CA FINAL - ADVANCED AUDITING & PROFESSIONAL ETHICS

CA FINAL AUDIT
ICAI STUDY MATERIAL
QUESTIONS & ANSWERS

COMPILER
CA AARTI N. LAHOTI

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AUDITING STANDARDS, STATEMENTS &

CH – 1 GUIDANCE
NOTES - AN OVERVIEW
Q. 1: ABC Company files a law suit against Unlucky Company for ` 5 crores. The Attorney of Unlucky
Company feels that the suit is without merit, so Unlucky Company merely discloses the existence of the law
suit in the notes accompanying its financial statements. As an auditor of Unlucky Company, how will you
deal with the situation?
Existence of Contingent Liability : As per AS 29 "Provisions, Contingent liabilities & Contingent Assets", a
contingent liability is a possible obligation that arises from past events & the existence of which will be
confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly
within the control of the enterprise.
Further, future events that may affect the amount required to settle an obligation should be reflected in the
amount of a provision where there is sufficient objective evidence that the event will occur.
As per SA 570 “Going Concern”, there are certain examples of events or conditions that, individually or
collectively, may cast significant doubt about the going concern assumption. Pending legal or regulatory
proceedings against the entity that may, if successful, result in claims that the entity is unlikely to be able to
satisfy is one of the example of such event.
When the auditor concludes that the use of the going concern assumption is appropriate in the circumstances
but a material uncertainty exists, the auditor shall determine whether the financial statements adequately
describe the principal events or conditions that may cast significant doubt on the entity’s ability to continue
as a going concern & management’s plans to deal with these events or conditions; & disclose clearly that
there is a material uncertainty related to events or conditions that may cast significant doubt on the entity’s
ability to continue as a going concern &, therefore, that it may be unable to realize its assets & discharge its
liabilities in the normal course of business.
In the instant case, ABC Company has filed a law suit against Unlucky Company for ` 5 crores. Though, the
attorney of Unlucky Company feels that the suit is without merit so the company merely discloses the
existence of law suit in the notes accompanying its financial statements. But the auditor may evaluate the
source data on which basis the opinion is formed. If the auditor finds the uncertainty, he may request the
management to adjust the sum of ` 5 crore by making provision for expenses as per AS 29. If the management
does not accept the request the auditor should qualify the audit report.
Q. 2 : In the course of audit of K Ltd., its auditor Mr. 'N' observed that there was a special audit conducted
at the instance of the management on a possible suspicion of a fraud & requested for a copy of the report
to enable him to report on the fraud aspects. Despite many reminders it was not provided. In absence of
the special audit report, Mr. 'N' insisted that he be provided with at least a written representation in
respect of fraud on/by the company. For this request also, the management remained silent. Please guide
Mr. 'N'.
Auditor’s Responsibilities Relating to Fraud: As per SA 240 on “The Auditor’s Responsibilities Relating to
Fraud in an Audit of Financial Statements”, the auditor is responsible for obtaining reasonable assurance that
the financial statements, taken as a whole, are free from material misstatement, whether caused by fraud or
error.
As per SA 580 “Written Representations”, if management modifies or does not provide the requested written
representations, it may alert the auditor to the possibility that one or more significant issues may exist.
In the instant case, the auditor observed that there was a special audit conducted at the instance of the
management on a possible suspicion of fraud. Therefore, the auditor requested for special audit report which
was not provided by the management despite of many reminders. The auditor also insisted for written

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representation in respect of fraud on/by the company. For this request also management remained silent.
It may be noted that, if management does not provide one or more of the requested written representations,
the auditor shall discuss the matter with management; re-evaluate the integrity of management & evaluate
the effect that this may have on the reliability of representations (oral or written) & audit evidence in general;
& take appropriate actions, including determining the possible effect on the opinion in the auditor’s report.
Further, as per section 143(12) of the Companies Act, 2013, if an auditor of a company, in the course of the
performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has
been committed against the company by officers or employees of the company, he shall immediately report
the matter to the Central Government (in case amount of fraud is ` 1 crore or above)or Audit Committee or
Board in other cases (in case the amount of fraud involved is less than ` 1 crore) within such time & in such
manner as may be prescribed.
The auditor is also required to report as per Clause (xi) of Paragraph 3 of CARO, 2020, Whether any fraud by
the company or any fraud on the company by its officers or employees has been noticed or reported during
the year; If yes, the nature & the amount involved is to be indicated.
If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters exceptional
circumstances that bring into question the auditor’s ability to continue performing the audit, the auditor shall:
(i) Determine the professional & legal responsibilities applicable in the circumstances, including whether
there is a requirement for the auditor to report to the person or persons who made the audit
appointment or, in some cases, to regulatory authorities;
(ii) Consider whether it is appropriate to withdraw from the engagement, where withdrawal from the
engagement is legally permitted; &
(iii) If the auditor withdraws:
1) Discuss with the appropriate level of management & those charged with governance, the auditor’s
withdrawal from the engagement & the reasons for the withdrawal; &
2) Determine whether there is a professional or legal requirement to report to the person or persons
who made the audit appointment or, in some cases, to regulatory authorities, the auditor’s
withdrawal from the engagement & the reasons for the withdrawal.
Q. 3 : During the course of audit of Star Limited the auditor received some of the confirmation of the
balances of trade payables outstanding in the balance sheet through external confirmation by negative
confirmation request. In the list of trade payables, there are number of trade payables of small balances
except one, old outstanding of ` 15 Lacs, of whom, no confirmation on the credit balance received.
Comment with respect to Standard of Auditing.
External Confirmation: As per SA 505, “External Confirmation”, Negative Confirmation is a request that the
confirming party respond directly to the auditor only if the confirming party disagrees with the information
provided in the request. Negative confirmations provide less persuasive audit evidence than positive
confirmations.
The failure to receive a response to a negative confirmation request does not explicitly indicate receipt by the
intended confirming party of the confirmation request or verification of the accuracy of the information
contained in the request. Accordingly, a failure of a confirming party to respond to a negative confirmation
request provides significantly less persuasive audit evidence than does a response to a positive confirmation
request. Confirming parties also may be more likely to respond indicating their disagreement with a
confirmation request when the information in the request is not in their favour, & less likely to respond
otherwise.
In the instant case, the auditor sent the negative confirmation requesting the trade payables having
outstanding balances in the balance sheet while doing audit of Star Limited. One of the old outstanding of ` 15
lacs has not sent the confirmation on the credit balance. In case of non response, the auditor may examine
subsequent cash disbursements or correspondence from third parties, & other records, such as goods
received notes. Further non response for negative confirmation request does not means that there is some
misstatement as negative confirmation request itself is to respond to the auditor only if the confirming party
disagrees with the information provided in the request.

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But, if the auditor identifies factors that give rise to doubts about the reliability of the response to the
confirmation request, he shall obtain further audit evidence to resolve those doubts.
Q. 4 : Mr. Z who is appointed as auditor of Elite Co. Ltd. wants to use confirmation request as audit
evidence during the course of audit. What are the factors to be considered by Mr. Z when designing a
confirmation request? Also state the effects of using positive external confirmation request by Mr. Z.
As per SA 505, “External Confirmation”, factors to be considered when designing confirmation requests
include:
(i) The assertions being addressed.
(ii) Specific identified risks of material misstatement, including fraud risks.
(iii) The layout & presentation of the confirmation request.
(iv) Prior experience on the audit or similar engagements.
(v) The method of communication (for example, in paper form, or by electronic or other medium).
(vi) Management’s authorisation or encouragement to the confirming parties to respond to the auditor.
Confirming parties may only be willing to respond to a confirmation request containing management’s
authorisation.
(vii) The ability of the intended confirming party to confirm or provide the requested information (for
example, individual invoice amount versus total balance).
A positive external confirmation request asks the confirming party to reply to the auditor in all cases, either
by indicating the confirming party’s agreement with the given information, or by asking the confirming party
to provide information. A response to a positive confirmation request ordinarily is expected to provide
reliable audit evidence. There is a risk, however, that a confirming party may reply to the confirmation
request without verifying that the information is correct. The auditor may reduce this risk by using positive
confirmation requests that do not state the amount (or other information) on the confirmation request, & ask
the confirming party to fill in the amount or furnish other information. On the other hand, use of this type of
“blank” confirmation request may result in lower response rates because additional effort is required of the
confirming parties.
Q. 5 : R & M Co. wants to be alert on the possibility of non-compliance with Laws & Regulations during the
course of audit of SRS Ltd. R & M Co. seeks your guidance for identifying the indications of non-compliance
with Laws & Regulations.
As per SA 250, “Consideration of Laws & Regulations, the auditor shall perform the audit procedures to help
identify instances of non-compliance with other laws & regulations that may have a material effect on the
financial statements by inquiring of management &, where appropriate, those charged with governance, as to
whether the entity is in compliance with such laws & regulations; & Inspecting correspondence, if any, with
the relevant licensing or regulatory authorities.
However, when the auditor becomes aware of the existence of, or information about, the following
matters, it may also be an indication of non-compliance with laws & regulations:
 Investigations by regulatory organisations & government departments or payment of fines or penalties.
 Payments for unspecified services or loans to consultants, related parties, employees or government
employees.
 Sales commissions or agent’s fees that appear excessive in relation to those ordinarily paid by the
entity or in its industry or to the services actually received.
 Purchasing at prices significantly above or below market price.
 Unusual payments in cash, purchases in the form of cashiers’ cheques payable to bearer or transfers to
numbered bank accounts.
 Unusual payments towards legal & retainership fees.
 Unusual transactions with companies registered in tax havens.
 Payments for goods or services made other than to the country from which the goods or services
originated.

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
 Payments without proper exchange control documentation.

 Existence of an information system which fails, whether by design or by accident, to provide an
adequate audit trail or sufficient evidence.

 Unauthorised transactions or improperly recorded transactions.

 Adverse media comment.
Q. 6 : KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y & Mr. Z as joint auditors to conduct
auditing for the financial year 2018-19. For the valuation of gratuity scheme of the company, Mr. X, Mr. Y &
Mr. Z wanted to refer their own known Actuaries. Due to difference of opinion, all the joint auditors
consulted their respective Actuaries. Subsequently, major difference was found in the actuary reports.
However, Mr. X agreed to Mr. Y’s actuary report, though, Mr. Z did not. Mr. X contends that Mr. Y’s actuary
report shall be considered in audit report due to majority of votes. Now, Mr. Z is in dilemma.
a) You are required to briefly explain the responsibilities of auditors when they are jointly & severally
responsible in respect of audit conducted by them & also guide Mr. Z in such situation.
b) Explain the responsibility of auditors, in case, report made by Mr. Y’s actuary, later on, found faulty.
a) Difference of Opinion Among Joint Auditors: SA 299 on, “Joint Audit of Financial Statements” deals with
the professional responsibilities, which the auditors undertake in accepting such appointments as joint
auditors. In respect of the work divided amongst the joint auditors, each joint auditor is responsible only
for the work allocated to him, whether or not he has made a separate report on the work performed by
him. On the other hand the joint auditors are jointly & severally responsible in respect of the audit
conducted by them as under:
(i) in respect of the audit work which is not divided among the joint auditors & is carried out by all of
them;
(ii) in respect of decisions taken by all the joint auditors under audit planning in respect of common
audit areas concerning the nature, timing & extent of the audit procedures to be performed by each
of the joint auditors;
(iii) in respect of matters which are brought to the notice of the joint auditors by any one of them & on
which there is an agreement among the joint auditors;
(iv) for examining that the financial statements of the entity comply with the requirements of the
relevant statute;
(v) for ensuring presentation & disclosure of the financial statements as required by the applicable
financial reporting framework;
(vi) for ensuring that the audit report complies with the requirements of the relevant statutes, the
applicable Standards on Auditing & the other relevant pronouncements issued by ICAI.
(vii) it is the separate & specific responsibility of each joint auditor to study & evaluate the prevailing
system of internal control relating to the work allocated to him, the extent of enquiries to be made
in the course of his audit;
(viii) the responsibility of obtaining & evaluating information & explanation from the management is
generally a joint responsibility of all the auditors;
(ix) each joint auditor is entitled to assure that the other joint auditors have carried out their part of
work in accordance with the generally accepted audit procedures & therefore it would not be
necessary for joint auditor to review the work performed by other joint auditors.
Where, in the course of the audit, a joint auditor comes across matters which are relevant to the areas of
responsibility of other joint auditors & which deserve their attention, or which require disclosure or
require discussion with, or application of judgment by other joint auditors, the said joint auditor shall
communicate the same to all the other joint auditors in writing prior to the completion of the audit.
Normally, the 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. A joint auditor is not bound by the views of the majority
of the joint auditors regarding the opinion or matters to be covered in the audit report & shall express

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opinion formed by the said joint auditor in separate audit report in case of disagreement. In such
circumstances, the audit report(s) issued by the joint auditor(s) shall make a reference to the separate
audit report(s) issued by the other joint auditor(s). Further, separate audit report shall also make
reference to the audit report issued by other joint auditors. Such reference shall be made under the
heading “Other Matter Paragraph” as per Revised SA 706, “Emphasis of Matter Paragraphs & Other
Matter Paragraphs in the Independent Auditor’s Report”.
In the instant case, there are three auditors, namely, Mr. X, Mr. Y & Mr. Z, jointly appointed as an auditor
of KRP Ltd. For the valuation of gratuity scheme of the Company they referred their own known Actuaries.
Mr. Z (one of the joint auditor) is not satisfied with the report submitted by Mr. Y’s referred actuary. He is
not agreed with the matters to be covered by the report whereas Mr. X agreed with the same.
Hence, as per SA 299, Mr. Z is suggested to express his own opinion through a separate report whereas
Mr. X & Mr. Y may provide their joint report for the same.
a) (b) Using the work of an Auditor’s Expert: As per SA 620 “Using the Work of an Auditor’s Expert”, the
expertise of an expert may be required in the actuarial calculation of liabilities associated with insurance
contracts or employee benefit plans etc., however, the auditor has sole responsibility for the audit opinion
expressed, & that responsibility is not reduced by the auditor’s use of the work of an auditor’s expert.
The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes,
including the relevance & reasonableness of that expert’s findings or conclusions, & their consistency with
other audit evidence as per SA 500.
Further, in view of SA 620, if the expert’s work involves use of significant assumptions & methods, then
the relevance & reasonableness of those assumptions & methods must be ensured by the auditor & if the
expert’s work involves the use of source data that is significant to that expert’s work, the relevance,
completeness, & accuracy of that source data in the circumstances must be verified by the auditor.
In the instant case, Mr. X, Mr. Y & Mr. Z, jointly appointed as an auditor of KRP Ltd., referred their own
known Actuaries for valuation of gratuity scheme. Actuaries are an auditor’s expert as per SA 620. Mr. Y’s
referred actuary has provided the gratuity valuation report, which later on found faulty. Further, Mr. Z is
not agreed with this report therefore he submitted a separate audit report specifically for such gratuity
valuation.
In such situation, it was duty of Mr. X, Mr. Y & Mr. Z, before using the gratuity valuation report of Actuary,
to ensure the relevance & reasonableness of assumptions & methods used. They were also required to
examine the relevance, completeness & accuracy of source data used for such report before expressing
their opinion.
Mr. X & Mr. Y will be held responsible for grossly negligence & using such faulty report without examining
the adequacy of expert actuary’s work whereas Mr. Z will not be held liable for the same due to separate
opinion expressed by him.
Q. 7 : As an auditor of RST Ltd. Mr. P applied the concept of materiality for the financial statements as a
whole. On the basis of obtaining additional information of significant contractual arrangements that draw
attention to a particular aspect of a company's business, he wants to re-evaluate the materiality concept.
Please, guide him.
Re-evaluation of the Materiality Concept: In the instant case, Mr. P, as an auditor of RST Ltd. has applied the
concept of materiality for the financial statements as a whole. But he wants to re-evaluate the materiality
concept on the basis of additional information of significant contractual arrangements which draws attention
to a particular aspect of the company’s business.
As per SA 320 “Materiality in Planning & Performing an Audit”, while establishing the overall audit strategy,
the auditor shall determine materiality for the financial statement as a whole. He should set the benchmark
on the basis of which he performs his audit procedure. If, in the specific circumstances of the entity, there is
one or more particular classes of transactions, account balances or disclosures for which misstatements of
lesser amounts than the materiality for the financial statements as a whole could reasonably be expected to
influence the economic decisions of users taken on the basis of the financial statements, the auditor shall also
determine the materiality level or levels to be applied to those particular classes of transactions, account

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balances or disclosures.
The auditor shall revise materiality for the financial statements in the event of becoming aware of information
during the audit that would have caused the auditor to have determined a different amount (or amounts)
initially.
If the auditor concludes a lower materiality for the same, then he should consider the fact that whether it is
necessary to revise performance materiality & whether the nature, timing & extent of the further audit
procedures remain appropriate.
Thus, Mr. P can re-evaluate the materiality concepts after considering the necessity of such revision.
Q. 8 : When a sub-service organization performs services for a service organization, there are two
alternative methods of presenting the description of controls. The service organization determines which
method will be used. As a user auditor what information would you obtain about controls at a sub-service
organization?
Controls at a Sub-Service Organisation: In accordance with SA 402 “Audit Considerations relating to an Entity
Using a Service Organisation”, a user entity may use a service organisation that in turn uses a sub-service
organisation to provide some of the services provided to a user entity that are part of the user entity’s
information system relevant to financial reporting. The sub-service organisation may be a separate entity
from the service organisation or may be related to the service organisation.
A user auditor may need to consider controls at the sub-service organisation. In situations where one or more
sub-service organisations are used, the interaction between the activities of the user entity & those of the
service organisation is expanded to include the interaction between the user entity, the service organisation
& the sub-service organisations. The degree of this interaction, as well as the nature & materiality of the
transactions processed by the service organisation & the sub-service organisations are the most important
factors for the user auditor to consider in determining the significance of the service organisation’s & sub-
service organisation’s controls to the user entity’s controls.
Further, the user auditor shall determine whether a sufficient understanding of the nature & significance of
the services provided by the service organisation & their effect on the user entity's internal control relevant to
the audit has been obtained to provide a basis for the identification & assessment of risks of material
misstatement.
If the user auditor is unable to obtain a sufficient understanding from the user entity, the user auditor shall
obtain that understanding by application of the following two methods of presenting description of internal
controls i.e. (i) Type 1 report; or
(ii) Type 2 report.
If a service organisation uses a subservice organisation, the service auditor's report may either include or
exclude the subservice organisation's relevant control objectives & related controls in the service
organisation's description of its system & in the scope of the service auditor's engagement. These two
methods of reporting are known as the inclusive method & the carve-out method respectively.
In either method, the service organisation includes in its description of controls a description of the functions
& nature of the processing performed by the sub-service organisation.
If the Type 1 or Type 2 report excludes the control at a subservice organization & the services provided by the
subservice organization are relevant to the audit of the user entity’s financial statements, the user auditor is
required to apply the requirements of the SA 402 in respect of the subservice organization.
The nature & extent of work to be performed by the user auditor regarding the services provided by a
subservice organization depend on the nature & significance of those services to the user entity & relevance
of those services to the audit.
Q. 9 : In an initial audit engagement the auditor will have to satisfy about the sufficiency & appropriateness
of ‘Opening Balances' to ensure that they free from misstatements, which may materially affect the current
financial statements. Lay down the audit procedure, you will follow, when financial statements are audited
for the first time. If, after performing the procedure, you are not satisfied about the correctness of 'Opening
Balances', what approach you will adopt in drafting your audit report?

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Audit Procedure for ensuring correctness of Opening Balances: As per SA 510 “Initial Audit Engagements-
Opening Balances”, the auditor shall obtain sufficient appropriate audit evidence about whether the opening
balances contain misstatements that materially affect the current period’s financial statements by -
(i) Determining whether the prior period’s closing balances have been correctly brought forward to the
current period or, when appropriate, any adjustments have been disclosed as prior period items in the
current year’s Statement of Profit & Loss;
(ii) Determining whether the opening balances reflect the application of appropriate accounting policies; &
(iii) By evaluating whether audit procedures performed in the current period provide evidence relevant to
the opening balances; or performing specific audit procedures to obtain evidence regarding the opening
balances.
If the auditor obtains audit evidence that the opening balances contain misstatements that could materially
affect the current period’s financial statements, the auditor shall perform such additional audit procedures as
are appropriate in the circumstances to determine the effect on the current period’s financial statements. If
the auditor concludes that such misstatements exist in the current period’s financial statements, the auditor
shall communicate the misstatements with the appropriate level of management & those charged with
governance.
Approach for drafting Audit Report: If the auditor concludes that the opening balances contain a
misstatement that materially affects the current period’s financial statements & the effect of the
misstatement is not properly accounted for or not adequately presented or disclosed, the auditor shall
express a qualified opinion or an adverse opinion, as appropriate, in accordance with SA 705 & in case where
the auditor is unable to obtain sufficient appropriate audit evidence regarding the opening balances, the
auditor shall express a qualified opinion or a disclaimer of opinion, as appropriate, in accordance with SA 705.
Q. 10 : An auditor of Sagar Ltd. was not able to get the confirmation about the existence & value of certain
machineries. However, the management gave him a certificate to prove the existence & value of the
machinery as appearing in the books of account. The auditor accepted the same without any further
procedure & signed the audit report. Is he right in his approach?
Validity of Written Representation: The physical verification of fixed assets is the primary responsibility of
the management. The auditor, however, is required to examine the verification programme adopted by the
management. He must satisfy himself about the existence, ownership & valuation of fixed assets. In the case
of Sagar Ltd., the auditor has
not been able to verify the existence & value of some machinery despite the verification procedure followed
in routine audit. He accepted the certificate given to him by the management without making any further
enquiry.
As per SA 580 “Written Representations”, when representation relate to matters which are material to the
financial information, then the auditor should seek corroborative audit evidence from other sources inside or
outside the entity.
He should evaluate whether such representations are reasonable & consistent with other evidences & should
consider whether individuals making such representations can be expected to be well informed on the
matter. “Written Representations” cannot be a substitute for other audit evidence that the auditor could
reasonably expect to be available.
If the auditor is unable to obtain sufficient appropriate audit evidence that he believes would be available
regarding a matter which has or may have a material effect on the financial information, this will constitute a
limitation on the scope of his examination even if he has obtained a representation from management on the
matter. Therefore, the approach adopted by the auditor is not right.
Q. 11 : Your firm has been appointed as the statutory auditors of AGM Private Limited for the financial year
2018-19. While verification of company’s trade receivables as on 31st March 2019, accountant of AGM Pvt.
Ltd. has requested you, not to send balance confirmations to a particular group of trade receivables since
the said balances are under dispute & the matter is pending in the Court. As a Statutory Auditor, how
would you deal in this situation?

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SA 505 “External Confirmations”, establishes standards on the auditor’s use of external confirmation as a
means of obtaining audit evidence. If the management refuses to allow the auditor to a send a confirmation
request, the auditor shall:
(i) Inquire as to Management’s reasons for the refusal, & seek audit evidence as to their validity &
reasonableness,
(ii) Evaluate the implications of management’s refusal on the auditor’s assessment of the relevant risks of
material misstatement, including the risk of fraud, & on the nature, timing & extent of other audit
procedures, &
(iii) Perform alternative audit procedures designed to obtain relevant & reliable audit evidence.
If the auditor concludes that management’s refusal to allow the auditor to send a confirmation request is
unreasonable or the auditor is unable to obtain relevant & reliable audit evidence from alternative audit
procedures, the auditor shall communicate with those in charge of governance & also determine its
implication for the audit & his opinion.
Q. 12 : RIM Private Ltd is engaged in the business of manufacturing of water bottles & is experiencing
significant increase in turnover year on year. During the financial year ended 31 March 2019, the company
carried out a detailed physical verification of its inventory & property, plant & equipment.
You are the auditor of RIM Private Ltd. The inventory as at the end of the year was ` 2.25 crores. Due to
unavoidable circumstances, you could not be present at the time of annual physical verification. Under the
above circumstances how would you ensure that the physical verification conducted by the management
was in order?
As per SA 501 “Audit Evidence – Additional Considerations for Specific Items”, the auditor should perform
audit procedures, designed to obtain sufficient appropriate audit evidence during his attendance at physical
inventory counting. SA 501 is additional guidance to that contained in SA 500, “Audit Evidence”, with respect
to certain specific financial statement amounts & other disclosures.
If the auditor is unable to be present at the physical inventory count on the date planned due to unforeseen
circumstances, the auditor should take or observe some physical counts on an
alternative date & where necessary, perform alternative audit procedures to assess whether the changes in
inventory between the date of physical count & the period end date are correctly recorded. The auditor
would also verify the procedure adopted, treatment given for the discrepancies noticed during the physical
count. The auditor would also ensure that appropriate cut off procedures were followed by the management.
He should also get management’s written representation on (a) the completeness of information provided
regarding the inventory, & (b) assurance with regard to adherence to laid down procedures for physical
inventory count.
By following the above procedure, it will be ensured that the physical verification conducted by the
management was in order.
Q. 13 : Mr. L while conducting the audit of ABC Ltd., observed that a substantial amount is recognized in
respect of obsolescence of inventory & warranty obligation in the financial statements. Mr. L wants to
obtain written representation from the management to determine whether the assumptions & estimates
used are reasonable. Guide Mr. L with reference to the relevant Standard on Auditing.
Written Representations: As per SA 540, “Auditing Accounting Estimates, Including Fair Value Accounting
Estimates, & Related Disclosures”, the auditor shall obtain written representations from management &,
where appropriate, those charged with governance whether they believe significant assumptions used in
making accounting estimates are reasonable.
SA 580, “Written Representations” discusses the use of written representations. Depending on the nature,
materiality & extent of estimation uncertainty, written representations about accounting estimates
recognised or disclosed in the financial statements may include representations:
(i) About the appropriateness of the measurement processes, including related assumptions & models,
used by management in determining accounting estimates in the context of the applicable financial
reporting framework, & the consistency in application of the processes.

