INTERMEDIATE COURSE

PAPER – 5
AUDITING AND ETHICS
[RELEVANT FOR MAY, 2025 EXAMINATION AND ONWARDS]

BOOKLET ON CASE SCENARIOS

BOARD OF STUDIES
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA
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 PREFACE

Under the New Scheme of Education and Training which began from
1st July, 2023, 30% of the examination assessment is by the way of Objective
Type Questions at Intermediate and Final level. Therefore, to facilitate hands
on practice for such type of questions, the BOS launched MCQ Paper Practice
Portal on 1st July, 2023. This online portal carried independent MCQs as well
as case scenario based MCQs both for conceptual clarity and practice of the
students.

In continuation to this handholding initiative and to provide quality academic

inputs to the students to help them grasp the intricate aspects of the subject,
the Board of studies had brought forth subject-wise booklets on Case
Scenarios at Intermediate and Final level. These booklets are meticulously
designed to assist Chartered Accountancy (CA) students in their preparation
of the CA course.

At the Intermediate level, the ‘Booklet on Case Scenarios for Paper 5:

Auditing and Ethics’ includes integrated case scenarios that cover
Engagement and Quality Control Standards, Audit of items of financial
statements, applicable regulatory frameworks and miscellaneous audits. This
booklet assimilates practical audit situations, ensuring that students develop a
comprehensive and application-based understanding of the subject. The case
scenario-based MCQs presented in this booklet are designed to be
application-oriented, requiring students to analyze facts, apply relevant
Standards on Auditing, Regulations and guidelines, and arrive at the correct
conclusions.

Each case scenario is followed by MCQs, along with correct answer and reason
or hint for the same. These reasonings/hints are intended to help students
recognize key concepts and identify areas requiring additional focus.
Students are strongly encouraged to first gain a thorough understanding of
the topics covered in syllabus and study material before attempting the case
scenario-based MCQs in this booklet. Achieving conceptual clarity will enable
students to apply their knowledge effectively, refine their analytical and
problem-solving abilities, and confidently approach their examinations with a
strategic mindset.

We are confident that this booklet will prove to be a valuable asset in your
preparation journey. We encourage students to immerse in the case scenarios,
engage critically with the MCQs, and embrace the learning experience to excel
in the CA Intermediate Examination.

Best wishes for your studies and success in the CA Intermediate

Examination!
 CASE SCENARIO 1

Sunlight Ltd. is a company engaged in the manufacture of solar panels. It is one

of the largest solar panel manufacturing companies in India. With over a decade
of experience, the company has implemented projects across the length and
breadth of the country in both commercial and residential sectors. For the
F.Y. 2023-24, Singhania & Co., an LLP of Chartered Accountants was appointed
as the statutory auditors of the company. The audit work for the F.Y. 2023-24 is
on the verge of completion.
During the audit, one of the audit team members, Mr. Rishab, was asked by the
engagement partner, to verify the ownership assertion of the inventories held
by the company. To verify such assertion, Mr. Rishab asked the concerned
official of the company to make arrangements for the attendance of the audit
team at the physical inventory count being conducted by the company.
Mr. Rishab was of the view that only by attending the physical inventory count,
the ownership assertion with respect to inventory of the company can be
checked. He discussed his view with another audit team member Ms. Soni who
had a different point of view for such situation. According to her, the correct
course of action in this regard is that Mr. Rishab should verify the purchase
requisition, purchase order, receiving reports, vendor invoices, inventory
records, payment file etc. as ownership assertion cannot be verified by
attending the physical inventory count only.
Further, while verifying the creditors and purchases balances, Ms. Soni decided
to check the creditors balance on sample basis with a sample size of 50 creditors
as she was satisfied with the Internal Control Procedures applied for the same.
She asked the management to provide the list of all the 550 creditors. For
deciding the sample, she took the sampling interval of every 11th creditor
balance and in this way created a sample size of 50 creditors balance for the
purpose of audit.
During the audit, while verifying the share capital balance of the company,
Mr. Rishab and Ms. Soni noticed that there has been no change in the share
capital raised by the company. Ms. Soni was of the view that since there has
2 AUDITING AND ETHICS

been no change in the share capital of the company, the audit team is not
required to obtain any evidence with respect to the share capital balance.
However, Mr. Rishab opined that they should obtain audit evidence even if
there is no change in the company’s capital structure during the year. According
to him such evidence can be a written confirmation from the accounts manager.
Before finalising the audit report, the Engagement Partner asked Mr. Rishab to
coordinate with the client for requesting written representation from the
management of the company with respect to the management responsibilities
and information provided by the management. Mr. Rishab did not accept the
representation given by the management as the same contained a qualifying
language to the effect that representations are made to the best of its
knowledge and belief, which according to Mr. Rishab was not reasonable to
accept.
Since the engagement partner was about to finalise and sign the audit report,
Mr. Rishab and Ms. Soni were discussing the various requirements of assembly
of the final audit file and the changes that can be made in the audit
documentation during the final assembly process. According to Ms. Soni only
changes of administrative nature can be made, like deleting superseded
documentation, sorting, collating and cross-referencing working papers and
changes like recalculation of depreciation etc. should not be made during such
final assembly process.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. While verifying the inventory as asked by the engagement partner, which

specific assertion can be best verified by following the specific audit
procedure considered appropriate by Mr. Rishab?
(a) Rights and Obligations.
(b) Existence and condition.
(c) Valuation.
(d) Presentation & Disclosure.
 CASE SCENARIOS 3

2. While selecting the sample for verification of creditors, which method of

sampling has been applied by Ms. Soni?

(a) Stratified sampling.

(b) Haphazard sampling.
(c) Systematic sampling.

(d) Simple random sampling.

3. What is the best course of action to be taken by Mr. Rishab for verifying
the assertion with respect to the inventory of the company, as asked by
the engagement partner?
(a) Mr. Rishab should attend the physical inventory count as the only
audit procedure.
(b) Mr. Rishab should agree with Ms. Soni and follow the course of
action as suggested by her.
(c) Mr. Rishab should ask the management to provide a written
representation in this regard as it is a sufficient and appropriate
audit evidence.
(d) Mr. Rishab should perform test count and inspection while
attending the physical inventory count to verify the assertion as
requested by the engagement partner.
4. With respect to verification of the share capital balance of the company,
which of the following is the most appropriate?
(a) The point of view of Ms. Soni is correct.
(b) The point of view of Mr. Rishab is correct.

(c) The point of view of Mr. Rishab is partly correct as written

confirmation should be obtained from the Company Secretary.
(d) The point of view of Ms. Soni is partly correct as no evidence is
required to be obtained if the same audit firm has conducted the
audit of the previous year thereby verifying the closing balance of
share capital in the previous year, which becomes the opening
balance of the share capital for the year under audit.
4 AUDITING AND ETHICS

5. Whether non-acceptance of the written representation by Mr. Rishab is

correct?

(a) The non-acceptance of written representation by Mr. Rishab is not

correct as the management of the company has the sole discretion
to decide as to which language is used or what limitations are
imposed in the written representation provided to the auditor.
(b) The non-acceptance of written representation by Mr. Rishab is
correct as it is not reasonable for the auditor to accept any
qualifying language in the written representations given by the
management.
(c) The non-acceptance of written representation by Mr. Rishab is
correct as SA 580 requires the auditor to accept the written
representation only if it is in the language as used in the letter of
audit engagement.

(d) The non-acceptance of written representation by Mr. Rishab is not

correct as it is reasonable for the auditor to accept such qualifying
language if the auditor is satisfied that the representations are being
made by those with appropriate responsibilities and knowledge of
the matters included in the representations.
6. Whether the view of Ms. Soni regarding assembly of the final audit file is
correct?
(a) View of Ms. Soni is not correct as changes which are administrative
in nature, cannot be made in the audit documentation during the
final assembly process.
(b) View of Ms. Soni is correct.
(c) View of Ms. Soni is not correct as changes in the form of
recalculation of depreciation amount can be made in the audit
documentation during the final assembly process.
(d) View of Ms. Soni is partly correct as during the final assembly
process changes like deleting superseded documents cannot be
made.
 CASE SCENARIOS 5

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) Existence and condition.

Reason:
As per SA 501, by attending the physical inventory count conducted by
the client organisation, the auditor can verify the existence and conditions
with respect to the inventory of the company.
2. Option (c) Systematic sampling.
Reason:
Interval Sampling or Systematic Sampling is a selection method in which
the number of sampling units in the population is divided by the sample
size to give a sampling interval.

3. Option (b) Mr. Rishab should agree to Ms. Soni and follow the course of
action as suggested by her.
Reason:
For verifying the ownership assertion i.e. rights of the entity over the
inventory, the auditor should verify the purchase requisition, purchase
order, receiving reports, vendor invoices, inventory records, payment file
etc. Only by attending the physical inventory count, the auditor can verify
the existence assertion and not the ownership assertion.
4. Option (c) The point of view of Mr. Rishab is partly correct as written
confirmation should be obtained from the company secretary.
Reason:
In case there is no change in the share capital during the year, auditor
should obtain a written confirmation/ representation from the Company
Secretary that there were no changes to entity’s capital structure during
the year.
5. Option (d) The non acceptance of written representation by Mr. Rishab
is not correct as it is reasonable for the auditor to accept such qualifying
language if the auditor is satisfied that the representations are being
6 AUDITING AND ETHICS

made by those with appropriate responsibilities and knowledge of the

matters included in the representations.

Reason:
In some cases, management may include in the written representations
qualifying language to the effect that representations are made to the
best of its knowledge and belief. It is reasonable for the auditor to accept
such wording if the auditor is satisfied that the representations are being
made by those with appropriate responsibilities and knowledge of the
matters included in the representations.
6. Option (b) View of Ms. Soni is correct.
Reason:

As per SA 230, changes may be made to the audit documentation during

the final assembly process, if they are administrative in nature. Examples
of such changes include deleting or discarding superseded
documentation, sorting, collating and cross-referencing working papers,
changes like recalculation of depreciation cannot be made at such stage.
 CASE SCENARIOS 7

CASE SCENARIO 2

Aditya & Co. LLP are the statutory auditors of Benuka Furniture Ltd., a company
engaged in the manufacture of wide range of office furniture that suits various
workspaces ranging from home offices to corporate environments. The audit
team is headed by CA Aditya, being the engagement partner who is further
assisted by 2 articled assistants namely Rohit and Mudit. Before starting the
audit work of the company, CA Aditya briefed the engagement team about the
client’s business, the various audit procedures the team can perform and the
Standard on Auditing that the team needs to be complied with while
conducting the audit of this company. While such discussions were going on,
Mudit showed no inclination towards understanding the business and business
environment of the company. He was of the view that as a member of the audit
team he needs to obtain an understanding about the audit procedures to be
performed during the course of audit and not about the client’s business.
Rohit was asked by CA Aditya to verify the trade receivables, loan and advances
given by the company, amounting to ` 20 crore and ` 20 lakhs respectively.
Rohit asked the concerned official of the company to provide him with the
ageing of trade receivables. Rohit decided to send confirmation requests to
debtors having balance as on the balance sheet date exceeding ` 5 lakhs. He
further decided to request to the third party in the request letters to reply
positively whether the balance in their books tallies with the balance mentioned
in the request letters. Also, while verifying the balance of loans and advances
given by the company, Rohit selected the sample for checking without following
any structured approach though he made sure to avoid any conscious biasness
or predictability. Thus, he made sure that all the individual balances constituting
the total of loans and advances given by the company had a chance of selection.
While checking the balances of fixed assets, Mudit asked the concerned
employee of the company to provide him with various documents related to all
the fixed assets appearing as on the balance sheet date. He asked for the title
deeds with respect to the building owned by the company and the purchase
bills for assets purchased by the company. While asking for such documents
from the client company, Mudit was of the view that as a member of the audit
team he can force the employee of the company to provide him with the
required documents.
8 AUDITING AND ETHICS

Further with respect to the inventory of the company, Mudit performed the
audit procedures to verify that any inventory balance as at the year end does
not include any element of next financial year.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Whether the view of Mudit regarding obtaining understanding of the

client business is correct?
(a) The view of Mudit is correct because as a member of the audit team,
he needs an understanding only about the audit procedures to be
performed by him.
(b) The view of Mudit is not correct because while conducting an audit,
the understanding of business and business environment of the
client whose audit is to be conducted is very important.
(c) The view of Mudit is partially correct because such understanding is
required only for the engagement partner and not be the members
of the audit team.
(d) The view of Mudit is not correct because such information forms a
crucial part of the audit report to be issued at the end of the audit
process.
2. Which type of confirmation requests Rohit decided to send the debtors
for verification of balances of trade receivables?
(a) Negative confirmation.
(b) Positive confirmation.

(c) Exception letter.

(d) Written Representation.
3. Which sample selection methods has been opted by Rohit while verifying
the loans and advances given by the company?
(a) Interval Sampling.
(b) Block Sampling.
 CASE SCENARIOS 9

(c) Haphazard Sampling.

(d) Monetary Unit Sampling.
4. While verifying the inventory of the client company, which assertion is
being verified by Mudit?
(a) Cut-off assertion.

(b) Valuation assertion.

(c) Presentation & Disclosure assertion.
(d) Rights & Obligations assertion.

5. With respect to fixed assets, which assertion does Mudit want to check?
(a) Valuation assertion.
(b) Presentation and Disclosure assertion.

(c) Rights and obligations assertion.

(d) Existence assertion.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) No, the view of Mr. Sumit is not correct as all the four clients
operate in different industries and evolving one audit programme for all
businesses is not practicable.
Reason:
Businesses vary in nature, size and composition; work which is suitable to
one business may not be suitable to others; efficiency and operation of
internal controls and the exact nature of the service to be rendered by the
auditor are the other factors that vary from assignment to assignment. On
account of such variations, evolving one audit programme applicable to
all business under all circumstances is not practicable.
2. Option (a) Substantive Analytical Procedures.
Reason:
The term analytical procedures means evaluations of financial information
through analysis of plausible relationships among both financial and non-
10 AUDITING AND ETHICS

financial data. One of the examples of analytical procedures is comparing

the entity’s financial information with the information pertaining to prior
periods.
3. Option (c) The understanding of Mr. Saurabh is correct as Special
Resolution is required in case of issue of sweat equity shares by the
company and reduction of share capital.
Reason:
As per Section 54 of the Companies Act, 2013, the issue of sweat equity
shares should be authorised by a Special Resolution passed by the
company. Also, as per requirements of section 66 which deals with
reduction of share capital, Special Resolution is required in case of
reduction of share capital by the company.
4. Option (c) No, the view of Mr. Sumit is not correct as the statutory auditor
has the sole responsibility for the audit opinion expressed.

Reason:
As per SA 610, the external auditor has sole responsibility for the audit
opinion expressed, and that responsibility is not reduced by the external
auditor’s use of the work of the internal audit function or internal auditors
to provide direct assistance on the engagement.
5. Option (c) Control Risk.
Reason:
In accordance with SA 200, control risk is the risk that a misstatement that
could occur in an assertion about a class of transaction, account balance
or disclosure and that could be material, either individually or when
aggregated with other misstatements, will not be prevented, or detected
and corrected, on a timely basis by the entity’s internal control.
 CASE SCENARIOS 11

CASE SCENARIO 3

Nath Shah & Associates is a firm of Chartered Accountants practicing in Delhi.

The firm consists of two partners namely, CA Ajay Nath and CA Ria Shah. The
Statutory audit team is generally headed by CA Ajay Nath and his team consists
of three articled assistants and one qualified Chartered Accountant, CA Reshu.
With respect to the audit work of 4 clients for which the audit team intends to
start the audit work, CA Ajay discussed with the team members about the
development of audit programmes for individual clients. One of the articled
assistants, Mr. Sumit, was of the view that one single audit programme can be
developed for all the 4 clients operating in different industries.
With respect to one of the clients namely, Saraswati Ltd., a labour intensive
company, CA Ajay asked CA Reshu to compare the amount of wages paid by
the company in the current year and last year. Also, she was asked to verify the
relationship between the number of employees and wages paid in both the
years by the company.
The audit firm started the audit of another client, namely, Sarthak Ltd. having
maximum transactions in foreign currency. CA Ajay asked one of the team
members, Mr. Rahul, to verify whether the calculations related to conversion of
the foreign currency into local currency is proper or not.
While verifying the share issue transactions of one client, namely, Laxman Ltd.,
CA Reshu found that the company has issued sweat equity shares during the
year under audit. She asked one of the articled assistants, Mr. Saurabh, to
further verify whether the relevant provisions of the Companies Act 2013, have
been complied by the company in this regard. Also, with respect to Sarthak Ltd.,
there was reduction of share capital during the year. Mr. Saurabh was asked by
the engagement partner to verify the compliance of relevant provisions of the
Companies Act, 2013 in this regard also. Mr. Saurabh was of the view that there
is requirement of passing of Special Resolution by the respective company for
both.
While starting the audit work of another client, Rintex Ltd., the audit team
noticed that the company has its internal audit team. Mr. Sumit was of the view
that the statutory audit team can use and rely on the work of the Internal
12 AUDITING AND ETHICS

Auditors of the company and as such there is no requirement for the statutory
audit team to perform audit procedures again as the internal audit team must
have verified the financial transactions of the company in detail. Further, while
verifying the expenses ledger, Mr. Sumit noticed that the company has
implemented a system whereby the entries related to expenses incurred during
the year can be entered into the accounting system by authorised personnels
only. However, with respect to travelling expenses which constituted about 30%
of the total expenses, the entries were made by employees who were not
authorised to make such entries.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Is the view of Mr. Sumit with respect to the development of audit

programme correct?
(a) Yes, the view of Mr. Sumit is correct as developing one audit
programme for all the clients will avoid duplication of efforts of
audit team.
(b) No, the view of Mr. Sumit is not correct as all the four clients operate
in different industries and evolving one audit programme for all
businesses is not practicable.
(c) Yes, the view of Mr. Sumit is correct as development of audit
programme is not affected by the nature of client business.
(d) No, the view of Mr. Sumit is not correct as development of audit
programme is not the responsibility of the audit team. The
individual clients will develop their respective audit programmes.
2. With respect to Saraswati Ltd., Ms. Reshu was asked by CA Ajay to perform
which kind of audit procedures?

(a) Substantive Analytical Procedures.

(b) Test of details.
(c) Test of transactions.

(d) Test of Controls.

 CASE SCENARIOS 13

3. Whether understanding of Mr. Saurabh regarding the passing of Special

Resolution is correct?

(a) The understanding of Mr. Saurabh is partly correct as ordinary

resolution is required in case of issue of sweat equity shares by the
company though special resolution is required to be passed by the
company in case of reduction of share capital.
(b) The understanding of Mr. Saurabh is partly correct as special
resolution is required in case of issue of sweat equity shares by the
company though ordinary resolution is required to be passed by the
company in case of reduction of share capital.
(c) The understanding of Mr. Saurabh is correct as special resolution is
required in case of issue of sweat equity shares by the company and
reduction of share capital.
(d) The understanding of Mr. Saurabh is not correct as ordinary
resolution is required in case of issue of sweat equity shares by the
company as well as in case of reduction of share capital.
4. Is the view of Mr. Sumit correct with respect to using and relying on the
work of the Internal Audit team of Rintex Ltd.?
(a) Yes, the view of Mr. Sumit is correct.
(b) No, the view of Mr. Sumit is not correct as the statutory audit team
cannot use the work of the internal audit team of the client
company.
(c) No, the view of Mr. Sumit is not correct as the statutory auditor has
the sole responsibility for the audit opinion expressed.
(d) The view of Mr. Sumit is partly correct as the statutory audit team
can use and rely on the work of the internal audit team if the same
is agreed while signing the engagement letter.
14 AUDITING AND ETHICS

5. Which kind of risk is noticed by Mr. Sumit with respect to entries related
to travelling expenses entered into the accounting system of Rintex Ltd.?

(a) Inherent Risk.

(b) Detection Risk.
(c) Control Risk.

(d) No risk is being noticed.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) No, the view of Mr. Sumit is not correct as all the four clients
operate in different industries and evolving one audit programme for all
businesses is not practicable.
Reason:
Businesses vary in nature, size and composition; work which is suitable to
one business may not be suitable to others; efficiency and operation of
internal controls and the exact nature of the service to be rendered by the
auditor are the other factors that vary from assignment to assignment.
On account of such variations, evolving one audit programme applicable
to all business under all circumstances is not practicable.
2. Option (a) Substantive Analytical Procedures.
Reason:
The term analytical procedures means evaluations of financial information
through analysis of plausible relationships among both financial and non-
financial data. One of the examples of analytical procedures is comparing
the entity’s financial information with the information pertaining to prior
periods.
3. Option (c) The understanding of Mr. Saurabh is correct as Special
Resolution is required in case of issue of sweat equity shares by the
company and reduction of share capital.
Reason:
As per Section 54 of the Companies Act, 2013, the issue of sweat equity
shares should be authorised by a Special Resolution passed by the
company. Also, as per requirements of section 66 which deals with
 CASE SCENARIOS 15

reduction of share capital, Special Resolution is required in case of

reduction of share capital by the company.
4. Option (c) No, the view of Mr. Sumit is not correct as the statutory auditor
has the sole responsibility for the audit opinion expressed.

