of assurance should consider the
appropriateness of doing so." Discuss. (RTP MAY 18)
OR

An auditor who, before the completion of the engagement, is requested to change the
engagement to one which provides a lower level of assurance, should consider the
appropriateness of doing so. Explain stating the factors based on which client can request
the auditor to change the engagement. (RTP Nov. 19)
OR

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 R & Co, a firm of Chartered Accountants have not revised the terms of engagements and
obtained confirmation from the clients for last 5 years despite changes in business and
professional environment.
OR

Elucidate the circumstances that may warrant the revision in terms of engagement.
(ILLUSTRATION SM)

Ans. Acceptance of a Change in Engagement: An auditor who, before the completion of the
engagement, is requested to change the engagement to one which provides a lower level of
assurance, should consider the appropriateness of doing so.
A request from the client for the auditor to change the engagement may result from
i) A change in circumstances affecting the need for the service,
ii) A misunderstanding as to the nature of an audit or related service originally requested or a
restriction on the scope of the engagement, whether imposed by management or caused by
circumstances.
The auditor would consider carefully the reason given for the request, particularly the
implications of a restriction on the scope of the engagement, especially any legal or contractual
implications.
If the auditor concludes that there is reasonable justification to change the engagement and
if the audit work performed complied with the SAs applicable to the changed engagement, the
report issued would be appropriate for the revised terms of engagement.
In order to avoid confusion, the report would not include reference to-
(i) The original engagement; or
(ii) Any procedures that may have been performed in the original engagement, except where the
engagement is changed to an engagement to undertake agreed-upon procedures and thus
reference to the procedures performed is a normal part of the report.
The auditor should not agree to a change of engagement where there is no reasonable
justification for doing so. If the terms of the audit engagement are changed, the auditor and
management shall agree on and record the new terms of the engagement in an engagement
letter or other suitable form of written agreement.
If the auditor is unable to agree to a change of the terms of the audit engagement and is not
permitted by management to continue the original audit engagement, the auditor shall-
(i) Withdraw from the audit engagement where possible under applicable law or regulation;
and
(ii) Determine whether there is any obligation, either contractual or otherwise, to report the
circumstances to other parties, such as those charged with governance, owners or regulators.

6. The firm’s system of quality control should include policies and procedures addressing
each and every element of system of quality control. State those elements. (MTP Oct. 19)

Ans. The firm’s system of quality control should include policies and procedures addressing
each of the following elements:
a) Leadership responsibilities for quality within the firm.
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 b) Ethical requirements.
c) Acceptance and continuance of client relationships and specific engagements.
d) Human resources.
e) Engagement performance.
f) Monitoring

7. As per SA 220, “Quality Control for an Audit of Financial Statements” the auditor
should obtain information considered necessary in the circumstances before accepting
an engagement with a new client, when deciding whether to continue an existing
engagement and when considering acceptance of a new engagement with an existing
client. Explain (RTP MAY 18)
OR

CA Raj, an engagement partner wants to take decision, regarding acceptance and

continuance of an audit engagement. Which in formations he should obtain before
accepting an engagement? (Exam May 19)

Ans. Information which assist the Auditor in accepting and continuing of relationship with
Client: As per SA 220, “Quality Control for an Audit of Financial Statements” the auditor should
obtain information considered necessary in the circumstances before accepting an engagement
with a new client, when deciding whether to continue an existing engagement and when
considering acceptance of a new engagement with an existing client.
The following information would assist the auditor in accepting and continuing of
relationship with the client:
(i) The integrity of the principal owners, key management and those charged with governance of
the entity;
(ii) Whether the engagement team is competent to perform the audit engagement and has the
necessary capabilities, including time and resources;
(iii) Whether the firm and the engagement team can comply with relevant ethical
requirements; and
(iv) Significant matters that have arisen during the current or previous audit engagement, and
their implications for continuing the relationship.

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 8. As per SA 220, the engagement partner shall take responsibility for the overall quality
on each audit engagement to which that partner is assigned. While taking responsibility
for the overall quality on each audit engagement, analyze and explain the emphasis of
the actions of the engagement partner and appropriate messages to the other members
of the engagement team. Also define engagement partner.

Ans. As per SA 220 “Quality Control for an Audit of Financial Statements”, the engagement
partner shall take responsibility for the overall quality on each audit engagement to which
that partner is assigned.
The actions of the engagement partner and appropriate messages to the other members of the
engagement team, in taking responsibility for the overall quality on each audit engagement,
emphasis:
(a) The importance to audit quality of:
(i) Performing work that complies with professional standards and regulatory and legal
requirements;
(ii) Complying with the firm’s quality control policies and procedures as applicable;
(iii) Issuing auditor’s reports that are appropriate in the circumstances; and
(iv) The engagement team’s ability to raise concerns without fear of reprisals; and
(b) The fact that quality is essential in performing audit engagements.
Engagement partner means: (definition)
Engagement partner refers to the partner or other person in the firm who is responsible for the
audit engagement and its performance, and for the auditor’s report that is issued on behalf of the
firm, and who, where required, has the appropriate authority from a professional, legal or
regulatory body.