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(ii) That the assumptions appropriately reflect management’s intent & ability to carry out specific courses of
action on behalf of the entity, where relevant to the accounting estimates & disclosures.
(iii) That disclosure related to accounting estimates are complete & appropriate under the applicable
financial reporting framework.
(iv) That no subsequent event requires adjustment to the accounting estimates & disclosures included in the
financial statements.
Q. 14 : LMP Associates, Chartered Accountants, conducting the audit of PQR Ltd., a listed Company for the
year ended 31st March 2019 is concerned with the auditor's responsibilities relating to other information,
both financial & non-financial, included in the Company’s annual report. While reading other information,
LMP Associates considers whether there is a material inconsistency between other information & the
financial statements. As a basis for the consideration the auditor shall evaluate their consistency, compare
selected amounts or other items in the other information with such amounts or other items in the financial
statements. Guide LMP Associates with examples of "Amounts" or "other items" that may be included in
the "other information" with reference to SA 720.
Examples of Amounts or Other Items that May Be Included in the Other Information: As per SA 720 “The
Auditor’s Responsibility in Relation to Other Information”, the following are examples of amounts & other
items that may be included in other information. This list is not intended to be exhaustive.
Amounts
(i) Items in a summary of key financial results, such as net income, earnings per share, dividends, sales &
other operating revenues, & purchases & operating expenses.
(ii) Selected operating data, such as income from continuing operations by major operating area, or sales
by geographical segment or product line.
(iii) Special items, such as asset dispositions, litigation provisions, asset impairments, tax adjustments,
environmental remediation provisions, & restructuring & reorganization expenses.
(iv) Liquidity & capital resource information, such as cash, cash equivalents & marketable securities;
dividends; & debt, capital lease & minority interest obligations.
(v) Capital expenditures by segment or division.
(vi) Amounts involved in, & related financial effects of, off-balance sheet arrangements.
(vii) Amounts involved in guarantees, contractual obligations, legal or environmental claims, & other
contingencies.
(viii) Financial measures or ratios, such as gross margin, return on average capital employed, return on
average shareholders’ equity, current ratio, interest coverage ratio & debt ratio. Some of these may be
directly reconcilable to the financial statements.
Other Items
(i) Explanations of critical accounting estimates & related assumptions.
(ii) Identification of related parties & descriptions of transactions with them.
(iii) Articulation of the entity’s policies or approach to manage commodity, foreign exchange or interest
rate risks, such as through the use of forward contracts, interest rate swaps, or other financial
instruments.
(iv) Descriptions of the nature of off-balance sheet arrangements.
(v) Descriptions of guarantees, indemnifications, contractual obligations, litigation or environmental
liability cases, & other contingencies, including management’s qualitative assessments of the entity’s
related exposures.
(vi) Descriptions of changes in legal or regulatory requirements, such as new tax or environmental
regulations, that have materially impacted the entity’s operations or fiscal position, or will have a
material impact on the entity’s future financial prospects.
(vii) Management’s qualitative assessments of the impacts of new financial reporting standards that have
come into effect during the period, or will come into effect in the following period, on the entity’s

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financial results, financial position & cash flows.

(viii) General descriptions of the business environment & outlook.
(ix) Overview of strategy.
(x) Descriptions of trends in market prices of key commodities or raw materials.
(xi) Contrasts of supply, demand & regulatory circumstances between geographic regions.
(xii) Explanations of specific factors influencing the entity’s profitability in specific segments.
Q. 15 : MB & Associates is a partnership firm of Chartered Accountants which was established seven years
back. The firm is getting new clients & has also, been offered new engagement services with existing
clients. The firm is concerned about obtaining such information as it considers necessary in the
circumstances before accepting an engagement with a new client & acceptance of a new engagement with
an existing client. The firm is looking to work with only select clients to adhere to the Quality Control
Standards. Guide MB & Associates about the matters to be considered with regard to the integrity of a
client, as per the requirements of SQC 1.
As per SQC 1, the firm should obtain such information as it considers necessary in the circumstances before
accepting an engagement with a new client, when deciding whether to continue an existing engagement, &
when considering acceptance of a new engagement with an existing client. Where issues have been
identified, & the firm decides to accept or continue the client relationship or a specific engagement, it should
document how the issues were resolved.
With regard to the integrity of a client, matters that the firm considers include, for example:
i. The identity & business reputation of the client’s principal owners, key management, related parties &
those charged with its governance.
ii. The nature of the client’s operations, including its business practices.
iii. Information concerning the attitude of the client’s principal owners, key management & those charged
with its governance towards such matters as aggressive interpretation of accounting standards & the
internal control environment.
iv. Whether the client is aggressively concerned with maintaining the firm’s fees as low as possible.
v. Indications of an inappropriate limitation in the scope of work.
vi. Indications that the client might be involved in money laundering or other criminal activities.
vii. The reasons for the proposed appointment of the firm & non-reappointment of the previous firm.
The extent of knowledge a firm will have regarding the integrity of a client will generally grow within the
context of an ongoing relationship with that client.

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CH – 2 AUDIT PLANNING, STRATEGY & EXECUTION

Q. 1 : CA. Amboj, a practicing chartered accountant has been appointed as an internal auditor of Textile
Ltd. He conducted the physical verification of the inventory at the year-end & handed over the report of
such verification to CA. Kishore, the statutory auditor of the Company, for his view & reporting. Can CA.
Kishore rely on such report?
Using the Work of Internal Auditor: As per SA 610 “Using the Work of Internal Auditors”, while determining
whether the work of the internal auditors can be used for the purpose of the audit, the external auditor shall
evaluate-
(a) The extent to which the internal audit function’s organizational status & relevant policies & procedures
support the objectivity of the internal auditors;
(b) The level of competence of the internal audit function; &
(c) Whether the internal audit function applies a systematic & disciplined approach, including quality
control.
Further, the external auditor shall not use the work of the internal audit function if the external auditor
determines that:
(a) The function’s organizational status & relevant policies & procedures do not adequately support the
objectivity of internal auditors;
(b) The function lacks sufficient competence; or
(c) The function does not apply a systematic & disciplined approach, including quality control. In the instant
case, CA. Kishore should ascertain the internal auditor’s scope of verification, area of coverage & method
of verification. He should review the report on physical verification taking into consideration these
factors. If possible, he should also test check few items & he can also observe the procedures performed
by the internal auditors. If the statutory auditor is satisfied about the appropriateness of the verification,
he can rely on the report but if he finds that the verification is not in order, he has to decide otherwise.
The final responsibility to express opinion on the financial statement remains with the statutory auditor.
Q. 2 : While doing audit, Ram, the Auditor requires reports from experts for the purpose of Audit evidence.
What types of reports/opinions he can obtain & to what extent he can rely upon the same?
Using the Work of an Auditor’s Expert: As per SA 620, “Using the Work of an Auditor’s Expert”, during the
audit, the auditor may seek to obtain, in conjunction with the client or independently, audit evidence in the
form of reports, opinions, valuations & statements of an expert.
While doing audit, Ram, the auditor can obtain the following types of reports, or options or statements of an
expert for the purpose of audit evidence:
(i) The valuation of complex financial instruments, land & buildings, plant & machinery, jewelry, works of
art, antiques, intangible assets, assets acquired & liabilities assumed in business combinations & assets
that may have been impaired.
(ii) The actuarial calculation of liabilities associated with insurance contracts or employee benefit plans.
(iii) The estimation of oil & gas reserves.
(iv) The valuation of environmental liabilities, & site clean-up costs. (v) The interpretation of contracts, laws
& regulations.
(v) The analysis of complex or unusual tax compliance issues.
When the auditor intends to use the work of an expert, he shall evaluate the adequacy of the auditor’s
expert’s work, including the relevance & reasonableness of that expert’s findings or conclusions, & their
consistency with other audit evidence; if that expert’s work involves use of significant assumptions &
methods, the relevance & reasonableness of those assumptions & methods in the circumstances; & if that
expert’s work involves the use of source data that is significant to his work, the relevance, completeness, &
accuracy of that source data. If the auditor determines that the work of the auditor’s expert is not adequate

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for the auditor’s purposes, he shall agree with that expert on the nature & extent of further work to be
performed by that expert; or perform further audit procedures appropriate to the circumstances
Q. 3 : Some accounting estimates involve relatively low estimation uncertainty & may give rise to lower
risks of material misstatements. Comment.
▪ Accounting estimates arising in entities that engage in business activities that are not complex.
▪ Accounting estimates that are frequently made & updated because they relate to routine transactions.
▪ Accounting estimates derived from data that is readily available, such as published interest rate data or
exchange-traded prices of securities. Such data may be referred to as “observable” in the context of a fair
value accounting estimate.
▪ Fair value accounting estimates where the method of measurement prescribed by the applicable financial
reporting framework is simple & applied easily to the asset or liability requiring measurement at fair
value.
▪ Fair value accounting estimates where the model used to measure the accounting estimate is well-known
or generally accepted, provided that the assumptions or inputs to the model are observable.
Q. 4 : For some accounting estimates, however, there may be relatively high estimation uncertainty,
particularly where they are based on significant assumptions. Comment.
▪ Accounting estimates relating to the outcome of litigation.
▪ Fair value accounting estimates for derivative financial instruments not publicly traded.
▪ Fair value accounting estimates for which a highly specialised entity-developed model is used or for
which, there are assumptions or inputs that cannot be observed in the marketplace. Accounting estimates
in cases of Wage Revision Agreements wherein negotiations with the Trade Unions is on the way or
Government’s sanction is awaited leading to uncertainty.
Q. 5 : While auditing Z Ltd., you observe certain material financial statement assertions have been based
on estimates made by the management. As the auditor how do you minimize the risk of material
misstatements?
As per SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, & Related
Disclosures”, the auditor shall obtain an understanding of the following in order to provide a basis for the
identification & assessment of the risks of material misstatements for accounting estimates:
(i) The requirements of the applicable financial reporting framework relevant to the accounting estimates,
including related disclosures.
(ii) How Management identifies those transactions, events & conditions that may give rise to the need for
accounting estimates to be recognised or disclosed, in the financial statements. In obtaining this
understanding, the auditor shall make inquiries of management about changes in circumstances that
may give rise to new, or the need to revise existing, accounting estimates.
(iii) The estimation making process adopted by the management including-
1) The method, including where applicable the model, used in making the accounting estimates.
2) Relevant controls.
3) Whether management has used an expert?
4) The assumption underlying the accounting estimates.
5) Whether there has been or ought to have been a change from the prior period in the methods for
making the accounting estimates, & if so, why; &
6) Whether &, if so, how the management has assessed the effect of estimation uncertainty.
Q. 6 : KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y & Mr. Z as joint auditors to conduct
audit for the financial year 2018-19. For the valuation of gratuity scheme of the company, Mr. X, Mr. Y &
Mr. Z wanted to refer their own known Actuaries. Due to difference of opinion, all the joint auditors
consulted their respective Actuaries. Subsequently, major difference was found in the actuarial reports.
However, Mr. X agreed to Mr. Y’s actuary report, though, Mr. Z did not. Mr. X contends that Mr. Y’s actuary

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report shall be considered in audit report due to majority of votes. Now, Mr. Z is in dilemma. Explain the
responsibility of auditors, in case, report made by Mr. Y’s actuary, later on, was found faulty.
Using the work of an Auditor’s Expert: As per SA 620 “Using the Work of an Auditor’s Expert”, the expertise
of an expert may be required in the actuarial calculation of liabilities associated with insurance contracts or
employee benefit plans etc., however, the auditor has sole responsibility for the audit opinion expressed, &
that responsibility is not reduced by the auditor’s use of the work of an auditor’s expert.
The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes, including
the relevance & reasonableness of that expert’s findings or conclusions, & their consistency with other audit
evidence as per SA 500.
Further, in view of SA 620, if the expert’s work involves use of significant assumptions & methods, then the
relevance & reasonableness of those assumptions & methods must be ensured by the auditor & if the
expert’s work involves the use of source data that is significant to that expert’s work, the relevance,
completeness, & accuracy of that source data in the circumstances must be verified by the auditor.
In the instant case, Mr. X, Mr. Y & Mr. Z, jointly appointed as auditors of KRP Ltd., referred their own known
Actuaries for valuation of gratuity scheme. Actuaries are an auditor’s expert as per SA 620. Mr. Y’s referred
actuary has provided the gratuity valuation report, which later on was found faulty. Further, Mr. Z is not in
agreement with this report, therefore, he submitted a separate audit report specifically for such gratuity
valuation.
In such situation, it was duty of Mr. X, Mr. Y & Mr. Z, before using the gratuity valuation report of Actuary, to
ensure the relevance & reasonableness of assumptions & methods used. They were also required to examine
the relevance, completeness & accuracy of source data used for such report before expressing their opinion.
Mr. X & Mr. Y will be held responsible for gross negligence & using such faulty report without examining the
adequacy of expert actuary’s work whereas Mr. Z will not be held liable for the same due to separate opinion
expressed by him.
Q. 7 : A & Co. was appointed as auditor of Great Airways Ltd. As the audit partner what factors shall be
considered in the development of overall audit plan?
Development of an overall plan - Overall plan is basically intended to provide direction for audit work
programming & includes the determination of timing, manpower development & co-ordination of work with
the client, other auditors & other experts. The auditor should consider the following matters in developing his
overall plan for the expected scope & conduct of the audit:
(i) Terms of his engagement & any statutory responsibilities.
(ii) Nature & timing of reports or other communications.
(iii) Applicable Legal or Statutory requirements.
(iv) Accounting policies adopted by the clients & changes, if any, in those policies.
(v) The effects of new accounting & auditing pronouncement on the audit.
(vi) Identification of significant audit areas
(vii) Setting of materiality levels for the audit purpose
(viii) Conditions requiring special attention such as the possibility of material error or fraud or involvement
of parties in whom directors or persons who are substantial owners of the entity are interested & with
whom transactions are likely.
(ix) Degree of reliance to be placed on the accounting system & internal control.
(x) Possible rotation of emphasis on specific audit areas.
(xi) Nature & extent of audit evidence to be obtained.
(xii) Work of the internal auditors & the extent of reliance on their work, if any in the audit.
(xiii) Involvement of other auditors in the audit of subsidiaries or branches of the client & involvement of
experts.
(xiv) Allocation of works to be undertaken between joint auditors & the procedures for its control & review.
(xv) Establishing & coordinating staffing requirements.

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Q. 8 : As an auditor of garment manufacturing company for the last five years, you have observed that
new venture of online shopping has been added by the company during current year. What factors would
be considered by you in formulating the audit strategy of the company?
Formulation of Audit Strategy: While formulating the audit strategy for a company, following factors may be
considered -
General Factors:
Factors while establishing Overall Audit Strategy
Overall audit strategy would involve-
(i) Determination of Characteristics of Audit: Identify the characteristics of the engagement that defines
its scope.
(ii) Reporting Objectives: Ascertain the reporting objectives of the engagement to plan the timing of the
audit & the nature of the communications required.
(iii) Team’s Efforts: Consider the factors that, in the auditor's professional judgment, are significant in
directing the engagement team's efforts.
(iv) Preliminary Work: Consider the results of preliminary engagement activities &, where applicable,
whether knowledge gained on other engagements performed by the engagement partner for the entity
is relevant.
(v) Nature, timing & Extent of Resources: Ascertain the nature, timing & extent of resources necessary to
perform the engagement.
Specific Factors for Online Shopping:
The auditor shall also obtain an understanding of the information system including the related business
processes due to new venture of online shopping in the following areas:
(i) The classes of transactions in the entity’s operations that are significant to the financial statements;
(ii) The procedures, within both information technology (IT) & manual systems, by which those
transactions are initiated, recorded, processed, corrected as necessary, transferred to the general
ledger & reported in the financial statements;
(iii) The related accounting records, supporting information & specific accounts in the financial statements
that are used to initiate, record, process & report transactions; this includes the correction of incorrect
information & how information is transferred to the general ledger. The records may be in either
manual or electronic form;
(iv) How the information system captures events & conditions, other than transactions, that are significant
to the financial statements;
(v) Controls surrounding journal entries, including non-standard journal entries used to record non-
recurring, unusual transactions or adjustments.
Q. 9 : During the audit of FMP Ltd, a listed company, Engagement Partner (EP) completed his reviews &
also ensured compliance with independence requirements that apply to the audit engagement. The
engagement files were also reviewed by the Engagement Quality Control Reviewer (EQCR) except the
independence assessment documentation. Engagement Partner was of the view that matters related to
independence assessment are the responsibility of the Engagement Partner & not Engagement Quality
Control Reviewer. Engagement Quality Control Reviewer objected to this & refused to sign off the
documentation. Please advise as per SA 220.
As per SA 220, Engagement Partner shall form a conclusion on compliance with independence requirements
that apply to the audit engagement. In doing so, Engagement Partner shall:
▪ Obtain relevant information from the firm &, where applicable, network firms, to identify & evaluate
circumstances & relationships that create threats to independence;
▪ Evaluate information on identified breaches, if any, of the firm’s independence policies & procedures to
determine whether they create a threat to independence for the audit engagement; &
▪ Take appropriate action to eliminate such threats or reduce them to an acceptable level by applying

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safeguards, or, if considered appropriate, to withdraw from the audit engagement, where withdrawal is
permitted by law or regulation. The engagement partner shall promptly report to the firm any inability to
resolve the matter for appropriate action.
Engagement Partner shall take responsibility for reviews being performed in accordance with the firm’s
review policies & procedures.
As per SA 220, “Quality Control for Audit of Financial Statements”, for audits of financial statements of listed
entities, Engagement Quality Control Reviewer (EQCR), on performing an engagement quality control review,
shall also consider the engagement team’s evaluation of the firm’s independence in relation to the audit
engagement.
In the given case, Engagement Partner is not right. The independence assessment documentation should also
be given to Engagement Quality Control Reviewer for his review.
Q. 10 : AKJ Ltd is a small-sized 30 years old company having business of manufacturing of pipes. Company
has a plant based out of Dehradun & have their corporate office in Delhi. Recently the company appointed
new firm of Chartered Accountants as their statutory auditors.
The statutory auditors want to enter into an engagement letter with the company in respect of their
services but the management has contended that since the statutory audit is mandated by law,
engagement letter may not be required. Auditors did not agree to this & have shared a format of
engagement letter with the management for their reference before getting that signed. In this respect
management would like to understand that as per SA 210 (auditing standard referred to by the auditors), if
the agreed terms of the engagement shall be recorded in an engagement letter or other suitable form of
written agreement, what should be included in terms of agreed audit engagement letter?
As per SA 210 ‘Agreeing the Terms of Audit Engagements’, the auditor shall agree the terms of the audit
engagement with management or those charged with governance, as appropriate.
The agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable
form of written agreement & shall include:
(i) The objective & scope of the audit of the financial statements;
(ii) The responsibilities of the auditor;
(iii) The responsibilities of management;
(iv) Identification of the applicable financial reporting framework for the preparation of the financial
statements; &
(v) Reference to the expected form & content of any reports to be issued by the auditor & a statement
that there may be circumstances in which a report may differ from its expected form & content.
Q. 11 : A Pvt Ltd is engaged in the business of real estate. The auditor of the company requested the
information from the management to review the outcome of accounting estimates (like estimated costs
considered for percentage completion etc.) included in the prior period financial statements & their
subsequent re-estimation for the purpose of the current period.
The management has refused the information to the auditor saying that the review of prior period
information should not be done by the auditor. Please advise.
As per SA 540, “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, & Related
Disclosures”, the auditor shall review the outcome of accounting estimates included in the prior period
financial statements, or, where applicable, their subsequent re-estimation for the purpose of the current
period. The nature & extent of the auditor’s review takes account of the nature of the accounting estimates,
& whether the information obtained from the review would be relevant to identifying & assessing risks of
material misstatement of accounting estimates made in the current period financial statements.
The outcome of an accounting estimate will often differ from the accounting estimate recognised in the prior
period financial statements. By performing risk assessment procedures to identify & understand the reasons
for such differences, the auditor may obtain:
▪ Information regarding the effectiveness of management’s prior period estimation process, from which
the auditor can judge the likely effectiveness of management’s current process.

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▪ Audit evidence that is pertinent to the re-estimation, in the current period, of prior period accounting
estimates.
▪ Audit evidence of matters, such as estimation uncertainty, that may be required to be disclosed in the
financial statements.
The review of prior period accounting estimates may also assist the auditor, in the current period, in
identifying circumstances or conditions that increase the susceptibility of accounting estimates to, or indicate
the presence of, possible management bias. The auditor’s professional skepticism assists in identifying such
circumstances or conditions & in determining the nature, timing & extent of further audit procedures.
However, the review is not intended to call into question the judgments made in the prior periods that were
based on information available at that time. In the given case, the management is not correct in refusing the
relevant information to the auditor.
Q. 12 : X Ltd had a net worth of INR 1300 crores because of which Ind AS became applicable to them. The
company had various derivative contracts – options, forward contracts, interest rate swaps etc. which were
required to be fair valued for which company got the fair valuation done through an external third party.
The statutory auditors of the company involved an auditor’s expert to audit valuation of derivatives.
Auditor & auditor’s expert were new to each other i.e. they were working for the first time together but
developed a good bonding during the course of the audit. The auditor did not enter into any formal
agreement with the auditor’s expert. Please advise.
As per SA 620, Using the work of an Auditor’s Expert, the nature, scope & objectives of the auditor’s expert’s
work may vary considerably with the circumstances, as may the respective roles & responsibilities of the
auditor & the auditor’s expert, & the nature, timing & extent of communication between the auditor & the
auditor’s expert. It is therefore required that these matters are agreed between the auditor & the auditor’s
expert.
In certain situations, the need for a detailed agreement in writing is required like -
▪ The auditor’s expert will have access to sensitive or confidential entity information.
▪ The matter to which the auditor’s expert’s work relates is highly complex.
▪ The auditor has not previously used work performed by that expert.
▪ The greater the extent of the auditor’s expert’s work, & its significance in the context of the audit.
In the given case, considering the complexity involved in the valuation & volume of derivatives & also due to
the fact that the auditor & auditor’s expert were new to each other, auditor should have signed a formal
agreement/ engagement letter with the auditor’s expert in respect of the work assigned to him.
Q. 13 : Cineplex, a movie theatre complex, is the foremost theatre located in Delhi. Along with the sale of
tickets over the counter & online booking, the major proportion of income is from the cafe, shops, pubs etc.
located in the complex. Its other income includes advertisements exhibited within/outside the premises
such as hoardings, banners, slides, short films etc. The facility for parking of vehicles is also provided in the
basement of the premises.
Cineplex appointed your firm as the auditor of the entity. Being the head of the audit team, you are,
therefore, required to draw an audit programme initially in respect of its revenue & expenditure
considering the above mentioned facts along with other relevant points relating to a complex.
Audit Programme of Movie Theatre Complex:
(i) Peruse the Memorandum of Association & Articles of Association of the entity.
(ii) Ensure the object clause permits the entity to engage in this type of business.
(iii) In the case of income from sale of tickets:
1) Verify the control system as to how it is ensured that the collections on sale of tickets of various
shows are properly & accurately accounted.
2) Verify the system relating to online booking of various shows & the system of realization of
money.
3) Check that there is overall system of reconciliation of collections with the number of seats

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available for different shows in a day.

(iv) Verify the internal control system & its effectiveness relating to the income from café, shops, pubs,
game zone etc., located within the multiplex.
(v) Verify the system of control exercised relating to the income receivable from advertisements exhibited
within the premises & inside the hall such as hoarding, banners, slides, short films etc.
(vi) Verify the system of collection from the parking areas in respect of the vehicles parked by the
customers.
(vii) In the case of payment to the distributors verify the system of payment which may be either through
out right payment or percentage of collection or a combination of both. Ensure at the time of
settlement, any payment of advance made to the distributor is also adjusted against the amount due.
(viii) Verify the system of payment of salaries & other benefits to the employees & ensure that statutory
requirements are complied with.
(ix) Verify the payments effected in respect of the maintenance of the building & ensure the same is in
order.
(x) Verify the insurance premium paid & ensure it covers the entire assets.

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CH – 3 RISK ASSESSMENT & INTERNAL CONTROL

Q. 1 : SA 315, “Identifying & Assessing the Risks of Material Misstatement Through Understanding the
Entity & Its Environment” categorises the types of assertions used by the auditor to consider the different
types of potential misstatements that may occur. Briefly explain with example.
Assertions about Occurrence— transactions & events that have been recorded have occurred &
classes of pertain to the entity.
transactions and Completeness— all transactions & events that should have been recorded have been
events for the recorded.
period under
audit: Accuracy— amounts & other data relating to recorded transactions & events have
been recorded appropriately.
Cut-off— transactions & events have been recorded in the correct accounting period.

Classification- transactions & events have been recorded in the proper accounts.

Assertions about Existence— assets, liabilities, & equity interests exist.

account balances Rights & obligations— the entity holds or controls the rights to assets, & liabilities are
at the period end: the obligations of the entity.
Completeness— all assets, liabilities & equity interests that should have been.
Valuation & allocation— assets, liabilities, & equity interests are included in the FS at
appropriate amounts & any resulting valuation or allocation adjustments are
appropriately recorded.
Assertions Occurrence & rights & obligations — disclosed events, transactions, & other matters
about have occurred & pertain to the entity.
presentation Completeness— all disclosures that should have been included in the financial
& statements have been included.
disclosure: Classification & understandability— financial information is appropriately
presented & described, & disclosures are clearly expressed.
Accuracy & valuation— financial & other information are disclosed fairly & at
appropriate amounts.
Q. 2 : What are the components of an internal control framework?
There are five components of an internal control framework. They are as follows:
▪ Control Environment;
▪ Risk Assessment;
▪ Information & Communication;
▪ Monitoring;
▪ Control Activities.
Q. 3 : During the course of his audit, the auditor noticed material weaknesses in the internal control
system & he wishes to communicate the same to the management. You are required to elucidate the
important points the auditor should keep in the mind while drafting the letter of weaknesses in internal
control system.
Important Points to be kept in Mind While Drafting Letter of Weakness: As per SA 265, “Communicating
Deficiencies in Internal Control to Those who Charged with Governance & Management”, the auditor shall
include in the written communication of significant deficiencies in internal control -
(i) A description of the deficiencies & an explanation of their potential effects; &
(ii) Sufficient information to enable those charged with governance & management to understand the
context of the communication.