Reason:
As per SA 610, the external auditor has sole responsibility for the audit
opinion expressed, and that responsibility is not reduced by the external
auditor’s use of the work of the internal audit function or internal auditors
to provide direct assistance on the engagement.
5. Option (c) Control Risk.
Reason:

In accordance with SA 200, control risk is the risk that a misstatement that
could occur in an assertion about a class of transaction, account balance or
disclosure and that could be material, either individually or when aggregated
with other misstatements, will not be prevented, or detected and corrected,
on a timely basis by the entity’s internal control.
16 AUDITING AND ETHICS

CASE SCENARIO 4

DLP & Associates, a firm of Chartered Accountants, are in midst of conducting

audit of Twist and Spin Limited. The company is in the business since last
15 years and have appointed DPL & Associates as their auditor for the first time
for a term of 5 years beginning from financial year 2023-24. While identifying
and assessing the risk of material misstatement at assertion level, the
engagement team had assessed risk of material misstatement for revenues and
trade receivables to be high.
The team is considering to send negative confirmation requests as sole
substantive procedure to some business entities representing trade receivables
appearing in the financial statements of the company. The company had made
sales to these business entities in January, 2024. Such business entities are few
and have quite large balances as on 31st March, 2024. However, team members
are not on the same page regarding sending negative confirmation requests.
Besides considering sending confirmation requests, the engagement team has
planned certain audit procedures pertaining to trade receivables. These
procedures include:
1. Verification of invoices issued during the last 7 days of financial year
2023-24 to verify that goods have been despatched by the company.
2. Selection of a few invoices from the ageing report of the month
March 2024 for verification of correctness of the billed amounts, to correct
customers and on correct dates.
3. Preparation of schedule of movement of bad debts.
4. Review of the process of providing discounts to ensure that it is in
accordance with company policy.
Another junior team member, S, observed that “Share Options Outstanding
Account” reflected in the financial statements of the company. He started
searching classification requirements of Schedule III of the Companies Act, 2013
in this regard.
The engagement team wants to ensure that only the inventories held by the
company have been recorded in the financial statements and do not include
 CASE SCENARIOS 17

any inventories belonging to third parties. They are keen to verify completeness
assertion for inventories. The team has planned the following audit procedures
in this respect: -
1. Comparison of inventory turnover ratio of current period with previous
years;

2. Vertical analysis of current period with previous years;

3. Comparison of budgetary expectations vis-à-vis actuals;
4. Performing purchase and sales cut-off tests.

During the course of audit, R, a team member concluded that company has
followed a particular accounting policy for revenue recognition during year
2023-24 which is in accordance with Accounting Standards and applicable
financial reporting framework, but it was not consistently applied in preceding
period having an impact upon opening balances of trade receivables of current
year 2023-24. R is confused regarding the possible implications on auditor’s
report on this issue.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. The engagement team members are not able to take decision on sending
negative confirmation requests to some entities described in case
scenario. Which of the following statements is in accordance with
Standards on Auditing?
(a) It would be appropriate for engagement team to send negative
confirmation requests to these business entities.
(b) It would be inappropriate for engagement team to send negative
confirmation requests to these business entities.
(c) Sending negative confirmation requests depends upon auditor’s
professional judgment and Standards on Auditing do not spell out
any confirmation requirements in this respect.
(d) Business entities are more likely to respond in case of disagreement.
Therefore, sending negative confirmation requests always provides
18 AUDITING AND ETHICS

better qualitative audit evidence as compared to other confirmation

modes.

2. Which of the planned audit procedure(s) pertaining to trade receivables

described in case scenario is/are not related to verification of
“Completeness assertion”?

(a) 2 only.
(b) 2 and 3.
(c) 3 only.

(d) 1 and 3.
3. Guide team member S by selecting the correct option with respect to
“Share Options Outstanding Account”:
(a) It is required to be classified under head “Current liabilities”.
(b) It is required to be classified under Shareholder funds under “Share
Capital”. Further, it is to be classified separately under “Paid up
Share Capital”.
(c) It is required to be classified under Shareholder funds under
“Reserves & Surplus”. Further, it is to be classified separately as such
under “Reserves & Surplus”.
(d) It is required to be classified under Shareholder funds under
“Reserves & Surplus”. However, it is shown as part of Capital
Reserve. No Separate disclosure is mandated under Schedule III of
the Companies Act, 2013.
4. Which of the planned audit procedures in relation to the inventories
described in the case scenario is/are not in nature of analytical
procedure(s)?
(a) 2 and 3.

(b) 3 only.
(c) 2 and 4.
(d) 4 only.
 CASE SCENARIOS 19

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) It would be inappropriate for engagement team to send

negative confirmation requests to these business entities.

Reason:

As per SA 505, “External Confirmations”, the auditor shall not use negative
confirmation requests as the sole substantive audit procedure to address
an assessed risk of material misstatement at the assertion level unless all
of the following are present:

(i) The auditor has assessed the risk of material misstatement as low
and has obtained sufficient appropriate audit evidence regarding
the operating effectiveness of controls relevant to the assertion;

(ii) The population of items subject to negative confirmation

procedures comprises a large number of small, homogeneous,
account balances, transactions or conditions;

(iii) A very low exception rate is expected; and

(iv) The auditor is not aware of circumstances or conditions that would

cause recipients of negative confirmation requests to disregard such
requests.

In the given case, aforementioned conditions are not present.

2. Option (c) 3 only.

Reason:

Preparation of the schedule of movement of bad debts is pertaining to

valuation assertion and all other procedures are related to completeness
assertion.

3. Option (c) It is required to be classified under Shareholder Funds under

“Reserves & Surplus”. Further, it is to be classified separately as such
under “Reserves & Surplus”.
20 AUDITING AND ETHICS

Reason:

Share Options Outstanding Account is required to be classified under

“Reserve & Surplus” separately in accordance with requirements of
Schedule III.
4. Option (d) 4 only.
Reason:
Purchase and sales cut-off tests are not in the nature of analytical
procedures.
 CASE SCENARIOS 21

CASE SCENARIO 5

Oval Services Ltd. appointed Rupa & Associates as the auditors for the financial
year 2023-24. The auditors believe that an audit program is crucial in providing
clear and comprehensive instructions for the tasks to be carried out, offering a
total perspective of the work involved. This is particularly important for large
audits, and as such, they prepared an initial audit program based on the
company’s organisational structure and effective internal controls. During the
audit, CA Nitin, Engagement Partner identified issues with the company’s debt
management practices, prompting the inclusion of a more detailed review of
the loan agreements. However, in his opinion the planned review of petty cash
was unnecessary due to the company’s policy of limiting cash transactions.
Thus, review procedure was removed from the audit programme.

To verify the balances of trade payables, the auditor decided to send external
confirmation requests to the creditors of the company. These requests were
made to verify the balances as on 20th March, 2024, a date chosen deliberately
to ensure the accuracy and completeness of the liabilities, free from any
influence or prior knowledge of management. This approach was taken to
maintain the integrity of the confirmation process. However, it was noted that
M/s. Keshav Traders and M/s. Amrit Distributors did not respond to the
confirmation requests.
Furthermore, the auditor noted that in the financial year 2023-24, the
company’s Property, Plant, and Equipment (PPE) was revalued, resulting in an
increase of 5% in the net carrying value of its machinery from ₹ 10 lakh to
₹ 10.5 lakh.
Also, due to the significant compliance burden, company is considering to
convert into a Limited Liability Partnership (LLP). Management views the LLP
structure as a hybrid business model that combines the advantages of both
companies and partnerships. Additionally, they believe this conversion would
relieve them from mandatory audit requirements.
Based on the above facts, answer the following MCQs:
22 AUDITING AND ETHICS

MULTIPLE CHOICE QUESTIONS

1. Whether audit team is correct in excluding the planned review of petty

cash from the audit programme?
(a) No, as the audit programme should always include a petty cash
review, regardless of company policy.

(b) Yes, as the company’s internal controls and policy of limiting cash
transactions reduce the need for a petty cash review in the audit
programme.

(c) No, as the audit programme must cover all the areas of financial
transactions, including petty cash, to ensure comprehensive
auditing.
(d) Yes, as the audit programme should only focus on areas with high
financial risk, and petty cash is not a high-risk area.
2. Whether the decision of auditor to send the confirmation request to the
creditors of the company as on 20th March, 2024 justified?
(a) Yes, decision of the auditor is correct as the auditor is allowed to
choose any date reasonably close to the balance sheet date for
confirmation, and the selected date helps to ensure the accuracy of
the liabilities without consultation from the management.
(b) No, decision of the auditor is not correct as the auditor should have
sent the confirmation requests for the balance sheet date as this
would accurately reflect the liabilities as on that date.
(c) Yes, decision of the auditor is correct as the auditor is allowed to
choose any date which is reasonably close to the balance sheet date
for confirmation, and the selected date should be decided in
consultation with the management.
(d) No, decision of the auditor is not correct as confirmation should be
asked within a week of the date of audit report.
3. Which of the following is not an appropriate procedure to verify the
balances for M/s. Keshav Traders and M/s. Amrit Distributers?
 CASE SCENARIOS 23

(a) Breaking down the balance into individual transactions and making
sure they actually happened.

(b) Checking payments made after the year-end to vendors who didn’t
respond to confirmation requests.
(c) Comparing the balance to the original invoices from the vendors.

(d) Request a written representation from management confirming that

all payables are accurately recorded and complete.
4. In the given case, is there any requirement for separate disclosure of the
PPE revaluation?
(a) Yes, separate disclosure is required due to the 5% increase in
carrying value.

(b) No, separate disclosure is not required as the change in carrying

value is less than 10%.
(c) Yes, separate disclosure is required regardless of the percentage
change.
(d) No, separate disclosure is not required unless the revaluation results
in a material change in the carrying value.
5. What is your perspective on the management's view regarding the audit
requirements for an LLP?
(a) An LLP is always required to conduct an audit, regardless of its
turnover or capital contribution.
(b) An LLP is always required to conduct an audit if either the turnover
exceeds ` 40 lakhs or the capital contribution exceeds ` 25 lakhs.

(c) An LLP is always required to conduct an audit if either the turnover

exceeds ` 25 lakhs or the capital contribution exceeds ` 40 lakhs.
(d) An LLP is always required to conduct an audit if the capital
contribution exceeds ` 25 lakhs and the turnover exceeds ` 40 lakhs.
24 AUDITING AND ETHICS

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) Yes, as the company’s internal controls and policy of limiting
cash transactions reduce the need for a petty cash review in the audit
programme.
Reason:

To start with, an auditor having regard to the nature, size and composition
of the business and the dependability of the internal control and the given
scope of work, should frame a programme which should aim at providing
for a minimum essential work which may be termed as a standard
programme. As experience is gained by actually carrying out the work, the
programme may be altered to take care of situations which were left out
originally but are found relevant for the particular concern. Similarly, if
any work originally provided for proves beyond doubt to be unnecessary
or irrelevant, it may be dropped.
2. Option (c) Yes, decision of the auditor is correct as the auditor is allowed
to choose any date which is reasonably close to the balance sheet date
for confirmation, and the selected date should be decided in consultation
with the management.
Reason:
The trade creditors may be requested to confirm the balances either (a)
as at the date of the balance sheet, or (b) as at any other selected date
which is reasonably close to the date of the balance sheet. The date
should be decided by the auditor in consultation with the Company.
3. Option (d) Request a written representation from management
confirming that all payables are accurately recorded and complete.
Reason:

Where no reply is received, the auditor should perform additional testing

regarding the balances. This testing could include:
 Testing of subsequent payments in respect of the trade payables to
whom confirmations were rolled out but no replies received;
 CASE SCENARIOS 25

 Agreeing the details of the respective balance to the underlying

vendor invoices;

 Preparing a detailed analysis of the balance, ensuring it consists of

identifiable transactions and confirming that these purchases/
expense transactions actually occurred.

4. Option (b) No, separate disclosure is not required as the change in

carrying value is less than 10%.
Reason:
A reconciliation of the gross and net carrying amounts of each class of
assets at the beginning and end of the reporting period showing
additions, disposals, acquisitions through business combinations, amount
of change due to revaluation (if change is 10% or more in the aggregate
of the net carrying value of each class of Property, Plant and Equipment)
and other adjustments and the related depreciation and impairment
losses/reversals shall be disclosed separately.
5. Option (b) An LLP is always required to conduct an audit if either the
turnover exceeds ` 40 lakhs or the capital contribution exceeds ` 25 lakhs.

Reason:
The accounts of every LLP shall be audited in accordance with Rule 24 of
LLP, Rules 2009. Such rules, inter-alia provides that any LLP, whose
turnover does not exceed, in any financial year, forty lakh rupees, or
whose contribution does not exceed twenty-five lakh rupees, is not
required to get its accounts audited.
26 AUDITING AND ETHICS

CASE SCENARIO 6

Shreyansh, a Chartered Accountancy student, is part of an engagement team

conducting audit of the Coimbatore branch of XYZ Bank under the guidance of
CA Dilip, the Engagement Partner. Shreyansh has been assigned the task of
verifying provisions made for the branch's non-performing assets (NPAs) and
classification of certain loans as on March 31, 2024, of which details are as
under:
Non-Performing Assets (NPAs):

Name of NPA Outstanding Amount Security

Account classification amount as of Available
on March provision
31st, 2024 made (In
(In ` lakhs) ` lakhs)
AB Industries Doubtful (D1) 10.00 5.00 Fully secured
Mars Traders Substandard 50.00 7.50 Fully secured
asset
RS Enterprises Doubtful (D2) 30.00 30.00 Fully secured
NPS & Sons Loss 1.00 1.00 Only
personal
guarantee of
proprietor
(Net worth
₹ 50 lakhs)
Housing Loan and Car Loan
A borrower Mr. Shyam has availed following two loans from the branch:
♦ Housing Loan: EMIs are overdue for 120 days as on March 31, 2024.
♦ Car Loan: EMIs are overdue for 60 days as on March 31, 2024.
CA Dilip has clarified that the NPA classification has been verified and is in
accordance with RBI guidelines. He instructed Shreyansh to focus on evaluating
the adequacy of the provisions, considering RBI Guidelines mandate specific
 CASE SCENARIOS 27

percentages for provisioning based on the NPA classification and the nature of
the security.

Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Is the provision made for AB Industries (Doubtful—D1) appropriate?

(a) Yes, as it exceeds the required 25% provisioning for secured assets.
(b) No, as it should be 40% of the outstanding amount.
(c) No, as the required provision is ₹ 2.50 lakhs (25% of ₹ 10.00 lakhs).
(d) Yes, as provisions for Doubtful assets can exceed the minimum
requirement.
2. Considering the Housing Loan and Car Loan availed by the borrower
Shyam, which of the following statements is appropriate?
(a) Both Housing Loan and Car Loan should be classified as “Non-
Performing Assets” in accordance with RBI norms on asset
classification.
(b) Housing Loan should be classified as “Non-Performing Asset” in
accordance with RBI norms. However, Car Loan should be classified
as Standard Asset.
(c) Car Loan should be classified as “Non-Performing Asset.” However,
Housing Loan should be classified as Standard Asset.

(d) Both Housing Loan and Car Loan should be classified as Standard
Assets.
3. What is the minimum provision required for RS Enterprises (Doubtful—
D2), considering the account is fully secured?
(a) ₹ 30.00 lakhs.
(b) ₹ 12.00 lakhs.

(c) ₹ 15.00 lakhs.

(d) ₹ 25.00 lakhs.
28 AUDITING AND ETHICS

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (c) No, as the required provision is ₹ 2.50 lakhs (25% of ₹ 10.00
lakhs).
Reason:
Provision required for Doubtful assets up to 1 Year is 25% of secured
amount.
2. Option (a) Both Housing Loan and Car Loan should be classified as “Non-
Performing Assets” in accordance with RBI norms on asset classification.
Reason:
Car loan and Housing Loan both would be treated as an NPA because the
NPA classification is Borrower wise and not Facility wise.

3. Option (b) ₹ 12.00 lakhs.

Reason:
Doubtful (D2) category requires provision of 40% of secured amount.
 CASE SCENARIOS 29

CASE SCENARIO 7

M/s MCP Associates are having 3 partners namely CA Mahavir, CA Chandana

and CA Prabha. CA Mahavir is about to conclude audit of a company. During
the audit, he noticed that there is a shortage of important raw material supplies
being imported from China due to prevailing geopolitical situation. The
company has shared with him its plan to deal with the situation. He is satisfied
with assessment of the company for dealing with the matter. The issue is
disclosed in financial statements and considering management’s assessment, it
is felt that use of going concern assumption by company in preparation of
financial statements is appropriate. He also verified that all subsequent events
have been accounted for and requested written representations from
management, although the representations include qualifying language.
Significant findings were communicated both orally and in writing to those
charged with governance, with relevant communications documented.
CA Chandana is conducting an audit of a manufacturing company dealing in
towels and bedspreads. The company’s inventory is spread across its own
locations and third-party premises. As part of audit procedures, she is
performing many audit procedures required under different Standards on
Auditing. She attends the physical inventory count, sends confirmation requests
for trade receivables, and assesses controls. She relies on sampling extensively
while auditing transactions, balances, and controls.
CA Prabha is auditing a firm’s financial statements and performs detailed
procedures to verify assertions. The firm is engaged in export of goods to
Europe. The sales invoices raised in Euros are converted into Indian rupees as
per applicable norms. She checks classification of expenses, ensures trade
payables are genuine, compares current and past wages, examines title deeds
for land, and check the accuracy of calculation of the conversion of foreign
currency into Indian rupees for export invoices.
Based on the above facts, answer the following MCQs:
30 AUDITING AND ETHICS

MULTIPLE CHOICE QUESTIONS

1. Which of the following best describes CA Mahavir’s responsibility for

subsequent events as per SA 560?
(a) He has no obligation to perform audit procedures for events
occurring between date of financial statements and date of auditor’s
report.
(b) He should perform necessary audit procedures to know about
events occurring between the date of financial statements and date
of auditor’s report.
(c) He has no obligation to perform audit procedures after signing of
auditor’s report, even if he comes to know of an event, which if
known to him earlier would have caused him to amend the audit
report.
(d) He has to only rely upon written representation of management
regarding subsequent events. He has no other means to know about
such events.
2. Which is the most appropriate action CA Chandana should take for
verifying inventories held at third-party premises?
(a) Request confirmation of the inventory’s quantity and condition from
third parties or inspect the inventory at their premises.

(b) Inspect all inventories at third-party premises without requesting

confirmation.
(c) Rely on management’s written representation regarding inventories
at third-party locations.
(d) Confirm the inventory’s value along with its quantity and condition
from third parties.
3. Which audit procedure CA Prabha performed to verify whether conversion
of foreign currency into Indian rupees is proper or not?
(a) Inspection.

(b) Recalculation.
 CASE SCENARIOS 31

(c) Observation.
(d) Reperformance.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) He should perform necessary audit procedures to know about

events occurring between the date of financial statements and date of
auditor’s report.
Reason:
As per SA 560, “Subsequent Events”, events occurring between the date
of the financial statements and the date of the auditor’s report and facts
that become known to the auditor after the date of the auditor’s report
are known as subsequent events.
2. Option (a) Request confirmation of the inventory’s quantity and
condition from third parties or inspect the inventory at their premises.
Reason:

When inventory under the custody and control of a third party is material
to the financial statements, the auditor shall request confirmation from
the third party as to the quantities and condition of inventory held on
behalf of the entity
3. Option (b) Recalculation.
Reason:

Recalculation consists of checking the mathematical accuracy of

documents or records. It may be performed manually or electronically.
32 AUDITING AND ETHICS

CASE SCENARIO 8

While auditing ANJ Industries Private Limited, CA J has decided that it would be
appropriate to examine 100% of the items comprising turnover of ` 30 crores
as reflected in its financial statements. For these transactions, he has designed
tests of details. The sales function is automated in the company’s information
system involving repetitive nature of calculations. Further, in respect of
designing of tests of controls pertaining to turnover, he is in a fix.

While verifying turnover of the company, CA J ensures that all the sales are
correctly recorded in the books of accounts and discounts have been properly
adjusted based on invoices. Similarly, in respect of verification of employee
benefit expenses reflected in the financial statements, he ensured that to TDS
related adjustments are correctly reconciled and accounted for.