9. The firm should establish policies and procedures designed to provide it with
reasonable assurance that the policies and procedures relating to the system of quality
control are relevant, adequate, operating effectively and complied with in practice. Such
policies and procedures should include an ongoing consideration and evaluation of the
firm’s system of quality control, including a periodic inspection of a selection of
completed engagements. Explain in the above context the purpose of monitoring
compliance with quality control policies and procedures. (RTP Nov. 19)

Ans. The firm should establish policies and procedures designed to provide it with reasonable
assurance that the policies and procedures relating to the system of quality control are relevant,
adequate, operating effectively and complied with in practice. Such policies and procedures
should include an ongoing consideration and evaluation of the firm’s system of quality control,
including a periodic inspection of a selection of completed engagements.
The purpose of monitoring compliance with quality control policies and procedures is to
provide an evaluation of:
(a) Adherence to professional standards and regulatory and legal requirements;
(b) Whether the quality control system has been appropriately designed and effectively
implemented; and
(c) Whether the firm’s quality control policies and procedures have been appropriately applied,
so that reports that are issued by the firm or engagement partners are appropriate in the
circumstances.
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(d) Follow-up by appropriate firm personnel so that necessary modifications are promptly made
to the quality control policies and procedures.

10. M/s Suresh Chandra & Co. has been appointed as an auditor of SC Ltd. for the
financial year 2014-15. CA. Suresh, one of the partners of M/s Suresh Chandra & Co.,
completed entire routine audit work by 29th May, 2015. Unfortunately, on the very next
morning, while roving towards office of SC Ltd. to sign final audit report, he met with a
road accident and died. CA. Chandra, another partner of M/s Suresh Chandra & Co.,
therefore, signed the accounts of SC Ltd., without reviewing the work performed by CA.
Suresh State with reasons whether CA. Chandra is right in expressing an opinion on
financial statements the audit of which is performed by another auditor. .
(ILLUSTRATION SM)

Ans. Relying on Work Performed by Another Auditor: As per SA 220 “Quality Control for an
Audit of Financial Statements”, an engagement partner taking over an audit during the
engagement may apply the review procedures such as the work has been performed in
accordance with professional standards and regulatory and legal requirements; significant
matters have been raised for further consideration; appropriate consultations have taken place
and the resulting conclusions have been documented and implemented; there is a need to
revise the nature, timing and extent of work performed; the work performed supports the
conclusions reached and is appropriately documented; the evidence obtained is sufficient
and appropriate to support the auditor’s report; and the objectives of the engagement
procedures have been achieved.
Further, one of the basic principles, which govern the auditor’s professional responsibilities and
which should be complied with wherever an audit is carried, is that when the auditor delegates
work to assistants or uses work performed by other auditor and experts, he will continue
to be responsible for forming and expressing his opinion on the financial information.
However, he will be entitled to rely on work performed by others, provided he exercises
adequate skill and care and is not aware of any reason to believe that he should not have
so relied. This is the fundamental principle which is ethically required as per Code of
Ethics.
However, the auditor should carefully direct, supervise and review work delegated. He should
obtain reasonable assurance that work performed by other auditors/experts and assistants is
adequate for his purpose.
Conclusion: In the given case, all the auditing procedures before the moment of signing of final
report have been performed by CA. Suresh. However, the report could not be signed by him due
to his unfortunate death. Later on, CA. Chandra signed the report relying on the work performed
by CA. Suresh. Here, CA. Chandra is allowed to sign the audit report, though, will be responsible
for expressing the opinion. He may rely on the work performed by CA. Suresh provided he further
exercises adequate skill and due care and review the work performed by him.

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 11. The matter of difficulty, time, or cost involved is not in itself a valid basis for the
auditor to omit an audit procedure for which there is no alternative or to be satisfied
with audit evidence that is less than persuasive. Explain. (RTP MAY 18)

Ans. Timeliness of Financial Reporting and the Balance between Benefit and Cost:
The matter of difficulty, time, or cost involved is not in itself a valid basis for the auditor to omit
an audit procedure for which there is no alternative or to be with audit evidence that is less
than persuasive. Appropriate planning assists in making sufficient time and resources available
for the conduct of the audit. Notwithstanding this, the relevance of information, and thereby its
value, tends to diminish over time, and there is a balance to be struck between the reliability
of information and its cost. There is an expectation by users of financial statements that the
auditor will form an opinion on the financial statements within a reasonable period of time and
at a reasonable cost, recognizing that it is impracticable to address all information that may exist
or to pursue every matter exhaustively on the assumption that information is in error or
fraudulent until proved otherwise.