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In other words, the auditor should communicate material weaknesses to the management or the audit
committee, if any, on a timely basis. This communication should be, preferably, in writing through a letter of
weakness or management letter. Important points with regard to such a letter are as follows-
1) The letter lists down the area of weaknesses in the system & offers suggestions for improvement.
2) It should clearly indicate that it discusses only weaknesses which have come to the attention of the
auditor as a result of his audit & that his examination has not been designed to determine the adequacy
of internal control for management.
3) This letter serves as a valuable reference document for management for the purpose of revising the
system & insisting on its strict implementation.
4) The letter may also serve to minimize legal liability in the event of a major defalcation or other loss
resulting from a weakness in internal control.
Q. 4 : Explain briefly the Flow Chart technique for evaluation of the Internal Control system.
The flow charting technique can also be resorted to for evaluation of the internal control system. It is a
graphic presentation of internal controls in the organisation & is normally drawn up to show the controls in
each section or sub-section. As distinct from a narrative form, it provides the most concise & comprehensive
way for reviewing the internal controls & the evaluator’s findings. In a flow chart, narratives, though cannot
perhaps be totally banished are reduced to the minimum & by that process, it can successfully bring the
whole control structure, specially the essential parts thereof, in a condensed but wholly meaningful manner.
It gives a bird’s eye view of the system & is drawn up as a result of the auditor’s review thereof. It should,
however, not be understood that details are not reflected in a flow chart. Every detail relevant from the
control point of view & the details about how an operation is performed can be included in the flow chart.
Essentially a flow chart is a diagram full with lines & symbols &, if judicious use of them can be made, it is
probably the most effective way of presenting the state of internal controls in the client’s organisation.
A properly drawn up flow chart can provide a neat visual picture of the whole activities of the section or
department involving flow of documents & activities. More specifically it can show-
(i) at what point a document is raised internally or received from external sources;
(ii) the number of copies in which a document is raised or received;
(iii) the intermediate stages set sequentially through which the document & the activity pass;
(iv) distribution of the documents to various sections, department or operations;
(v) checking authorisation & matching at relevant stages;
(vi) filing of the documents; &
(vii) final disposal by sending out or destruction.
As a matter of fact a very sound knowledge of internal control requirements is imperative for, adopting flow-
charting technique for evaluation of internal controls; also it demands a highly analytical mind to be able to
see clearly the inter division of a job & the appropriate control at relevant points.
It has been stated earlier that flow charts should be made section-wise or department-wise. The suggestion
has been made to ensure readability & intelligibility of the flow charts.
Drawing of a flow chart - A flow chart is normally a horizontal one in which documents & activities are shown
to flow horizontally from section to section & the concerned sections are shown as the vertical column heads;
in appropriate cases an individual also may be shown as the vertical column head. Care should be taken to see
that the first column head is devoted to the section or the individual wherefrom a transaction originates &
the placements of other column heads should be in the order of the actual flow of the transaction.
It has been started earlier that a flow chart is a symbolic representation the flow of activity & related
documents through the section from origin to conclusion. These can be sales, purchases, wages, production,
etc. Each one of the main functions is to be linked with related functions for making a complete course.
Purchase is to be linked with trade payables & payments; sales with trade receivables & collections. By this
process, a flow chart will become self contained, complete & meaningful for evaluation of internal controls.
Generally, a questionnaire is also enclosed with a flow chart, incorporating questions, the answers to which
are to be looked into from the flow chart. This is an evaluation of the control system through the process of

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flow charting. The internal control questionnaire contains questions; answers are available in the flow chart &
they will reveal weakness, if any, in the system. In fact, the questionnaire is a guide for the study of a control
system through flow charts.
Q. 5 : As auditor of Z Ltd., you would like to limit your examination of account balance tests. What are the
control objectives you would like the accounting control system to achieve to suit your purpose?
Basic Accounting Control Objectives: The basic accounting control objectives which are sought to be achieved
by any accounting control system are -
(i) Whether all transactions are recorded;
(ii) Whether recorded transactions are real;
(iii) Whether all recorded transactions are properly valued;
(iv) Whether all transactions are recorded timely;
(v) Whether all transactions are properly posted;
(vi) Whether all transactions are properly classified & disclosed;
(vii) Whether all transactions are properly summarized.
Q. 6 : New Life Hospital is a multi-speciality hospital which has been facing a lot of pilferage & troubles
regarding their inventory maintenance & control. On investigation into the matter it was found that the
person in charge of inventory inflow & outflow from the store house is also responsible for purchases &
maintaining inventory records. According to you, which basis system of control has been violated? Also list
down the other general conditions pertaining to such system which needs to be maintained & checked by
the management.
Basic system of Control: Internal Checks & Internal Audit are important constituents of Accounting Controls.
Internal check system implies organization of the overall system of book-keeping & arrangement of Staff
duties in such a way that no one person can carry through a transaction & record every aspect thereof.
In the given case of New Life Hospital, the person-in-charge of inventory inflow & outflow from the store
house is also responsible for purchases & maintaining inventory records. Thus, one of the basic system of
control i.e. internal check which includes segregation of duties or maker & checker has been violated where
transaction processing are allocated to different persons in such a manner that no one person can carry
through the completion of a transaction from start to finish or the work of one person is made complimentary
to the work of another person.
The general condition pertaining to the internal check system may be summarized as under-
(i) No single person should have complete control over any important aspect of the business operation.
Every employee’s action should come under the review of another person.
(ii) Staff duties should be rotated from time to time so that members do not perform the same function
for a considerable length of time.
(iii) Every member of the staff should be encouraged to go on leave at least once a year.
(iv) Persons having physical custody of assets must not be permitted to have access to the books of
accounts.
(v) There should exist an accounting control in respect of each class of assets, in addition, there should be
periodical inspection so as to establish their physical condition.
(vi) Mechanical devices should be used, where ever practicable to prevent loss or misappropriation of
cash.
(vii) Budgetary control should be exercised & wide deviations observed should be reconciled.
(viii) For inventory taking, at the close of the year, trading activities should, if possible be suspended, & it
should be done by staff belonging to several sections of the organization.
(ix) The financial & administrative powers should be distributed very judiciously among different officers
& the manner in which those are actually exercised should be reviewed periodically.
(x) Procedures should be laid down for periodical verification & testing of different sections of accounting
records to ensure that they are accurate.

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Q. 7 : Compute the overall Audit Risk if looking to the nature of business there are chances that 40% bills of
services provided would be defalcated, inquiring on the same matter management has assured that
internal control can prevent such defalcation to 75%.At his part the Auditor assesses that the procedure he
could apply in the remaining time to complete Audit gives him satisfaction level of detection of frauds &
error to an extent of 60%. Analyse the Risk of Material Misstatement & find out the overall Audit Risk.
According to SA-200, “Overall Objectives of the Independent Auditor & the Conduct of an Audit in Accordance
with Standards on Auditing”, the Audit Risk is a risk that Auditor will issue an inappropriate opinion while
Financial Statements are materially misstated.
Audit Risk, has two components: Risk of material Misstatement & Detection Risk. The relationship can be
defined as follows.
Audit Risk = Risk of material Misstatement X Detection Risk
Risk of material Misstatement: - Risk of Material Misstatement is anticipated risk that a material
Misstatement may exist in Financial Statement before start of the Audit. It has two components Inherent risk
& Control risk. The relationship can be defined as
Risk of material Misstatement = Inherent risk X control risk
Inherent risk: it is a susceptibility of an assertion about account balance; class of transaction, disclosure
towards misstatements which may be either individually or collectively with other Misstatement becomes
material before considering any related internal control which is 40% in the given case.
Control risk: it is a risk that there may be chances of material Misstatement even if there is a control applied
by the management & it has prevented defalcation to 75%.
Hence, control risk is 25% (100%-75%)
Risk of material Misstatement: Inherent risk X control risk i.e. 40% X 25 % = 10%
Chances of material Misstatement are reduced to 10% by the internal control applied by management.
Detection risk: It is a risk that a material Misstatement remained undetected even if all Audit procedures
applied, Detection Risk is 100-60=40%
In the given case, overall Audit Risk can be reduced up to 4% as follows:
Audit Risk: Risk of Material Misstatement X Detection Risk = 10X 40% = 4%
Q. 8 : ST Ltd is a growing company & currently engaged in the business of manufacturing of tiles. The
company is planning to expand & diversify its operations. The management has increased the focus on the
internal controls to ensure better governance. The management had a discussion with the statutory
auditors to ensure the steps required to be taken so that the statutory audit is risk based & focused on
areas of greatest risk to the achievement of the company’s objectives. Please advise the management &
the auditor on the steps that should be taken for the same.
General Steps in the Conduct of Risk Based Audit
The auditor’s objective in a risk-based audit is to obtain reasonable assurance that no material misstatements
whether caused by fraud or errors exist in the financial statements.
This involves the following three key steps:
▪ Assessing the risks of material misstatement in the financial statements
▪ Designing & performing further audit procedures that respond to assessed risks & reduce the risks of
material misstatements in the financial statements to an acceptably low level; &
▪ Issuing an appropriate audit report based on the audit findings.
The risk-based audit process is presented in three distinct phases:
Risk The risk assessment phase of the audit involves the following steps:
Assessment   Performing client acceptance or continuance procedures;
 Planning the overall engagement;
 Performing risk assessment procedures to understand the business & identify
inherent & control risks;

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
 Identifying relevant internal control procedures & assessing their design &
implementation (those controls that would prevent material misstatements from
occurring or detect & correct misstatements after they have occurred);

 Assessing the risks of material misstatement in the FS;

 Identifying the significant risks that require special audit consideration & those risks
for which substantive procedures alone are not sufficient;

 Communicating any material weaknesses in the design & implementation of internal
control to management & those charged with governance; &

 Making an informed assessment of the risks of material misstatement at the financial
statement level & at the assertion level.
Risk This phase of the audit is to design & perform further audit procedures that respond to
Response the assessed risks of material misstatement & will provide the evidence necessary to
support the audit opinion
Some of the matters the auditor should consider when planning the audit procedures
include –
 Assertions that cannot be addressed by substantive procedures alone. This can occur
where there is highly automated processing of transactions with little or no manual
intervention.
 Existence of internal control that, if tested, could reduce the need/scope for other
substantive procedures.
 The potential for substantive analytical procedures that would reduce the need/scope
for other types of procedures.
 The need to incorporate an element of unpredictability in procedures performed.
 The need to perform further audit procedures to address the potential for
management override of controls or other fraud scenarios.
 The need to perform specific procedures to address “significant risks” that have been
identified.
Audit procedures designed to address the assessed risks could include a mixture of:
 Tests of the operational effectiveness of internal control; &
 Substantive procedures such as tests of details & analytical procedures.
Reporting The final phase of the audit is to assess the audit evidence obtained & determine whether
it is sufficient & appropriate to reduce the risks of material misstatement in the FS to an
acceptably low level.
It is important at this stage to determine:
 If there had been a change in the assessed level of risk;

 Whether conclusions drawn from work performed are appropriate; &

 If any suspicious circumstances have been encountered.
Any additional risks should be appropriately assessed, & further audit procedures
performed as required.

 When all procedures have been performed & conclusions reached:

 Audit findings should be reported to management & those charged with governance;
&

 An audit opinion should be formed, & a decision made on the appropriate wording for
the auditor’s report.

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Q. 9 : Y Co. Ltd. has five entertainment centers to provide recreational facilities for public especially for
children & youngsters at 5 different locations in the peripheral of 200 kilometers. Collections are made in
cash. Specify the adequate system towards collection of money.
Control System over Selling & Collection of Tickets: In order to achieve proper internal control over the sale
of tickets & its collection by the Y Co. Ltd., following system should be adopted -
(i) Printing of tickets: Serially numbered pre-printed tickets should be used & designed in such a way
that any type of ticket used cannot be duplicated by others in order to avoid forgery. Serial numbers
should not be repeated during a reasonable period, say a month or year depending on the turnover.
The separate series of the serial should be used for such denomination.
(ii) Ticket sales: The sale of tickets should take place from the Central ticket office at each of the 5
centres, preferably through machines. There should be proper control over the keys of the machines.
(iii) Daily cash reconciliation: Cash collection at each office & machine should be reconciled with the
number of tickets sold. Serial number of tickets for each entertainment activity/denomination will
facilitate the reconciliation.
(iv) Daily banking: Each day’s collection should be deposited in the bank on next working day of the bank.
Till that time, the cash should be in the custody of properly authorized person preferably in joint
custody for which the daily cash in hand report should be signed by the authorized persons.
(v) Entrance ticket: Entrance tickets should be cancelled at the entrance gate when public enters the
centre.
(vi) Advance booking: If advance booking of facility is made available, the system should ensure that all
advance booked tickets are paid for.
(vii) Discounts & free pass: The discount policy of the Y Co. Ltd. should be such that the concessional
rates, say, for group booking should be properly authorized & signed forms for such authorization
should be preserved.
(viii) Surprise checks: Internal audit system should carry out periodic surprise checks for cash counts, daily
banking, reconciliation & stock of unsold tickets etc.
Q. 10 : The effectiveness of controls cannot rise above the integrity & ethical values of the people who
create, administer, & monitor them. Explain.
Control Environment
The control environment encompasses the following elements:
(a) Communication & enforcement of integrity & ethical values: The effectiveness of controls cannot rise
above the integrity & ethical values of the people who create, administer, & monitor them. Integrity &
ethical behavior are the product of the entity’s ethical & behavioral standards, how they are
communicated, & how they are reinforced in practice. The enforcement of integrity & ethical values
includes, for example, management actions to eliminate or mitigate incentives or temptations that might
prompt personnel to engage in dishonest, illegal, or unethical acts. The communication of entity policies
on integrity & ethical values may include the communication of behavioral standards to personnel
through policy statements & codes of conduct & by example.
(b) Commitment to competence: Competence is the knowledge & skills necessary to accomplish tasks that
define the individual’s job.
(c) Participation by those charged with governance: An entity’s control consciousness is influenced
significantly by those charged with governance. The importance of the responsibilities of those charged
with governance is recognised in codes of practice & other laws & regulations or guidance produced for
the benefit of those charged with governance. Other responsibilities of those charged with governance
include oversight of the design & effective operation of whistle blower procedures & the process for
reviewing the effectiveness of the entity’s internal control.
(d) Management’s philosophy & operating style: Management’s philosophy & operating style encompass a

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broad range of characteristics. For example, management’s attitudes & actions toward financial
reporting may manifest themselves through conservative or aggressive selection from available
alternative accounting principles, or conscientiousness & conservatism with which accounting estimates
are developed.
(e) Organisational structure: Establishing a relevant organizational structure includes considering key areas
of authority & responsibility & appropriate lines of reporting. The appropriateness of an entity’s
organisational structure depends, in part, on its size & the nature of its activities.
(f) Assignment of authority & responsibility: The assignment of authority & responsibility may include
policies relating to appropriate business practices, knowledge & experience of key personnel, &
resources provided for carrying out duties. In addition, it may include policies & communications
directed at ensuring that all personnel understand the entity’s objectives, know how their individual
actions interrelate & contribute to those objectives, & recognize how & for what they will be held
accountable.
(g) Human resource policies & practices: Human resource policies & practices often demonstrate important
matters in relation to the control consciousness of an entity. For example, standards for recruiting the
most qualified individuals – with emphasis on educational background, prior work experience, past
accomplishments, & evidence of integrity & ethical behaviour – demonstrate an entity’s commitment to
competent & trustworthy people. Training policies that communicate prospective roles & responsibilities
& include practices such as training schools & seminars illustrate expected levels of performance &
behaviour. Promotions driven by periodic performance appraisals demonstrate the entity’s commitment
to the advancement of qualified personnel to higher levels of responsibility.
Q. 11 : Your engagement team is seeking advice from you as engagement partner regarding steps for risk
identification. Elaborate.
Steps for Risk Identification
▪ Assess the significance of the assessed risk, impact of its occurrence & also revise the materiality
accordingly for the specific account balance.
▪ Determine the likelihood for assessed risk to occur & its impact on our auditing procedures.
▪ Document the assertions that are effected.
▪ Consider the impact of the risk on each of the assertions
▪ (completeness, existence, accuracy, validity, valuation & presentation) relevant to the account balance,
class of transactions, or disclosure.
▪ Identify the degree of Significant risks that would require separate attention & response by the auditor.
Planned audit procedures should directly address these risks.
▪ Enquire & document the management’s response.
▪ Consider the nature of the internal control system in place & its possible effectiveness in mitigating the
risks involved. Ensure the controls :
✓ Routine in nature (occur daily) or periodic such as monthly.
✓ Designed to prevent or detect & correct errors.
✓ Manual or automated.
▪ Consider any unique characteristics of the risk.
▪ Consider the existence of any particular characteristics (inherent risks) in the class of transactions,
account balance or disclosure that need to be addressed in designing further audit procedures.
▪ Examples could include high value inventory, complex contractual agreements, absence of a paper trail on
certain transaction streams or a large percentage of sales coming from a single customer.
Q. 12 : BSF Limited is engaged in the business of trading leather goods. You are the internal auditor of the
company for the year 2019-20. In order to review internal controls of the Sales Department of the

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company, you visited the Department & noticed the work division as follows:
(1) An officer was handling the sales ledger & cash receipts.
(2) Another official was handling dispatch of goods & issuance of Delivery challans.
(3) One more officer was there to handle customer/ debtor accounts & issue of receipts.
As an internal auditor, you are required to briefly discuss the general condition pertaining to the internal
check prevalent in internal control system. Do you think that there was proper division of work in BSF
Limited? If not, why?
THE GENERAL CONDITION PERTAINING TO THE INTERNAL CHECK SYSTEM MAY BE SUMMARIZED AS
UNDER:
▪ No single person should have complete control over any important aspect of the business operation. Every
employee’s action should come under the review of another person.
▪ Staff duties should be rotated from time to time so that members do not perform the same function for a
considerable length of time.
▪ Every member of the staff should be encouraged to go on leave at least once a year.
▪ Persons having physical custody of assets must not be permitted to have access to the books of accounts.
▪ There should exist an accounting control in respect of each class of assets, in addition, there should be
periodical inspection so as to establish their physical condition.
▪ Mechanical devices should be used, where ever practicable to prevent loss or misappropriation of cash.
▪ Budgetary control should be exercised & wide deviations observed should be reconciled.
▪ For inventory taking, at the close of the year, trading activities should, if possible be suspended, & it
should be done by staff belonging to several sections of the organization.
▪ The financial & administrative powers should be distributed very judiciously among different officers & the
manner in which those are actually exercised should be reviewed periodically.
▪ Procedures should be laid down for periodical verification & testing of different sections of accounting
records to ensure that they are accurate.
In the given scenario, Company has not done proper division of work as:
(i) the receipts of cash should not be handled by the official handling sales ledger &
(ii) delivery challans should be verified by an authorised official other than the officer handling despatch of
goods.

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CH – 4
SPECIAL ASPECTS OF AUDITING IN AN
AUTOMATED ENVIRONMENT
Q. 1 : Briefly describe the various stages of a Risk Assessment process.
Risk Assessment is one of the most critical components of Enterprise Risk Management. The risk assessment
process involves considerations for qualitative & quantitative factors, definition of key performance & risk
indicators, risk appetite, risk scores, scales & maps, use of data & metrics & benchmarking.
The various stages in a Risk Assessment process are as follows:
▪ Define Business Objectives & Goals;
▪ Identify events that affect achievement of business objectives;
▪ Assess likelihood & impact;
▪ Respond & mitigate risks;
▪ Assess residual risk.
Q. 2 : What are the components of an internal control framework?
There are five components of an internal control framework. They are as follows:
▪ Control Environment;
▪ Risk Assessment;
▪ Control Activities;
▪ Information & Communication;
▪ Monitoring.
Q. 3 : Describe application controls & give three examples of automated application controls.
Application Controls are automated or manual controls that operate at a business process level. Automated
Application controls are embedded into IT applications viz., ERPs & help in ensuring the completeness,
accuracy & integrity of data in those systems.
Examples of automated applications include:
▪ Edit checks & validation of input data;
▪ Sequence number check;
▪ Limit check;
▪ Reasonableness check;
▪ Format check;
▪ Mandatory data fields.
Q. 4 : A real-time environment is a type of automated environment in which business operations &
transactions are initiated, processed & recorded immediately (without any delay) as they happen. It has
several critical IT components that enable anytime, anywhere transactions to take place. You are required
to name the components & its example of real-time environment.
Real Time Environment: IT Components: To facilitate transactions in real-time, it is essential to have the
systems, networks & applications available during all times. A real-time environment has several critical IT
components that enable anytime, anywhere transactions
to take place. Any failure even in one component could render the real-time system unavailable & could
result in a loss of revenue. IT Components include:
(i) Applications: For example, ERP applications SAP, Oracle E-Business Suite, Core banking applications.
(ii) Middleware.: For example, Webservers like Apache, Oracle Fusion, IIS.
(iii) Networks: For example, Wide Area Networks, Local Area Network.

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(iv) Hardware: For example, Servers, Backup & Storage devices.

Q. 5 : The Entity’s Risk Assessment Process includes how management identifies business risks relevant to
the preparation of financial statements in accordance with the entity’s applicable financial reporting
framework, estimates their significance, assesses the likelihood of occurrence & decides upon actions to
respond to & manage them & the results thereof. Elucidate the circumstances in which risks can arise or
change.
Entity’s Risk Assessment Process: Risks can arise or change due to circumstances such as the following-
(i) Changes in operating environment: Changes in the regulatory or operating environment can result in
changes in competitive pressures & significantly different risks.
(ii) New personnel: New personnel may have a different focus on or understanding of internal control.
(iii) New or revamped information systems: Significant & rapid changes in information systems can change
the risk relating to internal control.
(iv) Rapid growth: Significant & rapid expansion of operations can strain controls & increase the risk of a
breakdown in controls.
(v) New technology: Incorporating new technologies into production processes or information systems may
change the risk associated with internal control.
(vi) New business models, products, or activities: Entering into business areas or transactions with which an
entity has little experience may introduce new risks associated with internal control.
(vii) Corporate restructurings: Restructurings may be accompanied by staff reductions & changes in
supervision & segregation of duties that may change the risk associated with internal control.
(viii) Expanded foreign operations: The expansion or acquisition of foreign operations carries new & often
unique risks that may affect internal control, for example, additional or changed risks from foreign
currency transactions.
(ix) New accounting pronouncements: Adoption of new accounting principles or changing accounting
principles may affect risks in preparing financial statements.
Q. 6 : In an automated environment, the data stored & processed in systems can be used to get various
insights into the way business operates. This data can be useful for preparation of management
information system (MIS) reports & electronic dashboards that give a high-level snapshot of business
performance. In view of above you are required to briefly discuss the meaning of data analytics & example
of circumstances when auditing in an automated environment, auditors can apply the concepts of data
analytics.
USING RELEVANT ANALYTICAL PROCEDURES & TESTS USING DATA ANALYTICS
In an automated environment, the data stored & processed in systems can be used to get various insights into
the way business operates. This data can be useful for preparation of management information system (MIS)
reports & electronic dashboards that give a high-level snapshot of business performance. Generating &
preparing meaningful information from raw system data using processes, tools, & techniques is known as
Data Analytics.
The data analytics methods used in an audit are known as Computer Assisted Auditing Techniques or
CAATs. When auditing in an automated environment, auditors can apply the concepts of data analytics for
several aspects of an audit including the following:
▪ preliminary analytics;
▪ risk assessment;
▪ control testing;
▪ non-standard journal analysis;
▪ evaluation of deficiencies;
▪ fraud risk assessment
There are several steps that should be followed to achieve success with CAATs & any of the supporting tools.

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Q. 7 : In a risk-based audit, the audit approach can be classified into three broad phases comprising of
planning, execution, & completion. You are required to briefly explain the relevant considerations for every
phase in above audit approach in case of an automated environment.
CONSIDERATION OF AUTOMATED ENVIRONMENT AT EACH PHASE OF AUDIT CYCLE
In a controls-based audit in an automated environment, the audit approach can be classified into three broad
phases comprising of planning, execution, & completion. In this approach, the considerations of automated
environment will be relevant at every phase as given below:
▪ during risk assessment, the auditor should consider risk arising from the use of IT systems at the
company;
▪ when obtaining an understanding of the business process & performing walkthroughs the use of IT
systems & applications should be considered;
▪ while assessing the entity level controls the aspects related to IT governance need to be understood &
reviewed;
▪ pervasive controls including segregation of duties, general IT controls & applications should be considered
& reviewed;
▪ during testing phase, the results of general IT controls would impact the nature, timing & extent of
testing;
▪ when testing of reports & information produced by the entity (IPE) generated through IT systems &
applications;
▪ at completion stage, evaluation of control deficiencies may require using data analytics & CAATs.
Q. 8 : Generating & preparing meaningful information from raw system data using processes, tools, &
techniques is known as Data Analytics & the data analytics methods used in an audit are known as
Computer Assisted Auditing Techniques or CAATs.” You are required to give illustration of a suggested
approach to get the benefit from the use of CAATs
There are several steps that should be followed to achieve success with CAATs & any of the supporting tools.
A suggested approach to benefit from the use of CAATs is given in the illustration below:

The illustration below is an example of a data analytics dashboard from which an auditor can see a high-level
view of the transaction patterns in terms of percentage, volume, distribution & type of transaction. Based on
this information the auditor can design appropriate procedures for audit.
Q. 9 : A Company is using ERP for all its business processes including Procurement, Sales, Finance &
Reporting. You are required to explain the Statutory Auditor’s approach to identify the risks associated
with the IT systems.
The Auditor should understand & document each of the business processes in form of narratives & / or
flowcharts. The next process will be to identify areas / events that can lead to risks, viz. manual Invoicing &
accounting once goods are dispatched could lead to incorrect Invoicing & accounting & hence is a ‘risk’. The
Auditor should also analyse the risks i.e. the impact it will have if materializes. Next will be prioritization in
terms of probability of how often the risks will materialize.
Q. 10 : Explain some of the International IT related Standards, Guidelines & Framework.

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STANDARDS, GUIDELINES & PROCEDURES - USING RELEVANT FRAMEWORKS & BEST PRACTICES
When auditing in an automated environment the auditor should be aware, adhere to & be guided by the
various standards, guidelines & procedures that may be relevant to both audit & the automated environment.
Given below are some of the common standards & guidelines that are relevant in this context include:
• Standards on Auditing issued by the ICAI, are required to be followed for an audit of financial
statements.
• Section 143 of Companies Act 2013 requires statutory auditors to provide an Independent Opinion on
the Design & Operating Effectiveness of Internal Financial Controls Over Financial Reporting (IFC-FR) of
the company as at Balance Sheet date. For this purpose, the Guidance Note on Audit of Internal
Financial Controls Over Financial Reporting issued by the ICAI, provides the framework, guidelines &
procedures for an audit of financial statements.
• Sarbanes Oxley Act of 2002, commonly known as SOX, is a requirement in America. Section 404 of this
act requires public listed companies to implement, assess & ensure effectiveness of internal controls
over financial reporting & auditors independent opinion on the design & operating effectiveness of
internal controls over financial reporting (ICFR) – which is similar to the requirements of IFC-FR for Indian
companies. Similar legal & statutory requirements over internal controls exist in several other countries
including Japan, China, European Countries, etc.
• ISO 27001:2013 is the Information Security Management System (ISMS) standard issued by the
International Organization for Standardization (ISO). This standard provides the framework, guidelines &
procedures for implementing information security & related controls in a company. For example, this
standard covers password security, application security, physical security, backup & recovery, that are
relevant when auditing in an automated environment.
• ITIL (Information Technology Infrastructure Library) & ISO 20000 provide a set of best practice
processes & procedures for IT service management in a company. For example, change management,
incident management, problem management, IT operations, IT asset management are some of the areas
that could be relevant to audit.
• The Payment Card Industry – Data Security Standard or PCI-DSS, is the most widely adopted
information security standard for the payment cards industry. Any company that is involved in the
storage, retrieval, transmission or handling of credit card/debit card information are required to
implement the security controls in accordance with this standard.
• The American Institute of Certified Public Accountants has published a framework under the Statements
on Standards for Attest Engagements (SSAE) No.16 for reporting on controls at a service organisation
that include
❖ SOC 1 for reporting on controls at a service organization relevant to user entities’ internal control over
financial reporting (ICFR).
❖ SOC 2 and SOC 3 for reporting on controls at a service organization relevant to security, availability,
processing integrity, confidentiality or privacy i.e., controls other than ICFR.
❖ While SOC 1 & SOC 2 are restricted use reports, SOC 3 is general use report.
• Control Objectives for Information & Related Technologies (CoBIT) is best practice IT Governance &
Management framework published by Information Systems Audit & Control Association. CoBIT provides
the required tools, resources & guidelines that are relevant to IT governance, risk, compliance &
information security.
• The Cybersecurity Framework (CSF) published by the National Institute of Standards & Technology is
one of the most popular framework for improving critical infrastructure cybersecurity. This framework
provides a set of standards & best practices for companies to manage cybersecurity risks.
Q. 11 : Explain Application Controls & General IT Controls.
ASSESSING IT-RELATED RISKS & CONTROLS
The auditing standards SA 315 & SA 330 require an auditor to understand, assess & respond to the risks
within a company, including those risks that pertain to the use of IT systems & applications in an automated

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environment. When assessing IT risks in the automated environment, the auditor should consider the
following:
As systems evolve & version updates happen so will new risks emerge. For example, as systems these days
are highly interconnected & accessible through public networks like the internet, cyber risks are a serious
threat.
The controls that are put in place to mitigate the IT risks & to maintain the confidentiality, integrity,
availability and security of data are as follows:
▪ General IT Controls;
▪ Application Controls;
▪ IT-Dependent Controls.
The illustration below is a sample representation of the various components of an automated environment
and where the different types of IT controls fit into the overall environment:
General IT Controls: “General IT controls are policies & procedures that relate to many applications & support
the effective functioning of application controls. They apply to mainframe, miniframe, & end-user
environment. General IT controls that maintain the integrity of information & security of data commonly
include controls over the following:” (SA 315)
▪ Data center & network operations;
▪ System software acquisition, change & maintenance
▪ Program change;
▪ Access security;
▪ Application system acquisition, development, & maintenance (Business Applications) .
These are IT controls generally implemented to mitigate the IT specific risks & applied commonly across
multiple IT systems, applications & business processes. Hence, General IT controls are known as “pervasive”
controls or “indirect” controls.