Ankush, a newly joined articled assistant under CA J, is also a part of the team
assisting seniors. Although he has read about assertions, there remain several
doubts about assertions in his mind. He noted down the following points about
assertions as per his understanding:

1. Assertions are the representations made by the auditors.

2. Assertions are generally explicit and not implicit.

3. Verification of the assertions helps the auditor in finding out whether

financial statements are in accordance with applicable financial reporting
framework or not.

In normal course of business, the company also holds a part of goods as a

consignee. While verifying assertions relating to inventories, he ensures that
inventory held by the company as consignee of goods on behalf of third parties
is excluded from inventories.

Based on the above facts, answer the following MCQs:

 CASE SCENARIOS 33

MULTIPLE CHOICE QUESTIONS

1. Based on CA J’s approach in designing tests of details and tests of controls

for sales, which of the following statements is the most appropriate?
(a) The approach for both designing tests of details and tests of
controls is proper.
(b) The approach for designing tests of details is proper. However, it is
an unlikely approach for tests of controls.
(c) The approach for designing tests of controls is proper. However, it
is an unlikely approach for tests of details.
(d) The approach for designing tests of details as well as tests of
controls is not proper.
2. Which assertion is CA J checking while verifying correctness of recording
of sales based on invoices (including adjustment of discounts) and TDS
adjustments for employee benefit expenses respectively?
(a) Measurement, Measurement.
(b) Completeness, Measurement.
(c) Existence, Measurement.
(d) Measurement, Completeness.
3. Considering the view of Ankush, which of the following(s) is/are false?
(a) 1 and 2.
(b) 1, 2 and 3.
(c) 1 only.
(d) 2 only.
4. As regards the matter of holding of certain inventories as consignee of
goods, which type of assertion(s) is/are being verified by the auditor?
(a) Cut-off and Valuation.
(b) Completeness and Rights & Obligations.

(c) Completeness only.

(d) Rights & Obligations only.

34 AUDITING AND ETHICS

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) The approach for designing tests of details is proper. However,
it is an unlikely approach for tests of controls.
Reason:
The auditor may decide that it will be most appropriate to examine the
entire population of items that make up a class of transactions or account
balance (or a stratum within that population). 100% examination is
unlikely in the case of tests of controls; however, it is more common for
tests of details.
2. Option (a) Measurement, Measurement.
Reason:
Transactions have been recorded accurately at their appropriate amounts
in the financial statements are verified under ‘Measurement’ assertion. In
the given case, the auditor is ensuring that sales are recorded correctly in
the books on the basis of invoices and discounts have been properly
adjusted or accounted for. In respect of employee benefit expenses, he is
verifying that any adjustments such as tax deduction at source have been
correctly reconciled and accounted for.
3. Option (a) 1 and 2.
Reason:
Assertions are representations by management and not by auditor. The
assertions are generally implied and not specifically spelt out. In
representing that the financial statements are in accordance with the
applicable financial reporting framework, management makes assertions,
which are verified by auditor.
4. Option (b) Completeness and Rights & Obligations.
Reason:
All assets, liabilities and equity balances that were supposed to be
recorded have been recognised in the financial statements is covered
under Completeness assertion. Further, entity has the right to assets i.e.
 CASE SCENARIOS 35

(whether the entity has ownership and legal title to assets) is covered
under Rights and Obligation Assertion. In the given case, the auditor
ensures that the inventory held by the entity as a Consignee (on behalf of
third party i.e. Consignor) is excluded and is covered under Completeness
assertion. Whereas verification of the inventory held by the entity on
behalf of another entity has not been recognised as part of inventory of
the entity is Rights and obligation assertion.
36 AUDITING AND ETHICS

CASE SCENARIO 9

Revanth, Manohar and Piyush are planning to set up a new business of trading
electronic goods. They have heard in business circles that many entrepreneurs
are setting up their organisations as Limited Liability Partnerships (LLPs).
However, they are least knowledgeable about such legal structures. In this
regard, they have decided to approach CA S through a mutual contact.
They want to understand the difference between a partnership firm, an LLP and
a private company as well as legal provisions regarding number of partners
allowed in an LLP and the paperwork involved in forming an LLP. Further, they
also have doubts regarding maintenance of books of accounts and the audit
requirement for such organisations. Revanth, being cost conscious, specifically
asks CA S regarding requirement of audit of LLPs. During the discussion, he
shares that they are expecting a turnover of ` 5 crores in the first year of their
business and funds amounting to ` 50 lakhs would be brought by partners as
their contribution.
Manohar is worried about the rules pertaining to the maintenance of accounts
in a software having feature of audit trail. He has unambiguous idea of such
rules to have become effective though social media handles. Additionally, he
feels that such features are useful only for the auditors. CA S tries to brief them
on these matters.
After resolving their doubts, they decided to constitute an LLP named Blitz
Products LLP with the professional assistance of CA S, who helped them in
completing the necessary paper formalities. After constituting an LLP, they
shifted their energies towards running their business. They acquired dealerships
of few reputed companies and received a good response from market due to
prominent location of their showroom and are confident of achieving their
turnover expectation within the first year of business.
They plan to get their accounts audited after closure of the financial year
2023-24 from CA S. The finance and accounts function of business is being seen
by Piyush and he plans to contact him somewhere around August 2024 for
getting audit of financial statements conducted, filing income tax return and
making necessary regulatory compliances on behalf of LLP.
 CASE SCENARIOS 37

Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Which of the following is correct regarding the difference in types of

organisational structures and connected matters?
(a) LLP gives the benefit of flexibility of limited liability of a partnership
and good governance of a company. A minimum of two individuals
are required to form an LLP and at least 2 partners are required to
obtain DIN. The regulatory authority in the case of LLPs is the
Registrar of firms of the respective state where the LLP is located.
(b) LLP gives the benefit of limited liability of a company and flexibility
of partnership. A minimum of two individuals are required to form
an LLP and at least 2 partners are required to obtain DPIN. The
regulatory authority in the case of LLPs is the Registrar of
Companies (ROC).
(c) LLP gives the benefits of limited liability of a company and flexibility
of partnership. A minimum of two individuals are required to form
an LLP and at least 2 partners are required to obtain DIN. The
regulatory authority in the case of LLPs is the Registrar of
Companies (ROC).
(d) LLP gives the benefits of limited liability of a company and flexibility
of partnership. A minimum of three individuals are required to form
an LLP and at least 2 partners are required to obtain DPIN. The
regulatory authority in the case of LLPs is the Registrar of
Companies (ROC).
2. In the above case scenario, what guidance would CA S have likely
provided to Revanth regarding audit of financial statements of LLP?

(a) There is no provision for compulsory audit of LLPs under the LLP
Act, 2008 and relevant rules. However, partners may choose to get
accounts audited due to advantages associated with an audit.

(b) Every LLP is compulsorily required to get its accounts audited under
the LLP Act, 2008 and relevant rules.
38 AUDITING AND ETHICS

(c) There exist provisions under the LLP Act, 2008 and relevant rules for
audit of LLPs based upon twin criteria of turnover and contribution
thresholds. However, the proposed business doesn’t meet
thresholds and would not be required to get its accounts audited.
(d) There exist provisions under the LLP Act, 2008 and relevant rules for
audit of LLPs based upon twin criteria of turnover and contribution
thresholds. The proposed business meets thresholds and would be
required to get its accounts audited.

(3) Which of the following statement is correct regarding Manohar’s point of

view?
(a) Audit trails are useful only for auditors. However, maintenance of
accounts in a software having feature of audit trail is not compulsory
for LLPs.
(b) Audit trails are useful for businesses as well as auditors. However,
maintenance of accounts in a software having feature of audit trail
is not compulsory for LLPs.
(c) Audit trails are useful for businesses as well as auditors.
Maintenance of accounts in a software having feature of audit trail
is compulsory for LLPs.
(d) Audit trails are useful for businesses as well as auditors.
Maintenance of accounts in a software having feature of audit trail
is compulsory for LLPs having certain turnover thresholds.
4. Which of the following statement is correct regarding Piyush’s plan?
(a) Auditor is required to be appointed at least 30 days prior to
March 31st, 2024. Therefore, Piyush’s plan to approach CA S is not
in accordance with the relevant rules and regulations.

(b) Auditor is required to be appointed at least 60 days prior to

March 31st, 2024. Therefore, Piyush’s plan to approach CA S is not
in accordance with the relevant rules and regulations.

(c) Auditor is required to be appointed at any time before

March 31st, 2024. Therefore, Piyush’s plan to approach CA S is not
in accordance with the relevant rules and regulations.
 CASE SCENARIOS 39

(d) Piyush’s plan is proper and there are no specific provisions for
appointment of auditor of an LLP in accordance with relevant rules
and regulations.
5. Considering Piyush’s plan to contact CA S in August 2024 for making
necessary regulatory compliances. What would be its consequences for
LLP?
(a) Default by LLP in filing its annual return.
(b) Default by LLP in filing its Statement of Account and Solvency.
(c) Default by LLP in filing its annual return as well as Statement of
Account and Solvency.
(d) No default by LLP in making necessary compliances.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) LLP gives the benefit of limited liability of a company and
flexibility of partnership. A minimum of two individuals are required to
form an LLP and at least 2 partners are required to obtain DPIN. The
regulatory authority in the case of LLPs is the Registrar of Companies
(ROC).

Reason:
LLP gives the benefits of limited liability of a company and flexibility of
partnership. Minimum two persons are required to form an LLP. Further,
at least 2 partners are required to take DPIN (Designated Partner
Identification number). The regulatory authority in the case of LLPs is
Registrar of Companies (ROC) and returns/forms are to be filed with ROC.

2. Option (d) There exist provisions under the LLP Act, 2008 and relevant
rules for audit of LLPs based upon twin criteria of turnover and
contribution thresholds. The proposed business meets thresholds and
would be required to get its accounts audited.
Reason:
The accounts of every LLP shall be audited in accordance with Rule 24 of
LLP, Rules 2009. Such rules, inter-alia, provides that any LLP, whose
40 AUDITING AND ETHICS

turnover does not exceed, in any financial year, forty lakh rupees, or
whose contribution does not exceed twenty-five lakh rupees, is not
required to get its accounts audited. Other LLPs are required to get their
accounts audited.
3. Option (b) Audit trails are useful for businesses as well as auditors.
However, maintenance of accounts in a software having feature of audit
trail is not compulsory for LLPs.
Reason:
Audit trails (or audit logs) act as record-keepers that document evidence
of certain events, procedures or operations, because their purpose is to
reduce fraud, material errors, and unauthorised use. Audit trails help to
enhance internal controls and data security. Systems which have a feature
of audit trail inspire confidence in auditors. It helps auditors in verifying
whether controls devised by the management were operating effectively
or not. Therefore, audit trails are used for businesses as well as auditors.
However, maintenance of accounts in a software having feature of audit
trail is not compulsory for LLPs.
4. Option (c) Auditor is required to be appointed at any time before
March 31st, 2024. Therefore, Piyush’s plan to approach CA S is not in
accordance with the relevant rules and regulations.
Reason:
The auditor may be appointed by the designated partners of the LLP at
any time for the first financial year but before the end of first financial
year.
5. Option (a) Default by LLP in filing its annual return.

Reason:
Every LLP would be required to file annual return in Form 11 with ROC
within 60 days of closure of financial year. Every LLP is also required to
submit a Statement of Account and Solvency in Form 8 which shall be
filed within a period of thirty days from the end of six months the financial
year to which the Statement of Account and Solvency relates. Therefore,
plan to visit CA S in August 2024 could lead to default by LLP in filing its
annual return.
 CASE SCENARIOS 41

CASE SCENARIO 10

Vama & Associates were appointed as auditors for Royal Constructions Ltd. for
the financial year 2023-24. During the audit, the auditors observed a significant
amount of work-in-progress inventory. Instead of attending the physical
inventory count, they relied on alternative procedures. These included
reviewing production reports, reconciling them with recorded inventory levels,
and analysing variance trends to assess the accuracy of the work-in-progress
balance.
The auditor also noticed that the company has obsolete inventory of ` 1,75,000,
which had an estimated realisable value of ` 50,000, and the company has
valued it at cost in its financial statements.
During the review of Property Plan and Equipment (PPE), the audit team noted
that the company included ` 1,05,000 for employee benefits related to the
acquisition of PPE and ` 1,25,000 for testing the functionality of the equipment,
offset by ` 35,000 received from the sale of samples produced during testing.
Vama & Associates derive a significant portion of their income from Royal
Constructions Ltd., amounting to ` 10,00,000, which represents 65% of their
total annual revenue. Despite finding financial discrepancies of ` 3,00,000 in the
company’s accounts, the partners decided to overlook these issues to maintain
their lucrative relationship with the client.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Royal Constructions Ltd. should value the obsolete inventory at:

(a) ` 50,000.
(b) ` 1,25,000.
(c) ` 1,75,000.
(d) It should be written off completely.
42 AUDITING AND ETHICS

2. What amount should be included in the cost of PPE in the financial

statements of Royal Constructions Ltd.?

(a) ` 1,95,000.
(b) ` 2,30,000.
(c) ` 2,65,000.

(d) ` 1,05,000.
3. What potential threat to the independence of Vama & Associates arises
from receiving fees of ` 10,00,000 from Royal Constructions Ltd.?

(a) Self-interest Threat.

(b) Self-review Threat.
(c) Intimidation Threats.

(d) Familiarity Threats.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (a) ` 50,000.

Reason:
The auditor should follow up valuation of all damaged or obsolete
inventories noted during observance of physical counting with a view to
establishing a realistic net realisable value.
2. Option (a) ` 1,95,000.
Reason:
Directly attributable costs in the Property, Plant and Equipment includes
costs of employee benefits (as defined in AS 15, Employee Benefits)
arising directly from the construction or acquisition of the item of
property, plant and equipment; costs of testing whether the asset is
functioning properly, after deducting the net proceeds from selling any
items produced while bringing the asset to that location and condition.
 CASE SCENARIOS 43

3. Option (a) Self-interest Threat.

Reason:
Self-interest Threats 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.
44 AUDITING AND ETHICS

CASE SCENARIO 11

Ekum & Associates is a firm of Chartered Accountants practicing in Delhi. The

firm has been appointed as the statutory auditors of Energy Synergy Ltd. The
company is engaged in the manufacture of energy equipment and related
systems.
At the time of starting the audit work of the company, CA Ekum, the
engagement partner, reviewed the Gross Profit Ratio of the company for the
year under audit. He also compared GP ratio of Energy Synergy Ltd. with the
other companies operating in similar industry. During the audit, Mr. Sachin, one
of the team members, was asked by CA Ekum to verify the expenditure incurred
on PPE to analyse whether the cost of an item of PPE is recognised as an asset
only when such cost meet the criteria as specified in AS 10. Mr. Sachin is of the
view that the cost of an item of PPE comprises the following:
♦ Its purchase price, including import duties and non-refundable purchase
taxes, after deducting trade discounts and rebates.
♦ Any costs directly attributable to bringing the asset to the location and
condition necessary for it to be capable of operating in the manner
intended by management.
♦ Costs of introducing a new product or service (including cost of
advertising and promotional activities).
♦ Administration and other general overhead costs.

Mr. Sachin was also asked by CA Ekum to verify various assertions related to
sales transactions of the company during the year. Before conducting detailed
testing of sales transactions, Mr. Sachin decided to evaluate the internal control
system implemented by the company with respect to sales transactions. For
this, he gave a comprehensive series of questions concerning the internal
control related to sales to the client and requested the client to get it filled by
the concerned executive.
While verifying sales transactions, Mr. Sachin carried out various audit
procedures, specifically to confirm whether the recorded sales pertained to
 CASE SCENARIOS 45

goods ordered by valid customers, duly despatched, and invoiced during the
audit period.

Mr. Sachin also noticed that one of the internal controls implemented by the
company for sales transactions was segregation of duty that is the person who
checks the credit limit, the person who authorises the sales order, the person
who raises the sales invoices, the person who collects and records the amounts
received from debtors are different. However, he noticed that this segregation
of duties was often not followed in practice. He concluded that the lack of
proper segregation gives rise to specific risks that need to be addressed and
discussed with the company's management.
While verifying the trade receivable balance, Mr. Sachin decided to test such
balance on sample basis. For deciding the sample selection, he divided the trade
receivable balance into 4 groups as follows:
(a) balance is in excess of ₹ 20,00,000.

(b) balances in the range of ₹ 12,50,001 to ₹ 20,00,000.

(c) balances in the range of rupees ₹ 7,50,001 to ₹ 12,50,000.
(d) balances equal to ₹ 7,50,000 and below.
From the above groups, Mr. Sachin picked up different percentage of items to
be examined in detail according to his professional judgment.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Which audit procedure did CA Ekum perform at the time of starting the
audit work of the company?
(a) Reperformance.
(b) Analytical Procedure.
(c) Inquiry.
(d) Recalculation.
46 AUDITING AND ETHICS

2. Whether the view of Mr. Sachin with respect to recognition of cost of PPE
correct?
(a) View of Mr. Sachin is correct.
(b) View of Mr. Sachin is partially correct as the purchase price,
including import duties and non-refundable purchase taxes, after
deducting trade discounts and rebates will not be included in the
cost of PPE.
(c) View of Mr. Sachin is partially correct as the cost of introducing a
new product or service and administration and other general
overhead costs will not be included in the cost of PPE.
(d) View of Mr. Sachin is partially correct as any costs directly
attributable to bringing the asset to the location and condition
necessary for it to be capable of operating in the manner intended
by management will not be included in the cost of PPE.
3. Which method is followed by Mr. Sachin for evaluating the internal
control for the sales transactions?
(a) Check list.
(b) Narrative record.
(c) Internal Control Questionnaire.
(d) Flow Chart.
4. Which specific assertions did Mr. Sachin intend to verify while performing
various audit procedures for sales transactions?
(a) Occurrence.
(b) Completeness.
(c) Measurement.
(d) Presentation & Disclosure.
5. Mr. Sachin concluded that a specific risk is present that needs to be
addressed and discussed with the management of the company. Which
kind of risk is Mr. Sachin referring to?
(a) Detection Risk.
(b) Audit Risk.
 CASE SCENARIOS 47

(c) Inherent Risk.

(d) Control Risk.
6. Which sample selection method is used by Mr. Sachin to select sample of
trade receivable balance for examination?
(a) Haphazard Sampling.
(b) Monetary unit sampling.
(c) Stratified Sampling.
(d) Interval Sampling.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) Analytical Procedure.