12. The IAASB functions as an independent standard-setting body under the auspices of
IFAC. Explain stating the objective of IAASB and also how it achieves those objectives.
(RTP May 19)

Ans. Objectives of International Auditing and Assurance Standards Board: In 1977, the
International Federation of Accountants (IFAC) was set up with a view to bringing harmony in
the profession of accountancy on an international scale. In pursuing this mission, the IFAC Board
has established the International Auditing and Assurance Standards Board (IAASB) to develop
and issue, in the public interest and under its own authority, high quality auditing standards for
use around the world. The IFAC Board has determined that designation of the IAASB as the
responsible body, under its own authority and within its stated terms of reference, best serves
the public interest in achieving this aspect of its mission.
The IAASB functions as an independent standard-setting body under the auspices of IFAC.
The objective of the IAASB is to serve the public interest by setting high quality auditing standards
and by facilitating the convergence of international and national standards, thereby enhancing
the quality and uniformity of practice throughout the world and strengthening public confidence
in the global auditing and assurance profession.
The IAASB achieves this objective by.
• Establishing high quality auditing standards and guidance for financial statement audits that
are generally accepted and recognized by investors, auditors, governments, banking
regulators, securities regulators and other key stakeholders across the world;
• Establishing high quality standards and guidance for other types of assurance services on both
financial and non-financial matters;
• Establishing high quality standards and guidance for other related services;
• Establishing high quality standards for quality control covering the scope of services addressed
by the IAASB; and
Publishing other pronouncements on auditing and assurance matters, there by advancing public
understanding of the roles and responsibility of professional auditors and assurance service
providers.

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 13. Lord Justice Lindley in the course of the judgment in the famous London & General
Bank case had succinctly summed up the overall view of what an auditor should be as
regards the personal qualities. Explain stating also the qualities of Auditor. (RTP May 19)
Ans. It is not enough to realize what an auditor should be. He is concerned with the reporting on
financial matters of business and other institutions. Financial matters inherently are to be set
with the problems of human fallibility, errors and frauds are frequent. The qualities required,
according to Dicksee, are tact, caution, firmness, good temper, integrity, discretion,
industry, judgement, patience, clear headedness and reliability. In short, all those personal
qualities that go to make a good businessman contribute to the making of a good auditor. In
addition, he must have the shine of culture for attaining a great height. He must have the
highest degree of integrity backed by adequate independence. In fact, Code of ethics
mentions integrity, objectivity and independence as one of the fundamental principles of
professional ethics.
He must have a thorough knowledge of the general principles of law which govern matters
with which he is likely to be in intimate contact. The Companies Act need special mention but
mercantile law, specially the law relating to contracts, is no less important. Needless to say, where
undertakings are governed by a special statute, its knowledge will be imperative; in addition, a
sound knowledge of the law and practice of taxation is unavoidable.
He must pursue an intensive program of theoretical education in subjects like financial and
management accounting, general management, business and corporate laws, computers
and information systems, taxation, economics, etc. Both practical training and theoretical
education are equally necessary for the development of professional competence of an auditor for
undertaking any kind of audit assignment. The auditor should be equipped not only with a
sufficient knowledge of the way in which business generally is conducted but also with an
understanding of the special features peculiar to a particular business whose accounts are under
audit. The auditor, who holds a position of trust, must have the basic human qualities apart from
the technical requirement of professional training and education.
He is called upon constantly to critically review financial statements and it is obviously
useless for him to attempt that task unless his own knowledge is that of an expert. An exhaustive
knowledge of accounting in all its branches is the sine qua non of the practice of auditing. He
must know thoroughly all accounting principles and techniques.
Lord Justice Lindley in the course of the judgment in the famous London & General Bank case
had succinctly summed up the overall view of what an auditor should be as regards the personal
qualities. He said, “an auditor must be honest that is, he must not certify what he does not believe
to be true and must take reasonable care and skill before he believes that what he certifies is
true”.

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 14. “An audit is independent examination of financial information of any entity, whether
profit oriented or not, and irrespective of its size or legal form, when such an examination
is conducted with a view to expressing an opinion thereon.”
Explain stating clearly how the person conducting this task should take care to ensure
that financial statements would not mislead anybody. (MTP Oct. 19)

Ans. “An audit is independent examination of financial information of any entity, whether profit
oriented or not, and irrespective of its size or legal form, when such an examination is
conducted with a view to expressing an opinion thereon.”
Analysis of the Definition
1. Audit is Independent examination of financial information.
2. of any entity – that entity may be profit oriented or not and irrespective of its size or legal form.
For example – Profit oriented – Audit of Listed Company engaged in business. On the other
hand, Audit of NGO – not profit oriented.
3. The objective of the audit is to express an opinion on the financial statements.
The person conducting this task should take care to ensure that, financial statements would
not mislead anybody. This he can do honestly by satisfying himself that:
(i) The accounts have been drawn up with reference to entries in the books of account;
(ii) The entries in the books of account are adequately supported by sufficient and appropriate
evidence;
(iii) None of the entries in the books of account has been omitted in the process of compilation
and nothing which is not in the books of account has found place in the statements;
(iv) The information conveyed by the statements is clear and unambiguous;
(v) The financial statement amounts are properly classified, described and disclosed in
conformity with accounting standards; and
(vi) The statement of accounts presented true and fair picture of the operational results and of
the assets and liabilities.