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CH – 5 COMPANY AUDIT
EXAMPLE : 1
Managing Director of PQR Ltd. himself wants to appoint Shri Ganpati, a practicing Chartered Accountant, as
first auditor of the company. Comment on the proposed action of the Managing Director.
Provisions & Explanation: Section 139(6) of the Companies Act, 2013 lays down that “the first auditor or
auditors of a company shall be appointed by the Board of directors within 30 days from the date of
registration of the company”. In the instant case, the proposed appointment of Shri Ganpati, a practicing
Chartered Accountant as first auditors by the Managing Director of PQR Ltd by himself is in violation of
Section 139(6) of the Companies Act, 2013, which requires the Board of Directors to appoint the first
auditor of the company.
Conclusion: In view of the above, the Managing Director of PQR Ltd cannot appoint the first auditor of the
company.
EXAMPLE : 2
The first auditor of Healthy Wealthy Ltd., a Government company, was appointed by the Board of
Directors.
Provisions & Explanation: Section 139(6) of the Companies Act, 2013 (the Act) lays down that “the first
auditor or auditors of a company shall be appointed by the Board of directors within 30 days from the date
of registration of the company”. Thus, the first auditor of a company can be appointed by the Board of
Directors within 30 days from the date of registration of the company. However, in the case of a
Government Company, the appointment of first auditor is governed by the provisions of Section 139(7) of
the Companies Act, 2013 which states that in the case of a Government company, the first auditor shall be
appointed by the Comptroller & Auditor General of India within 60 days from the date of registration of
the company. Hence, in the case of Healthy Wealthy Ltd., being a government company, the first auditors
shall be appointed by the Comptroller & Auditor General of India. Conclusion: Thus, the appointment of
first auditors made by the Board of Directors of Healthy Wealthy Ltd. is null & void.
EXAMPLE : 3
G, a CA in practice is a director in RST Ltd. On combined reading of Section 141(3)(b) & Section 2(59), it may
be concluded that CA G would be disqualified to be appointed as an auditor of RST Ltd.
EXAMPLE : 4
G, a CA in practice is a director in Zed Ltd., holding company of RST Ltd. On combined reading of Section
141(3)(b) & Section 2(59), it may be concluded that CA. G would be disqualified to be appointed as an
auditor of Zed Ltd. but would not be disqualified in case of RST Ltd.
EXAMPLE : 5
“Mr. Avi”, a practicing Chartered Accountant, is holding securities of “XYZ Ltd.” having face value of ` 990/-.
Whether Mr. Avi is qualified for appointment as an Auditor of “XYZ Ltd.”?
As per section 141(3)(d)(i), a person is disqualified to be appointed as an auditor if he, or his relative or
partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate
company or a subsidiary of such holding company.
In the present case, Mr. Avi. is holding security of ` 900 in XYZ Ltd, therefore, he is not eligible for
appointment as an auditor of “XYZ Ltd”.
EXAMPLE : 6
“Mr. PK” is a practicing Chartered Accountant & “Mr. Qurashi”, the relative of “Mr. PK”, is holding
securities of “ABC Ltd.” having face value of ` 99,000/-.
Whether “Mr. PK” is Qualified for being appointed as an auditor of “ABC Ltd.”?
As per section 141(3)(d)(i), a person is disqualified to be appointed as an auditor if he, or his relative or
partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate

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company or a subsidiary of such holding company. Further, as per proviso to this Section, the relative of
the person may hold the securities or interest in the company of face value not exceeding of ` 1,00,000.
In the present case, Mr. Qurashi (relative of Mr. PK), is having securities of ` 99,000 face Value in ABC Ltd.,
which is as per requirements of proviso to section 141(3)(d)(i). Therefore, Mr. PK will not be disqualified to
be appointed as an auditor of ABC Ltd
EXAMPLE : 7
“M/s Bhavin & Co.” is an Audit Firm having partners “Mr. Bala” & “Mr. Chandu”. “Mr. A” the relative of
“Mr. Chandu”, is holding securities of “AMD Ltd.” having face value of ` 1,00,100/-. Whether “M/s Bhavin &
Co.” is qualified for being appointed as an auditor of “AMD Ltd.”?
As per section 141(3)(d)(i), a person is disqualified to be appointed as an auditor if he, or his relative or
partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate
company or a subsidiary of such holding company: Further as per proviso to this Section, the relative of the
person may hold the securities or interest in the company of face value not exceeding of ` 1,00,000.
In the instant case, M/s Bhavin & Co, will be disqualified for appointment as an auditor of AMD Ltd as the
relative of Mr. Chandu (i.e. partner of M/s Bhavin & Co.), is holding the securities in AMD Ltd which is
exceeding the limit mentioned in proviso to section 141(3)(d)(i).
EXAMPLE : 8
M/s Rajamohan & Co. is an audit firm having partners CA. Raja & CA. Mohan. The firm has been offered the
appointment as an auditor of Inn Ltd. for the Financial Year 2019-20. Mr. Bee, the relative of CA. Raja, is
holding 8,000 shares (face value of ` 10 each) in Inn Ltd. having market value of ` 1,60,000. Whether M/s
Rajamohan & Co. is disqualified to be appointed as auditors of Inn Ltd.?
As per section 141(3)(d)(i), a person shall not be eligible for appointment as an auditor of a company, who,
or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its
holding or associate company or a subsidiary of such holding company. However, as per proviso to this
section, the relative of the person may hold the securities or interest in the company of face value not
exceeding of ` 1,00,000.
In the instant case, M/s Rajamohan & Co. is an audit firm having partners CA. Raja & CA. Mohan. Mr. Bee is
a relative of CA. Raja & he is holding shares of Inn Ltd. of face value of ` 80,000 only (8,000 shares x ` 10 per
share).
Therefore, M/s Rajamohan & Co. is not disqualified for appointment as an auditors of Inn Ltd. as the
relative of CA. Raja (i.e. partner of M/s Rajamohan & Co.) is holding the securities in Inn Ltd. which is within
the limit mentioned in proviso to section 141(3)(d)(i) of the Companies Act, 2013.
EXAMPLE : 9
CA. P is providing the services of Design & implementation of financial information system to C Ltd. Later
on, he was also offered to be appointed as an auditor of the company for the current financial year.
Advise. Section 141(3)(i) of the Companies Act, 2013 disqualifies a person for appointment as an auditor of
a company who is engaged as on the date of appointment in consulting & specialized services as provided
in section 144. Section 144 of the Companies Act, 2013 prescribes certain services not to be rendered by
the auditor which includes Design & implementation of financial information system.
Therefore, CA. P is advised not to accept the assignment of auditing as the service he is rendering is
specifically notified in the list of services not to be rendered by him as per section 141(3)(i) read with
section 144 of the Companies Act, 2013.
CASE STUDY 1
Mr. Ajay, a Chartered Accountant has been appointed as an auditor of Bharat Ltd. in the Annual General
Meeting of the company held in September, 2019, which assignment he accepted. Subsequently in
February, 2020, he joined Mr. Bajaj, another Chartered Accountant, who is the Manager Finance of Bharat
Ltd., as partner.
Provisions & Explanation: Section 141(3)(c) of the Companies Act, 2013 prescribes that any person who is a
partner or in employment of an officer or employee of the company will be disqualified to act as an auditor of

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a company. Sub-section (4) of Section 141 provides that an auditor who becomes subject, after his
appointment, to any of the disqualifications specified in sub-sections (3) of Section 141, he shall be deemed to
have vacated his office as an auditor.
Conclusion: In the present case, Mr. Ajay, an auditor of Bharat Ltd., joined as partner with Mr. Bajaj, who is
Manager Finance of Bharat Limited. The given situation has attracted sub-section (3)(c) of Section 141 &,
therefore, he shall be deemed to have vacated office of the auditor of Bharat Limited.
EXAMPLE : 10
Mishra Ltd. is a private limited Company, having paid up share capital of rupees 48 crore but having public
borrowing from nationalized banks & financial institutions of rupees 42 crore, manner of rotation of auditor
will not be applicable.
EXAMPLE : 11
PRTK Ltd. is a listed company engaged in the business of textiles. The company has appointed Rahul & Co. as
its statutory auditor in its AGM dated 29th September, 2018. Rahul & Co. will hold office of auditor from the
conclusion of this meeting upto conclusion of sixth AGM i.e. AGM to be held in the year 2023. Now as per
sub-section (2), Rahul & Co. shall not be re-appointed as auditor in PRTK Ltd. for further term of five years i.e.
he cannot be appointed as auditor upto year 2028.
EXAMPLE : 12
Meet Ltd., a listed company, appointed M/s Preet & Co., a Chartered Accountant firm, as the statutory
auditor in its AGM held at the end of September, 2019 for 11 years. Here, the appointment of M/s Preet &
Co. is not valid as the appointment can be made only for one term of five consecutive years & then another
one more term of five consecutive years. It cannot be appointed for two terms in one AGM only. Further, a
cooling period of five years from the completion of term is required i.e. the firm cannot be re-appointed for
further 5 years after completion of two terms of five consecutive years.
EXAMPLE : 13
M/s PQR & Co., is an audit firm having partner Mrs. P, Mr. Q & Mr. R, whose tenure has expired in the
company immediately preceding the financial year, M/s APJ & Co., is another audit firm in which Mr. P is a
common partner, will also be disqualified for the same company along with M/S PQR & Co. for the period of
five years.
EXAMPLE : 14
Mr. P, a Chartered Accountant, is an individual auditor of XYZ Limited for last 5 years as on March, 2013 (i.e.
existing on or before the date of Commencement of Companies Act, 2013), here a break in the term for a
continuous period of five years will not be considered as fulfilling the requirement of rotation. Thus, Mr. P
can continue the audit of XYZ Ltd. upto the first annual general meeting to be held after three years from the
date of commencement of the Act due to transitional effect.
EXAMPLE : 15
M/s PQR Associates, a Chartered Accountants Audit Firm, is doing audit of XYZ Limited for last 11 years as on
March, 2013 (i.e. existing on or before the date of Commencement of Companies Act, 2013), here a break in
the term for a continuous period of two terms of five consecutive years will not be considered as fulfilling
the requirement of rotation.
Thus, M/s PQR Associates can continue the audit of XYZ Ltd. upto the first annual general meeting to be held
after three years from the date of commencement of the Act due to transitional effect.
EXAMPLE : 16
Radheshyam Ltd., a public company having paid up capital of ` 7 crore but having turnover of ` 130 crore, will
be required to constitute an Audit Committee under section 177 because the requirement for constitution of
Audit Committee arises if the company falls into any of the prescribed condition.
CASE STUDY 2
“PQRST & Co.” is an Audit Firm having partners “Mr. P”, “Mr. Q”, “Mr. R”, “Mr. S” & “Mr. T”, Chartered
Accountants. “Mr. P”, “Mr. Q”, “Mr. R”, “Mr. S” & “Mr. T” are holding appointment as an Auditor in 4, 5, 6, 10

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& 15 Companies respectively.

(i) Provide the maximum number of Audits remaining in the name of “PQRST & Co.”
(ii) Provide the maximum number of Audits remaining in the name of individual partner i.e. “Mr. P”, “Mr.
Q”, Mr. R, Mr. S & Mr. T.
(iii) Can PQRST & Co. accept the appointment as an auditor in 80 private companies having paid-up share
capital less than ` 100 crore which has not committed default in filing its financial statements u/s 137 or
annual return u/s 92 of the Companies Act with the Registrar, 2 small companies & 1 dormant company?
(iv) Would your answer be different, if out of those 80 private companies, 65 companies are having paid-up
share capital of ` 115 crore each?
Fact of the Case: In the instant case, Mr. P is holding appointment in 4 companies, Mr. Q is holding
appointment in 5 companies, Mr. R is holding appointment in 6 companies, whereas Mr. S is having
appointment in 10 Companies & Mr. T is having appointment in 15 Companies. In aggregate all five partners
are having 40 audits.
Provisions & Explanations: As per section 141(3)(g) of the Companies Act, 2013, a person shall not be eligible
for appointment as an auditor if he is in full time employment elsewhere or a person or a partner of a firm
holding appointment as its auditor, if such person or partner is at the date of such appointment or
reappointment holding appointment as auditor of more than twenty companies other than one person
companies, dormant companies, small companies & private companies having paid-up share capital less than
` 100 crore (private company which has not committed a default in filing its financial statements u/s 137 of
the said Act or annual return u/s 92 of the said Act with the Registrar).
As per section 141(3)(g), this limit of 20 company audits is per person. In the case of an audit firm having 5
partners, the overall ceiling will be 5 × 20 = 100 company audits. Sometimes, a Chartered Accountant is a
partner in a number of auditing firms. In such a case, all the firms in which he is partner or proprietor will be
together entitled to 20 company audits on his account.
Conclusion:
(i) Therefore, PQRST & Co. can hold appointment as an auditor of 60 more companies:
Total Number of Audits available to the Firm = 20*5 = 100
Number of Audits already taken by all the partners
In their individual capacity = 4+5+6+10+15 = 40
Remaining number of Audits available to the Firm = 60
(ii) With reference to above provisions, an auditor can hold more appointment as auditor = ceiling limit as
per section 141(3)(g)- already holding appointments as an auditor. Hence (1) Mr. P can hold: 20 - 4 = 16
more audits. (2) Mr. Q can hold: 20 - 5 = 15 more audits. (3) Mr. R can hold: 20 - 6 = 14 more audits. (4)
Mr. S can hold 20-10 = 10 more audits & (5) Mr. T can hold 20-15 = 5 more audits.
(iii) In view of above discussed provisions, PQRST & Co. can hold appointment as an auditor in all the 80
private companies having paid-up share capital less than ` 100 crore (private company which has not
committed a default in filing its financial statements u/s 137 of the said Act or annual return u/s 92 of
the said Act with the Registrar), 2 small companies & 1 dormant company as these are excluded from the
ceiling limit of company audits given u/s 141(3)(g) of the Companies Act, 2013.
(iv) As per fact of the case, PQRST & Co. is already having 40 company audits & they can accept only 60 more
company audits. In addition, they can also conduct the audit of one person companies, small companies,
dormant companies & private companies having paid up share capital less than ` 100 crores (private
company which has not committed a default in filing its financial statements u/s 137 of the said Act or
annual return u/s 92 of the said Act with the Registrar). In the given case, out of the 80 private
companies PQRST & Co. is being offered, 65 companies have paid-up share capital of ` 115 crore each.
Therefore, PQRST & Co. can accept the appointment as an auditor for 2 small companies, 1 dormant
company, 15 private companies having paid-up share capital less than ` 100 crore (private company which has
not committed a default in filing its financial statements u/s 137 of the said Act or annual return u/s 92 of the
said Act with the Registrar.”) & 60 private companies having paid-up share capital of ` 115 crore each in

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addition to above 40 company audits already held.

CASE STUDY 3
While conducting the audit of a limited company for the year ended 31st March, 2020, the auditor wanted to
refer to the Minute Books. The Board of Directors refused to show the Minute Books to the auditor.
Provisions & Explanation: Section 143 of the Companies Act, 2013 grants powers to the auditor that every
auditor has a right of access, at all times, to the books & account including all statutory records such as
minute books, fixed assets register, etc. of the company for conducting the audit. In order to verify actions of
the company & to vouch & verify some of the transactions of the company, it is necessary for the auditor to
refer to the decisions of the shareholders &/or the directors of the company.
It is, therefore, essential for the auditor to refer to the Minute Books. In the absence of the Minute Books,
the auditor may not be able to vouch/verify certain transactions of the company.
Conclusion: In case the directors have refused to produce the Minute Books, the auditor may consider
extending the audit procedure & also consider modifying/ qualifying his report in an appropriate manner.
EXAMPLE : 17
The Senior Manager on the instruction of Chief Executive Officer of a company entered fake invoices of credit
purchases in the books of account aggregating to ` 95 lakh & cleared all the payments to such bogus creditor.
Here, the auditor of the company is required to report the fraudulent activity to the Board or Audit
Committee (as the case may be) within 2 days of his knowledge of fraud. Further, the company is also
required to disclose the same in Board’s Report.
It may be noted that the auditor need not to report to the Central Government as the amount of fraud
involved is less than ` 1 crore, however, reporting under CARO, 2020 is required
EXAMPLE : 18
Physical verification of only 30% (in value) of items of inventory has been conducted by the company. The
balance 70% will be conducted in next year due to lack of time & resources.
Reporting for Physical Verification of Inventory: clause (ii) of Para 3 of CARO, 2020 requires the auditor to
state in his report whether physical verification of inventory has been conducted at reasonable interval by
the management & whether, in the opinion of the auditor, the coverage & procedure of such verification by
the management is appropriate.. What constitutes “reasonable intervals” depends on circumstances of each
case. The periodicity of the physical verification of inventories depends upon the nature of inventories, their
location & the feasibility of conducting a physical verification. The management of a company normally
determines the periodicity of the physical verification of inventories considering these factors. Normally,
wherever practicable, all the items of inventories should be verified by the management of the company at
least once in a year. The auditor in order to satisfy himself about verification at reasonable intervals & about
coverage & procedures applied, should examine the adequacy of evidence & records of verification.
In the given case, the management conducted the physical verification of inventory only upon 30% (in value)
of the total inventory for the reason of lack of time & resources. The above requirement of CARO, 2020 has
not been fulfilled as such & the auditor should point out the specific areas where he believes the procedures
of inventory verification are inadequate & unreasonable. He may also consider the impact on financial
statements & report accordingly.
EXAMPLE : 19
K Ltd. took a term loan from a nationalized bank in 2015 for ` 200 lakhs repayable in five equal instalments
of ` 40 lakhs from 31st March, 2016 onwards. It repaid the loans due in 2016 & 2017, but defaulted in
2018, 2019 & 2020. As the auditor of K Ltd, what is your responsibility assuming that company has sought
reschedulement of loan?
Reporting for Default in Repayment of Dues: As per clause (ix) of Para 3 of CARO, 2020, the auditor of a
company has to report whether the Company has defaulted in repayment of loans or other borrowings or in
the payment of interest thereon to any lender, & if yes, the nature of borrowing, name of lender , period &
amount of default to be reported. The Auditor is also required to report whether the company is a declared
wilful defaulter by any bank or financial institution or other lender.

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In this case, K Ltd. has defaulted in repayment of dues for three years. Application for rescheduling will not
change the default position. Hence, the auditor shall report in his CARO report that the Company has
defaulted in its repayment of dues to the bank to the extent of ` 120 lakhs & evaluate its consequential
impact on the audit report as well.
EXAMPLE : 20
LM Ltd. had obtained a term loan of ` 300 lakhs from a bank for the construction of a factory. Since there
was a delay in the construction activities, the said funds were temporarily invested in short term deposits.
Term loan invested in short term deposits: As per clause (ix) of Para 3 of CARO, 2020, an auditor needs to
state in his report that whether the term loans were applied for the purpose for which the loans were
obtained. In the present case, the proceeds of the term loan obtained by LM Ltd. have not been put to use for
construction activities & have been temporarily invested in short term deposit. Here, the auditor should
report the fact in his report that pending utilization of the term loan for construction of a factory, the funds
were temporarily used for the purpose other than the purpose for which the loan was sanctioned, as per
clause (ix) of Para 3 of CARO, 2020.
EXAMPLE : 21
For the purpose of assessing applicability of CARO, what kind of loans need to be considered?
Borrowings from banks or financial institutions can be long term or short term & are normally in the form of
term loans, demand loans, export credits, cash credits, overdraft facilities, bills purchased or discounted.
Outstanding balances of such borrowings should be considered as borrowing outstanding for the purpose of
computing the limit of rupees one crore. Non-fund based credit facilities, to the extent such facilities have
devolved & have been converted into fund-based credit facilities, should also be considered as outstanding
borrowings. The figures of outstanding borrowing would also include the amount of bank guarantees issued
by the company where such guarantee(s) has (have) been invoked & encashed or where, say, a letter of credit
has been devolved on the company. In case of term loans, interest accrued & due is considered as a
borrowing whereas interest accrued but not due is not considered as a borrowing. Further, in case the
company enjoys a facility, say, a cash credit facility, whose balance is fluctuating in nature, the Order would
apply to the company in case on any day during the financial year concerned, the amount outstanding in the
cash credit facility exceeds Rs. one crore as per books of the company along with other borrowings. The
aggregate borrowings disclosed in the financial statements would need to be considered based on applicable
generally accepted accounting principles in India (Ind AS/ AS).
EXAMPLE : 22
Whether CARO is Applicable to the auditor of consolidated financial statement?
Order shall not apply to the auditor’s report on consolidated financial statements except clause (xxi) of
paragraph 3.
EXAMPLE : 23
What documents constitute title deed?
Following documents mainly constitute title deeds of the immovable property:-
(i) Registered sale deed / transfer deed / conveyance deed, etc. of land, land & building together, etc.
purchased, allotted, transferred by any person including any government, government authority / body /
agency/ corporation, etc. to the company.
(ii) In case of leasehold land & land & buildings together, covered under the head property, plant &
equipment (fixed assets), the lease agreement duly registered with the appropriate authority.
EXAMPLE : 24
Should the auditor examine the cost record in detail while reporting under CARO?
CARO does not require a detailed examination of Cost Records. The Auditor should, therefore, conduct a
general review of Cost Records to ensure that the records as prescribed are made & maintained. The word
"made" applies in respect of Cost Accounts, & the word "maintained" applies in respect of Cost Records
relating to Materials, Labour, Overheads, etc.

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Q. 1 : While adopting the accounts for the year, the Board of Directors of Sunrise Ltd. decided to consider
the Interim Dividend declared @15% as final dividend & did not consider transfer of Profit to reserves.
Comment.
Declaration of Interim Dividend: Section 123(3) of the Companies Act, 2013 provides that the Board of
Directors of a company may declare interim dividend during any financial year out of the surplus in the
Statement of Profit & Loss & out of profits of the financial year in which such interim dividend is sought to be
declared. The amount of dividend including interim dividend should be deposited in a separate bank account
within five days from the declaration of such dividend for the compliance of Section 123(4) of the said Act.
Based on Section 2(35) of the Act, it can be said that since interim dividend is also a dividend, companies
should provide for depreciation as required by Section 123 before declaration of interim dividend. However,
the first proviso to Section 123(1) provides that a company may, before the declaration of any dividend in any
financial year, transfer such percentage of its profit for that financial year as it may consider appropriate to
the reserves of the company irrespective of the size of the declared dividend i.e. the company is not
mandatorily required to transfer the profit to the reserves, it is an option available to the company to transfer
such percentage.
In the instant case, the Board has decided to pay interim dividend @15% of the paid-up capital. Assuming that
the company has complied with the depreciation requirement, the interim dividend can be declared without
transferring such percentage of its profits to the reserves of the company.
Q. 2 : Ram & Hanuman Associates, Chartered Accountants in practice, have been appointed as Statutory
Auditor of Krishna Ltd. for the accounting year 2019-2020. Mr. Hanuman, a partner of Ram & Hanuman
Associates, holds 100 equity shares of Shiva Ltd., a subsidiary company of Krishna Ltd. As an auditor, how
would you deal in above situation:
Auditor Holding Securities of a Company: As per sub-section (3)(d)(i) of Section 141 of the Companies Act,
2013 along with Rule 10 of the Companies (Audit & Auditors) Rule,
a person shall not be eligible for appointment as an auditor of a company, who, or his relative or partner is
holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a
subsidiary of such holding company. Provided that the relative may hold security or interest in the company
of face value not exceeding rupees one lakh.
Also, as per sub-section (4) of Section 141 of the Companies Act, 2013, where a person appointed as an
auditor of a company incurs any of the disqualifications mentioned in subsection (3) after his appointment, he
shall vacate his office as such auditor & such vacation shall be deemed to be a casual vacancy in the office of
the auditor.
In the present case, Mr. Hanuman, Chartered Accountant, a partner of M/s Ram & Hanuman Associates, holds
100 equity shares of Shiva Ltd. which is a subsidiary of Krishna Ltd. Therefore, the firm, M/s Ram & Hanuman
Associates would be disqualified to be appointed as statutory auditor of Krishna Ltd., as per section
141(3)(d)(i), which is the holding company of Shiva Ltd., because Mr. Hanuman, one of the partners, is holding
equity shares of its subsidiary.
Q. 3 : Nick Ltd. is a subsidiary of Ajanta Ltd., whose 20% shares have been held by Central Government,
25% by Uttar Pradesh Government & 10% by Madhya Pradesh Government. Nick Ltd. appointed Mr. Prem
as its statutory auditor. As an auditor, how would you deal in above situation.
According to Section 139(7) of the Companies Act, 2013, the auditors of a government company shall be
appointed or re-appointed by the Comptroller & Auditor General of India(C&AG). As per section 2(45), a
Government company is defined as any company in which not less than 51% of the paid-up share capital is
held by the Central Government or by any State Government or Governments or partly by the Central
Government & partly by one or more State Governments & includes a company which is a subsidiary of a
Government Company as thus defined.
In the given case, Ajanta Ltd is a government company as its 20% shares have been held by Central
Government, 25% by U.P. State Government & 10% by M.P. State Government. Total 55% shares have been

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held by Central & State governments, therefore, it is a Government company.