Reason:
The term analytical procedures mean evaluations of financial information
through analysis of plausible relationships among both financial and non-
financial data. One of the examples of analytical procedures is comparing
the entity’s financial information with the information pertaining to prior
periods and other companies in similar industry.
2. Option (c) The view of Mr. Sachin is partially correct as the cost of
introducing a new product or service and administration and other
general overhead costs will not be included in the cost of PPE.
Reason:
Examples of costs that are not costs of an item of property, plant and
equipment are:
(i) costs of opening a new facility or business, such as, inauguration
costs;
(ii) costs of introducing a new product or service (including costs of
advertising and promotional activities);
(iii) costs of conducting business in a new location or with a new class
of customer (including costs of staff training); and administration
and other general overhead costs.
48 AUDITING AND ETHICS

3. Option (c) Internal Control Questionnaire.

Reason:
Internal Control Questionnaire is a comprehensive series of questions
concerning internal control. This is the most widely used form for
collecting information about the existence, operation and efficiency of
internal control in an organisation. With a proper questionnaire, all
internal control evaluation can be completed at one time or in sections.
4. Option (a) Occurrence.
Reason:
While verifying occurrence assertion, auditor verifies whether transactions
recognised in the financial statements have occurred and relate to the
entity.
5. Option (d) Control Risk.
Reason:
Control risk is a risk that internal control existing and operating in an
entity would not be efficient enough to stop from happening, or find and
then rectify in an appropriate time, any material misstatement relating to
a transaction, balance of an account or disclosure required to be made in
the financial statements of that entity. Segregation of duties is one of the
internal controls implemented by the company with respect to the sales
transactions.
6. Option (c) Stratified Sampling.
Reason:
Stratified Sampling method involves dividing the whole population to be
tested in a few separate groups called strata and taking a sample from
each of them. Each stratum is treated as if it was a separate population
and if proportionate items are selected from each of these stratums. The
number of groups into which the whole population has to be divided is
determined on the basis of auditor judgment.
 CASE SCENARIOS 49

CASE SCENARIO 12

CA J is nearing completion of audit of Cheap Cost Private Limited, a

manufacturing company for the year 2023-24. The draft financial statements of
the company show a profit before tax of ` 5 crores. Materiality for financial
statements as a whole has been determined @ 5% of Profit before Tax. At the
end of June 2024, he is considering following issues flagged during the course
of audit which remain uncorrected:
• A fire took place in one of the premises of the company on 1 st May,
2024 resulting in damages to all the inventories lying there amounting
to ` 1 crores. The inventories of affected premises are insured with
Quick Bima Limited for ` 50 lakhs and the company has also lodged a
claim with it which is still to be settled.
• The company has debited ` 10 lakhs under “Machinery Account”
whereas expenditure relates to normal wear and tear of high-speed
automated machinery. The amount has been wrongly capitalised under
“Machinery account”. (Ignore depreciation effect).
• The company has not properly accounted for the necessary elements
of cost in arriving at work in progress. Further, estimates regarding
various stages of production have not been made properly. All such
factors have resulted in overstatement of work in progress inventories
by ` 20 lakhs.
No other issues except as stated above merit attention. Besides, written
representation letter has also been obtained on matters concerning
management’s responsibilities regarding fulfilment of responsibilities for
preparation of financial statements and providing access to all information
to CA J. However, the written representation provided to CA J begins in the
below stated manner:

“This representation letter is provided in connection with your audit of the

financial statements of Cheap Cost Private Limited for the year ended
March 31, 2024, for the purpose of expressing an opinion as to whether the
financial statements give a true and fair view in accordance with the
applicable accounting standards in India.
50 AUDITING AND ETHICS

We confirm that (to the best of our knowledge and belief, having made such
inquiries as we considered necessary for the purpose of appropriately
informing ourselves) ………………”
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Which of the following statements is most appropriate as regards to the

fire incident?
(a) The auditor should ask management to adjust financial statements
for period under audit and book a loss of ` 50 lakhs in its Statement
of Profit and Loss.
(b) The auditor should ask management to adjust financial statements
for period under audit and book a loss of ` 1 crores in its Statement
of Profit and Loss.
(c) The auditor should ask management to disclose it in notes to
accounts.
(d) The auditor has no responsibility regarding described fire incident.
2. Identify the correct option regarding materiality of uncorrected
misstatements relating to wrong capitalisation under “Machinery
Account” and overstatement of inventories of work in progress.
(a) The uncorrected misstatements are not material in context of audit
of financial statements as a whole as these are below materiality
level determined by auditor.
(b) The uncorrected misstatements are material in context of audit of
financial statements as a whole and their effect on opinion should
be considered by auditor.
(c) The uncorrected misstatements are not material in context of audit
of financial statements as a whole as these are in nature of
management’s judgment.
(d) The uncorrected misstatements are material in context of audit of
financial statements as a whole and auditor should correct these.
 CASE SCENARIOS 51

3. The auditor has performed certain audit procedures described in case

scenario relating to inventories of work in progress. Such procedures are
related to verification of _______ assertion.
(a) Completeness.
(b) Valuation.
(c) Existence.
(d) Rights and obligations.
4. Which of the following statements is correct in respect to manner of
providing written representations by management?
(a) The extract of written representations provided in case scenario is
proper.
(b) The use of words “having made such enquiries” is not permitted.
(c) The use of words “to the best of our knowledge and belief” is not
permitted.
(d) The use of both kind of words “having made such enquiries” and “to
the best of our knowledge and belief” is not permitted.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (c) The auditor should ask management to disclose it in notes to

accounts.
Reason:
As per SA 560, “Subsequent Events”, events occurring between the date
of the financial statements and the date of the auditor’s report and facts
that become known to the auditor after the date of the auditor’s report
are known as subsequent events. Such events include those events that
provide evidence of conditions that arose after the date of the financial
statements and may significantly impact the company’s financial position,
the auditor should ensure that the event is adequately disclosed in the
notes to accounts in the financial statements.
2. Option (b) The uncorrected misstatements are material in context of
audit of financial statements as a whole and their effect on opinion should
be considered by auditor.
52 AUDITING AND ETHICS

Reason:
As per SA 450, “Evaluation of Misstatements Identified during the Audit”,
uncorrected misstatements refer to those misstatements that the auditor
has accumulated during the audit and that have not been corrected. The
auditor shall determine whether uncorrected misstatements are material,
individually or in aggregate.
In the given case, the misstatement of ` 10 lakh is material in aggregate
with misstatement related to overstatement of work in progress
(` 20 lakh) as both together are more than 5% of PBT (i.e., ` 25 lakhs).
Further, the misstatement of ` 40 lakh is material individually and is
required to be considered separately.
3. Option (b) Valuation.
Reason:
As per the Valuation Assertion, the auditor should ensure that inventories
have been VALUED appropriately and as per generally accepted
accounting policies and practices. For WIP, the auditor should ascertain:
• how the various stages of production/ value additions are measured
and in case estimates are made, understand the basis for such
estimates and
• what elements of cost are included. If overheads are included,
ascertain the basis on which they are included and compare such
basis with the available costing and financial data/ information
maintained by the entity.
4. Option (a) The extract of written representations provided in case
scenario is proper.
Reason:
In some cases, management may include in the written representations
qualifying language to the effect that representations are made to the
best of its knowledge and belief.
 CASE SCENARIOS 53

CASE SCENARIO 13

MPM & Associates, a firm of Chartered Accountants, have received offer letter
from PST Bank for carrying out statutory audit of their Chandigarh branch for
the financial year 2023-24. The offer letter, inter alia, requests audit firm to give
an undertaking in writing that the firm is not disqualified under Section
141(3)(d)(ii) of the Companies Act, 2013. Such a provision relates to the
disqualification of a person as auditor of a company if he, his relative or partner
is indebted to the company subject to certain prescribed conditions. Before
accepting the said audit, the firm checks out whether it complies with law
requirements. However, there is a difference of opinion among firm personnel
whether such an undertaking can be given in the case of banks.
The offer letter also contains the following declaration to be signed by the
auditors in case they choose to accept the appointment:
“We declare that we will not communicate or allow to be communicated to any
person, not legally entitled thereto, any information relating to the affairs of
PST Bank or to the affairs of the person having any dealing with the Bank, nor
will we allow any such person to inspect or have access to any books or
documents belonging to or in possession of the Bank relating to the business
of any person having any dealing with the Bank.”
The audit firm has also received a document kit provided by Statutory Central
Auditors of Bank. It relates to scope of audit, areas of special consideration
while performing audit and requires an audit firm to confirm certain matters
like adherence to RBI Master Circulars for income recognition, asset
classification & provisioning and adequacy of checking of books of accounts
based on sample etc. to them by way of a letter.
The document kit received also requires MPM & Associates to consider adverse
comments made by stock auditors of borrowers enjoying cash credit facilities
in their reports for purpose of reporting. It also contains specific instructions to
check foreign letters of credit (FLCs) issued during the year in compliance with
sanction terms of the respective borrowers and to verify income recognised in
respect of FLCs.
Based on the above facts, answer the following MCQs:
54 AUDITING AND ETHICS

MULTIPLE CHOICE QUESTIONS

1. Which of the following statements is likely to be most appropriate regarding

required undertaking in accordance with the Companies Act, 2013?
(a) The referred provision mainly addresses self-interest threats to
independence of auditors. The audit firm can give such an
undertaking after verifying if it complies with such requirements.
(b) The referred provision mainly addresses self-review threats to
independence of auditors. The audit firm can give such an
undertaking after verifying if it complies with such requirements.
(c) The referred provision mainly addresses self-interest threats to
independence of auditors. However, the audit firm can’t give such
an undertaking as such provisions are applicable to companies and
not to banks.
(d) The referred provision mainly addresses self-review threats to
independence of auditors. However, the audit firm can’t give such
an undertaking as such provisions are applicable to companies and
not to banks.
2. The declaration relating to non-communication of information related to
affairs of Bank is related to adherence to which fundamental principle
governing professional ethics?

(a) Objectivity.
(b) Confidentiality.
(c) Independence.
(d) Professional Competence and due care.
3. MPM & Associates are required to report on adverse comments made by
stock auditors of borrowers of branch enjoying cash credit facilities.
Which of the following statement is most appropriate in this regard?
(a) Stock auditors make comments in their reports on valuation of
security and calculation of drawing power.
 CASE SCENARIOS 55

(b) Stock auditors make comments in their reports on valuation of

security only. However, no comments are made on calculation of
drawing power.
(c) Stock auditors make comments in their reports on valuation of
security, documentation made by bank in respect of sanctioned
credit facilities, leakage of revenue and calculation of drawing
power only.
(d) Stock auditors make comments in their reports on calculation of
drawing power only.
4. Keeping in view the matter of foreign letters of credits (FLCs) described in
case scenario, consider following statements: -
1. Foreign letter of credit issued by branch is a non-funded loan.
2. Branch earns interest on issuance of foreign letter of credit which is
credited in interest earned account of profit and loss account of
branch.
3. The bank which receives foreign letter of credit is known as
beneficiary bank.

Which of following statement(s) is/are true?

(a) Only statement 1 is correct.
(b) Only statements 1 and 3 are correct.
(c) Only statements 1 and 2 are correct.
(d) Only statements 2 and 3 are correct.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (a) The referred provision mainly addresses self-interest threats

to independence of auditors. The audit firm can give such an undertaking
after verifying if it complies with such requirements.
Reason:
Self-interest threats to independence occur when an auditor takes loan
from a client. The provisions in the Companies Act, 2013 address self-
56 AUDITING AND ETHICS

interest threats. Besides, the provisions of the Companies Act, 2013 are
also applicable to banks so far as these are not inconsistent with
provisions of the Banking Regulation Act, 1949. The audit firm can give
such an undertaking.
2. Option (b) Confidentiality.

Reason:
Confidentiality principle requires a professional accountant to respect the
confidentiality of information acquired as a result of professional or
business relationships.
3. Option (a) Stock auditors make comments in their reports on valuation
of security and calculation of drawing power.

Reason:
Stock auditors are required to make comments in their reports on
valuation of security and calculation of drawing power.
4. Option (a) Only statement 1 is correct.
Reason:
Letter of credit is a non-funded facility. Bank earns commission/charges
on it which are credited in “other income” in Profit and loss account. The
bank receiving letter of credit is known as Advising bank. Therefore, only
Statement 1 is correct.
 CASE SCENARIOS 57

CASE SCENARIO 14

M/s. Vishwacharya and Associates, a CA firm based in Orissa, is appointed as an

auditor of CBF Bank for the financial year 2023-24. During the course of audit,
it came to notice that CBF Bank has sanctioned an overdraft facility of ` 75 lakh
to Times Ltd. However, as per the stock statement furnished for the last quarter,
the drawing power was calculated to be ` 50 lakh. It was observed that few
advances were guaranteed by the:
(i) Central Government as part of ‘Make in India’ initiative. However, the
guarantee was not invoked, and the advances were overdue by 95 days.
These advances were classified as standard assets and were regarded as
NPA for income recognition purpose.
(ii) State Government as part of power generation initiative. However, the
guarantee was not invoked, and the advances were overdue by 80 days.
These advances were also classified as standard assets and were regarded
as NPA for income recognition purpose.
Additionally, XYZ Ltd., is a borrower availing cash credit facility of ` 110 Lakh
against security of paid stocks and debtors up to 90 days. Margin stipulated
was 25% of stock as and 40% for debtors. Bank has calculated drawing power
based on following information provided by XYZ Ltd.

Particulars Amount
(`)

Value of Stocks (as on 31.12.2023) 130 Lakh

Value of Debtors (as on 31.12.2023) 75 Lakh

Value of stocks (Fully damaged and included in (i) above) 7 Lakh

Value of Debtors (exceeding 90 days included in (ii) above) 10 Lakh

Value of creditors for goods 60 Lakh

Also, the outstanding balance in one of the Loan accounts was ` 25 Lakh and
the realisable value of the security as assessed by the bank / approved
valuers was ` 2.25 Lakh. Bank identified the same as erosion in the value of
58 AUDITING AND ETHICS

security. It was classified as doubtful category and provision was made for
the doubtful assets. A discussion also took place among the team members
regarding issuance of the audit reports after completion of the bank audit
and annexure to the same such as Long Form Audit Report, Report on
compliance with SLR Requirements, Report on Treasury Operations – as per
RBI guidelines, Report on compliance as per Ghosh committee
recommendations and Report on adverse credit - lending ratio in the rural
areas, etc.

Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. With respect to the overdraft facility sanctioned to Times Ltd., the account
would be termed as out of order if:
(i) The outstanding balance remains continuously in excess of
` 75 Lakh.
(ii) The outstanding balance remains continuously in excess of
` 50 Lakh.
(iii) The outstanding balance in the account is less than ` 75 Lakh but
there are no credits or payments deposited into the account
continuously for 90 days as on balance sheet date.
(iv) The outstanding balance is less than ` 50 Lakh.
Choose the correct option from below:
(a) (i), (ii) and (iii).
(b) (i), (iii) and (iv).
(c) (ii),(iii) and (iv).
(d) (iii) and (iv).
2. Which of the treatment by the bank on the provisioning and income
recognition is correct in case of bank guarantee given by the Central
Government and State Government?
(a) Both (i) and (ii) are correct.
(b) Only (ii) is correct.
 CASE SCENARIOS 59

(c) Only (i) is correct.

(d) Both (i) and (ii) are incorrect.
3. In the given case, drawing power of the borrower XYZ Limited should be:
(a) ` 86.25 Lakh.
(b) ` 76.35 Lakh.
(c) ` 96.25 Lakh.
(d) ` 85.45 Lakh.
4. The bank has identified an erosion in the value of security and made
provision for doubtful assets. Whether the treatment by bank for the
doubtful asset is correct?
(a) Yes. The security should be classified under doubtful category. It
may be either written off or fully provided by the bank.
(b) No. The existence of such security should be ignored, and the asset
should straight away be classified as loss asset. It may be either
written off or fully provided by the bank.
(c) Yes. The security should be classified under doubtful category and
provisioning should be made as applicable for doubtful assets.
(d) No. The existence of the security should be ignored, and the asset
should straight away be classified as loss asset. Provisioning should
be made for doubtful assets.
5. The Statutory Central Auditors of a bank must furnish, in addition to the
main audit report, various other audit reports. From the options, choose
the audit reports that M/s. Vishwacharya and Associates shall furnish:
(i) Long Form Audit Report.
(ii) Report on compliance with SLR Requirements.
(iii) Report on Treasury Operations – as per RBI guidelines.
(iv) Report on compliance as per Ghosh committee recommendations.
(v) Report on adverse credit - lending ratio in the rural areas.
Choose the correct answer:
(a) (i), (ii), (iii), (iv) and (v).
60 AUDITING AND ETHICS

(b) Only (i), (ii), (iii) and (iv).

(c) Only (i), (ii) and (iii).
(d) Only (i), (ii) and (v).

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (a) (i), (ii) and (iii).

Reason:
An account should be treated as ‘out of order’ if:-
♦ the outstanding balance remains continuously in excess of the
sanctioned limit/drawing power or
♦ In cases where the outstanding balance in the principal operating
account is less than the sanctioned limit/drawing power, but there
are no credits continuously for 90 days as on the date of Balance
Sheet; or
♦ credits are there but are not enough to cover the interest debited
during the same period, these accounts should be treated as ‘out of
order’.
2. Option (c) Only (i) is correct.
Reason:
In case of Central Government guaranteed advances, where the guarantee
is not invoked/ repudiated would be classified as Standard Assets but
regarded as NPA for Income Recognition purpose. The situation would be
different if the advance is guaranteed by State Government, where
advance is to be considered NPA if it remains overdue for more than 90
days for both Provisioning and Income recognition purposes.
3. Option (a) ` 86.25 Lakh.
Reason:

Particulars Amount (` In lakhs)

Value of stocks (as on 31.12.2023) 130.00
Less: Value of damaged stocks (7.00)
 CASE SCENARIOS 61

123.00
Less: Creditors for goods (as on 31.12.2023) (60.00)
Value of paid stocks 63.00
Less: Margin @25% (15.75)
Drawing power (A) 47.25
Value of Debtors (as on 31.12.2023) 75.00
Less: Debtors exceeding 90 days (10.00)
65.00
Less: Margin @ 40% (26.00)
Drawing power (B) 39.00
Drawing power (A+B) 86.25

4. Option (b) No. The existence of such security should be ignored, and the
asset should straight away be classified as loss asset. It may be either
written off or fully provided by the bank.
Reason:
(i) Erosion in the value of security can be reckoned as significant when
the realisable value of the security is less than 50 per cent of the
value assessed by the bank or accepted by RBI at the time of last
inspection, as the case may be. Such NPAs may be straight-away
classified under doubtful category and provisioning should be made
as applicable to doubtful assets.
(ii) If the realisable value of the security, as assessed by the bank/
approved valuers/ RBI is less than 10 per cent of the outstanding in
the borrowal accounts, the existence of security should be ignored,
and the asset should be straight-away classified as loss asset. It may
be either written off or fully provided for by the bank.
5. Option (b) Only (i), (ii), (iii) and (iv).
Reason:
The Statutory Central Auditors are not required to furnish Report on
adverse credit - lending ratio in the rural areas along with the main audit
report.
62 AUDITING AND ETHICS

CASE SCENARIO 15

Priority Limited is a large company engaged in the manufacturing of terry

towels making steady profits on a year-to-year basis. PMR & Associates,
statutory auditors of the company since last two years, are in process of
establishing audit strategy for conducting statutory audit under the Companies
Act, 2013 for year 2023-24.
The company has 5 branches which are audited by independent auditors
appointed under the Companies Act, 2013. It also has a wholly owned subsidiary
company which is audited by another audit firm under the name of JKL &
Associates. The engagement team has noticed that company has maintained
several bank accounts and there is substantial movement in fixed deposits
during the year leading to risk of misstatement in cash and cash equivalents.
The engagement team has planned procedures regarding the same.
(i) At planning stage, engagement partner is also trying to set materiality for
financial statements as a whole. The following information extracted from
financial statements is given as under:

Particulars (Amount in ` crores)

Revenue 100
Total Assets 40
Profit before Tax 8
Total Liabilities (excluding Equity) 30
(ii) While designing a sample for verifying revenues of company as part of
tests of details, engagement partner has determined “tolerable
misstatement” for ` 5 Lakh in order to address the risk that aggregate of
individual immaterial misstatements may cause the financial statements
to be materially misstated and provide a margin for possible undetected
misstatements. One of the newly joined engagement team members has
little conceptual understanding of “tolerable misstatement” determined
by engagement partner. He also has no idea of the effect of change in
tolerable misstatement on sample size.
 CASE SCENARIOS 63

(iii) During the course of audit, while performing tests of details, engagement
team has come across certain misstatements in selected sample
pertaining to verification of revenues. The team has projected
misstatements to population of revenues. The team wants to comply with
the Standards on Auditing strictly.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. The auditors of company are in process of establishing audit strategy.

Which of the following is not a relevant factor in establishing overall audit
strategy in the given case scenario?
(a) Consideration of 5 branches which are audited by independent
auditors.
(b) Consideration of wholly owned subsidiary company audited by
another audit firm.
(c) Expected time of holding AGM in accordance with provisions of the
Companies Act, 2013.
(d) Nature, timing and extent of planned procedures for cash and cash
equivalents.
2. For Priority limited, which benchmark would the engagement partner
most likely to use for setting materiality for the financial statements as a
whole?
(a) A percentage of Revenue.
(b) A percentage of Total assets.
(c) A percentage of Profit before tax.
(d) A percentage of Total liabilities (excluding equity).
3. In the given case scenario, assume that the engagement partner has
decided to increase tolerable misstatement to ` 10 Lakh while designing
sample described. Select the correct statement.
(a) It would lead to decrease in sample size.
(b) It would lead to an increase in sample size.
64 AUDITING AND ETHICS

(c) It would have no effect on sample size.