15. The auditor shall plan and perform an audit with professional skepticism recognizing
that circumstances may exist that cause the financial statement to be materially
misstated. Discuss any four examples of professional skepticism. (Exam Nov. 19)

Ans. Professional skepticism refers to an attitude that includes a questioning mind, being alert
to conditions which may indicate possible misstatement due to error or fraud, and a critical
assessment of audit evidence.
Professional Skepticism Requirement and Auditor Expectation.
1. The auditor shall plan and perform an audit with professional skepticism.
2. It Reduces risk of:
 Overlooking unusual circumstances.
 Over generalizing when drawing conclusions from audit observations.
 Using inappropriate assumptions in determining Nature, Time, Extent of audit procedures &
evaluating the results thereof.
3. Professional skepticism includes being alter to:
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  Contradictory audit evidence.
 Questions on reliability of documents.
 Conditions indicating possible frauds.
 Circumstances suggesting need for audit procedures in addition to those suggested in SAs.
Professional skepticism is necessary to the critical assessment of audit evidence. It also
includes consideration of the sufficiency and appropriateness of audit evidence obtained in the
light of the circumstances, for example in the case where fraud risk factors exist and a single
document, of a nature that is susceptible to fraud, is the sole supporting evidence for a material
financial statement amount.
The auditor may accept records and documents as genuine unless the auditor has reason
to believe the contrary. Nevertheless, the auditor is required to consider the reliability of
information to be used as audit evidence. In cases of doubt about the reliability of information
or indications of possible fraud, the SAs require that the auditor investigate further and
determine what modifications or additions to audit procedures are necessary to resolve the
matter.
The auditor cannot be expected to disregard past experience of the honesty and integrity of the
entity's management and those charged with governance. Nevertheless, a belief that
management and those charged with governance are honest and have integrity does not relieve
the auditor of the need to maintain professional skepticism.

16. DEF & Co. Chartered Accountants successfully carried out the audit of Shree
Garments for the F.Y. 2015-2016. After the completion of the audit, there were found
material misstatements due to fraud in the financial statements which were not noticed
and reported by the auditor. Management alleges that it is failure on the part of auditor.
Comment. (ILLUSTRATION SM)

SOLUTION: Because of the limitations of an audit, there is an unavoidable risk that some
material misstatements of the financial statements may not be detected, even though the
audit is properly planned and performed in accordance with SAs. Accordingly, the subsequent
discovery of a material misstatement of the financial statements resulting from fraud or
error does not by itself indicate a failure to conduct an audit in accordance with SAs.

However, the inherent limitations of an audit are not a justification for the auditor to be satisfied
with less-than-persuasive audit evidence. Whether the auditor has performed an audit in
accordance with SAs is determined by the audit procedures performed in the circumstances, the
sufficiency and appropriateness of the audit evidence obtained as a result thereof and the
suitability of the auditor’s report based on an evaluation of that evidence in light of the overall
objectives of the auditor.

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 Category B

17. Principal aspects to be considered by an auditor while conducting an audit of final

statements of accounts. (Exam May 18)
OR

GST & Co., a firm of Chartered Accountants has been appointed to audit the accounts of
XYZ Ltd. The partner wanted to cover principal aspects while conducting its audit of
financial statements. Advise those principal aspects. (RTP MAY 18)
OR

SWM is proprietorship firm engaged in the manufacturing of different kind of yarns. It

sells its finished products both in the domestic as well as in the international market.
The company is making total turnover of Rs. 30 crores. It has also availed cash credit
limit of Rs. 3 crores from Dena Bank. In the year 2018-19. Proprietor of the firm is
worried about the financial position of the company and is under the impression that
since he is out of India, therefore firm might not run well. He approaches an Internal
Auditor about as to what would be covered in Audit. Advise regarding principal aspects
(any four) to be covered in getting accounts audited. (MTP Mar. 19)
Ans.
The principal aspects to be covered in an audit concerning final statements of account are
the following:
(i) An examination of the system of accounting and internal control to ascertain whether it
is appropriate for the business and helps in properly recording all transactions.
(ii) Reviewing the system and procedures to find out whether they are adequate and
comprehensive and incidentally whether material inadequacies and weaknesses exist to allow
frauds and errors going unnoticed.
(iii) Checking of the arithmetical accuracy of the books of account by the verification of
postings, balances, etc.
(iv) Verification of the authenticity and validity of transaction entered into by making an
examination of the entries in the books of accounts with the relevant supporting documents.
(v) Ascertaining that a proper distinction has been made between items of capital and of
revenue nature and that the amounts of various items of income and expenditure adjusted
in the accounts corresponding to the accounting period.

(vi) Comparison of the balance sheet and profit and loss account or other statements with
the underlying record in order to see that they are in accordance therewith.
(vii) Verification of the title, existence and value of the assets appearing in the balance sheet.

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Assertions about account balances at the period end:
1. Existence— assets, liabilities, and equity interests exist.
2. Rights and obligations— the entity holds or controls the rights to assets, and liabilities are
the obligations of the entity.
3. Completeness— all assets, liabilities and equity interests that should have been recorded
have been recorded.
4. Valuation and allocation— assets, liabilities, and equity interests are included in the
financial statements at appropriate amounts and any resulting valuation or allocation
adjustments are appropriately recorded.
(viii) Verification of the liabilities stated in the balance sheet.
(ix) Checking the result shown by the profit and loss and to see whether the results shown
are true and fair.
(x) Where audit is of a corporate body, confirming that the statutory requirements have been
complied with.
(xi) Reporting to the appropriate person/body whether the statements of account examined
do reveal a true and fair view of the state of affairs & of the profit & loss of the organization.