Nick Ltd. is a subsidiary company of Ajanta Ltd. Hence, Nick Ltd. is covered in the definition of a government
company. Therefore, auditor of Nick Ltd. can be appointed only by C&AG.
Consequently, appointment of Mr. Prem is invalid & he should not give acceptance to the Directors of Nick
Ltd.
Q. 4 : Contravene Ltd. appointed CA Innocent as an auditor for the company for the current financial year.
Further the company offered him the services of actuarial, investment advisory & investment banking
which was also approved by the Board of Directors. As an auditor, how would you deal in above situation.
Services not to be Rendered by the Auditor: Section 144 of the Companies Act, 2013 prescribes certain
services not to be rendered by the auditor. An auditor appointed under the Act shall provide to the company
only such other services as are approved by the Board of Directors or the audit committee, as the case may
be, but which shall not include any of the following services (whether such services are rendered directly or
indirectly to the company or its holding company or subsidiary company), namely:
(i) accounting & book keeping services;
(ii) internal audit;
(iii) design & implementation of any financial information system;
(iv) actuarial services;
(v) investment advisory services;
(vi) investment banking services;
(vii) rendering of outsourced financial services;
(viii) management services; &
(ix) any other kind of services as may be prescribed.
Further section 141(3)(i) of the Companies Act, 2013 also disqualifies a person for appointment as an auditor
of a company who is engaged as on the date of appointment in consulting & specialized services as provided
in section 144.
In the given case, CA Innocent was appointed as an auditor of Contravene Ltd. He was offered additional
services of actuarial, investment advisory & investment banking which was also approved by the Board of
Directors. The auditor is advised not to accept the services as these services are specifically notified in the
services not to be rendered by him as an auditor as per section 144 of the Act.
Q. 5 : Mr. Amar, a Chartered Accountant, bought a car financed at ` 7,00,000 by Chaudhary Finance Ltd.,
which is a holding company of Charan Ltd. & Das Ltd. Mr. Amar has been the statutory auditor of Das Ltd. &
continues to be even after taking the loan. As an auditor, how would you deal in above situation.
According to section 141(3)(d)(ii) of the Companies Act, 2013, a person is not eligible for appointment as
auditor of any company, if he is indebted to the company, or its subsidiary, or its holding or associate
company or a subsidiary of such holding company, in excess of rupees five lakh.
In the given case, Mr. Amar is disqualified to act as an auditor u/s 141(3)(d)(ii) as he is indebted to Chaudhary
Finance Ltd. for more than ' 5,00,000. Also, according to section 141(3)(d)(ii), he cannot act as an auditor of
any subsidiary of Chaudhary Finance Ltd. i.e. he is also disqualified to work in Charan Ltd. & Das Ltd.
Therefore, he has to vacate his office in Das Ltd. even though it is a subsidiary of Chaudhary Finance Ltd.
Hence, audit work performed by Mr. Amar as an auditor is invalid, he should vacate his office immediately &
Das Ltd. should appoint another auditor for the company.
Q. 6 : Astha Pvt. Ltd. has fully paid capital of ` 140 lakhs. During the year, the company had borrowed ` 15
lakhs each from a bank & a financial institution. It had the turnover (Net of GST ` 50 lakhs which is credited
to a separate account) of ` 475 lakhs. Will Companies (Auditor’s Report) Order, 2020 be applicable to Astha
Pvt. Ltd.?
Applicability of CARO, 2020: The CARO, 2020 specifically exempts a private limited company, not being a
subsidiary or holding company of a public company, having a paid up capital & reserves & surplus not more

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than rupees one crore as on the balance sheet date & which does not have total borrowings exceeding rupees
one crore from any bank or financial institution at any point of time during the financial year & which does
not have a total revenue as disclosed in Scheduled III to the Companies Act, 2013 (including revenue from
discontinuing operations) exceeding rupees ten crore during the financial year as per the financial statements.
In the case of Astha Pvt. Ltd., it has outstanding loan of ' 30 lakhs (' 15 lakhs + ' 15 lakhs) collectively from
bank & financial institution which is less than ' 1 crore rupees & turnover is ' 475 lakhs i.e. also less than ' 10
crores & not exceeding the limit. However, it has paid capital of ' 140 lakhs i.e. more than ' 1 crore.
Thus, considering its paid up capital which is exceeding the prescribed limit for exemption, CARO, 2020 will be
applicable to Astha Pvt. Ltd.
Q. 7 : A term loan was obtained from a bank for ` 80 lakhs for acquiring R&D equipment, out of which ` 15
lakh was used to buy a car for use of the concerned director who was looking at the R&D activities. As a
statutory auditor, how would you report under CARO 2020.
Utilisation of Term Loans: According to clause (ix) of Para 3 of CARO, 2020, the auditor is required to report
"whether term loans were applied for the purposes for which those were obtained. If not, the amount of loan
so diverted & the purpose for which it is used may be reported”.
The auditor should examine the terms & conditions of the term loan with the actual utilisation of the loans. If
the auditor finds that the fund has not been utilized for the purpose for which they were obtained, the report
should state the fact.
In the instant case, term loan taken for the purpose of R&D equipment has been utilized for the purchase of
car which has no relation with R&D equipment.
Therefore, car though used for R&D Director cannot be considered as R&D equipment. The auditor should
state the fact in his report as per Paragraph 3 clause (ix) of the CARO 2020, that out of the term loan taken for
R&D equipment, ' 15 lakhs was not utilised for the intended purpose of acquiring R&D equipment.
Q. 8 : Physical verification of only 40% of items of inventory has been conducted by the company. The
balance 60% will be conducted in next year due to lack of time & resources. As a statutory auditor, how
would you report under CARO 2020.
Physical Verification of Inventory: Clause (ii) of Para 3 of CARO, 2020 requires the auditor to report on
whether physical verification of inventory has been conducted at reasonable intervals by the management &
whether, in the opinion of the auditor, the coverage & procedure of such verification by the management is
appropriate. Physical verification of inventory is the responsibility of the management which should normally
verify all material items at least once in a year & more often in appropriate cases. The auditor in order to
satisfy himself about verification at reasonable intervals & on coverage & procedures applied should examine
the adequacy of evidence & record of verification.
In the given case, the above requirement of CARO, 2020 has not been fulfilled as such & the auditor should
point out the specific areas where he believes the procedure of inventory verification is not reasonable. He
may consider the impact thereof on financial statements & his report accordingly.
Q. 9 : T Pvt. Ltd.’s paid up capital & reserves are less than ` 50 lakhs & it has no outstanding loan exceeding
` 25 lakhs from any bank or financial institution. Its sales are ` 6 crores before deducting trade discount ` 10
lakhs & sales returns ` 95 lakhs. The services rendered by the company amounted to ` 10 lakhs. The
company contends that reporting under Companies Auditor’s Reports Order (CARO) is not applicable.
Discuss.
Applicability of CARO, 2020: The CARO, 2020 specifically exempts a private limited company, not being a
subsidiary or holding company of a public company, having a paid up capital & reserves & surplus not more
than rupees one crore as on the balance sheet date & which does not have total borrowings exceeding rupees
one crore from any bank or financial institution at any point of time during the financial year & which does
not have a total revenue as disclosed in Scheduled III to the Companies Act, 2013 (including revenue from
discontinuing operations) exceeding rupees ten crore during the financial year as per the financial statements.
In the given case, paid up capital & reserves of T Pvt. Ltd. are less than ' 1 crore & has no loan outstanding

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exceeding ' one crore from any bank or financial institution.

Further, its total revenue as disclosed in Scheduled III to the Companies Act, 2013 (including revenue from
discontinuing operations) is not exceeding rupees ten crore during the financial year as per the financial
statements.
Thus, CARO 2020 will not be applicable to T Pvt. Ltd.
Q. 10 : ABC Limited is in the practice of maintaining consistent dividend payment over a minimum of 14%.
The Financial year 2019-20 was so very bad for the Company that it was not possible for the Company to
maintain the payment of consistent dividend as above. The Management, being hopeful of recovery of its
performance in next year, felt that the depreciation of the year to the extent of 75% alone be charged to
the Statement of Profit & Loss & the remaining 25% be kept in a separate account code in the Balance
Sheet- 'Debit Balances Adjustable against Revenue account'. The Management was of the view that it
would be in fair practice of accounting if the depreciation for asset is charged before the expiry of the life of
assets & the amount parked in asset code as above would unfailingly be adjusted to Revenue before the
close of next financial year anyway. Analyse the issues involved & state how the Auditor should decide on
this matter.
Provision of Depreciation : Section 123(1) of the Companies Act, 2013 provides that dividend cannot be
declared or paid by a company for any financial year except out of profits of the company for that year arrived
at after providing for depreciation in accordance with the provisions of Section 123(2), or out of the profits or
the company for any previous financial year or years arrived at after providing for depreciation in the manner
aforementioned & remaining undistributed, or out of both. Further, it is the duty of auditor to check whether
the depreciation was provided according to provision of AS 10 / IND AS 16/Schedule II to the Act.
In the instant case, ABC Limited is in the practice of maintaining consistent dividend payment over a minimum
of 14%. Due to bad financial condition, company has not provided for dividend for the year 2019-20. In
addition to this management has also taken decision to charge 75% of the depreciation in the statement of
Profit & Loss whereas 25% of the depreciation amount kept in a separate account code in the Balance Sheet -
‘Debit Balances Adjustable against Revenue Account'.
Contention of management that it would be in fair practice of accounting where the depreciation on asset is
charged before the expiry of the life of assets & the amount parked in asset code would unfailingly be
adjusted to revenue before the close of next financial year is not tenable.
The practice of the company in not charging the depreciation & accumulating 25% of it in a debit balance for
being written off in the next year is not an acceptable accounting treatment. If dividend is declared in such
situation, it would mean payment out of capital.
Therefore, the auditor of the company should ensure the compliance of provisions of section 123 & Schedule
II. In case the management does not comply with the provisions & does not charge the 100% depreciation,
the auditor of the company should suggest the management for the same & if management refuses, the
auditor should qualify his report accordingly.
Q. 11 : The financial statements of MP Ltd. as on March 31, 2020 are to be prepared under Division Il of
Schedule III to the Companies Act, 2013. Comment on the disclosure compliances for MP Ltd. from the
following information in the financial statements which are required to be drawn up in compliance with Ind
AS.
1. Property, Plant & Equipment include ` 2.50 crore for a boiler-plant under construction.
2. Cash & cash equivalents include ` 1.25 crore deposited with a nationalized bank on 31st March, 2020 for
18 months. It is shown under current assets.
3. Non-current assets include under caption "Biological assets other than bearer Plants" a sum of ` 1.50
crore being cost of cultivation for bringing to yield level, the cashewnut trees whose yield period,
according to estimate shall not be less than 10 years.
(i) Disclosure of Boiler Plant under Construction: Boiler plant under construction should be shown under the
heading ‘Capital Work in Progress' instead of Property Plan & Equipment. Thus, inclusion of value of

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boiler plant under construction in Property Plan & Equipment is not in order.
(ii) Disclosure of Cash & Cash Equivalents deposited with Nationalised Bank: Bank deposits with more than
12 months maturity shall be disclosed under 'Other financial assets'. Therefore, disclosure of deposits
rupees 1.25 crores in a nationalized bank for 18 months as Cash & Cash Equivalents is not in order as per
Division II of Schedule III.
(iii) Disclosure of Cost of Cultivation for bringing to yield level the Cashewnut trees: Cost of 1.5 crore rupees
for Cultivation for bringing to yield level, the cashewnut trees whose yield period is more than one
period will form part of ‘Bearer Plant'. Hence it will not be considered as ‘Biological Assets other than
bearer plant'. Therefore, it should be shown under the heading ‘Property Plant & Equipment' as Bearer
Plant as per Division II of Schedule III.
Q. 12 : What are the reporting requirements in the audit report under the Companies Act, 2013 / CARO,
2020 for the following situations?
i. A fraud has been committed against the company by a vendor of the company.
ii. The company has committed a major fraud on its customer & the case is pending in the court.
Reporting Requirements in the Audit Report under the Companies Act, 2013 / CARO 2020: According to
Clause (xi) (a) of Para 3 of CARO 2020, the auditor is required to report whether any fraud by the company or
any fraud on the company has been noticed or reported during the year. If yes, the nature & the amount
involved is to be indicated; Further, as per Clause (xi) (b) of Para 3 of CARO 2020, whether any report under
sub-section (12) of section 143 of the Companies Act has been filed by the auditors in Form ADT-4 as
prescribed under rule 13 of Companies (Audit & Auditors) Rules, 2014 with the Central Government;
As per section 143(12) of the Companies Act, 2013, if an auditor of a company, in the course of the
performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has
been committed against the company by officers or employees of the company, he shall immediately report
the matter to the Central Government (in case amount of fraud is rupees 1 crore or above) or Audit
Committee or Board in other cases (in case the amount of fraud involved is less than rupees 1 crore) within
such time & in such manner as may be prescribed.
(i) Fraud committed against the company by a vendor of the Company: In case employees or management
are involved in fraud committed by vendor, reporting has to be done in accordance with CARO 2020 & as
per section 143 (12) of the Companies Act, 2013. Suspected fraud by vendors, customers & other third
parties should be dealt with in accordance with SA 240. Therefore, reporting has to be done in
accordance with SA 240, "The Auditor's Responsibilities relating to Fraud in an audit of Financial
Statements”.
(ii) Company has committed major fraud on its customer of which case is pending in the court: Major fraud
committed by the company on its customer has to be reported in accordance with Clause (xi) of Para 3 of
CARO 2020.
Q. 13 : Pearl Ltd. is an exporter of precious & semi-precious stones. The turnover of the company is ` 150
crore, out of which ` 105 crore is from export business & remaining ` 45 crore from domestic sales. Amount
received from export business is all in foreign currency. Directors of Pearl Ltd. are of the opinion that cost
audit is not applicable to their company as maximum revenue has been generated from export business.
Give your opinion.
Cost Audit Rules not to apply in certain cases: The requirement for cost audit shall not be applicable to a
company whose revenue from exports, in foreign exchange, exceeds seventy- five per cent of its total
revenue (as per Rule 3 of the Companies (Cost Records & Audit) Rules, 2014).
In the instant case, Peral Ltd. is an exporter of precious & semi-precious stones & the turnover of the
company is rupees 150 crore out of which rupees 105 crore i.e. 70% is from export business & remaining
rupees 45 crore i.e. 30% from domestic sales.
Thus, opinion of director is not tenable as revenue from exports in foreign exchanges is below prescribed
limit. Therefore, cost audit is applicable on Pearl Ltd. as per Rule 3 of the Companies (Cost Records & Audit)

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Rules, 2014. Pearl Ltd. has to appoint cost auditor to get the cost accounts of the company audited.

Q. 14 : MG Pvt. Ltd. seeks your advice while preparing the financial statements i.e. the general instructions
to be followed while preparing Balance Sheet under Companies Act, 2013 in respect of current assets &
liabilities.
General Instructions for Preparation of Balance Sheet:
(I) General Instruction in respect of Current Assets: An asset shall be classified as current when it satisfies
any of the following criteria-
(1) it is expected to be realized in, or is intended for sale or consumption in, the company's normal
operating cycle;
(2) it is held primarily for the purpose of being traded;
(3) it is expected to be realized within twelve months after the reporting date; or
(4) it is cash or cash equivalent unless it is restricted from being exchanged or used to settle a
liability for at least twelve months after the reporting date.
(II) General Instruction in respect of Current Liabilities: A liability shall be classified as current when it
satisfies any of the following criteria-
(1) it is expected to be settled in the company's normal operating cycle;
(2) it is held primarily for the purpose of being traded;
(3) it is due to be settled within twelve months after the reporting date; or
(4) the company does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting date. Terms of a liability that could, at the option of the
counterparty, result in its settlement by the issue of equity instruments do not affect its
classification.
Q. 15 : Z Ltd. changed its employee remuneration policy from 1st April, 2019 to provide for 12%
contribution to provident fund on leave encashment also. As per the leave encashment policy, the
employees can either utilize or encash it. As at 31st March, 2020, the company obtained an actuarial
valuation for leave encashment liability. However, it did not provide for 12% PF contribution on it. The
auditor of the company wants it to be provided but the management replied that as & when the employees
availed leave encashment, the provident fund contribution was made. The company further contends that
this is the correct treatment as it is not sure whether the employees will avail leave encashment or utilize
it. Comment in view of relevant IND-AS.
As per Para 13 of Ind AS-19 on “Employee Benefits”, notified under the Companies (Indian Accounting
Standards) Rules, 2015, as amended from time to time, an entity shall recognize the expected cost of short-
term employee benefits in the form of paid absences, when the employees render service that increase their
entitlement to future paid absences.
Since the company obtained actuarial valuation for leave encashment, it is obvious that the paid absences are
accumulating in nature. An enterprise should measure the expected cost of accumulating paid absences as
the additional amount that the enterprise expects to pay as a result of the unused entitlement that has
accumulated at the balance sheet date.
Here, Z Ltd. will accumulate the amount of leave encashment benefits as it is the liability of the company to
provide 12% PF on amount of leave encashment. Hence, the contention of the auditor is correct that full
provision should be provided by the company.
Q. 16 : K Ltd. had 5 subsidiaries as at 31st March, 2020 & the investments in-subsidiaries are considered as
long term & valued at cost. Two of the subsidiaries had their net worth eroded as at 31st March 2020 & the
prospects of their recovery are very bleak & the other three subsidiaries are doing exceptionally well. The
company did not provide for the decline in the value of investments in two subsidiaries because the overall
investment portfolio in subsidiaries did not suffer any decline as the other three subsidiaries are doing

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exceptionally well. Comment in view of relevant IND-AS.

17. The Balance Sheet of G Ltd. as at 31st March, 20 is as under. Comment on the presentation in terms of
Division I & Division II of Schedule III.
As per Para 10 of Ind AS-27 on “Separate Financial Statements”, notified under the Companies (Indian
Accounting Standards) Rules, 2015, as amended from time to time, when an entity prepares separate
financial statements, it shall account for investments in subsidiaries, joint ventures & associates either at cost
or in accordance with Ind AS 109.
In the given situation, K Ltd. has valued the investments in subsidiaries at cost.
Ind AS 36 “Impairment” deals with impairment of investments in subsidiaries accounted for at cost under Ind
AS 27. As per Para 9 of Ind AS 36, an entity shall assess at the end of each reporting period whether there is
any indication that an asset may be impaired. If any such indication exists, the entity shall estimate the
recoverable amount of the asset. It implies that impairment indicators for investment in subsidiaries is to be
assessed by K Ltd. individually for each investment & not as group of investment.
As provided, two of the subsidiaries of K Ltd. has their net-worth eroded on 31st March XX & chances of
recovery is bleak. As such, the indicators of impairment in value of investment in such two subsidiaries exist
on reporting date.
Keeping in view the above, K Ltd. should provide for the impairment in the value of investments in two
subsidiaries despite the fact that the other investments in subsidiaries did not suffer any impairment.
Q. 17: The Balance Sheet of G Ltd. as at 31st March, 20 is as under. Comment on the presentation in terms of
Division I & Division II of Schedule III
Heading Note No. 31st March, 20 31st March, 19
Equity & Liabilities
Share Capital 1 XXX XXX
Reserves & Surplus 2 0 0
Employee stock option outstanding 3 XXX XXX
Share application money refundable 4 XXX XXX
Non-Current Liabilities XXX XXX
Deferred tax liability (Arising from 5 XXX XXX
Indian Income Tax)
Current Liabilities
Trade Payables 6 XXX XXX
Total XXXX XXXX
Assets
Non-Current Assets
Fixed Assets-Tangible 7 XXX XXX
CWIP (including capital advances) 8 XXX XXX
Current Assets
Trade Receivables 9 XXX XXX
Deferred Tax Asset (Arising from 10 XXX XXX
Indian Income Tax)
Debit balance of Statement of XXX XXX
Profit & Loss
Total XXXX XXXX
(a) Following Errors are noticed in presentation as per Division I of Schedule III:

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(i) Share Capital & Reserve & Surplus are to be reflected under the heading "Shareholders' funds”,
which is not shown while preparing the balance sheet. Although it is a part of Equity & Liabilities, yet
it must be shown under head "shareholders' funds”. The heading "Shareholders' funds” is missing in
the balance sheet given in the question.
(ii) Reserve & Surplus is showing zero balance, which is not correct in the given case. Debit balance of
statement of Profit & Loss should be shown as a negative figure under the head ‘Surplus'. The
balance of ‘Reserves & Surplus', after adjusting negative balance of surplus shall be shown under the
head ‘Reserves & Surplus' even if the resulting figure is in the negative.
(iii) Schedule III requires that Employee Stock Option outstanding should be disclosed under the heading
"Reserves & Surplus”.
(iv) Share application money refundable shall be shown under the sub-heading "Other Current
Liabilities”. As this is refundable & not pending for allotment, hence it is not a part of equity.
(v) Deferred Tax Liability has been correctly shown under Non-Current Liabilities. But Deferred tax
assets & deferred tax liabilities, both, cannot be shown in balance sheet because only the net
balance of Deferred Tax Liability or Asset is to be shown if the enterprise has a legally enforceable
right to set off assets against liabilities representing current tax; & it relates to the same governing
tax laws.
(vi) Under the main heading of Non-Current Assets, Property, Plant & Equipment are further classified
as under:
(a) Tangible assets
(b) Intangible assets
(c) Capital work in Progress
(d) Intangible assets under development.
Keeping in view the above, the CWIP shall be shown under Property, Plant & Equipment as
Capital Work in Progress. The amount of Capital advances included in CWIP shall be disclosed
under the sub-heading "Long term loans & advances” under the heading Non-Current Assets.
Subsequent to the notification of Ministry of Corporate Affairs dated October 11, 2018 u/s
467(1) of the Companies Act, 2013, the words "Fixed assets” shall be substituted with the words
"Property, Plant & Equipment”.
(e) Deferred Tax Asset shall be shown under Non-Current Asset. It should be the net balance of
Deferred Tax Asset after adjusting the balance of deferred tax liability if the enterprise has a
legally enforceable right to set off assets against liabilities representing current tax; & it relates
to the same governing tax laws.
(f) Subsequent to the notification of Ministry of Corporate Affairs dated October 11, 2018 u/s
467(1) of the Companies Act, 2013, Trade Payables should be disclosed as follows:-
(A) total outstanding dues of micro enterprises & small enterprises; &
(B) total outstanding dues of creditors other than micro enterprises & small enterprises.”
(b) Following Errors have been noticed in presentation, as per Division II of Schedule III:
(i) Balance sheet should begin with Assets on top & then, Equity & Liabilities should be presented.
(ii) Under the main heading of Non-Current Assets, following sub-headings are provided in the
format as per Division II:
(a) Property, plant & equipment
(b) Capital work-in-progress
In view of the above, the Fixed asset- Tangible should be presented as "Property, Plant &
Equipment”. CWIP should be presented as "Capital Work in Progress”. Under Ind AS Schedule III,
‘Capital Advances' are not to be classified under ‘Capital Work in Progress', since they are
specifically to be disclosed under ‘Other non-current assets' .

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(iii) Deferred Tax Asset should be presented under "Non-Current Asset”. It should be the net balance
of Deferred Tax Asset, after adjusting the balance of deferred tax liability, if the enterprise has a
legally enforceable right to set off assets against liabilities representing current tax; & it relates to
the same governing tax laws.
(iv) Trade receivables shall be presented under sub-heading "Financial assets” under heading
"Current Assets”.
(v) Share capital & Reserves & Surplus need to be presented under the heading "Equity”. The
heading Equity is missing in the balance sheet given in the question. Reserves & Surplus would
form part of sub-heading "Other Equity” in the notes to accounts & such balance of "Other
Equity” would be presented on face of balance sheet under the heading "Equity”.
(vi) Debit balance of statement of profit & loss would be presented as negative balance under
"Retained Earnings” in sub-heading "Other Equity” in the notes to accounts. Such balance of
"Other Equity” even if negative, would be presented on face of balance sheet under the heading
"Equity”.
(vii) Division II of Schedule III requires that Employee Stock Option outstanding should be disclosed
under the sub-heading "Other Equity” in the notes to accounts which should be presented on
face of balance sheet under the heading "Equity”.
(viii) Share application money refundable should be presented under the sub-subheading "Other
Financial Liabilities” under the sub-heading "Financial Liability”.
(ix) As this is refundable & not pending for allotment, hence, it should not form part of equity.
(x) Deferred Tax Liability has been correctly presented under "Non-Current Liabilities”. But Deferred
tax assets & deferred tax liabilities, both, cannot be presented in balance sheet since only the net
balance of Deferred Tax Liability or Asset is to be disclosed if the enterprise has a legally
enforceable right to set off assets against liabilities representing current tax; & it relates to the
same governing tax laws.
(xi) Trade payables should be presented under sub-heading "Financial liabilities” under the heading
"Current liabilities”. Subsequent to notification by Ministry of Corporate Affairs dated October
11, 2018 u/s 467(1) of the Companies Act, 2013, Trade Payables should be disclosed as follows:
(a) total outstanding dues of micro enterprises & small enterprises; &
(b) total outstanding dues of creditors other than micro enterprises & small enterprises.