(d) It is not possible to draw inference on sample size due to increase
in tolerable misstatement.
4. While performing procedures on designed sample, the engagement team
identified certain misstatements in selected sample and projected these
to the entire population of revenues. According to the requirements of
the Standards on Auditing, which statement is correct in this regard?
(a) Anomalous misstatement is auditor’s best estimate of misstatement
in population.
(b) The projected misstatement plus anomalous misstatement, if any, is
best estimate of misstatement in population.
(c) When projected misstatement exceeds tolerable misstatement,
sample provides a reasonable basis for conclusion about tested
population.
(d) When projected misstatement plus anomalous statement, if any,
exceeds tolerable misstatement, sample provides a reasonable basis
for conclusion about tested population.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (d) Nature, timing and extent of planned procedures for cash and
cash equivalents.
Reason:
Planned procedures for cash and cash equivalents are not a factor to be
considered for establishing audit strategy. These form part of developing
audit plan.
2. Option (c) A percentage of Profit before tax.
Reason:
As per SA 320, PBT is often used as a benchmark for profit making entities.
 CASE SCENARIOS 65

3. Option (a) It would lead to decrease in sample size.

Reason:
Increase in tolerable misstatement would lead to decrease in sample size
as lower the tolerable misstatement, the larger the sample size needs to
be.
4. Option (b) The projected misstatement plus anomalous misstatement, if
any, is best estimate of misstatement in population.
Reason:
While performing procedures on designed sample the projected
misstatement plus anomalous misstatement, if any, is the best estimate
of misstatement in population. The effect of anomaly still needs to be
considered in addition to projection of non-anomalous misstatements.
66 AUDITING AND ETHICS

CASE SCENARIO 16

Bandhu Charitable Trust is considering the appointment of MNO &

Associates, Chartered Accountants, as independent auditors of its financial
statements. The Trust is engaged in providing affordable healthcare services.
It is in the interest of both auditor and client to issue an engagement letter
so that the possibility of misunderstanding is reduced to a great extent. It is,
therefore, important that each party should be clear about the nature of
engagement. It should exactly specify the scope of work. Such an
“engagement letter” is exchanged between Trust management and auditors.

While performing audit procedures, it is noticed by auditors that bills of two

vehicles are not in the name of Trust but in the name of trustees. However,
payment of these vehicles was made from the bank account of Trust. The
said vehicles are used for activities of Trust.
It is also noticed that a sum of ` 50 Lakh is reflected in Trust’s financial
statements in the name of Gamma Instrument and Equipment in schedule of
creditors. The said amount has been outstanding for the last two years. The
auditors sent confirmation requests to the said supplier and seek
management’s co-operation in this regard. However, management of the
Trust informs the auditor regarding a certain dispute going on with the
supplier of equipment due to some quality issues. It is further informed that
the dispute is near settlement, and it would not be proper to send
confirmation requests as it can affect the negotiation process.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. As regards exchange of engagement letter between Trust management

and auditors is concerned, which of the following statements is likely to
be true?
(a) Engagement letter is sent by MNO & Associates to Bandhu
Charitable Trust. It includes reference to the expected form and
content of the report to be issued by them and a statement that
 CASE SCENARIOS 67

there may be circumstances in which such report may differ from its
expected form and content.
(b) Engagement letter is sent by Bandhu Charitable Trust to MNO &
Associates. It includes reference to the expected form and content
of report to be issued by auditors. However, it does not include a
statement that such report may differ from its expected form and
content.
(c) Engagement letter is sent by MNO & Associates to Bandhu
Charitable Trust. It includes reference to expected form and content
of report to be issued by them. However, it does not include a
statement that such a report may differ from its expected form and
content.
(d) Engagement letter is sent by MNO & Associates to Bandhu
Charitable Trust. It does not include reference to the expected form
and content of report to be issued by them.
2. Considering the issues related to vehicles as described in the case study,
identify the most appropriate statement.
(a) Auditors have identified misstatement concerning “Existence”
assertion made by Trust management.
(b) Auditors have identified misstatement concerning “Rights and
Obligations” assertion made by Trust management.
(c) Auditors have identified misstatement concerning “Accuracy”
assertion made by Trust management.
(d) Auditors have identified misstatement concerning “Completeness”
assertion made by Trust management.
3. What course of action should the auditor take regarding the amount
payable to the equipment supplier when management has communicated
that sending a confirmation request could negatively impact the
negotiation process?
(a) The auditor should issue adverse opinion in auditor’s report.
(b) The auditor should seek audit evidence as to the validity and
reasonableness of the reasons for refusal and perform alternative
audit procedures.
68 AUDITING AND ETHICS

(c) The auditor should withdraw from engagement as Trust

management’s refusal is a limitation on scope of independent audit.
(d) The auditor should disclaim opinion in auditor’s report.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (a) Engagement letter is sent by MNO & Associates to Bandhu

Charitable Trust. It includes reference to the expected form and content
of the report to be issued by them and a statement that there may be
circumstances in which such report may differ from its expected form and
content.
Reason:
An engagement letter is sent by auditor to client. In terms of the
requirements of SA 210, it includes reference to expected form and
content of report to be issued by them and a statement that there may
be circumstances in which such report may differ from its expected form
and content.
2. Option (b) Auditors have identified misstatement concerning “Rights and
Obligations” assertion made by Trust management.
Reason:
With respect to Rights and Obligations assertions, the auditor should
verify that the entity holds or controls the rights to assets of the entity.
3. Option (b) The auditor should seek audit evidence as to the validity and
reasonableness of the reasons for refusal and perform alternative audit
procedures.

Reason:
In terms of requirements of SA 505, the auditor should seek audit
evidence as to the validity and reasonableness of the reasons for refusal
and perform alternative audit procedures. The issues of opinion or
withdrawal from engagement come afterwards.
 CASE SCENARIOS 69

CASE SCENARIO 17

Pluto Limited is engaged in the manufacturing and distribution of furniture.

After Covid, as the number of people working from home has gone up, this
customisable range of home office furniture has gained lot of importance. They
were able to perform very well over the years and the same has been reflected
in their financial statements.
During the year 2023-24, M/s Saha and Associates was reappointed as the
auditor. The new engagement team has CA Saha (partner) and five article
assistants. Given the large volume of transactions, the partner instructed the
article assistants to review the financial statements and auditor's report from
the previous year, 2022-23, to gain a thorough understanding.
While reviewing the summary page, one of the articles, Kabir noticed that a few
points were under discussion with the partner before finalising the audit.
The team verified the following points with respect to employee benefit
expenses:
• The employee benefit expenses recorded in the books were actually
incurred during the relevant period.
• The expenses in respect of all personnel have been accounted for.
• The expenses recognised during the period are pertaining to the current
accounting period.
It was also noted that dividend to equity shareholders for the year 2022-23, was
declared on 15.04.2023 and was recognised as liability in the year 2022-23.
Another article Krish noticed that debtors constitute a major component of the
company’s financial statements. As part of the audit procedure, the auditor
requested the client to obtain external confirmations from the parties. For this,
a list of all the debtors were obtained and a random sampling was performed
by the auditor. The client directly obtained the selected debtor confirmations
from the customers on time.
Krish also observed addition in the assets amounting ₹ 50 lakhs during the year
supported by sufficient audit evidence. However, upon scrutiny, it was found
that some of the invoices were not in the name of the company. Further, Cash
and cash equivalents were classified as balances with banks, cheques and drafts
70 AUDITING AND ETHICS

on hand, cash on hand and earmarked balances with banks (e.g. unpaid
dividend).
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Which among the following assertions are discussed with respect to the
employee benefit expenses?
(i) Measurement.
(ii) Occurrence.

(iii) Cut-off.
(iv) Completeness.
Choose the correct combination from below:

(a) (i), (ii) and (iv).

(b) (ii), (iii) and (iv).
(c) (i), (iii) and (iv).
(d) (i), (ii) and (iii).
2. Whether disclosure of dividend under the liability head during the year
2022-23 is appropriate?
(a) Yes, it should be recognised in the same year irrespective of the year
of declaration as the amount of dividend belongs to the year
2022-23.

(b) No, the amount should be recognised equally between two financial
years.
(c) No, the amount should not be recognised as a liability. It should be
disclosed in the notes to accounts.
(d) No, the amount should neither be recognised as liability nor
disclosure is required in the financial statements.
3. Krish pointed out that that the method followed to obtain debtor
confirmation in the previous year was not in accordance with SA 505.
 CASE SCENARIOS 71

Therefore, M/s Saha & Associated should reperform the same in the
correct manner. Select the most appropriate procedure among the
following:
(a) As per SA 505, confirmation should be directly obtained by the
auditor. Further, for all significant account balances as on the
Balance sheet date confirmations should necessarily be collected
and for the smaller outstanding balances, random sampling could
be performed.
(b) It is ok to obtain confirmation through clients as they are in constant
contact with their customers. Also, many customers may not
respond to auditor’s external confirmation request mail. Random
selection can be done for all debtors irrespective of the amount in
accordance with SA 505.
(c) As per SA 505, confirmation should be directly obtained by the
auditor. Whereas random selection can be done for all debtors
irrespective of the amount.
(d) Either auditor or client can obtain confirmation based on time
availability. However, it is necessary to obtain confirmation for all
significant account balances as on the Balance sheet date and for
the remaining random sampling could be performed in accordance
with SA 505.
4. Which assertion has been affected in the case of fixed assets?
(a) Existence.
(b) Rights and obligation.
(c) Completeness.
(d) Measurement.
5. Cash and cash equivalents were not properly classified by the client.
Which of the following is incorrect disclosure of the same?
(a) Balances with banks.
(b) Cheques and drafts on hand.
(c) Cash on hand.
(d) Earmarked balances with banks. (e.g.: unpaid dividend)
72 AUDITING AND ETHICS

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) (ii), (iii) and (iv).

Reason:
In the given case, the assertions of Occurrence, Cut-off, and Completeness
are being evaluated concerning employee benefit expenses. The
Occurrence assertion requires the auditor to ensure that the recorded
expenses were actually incurred during the relevant period itself.
Additionally, the Completeness assertion ensures that all personnel-
related expenses have been accounted for. Lastly, the Cut-off assertion
verifies that the recognised expenses during the period are pertaining to
the current accounting period.
2. Option (c) No. The amount should not be recognised as a liability. It
should be disclosed in the notes to accounts.
Reason:

As per AS-4 (Revised)or IND AS 10, if dividends to holders of equity

instruments are proposed or declared after the balance sheet date, an
entity should not recognise those dividends as a liability as at the balance
sheet date. It should, however, disclose the amount of dividends that were
proposed or declared after the balance sheet date, but before the
financial statements were approved for issue.

3. Option (a) As per SA 505, confirmation should be directly obtained by

the auditor. Further, for all significant account balances as on the Balance
sheet date confirmations should necessarily be collected and for the
smaller outstanding balances, random sampling could be performed.
Reason:
To verify the existence of trade receivables at the period-end, the auditor
should obtain direct confirmations from customers. Direct confirmation
audit procedure involves directly contacting customers to confirm the
amounts of unpaid accounts receivable as of the end of the reporting
period under audit. This should necessarily be done for all significant
account balances as at the period-end while certain random customers
having smaller outstanding invoices should also be selected.
 CASE SCENARIOS 73

4. Option (b) Rights and obligation.

Reason:
As per Rights and obligations assertion the auditor is required to verify
that the entity has valid legal ownership over the PPE claimed to be held
and recorded in the financial statements.

5. Option (d) Earmarked balances with banks. (e.g.: unpaid dividend)

Reason:
Cash and cash equivalents shall be classified as:

• Balances with banks, Cheques, drafts on hand, Cash on hand, Others

(specify nature)
• Earmarked balances with banks (for example, for unpaid dividend) shall
be separately stated.
74 AUDITING AND ETHICS

CASE SCENARIO 18

Watch IT India Private Limited is a company engaged in business of

manufacturing smart watches. The company had a slow start in the
beginning as company’s products were gaining traction with customers.
However, momentum has picked up during the year. The company wants to
appoint M/s Tripati & Associates, a CA firm as their auditor for the year
2023-24 by replacing their existing auditors M/s Sreepath and Co.
M/s Tripati & Associates are willing to accept the engagement. They
communicated with previous auditors before accepting the engagement.
However, M/s Sreepath and Co. have failed to respond.
CA Kishan, partner of M/s Tripati & Associates explained to his team
members about the importance of the engagement letter. He also arranged
a team discussion on matters relating to acceptance of terms of engagement.
The first point of consideration was concerning preconditions for an audit.
Mr. Arun, a team member, could recollect a few of them. Those included
determining whether the financial reporting framework used in the
preparation of financial statement is acceptable, management providing
auditor with access to all relevant information and additional information
upon auditor’s request. It was further elaborated by Arun that management
has to provide unrestricted access to employees within entity as may be
required by auditor for obtaining audit evidence. Team members were asked
to list factors that may necessitate revision of engagement letters in case of
recurring audits. Mr. Kumar, another team member replied that revision may
be required in cases involving significant change in ownership, recent
changes in senior management, change in financial reporting framework
adopted in preparation of financial Statements, modest change in nature or
size of the entity’s business, change in legal and regulatory requirements etc.
Mr. Ram, one of the team members, raised a doubt. He enquired regarding
recourse available to incoming auditor in case management makes it clear
before acceptance of engagement by auditor regarding its inability in
providing support to him in respect of certain procedures expected to be
performed during the audit. In this respect, specific questions were raised
 CASE SCENARIOS 75

relating to sending of confirmation requests to material trade payables

reflecting in financial statements of a company. Trade payables pertain to
material input and input services acquired and utilised by the company
during the year. Lack of support by management in such a case would, in
effect, signify management’s refusal to allow the auditor to send
confirmation requests at the outset before engagement is accepted by
auditor.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. As regards the doubt of Mr. Ram described in last para of case scenario,
which of the following statements is likely to be in accordance with
Standards on Auditing?
(a) The auditor needs to inquire into management’s reasons for the
refusal and perform alternative audit procedures to obtain relevant
and reliable audit evidence.
(b) The auditor needs to evaluate implications of management’s refusal
on auditor’s assessment of risk of material misstatement and
perform alternative audit procedures to obtain relevant and reliable
audit evidence.
(c) The auditor should not accept such an engagement.
(d) The auditor needs to evaluate implications of management’s refusal
on risk of fraud and perform alternative audit procedures to obtain
relevant and reliable audit evidence.
2. When CA Kishan, the partner, asked about preconditions for an audit, Mr.
Arun could recollect only a few of them. Which among the following
points were missed by him?
(i) Obtaining management responsibility on specific legal aspects
governing the organisation.
(ii) Obtaining management responsibility on Standards on Auditing
applicable to the organisation.
(iii) Obtaining management responsibility for the preparation of
financial statements as per applicable financial reporting framework.
76 AUDITING AND ETHICS

(iv) Obtaining management responsibility on necessary Internal

controls to enable preparation of financial statements which are free
from material misstatement whether due to error or fraud.
Select the correct option
(a) (i), (ii) and (iii).

(b) (ii), (iii) and (iv).

(c) (iii) and (iv).
(d) (i) and (iv).
3. Identify the incorrect factor mentioned by Mr. Kumar regarding the need
for a revision of the Engagement Letter:
(a) A significant change in ownership.
(b) A recent change in management.
(c) A change in financial reporting framework adopted in preparation
of Financial Statements.
(d) A modest change in nature or size of the entity’s business.
4. M/s Sreepath & Co. have failed to respond to incoming auditors. In this
regard, choose the most appropriate option:
(a) It was unethical on part of outgoing auditors for failing to respond
to communication made by incoming auditors. It is violation of
objectivity principle.
(b) It was ethical on part of outgoing auditors for failing to respond to
communication made by incoming auditors. It does not involve
violation of any fundamental principles governing professional
ethics.
(c) It was unethical on part of outgoing auditors for failing to respond
to communication made by incoming auditors. It is violation of
Professional competence and due care principle.
(d) It was unethical on part of outgoing auditors for failing to respond
to communication made by incoming auditors. It is a violation of
professional behaviour principle.
 CASE SCENARIOS 77

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (c) The auditor should not accept such an engagement.

Reason:
If the auditor is unable to agree to a change of the terms of the audit
engagement and is not permitted by management to continue the
original audit engagement, the auditor shall: (a) Withdraw from the audit
engagement where possible under applicable law or regulation; and (b)
Determine whether there is any obligation, either contractual or
otherwise, to report the circumstances to other parties, such as those
charged with governance, owners or regulators.
2. Option (c) (iii) and (iv).
Reason:
In order to establish whether the preconditions for an audit are present,
the auditor shall:
Obtain the agreement of management that it acknowledges and
understands its responsibility: (i) For the preparation of the financial
statements in accordance with the applicable financial reporting
framework including where relevant their fair representation; Use by
management of an acceptable financial reporting framework in the
preparation of the financial statements and the agreement of
management to the premise on which an audit is conducted a (ii) For such
internal control as management considers necessary to enable the
preparation of financial statements that are free from material
misstatement, whether due to fraud or error; and
3. Option (d) A modest change in nature or size of the entity’s business.
Reason:
In case of recurring audits revision of terms audit engagement is
mandated in following cases:
(i) Any indication that the entity misunderstands the objective and
scope of the audit.
(ii) Any revised or special terms of the audit engagement.
78 AUDITING AND ETHICS

(iii) A recent change of senior management.

(iv) A significant change in ownership.
(v) A significant change in nature or size of the entity’s business.
(vi) A change in legal or regulatory requirements.
(vii) A change in the financial reporting framework adopted in the
preparation of the financial statements.
(viii) A change in other reporting requirements.
4. Option (d) It was unethical on part of outgoing auditors for failing to
respond to communication made by incoming auditors. It is a violation of
principle of professional behaviour governing professional ethics.
Reason:
In case where previous auditor does not communicate with current
auditor, one of the important fundamental principles of Professional
behaviour has been violated. Since, it requires an accountant to comply
with relevant laws and regulations and avoid any conduct that the
accountant knows or should know might discredit the profession.
 CASE SCENARIOS 79

CASE SCENARIO 19

GHB Ltd., a listed company, having its registered office at New Delhi, is in the
business of blending, processing, packing and selling various brands of Tea.
BPP & Co. LLP, Chartered Accountants, are appointed as the statutory auditors
of the company for the financial year 2023-24, CA B is the engagement partner
for the assignment.

The company has a centralised warehouse near the border of Himachal Pradesh.
CA B's attendance, on 31 March 2024, at the physical inventory counting in
aspect of the said warehouse became impracticable on account of natural
calamity in that area. It also became impossible for CA B to perform alternative
audit procedures to obtain sufficient appropriate audit evidence regarding the
existence and condition of the inventory.

The company had spent huge amount on employee benefits. Hence, CA B

instructed his assistants to test the controls that the company had set around
the employee benefit expenses. After being satisfied with the controls
maintained by the company, he instructed his team to bifurcate the employee
benefit expenses into salaries and wages, contribution to PF, expenses on ESOP/
ESPP and staff welfare expenses.

Due to time constraints, CA B is under pressure to issue a clean report in the

limited time frame. He has insufficient time to properly perform or complete
the relevant duties and issue appropriate audit report.

The Board of Directors want CA B to certify the debtors to be sent to the bank
without checking. CA B agrees, as most of the professional income of
BPP & Co. LLP comes from GHB Ltd. They have undue dependence on the fees
from GHB Ltd., hence, they are concerned about losing the engagement.

Based on the above facts, answer the following MCQs:

80 AUDITING AND ETHICS

MULTIPLE CHOICE QUESTIONS

1. Since it became impracticable for CA B, on 31 March, 2024, to attend

physical inventory counting at the warehouse and also became impossible
to perform alternative audit procedures to obtain sufficient appropriate
audit evidence regarding the existence and conditions of inventory, CA B
shall:
(a) Take Management Representation regarding the existence and
valuation of inventory and mention in Emphasis of Matter
paragraph.
(b) Rely on GHB Ltd.'s perpetual inventory records as audit evidence
and express unmodified opinion.
(c) Omit altogether the audit procedure of physical inventory counting
from the audit programme because of impracticability.
(d) Modify the opinion in the auditor's report in accordance with
SA 705 as a result of the scope limitation.
2. Which assertion concerning the bifurcation of employee expenses into
various heads are being verified by CA B?
(a) Occurrence.
(b) Measurement.
(c) Completeness.
(d) Disclosures.
3. Due to tight deadlines, CA B has insufficient time to properly perform or
complete the relevant duties and he has to sign off clean audit report.
Which fundamental principle governing professional ethics is disregarded
by him?
(a) Professional competence and due care.
(b) Professional behaviour.
(c) Integrity.

(d) Objectivity.
 CASE SCENARIOS 81

4. Undue dependence on the fees from GHB Ltd. creates which threat of
independence for the auditors?
(a) Intimidation Threat.
(b) Familiarity Threat.

(c) Self-interest Threat.