18. What constitutes a 'true and fair' view, is the matter of an auditor's judgement in the
particular circumstances of a case. In order to ensure 'true and fair' view, auditor has to
review certain points. Mention any such 5 (five) points in brief. (Exam May 18)

Ans. True and Fair View: To ensure true and fair view, an auditor has to see:
(i) That the assets are neither undervalued or overvalued, according to the applicable accounting
principles,
(ii) No material asset is omitted;
(iii) The charge, if any, on assets are disclosed;
(iv) Material liabilities should not be omitted;
(v) The profit & loss account and balance sheet discloses all the matters required to be disclosed;
(vi) Accounting policies have been followed consistently; and
(vii) All unusual, exceptional or non-recurring items have been disclosed separately.

19. "Professional judgment is essential to the proper conduct of an audit." Discuss. (Exam
Nov. 18)

Ans. Professional judgment is essential to the proper conduct of an audit. This is because
interpretation of relevant ethical requirements and the SAs and the informed
decisions required throughout the audit cannot be made without the application of
relevant knowledge and experience to the facts and circumstances.
Professional judgment is necessary in particular regarding decisions about:
(i) Materiality and audit risk.
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 (ii) The nature, timing, and extent of audit procedures used to meet the requirements of the SAs
and gather audit evidence.
(iii) Evaluating whether sufficient appropriate audit evidence has been obtained, and whether
more needs to be done to achieve the objectives of the SAs and thereby, the overall objectives
of the auditor.
(iv) The evaluation of management’s judgments in applying the entity’s applicable
(v) Financial reporting framework.
(vi) The drawing of conclusions based on the audit evidence obtained, for example, assessing the
reasonableness of the estimates made by management in preparing the financial statements.

20. MNO Ltd requested the auditor CA P to provide for absolute assurance in respect of
its ten branches scattered in Delhi and confirm that the financial statements are free
from material misstatement due to fraud or error. Advise. (ILLUSTRATION SM)

Ans. The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore
obtain absolute assurance that the financial statements are free from material misstatement due
to fraud or error. This is because there are inherent limitations of an audit, which result in
most of the audit evidence on which the auditor draws conclusions and bases the auditor’s
opinion being persuasive rather than conclusive.
In view of the above, CA P cannot provide audit absolute assurance to MNO Ltd in respect of its
branches.
The Inherent limitations of an audit arise from:
(i) The Nature of Financial Reporting: The preparation of financial statements involves
judgment by management in applying the requirements of the entity’s applicable financial
reporting framework to the facts and circumstances of the entity. In addition, many financial
statement items involve subjective decisions or assessments or a degree of uncertainty, and
there may be a range of acceptable interpretations or judgments that may be made.
(ii) The Nature of Audit Procedures: There are practical and legal limitations on the auditor’s
ability to obtain audit evidence.

For example:
There is the possibility that management or others may not provide, intentionally or
unintentionally, the complete information that is relevant to the preparation and presentation
of the financial statements or that has been requested by the auditor.
(iii) Timeliness of Financial Reporting and the Balance between Benefit and Cost: The matter
of difficulty, time, or cost involved is not in itself a valid basis for the auditor to omit an audit
procedure for which there is no alternative. Appropriate planning assists in making sufficient
time and resources available for the conduct of the audit. Notwithstanding this, the relevance
of information, and thereby its value, tends to diminish over time, and there is a balance to
be struck between the reliability of information and its cost.
(iv) Other Matters that Affect the Limitations of an Audit: In the case of certain subject
matters, limitations on the auditor’s ability to detect material misstatements are particularly
significant. Such assertions or subject matters include:
 Fraud, particularly fraud involving senior management or collusion.
 The existence and completeness of related party relationships and transactions.
 The occurrence of non-compliance with laws and regulations.
 Future events or conditions that may cause an entity to cease to continue as going concern.

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 PART (C)

21. State the objectives of Audit according to SA 200 (SM)

OR
Explain the overall objective of the auditor as contained in SA 200. (RTP May 19

Ans. Overall Objectives of the Auditor

As per SA-200 "Overall Objectives of the Independent Auditor", in conducting an audit of
financial statements, the overall objectives of the auditor are:
a) To obtain reasonable assurance about whether the F. S. as a whole are free from
material misstatement, whether due to fraud or error, thereby enabling the auditor to
express an opinion on whether the F.S. are prepared, in all material respects, in accordance
with an applicable FRF, and
b) To report on the Financial Statements and communicate as required by the SAs, in
accordance with the auditor’s findings.
In all cases when reasonable assurance cannot be obtained and a qualified opinion in the
auditor’s report is insufficient, the SAs require that the auditor disclaim an opinion or
withdraw from the engagement.