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CH -6 AUDIT REPORTS
ILLUSTRATION 1:
CA Sameer is the statutory auditor of Tram Fram Ltd. for the FY 2020-21. While concluding the audit CA
Sameer decided to issue an unmodified opinion, though he also concluded that a material uncertainty
exists with respect to the company’s ability to continue as a going concern on account of a pending
litigation related to labour laws. He is of the view that the company has made appropriate disclosures with
respect to such pending litigation in the notes to accounts annexed to the financial statements of Tram
Fram Ltd. for the FY 2020-21. Explain how CA Sameer will deal with the above situation in his auditor’s
report (draft the relevant portion of the auditor’s report.)
Material Uncertainty Related to Going Concern We draw attention to Note 10 in the financial statements,
which indicates that the outcome of a litigation on account of labour laws is pending in case of the company
during the year 31 March, 2021. As stated in Note 11, this event or condition, indicate that a material
uncertainty exists that may cast significant doubt on the Company’s ability to continue as a going concern.
Our opinion is not modified in respect of this matter.
ILLUSTRATION 2
The following illustrates the presentation in the auditor’s report if the auditor has determined there are no
key audit matters to communicate:
Key Audit Matters [Except for the matter described in the Basis for Qualified (Adverse) Opinion section or
Material Uncertainty Related to Going Concern section,] We have determined that there are no [other] key
audit matters to communicate in our report.]
ILLUSTRATION 3
XYZ Ltd. is a company engaged in the manufacture of cranes. CA Sudhir is the statutory auditor of the
company for the FY 2020-21. The company has taken long term funding for fixed capital requirements &
short term funding for its working capital requirements. During the course of audit, CA Sudhir found that
the company’s financing arrangements are about to expire & the company is unable to re- negotiate or
obtain the replacement financing. As such the company may be unable to realize its assets & discharge its
liabilities in the normal course of business. Notes to accounts annexed to the financial statements discuss
the magnitude of financing arrangements, the expiration & the total financing arrangements; however the
financial statements do not include discussion on the impact or the availability of refinancing. Thus, the
financial statements (& notes thereto) do not fully disclose this fact. What kind of opinion should CA Sudhir
issue in case of XYZ Ltd.?
In the present case, XYZ Ltd. is unable to re- negotiate or obtain the replacement financing for its long term &
short term funding requirements. This situation indicates the existence of a material uncertainty that may
cast significant doubt on the Company’s ability to continue as a going concern & therefore, XYZ Ltd. may be
unable to realize its assets & discharge its liabilities in the normal course of business. Further, the financial
statements of XYZ Ltd. do not disclose this fact adequately.
Thus, the financial statements of XYZ Ltd. are materially misstated due to the inadequate disclosure of the
material uncertainty. CA Sudhir will express a qualified opinion as the effects on the financial statements of
this inadequate disclosure are material but not pervasive to the financial statements.
The relevant extract of the Qualified Opinion Paragraph & Basis for Qualified Opinion paragraph is as
under:
Qualified Opinion
In our opinion & to the best of our information & according to the explanations given to us, except for the
incomplete disclosure of the information referred to in the Basis for Qualified Opinion
section of our report, the aforesaid standalone financial statements give the information required by the Act
in the manner so required & give a true & fair view in conformity with the accounting principles generally

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accepted in India, of the state of affairs of XYZ Ltd. as at March 31, 2021, & profit/loss, for the year ended on
that date.
Basis for Qualified Opinion
As discussed in Note 6, the Company’s financing arrangements are about to expire & the Company has been
unable to conclude renegotiations or obtain replacement financing. This situation indicates that a material
uncertainty exists that may cast significant doubt on the Company’s ability to continue as a going concern.
The financial statements do not adequately disclose this matter.
ILLUSTRATION 4
ABC Ltd. is a company engaged in the manufacture of iron & steel bars. PP & Associates are the statutory
auditors of ABC Ltd. for the FY 2020-21. During the course of audit, CA Prakash, the engagement partner,
found that the Company’s financing arrangements have expired & the amount outstanding was payable on
March 31, 2021. The Company has been unable to re-negotiate or obtain replacement financing & is
considering filing for bankruptcy. These events indicate a material uncertainty that may cast significant
doubt on the Company’s ability to continue as a going concern & therefore it may be unable to realize its
assets & discharge its liabilities in the normal course of business. The financial statements (& notes thereto)
do not disclose this fact. What opinion should CA Prakash express in case of ABC Ltd.?
In the present case based on the audit evidence obtained, CA Prakash has concluded that a material
uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to
continue as a going concern, & the entity is considering bankruptcy. The financial statements of ABC Ltd. omit
the required disclosures relating to the material uncertainty.
In such circumstances, CA Prakash should express an adverse opinion because the effects on the financial
statements of such omission are material & pervasive.
The relevant extract of the Adverse Opinion Paragraph & Basis for Adverse Opinion paragraph is as under:
Adverse Opinion
In our opinion, because of the omission of the information mentioned in the Basis for Adverse Opinion section
of our report, the accompanying financial statements do not present fairly, the financial position of the entity
as at March 31, 2021, & of its financial performance & its cash flows for the year then ended in accordance
with the Accounting Standards issued by the ICAI. Basis for Adverse Opinion The financing arrangements of
ABC Ltd. has expired & the amount outstanding was payable on March 31, 2021. The entity has been unable
to conclude re-negotiations or obtain replacement financing & is considering filing for bankruptcy. This
situation indicates that a material uncertainty exists that may cast significant doubt on the Company’s ability
to continue as a going concern. The financial statements do not adequately disclose this fact.
ILLUSTRATION 5
MNO Ltd. is a power generating company having its plants in the north eastern states of the country. For
the FY 2020-21, M/s PRT & Associates are the statutory auditors of the company. During the course of
audit, the audit team was unable to obtain sufficient appropriate audit evidence about a single element of
the consolidated financial statements. That is, the auditor was also unable to obtain audit evidence about
the financial information of a joint venture investment (in XYZ Ltd.) that represents over 90% of the entity’s
net assets. What kind of opinion should the statutory auditors issue in such case?
M/s PRT & Associates are unable to obtain sufficient appropriate audit evidence about the financial
information of a joint venture investment that represents over 90% of the entity’s net assets. The possible
effects of this inability to obtain sufficient appropriate audit evidence are both material & pervasive to the
consolidated financial statements.
Therefore, the statutory auditor should issue a disclaimer of opinion.
The relevant extract of the Disclaimer of Opinion Paragraph & Basis for Disclaimer of Opinion paragraph is
as under:
Disclaimer of Opinion
We do not express an opinion on the accompanying financial statements of MNO Ltd. Because of the
significance of the matters described in the Basis for Disclaimer of Opinion section of our report, we have not

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been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion on these
financial statements.
Basis for Disclaimer of Opinion
The Group’s investment in its joint venture XYZ Company is carried at ` 95 crores on the Group’s consolidated
balance sheet, which represents over 90% of the Group’s net assets as at March 31, 2021. We were not
allowed access to the management & the auditors of XYZ Company, including XYZ Company’s auditors’ audit
documentation. As a result, we were unable to determine whether any adjustments were necessary in
respect of the Group’s proportional share of XYZ Company’s assets that it controls jointly, its proportional
share of XYZ Company’s liabilities for which it is jointly responsible, its proportional share of XYZ’s income &
expenses for the year, (& the elements making up the consolidated statement of changes in equity) & the
consolidated cash flow statement.
ILLUSTRATION 6:
CA Yash is the statutory auditor of Laksmi Vardhan Limited for the FY 2020-21. In respect of loans &
advances of ` 55,00,000/- given to Sarvagya Private Limited, the Company has not furnished any agreement
to CA Yash & in absence of the same, he is unable to verify the terms of repayment, chargeability of
interest & other terms.
What kind of opinion should CA Yash give in such situation?
In the present case, with respect to loans & advances of ` 55,00,000/- given to Sarvagya Private Limited, the
Company has not furnished any agreement to CA Yash. In absence of such agreement, CA Yash is unable to
verify the terms of repayment, chargeability of interest & other terms. For an auditor, while verifying any
loans & advances, one of the most important audit evidences is the loan agreement. Therefore, the absence
of such document in the present case, tantamount to a material misstatement in the financial statements of
the company. However, the inability of CA Yash to obtain such audit evidence is though material but not
pervasive so as to require him to give a disclaimer of opinion.
Thus, in the present case, CA Yash should give a qualified opinion
The relevant extract of the Qualified Opinion Paragraph & Basis for Qualified Opinion paragraph is as
under:
Qualified Opinion
In our opinion & to the best of our information & according to the explanations given to us, except for the
effects of the matter described in the Basis for Qualified Opinion section of our report, the financial
statements of Laksmi Vardhan Limited give a true & fair view in conformity with the accounting principles
generally accepted in India, of the state of affairs of the Company as on 31.03.2021 & profit/ loss for the year
ended on that date.
Basis for Qualified Opinion
The Company is unable to furnish the loan agreement with respect to loans & advances of ` 55,00,000/- given
to Sarvagya Private Limited. Consequently, in absence of such agreement, we are unable to verify the terms
of repayment, chargeability of interest & other terms.
ILLUSTRATION 7:
In the financial year 2020-21, MSD Ltd. faced an extraordinary event (earthquake), which destroyed a lot of
business activity of the company. These circumstances indicate material uncertainty on the company’s
ability to continue as going concern. Due to such event it may not be possible for the company to realize its
assets or pay off the liabilities during the regular course of its business. The financial statement & notes to
the financial statements of the company do not disclose this fact. What kind of opinion should the
statutory auditor of MSD Ltd. issue in such circumstances?
In the present case, there exists a material uncertainty that cast a significant doubt on the company’s ability
to continue as going concern & the same is not disclosed in the financial statements of MSD Ltd.
As such, the financial statements of MSD Ltd. for the FY 2020-21 are materially misstated & the effect of the
misstatement is so material & pervasive on the financial statements that giving only a qualified opinion will be
insufficient & therefore the statutory auditor of MSD Ltd. should issue an adverse opinion.

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The relevant extract of the Adverse Opinion Paragraph & Basis for Adverse Opinion paragraph is as under:
Adverse Opinion
In our opinion, because of the omission of the information mentioned in the Basis for Adverse Opinion section
of our report, the accompanying financial statements do not present fairly, the financial position of MSD Ltd.
as at March 31, 2021, & of its financial performance & its cash flows for the year then ended in accordance
with the Accounting Standards issued by the ICAI. Basis for Adverse Opinion MSD Ltd. has faced an
extraordinary event (earthquake), which destroyed a lot of business activity of the company. Due to such
event it may not be possible for the company to realize its assets or pay off the liabilities during the regular
course of its business. This situation indicates that a material uncertainty exists that may cast significant
doubt on the Company’s ability to continue as a going concern. The financial statement & notes to the
financial statements of the company do not disclose this fact.
ILLUSTRATION 8 :
CA Abhimanyu is the statutory auditor of PQR Ltd. for the FY 2020-21. During the course of audit CA
Abhimanyu noticed the following: 1. With respect to the debtors amounting to ` 150 crores, no balance
confirmation was received by the audit team. Further, there have been defaults on the payment obligations
by debtors on the due dates during the year under audit. The Company has created a provision for doubtful
debts to the tune of `25 Cr. during the year under audit. The Company has stated that the provision is based
on receivables which are older than 36 months, which according to the audit team is inadequate & as such
the audit team is unable to ascertain the carrying value of trade receivables. 2. Further, in respect of
Inventories (which constitutes 40% of the total assets of the company), during the reporting period, the
management has not undertaken physical verification of inventories at periodic intervals. Also, the
Company has not maintained adequate inventory records at the factory. The audit team was unable to
undertake the physical inventory count as such the value of inventory could not be verified.
Under the above circumstances what kind of opinion should CA Abhimanyu give?
In the present case, CA Abhimanyu is unable to obtain sufficient & appropriate audit evidence with respect to
the following:
1) The balance confirmation with respect to debtors amounting to ` 150 crores is not available. Further there
has been default in payment by the debtors & the provision so made is not adequate. The audit team is
also unable ascertain the carrying value of trade receivables.
2) With respect to 40% of the company’s inventory, neither the physical verification has been done by the
management nor are adequate inventory records maintained. The audit team is also unable to undertake
the physical inventory count as such the value of inventory could not be verified.
In the above two circumstances the auditor is unable to obtain sufficient appropriate audit evidence on which
to base the opinion, & the possible effects on the financial statements of undetected misstatements, if any,
could be both material & pervasive.
Thus, CA Abhimanyu should give a Disclaimer of Opinion.
The relevant extract of the Disclaimer of Opinion Paragraph & Basis for Disclaimer of Opinion paragraph is
as under:
Disclaimer of Opinion
We do not express an opinion on the accompanying financial statements of PQR Ltd. Because of the
significance of the matters described in the Basis for Disclaimer of Opinion section of our report, we have not
been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion on these
financial statements.
Basis for Disclaimer of Opinion
We are unable to obtain balance confirmation with respect to the debtors amounting to ` 150 crores. Further,
there have been defaults on the payment obligations by debtors on the due dates during the year under
audit. The Company has created a provision for doubtful debts to the tune of `25 Cr. during the year under
audit which is inadequate in the circumstances of the company. The carrying value of trade receivables could
not be ascertained.

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Further, in respect of Inventories (which constitutes 40% of the total assets of the company), during the
reporting period, the management has not undertaken physical verification of inventories at periodic
intervals. Also, the Company has not maintained adequate inventory records at the factory. We were unable
to undertake the physical inventory count & as such the value of inventory could not be verified.
ILLUSTRATION 9:
In respect of the audit of BDS Ltd., the statutory auditor of the company noticed some matters. The
statutory auditor wants to draw the user’s attention towards such matters, though his opinion is not
modified in respect of such matters. Draft the relevant paragraphs of the audit report for the following
matters:
(i) The company has a plan to resume its construction activities with respect to one of its thermal power
project, The activity of such power plant was suspended in the FY 2018-19. The thermal power project
comprises of the plant & equipment amounting to ` 5.95 crore & capital work in progress of ` 147.50
crore.
(ii) The financial statements of 5 branches are included in the Standalone Financial Statements of BDS Ltd.
whose financial statements reflect total assets of ` 90 crores as at 31.03.2021 & total revenue from
operations of ` 40 crores for the year ended on that date. The financial statements of these branches
have been audited by the branch auditors.
Emphasis of Matter
We draw attention to the following note of the standalone financial statements:
Note 27 regarding the plans of the Company to resume construction/developmental activities of a thermal
power project. The carrying amounts related to the project as at 31st March, 2021 comprise of plant &
equipment of ` 5.95 crore & capital work in progress of ` 147.50 crore.
Our opinion is not modified in respect of this matter.
Other Matter
We did not audit the financial statements of 5 branches included in the Standalone Financial Statements of
the company whose financial statements reflect total assets of ` 90 crores as at 31.03.2021 & total revenue
from operations of ` 40 crores for the year ended on that date. The financial statements of these branches
have been audited by the branch auditors whose reports have been furnished to us, & our opinion in so far as
it relates to the amounts & disclosures included in respect of these branches, is based solely on the report of
the branch auditors.
Our opinion is not modified in respect of this matter.
Q. 1 : What special consideration is required for expressing Disclaimer of Opinion?
When the auditor disclaims an opinion due to an inability to obtain sufficient appropriate audit evidence, the
auditor shall:
(a) State that the auditor does not express an opinion on the accompanying financial statements;
(b) State that, because of the significance of the matter(s) described in the Basis for Disclaimer of Opinion
section, the auditor has not been able to obtain sufficient appropriate audit evidence to provide a basis
for an audit opinion on the financial statements; &
Amend the statement required in SA 700 (Revised), which indicates that the financial statements have been
audited, to state that the auditor was engaged to audit the financial statements.
Q. 2 : What is the Basis for Modification of Opinion (Qualified/Disclaimer /Adverse)?
When the auditor modifies (Qualification/ Disclaimer/ Adverse) the opinion as above on the financial
statements, the auditor shall, in addition to the specific elements required by SA 700 (Revised):
a) Amend the heading “Basis for Opinion” to “Basis for Qualified Opinion,” “Basis for Adverse Opinion,” or
“Basis for Disclaimer of Opinion,” as appropriate; &
b) Within this section, include a description of the matter giving rise to the modification.
If there is a material misstatement of the financial statements that relates to specific amounts in the financial
statements (including quantitative disclosures in the notes to the financial statements), the auditor shall

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include in the Basis for Opinion section, a description & quantification of the financial effects of the
misstatement, unless impracticable. If it is not practicable to quantify the financial effects, the auditor shall so
state in this section.
If there is a material misstatement of the financial statements that relates to narrative disclosures, the auditor
shall include in the Basis for Opinion section an explanation of how the disclosures are misstated.
If there is a material misstatement of the financial statements that relates to the non- disclosure of
information required to be disclosed, the auditor shall:
a) Discuss the non-disclosure with those charged with governance;
b) Describe in the Basis for Opinion section the nature of the omitted information; &
c) Unless prohibited by law or regulation, include the omitted disclosures, provided it is practicable to do so
& the auditor has obtained sufficient appropriate audit evidence about the omitted information.
If the modification results from an inability to obtain sufficient appropriate audit evidence, the auditor shall
include in the Basis for Opinion section the reasons for that inability.
When the auditor expresses a qualified or adverse opinion, the auditor shall amend the statement about
whether the audit evidence obtained is sufficient & appropriate to provide a basis for the auditor’s opinion to
include the word “qualified” or “adverse”, as appropriate.
When the auditor disclaims an opinion on the financial statements, the auditor’s report shall not include
following elements required under SA 700
a) A reference to the section of the auditor’s report where the auditor’s responsibilities are described; &
b) A statement about whether the audit evidence obtained is sufficient & appropriate to provide a basis for
the auditor’s opinion.
Even if the auditor has expressed an adverse opinion or disclaimed an opinion on the financial statements,
the auditor shall describe in the Basis for Opinion section the reasons for any other matters of which the
auditor is aware that would have required a modification to the opinion, & the effects thereof.
Q.3 : How Auditor should give description of Auditor’s Responsibilities for the Audit of the Financial
Statements When the Auditor Disclaims an Opinion on the Financial Statements?
When the auditor disclaims an opinion on the financial statements due to an inability to obtain sufficient
appropriate audit evidence, the auditor shall amend the description of the auditor’s responsibilities required
by SA 700 (Revised) to include only the following:
a) A statement that the auditor’s responsibility is to conduct an audit of the entity’s financial statements in
accordance with Standards on Auditing & to issue an auditor’s report;
b) A statement that, however, because of the matter(s) described in the Basis for Disclaimer of Opinion
section, the auditor was not able to obtain sufficient appropriate audit evidence to provide a basis for an
audit opinion on the financial statements; &
The statement about auditor independence & other ethical responsibilities required in SA 700.
Q.4 : When to issue other Matter Paragraphs in the Auditor’s Report?
If the auditor considers it necessary to communicate a matter other than those that are presented or
disclosed in the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the
audit, the auditor’s responsibilities or the auditor’s report, the auditor shall include an Other Matter
paragraph in the auditor’s report, provided:
a) This is not prohibited by law or regulation; &
b) When SA 701 applies, the matter has not been determined to be a key audit matter to be communicated
in the auditor’s report.
When the auditor includes an Other Matter paragraph in the auditor’s report, the auditor shall include the
paragraph within a separate section with the heading “Other Matter,” or other appropriate heading.
Q.5 : Under the applicable Standards on Auditing, in what circumstances does the report of the statutory
auditor require modifications? What are the types of modifications possible to the said report?

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Modified Opinions: SA 705 deals with the auditor’s responsibility to issue an appropriate report in
circumstances when, in forming an opinion in accordance with SA 700 (Revised), the auditor concludes that a
modification to the auditor’s opinion on the financial statements is necessary.
The succinct requirements of this SA 705 are given below-
Types of Modified Opinions as per SA 705 –
1. Qualified Opinion
2. Adverse Opinion
3. Disclaimer of Opinion
The decision regarding which type of modified opinion is appropriate depends upon:
(a) The nature of the matter giving rise to the modification, that is, whether the financial statements are
materially misstated or, in the case of an inability to obtain sufficient appropriate audit evidence, may
be materially misstated; and
(b) The auditor's judgment about the pervasiveness of the effects or possible effects of the matter on the
financial statements.
Q.6 : Write a short note on Emphasis of matter paragraph in Audit Reports.
When the auditor includes an Emphasis of Matter paragraph in the auditor’s report, the auditor shall:
(a) Include the paragraph within a separate section of the auditor’s report with an appropriate heading that
includes the term “Emphasis of Matter”;
(b) Include in the paragraph a clear reference to the matter being emphasized & to where relevant
disclosures that fully describe the matter can be found in the financial statements. The paragraph shall
refer only to information presented or disclosed in the financial statements; &
(c) Indicate that the auditor’s opinion is not modified in respect of the matter emphasized.
When to issue other Matter Paragraphs in the Auditor’s Report?
If the auditor considers it necessary to communicate a matter other than those that are presented or
disclosed in the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the
audit, the auditor’s responsibilities or the auditor’s report, the auditor shall include an Other Matter
paragraph in the auditor’s report, provided:
(a) This is not prohibited by law or regulation; &
(b) When SA 701 applies, the matter has not been determined to be a key audit matter to be communicated
in the auditor’s report.
When the auditor includes an Other Matter paragraph in the auditor’s report, the auditor shall include the
paragraph within a separate section with the heading “Other Matter,” or other appropriate heading.
Q.7 : Write a short note on Certificate for Special Purpose vs. Audit Report.
Certificate for Special Purpose vs. Audit Report: A certificate is a written confirmation of the accuracy of the
facts stated therein & does not involve any estimate or opinion. The term ‘certificate’ is, therefore, used
where the auditor verifies the accuracy of facts. An auditor may thus, certify the circulation figures of a
newspaper or the value of imports or exports of a company. An auditor’s certificate represents that he has
verified certain figures & is in a position to vouch safe their accuracy as per his examination of documents &
books of account. A report, on the other hand, is a formal statement usually made after an enquiry,
examination or review of specified matters under report & includes the reporting auditor’s opinion thereon.
Thus, when a reporting auditor issues a certificate, he is responsible for the factual accuracy of what is stated
therein. On the other hand, when a reporting auditor gives a report, he is responsible for ensuring that the
report is based on factual data, that his opinion is in due accordance with facts, & that it is arrived at by the
application of due care & skill. The ‘report’ involves expression of opinion which may differ from one
professional to another. There is no question of exactitude in case of a report since the information contained
therein is based on estimates & involves judgement element.
Q.8 : Compare & explain the following:
(i) Reporting to Shareholders vs. Reporting to those Charged with Governance

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(ii) Audit Qualification vs. Emphasis of Matter.

A. Reporting to Shareholders vs. Reporting to those Charged with Governance:
REPORT
Reporting to Shareholders Reporting to those Charged with Governance
 Section 143 of the Companies Act, 2013 deals   Standard on Auditing 260 deals with the
with the provisions relating to reporting to provisions relating to reporting to those
Shareholders. Thus, it is a Statutory Audit Charged with Governance.
Report which is addressed to the members
 Statutory Audit Report is on true & fair view & 
 It is a reporting on matters those charged with
as per prescribed Format. governance like scope of audit, audit
procedures, audit modifications, etc.

 Statutory Audit Reports are in public domain. 
 Reporting to those Charged with Governance is
an internal document i.e. private report.
B. Audit Qualification vs. Emphasis of Matter:
REPORT
Audit Qualification Audit Qualification

 Standard on Auditing 705 “Modifications to the 
 Standard on Auditing 705 “Modifications to the
Opinion in the Independent Auditor’s Report”, Opinion in the Independent Auditor’s Report”,
deals with the provisions relating to Audit deals with the provisions relating to Audit
Qualification. Qualification.

 Audit Qualifications are also known as “subject 
 Emphasis of Matter is a paragraph which is
to report” or “except that report”. included in auditor’s report to draw users’
attention to important matter(s) which are
already disclosed in Financial Statements & are
fundamental to users’ for understanding of
Financial Statements.

 Audit Qualifications are given when auditor is   Emphasis of Matter is a paragraph which is
having reservations on some of the items out of issued when there is a uncertainty relating to
the financial statements as a whole i.e. future outcome of exceptional litigation,

 Auditor’s Judgment about the Pervasiveness of regulatory action, etc.; or there is early
the Effects or Possible Effects on the Financial application (where permitted) of a new
Statements relating to if the impact of material accounting standard that has a pervasive effect
misstatements is not pervasive on the financial on the financial statements in advance of its
statements but is present at some levels of the effective date.
financial statements, qualified report is issued.
Q.9 : “When the auditor modifies the audit opinion, the auditor shall use the heading “Qualified Opinion,”
“Adverse Opinion,” or “Disclaimer of Opinion,” as appropriate, for the Opinion section.” As an expert you
are required to brief the special considerations required for expressing:
(a) Qualified Opinion;
(b) Adverse Opinion &
(c) Disclaimer of Opinion.
Form & Content of the Auditor’s Report When the Opinion is Modified
When the auditor modifies the audit opinion, the auditor shall use the heading “Qualified Opinion,” “Adverse
Opinion,” or “Disclaimer of Opinion,” as appropriate, for the Opinion section.
What special consideration are required for expressing Qualified Opinion?
When the auditor expresses a qualified opinion due to a material misstatement in the financial statements,
the auditor shall state that, in the auditor’s opinion, except for the effects of the matter(s) described in the

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Basis for Qualified Opinion section:

(a) When reporting in accordance with a fair presentation framework, the accompanying financial
statements present fairly, in all material respects (or give a true & fair view of) […] in accordance with
[the applicable financial reporting framework]; or
(b) When reporting in accordance with a compliance framework, the accompanying financial statements
have been prepared, in all material respects, in accordance with [the applicable financial reporting
framework].
When the modification arises from an inability to obtain sufficient appropriate audit evidence, the auditor
shall use the corresponding phrase “except for the possible effects of the matter(s) ...” for the modified
opinion.
Q.10 : ADKS & Co LLP are the newly appointed statutory auditors of PKK Ltd. During the course of audit, the
statutory auditors have come across certain significant observations which they believe could lead to
material misstatement of financial statements. Management has a different view & does not concur with
the view of the statutory auditors. Considering this the statutory auditors are determining as to how to
address these observations in terms of their reporting requirement. Please advise.
As per SA 705, if the auditor concludes that, based on the audit evidence obtained, the financial statements
as a whole are not free from material misstatement or the auditor is unable to obtain sufficient appropriate
audit evidence to conclude that the financial statements as a whole are free from material misstatement, the
auditor shall modify the opinion in his report.
The auditor in such a case needs to determine the modification as follows:
(i) Qualified Opinion: The auditor shall express a qualified opinion when:
4. The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements,
individually or in the aggregate, are material, but not pervasive, to the financial statements; or
5. The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but
the auditor concludes that the possible effects on the financial statements of undetected
misstatements, if any, could be material but not pervasive.
(ii) Adverse Opinion: The auditor shall express an adverse opinion when the auditor, having obtained
sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are
both material & pervasive to the financial statements
(iii) Disclaimer of Opinion: The auditor shall disclaim an opinion when the auditor is unable to obtain
sufficient appropriate audit evidence on which to base the opinion, & the auditor concludes that the
possible effects on the financial statements of undetected misstatements, if any, could be both material
& pervasive. The auditor shall disclaim an opinion when, in extremely rare circumstances involving
multiple uncertainties, the auditor concludes that, notwithstanding having obtained sufficient
appropriate audit evidence regarding each of the individual uncertainties, it is not possible to form an
opinion on the financial statements due to the potential interaction of the uncertainties & their possible
cumulative effect on the financial statements.
If, after accepting the engagement, the auditor becomes aware that management has imposed a
limitation on the scope of the audit that the auditor considers likely to result in the need to express a
qualified opinion or to disclaim an opinion on the financial statements, the auditor shall request that
management remove the limitation.
If management refuses to remove the limitation, the auditor shall communicate the matter to those
charged with governance, unless all of those charged with governance are involved in managing the
entity, & determine whether it is possible to perform alternative procedures to obtain sufficient
appropriate audit evidence.
Q.11 : KPI Ltd is a joint venture of KPI Inc, a company based in US, & OPQ Ltd, a company based in Japan
(hereinafter referred to as ‘JV partners’). KPI Ltd was registered in India & is operating as a marketing
support company for KPI Inc. All the costs of KPI Ltd are incurred in India & entire revenue of KPI Inc is
generated in USD. The entire funding requirements of KPI Ltd are taken care of by the JV partners. Since KPI