(d) Advocacy Threat.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (d) Modify the opinion in the auditor's report in accordance with
SA 705 as a result of the scope limitation.
Reason:
As per SA 501,”Audit Evidence - Specific Considerations for Selected
Items”, if attendance at physical inventory counting is impracticable, the
auditor shall perform alternative audit procedures to obtain sufficient
appropriate audit evidence regarding the existence and condition of
inventory. If it is not possible to do so, the auditor shall modify the opinion
in the auditor’s report in accordance with SA 705.
2. Option (d) Disclosures.
Reason:
A Company shall disclose by way of notes additional information
regarding aggregate expenditure and income on Employee Benefits
Expense (i) salaries and wages, (ii) contribution to provident and other
funds, (iii) expense on Employee Stock Option Scheme (ESOP) and
Employee Stock Purchase Plan (ESPP), (iv) staff welfare expenses.
3. Option (a) Professional competence and due care.
Reason:
A professional accountant shall comply with the principle of professional
competence and due care, which requires an accountant to attain and
maintain professional knowledge and skill at the level required to ensure
that a client or employing organisation receives competent professional
service, based on current technical and professional standards and
82 AUDITING AND ETHICS

relevant legislation, and act diligently and in accordance with applicable

technical and professional standards.
4. Option (c) Self-interest Threat.
Reason:
Self-interest threats occur when an auditing firm, its partner or associate
could benefit from a financial interest in an audit client. Examples include
undue dependence on a client’s fees and, hence, concerns about losing
the engagement.
 CASE SCENARIOS 83

CASE SCENARIO 20

M/s KRISH & Company is a firm of Chartered Accountants based in Punjab,

CA K, CA R, CA I, and CA SH are the partners of the firm. The firm is engaged
in various audit assignments. The engagement partners, who were handling
their respective assignments for the financial year 2023-24, dealt with the
following issues raised during the course of their respective audits.
M/s KRISH & Co. is appointed as the joint auditor along with M/s. PK and
Associates and M/s. RS and Associates for the audit of a large manufacturing
company for the financial year 2023-24. CA K is in charge of this audit. They
have divided their audit areas and have also identified the common audit
areas, which will be applicable to all the joint auditors. While forming the
opinion, CA K had a different opinion whereas the other two audit firms
shared the same opinion. Both of them contended that as they were forming
a majority, M/s. KRISH & Co. will have to agree with their opinion.
CA R is conducting the statutory audit of PAWAN Ltd. He observed that,
during the year, the company has issued shares at premium and has
transferred the amount received as premium to securities premium account.
He wants to ensure that PAWAN Ltd. has utilised the amount available in the
securities premium amount for the purposes permitted under the
Companies Act, 2013.
The Registrar of Co-operative Societies has appointed M/s KRISH & Co. as
the statutory auditor of NAND Co-operative Society for the financial year
2023-24. CA I is looking after the audit of the said registered society. During
the year, in terms of Section 34 of the Cooperative Societies Act, with the
sanction of the Registrar, Society contributed for charitable purposes as
defined in section 2 of the Charitable Endowments Act, 1890. CA I is ensuring
whether requirements, as regards contribution made, have been complied
with.
All the engagement partners and the audit team of M/s KRISH & Co. have
deliberations and discussions every week through google meet to review the
progress of their respective assignments. During the last meeting, CA SH,
the managing partner, briefed the team about the form, content, and extent
84 AUDITING AND ETHICS

of audit documentation in terms of SA 230, while citing examples of records

to be excluded as well as to be included as a part of audit documentation.

Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. In case of difference of opinion between the joint auditors, what course

of action can M/s. KRISH & Co. take while issuing the audit report?
(a) They will have to agree with the opinion formed by the majority of
auditors.
(b) They will have to agree with the opinion formed by the majority
auditors, but they can mention their view in the Emphasis of Matter
Paragraph.
(c) They can add a separate audit opinion paragraph in the common
audit report.

(d) They can issue a separate audit report and the audit reports issued
by the joint auditors shall make a reference to each other's audit
report.
2. The securities premium account of PAWAN Ltd. cannot be applied for
which of the following purposes?
(a) In writing off the debit balance in the Profit & Loss account.
(b) In writing off the expenses of, or the commission paid or discount
allowed on any issue of equity shares of the company.

(c) For the purchase of its own shares or other securities under
section 68.
(d) In paying up unissued equity shares of the company to be issued to
the members of the company as fully paid bonus shares.
3. CA I, who is in charge of audit of NAND Co-operative Society, wants to
ensure that the society has contributed for charitable purposes within the
limits prescribed. How much is the society allowed to contribute for
charitable purposes?
 CASE SCENARIOS 85

(a) Contribute an amount not exceeding 10% of the net profits

remaining after the compulsory transfer to the reserve fund.

(b) Contribute an amount at the appropriate rate as per class of the

society.
(c) Contribute an amount not exceeding 20% of the net profits
remaining after the compulsory transfer to the reserve fund.
(d) Contribute annually at prescribed percentage of the profits as
approved by the General body of the society.
4. Which of the following need not be included by the audit team as a part
of audit documentation during handling of their respective assignments?
(a) Significant and specific contracts and agreements.
(b) Draft audit engagement letter.
(c) Summaries of significant matters.
(d) Checklists.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (d) They can issue a separate audit report and the audit reports
issued by the joint auditors shall make a reference to each other's audit
report.
Reason:
As per SA 299, “Joint Audit of Financial Statements”, joint auditors are
required to issue common audit report. However, where the joint auditors
are in disagreement with regard to the opinion or any matters to be
covered by the audit report, they shall express their opinion in a separate
audit report. In such circumstances, the audit report(s) issued by the joint
auditor(s) shall make a reference to each other’s audit report(s).
2. Option (a) In writing off the debit balance in the Profit & Loss account.
Reason:
The securities premium account cannot be applied by the Company for
writing off the debit balance in the Profit & Loss account.
86 AUDITING AND ETHICS

3. Option (a) Contribute an amount not exceeding 10% of the net profits
remaining after the compulsory transfer to the reserve fund.

Reason:
According to section 34, a registered society may, with the sanction of the
Registrar, contribute an amount not exceeding 10% of the net profits
remaining after the compulsory transfer to the reserve fund for any
charitable purpose as defined in section 2 of the Charitable Endowments
Act, 1890.
4. Option (b) Draft audit engagement letter.
Reason:
Audit Documentation includes:
• Audit programmes.
• Analyses.
• Issues memoranda.
• Summaries of significant matters.
• Letters of confirmation and representation.
• Checklists.
• Correspondence (including e-mail) concerning significant matters.
• Significant and specific contracts and agreements.

Thus, Draft audit engagement letter is not included in Audit

Documentation.
 CASE SCENARIOS 87

CASE SCENARIO 21

Mega Power Ltd. is a manufacturer of solar lanterns, which are used in

remote villages where there is no reliable supply of electricity. However, due
to power projects undertaken by the government, the demand for their solar
lanterns has significantly declined over the past few years.
The company was in need of ` 2 crores for working capital and other
expenses but was not able to fund this amount. Consequently, their suppliers
were paid much later than usual and hence some of them withdrew the credit
terms, meaning the company had to pay cash on delivery. This created a
severe cash crunch, and the auditor feels that other than the cash crunch,
there are several other financial indicators that cast a significant doubt on
the company's ability to continue as a going concern.
The management of the company, however, assures the auditor that this is
temporary, and the situation will change soon as they are planning to
diversify their business. They are ready to provide written representation for
the same. The auditor feels that material uncertainty still exists. The auditor
wants the management to make adequate disclosure about this in the
financial statements. The auditor wants to include a separate section about
this in his audit report. He is also contemplating about the kind of audit
report that should be issued.
The auditor has concerns about ethical values and diligence of management.
He is concerned about the reliability of the representations made by the
management and the audit evidence in general. The auditor is of the opinion
that the written representations from management are not reliable.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Financial events or conditions that may cast significant doubt on the

entity's ability to continue as a going concern does not include
(a) Inability to comply with the terms of loan agreements.
(b) Inability to pay creditors on due dates.
88 AUDITING AND ETHICS

(c) Shortage of important supplies.

(d) Substantial operating losses.
2. Which type of audit report will the auditor issue, if the use of going
concern basis of accounting is appropriate, but a material uncertainty
exists and adequate disclosure of the material uncertainty is made in the
financial statements by the management?
(a) Adverse opinion.
(b) Disclaimer of opinion.
(c) Unmodified opinion.

(d) Qualified opinion.

3. If the auditor is of the opinion that the written representations are not
reliable, what type of audit opinion should be issued by him?
(a) Disclaimer of opinion.
(b) Adverse opinion.
(c) Unmodified opinion and mention the facts in Other Matters
Paragraph.
(d) Unmodified opinion and mention the facts in Emphasis of Matter
Paragraph.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (c) Shortage of important supplies.

Reason:
As per SA 570, “Going Concern”, shortage of important supplies does not
comes under events or conditions that may cast significant doubt on the
entity’s ability to continue as a going concern.
2. Option (c) Unmodified opinion.
Reason:
As per SA 570, “Going Concern”, the auditor shall issue unmodified
opinion if the use of going concern basis of accounting is appropriate,
 CASE SCENARIOS 89

but a material uncertainty exists, and adequate disclosure of the material

uncertainty is made in the financial statements by the management

3. Option (a) Disclaimer of opinion.

Reason:
If the auditor concludes that the written representations are not reliable,
the auditor shall take appropriate actions, including determining the
possible effect on the opinion in the auditor’s report in accordance with
SA 705, having regard to the requirement of disclaimer of opinion.
90 AUDITING AND ETHICS

CASE SCENARIO 22

Renu & Associates have been appointed as the auditors for Kailash Ltd., a
manufacturing industry, for the financial year 2023-24. During the audit, one of the
Engagement Partner CA Renu noticed a significant increase in raw material
consumption in comparison to previous years, despite a decrease in production
volumes. This raised concerns, instigating a detailed review of the vendors
supplying these raw materials. Upon inquiry, the management explained that the
company had transitioned to a new vendor offering premium materials to improve
product quality.

Additionally, CA Renu observed that several credit notes were issued after the end
of the accounting period.
During the verification of immovable properties, she discovered that Kailash Ltd.
had pledged one of its commercial properties as security for a bank loan. However,
the company did not possess the original title deeds for that property.
Further, CA Renu conducted a stock audit of a borrower availing a cash credit
facility of ₹ 100 lacs from a bank branch. The cash credit facility was secured against
paid stocks and debtors up to 90 days, with a margin of 25% for stocks and 40%
for debtors. She observed that the computed drawing power of ₹ 82.50 lacs was
incorrect, based on the following information as on 31.12.2023:

Value of stocks ` 125 lacs

Value of stocks (fully damaged) included in above ` 5 lacs
Value of debtors ` 50 lacs
Value of debtors exceeding 90 days included in above ` 10 lacs
Value of creditors for goods ` 50 lacs

Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. What audit procedure should auditor perform to check ownership of

commercial property discussed in the scenario?
 CASE SCENARIOS 91

(a) The auditor should request management to obtain confirmation

from the bank for holding original title deeds of pledged immovable
property are held as security.

(b) The auditor can obtain a list of immovable properties from

management at Kailash Ltd., along with management’s
representation regarding the ownership of these properties.

(c) If the auditor is unable to verify the original title deeds of the
pledged property, they may need to qualify the audit report
accordingly.

(d) The auditor can assume ownership of immovable properties without

obtaining a written representation from management, as long as
there is a general understanding of the assets.

2. Which assertion is the auditor evaluating while verifying the existence of

vendors and the actual receipt of goods or raw materials by the company?

(a) Occurrence.

(b) Completeness.

(c) Measurement.

(d) Existence.

3. What could be the possible reasons for issuing credit notes after the end
of the accounting period as mentioned in the above case?

(a) Fictitious sales by the sales team to meet targets and cancel out
those sales later with a credit note.

(b) Ensuring necessary corrections are reflected in the financial records

for accuracy.

(c) When issues arise that lead to customer dissatisfaction, credit notes
may be issued to resolve these disputes amicably.

(d) Such adjustments may be made based on negotiations or changes

in market conditions that occurred post-period.
92 AUDITING AND ETHICS

4 In the given case, CA Renu found that the drawing power calculated was
incorrect. What should be the correct drawing power?
(a) ₹ 75.00 lacs.
(b) ₹ 76.50 lacs.
(c) ₹ 78.00 lacs.
(d) ₹ 74.50 lacs.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (a) The auditor should request management to obtain

confirmation from the bank for holding original title deeds of pledged
immovable property are held as security.
Reason:
The auditor should insist and verify the original title deeds for all
immoveable properties held as at the balance sheet date. In case the
entity has given such immoveable property as security for any borrowings
and the original title deeds are not available with the entity, the auditor
should request the entity’s management for obtaining a confirmation
from the respective lenders that they are holding the original title deeds
of immoveable property as security.
2. Option (a) Occurrence.
Reason:
While testing occurrence assertion, auditor checks whether any fictitious
vendors have been booked or purchases have been recorded by reviewing
the vendor selection process followed by the entity and also performing
procedures to ensure existence of the vendors.
3. Option (a) Fictitious sales by the sales team to meet targets and cancel
out those sales later with a credit note.
Reason:
Auditors should verify the credit notes issued after the accounting period.
Sometimes sales team or sales personnel can make fictitious sales before
 CASE SCENARIOS 93

the year end to meet performance target and cancel out those sales with
a post year end credit note.
4. Option (b) ₹ 76.50 lacs.
Reason:
The computation of Drawing power is as under: -

Particulars Amount
(` In lacs)
Value of stocks as on 31.12.23 125
Less: value of damaged stocks (5)
120
Less: creditors for goods as on 31.12.23 (50)
Value of Paid stocks 70.00
Less: Margin @ 25% (17.50)
Drawing power (A) 52.50
Value of debtors as on 31.12.23 50
Less: debtors exceeding 90 days (10)
40
Less: Margin @ 40% (16)
Drawing Power (B) 24
Drawing Power (A+B) 76.50

The drawing power calculated by CA P is not proper. Drawing Power

comes to ` 76.50 lacs.
94 AUDITING AND ETHICS

CASE SCENARIO 23

CA Neel has accepted the offer of appointment of an auditor of an entity. As

business carried on by the entity is new to him, he wants to gain an
understanding about the entity and its environment including its internal
control. In this regard, he has performed procedures to obtain audit evidence
about design and implementation of relevant controls. He has performed
various procedures like inquiry, inspection and observation in this regard.
He wants reasonable assurance that the accounting system is adequate and
that all accounting information which should be recorded has, in fact, been
recorded.
Further, during the course of audit, he has noticed as under:
• As required by the management, bank reconciliation is required to be
performed monthly. However, the same is not carried out as stipulated
due to time constraints faced by accountant.
• The entity has a system of procuring its raw material supplies on the
basis of valid purchase orders issued by the entity. However, purchase
orders are not numbered in a sequence properly.
• Wage sheets are not verified by a responsible official as required by
management.
Staff of the entity is responsible for bringing cash from centers in
nearby areas to entity’s premises from where it is deposited into
entity’s bank account. However, the concerned officer has not renewed
insurance for cash in transit.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. The auditor has performed procedures to obtain audit evidence about

design and implementation of controls. Which of the following
procedures is more reliable to obtain audit evidence relating to
application of a control?
 CASE SCENARIOS 95

(a) Observing application of control.

(b) Inspecting documentation pertaining to control.
(c) Inquiry about application of control.
(d) Studying design of control.
2. Examination and evaluation of internal control is indispensable for
CA Neel. It provides him necessary comfort relating to completeness of
accounting information. However, review of internal controls of the entity
will not enable him to know__________________.
(a) whether errors or frauds are likely to be located in ordinary course
of operations of business.
(b) whether an effective internal audit department is operating.
(c) whether his opinion needs modification.
(d) whether any administrative control has bearing on his work.
3. As regards weaknesses identified by the auditor in control system, which
of the following represent(s) significant deficiencies in internal control?
(a) Not performing bank reconciliation timely and not verifying wage
sheets by responsible official only.
(b) Not performing bank reconciliation timely and lack of proper
sequence in purchase orders only.
(c) Not performing bank reconciliation timely, lack of proper sequence
in purchase orders, not verifying wage sheets by responsible official
and lack of insurance for cash in transit.
(d) Lack of insurance for cash in transit only.
4. Which of the following is most appropriate regarding auditor’s
responsibility in accordance with SA 265?
(a) To communicate significant deficiencies in internal control to
management.
(b) To communicate significant deficiencies in internal control along
with explanation of their potential effects to management.
96 AUDITING AND ETHICS

(c) To communicate significant deficiencies in internal control along

with explanation of their potential effects, to provide sufficient
information to understand context of communication to
management and express opinion on effectiveness of internal
control.
(d) To communicate significant deficiencies in internal control along
with explanation of their potential effects and to provide sufficient
information to understand context of communication to
management.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (a) Observing application of control.

Reason:

Observation consists of looking at a process or procedure being

performed by others. Observation provides audit evidence about the
performance of a process or procedure, but is limited to the point in time
at which the observation takes place, and by the fact that the act of being
observed may affect how the process or procedure is performed.
2. Option (c) Whether his opinion needs modification.
Reason:

The review of internal controls will not enable the auditor to know
whether his opinion needs modification.
3. Option (c) Not performing bank reconciliation timely, lack of proper
sequence in purchase orders, not verifying wage sheets by responsible
official and lack of insurance for cash in transit.
Reason:
The significance of a deficiency or a combination of deficiencies in internal
control depends not only on whether a misstatement has actually
occurred, but also on the likelihood that a misstatement could occur and
the potential magnitude of the misstatement. Significant deficiencies
may, therefore, exist even though the auditor has not identified
misstatements during the audit.
 CASE SCENARIOS 97

4. Option (d) To communicate significant deficiencies in internal control

along with explanation of their potential effects and to provide sufficient
information to understand context of communication to management.
Reason:
Communication in writing significant deficiencies in internal control
identified during the audit to those charged with governance on a timely
basis giving their description, explanation of potential effects and
sufficient information by the auditor to those charged with governance
and management to understand context of communication.
98 AUDITING AND ETHICS

CASE SCENARIO 24

Hill Ltd., a company engaged in the business of trekking essentials,

appointed CA Gagan as the statutory auditor for the year. Due to the large
volume of transactions of the company, the audit engagement team of
CA Gagan realised that it would not be feasible to audit each transaction
separately during the financial year under audit. Therefore, the Engagement
Partner decided to apply following audit sampling techniques:
• Random number tables were used for selection of sample for power,
telephone, and fuel charges.

• No structured method of sampling was used for office stationery.

• Transactions exceeding ` 8,000 were selected for travel expenses.
• The first 200 sales invoices from the sales book for the month of July
were selected for sales.
Mr. Kush, one of the team members, compared the salary expenses incurred
by the company during the current year with those of the previous five years.
He noticed a significant percentage increase in the expenses. This unusual
increase raised doubts in his mind. He decided to compare such an increase
in salary expenses with the increase in the number of employees.

The company is having warehouse at 2 locations. CA Gagan is planning to

attend the physical inventory count process. The inventory includes finished
products such as trekking jackets, bags, shoes etc., and raw materials like
leather, cloth, chemicals, etc. Some of the inventory is also held by a third
party.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Which of the sampling techniques were used for the following

transactions?
(i) Power, telephone and fuel charges.
(ii) Office Stationery.
 CASE SCENARIOS 99

(iii) Travel expenses.

(iv) Sales.
(Answer in the given order)
(a) Random sampling, Systematic sampling, Monetary unit sampling,
Block sampling.

(b) Systematic sampling, Random sampling, Block sampling, Haphazard

sampling.
(c) Random sampling, Haphazard sampling, Monetary unit sampling
and Block sampling.
(d) Random sampling, Haphazard sampling, Monetary unit sampling
and Systematic sampling.
2. Which audit procedure was Mr. Kush intended to perform by comparing
salary expenses?
(a) Test of details.
(b) Test of balances.
(c) Test of control.

(d) Substantive analytical procedure.

3. Which of the following is not part of CA Gagan’s responsibility with
respect to the inventories held by the third parties?
(a) CA Gagan should request confirmation from the third party
regarding the quantity and condition of the inventory held by them.

(b) CA Gagan should perform an independent valuation of the

inventory based solely on the company’s internal records.
(c) CA Gagan should request the third party to allow him to physically
inspect the inventories held by them.
(d) CA Gagan should review the terms of the agreement between the
company and the third party to understand the responsibilities
related to inventory management.
100 AUDITING AND ETHICS

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (c) Random sampling, Haphazard sampling, Monetary unit

sampling and Block sampling.
Reason:
Random Sampling: Random selection ensures that all items in the
population or within each stratum have a known chance of selection.
Haphazard sampling: Haphazard selection, in which the auditor selects
the sample without following a structured technique.

Monetary Unit Sampling: It is a type of value-weighted selection in

which sample size, selection and evaluation results in a conclusion in
monetary amounts.
Block Sampling: This method involves selection of a block(s) of
contiguous items from within the population.
2. Option (d) Substantive analytical procedure.
Reason:
Trend analysis is a commonly used technique of substantive analytical
procedure. It is the comparison of current data with the prior period
balance or with a trend in two or more prior period balances. The auditor
evaluates whether the current balance of an account moves in line with
the trend established with previous balances for that account, or based
on an understanding of factors that may cause the account to change.
3. Option (b) CA Gagan should perform an independent valuation of the
inventory based solely on the company’s internal records.