22. The auditor is not expected to, and cannot, reduce audit risk to zero and cannot
therefore obtain absolute assurance that the financial statements are free from material
misstatement due to fraud or error. This is because there are inherent limitations of an
audit. Explain (RTP NOV. 18)

Ans. The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore
obtain absolute assurance that the financial statements are free from material misstatement
due to fraud or error. This is because there are inherent limitations of an audit.
The Inherent limitations of an audit arise from:
(iii) The Nature of Financial Reporting: The preparation of financial statements involves
judgment by management in applying the requirements of the entity’s applicable financial
reporting framework to the facts and circumstances of the entity. In addition, many financial
statement items involve subjective decisions or assessments or a degree of uncertainty, and
there may be a range of acceptable interpretations or judgments that may be made.
(iv) The Nature of Audit Procedures: There are practical and legal limitations on the auditor’s
ability to obtain audit evidence.
For example:
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1. There is the possibility that management or others may not provide, intentionally or
unintentionally, the complete information that is relevant to the preparation and presentation
of the financial statements or that has been requested by the auditor.
2. Fraud may involve sophisticated and carefully organized schemes designed to conceal
it. Therefore, audit procedures used to gather audit evidence may be ineffective for detecting
an intentional misstatement that involves, for example, collusion to falsify documentation
which may cause the auditor to believe that audit evidence is valid when it is not. The auditor
is neither trained as nor expected to be an expert in the authentication of documents.
3. An audit is not an official investigation into alleged wrongdoing. Accordingly, the auditor
is not given specific legal powers, such as the power of search, which may be necessary for
such an investigation.
(iii) Timeliness of Financial Reporting and the Balance between Benefit and Cost: The matter
of difficulty, time, or cost involved is not in itself a valid basis for the auditor to omit an audit
procedure for which there is no alternative. Appropriate planning assists in making sufficient
time and resources available for the conduct of the audit. Notwithstanding this, the relevance
of information, and thereby its value, tends to diminish over time, and there is a balance to
be struck between the reliability of information and its cost.
(iv) Other Matters that Affect the Limitations of an Audit: In the case of certain subject
matters, limitations on the auditor’s ability to detect material misstatements are particularly
significant. Such assertions or subject matters include:
 Fraud, particularly fraud involving senior management or collusion.
 The existence and completeness of related party relationships and transactions.
 The occurrence of non-compliance with laws and regulations.
 Future events or conditions that may cause an entity to cease to continue as going concern.

23. The Chartered Accountant has a responsibility to remain independent by taking into
account the context in which they practice, the threats to independence and the
safeguards available to eliminate the threats.
In the above context, explain the guiding principles. (RTP Nov. 19)

Ans. The Chartered Accountant has a responsibility to remain independent by taking into
account the context in which they practice, the threats to independence and the safeguards
available to eliminate the threats.
The following are the guiding principles in this regard: -
For the public to have confidence in the quality of audit, it is essential that auditors should always
be and appears to be independent of the entities that they are auditing.
1. In the case of audit, the key fundamental principles are integrity, objectivity and
professional skepticism, which necessarily require the auditor to be independent.
2. Before taking on any work, an auditor must conscientiously consider whether it involves
threats to his independence.
3. When such threats exist, the auditor should either desist from the task or put in place
safeguards that eliminate them.
4. If the auditor is unable to fully implement credible and adequate safeguards, then he must not
accept the work.

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 24. The auditor shall comply with relevant ethical requirements, including those
pertaining to independence, relating to financial statement audit engagements. (MTP
April 19)
OR
Relevant ethical requirements ordinarily comprise the Code of Ethics for Professional
Accountants (IESBA Code) related to an audit of financial statements. Discuss with
reference to those fundamental principles of professional ethics. (RTP May 19)

Ans. Ethical Requirements Relating to an Audit of Financial Statements: The auditor shall
comply with relevant ethical requirements, including those pertaining to independence, relating
to financial statement audit engagements. Relevant ethical requirements ordinarily comprise the
Code of Ethics for Professional Accountants (IESBA Code) related to an audit of financial
statements.
The Code establishes the following as the fundamental principles of professional ethics
relevant to the auditor when conducting an audit of financial statements:
a) Integrity;
b) Objectivity;
c) Professional competence and due care;
d) Confidentiality; and
e) Professional behavior.

25. State six important advantages of audit of accounts of a Partnership firm. (MTP April
19)

Ans. Advantages of Audit of Accounts of a Partnership: On broad considerations, the

advantages of audit of accounts of a partnership could be stated as follows:
1. Audited accounts provide a convenient and reliable means of settling accounts between
the partners and, thereby, the possibility of occurrence of a dispute among them is mitigated.
On this consideration, it is usually provided in and accepted by the partners, shall be binding
upon them, unless some manifest error is brought to light within a specified period subsequent
to the accounts having been signed.
2. On the retirement or death of a partner, audited accounts, which have been accepted by the
partners, constitute a reliable evidence for computing the amounts due to the retiring
partner or to the representative of the deceased partner in respect of his share of capital, profits
and goodwill.
3. The accounts of a partnership, which have been audited, are generally accepted by the
Income Tax Department as the basis for computing the assessable income of the partners.
4. Audited statement of accounts is relied upon by the banks when advancing loans, as well as
by prospective purchasers of the business, as evidence of the profitability of the concern and
its financial position.

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5. Audited statements of account can be helpful in the negotiations to admit a person as a
partner, especially when they are available for a number of past years.
6. An audit is an effective safeguard against any undue advantage being taken by a working
partner or partners especially in the case of those partners who are not actively associated
with the working of the firm.