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Ltd is based in India, hence it is also required to get its financial statements audited.
The company appointed new auditors for the audit of the financial statements for the year ended 31 March
2020 after doing all appointment formalities wherein auditors are required to ensure compliance with
Standards on Auditing & Internal Standards on Auditing.
As an expert you are required to advise the auditor about the requirements regarding auditor’s report for
audits conducted in accordance with both Standards on Auditing issued by ICAI & International Standards
on Auditing.
Auditor’s Report for Audits Conducted in Accordance with Both Standards on Auditing Issued by ICAI &
International Standards on Auditing or Auditing Standards of Any Other Jurisdiction:
An auditor may be required to conduct an audit in accordance with, in addition to the Standards on Auditing
issued by ICAI, the International Standards on Auditing or auditing standards of any other jurisdiction. If this is
the case, the auditor’s report may refer to Standards on Auditing in addition to the International Standards on
Auditing or auditing standards of such other jurisdiction, but the auditor shall do so only if:
(a) There is no conflict between the requirements in the ISAs or such auditing standards of other jurisdiction
and those in SAs that would lead the auditor:
(i) to form a different opinion, or
(ii) not to include an Emphasis of Matter paragraph or Other Matter paragraph that,
in the particular circumstances, is required by SAs; &
(b) The auditor’s report includes, at a minimum, each of the elements set out in Auditor’s Report Prescribed
by Law or Regulation discussed above when the auditor uses the layout or wording specified by the
Standards on Auditing. However, reference to “law or regulation” in above paragraph shall be read as
reference to the Standards on Auditing. The auditor’s report shall thereby identify such Standards on
Auditing.
When the auditor’s report refers to both the ISAs or the auditing standards of a specific jurisdiction & the
Standards on Auditing issued by ICAI, the auditor’s report shall clearly identify the same including the
jurisdiction of origin of the other auditing standards.
Q.12 : TUV Ltd. is a company engaged in the business of manufacture of spare parts. Saroj & Associates are
the statutory auditors of the company for the FY 2020-21. During the course of audit, CA Saroj noticed that
the company had a major customer, namely, Korean Mart from South Korea. Owing to an outbreak of war
& subsequent destruction leading to government ban on import & export in South Korea, the demand from
Korean Mart for the products of TUV Ltd. ended for an unforeseeable time period. When discussed with the
management, CA Saroj was told that the company is in the process of identifying new customers for their
products. CA Saroj understands that though the use of going concern assumption is appropriate but a
material uncertainty exists with respect to the identification of new customers. This fact is duly reflected in
the financial statements of TUV Ltd. for the FY 2020-21. How should CA Saroj deal with this matter in the
auditor’s report for the FY 2020-21?
As per SA 570, “Going Concern”, loss of a major market or a key customer is one of the operating indicators
that may cast significant doubt on the company’s ability to continue as a going concern.
In the present case, TUV Ltd. has a key customer in South Korea from which the demand for its products has
ended on account of outbreak of war, subsequent destruction & government ban on import & export in South
Korea. Further, the company has not yet identified new customers & is in the process of doing the same. As
such, the identification of new customer is a material uncertainty that cast a significant doubt on the
company’s ability to continue as a going concern.
However, this matter is duly disclosed by the management of TUV Ltd. in the financial statements for the year
ended 31.03.2021.
As such, considering that the going concern assumption is appropriate but a material uncertainty exists with
respect to identification of new customer, CA Saroj should:
(1) Express an unmodified opinion &
(2) Include in his audit report, a separate section under the heading “Material Uncertainty Related to Going

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Concern” to:
(i) Draw attention to the note in the financial statements that discloses the matters &
(ii) State that these events or conditions indicate that a material uncertainty exists that may cast
significant doubt on the entity’s ability to continue as a going concern & that the auditor’s opinion is
not modified in respect of the matter.
Thus, CA Saroj should deal with this matter in his auditor’s report in the above mentioned manner.
Q.13 : Sun Moon Ltd. is a power generating company which uses coal as raw material for its power
generating plant. The company has been allotted coal blocks in the state of Jharkhand & Odhisa. During the
FY 2020-21, a scam regarding allotment of coal blocks was unveiled
leading to a ban on the allotment of coal blocks to various companies including Sun Moon Ltd. This
happened in the month of December 2020 & as such entire power generation process of Sun Moon Ltd,
came to a halt in that month. As a result of such ban, & the resultant stoppage of the production process,
many key managerial personnel of the company left the company. There were delays in the of payment of
wages & salaries & the banks from whom the company had taken funds for project financing also decided
not to extend further finance or to fund further working capital requirements of the company.
Further, when discussed with the management, the statutory auditor understood that the company had no
action plan to mitigate such circumstances. Further, all such circumstances were not reflected in the
financial statements of Sun Moon Ltd. What course of action should the statutory auditor of the company
consider in such situation?
SA 570- “Going Concern” deals with the auditor’s responsibilities in the audit of financial statements relating
to going concern & the implications for the auditor’s report.
The auditor’s responsibilities are to obtain sufficient appropriate audit evidence regarding, & conclude on, the
appropriateness of management’s use of the going concern basis of accounting in the preparation of the
financial statements, & to conclude, based on the audit evidence obtained, whether a material uncertainty
exists about the entity’s ability to continue as a going concern.
When the use of Going Concern Basis of Accounting Is Inappropriate i.e. if the financial statements have been
prepared using the going concern basis of accounting but, in the auditor’s judgment, management’s use of
the going concern basis of accounting in the preparation of the financial statements is inappropriate, the
auditor shall express an adverse opinion.
Also when adequate Disclosure of a Material Uncertainty Is Not Made in the Financial Statements the auditor
shall:
(i) Express a qualified opinion or adverse opinion, as appropriate, in accordance with SA 705 (Revised); &
(ii) In the Basis for Qualified (Adverse) Opinion section of the auditor’s report, state that a material
uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern &
that the financial statements do not adequately disclose this matter.
In the present case, the following circumstances indicate the inability of Sun Moon Ltd. to continue as a going
concern:
 Ban on the allotment of coal blocks
 Halt in power generation
 Key Managerial Personnel leaving the company.
 Banks decided not to extend further finance & not to fund the working capital requirements of the
company.
 Non availability of sound action plan to mitigate such circumstances.
Therefore, considering the above factors it is clear that the going concern basis is inappropriate for the
company. Further, such circumstances are not reflected in the financial statements of the company. As such,
the statutory auditor of Sun Moon Ltd. should:
(1) Express an adverse opinion in accordance with SA 705 ( Revised) &
(2) In the Basis of Opinion paragraph of the auditor’s report, the statutory auditor should state that a
material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going

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concern & that the financial statements do not adequately disclose this matter.
Q.14 : CA Omkar is the statutory auditor of Sabhyata Ltd. for the FY 2020-21. The company is engaged in
the business of manufacture of floor tiles. During the course of audit, CA Omkar obtained certain audit
evidence which were not consistent with the affirmation made in the financial statements. Discuss as to
how CA Omkar should deal with the situation in the auditor’s report.
SA 705 deals with the auditor’s responsibility to issue an appropriate report in circumstances when, in
forming an opinion in accordance with SA 700 (Revised), the auditor concludes that a modification to the
auditor’s opinion on the financial statements is necessary.
The decision regarding which type of modified opinion is appropriate depends upon:
a) The nature of the matter giving rise to the modification, that is, whether the financial statements are
materially misstated or, in the case of an inability to obtain sufficient appropriate audit evidence, may be
materially misstated; &
b) The auditor’s judgment about the pervasiveness of the effects or possible effects of the matter on the
financial statements.
Further, the auditor shall modify the opinion in the auditor’s report when the auditor concludes that based on
the audit evidence obtained, the financial statements as a whole are not free from material misstatement.
In the present case, during the course of audit, CA Omkar obtained certain audit evidence which were not
consistent with the affirmation made in the financial statements. Therefore, CA Omkar should modify his
report in accordance with SA 705- “Modifications To The Opinion In The Independent Auditor’s Report.
CA Omkar should issue either a qualified opinion or an adverse opinion depending upon the circumstances of
the case:
a) CA Omkar shall express a qualified opinion when, having obtained sufficient appropriate audit evidence,
he concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the
financial statements
b) CA Omkar shall express an adverse opinion, when the auditor, having obtained sufficient appropriate
audit evidence, concludes that misstatements, individually or in the aggregate, are both material &
pervasive to the financial statements.
Thus, since CA Omkar has obtained audit evidence which are inconsistent with the affirmations made in the
financial statement, CA Omkar should modify his opinion as per the circumstances of the case.

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CH -7
AUDIT COMMITTEE & CORPORATE
GOVERNANCE
Q.1 : State the main features of the Qualified & Independent Audit Committee set up SEBI (Listing
Obligations & Disclosure Requirements) Regulations, 2015.
1. The main features of a qualified & independent audit committee to be set up under SEBI (Listing
Obligations & Disclosure Requirements) Regulations, 2015 are as follows:
(i) The audit committee shall have minimum three directors as members. Two-thirds of the members of
audit committee shall be independent directors, however, in case of a listed entity having
outstanding SR (Superior Rights) equity shares, the audit committee shall only comprise of
independent directors;
(ii) All members of audit committee shall be financially literate & at least one member shall have
accounting or related financial management expertise;
Explanation (i): The term “financially literate” means the ability to read & understand basic financial
statements i.e. balance sheet, profit & loss account, & statement of cash flows.
Explanation (ii): A member will be considered to have accounting or related financial management
expertise if he or she possesses experience in finance or accounting, or requisite professional
certification in accounting, or any other comparable experience or background which results in the
individual’s financial sophistication, including being or having been a chief executive officer, chief
financial officer or other senior officer with financial oversight responsibilities.
(iii) The Chairperson of the Audit Committee shall be an independent director;
(iv) The Chairperson of the Audit Committee shall be present at Annual General Meeting to answer
shareholder queries;
(v) The Audit Committee at its discretion shall invite the finance director or the head of the finance
function, head of internal audit & a representative of the statutory auditor & any other such
executives to be present at the meetings of the committee; provided that occasionally, the Audit
Committee may meet without the presence of any executives of the listed entity;
(vi) The Company Secretary shall act as the secretary to the committee.
Q.2 : Write short notes on the following:
(a) Content of Management Discussion & Analysis.
(b) Corporate Governance
a) Content of Management Discussion & Analysis: As part of the directors’ report or as an addition thereto,
a Management Discussion & Analysis report should form part of the Annual Report to the shareholders.
This Management Discussion & Analysis should include discussion on the following matters within the
limits set by the company’s competitive position-
(i) Industry structure & developments.
(ii) Opportunities & Threats.
(iii) Segment–wise or product-wise performance.
(iv) Outlook.
(v) Risks & concerns
(vi) Internal control systems & their adequacy.
(vii) Discussion on financial performance with respect to operational performance.
(viii) Material developments in Human Resources/Industrial Relations front, including number of people
employed.
(ix) Details of significant changes (i.e. change of 25% or more as compared to the immediately previous

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financial year) in key financial ratios, along with detailed explanations therefor, including:
(1) Debtors Turnover
(2) Inventory Turnover
(3) Interest Coverage Ratio
(4) Current Ratio
(5) Debt Equity Ratio
(6) Operating Profit Margin (%)
(7) Net Profit Margin (%)
or sector-specific equivalent ratios, as applicable.
(x) Details of any change in Return on Net Worth as compared to the immediately previous financial year
along with a detailed explanation thereof.
(b) Corporate Governance: Corporate governance is the system by which companies are directed &
controlled by the management in the best interest of the shareholders & others ensuring greater
transparency & better & timely financial reporting. The Board of Directors are responsible for governance
of their companies. A number of reports & codes of corporate governance have been published
internationally.
SEBI on September 2, 2015, issued the Securities & Exchange Board of India (Listing Obligations &
Disclosure Requirements) Regulations, 2015 (“LODR Regulations”), with the objective of streamlining &
consolidating the provisions of various listing agreements in operation for different segments of the
capital markets, such as equity shares, preference shares, debt instruments, units of mutual funds, Indian
depository receipts, securitised debt instruments & any other securities that the SEBI may specify.
The LODR Regulations are divided into two parts - the substantive provisions are incorporated in the main
body while the procedural requirements are incorporated in the form of schedules. The LODR Regulations
also capture the corporate governance principles found in Clause 49 of SEBI’s Model Listing Agreement. It
may be noted that the LODR Regulations deal with only post-listing requirements & exclude all pre-listing
requirements.
Q.3 : Dishonest Limited, a company incorporated in India has six members in its Audit Committee. Due to
recessionary conditions in India the revenue of the company is going down & there is slow down in other
activities of the company. Therefore, it was expected that there would not be significant work for members
of the Audit Committee. Considering the overall recession in the company & the economy, the members of
the Committee decided unanimously to meet once in a year only on March 31, 2020. They reviewed
monthly information system of the Company & found no errors. As an auditor of Dishonest Limited would
you consider the decision taken by the Audit Committee is in line with the SEBI (Listing Obligations &
Disclosure Requirements) Regulations, 2015?
One of the following additional requirement as stipulated under SEBI (Listing Obligations & Disclosure
Requirements) Regulations, 2015 (“LODR Regulations”) on which Section 177 of the Companies Act, 2013
(relating to audit committee) is silent is – The Audit Committee should meet at least four times in a year & not
more than one hundred & twenty days shall elapse between two meetings. The quorum shall be either two
members or one third of the members of the audit committee, whichever is greater, but there should be a
minimum of two independent directors present.
Besides, there is a mandatory review requirement & to review only monthly information system is not
sufficient. Here the audit committee members reviewed only monthly information system of the company &
the same is not sufficient as per LODR Regulations.
The Audit Committee shall mandatorily review the following information as per LODR Regulations:
(i) Management discussion & analysis of financial condition & results of operations;
(ii) Statement of significant related party transactions (as defined by the Audit Committee), submitted by
management
(iii) Management letters / letters of internal control weaknesses issued by the statutory auditors;
(iv) Internal audit reports relating to internal control weaknesses;

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(v) The appointment, removal & terms of remuneration of the Chief internal auditor shall be subject to
review by the Audit Committee; &
(vi) Statement of deviations: (a) quarterly statement of deviations including report of monitoring agency if
applicable & (b) annual statement of funds utilized for purposes other than those stated in the offer
document/ prospectus/ notice.
Applying the above, the decision taken by the audit committee is not in line with the LODR Regulations.
Q.4 : Comment on the following in the light of certificate of compliance of conditions of Corporate
Governance to be issued for a listed company where the Board consists of 10 directors including a non-
executive director as its chairman & further:
(i) There were 5 meetings held during the year as follows 01.04.2019, 01.06.2019, 01.09.2019,
03.01.2020, 25.03.2020.
(ii) There are 4 independent directors. One of them resigned on 25.05.2019. A new independent director
was appointed on 01.09.2019.
(iii) The Chairman of Audit Committee did not attend the Annual General meeting held on 14.09.2019.
(iv) The internal audit reports were obtained by Audit Committee on quarterly basis. Quarter 1 internal
audit report commented on certain serious irregularities as regards electronic online auction of
scrap. The agenda of Audit Committee did not deliberate or take note of the issue.
(v) There is no women director.
Compliance of conditions of Corporate Governance in case of Listed Company: As per Listing Obligation &
Disclosure Requirements Regulations 2015, depending upon the facts & circumstances, some situations may
require an adverse or qualified statement or a disclosure without necessarily making it a subject matter of
qualification in the Auditors’ Certificate, in respect of compliance of requirements of corporate governance
for example:
i. The Audit Committee shall meet at least four times in a year & not more than one hundred & twenty
days shall lapse between two meetings. The number of days between the meetings held on 1.9.2019 &
3.01.2020 is more than 120 days. Hence it is a non-compliance & would require qualification in
certificate of corporate governance
ii. Since the Chairman is the non-executive director, there should be 1/3rd of directors (rounded to next
integer) to be independent. In this case, 4 directors need to be independent. Any vacancy during
shortfall of independent directorship should be filled within next 3 months or before the start of next
meeting, whichever is later. In the instant case, since the independent director was appointed after lapse
of 3 months (i.e. on 1.9.2019) & after next first meeting 1.6.2019, there is default which would require
qualification in certificate on corporate governance.
iii. Chairman shall be present at Annual General Meeting to answer shareholder queries. In the given
scenario, Chairman of Audit Committee did not attend the Annual General Meeting held on 14.09.2019
which is not in order/compliance.
iv. The Audit Committee shall mandatorily review the Internal audit reports relating to internal control
weaknesses as per Part C (B) of Schedule II & the auditor should ascertain from the minutes book of the
Audit Committee & other sources like agenda papers, etc. whether the Audit Committee has reviewed
the above-mentioned information. In the given situation, the agenda of Audit Committee did not
deliberate or take note of serious irregularity mention in Internal Audit Report which is again not in
compliance of conditions of Corporate Governance & warrant audit qualification in certificate on
corporate governance.
v. The auditor should ascertain whether, throughout the reporting period, the Board of Directors comprises
an optimum combination of executive & non-executive directors, with at least one-woman director.
Therefore, there should be at least one-woman director. In the given situation there is no woman
director which is again not in compliance.
Q.5 : M/s AIl-in-One Iimited is a large-sized listed Indian Company with focus on design & delivery of
custom made Information Technology applications for various business entities in India & abroad. The

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Management wants to know whether they are required to constitute

Risk Management Committee as per LODR, 2015 & if so, required, what should be its composition? Advise.
RISK MANAGEMENT COMMITTEE [REGULATION 21]
(a) The Board of Directors shall constitute a Risk Management Committee.
(b) The majority of members of Risk Management Committee shall consist of members of the Board of
Directors. However, in case of a listed entity having outstanding SR equity shares, at least two thirds of
the Risk Management Committee shall comprise of independent directors.
(c) The Chairperson of the Risk Management Committee shall be a member of the Board of Directors &
senior executives of the listed entity may be members of the committee.
(d) The risk management committee shall meet at least once in a year.
(e) The Board of Directors shall define the role & responsibility of the Risk Management Committee & may
delegate monitoring & reviewing of the risk management plan to the committee & such other functions
as it may deem fit & such function shall specifically cover cyber security.
(f) The provisions of this regulation shall be applicable to top 500 listed entities, determined on the basis of
market capitalisation, as at the end of the immediate previous financial year.
These procedures shall be periodically reviewed to ensure that executive management controls risk through
means of a properly defined framework. A majority of this Committee will be the members of the Board of
Directors. Senior executives of the company may be also be members of the Committee, but the Chairperson
of the Committee shall be a member of the Board of Directors.
Q.6 : XYZ Limited has conducted 4 meetings in 2019-20. i.e. June 15, 2019, October 18, 2019, February 10,
2020 & June 10, 2020. Does it comply with provisions of conducting meeting?
As per Listing Obligation & Disclosure Requirements Regulations 2015, depending upon the facts &
circumstances, some situations may require an adverse or qualified statement or a disclosure without
necessarily making it a subject matter of qualification in the Auditors’ Certificate, in respect of compliance of
requirements of corporate governance. The Audit Committee shall meet at least four times in a year & not
more than one hundred & twenty days shall lapse between two meetings.
In the given case, XYZ Limited has conducted 4 meetings in 2019-20. i.e. June 15, 2019, October 18, 2019,
February 10, 2020 & June 10, 2020. It does not comply with provisions because time gap between June 15 &
October 18 is more than 120 days i.e. 125 days.
Q.7 : Statutory auditor of ABC Limited has resigned on July 10, 2020. Whether he shall be liable for issuing
limited review report for quarter ended June 30, 2020.
All listed entities/material subsidiaries while appointing/re-appointing an auditor shall ensure compliance
with:
If the auditor resigns within 45 days from the end of a quarter of a financial year, then the auditor shall,
before such resignation, issue the limited review/ audit report for such quarter.
In the given situation, statutory auditor of ABC Limited has resigned on July 10, 2020. he would be liable for
issuing limited review report for quarter ended June 30, 2020 because time gap between July 13, 2020 & June
30, 2020 is less than 45 days.
Q.8 : PQR, auditor of XYZ Limited has signed limited review report of 2nd & 3rd quarter. Whether auditor is
liable to issue limited review report of 4th quarter before resignation?
All listed entities/material subsidiaries while appointing/re-appointing an auditor shall ensure compliance in
case the auditor has signed the limited review/ audit report for the first three quarters of a financial year,
then the auditor shall, before such resignation, issue the limited review/ audit report for the last quarter of
such financial year as well as the audit report for such financial year. In the instant case, PQR, auditor of XYZ
Limited has signed limited review report of 2nd & 3rd quarter. Auditor is not liable to issue limited review
report of 4th quarter because he has not signed limited review report of first 3 quarters.
Q.9 : The Board of Directors of PQR Ltd. have laid down the code of conduct for all Board members & senior
management. The auditor is provided with the annual compliance affirmations received from the Board

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members & explained that since there has been no change in the composition of the senior management,
the previous year’s affirmations may be considered valid. Is the contention of the Company valid?
Under Regulation 26(3) of LODR, all Board members & senior management personnel have to affirm
compliance with the code on an annual basis. The decision to consider the previous year’s affirmations from
the senior management personnel as valid is not in line with the LODR Regulations.
Q.10 : RST Ltd. has established a vigil mechanism to enable its directors & employees to report genuine
concerns & seek protection against victimization. The details of the mechanism are available on the
company intranet which is accessible by the directors & employees. Are the measures taken by the
Company in line with the LODR Regulations?
Under Regulation 22 of the LODR, the vigil mechanism can be used by directors, employees & any other
person. To that effect, Regulation 46 of the LODR requires the details of establishment of such mechanism to
be disclosed by the Company on its website & in the Board Report. By only providing the details in the
intranet, the Company has failed to meet the LODR Regulations.
Q.11 : Genuine Ltd. has established the Internal Complaints Committee under the Sexual Harassment of
Women at Workplace (Prevention, Prohibition & Redressal) Act, 2013 (‘POSH Act’). The details (names,
email addresses & contact numbers) of the Committee members are available on the company intranet
which is accessible by all employees. However, no disclosure regarding number of complaints pertaining to
sexual harassment of women at workplace is being made. Are the measures taken by the Company
adequate?
As per Schedule V Disclosures in relation to the Sexual Harassment of Women at Workplace (Prevention,
Prohibition & Redressal) Act, 2013, amongst other matters, following should be disclosed in the section on
Corporate Governance of the Annual Report:

 number of complaints filed during the financial year

 number of complaints disposed of during the financial year

 number of complaints pending as on end of the financial year .
The POSH Act offers protection to all women, be it employees or contract staff or any other women who are
associated with the Company in any other capacity (including service providers, vendors, professionals, etc.)
By only providing the details in the intranet, the Company has failed to meet the requirements under the
POSH Act. In view of above, Genuine Ltd. is required to make necessary disclosures in accordance with
Schedule V of SEBI (LODR) Regulation 2015.
Q.12 : Discuss any 8 adverse or qualified statement or disclosure, which you would like to make in respect
of non-compliance with requirements of Corporate Governance of a company.
1) The number of non-executive directors is less than 50% of the strength of Board of directors.
2) A qualified & independent audit committee is not set up.
3) The Chairman of the audit committee is not an independent director.
4) The Audit Committee does not meet four times a year.
5) The necessary powers in terms of Part C of Schedule II have not been vested by the Board in the Audit
Committee.
6) The time gap between two Board meetings is more than one hundred & twenty days.
7) A director is a member of more than ten committees or acts as Chairman of more than five committees
across all companies in which he is a director.
8) The information of quarterly results is neither put on the listed entity’s website nor sent in a form so as to
enable the stock exchange on which the entity’s securities are listed to enable such stock exchange to put
it on its own website.
9) The power of share transfer is not delegated to an officer or a committee or to the registrar & share
transfer agents.

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CH-8
AUDIT OF CONSOLIDATED FINANCIAL
STATEMENTS
Q.1 : Whether preparation of consolidated financial statements is mandatory? If yes, please elaborate on
the requirements under the statute.
Consolidation of Financial Statements - Mandatory under Companies Act, 2013
According to Section 129(3) of the Companies Act, 2013, where a company has one or more subsidiaries,
including associate company & joint venture, it shall, in addition to its own financial statements prepare a
consolidated financial statement of the company & of all the subsidiaries in the same form & manner as that
of its own. Further, section 129(4) of the said Act, provides that the provisions applicable to the preparation,
adoption & audit of the financial statements of a holding company shall, mutatis mutandis, also apply to its
the consolidated financial statements.
The consolidated financial statements shall also be approved by the Board of Directors before they are signed
on behalf of the Board, along with its standalone financial statements & shall also be laid before the annual
general meeting of the company along with the laying of its standalone financial statement.
The company shall also attach along with its financial statement, a separate statement containing the salient
features of the financial statement of its subsidiary(ies) in Form AOC-1.
According to the Companies (Accounts) Rules, 2014, the consolidation of financial statements of the company
shall be made in accordance with the provisions of Schedule III to the Act & the applicable accounting
standards. However, a company which is not required to prepare consolidated financial statements under the
Accounting Standards, it shall be sufficient if the company complies with provisions of consolidated financial
statements provided in Schedule III of the Act [refer Appendix given at the end of Chapter 5 for Schedule III].
However, the requirement related to preparation of consolidated financial statements shall not apply to
a company if it meets the following conditions:
(i) it is a wholly-owned subsidiary, or is a partially-owned subsidiary of another company & all its other
members, including those not otherwise entitled to vote, having been intimated in writing & for which
the proof of delivery of such intimation is available with the company, do not object to the company
not presenting consolidated financial statements;
(ii) it is a company whose securities are not listed or are not in the process of listing on any stock exchange,
whether in India or outside India; &
(iii) its ultimate or any intermediate holding company files consolidated financial statements with the
Registrar which are in compliance with the applicable Accounting Standards.
As per sub-section 6 of the section 129 of the Companies Act, 2013, the Central Government may, on its own
or on an application by a class or classes of companies, by notification, exempt any class or classes of
companies from complying with any of the requirements of section 129 or the rules made thereunder, if it is
considered necessary to grant such exemption in the public interest & any such exemption may be granted
either unconditionally or subject to such conditions as may be specified in the notification.
Thus, the companies having subsidiaries, which have previously never prepared the consolidated financial
statements, must prepare their consolidated financial statements in adherence with this mandatory
requirement. This will provide the holding companies’ stakeholders more transparency about the companies’
businesses.
An investment entity need not present consolidated financial statements if it is required, in accordance with
paragraph 31 of Ind AS 110, to measure all of its subsidiaries at fair value through profit or loss. A parent shall
determine whether it is an investment entity.
An investment entity is an entity that:

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(a) obtains funds from one or more (b) commits to its investor(s) that its (c) measures & evaluates
investors for the purpose of business purpose is to invest the performance of
providing those investor(s) funds solely for returns from substantially all of its
with investment management capital appreciation, investment investments on a fair
services; income, or both; & value basis.
However, as per paragraph 33 of Ind AS 110, parent of an investment entity shall consolidate all entities that
it controls, including those controlled through an investment entity subsidiary, unless the parent itself is an
investment entity.
Q.2 : Please elaborate on the situations wherein the requirement related to preparation of consolidated
financial statements may not apply.
The requirement related to preparation of consolidated financial statements shall not apply to a company if it
meets the following conditions:
(i) it is a wholly-owned subsidiary, or is a partially-owned subsidiary of another company & all its other
members, including those not otherwise entitled to vote, having been intimated in writing & for which
the proof of delivery of such intimation is available with the company, do not object to the company not
presenting consolidated financial statements;
(ii) it is a company whose securities are not listed or are not in the process of listing on any stock exchange,
whether in India or outside India; &
(iii) its ultimate or any intermediate holding company files consolidated financial statements with the
Registrar which are in compliance with the applicable Accounting Standards.
Q.3 : While doing the audit of Consolidated Financial Statements, which current period consolidation
adjustments are to be taken into account?
Current Period Consolidation Adjustments
Current period adjustments are those adjustments that are made in the accounting period for which the
consolidation of financial statements is done.
Current period consolidation adjustments primarily relate to elimination of intra-group transactions &
account balances including:
(a) intra-group interest paid & received, or management fees, etc.;
(b) unrealised intra-group profits on assets acquired/ transferred from/ to other subsidiaries;
(c) record deferred taxes on unrealised intercompany profits elimination in accordance with Ind AS 12;
(d) intra-group indebtedness;
(e) adjustments related to harmonising the different accounting policies being followed by the parent & its
components;
(f) adjustments to the financial statements (of the parent & the components being consolidated) for
recognized subsequent events or transactions that occur between the balance sheet date & the date of
the auditor’s report on the consolidated financial statements of the group.
There are two types of subsequent events:
(i) The first type of subsequent events consists of events or transactions that provide additional
evidence about conditions that existed at the date of the financial statements, including the
estimates inherent in the process of preparing financial statements (i.e. adjusting events).
(ii) The second type of subsequent events consists of events that provide evidence about conditions
that did not exist at the date of the financial statements but arose subsequent to that date (i.e. non-
adjusting events).
Events occurring after balance sheet date which do not require adjustments would not normally require
disclosure, although they may be of such significance that they may require a disclosure in the report of
approving authority in the case of accounting standards & in the financial statements in case of Ind AS.
For such events, the following shall be disclosed:
(i) The nature of the event; &
(ii) An estimate of its financial effect or a statement that such an estimate cannot be made.