Reason:
Performing an independent valuation of the inventory based solely on the
company’s internal records is not part of CA Gagan’s responsibility with
respect to the inventories held by the third parties.
 CASE SCENARIOS 101

CASE SCENARIO 25

PKH & Associates, a Chartered Accountant firm, is practicing in Mumbai since

last two decades. Rahul got the opportunity to work as an article clerk with PKH
& Associates. After completion of formalities of article clerk registration, Rahul
is placed in the statutory audit team of the firm. CA P, the partner heading audit
team, planned to take Rahul in the audit work of M/s Fox India Limited for the
financial year 2023-24. Till last year, CA K was the head of the audit team for
audit of M/s Fox India Limited. As it is the first assignment of Rahul, he was
instructed by the partner to go through the audit file of M/s Fox India Limited
for the financial year 2022-23 and familiarise himself with audit procedures and
methodology to be followed for upcoming audit assignment.
On-going through the audit file of F.Y. 2022-23, Rahul found revised
engagement letter, other working papers relating to MAT & Deferred tax
calculations and the following extract on verification of expenses:
Name of concern M/s. Fox India Limited
Financial Year 2022-23
Prepared by D (05.05.2023)
Reviewed by F (06.05.2023)
Approved by CA K (07.05.2023)

Sr. Nature of Procedure Extent of Basis of Sample Done

No. Check by
1. Vouch few expense invoices 10% Random Sampling D
available in record of concern
2. Trace these invoices into the 10% Random Sampling D
account books of the concern.
3. Verify few invoices with the 10% Random Sampling D
GST data of the concern

Rahul immediately drafted a revised engagement letter for the financial year
2023-24 and also specified the scope of audit to include the following statements:
102 AUDITING AND ETHICS

Statement I: Reliability and sufficiency of financial information,

Statement II: Proper disclosure of financial information,
Statement III: Responsibility of an auditor to prepare the financial statements, and
Statement IV: Coverage of all aspects of entity relevant to the financial statements
being audited.
He thought that it is mandatory to obtain engagement letter every year and
handed over revised draft to CA P. CA P is surprised as to why Rahul drafted the
same and explained him the situations under which it is necessary to obtain a
revised engagement letter.
Before finalising the audit report of M/s. Fox India Limited for the F.Y. 2023-24,
Rahul performed the following procedures regarding subsequent events:
(i) Obtained an understanding of procedures established by the company to
ensure that subsequent events are identified.
(ii) Inquired management of the company as to whether any subsequent
events have occurred which affects the financial statements as on
31.03.2024.
(iii) Read the entity's latest subsequent interim financial statements.
(iv) Read the minutes of meetings of M/s. Fox India Limited that have been
held up to 31.03.2024.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Which of the following would not form part of the explanation given by
CA P to Rahul?

(a) A recent change of senior management.

(b) A significant change in nature or size of the entity's business.
(c) Replacement of CA K by CA P.

(d) A change in legal or regulatory requirements.

2. Which of the statements included by Rahul in revised draft engagement
letter is incorrect?
 CASE SCENARIOS 103

(a) Statement I.
(b) Statement II.
(c) Statement III.
(d) Statement IV.
3. How will you categorise the information pertaining to F.Y. 2022-23 in
relation to extract found?
(a) The same was a part of Audit plan.
(b) The same was a part of Audit programme.

(c) The same was a part of Audit guidelines.

(d) The same was a part of Audit procedures.

4. Which of the audit procedure performed (before finalising the audit

report of M/s. Fox India Limited) by Rahul is not as per SA 560?
(a) Procedure (i).

(b) Procedure (ii).

(c) Procedure (iii).

(d) Procedure (iv).

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (c) Replacement of CA K by CA P.

Reason:
As per SA 210 replacement of head of audit team does not comes under
factor that may make it appropriate to revise the terms of the audit
engagement or to remind the entity of existing terms.
2. Option (c) Statement III.
Reason:
Scope of audit of financial statements:
• Coverage of all aspects of entity relevant to the financial statements
being audited.
104 AUDITING AND ETHICS

• Reliability and Sufficiency of financial information.

• Proper disclosure of financial information.
• Expression of an opinion on financial statements.
3. Option (b) The same was a part of Audit programme.
Reason:
An audit programme is a detailed plan of applying the audit procedures
in the given circumstances with instructions for the appropriate
techniques to be adopted for accomplishing the audit objectives.

4. Option (d) Procedure (iv).

Reason:
Reading minutes, if any, of the meetings, of the entity’s owners,
management and those charged with governance, that have been held
after the date of the financial statements and inquiring about matters
discussed at any such meetings for which minutes are not yet available.
 CASE SCENARIOS 105

CASE SCENARIO 26

CA F has been appointed as an auditor of a manufacturing entity. Pursuant to

appointment, CA F planned to assess the risk of material misstatement. During
this process, CA F observed that entity has identified various controls to
mitigate the risk. The entity has implemented a control (named TARGET) whose
objective is to ensure that production systems are processed to meet financial
reporting objectives.
On completion of risk assessment procedure, CA F was wandering as to how he
can verify the existence of related party relationships and transactions. So, he
consulted one of his colleagues, CA Z, who suggested following ways to identify
the same:
(1) Information supplied by the entity to regulatory authorities.
(2) Entity's income tax returns.
(3) Inventory records maintained by the entity.
(4) Life insurance policies acquired by the entity. On-going through the
financial statement provided by the entity, CA F observed that the entity
has significantly borrowed the amount during the financial year 2023-24.
CA F wanted to ensure that all borrowing on the balance sheet represent
valid claims by banks or other third parties. Accordingly, he performed
the following procedures:
(i) Reviewed subsequent transactions after the end of the reporting
period.
(ii) Recomputed the interest on borrowing.
(iii) Reviewed board minutes for approval of new lending agreements.

(iv) Agreed loan balance and loan payables to the loan agreement.
CA F decided to perform analytical procedures to obtain audit evidence as to
overall reasonableness of purchase quantity and price. For this, CA F scrutinised
raw material consumed as per manufacturing account and compared the same
with previous years with closing stock. The variations observed were discussed
with the management of the entity.
106 AUDITING AND ETHICS

Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Control "TARGET" will be categorised in which of the following?

(a) Data center and network operations.
(b) Program Control.

(c) Processing control.

(d) Application Control.
2. Which of the procedures performed by CA F is suitable for satisfaction of
concern regarding borrowing?
(a) Procedure (i).
(b) Procedure (ii).
(c) Procedure (iii).
(d) Procedure (iv).
3. Do you agree with all the ways suggested by CA Z to CA F?
(a) No. Suggestion (i) is not correct.
(b) No. Suggestion (ii) is not correct.
(c) No. Suggestion (iii) is not correct.

(d) No. Suggestion (iv) is not correct.

4. CA F performed which of the following analytical procedures to obtain
the audit evidence with respect to the overall reasonableness of
purchase quantity and price of raw material?
(a) Consumption Analysis.
(b) Stock Composition Analysis.

(c) Trend Analysis.

(d) Ratio Analysis.
 CASE SCENARIOS 107

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (a) Data center and network operations.

Reason:

The objective of controls over Data centre and network operations is to

ensure that production systems are processed to meet financial reporting
objectives.
2. Option (c) Procedure (iii).
Reason:
To ensure that all borrowing on the balance sheet represent valid claims
by banks or other third parties, auditor should review board minutes for
approval of new lending agreements.
3. Option (c) No. Suggestion (iii) is not correct.
Reason:
During the audit, the auditor should maintain alertness for related party
information while reviewing records and documents. He may inspect the
following records or documents that may provide information about
related party relationships and transactions. He will not inspect inventory
records maintained by the entity for verifying the existence of related
party relationships and transactions.
4. Option (a) Consumption Analysis.
Reason:

In Consumption Analysis, auditor should scrutinise raw material

consumed as per manufacturing account and compare the same with
previous years with closing stock and ask for the Reasons from the
management, if any significant variations are found.
108 AUDITING AND ETHICS

CASE SCENARIO 27

GNH & Co., Chartered Accountants, has been appointed as the statutory branch
auditors of Chandigarh branch of HFC Bank, a nationalised bank. While carrying
out the audit, the following key issues were identified:
Issue 1: Consortium Cash Credit Facility granted to X Ltd.: HFC Bank is a
consortium member providing cash credit facilities of ` 50 crores to X Ltd., with
HFC's share being ` 10 crores. Over the past two quarters, interest amounting
to ` 1.75 crores have been debited in cash credit account of X Ltd., while credits
in the account amounts to only ` 1.25 crores. Despite this shortfall, the account
has been classified as performing asset, based on a certificate from the lead
bank (UNC Bank Limited).
Issue 2: Asset Classification of SJ Ltd.: SJ Ltd.'s account has seen no recovery for
the past 18 months. However, the bank has not applied NPA norms or income
recognition norms to this account. The management justifies this by stating that
the account is guaranteed by the Central Government and that NPA and income
recognition norms are not applicable. Government has not invoked the
guarantee.
Issue 3: Loan Application from ABC Traders: ABC Traders has applied for a cash
credit limit from HFC Bank for supporting working capital requirements on
account of business expansion. In discussions with ABC Traders, HFC Bank has
requested different forms of security, depending on the nature of the assets
offered, which includes immovable property (warehouse), goods in stock,
accounts receivable, and insurance policies. Borrower provided the security and
was sanctioned cash credit limit of ` 4.50 Crores.

Issue 4: Precision Engineering (one of the borrowers of the branch) has utilised
the entire sanctioned cash credit limit of ` 300.00 Lacs. Outstanding balance as
on 31 March 2024 is ` 308.00 Lacs. Bank classified the account as Substandard
Asset. One fine day DGM (Inspection) of Bank was passing through the area in
which borrower is located and observed that building occupied by the borrower
is damaged and there is no machinery, stock and other assets available in the
premises. Borrower was not available telephonically and no contact could be
made with him. He ordered independent verification of assets and report was
 CASE SCENARIOS 109

submitted that no security mortgaged with bank is available. Report has been
accepted by the bank authorities. Only a piece of land with realisable value
` 25 Lacs is available as of now. Bank made a provision in its books of accounts
considering the account as Substandard Asset.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Whether the asset classification of account of X Limited is correct?

(a) Classification is correctly done on the basis of certificate provided
by UNC Bank Limited.
(b) Classification is correctly done subject to confirmation from the
Central statutory auditor of the bank.

(c) Classification is correctly done subject to confirmation from the

Central statutory auditor of the bank and also other parameters
specified in the RBI guidelines have been followed.
(d) Classification is not in order as classification has to be done on the
basis of record of recovery of the HFC Bank only.
2. Is the bank's decision not to apply NPA and income recognition norms to
account of SJ Ltd. valid under regulatory guidelines?
(a) The bank is correct to the extent of not applying the NPA norms for
provisioning purposes. However, this exemption is not available in
respect of income recognition norms.
(b) The bank is not correct for not applying the NPA norms for
provisioning purposes. But this exemption is available in respect of
income recognition norms.
(c) The bank is correct in not applying the NPA norms and income
recognition norms as both are not applicable.
(d) The bank is not correct in not applying the NPA norms and income
recognition norms as both are applicable.
3. ABC Traders offered its warehouse as security for the loan. HFC Bank
created a charge on the warehouse. Which form of security has been
110 AUDITING AND ETHICS

created and whether bank is required to get stock audit done of cash
credit account of ABC Traders?

(a) Security created is Pledge and bank is required to get stock audit
done of cash credit account of ABC Traders.
(b) Security created is Mortgage and bank is required to get stock audit
done of cash credit account of ABC Traders.
(c) Security created is Pledge and bank is not mandatorily required to
get stock audit done of cash credit account of ABC Traders.

(d) Security created is Mortgage and bank is not mandatorily required

to get stock audit done of cash credit account of ABC Traders.
4. Whether correct classification and provisioning norms have been applied
in the account of Precision Engineering?
(a) The account is correctly classified, but provision should be made for
100% of the unsecured portion besides making specified provision
on secured portion.
(b) The account should have been classified as Doubtful asset and
besides making required provision on secured portion, provision
should have been made for 100% of the unsecured portion.
(c) The account should have been classified as loss asset and full
provision should have been made in the books of accounts.
(d) The account should have been classified as Doubtful asset and full
provision should have been made in the books of accounts.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (d) Classification is not in order as classification has to be done

on the basis of record of recovery of the HFC Bank only.
Reason:

Consortium advances should be based on the record of recovery of the

respective individual member banks and other aspects having a bearing
on the recoverability of the advances. Where the remittances by the
borrower under consortium lending arrangements are pooled with one
 CASE SCENARIOS 111

bank and/or where the bank receiving remittances is not parting with the
share of other member banks, the account should be treated as not
serviced in the books of the other member banks and therefore, will be
classified as an NPA.
2. Option (a) The bank is correct to the extent of not applying the NPA
norms for provisioning purposes. However, this exemption is not available
in respect of income recognition norms.
Reason:

Central Government guaranteed Advances, where the guarantee is not

invoked/ repudiated would be classified as Standard Assets but regarded
as NPA for Income Recognition purpose.
3. Option (d) Security created is Mortgage and bank is not mandatorily
required to get stock audit done of cash credit account of ABC Traders.
Reason:
A pledge involves bailment or delivery of goods by the borrower to the
lending bank with the intention of creating a charge thereon as security
for the advance. In case of Assets security created is Mortgage. Further,
the stock audit should be carried out by the bank for all accounts having
funded exposure of more than 5 crores in the given case cash credit limit
is ` 4.50 Crores.
4. Option (c) The account should have been classified as loss asset and full
provision should have been made in the books of accounts.
Reason:

If the realisable value of the security, as assessed by the bank/ approved

valuers/ RBI is less than 10% of the outstanding in the borrower accounts,
the existence of security should be ignored and the asset should be
straight-away classified as loss asset. It may be either written off or fully
provided for by the bank.
112 AUDITING AND ETHICS

CASE SCENARIO 28

A government department has been allocated a budget for infrastructure

development. During the audit, the auditor observed several discrepancies that
raise concern regarding the management and utilisation of funds. The key
findings include:
• Some payments were processed without proper approval from the
competent authority.
• A large-scale project was implemented, but no assessment was made to
determine whether the expected benefits were achieved or not.
• Funds were utilised from an account for which no budgetary provision had
been made.
• Certain expenditures were made without adhering to prescribed financial
regulations.
• There were instances of unnecessary spending that did not align with the
principles of financial propriety.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Which type of audit would most likely identify the issue of payments
processed without proper approval from the competent authority?

(a) Audit against Rules & Orders.

(b) Audit of Sanctions.
(c) Audit against Provision of Funds.

(d) Propriety Audit.

2. Which type of audit would evaluate whether the expected benefits of a
large-scale infrastructure project were achieved?

(a) Propriety Audit.

(b) Audit against Rules & Orders.
 CASE SCENARIOS 113

(c) Audit of Sanctions.

(d) Performance Audit.
3. Out of the following, which audit would address the issue of funds being
utilised from an account with no budgetary provision?
(a) Audit against Provision of Funds.

(b) Audit of Sanctions.

(c) Performance Audit.
(d) Audit against Rules & Orders.

4. Which audit type would be relevant to detect expenditures made without

following prescribed financial regulations?
(a) Performance Audit.
(b) Audit against Rules & Orders.
(c) Audit against Provision of Funds.
(d) Audit of Sanctions.

5. What type of audit would most effectively identify instances of

unnecessary spending that do not align with financial propriety?
(a) Performance Audit.

(b) Audit of Sanctions.

(c) Propriety Audit.
(d) Audit against Rules & Orders.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) Audit of Sanctions.

Reason:
When payments are processed without proper approval from the
competent authority, an Audit of Sanctions is required. This ensures that
there is sanction, either special or general, accorded by competent
authority authorising the expenditure.
114 AUDITING AND ETHICS

2. Option (d) Performance Audit.

Reason:
In cases where a large-scale project has been implemented without any
assessment of whether the expected benefits were achieved, a
Performance Audit is necessary. This type of audit ensures that the various
programmes, schemes and projects where large financial expenditure has
been incurred are being run economically and are yielding results
expected of them.
3. Option (a) Audit against Provision of Funds.
Reason:
When funds were utilised from an account for which no budgetary
provision was made, an Audit Against Provision of Funds is conducted.
This ensures that there is a provision of funds out of which expenditure
can be incurred and the same has been authorised by competent
authority.
4. Option (b) Audit against Rules & Orders.
Reason:
If expenditure is made without adhering to the prescribed financial
regulations, an Audit Against Rules and Orders is applicable. This audit
ensures that the expenditure incurred conforms to the relevant provisions
of the statutory enactment and in accordance with the Financial Rules and
Regulations framed by the competent authority.
5. Option (c) Propriety Audit
Reason:
Instances of unnecessary spending that do not align with financial
propriety fall under the scope of a Propriety Audit. It ensures that the
expenditure is incurred with due regard to broad and general principles
of financial propriety.
 CASE SCENARIOS 115

CASE SCENARIO 29

CA Sumit, working in BRS & Associates, Chartered Accountants, has been

assigned to prepare the year-end financial statements for a rapidly growing
tech startup, "InnoTech". The company has been under pressure to show
strong financial results to attract new investors. Sumit's manager, Viraj, has
instructed him to arrange some of the numbers, particularly the reported
revenues and expenses, to present a more favourable picture of the
company’s financial health.
During the preparation of the Financial Statements, CA Sumit noticed several
irregularities, such as overstated revenues and understated liabilities.
Although these adjustments are not explicitly illegal, they could mislead
investors and stakeholders. Sumit also knows that Viraj has developed good
family terms with the CEO of InnoTech over the year.
As Sumit continues working on the financial statements, he realised that the
pressure to comply with Viraj's requests could violate his fundamental
principles of professional ethics. He must decide whether to sign off on the
reports or to raise his concerns, risking his professional relationship with
Viraj and the firm.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Which of the following fundamental principles of ethics is being violated

when Sumit was instructed to present a more favourable picture of the
company's financial health?
(a) Professional competence and due care.
(b) Integrity.

(c) Objectivity.
(d) Professional behaviour.
2. Which type of threat arises in case of development of relationship with
CEO of InnoTech?
116 AUDITING AND ETHICS

(a) Advocacy Threat.

(b) Self-interest Threat.
(c) Intimidation Threat.
(d) Familiarity Threat.
3. Which principle would Sumit violate if he disclosed financial details to a
third party without the permission of the company?
(a) Integrity.
(b) Professional behaviour.

(c) Confidentiality.
(d) Professional competence and due care.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) Integrity.

Reason:
A professional accountant shall comply with the principle of integrity,
which requires an accountant to be straightforward and honest in all
professional and business relationships. Integrity implies fair dealing and
truthfulness.
2. Option (d) Familiarity Threat.
Reason:
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.
3. Option (c) Confidentiality.

Reason:
Confidentiality principle requires a professional accountant to respect the
confidentiality of information acquired as a result of professional or
business relationships.
 CASE SCENARIOS 117

CASE SCENARIO 30

CA B is conducting statutory audit of branch of a nationalised bank. Saurabh, a

CA student, is also part of engagement team conducting statutory branch audit.
The field of bank branch audit is new to him, and he is following instructions as
required by engagement partner.
The engagement partner has asked him to prepare a summary of non-funded
credit facilities outstanding as on balance sheet date. The following information
is appearing in branch’s CBS data/records as on 31st March 2024:

Serial Particulars in CBS (Core Banking solution)/ Amount

number records in ` crores
1. Agricultural term loans 15.00
2. Staff housing loans 3.50
3. Staff vehicle loans 0.20
4. Housing loans-General public 10.00
5. Letters of credit issued 2.50
6. Education loans 1.50
7. Guarantees issued (Fully secured by 100% margin) 1.00
8. Bills purchased and discounted 2.00
9. Bills for collection 0.10

On going through listing of housing loans to general public, CA B notices that

branch has sanctioned many housing loans of small ticket size ranging between
` 10.00 lakhs to ` 20.00 lakhs. Therefore, he has assessed risk of material
misstatements to be high. Consequently, he has designed procedures to
perform tests of controls as well as substantive tests.
Saurabh has been further asked to go through SMA (Special Mention Accounts)
jotting as on 30th November 2023. Such reports are available from system on
monthly frequency. Being new to such type of assignment, he is unable to
understand relevance of above audit procedure mandated by engagement
partner.
Based on the above facts, answer the following MCQs:
118 AUDITING AND ETHICS

MULTIPLE CHOICE QUESTIONS

1. Considering table given in the case scenario, which of the following

combination is an appropriate example of non-funded credit facilities
provided by the branch to its customers?

(a) Bills purchased and discounted; bills for collection.