26. The firm’s system of quality control should include policies and procedures
addressing each element. Explain. (RTP NOV. 18)

Ans. The firm’s system of quality control should include policies and procedures
addressing each of the following elements:
a) Leadership responsibilities for quality within the firm.
b) Ethical requirements.
c) Acceptance and continuance of client relationships and specific engagements.
d) Human resources.
e) Engagement performance.
f) Monitoring.

27. The relationship between auditing & law is very close one. Discuss. (MTP OCT. 19)

Ans. The relationship between auditing and law is very close one.
Auditing involves examination of various transactions from the view point of whether or not
these have been properly entered into it necessitates that an auditor should have a good
knowledge of business laws affecting the entity. He should be familiar with the law of
contracts, negotiable instruments, etc. The knowledge of taxation laws is also inevitable as
entity is required to prepare their financial statements taking into account various provisions
affected by various tax laws. In analyzing the impact of various transactions particularly from the
accounting aspect, an auditor ought to have a good knowledge about the direct as well as
indirect tax laws.

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 28. “The independent audit of an entity’s financial statements is a vital service to
investors, trade payables, and other participants in economic exchange.” Explain (SM)

Ans. Auditing along with other disciplines such as accounting and law, equips you with all the
knowledge that is required to enter into auditing as a profession. No business or institution can
effectively carry on its activities without the help of proper records and accounts, since
transactions take place at different points of time with numerous persons and entities.
The effect of all transactions has to be recorded and suitably analyses to see the results as
regards the business as a whole. Periodical statements of account are drawn up to measure
the success or failure of the activities in achieving the objective of the organization. This would
be impossible without a systematic record of transactions.

Financial Statements are often the basis for decision making by the management and for
corrective action so as to even closing down the organization or a part of it. All this would be
possible only if the statements are reliable; decisions based on wrong accounting statements
may prove very harmful or even fatal to the business.

For example, if the business has really earned a profit but because of wrong accounting, the
annual accounts show a loss, the proprietor may take the decision to sell the business at a loss.
Thus, from the point of view of the management itself, authenticity of financial statements is
essential. It is more essential for those who have invested their money in the business but,
cannot take part in its management, for example, shareholders in a company, such persons
certainly need an assurance that the annual statements of accounts sent to them are fully
reliable. It is auditing which ensures that the accounting statements are authentic. In today’s
economic environment, information and accountability have assumed a larger role than ever
before. As a result, the independent audit of an entity’s financial statements is a vital service to
investors, trade payables, and other participants in economic exchange.

29. Briefly explain self – revealing errors with the help of some illustration. (SM)

Ans. Self – Revealing Errors: These are such errors the existence of which becomes apparent
in the process of compilation of accounts. A few illustrations of such errors are given hereunder,
showing how they become apparent.

I Omission to post a part of a Trial balance is thrown out of agreement

journal entry to the ledger.
Ii Wrong totaling of the purchase Control account (e.g., the Sundry Trade
register payables Account) balances and the
aggregate of the balances in the personal
ledger will disagree.
iii A failure to record in the cash Bank reconciliation statement will show
book amounts paid into or up error.
withdrawn from the bank
iv A mistake in recording amount Statements of account of parties will re-
received from x in the account of veal mistake.
Y.

From the above, it is clear that certain apparent errors balance almost automatically by double
entry accounting procedure and by following established practices that lie within the accounting
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 system but not being generally considered to be a part of it, like bank reconciliation or sending
monthly statements of account for confirmation.

30. The Chartered Accountant has a responsibility to remain independent by taking into
account the context in which they practice, the threats to independence and the safeguards
available to eliminate the threats. State the guiding principles in this regards.
Ans: Safeguards to independence: -
I. Auditors should always be and appears to be independent of the entities that they are
auditing.
II. Auditor should abide himself with the key fundamental principles are integrity, objectivity
and professional skepticism.
III. Auditor should consider threats to independence before accepting any audit assignment.
IV. In case of existence of any threats to independence, auditor should not accept the
engagement or put in place safeguards that eliminate them. If necessary safeguards cannot
be put in place due to circumstances, auditor should withdraw.

CASE STUDY
Mr. Veeru of Delhi has started a new business of selling of Handloom items. He purchases these
items from a factory situated in Ludhiana and sells to local customers at a price which gives
him reasonable amount of profit. All gets well in the first year and he earns some income from
the business.
However, he feels that he could expand this business if he was able to bring more items to the
place where he sells them and also, he is aware of the fact that there are several other locations
as well where he could sell these items. He could achieve this by buying a van and by employing
other people who will assist him in his business on the other locations.
He needs more money to achieve this expansion of his business. He decides to ask his friend
Raju to invest in the business.
Having seen the potential of Veeru’s business, Raju wants to invest, but neither he wants to
manage nor wants to have ultimate liability for the debts of the business in case business fails.
He therefore suggested that they should set up a proprietary firm. He will be the owner of the
firm and will be entitled to profits. On the other hand, Veeru would be the Manager and be paid
a salary.
At the end of the first year of trading when Raju receives copy of the financial statements, he
finds that Profits are much lower than what was expected. Raju knows that Veeru is paid salary
so he may not care for low profits. Raju is concerned by the level of profits and feels that he
wants further assurance on the accounts. He does not know whether the accounts give a true
and fair view of the last year’s trading because the profits do not seem as high as those Veeru
had predicted when he agreed to invest.
Raju seeks solution for his problem.
The solution is that the assurance Raju is seeking may be given by an Independent Audit of
accounts.