(b) Bills for collection; staff housing loans; letters of credit issued.

(c) Bills purchased and discounted; letters of credit issued; guarantees

issued (fully secured by 100% margin).

(d) Letters of credit issued, guarantees issued (fully secured by 100%

margin).

2. CA B’s decision to perform both tests of control as well as substantive

tests was taken after he had assessed risk of material misstatement in
financial statements to be high due to large number of small ticket size
loans. Which Standard on Auditing deals with auditor’s responsibility to
design such tests?

(a) SA 500.

(b) SA 330.

(c) SA 300.

(d) SA 315.

3. Saurabh is unable to understand the relevance of going through SMA

jotting as on 30th November 2023. Which of the following statement is
most appropriate in this context?

(a) It would necessarily help auditor in identifying accounts with

significant lending exposure.

(b) It would help auditor in identifying accounts which may involve

downgrading from Sub-standard asset category to doubtful
category.
 CASE SCENARIOS 119

(c) It would help auditor in identifying accounts where substantial

recoveries have been received during the year.

(d) It would help auditor in identifying accounts which may involve

downgrading from standard category to non-performing asset.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (d) Letters of credit issued, guarantees issued (fully secured by

100% margin).

Reason:
Non-funded facilities are those which do not involve such transfer.
Examples of non-funded loans are Letters of credit, Bank guarantees, etc.

2. Option (b) SA 330.

Reason:
SA 330, “The Auditor’s Responses to Assessed Risks”, states that: -

(i) The auditor shall design and implement overall responses to

address the assessed risks of material misstatement at the financial
statement level.

(ii) The auditor shall design and perform further audit procedures
whose nature, timing and extent are based on and are responsive to
the assessed risks of material misstatement at the assertion level.

3. Option (d) It would help auditor in identifying accounts which may

involve downgrading from standard category to non-performing asset.
Reason:

Special Mention Account (SMA) is an account which exhibits signs of

incipient stress resulting in the borrower defaulting in timely servicing of
debt obligations, though the account has not yet been classified as NPA
as per the RBI guidelines. Such a classification is significant as early
recognition of such accounts enables banks to initiate timely remedial
actions to prevent potential slippages of such accounts into NPAs.
120 AUDITING AND ETHICS

CASE SCENARIO 31

Wire Ltd. is a leading electronics manufacturer specialising in televisions and

accessories. The company has grown rapidly over the last few years, with a
significant increase in both employees and inventory. The company is currently
in the process of preparing its financial statements for the F.Y. 2023-24. The
company appointed CA Ravi for an independent audit to ensure compliance
with Accounting Standards and Standards on Auditing. CA Ravi, the auditor will
focus on key financial assertions and implement specific audit procedures for
the following items.

• Employee Benefit Expenses:

CA Ravi will review whether employee benefit expense has been incurred
during the period in respect of the personnel employed by the entity and
does not include the cost of any unauthorised personnel.
• Inventory:
(i) CA Ravi will check Inventory balance as at the year-end does not
include any element of next financial year. All items of inventory
pertaining to the relevant year shall be included regardless of the
location.
(ii) He will verify whether the entity owns or controls the inventory
recorded in the financial statements i.e. the purchase invoices have
been made in the name of client. Any inventory held by the entity
on behalf of another entity has not been recognised as part of
inventory of the entity.
(iii) He will also check that Inventory has been recognised at the lower
of cost and net realisable value in accordance with AS 2 -
Inventories.
(iv) He will also ensure that any costs that could not be reasonably
allocated to the cost of production and any abnormal wastage have
been excluded from the cost of inventory. An acceptable valuation
basis (e.g. FIFO, Weighted average etc.) has been used to value
inventory as at the period-end.
 CASE SCENARIOS 121

By performing these procedures, the auditor will ensure that the financial
statements reflect the true and fair financial position of the company.

Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Which assertion is the auditor testing when they verify that employee
benefit expenses do not include the cost of unauthorised personnel?
(a) Completeness.
(b) Occurrence.

(c) Valuation.
(d) Existence.
2. All the items of inventory pertaining to the relevant year shall be included
regardless of the location, which assertion is the auditor testing?
(a) Completeness.
(b) Accuracy.
(c) Rights and Obligations.
(d) Cut-off.
3. The auditor reviews purchase invoices have been made in the name of
client. Which assertion is he primarily testing?
(a) Valuation.
(b) Rights and Obligations.
(c) Completeness.
(d) Occurrence.
4. When the auditor assesses whether inventory has been valued at the
lower of cost and net realisable value, which assertion does he wants to
test?
(a) Valuation.
(b) Completeness.
122 AUDITING AND ETHICS

(c) Existence.
(d) Occurrence.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) Occurrence.

Reason:
As per Occurrence assertion the auditor is required to check that whether
employee benefit expense has been incurred during the period in respect
of the personnel employed by the entity.

2. Option (d) Cut-off.

Reason:
Since inventory balance as at the yearend does not include any element
of next financial year. All items of inventory pertaining to the relevant year
shall be included regardless of the location, here assertion tested by
auditor is Cut-off.

3. Option (b) Rights and Obligations.

Reason:
As per Rights and Obligations assertion the auditor needs to verify that
the entity owns or controls the inventory recorded in the financial
statements i.e. the purchase invoices have been made in the name of
client.
4. Option (a) Valuation.
Reason:
As per Valuation assertion the auditor assesses whether inventory has
been recognised at the lower of cost and net realisable value in
accordance with AS 2 - Inventories.
 CASE SCENARIOS 123

CASE SCENARIO 32

CA Nagar is the managing partner of Nagar & Co., a CA Firm. As part of the
firm’s annual review, CA Nagar assessed whether any independence threats
exist in the firm for the F.Y. 2023-24. The firm has recently taken on multiple
clients and engagements, and CA Nagar has noted a few observations
regarding the independence of the firm's staff and partners.
CA Nagar wants to classify and evaluate the threats to the firm’s independence
based on the observations received from the staff and partners for the year.
Observations:

Observation 1: CA P, a partner of the firm, performed both the statutory

audit and the non-audit engagement services for Green Pvt. Ltd.
Observation 2: CA L, a partner of the firm, who has done income tax audit
for M/s. Future Associates where in CA L has material significant indirect
financial interest.
Observation 3: Nagar & Co. accepted expensive gifts and hospitality
(including a luxury dinner) from the client after completing the year end
audit.
Observation 4: One of the clients, M/s. Walk Limited, threatened to replace
them as auditors because the audit team insisted to make provision for
expected credit loss which the company was not willing to provide.
CA Nagar needs to classify the threats to independence arising from each of
the above observations in order to identify the specific risks and mitigate
them.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Which threat to the firm’s independence exists in the case of CA P as

referred in Observation 1?
(a) Self-interest Threat.
124 AUDITING AND ETHICS

(b) Self-review Threat.

(c) Familiarity Threat.
(d) Intimidation Threat.
2. With reference to Observation 2 related to CA L, which type of threat
exists?

(a) Self-interest Threat.

(b) Familiarity Threat.
(c) Advocacy Threat.

(d) Intimidation Threat.

3. Which threat to independence is involved in Observation 3, wherein the
audit team accepted expensive gifts and hospitality from the client?
(a) Advocacy Threat.
(b) Self-interest Threat.
(c) Intimidation Threat.

(d) Familiarity Threat.

4. Identify the type of threat to independence on the basis of threat given
by client M/s. Walk Limited in the Observation 4.

(a) Intimidation Threat.

(b) Self-review Threat.
(c) Familiarity Threat.

(d) Advocacy Threat.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) Self-review Threat.

Reason:
When auditors perform services that are themselves subject matters of
audit, it will be considered as Self-review threat.
 CASE SCENARIOS 125

2. Option (a) Self-interest Threat.

Reason:
Self-interest threat includes direct financial interest or materially
significant indirect financial interest in a client.
3. Option (d) Familiarity Threat.

Reason:
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.
4. Option (a) Intimidation Threat.
Reason:
Intimidation threats occur when auditors are deterred from acting
objectively with an adequate degree of professional skepticism.
126 AUDITING AND ETHICS

CASE SCENARIO 33

Elite Fashions, a well-known retail brand with multiple outlets, has submitted its
financial statements for audit to CA Riya. As part of her review, she plans to
verify several key financial assertions and has outlined specific procedures for a
detailed examination.
(A) She intends to check major invoices recorded under the “Store
Renovation Expenses” account to ensure proper recording and
classification.
(B) She plans to confirm that all balances under trade receivables are genuine
and not overstated.
(C) She wants to compare advertising expenses incurred this year with the
previous year and analyse their relationship with total sales.
(D) She decides to review property documents for a newly acquired
showroom to confirm ownership.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. What type of audit test is CA Riya performing when verifying major

invoices in the “Store Renovation Expenses” account?

(a) Tests of Controls.

(b) Tests of Transactions.

(c) Tests of Balances.

(d) Risk Assessment Procedures.

2. Identify which type of assertion she intends to test when she wants to
ensure genuineness of trade receivables.

(a) Occurrence.

(b) Cut-off.
 CASE SCENARIOS 127

(c) Existence.

(d) Accuracy.

3. When analysing advertising expenses of the current and previous years

and their relationship with total sales, which type of audit procedure is
being performed by CA Riya?

(a) Tests of Details.

(b) Tests of Transactions.

(c) Tests of Balances.

(d) Substantive Analytical Procedures.

4. Which audit procedure is being performed by CA Riya by reviewing

property documents for the newly acquired showroom?

(a) Observation.

(b) Inspection.

(c) External Confirmation.

(d) Inquiry.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (b) Tests of Transactions.

Reason:

Tests of transactions ensure that individual transactions are correctly

recorded and classified.

2. Option (c) Existence.

Reason:

The existence assertion ensures that recorded trade receivables actually

exist and properly valued. By confirming their validity, CA Riya is checking
whether the amounts shown in the financial statements represent genuine
customer balances.
128 AUDITING AND ETHICS

3. Option (d) Substantive Analytical Procedures.

Reason:

Substantive analytical procedures involve identifying trends, patterns, and

relationships in financial data. By comparing advertising expenses across
two years and analysing their impact on sales, CA Riya is performing an
analytical review to detect any inconsistencies or unusual patterns.

4. Option (b) Inspection.

Reason:

Inspection involves examining records, documents, or tangible assets to

verify their authenticity. Reviewing the property documents ensures that
Elite Fashions has legal ownership of the newly acquired showroom,
making this an inspection procedure.
 CASE SCENARIOS 129

CASE SCENARIO 34

MA & Associates, a Chartered Accountant firm is appointed as an auditor of

XYZ Pvt. Ltd. Amit, partner of the firm, has recently bought stock in XYZ Pvt. Ltd.
He believes that the company's goodwill will increase after the audit report is
finalised, which could lead to a rise in stock price. As he reviews the company’s
financial statements, Amit decides to give unmodified opinion to help his
investment.
During the audit of trade receivables, Amit selects a sample using a technique
that ensures larger balances have a higher chance of being selected. However,
this approach results in the exclusion of many smaller balances, potentially
overlooking some crucial misstatements.
Meera, another Partner of Firm, is reviewing calculation of software
development costs method adopted by XYZ Pvt. Ltd. Meera helped in creating
this method earlier. She worries that her previous involvement in this method
might affect her ability to review it.
Meanwhile, Raj, the CEO of XYZ Pvt. Ltd., has requested them to modify certain
disclosures in the financial statements in a way that could mislead stakeholders.
He argues that a more favourable presentation will help the company secure
additional investments. Meera feels that complying with this request would
compromise ethical standards and worries about potential conflicts with the
client.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Amit has bought stock in XYZ Pvt. Ltd., and his investment could benefit
from issuance of unmodified opinion in his audit report. This indicates
existence of:

(a) Self-interest Threat.

(b) Self-review Threat.

(c) Advocacy Threat.

(d) Familiarity threat.

130 AUDITING AND ETHICS

2. In the given case, Amit is selecting a sample to verify the trade receivables
balances where larger balances have a higher chance of being included,
causing smaller balances to be overlooked. This method is known as:

(a) Random Sampling.

(b) Systematic Sampling.

(c) Block Sampling.

(d) Monetary Unit Sampling.

3. Meera is reviewing a method for calculating software development costs

that she helped in creating while working at XYZ Pvt. Ltd. This may involve:

(a) Advocacy Threat.

(b) Self-interest Threat.

(c) Familiarity Threat.

(d) Self-review Threat.

4. Raj, the CEO, is requesting the Meera and Amit to modify the financial
statement disclosures in a misleading manner. Which fundamental
principle of professional ethics would be violated if they agree to do so?

(a) Integrity.

(b) Objectivity.

(c) Confidentiality.

(d) Professional Competence and Due Care.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (a) Self-interest Threat.

Reason:
Self-interest threat includes direct financial interest or materially
significant indirect financial interest in a client.
 CASE SCENARIOS 131

2. Option (d) Monetary Unit Sampling.

Reason:
In the given case, Amit used a sampling method where larger balances
have a higher chance of being selected. Monetary Unit Sampling is a
value-weighted selection method where each monetary unit in the
population has an equal chance of being chosen. This approach increases
the likelihood of selecting high-value items but may overlook smaller
balances, potentially missing some misstatements.
3. Option (d) Self-review Threat.
Reason:
When auditors perform services that are themselves subject matters of
audit, it will be considered as Self-review threat.
4. Option (a) Integrity.
Reason:

If the auditors modify disclosures in a misleading manner as requested by

Raj, they would violate the fundamental principle of Integrity, which
requires accountants to be straightforward and honest in all professional
relationships.
132 AUDITING AND ETHICS

CASE SCENARIO 35

DS & Co., Chartered Accountants, are statutory auditors of SAR Industries Pvt.
Ltd., a company engaged in manufacturing business since 2018. The company
operates from rented premises, and it does not have building of its own. It had
upgraded its machinery last time in 2020. Except interest in this company,
promoters, directors, key managerial persons and their relatives do not have
interest or ownership in any other entity. Also, the company does not enter into
any business dealings with promoters, directors, key managerial persons and
their relatives. The directors and key managerial persons get only reasonable
remuneration from the company. Though the company has an internal control
system in place, it has not appointed an internal auditor. It is also not
mandatorily required to make such an appointment under the provisions of the
Companies Act, 2013.
DS & Co. have accepted an audit of the above company for the year 2023-24
for the first time. Promoters and directors of the company are known to
engagement partner only socially for quite some time. However, it is for the first
time that any type of professional work related to this company has been
accepted by them.
While formulating audit plan for the company, CA D (engagement partner) has
planned certain risk assessment procedures and further audit procedures
consisting of tests of controls and substantive procedures in relation to
different areas.
The following is extract of financial information of the company: -
(figures in rupees crores)

S. No. Particulars Year 2023-24 Year 2022-23

1. Turnover 30.00 15.00
2. Inventories 5.00 2.00
3. Property, plant and equipment 1.25 1.25
(Gross block)
4. Property, plant and equipment 1.00 1.25
(Net block)
 CASE SCENARIOS 133

5. Gross profit 6.00 3.75

6. Trade receivables 12.50 5.00

The PPE items consist of machinery only. While planning procedures in respect
of Property, Plant and Equipment, auditor has included audit procedures like
inspecting and reviewing company’s plan for performing physical verification
of PPE, assessing depreciation method used, verifying cost of PPE items
acquired during the year with purchase bills and recalculation of depreciation
charged in statement of profit and loss.
Further, while performing risk assessment procedures to identify risk of material
misstatements in financial statements, engagement partner has come to notice
that there is considerable variation in gross profit ratio as compared to last year.
During performance of substantive procedures, he has also studied data of
purchases and sales of the company during the year under audit and has also
compared such data with preceding year and earlier years also.
Based on the above facts, answer the following MCQs:

MULTIPLE CHOICE QUESTIONS

1. Keeping in view the description provided in the case scenario, which of

the following statements is likely to be most appropriate?
(a) Engagement partner is known socially to promoters and directors
of the company. The situation mandatorily involves advocacy threat
casting a doubt on auditor’s independence. Irrespective of this,
detection risk in engagement is low.

(b) Engagement partner is known socially to promoters and directors

of the company. The situation mandatorily involves familiarity threat
casting a doubt on auditor’s independence. Irrespective of this,
detection risk in engagement is high.
(c) The situation reflected in the case scenario may not constitute threat
to independence of auditor mandatorily. Irrespective of this,
detection risk in engagement is low.
134 AUDITING AND ETHICS

(d) The situation reflected in the case scenario may not constitute threat
to independence of auditor mandatorily. Irrespective of this,
detection risk in engagement is high.
2. CA D has included in the audit plan certain procedures in respect of PPE
items. Which of the following audit procedure included in audit plan is
likely to be least relevant?
(a) Inspecting and reviewing company’s plan for physical verification of
PPE.
(b) Assessing depreciation method used.
(c) Verifying cost of PPE items acquired during the year with purchase
bills.

(d) Recalculation of depreciation charged in statement of profit and

loss.
3. Which of the following statements is likely to be most suitable to explain
the fact relating to variation in gross profit ratio as compared to last year?
(a) Gross profit ratio has decreased in year 2023-24 as compared to
year 2022-23. It may be due to the fact that sales prices may have
been reduced by the company to procure more orders.
(b) Gross profit ratio has increased in year 2023-24 as compared to year
2022-23. It may be due to the reason that the cost of materials
purchased by company could have decreased.
(c) Gross profit ratio has decreased in year 2023-24 as compared to
year 2022-23. It may be due to the fact that office staff salary
engaged in administrative functions and office maintenance
expenditure could have increased.
(d) Gross profit ratio has decreased in year 2023-24 as compared to
year 2022-23. It may be due to the reason that the company has not
made an allowance for obsolescence in respect of inventories
during the year.
4. CA D has also studied purchases and sales data of the company during
the year and has also compared such data with the preceding year and
earlier years also. It is an example of __________.
 CASE SCENARIOS 135

(a) Ratio analysis forming part of substantive analytical procedures.

(b) Trend analysis forming part of substantive analytical procedures.
(c) Reasonable test forming part of substantive analytical procedures.
(d) Structural modelling forming part of substantive analytical
procedures.
5. Considering the whole case scenario, identify which of the following
combination of Standards is not proper for their likely relevance in
performing and completing the above engagement?
(a) SQC 1, SA 220, SA 501, SA 505.
(b) SA 550, SA 510, SA 220, SA 610.
(c) SA 700, SA 510, SA 220, SA 500.
(d) SQC 1, SA 700.

ANSWERS TO MULTIPLE CHOICE QUESTIONS

1. Option (d) The situation reflected in case scenario may not constitute
threat to independence of auditor mandatorily. Irrespective of this,
detection risk in engagement is high.
Reason:
The engagement partner’s social acquaintance with the promoters does
not create a familiarity threat mandatorily as it does not influence
professional judgment. However, detection risk is high since it is the firm’s
first audit of the company, and there is a significant increase in turnover
and trade receivables, indicating potential misstatements.
2. Option (c) Verifying cost of PPE items acquired during the year with
purchase bills.
Reason:
While comparing given procedure in the questions more relevant audit
procedures include inspecting and reviewing company’s plan for physical
verification of PPE, assessing depreciation method used, and recalculation
of depreciation charged in statement of profit and loss to be included in
136 AUDITING AND ETHICS

audit plan. Thus, verifying cost of PPE items acquired with purchase bills
during the year only will be least relevant.

3. Option (a) Gross profit ratio has decreased in year 2023-24 as compared
to year 2022-23. It may be due to the fact that sales prices may have been
reduced by the company to procure more orders.

Reason:
The Gross Profit Ratio for 2022-23 is 25% [(3.75/15) * 100], whereas for
2023-24, it has decreased to 20% [(6/30) * 100]. This indicates a decline in
the gross profit ratio. A possible Reason for this decrease could be that
the company lowered its selling prices to secure more orders. Further,
office staff salary engaged in administrative functions and office
maintenance expenditure and allowance for obsolescence in respect of
inventories primarily impact net profit, not gross profit.
4. Option (b) Trend analysis forming part of substantive analytical
procedures.
Reason:
Trend analysis is the comparison of current data with the prior period
balance or with a trend in a two or more prior period balances. In other
words, trend analysis implies analysing account fluctuations by comparing
current year to prior year information and, also, to information derived
over several years.
5. Option (b) SA 550, SA 510, SA 220, SA 610.
Reason:
As per given facts in the question combination of option covering SA 550,
SA 510, SA 220, SA 610 are not relevant. Since the company does not
engage in related party transactions SA 550, “Related Parties”, is not
relevant. Further, SA 610 based on Using Work of Internal Auditors is also
irrelevant as the company does not have an internal auditor. Furthermore,
SA 220 and SA 510 is relevant but does not fit the overall combination
when paired with SA 550 and SA 510.