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 SUMMARY
An audit is independent examination of financial information of any entity, whether profit
oriented or not, and irrespective of its size or legal form, when such an examination is
conducted with a view to expressing an opinion thereon. The person conducting this task
should take care to ensure that financial statements would not mislead anybody. As per SA-
200 “Overall Objectives of the Independent Auditor”, in conducting an audit of financial
statements, the overall objectives of the auditor are to obtain reasonable assurance about
whether the financial statements as a whole are free from material misstatement and to report
on the financial statements. The auditor should get the scope of his duties and responsibilities
defined by obtaining instructions in writhing. The chief utility of audit lies in reliable financial
statements on the basis of which the state of affairs may be easy to understand. The auditor
is not expected to, and cannot, reduce audit risk to zero and cannot therefore obtain absolute
assurance that the financial statements are free from material misstatement due to fraud or
error. This is because there are inherent limitations of an audit.
A significant step has been taken aimed at bringing in the desired transparency in the working
of the Auditing and Assurance Standards Board, through participation of representatives of
various segments of the society and interest groups, such as, regulators, industry and
academics.
The auditor shall comply with relevant ethical requirements including those pertaining to
independence. Relevant ethical requirements ordinarily comprise the Code of Ethics for
Professional Accountants (IESBA Code) related to an audit of financial statements. The Code
establishes the five fundamental principles of professional ethics relevant to the auditor when
conducting an audit of financial statements.
(a) Integrity;
(b) Objectivity
(c) Professional competence and due care
(d) Confidentiality; and (e) Professional behavior.

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 RTP MAY2020

2(a) The person conducting audit should take care to ensure that financial statements
would not mislead anybody. Explain stating clearly the meaning of Auditing.

Ans. “An audit is independent examination of financial information of any entity, whether profit
oriented or not, and irrespective of its size or legal form, when such an examination is conducted
with a view to expressing an opinion thereon.”
Analysis of the Definition
1. Audit is Independent examination of Financial information.
2. of any entity – that entity may be profit oriented or not and irrespective of its size or legal
form. For example – Profit oriented – Audit of Listed company engaged in business. On the
other hand, Audit of NGO – not profit oriented.
3. The objective of the audit is to express an opinion on the financial statements.
The person conducting this task should take care to ensure that financial statements
would not mislead anybody. This he can do honestly by satisfying himself that:
(i) The accounts have been drawn up with reference to entries in the books of account;
(ii) The entries in the books of account are adequately supported by sufficient and
appropriate evidence;
(iii) None of the entries in the books of account has been omitted in the process of
compilation and nothing which is not in the books of account has found place in the
statements;
(iv) The information conveyed by the statements is clear and unambiguous;
(v) The financial statement amounts are properly classified, described and disclosed
in conformity with accounting standards; and
(vi) The statement of accounts presents a true and fair picture of the operational results and
of the assets and liabilities.

2(b) Explain the objectives of an Audit as per SA 200.

Ans.
As per SA-200 “Overall Objectives of the Independent Auditor”, in conducting an audit of financial
statements, the overall objectives of the auditor are:
(a) To obtain reasonable assurance about whether the financial statements as a whole are free
from material misstatement; and
(b) To report on the financial statements, and communicate as required by the SAs, in
accordance with the auditor’s findings.

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3(a) There are practical and legal limitations on the auditor’s ability to obtain audit
evidence. Explain with examples.

Ans. The Nature of Audit Procedures: There are practical and legal limitations on the auditor’s
ability to obtain audit evidence. For example:
1. There is the possibility that management or others may not provide, intentionally or
unintentionally, the complete information that is relevant to the preparation and presentation
of the financial statements or that has been requested by the auditor.
2. Fraud may involve sophisticated and carefully organised schemes designed to conceal
it. Therefore, audit procedures used to gather audit evidence may be ineffective for detecting
an intentional misstatement that involves, for example, collusion to falsify documentation
which may cause the auditor to believe that audit evidence is valid when it is not. The auditor
is neither trained as nor expected to be an expert in the authentication of documents.
3. An audit is not an official investigation into alleged wrong doing. Accordingly, the auditor
is not given specific legal powers, such as the power of search, which may be necessary for
such an investigation.

3(b) In case of certain subject matters, limitations on the auditor’s ability to detect
material misstatements are particularly significant. Explain such assertions or subject
matters.

Ans. Other Matters that Affect the Limitations of an Audit: In these of certain subject matters,
limitations on the auditor’s ability to detect material misstatements are particularly significant.
Such assertions or subject matters include:
 Fraud, particularly fraud involving senior management or collusion.
 The existence and completeness of related party relationships and transactions.
 The occurrence of non-compliance with laws and regulations.
 Future events or conditions that may cause an entity to cease to continue as a going concern.

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