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(g) adjustments for the effects of significant transactions or other events that occur between the date of the
components balance sheet & not already recognised in its financial statements & the date of the
auditor’s report on the group’s consolidated financial statements when the financial statements of the
component to be used for consolidation are not drawn upto the same balance sheet date as that of the
parent;
(h) In case of a foreign component, adjustments to convert a component’s audited financial statements
prepared under the component’s local GAAP to the GAAP under which the consolidated financial
statements are prepared;
(i) determination of movement in equity attributable to the minorities interest/non-controlling interest
since the date of acquisition of the subsidiary. It should also be noted that under Ind AS, non-controlling
interest can also result in negative balance. Unlike earlier AS, as per paragraph 28 of Ind AS 27, if the net
worth of subsidiary is negative, non-controlling interest could have deficit balance;
(j) adjustments of deferred tax on account of temporary differences arising out of elimination of profit &
losses resulting from intragroup transactions & undistributed profits of the component in case of
consolidated financial statements prepared under Ind AS.
The adjustments required for preparation of consolidated financial statements are made in memorandum
records kept for the purpose by the parent. The auditor should review the memorandum records to verify the
adjustment entries made in the preparation of consolidated financial statements.
Apart from reviewing the memorandum records, the auditor should inter alia:
(a) verify that the intra group transactions & account balances have been eliminated;
(b) verify that the consolidated financial statements have been prepared using uniform accounting policies
for like transactions & other events in similar circumstances;
(c) verify that adequate disclosures have been made in accordance with AS 21 in the consolidated financial
statements of application of different accounting policies in case, it was impracticable to harmonize
them. Applying a requirement is impracticable when the entity cannot apply it after making every
reasonable effort to do so4 but while preparing CFS under Ind AS, auditors should ensure that
appropriate adjustments are made to that group member’s financial statements in preparing the
consolidated financial statements to ensure conformity with the group’s accounting policies in
accordance with Ind AS 110;
(d) verify the adjustments made to harmonise the different accounting policies including adjustments made
by management to convert a component’s financial statements prepared under the component’s GAAP
to the GAAP under which the consolidated financial statements are prepared;
(e) verify the calculation of minorities/non-controlling interest;
(f) verify adjustments relating to deferred tax on account of temporary differences arising out of elimination
of profit & losses resulting from intergroup transactions (where the parent’s accounts are maintained in
Ind AS);
(g) verify that income & expenses of the subsidiary are included in consolidated financial statements from
the date it gains control until the date when the entity ceases to control the subsidiary & further such
income & expenses are based on the amounts of the assets & liabilities recognised in consolidated
financial statements at the acquisition date5.
The auditor should gain an understanding of the procedures adopted by the management of the
enterprise to make the above mentioned adjustments. This helps the auditor in reducing the audit risk to
an acceptably low level.
One of the important adjustment that may be required in the current period is determination of
impairment loss that might exist for goodwill arising on consolidation. Goodwill arising on consolidation
is carried at the value determined at the date of acquisition of the component, & the same is to be
tested for impairment loss at every balance sheet date.
Q.4: Write a short note on:
(a) Responsibility of holding company for preparation of Consolidated Financial Statements.
(b) Permanent Consolidated Adjustments.

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(a) The responsibility for the preparation & presentation of consolidated financial statements, among other
things, is that of the management of the parent. This includes:
(a) identifying components, & including the financial information of the components to be included in the
consolidated financial statements;
(b) where appropriate, identifying reportable segments for segmental reporting;
(c) identifying related parties & related party transactions for reporting;
(d) obtaining accurate & complete financial information from components;
(e) making appropriate consolidation adjustments;
(f) harmonization of accounting policies & accounting framework; &
(g) GAAP conversion, where applicable.
Apart from the above, the parent ordinarily issues instructions to the management of the component
specifying the parent’s requirements relating to financial information of the components to be included in the
consolidated financial statements. The instructions ordinarily cover the accounting policies to be applied,
statutory & other disclosure requirements applicable to the parent, including the identification of & reporting
on reportable segments, & related parties & related party transactions, & a reporting timetable.

(b) Permanent Consolidation Adjustments

Permanent consolidation adjustments are those adjustments that are made only on the first occasion or
subsequent occasions in which there is a change in the shareholding of a particular entity which is
consolidated. Permanent consolidation adjustments are:
(a) Determination of goodwill or capital reserve as per applicable accounting standards.
(b) Determination of amount of equity attributable to minority/ non- controlling interests.
The auditor should verify that the above calculations have been made appropriately.
- The auditor should pay particular attention to the determination of pre-acquisition reserves of the
components. Date(s) of investment in components assumes importance in this regard.
- The auditor should also examine whether the pre-acquisition reserves have been allocated
appropriately between the parent and the minority interests/ non-controlling interests of the
subsidiary.
- The auditor should also verify the changes that might have taken place in these permanent
consolidation adjustments on account of subsequent acquisition of shares in the components,
disposal of the components in the subsequent years.
It may happen that while working out the permanent consolidation adjustments, in the case of one
subsidiary, goodwill arises and in the case of another subsidiary, capital reserve arises. The parent may
choose to net off these amounts to disclose a single amount in the consolidated balance sheet where
permitted by the applicable financial reporting framework. In such cases, the auditor should verify that the
gross amounts of goodwill and capital reserves arising on acquisition of various subsidiaries have been
disclosed in the notes to the consolidated financial statements to reflect the excess/shortage over the
parents' portion of the subsidiary's equity.

Q.5: R Ltd. owns 51% voting power in S Ltd. It however, holds & discloses all the shares as "Stock-in-trade"
in its accounts. The shares are held exclusively with a view to their subsequent disposal in the near future.
R Ltd. represents that while preparing Consolidated Financial Statements, S Ltd. can be excluded from the
consolidation. As a Statutory Auditor, how would you deal?
Consolidation of Financial Statement: AS 21 “Consolidated Financial Statements”, states that a subsidiary
should be excluded from consolidation when:
(i) Control is intended to be temporary because the shares are acquired & held exclusively with a view to
its subsequent disposal in the near future or
(ii) Subsidiary operates under severe long- term restrictions which significantly impair its ability to transfer

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funds to the parent.

Where an enterprise owns majority of voting power by virtue of ownership of the shares of another
enterprise & all the shares held as ‘stock-in-trade’ are acquired & held exclusively with a view to their
subsequent disposal in the near future, the control by the first mentioned enterprise would be considered
temporary & the investments in such subsidiaries should be accounted for in accordance with AS 13
“Accounting for Investments”.
As per Ind AS 110, there is no such exemption for ‘temporary control’, or “for operation under severe long-
term funds transfer restrictions” & consolidation is mandatory for Ind AS compliant financial statement in this
case. Paragraph 20 of Ind AS 110 states that “Consolidation of an investee shall begin from the date the
investor obtains control of the investee & cease when the investor loses control of the investee”.
However, as per Section 129(3) of the Companies Act, 2013 read with rule 6 of the Companies (Accounts)
Rules, 2014, where a company having subsidiary, which is not required to prepare consolidated financial
statements under the Accounting standards, it shall be sufficient if the company complies with the provisions
on consolidated financial statements provided in Schedule III to the Act.
In the given case, R Ltd.’s intention is to dispose off the shares in the near future as shares are being held as
stock in trade & it is quite clear that the control is temporary, Therefore, R Ltd. is not required to prepare
consolidated financial statement as per AS 21, however, for the compliance of provisions related to
consolidation of financial statements given under
section 129(3) of the Companies Act, 2013 read with Companies (Accounts) Rules, 2014, R Ltd. is required to
make disclosures in the financial statements as per the provisions provided in Schedule III to the Companies
Act, 2013. However, if R Ltd. is required to prepare its financial statements under Ind AS, it shall have to
prepare Consolidated Financial Statements in accordance with Ind AS 110 as exemption for ‘temporary
control’ is not available under Ind AS 110.
Q.6: A Ltd. holds the ownership of 10% of voting power & control over the composition of Board of
Directors of B Ltd. While planning the statutory audit of A Ltd., what factors would be considered by you as
the statutory auditors of A Ltd for the audit of its consolidated financial statements prepared under Ind AS?
10% Voting Power & Control over the composition of Board of Directors: In this case, A Ltd. holds only 10
percent of the voting power but has control over the composition of the Board of Directors of B Ltd.
In such a case, A Ltd shall be considered as a parent of B Ltd &, therefore, it would consolidate B Ltd in its
consolidated financial statements as a subsidiary.
The auditor should verify A Ltd.’s management’s assessment of having control in B Ltd despite having only
10% voting power as per the requirements of Ind AS 110. Auditor would need to verify as to how A Ltd
controls the composition of the Board of Directors or corresponding governing body of B Ltd.
There can be various means by which such kind of control can be established. In this regard, the auditor may
verify the minutes of Board meetings, shareholder agreement entered into by the parent, agreements with B
Ltd to which the parent might have provided any technology or know how, enforcement of statute, etc.
Further, the auditor should verify that the adjustments warranted by Ind AS 110 have been made wherever
required & have been properly authorised by the management of the parent. The preparation of consolidated
financial statements gives rise to permanent consolidation adjustments & current period consolidation
adjustments. The auditor should make plan, among other things, for the understanding of accounting policies
of the A Ltd & B Ltd & determining & programming the nature, timing, & extent of the audit procedures to be
performed etc.
Further, the duties of an auditor with regard to reporting of transactions with any other related parties are
given in SA 550 on Related Parties. As per SA 550 on, “Related Parties”, the auditor should review information
provided by the management of the entity identifying the names of all known related parties. A person or
other entity that has control or significant influence, directly or indirectly through one or more intermediaries,
over the reporting entity are considered as Related Party.
In forming an opinion on the financial statements, the auditor shall evaluate whether the identified related
party relationships & transactions have been appropriately accounted for & disclosed in accordance with Ind
AS 110 & Schedule III & whether the effects of the related party relationships & transactions prevent the

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financial statements from achieving true & fair presentation (for fair presentation frameworks) or cause the
financial statements to be misleading (for compliance frameworks).
Q.7: You are appointed as an auditor of Nawab Limited, a listed company who is a main supplier to the UK
building & construction market. With a turnover of ` 2.9 billion, the company operates through 11 business
units & has nearly 180 branches across the countries .
As an auditor, how will you draft the report in case:
a) When the Parent’s Auditor is also the Auditor of all its Components?
b) When the Parent’s Auditor is not the Auditor of all its Components?
c) When the Component(s) Auditor Reports on Financial Statements under an Accounting Framework
Different than that of the Parent?
d) When the Component(s) Auditor Reports under an Auditing Framework Different than that of the
Parent?
e) Where the financial statements of one or more components is not audited?
REPORTING
There could be two situations in an audit of consolidated financial statements–-when the parent’s auditor is
also the auditor of all the components to be included in the consolidated financial statements & when the
parent’s auditor is not the auditor of one or more components & therefore, uses the work of other auditors in
the audit. The auditor should, while preparing the report, consider the requirements of Standard on Auditing
(SA) 700, “Forming an Opinion & Reporting on Financial Statements”, SA 705, “Modifications to the Opinion in
the Independent Auditor’s Report & SA 706, “Emphasis of Matter Paragraphs & Other Matter Paragraphs in
the Independent Auditor’s Report. Where, the auditor uses the work of other auditors in the audit of
consolidated financial statements, the requirements of SA 600, “Using the Work of Another Auditor” should
also be considered.
When the Parent’s Auditor is also the Auditor of all its Components
While drafting the audit report, the auditor should report :
▪ Whether principles & procedures for preparation & presentation of consolidated financial statements as
laid down in the relevant accounting standards have been followed. In case of any departure or deviation,
the auditor should consider the requirements given in SA 705, Modifications to the Opinion in the
Independent Auditor’s reports in the audit report so that users of the consolidated financial statements
are aware of such deviation.
▪ Auditor should issue an audit report expressing opinion whether the consolidated financial statements
give a true & fair view of the state of affairs of the Group as on balance sheet date & as to whether
consolidated profit & loss statement gives true & fair view of the results of consolidated profit or losses of
the Group for the period under audit.
▪ Where the consolidated financial statements also include a cash flow statement, the auditor should also
give his opinion on the true & fair view of the cash flows presented by the consolidated cash flow
statements.
When the Parent’s Auditor is not the Auditor of all its Components
In a case where the parent’s auditor is not the auditor of all the components included in the consolidated
financial statements, the auditor of the consolidated financial statements should also consider the
requirement of SA 600. As prescribed in SA 706, if the auditor considers it necessary to make reference to
the audit of the other auditors, the auditor’s report on the consolidated financial statements should
disclose cl early the magnitude of the portion of the financial statements audited by the other auditor(s).
This may be done by stating aggregate rupee amounts or percentages of total assets, revenues & cash
flows of components included in the consolidated financial statements not audited by the parent’s
auditor.
Total assets, revenues & cash flows not audited by the parent’s auditor should be presented before giving
effect to permanent & current period consolidation adjustments.

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Reference in the report of the auditor on the consolidated financial statements to the fact that part of the
audit of the group was made by other auditor(s) is not to be construed as a qualification of the opinion but
rather as an indication of the divided responsibility between the auditors of the parent & its subsidiaries.
When the Component(s) Auditor Reports on Financial Statements under an Accounting Framework
Different than that of the Parent
The parent may have components located in multiple geographies outside India applying an accounting
framework (GAAP) that is different than that of the parent in preparing its financial statements. Foreign
components prepare financial statements under different financial reporting frameworks, which may be a
well-known framework (such as US GAAP or IFRS) or the local GAAP of the jurisdiction of the component.
Local component auditors may be unable to report on financial statements prepared using the parent’s
GAAP because of their unfamiliarity with such GAAP.
When a component’s financial statements are prepared under an accounting framework that is different
than that of the framework used by the parent in preparing group’s consolidated financial statements, the
parent’s management perform a conversion of the components’ audited financial statements from the
framework used by the component to the framework under which the consolidated financial statements
are prepared. The conversion adjustments are audited by the principal auditor to ensure that the financial
information of the component(s) is suitable & appropriate for the purposes of consolidation.
A component may alternatively prepare financial statements on the basis of the parent’s accounting
policies, as outlined in the group accounting manual, to facilitate the preparation of the group’s
consolidated financial statements. The group accounting manual would normally contain all accounting
policies, including relevant disclosure requirements, which are consistent with the requirements of the
financial reporting framework under which the group’s consolidated financial statements are prepared.
The local component auditor can then audit & issue an audit report on the components financial
statements prepared in accordance with “group accounting policies”.
When applying the approach of using group accounting policies as the financial accounting framework for
components to report under, the principal/parent auditors should perform procedures necessary to
determine compliance of the group accounting policies with the GAAP applicable to the parent’s financial
statements. This ensures that the information prepared under the requirements of the group accounting
policies will be directly usable & relevant for the preparation of consolidated financial statements by the
parent entity, eliminating the need for auditing by the auditor, the differences between the basis used for
the component’s financial statements & that of the consolidated financial statements. The Principal
auditor can then decide whether or not to rely on the components’ audit report & make reference to it in
the auditor’s report on the consolidated financial statements.
When the Component(s) Auditor Reports under an Auditing Framework Different than that of the Parent
Normally, audits of financial statements, including consolidated financial statements, are performed under
auditing standards generally accepted in India (“Indian GAAS”).
In order to maintain consistency of the auditing framework & to enable the parent auditor to rely & refer
to the other auditor’s audit report in their audit report on the consolidated financial statements, the
components’ financial statements should also be audited under a framework that corresponds to Indian
GAAS.
Components Not Audited
Generally, the financial statements of all components included in consolidated financial statements should be
audited or subjected to audit procedures in the context of a multi-location group audit. Such audits & audit
procedures can be performed by the auditor reporting on the consolidated financial statements or by the
components’ auditor.
Where the financial statements of one or more components continue to remain unaudited, the auditor
reporting on the consolidated financial statements should consider unaudited components in evaluating a
possible modification to his report on the consolidated financial statements. The evaluation is necessary
because the auditor (or other auditors, as the case may be) has not been able to obtain sufficient appropriate

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audit evidence in relation to such consolidated amounts/balances. In such cases, the auditor should evaluate
both qualitative & quantitative factors on the possible effect of such amounts remaining unaudited when
reporting on the consolidated financial statements using the guidance provided in SA 705, “Modifications to
the Opinion in the Independent Auditor’s Report”.
Q.8: M Ltd. acquired 51 % shares of S Ltd. on 01-04-2019 & sold 25% of these shares during the financial
year 2019-20. M Ltd. did not prepare Consolidated Financial Statements for the financial year 2019-20 on
the plea that the control was only temporary. Do you agree with the view of M Ltd.? Decide, assuming, that
M Ltd. is required to prepare its financial statements under Ind AS.
Consolidation of Financial Statement: As per Ind AS 110, there is no such exemption for ‘temporary control’,
or “for operating under severe long-term funds transfer restrictions” & consolidation is mandatory for Ind AS
compliant financial statement in this case.
Ind AS 110 states that “Consolidation of an investee shall begin from the date the investor obtains control of
the investee & cease when the investor loses control of the investee”.
In the given case, M Ltd acquired 51% shares of S Ltd on 01.04.2019 & sold 25% shares during the year ended
2019-20. M Ltd did not consolidate the financial statements of S Ltd for the year ended 31.03.2020 on the
plea that control was only temporary. The intention of M Ltd. is quite clear that the control in S Ltd. is
temporary as the former company disposed off the acquired shares in the same year of its purchase.
However, even though the intention of M Ltd. is for temporary holding of shares in S Ltd. as per Ind AS, M Ltd
is required to prepare Consolidated Financial Statements in accordance with Ind AS 110 as exemption for
‘temporary control’ is not available under Ind AS 110. However, “Consolidation of an investee shall begin from
the date the investor obtains control of the investee & cease when the investor loses control of the investee”.
Here, due to sale of investment in S Ltd. up to 25%, M Ltd. loses control of S Ltd.
Accordingly, M Ltd., is required to prepare consolidated statement till the date of disposal of the 25% shares
to comply with the same.
Q.9: H Limited is an Investment Company preparing its Financial Statements in accordance with Ind AS. The
Company obtains funds from various investors & commits its performance for fair return & capital
appreciation to its investors. During the year under audit, it had been observed that the Company had
invested 25% in S1 Ltd., 50% in S2 Ltd. & 60% in S3 Ltd. of the respective share capitals of the Investee
Companies. When checking the investment schedule of the Company, an issue cropped as to whether there
would arise any need to consolidate accounts of any such investee companies with those of H Limited in
accordance with section 129(3) of the Companies Act, 2013 which contains no exclusion from consolidation.
Analyse the issues involved & give your views.
Consolidated Financial Statements: According to Section 129(3) of the Companies Act, 2013, where a
company has one or more subsidiaries, including associate company & joint venture, it shall, in addition to its
own financial statements prepare a consolidated financial statement of the company & of all the subsidiaries
in the same form & manner as that of its own.
Further, as per Companies (Accounts) Rules, 2014, the consolidation of financial statements of the company
shall be made in accordance with the provisions of Schedule III to the Act & the applicable accounting
standards. However, a company which is not required to prepare consolidated financial statements under the
Accounting Standards, it shall be sufficient if the company complies with provisions on consolidated financial
statements provided in Schedule III of the Act.
However, an investment entity need not present consolidated financial statements if it is required, in
accordance with Ind AS 110‘Consolidated Financial Statements’, to measure all of its subsidiaries at fair value
through profit or loss. A parent shall determine whether it is an investment entity.
(An investment entity is an entity that(a) obtains funds from one or more investors for the purpose of
providing those investor(s) with investment management services; (b) commits to its investor(s) that its
business purpose is to invest funds solely for returns from capital
appreciation, investment income, or both; & (c) measures & evaluates the performance of substantially all of
its investments on a fair value basis.)

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In the given case, H Limited is an investment company preparing its financial statements in accordance with
Ind AS & the company had invested 25% in SI Ltd., 50% in S2 Ltd. & 60% in S3 Ltd. of the respective share
capitals of the investee companies. In view of provisions discussed in Ind AS 110, the Company is not required
to prepare consolidated financial statements however, for the compliance of Companies (Accounts) Rules,
2014, it shall be sufficient if the company complies with provisions on consolidated financial statements
provided in Schedule III of the Act.
Thus, it can be concluded that ultimate authority on consolidation is AS / Ind AS as prescribed by law & if they
give some exemption it should be followed. If out of exemption some subsidiaries are not consolidated, then
list should be disclosed in notes to accounts with reason.

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CH-9 AUDIT OF BANKS

Q.1: Your firm has been appointed as Central Statutory Auditors of a Nationalised Bank. The Bank follows
financial year as accounting year. Your Audit Manager informed that the bank has recognised on accrual
basis income from dividends on securities & Units of Mutual Funds held by it as at the end of financial year.
The dividends on securities & Units of Mutual Funds were declared after the end of financial year. Comment.
Banks may book income from dividend on shares of corporate bodies on accrual basis, provided dividend on
the shares has been declared by the corporate body in its annual general meeting & the owner's right to
receive payment is established. This is also in accordance with AS 9. In this case the dividends have been
declared after the financial year end. Therefore, the recognition of income by the bank on accrual basis is not in
order.
In respect of income from government securities & bonds & debentures of corporate bodies, where interest
rates on these instruments are pre-determined, income could be booked on accrual basis, provided interest is
serviced regularly & as such is not in arrears. It was further, however, clarified that banks may book income on
accrual basis on securities of corporate bodies/public sector undertakings in respect of which the payment of
interest & repayment of principal have been guaranteed by the central government or a State government.
Q.2: As statutory central auditors of a Nationalized bank, what special points are to be borne in mind in the
audit of compliance with "Statutory Liquidity Ratio" (SLR) requirements?
COMPLIANCE WITH CRR & SLR REQUIREMENTS
(i) Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of customers, which
commercial banks have to hold as reserves either in cash or as deposits with the central bank. One of the
important determinants of cash balances to be maintained by banking companies & other scheduled
banks is the requirement for maintenance of a certain minimum cash reserve. While the requirement for
maintenance of cash reserve by banking companies is contained in the Banking Regulation Act, 1949,
corresponding requirement for scheduled banks is contained in the Reserve Bank of India Act, 1934. The
RBI, from time to time, reviews the evolving liquidity situation & accordingly decides the rate of CRR
required to be maintained by scheduled commercial banks. Therefore, the auditor need to refer the
master circular issued from time to time in this regard to ensure the compliance of CRR requirements.
(ii) Statutory Liquidity Ratio (SLR) Requirements – SLR is the requirement that every scheduled commercial
bank in India is required to maintain in the form of certain liquid assets such as gold, cash & government
approved securities before providing credit to the customers. The Reserve Bank of India requires statutory
central auditors of banks to verify the compliance with SLR requirements of 12 odd dates in different
months of a fiscal year not being Fridays. The objective of maintaining SLR is to have an amount in the
form of liquid assets which can be used to handle a sudden increase in demand for the amount from the
depositors. The resultant report is to be sent to the top management of the bank & to the Reserve Bank.
Q.3: Explain the scope of concurrent audit of a bank with reference to Reserve Bank of India guidelines.
Scope of Concurrent Audit
The detailed scope of the concurrent audit should be clearly & uniformly determined for the Bank as a whole
by the Bank’s Inspector & Audit Department in consultation with the Bank’s Audit Committee of the Board of
Directors (ACB). In determining the scope, importance should be given to checking high-risk transactions having
large financial implications as opposed to transactions involving lesser amounts. The detailed scope of the
concurrent audit may be determined & approved by the ACB.
Further, the guidelines issued by the RBI cover all the key areas of activities of the branch which is under
concurrent audit. Most banks have prepared an Audit Manual for this purpose. Broadly stated, the following
areas are covered by these guidelines:
1. Cash
2. Deposits

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3. Advances
4. Investments
5. Foreign Exchange
6. House Keeping
7. Other Items
Q.4: In course of audit of Good Samaritan Bank as at 31st March, 19 you observed the following:
(a) In a particular account there was no recovery in the past 18 months. The bank has not applied the NPA
norms as well as income recognition norms to this particular account. When queried the bank
management replied that this account was guaranteed by the central government & hence these norms
were not applicable. The bank has not invoked the guarantee. Please respond. Would your answer be
different if the advance is guaranteed by a State Government?
(b) The bank’s advance portfolio comprised of significant loans against Life Insurance Policies. Write suitable
audit program to verify these advances.
(a) Government Guaranteed Advance: If a government guaranteed advance becomes NPA, then for the
purpose of income recognition, interest on such advance should not to be taken to income unless interest
is realized. However, for purpose of asset classification, credit facility backed by Central Government
Guarantee, though overdue, can be treated as NPA only when the Central Government repudiates its
guarantee, when invoked. Since the bank has not invoked the guarantee, the question of repudiation does
not arise. Hence the bank is correct to the extent of not applying the NPA norms for provisioning purpose.
But this exemption is not available in respect of income recognition norms. Hence the income to the
extent not recovered should be reversed. The situation would be different if the advance is guaranteed by
State Government because this exception is not applicable for State Government Guaranteed advances,
where advance is to be considered NPA if it remains overdue for more than 90 days. In case the bank has
not invoked the Central Government Guarantee though the amount is overdue for long, the reasoning for
the same should be taken & duly reported in LFAR.
(b) The Audit Programme to Verify Advances against Life Insurance Policies is as under-
(i) The auditor should inspect the policies & see whether they are assigned to the bank & whether such
assignment has been registered with the insurer.
(j) The auditor should also examine whether premium has been paid on the policies & whether they
are in force.
(k) Certificate regarding surrender value obtained from the insurer should be examined.
(l) The auditor should particularly see that if such surrender value is subject to payment of certain
premium, the amount of such premium has been deducted from the surrender value.
Q.5: Your firm has been appointed as Central Statutory Auditors of a Nationalised Bank. The bank is a
consortium member of Cash Credit Facilities of ` 50 crores to X Ltd. Bank's own share is ` 10 crores only.
During the last two quarters against a debit of ` 1.75 crores towards interest the credits in X Ltd.’s account
are to the tune of ` 1.25 crores only. Based on the certificate of lead bank, the bank has classified the account
of X Ltd as performing. The Bank follows financial year as accounting year. Advise your views on the issue
which were brought to your notice by your Audit Manager.
The bank is a consortium member of cash credit facilities of ` 50 crores to X Ltd. Bank's own share is ` 10 crores
only. During the last two quarters against a debit of ` 1.75 crores towards interest, the credits in X Ltd.’s
account are to the tune of ` 1.25 crores only. Sometimes, several banks form a group (the 'consortium') under
the leadership of a 'lead bank' to make advance to a large customer on same conditions & security with
proportionate rights. In such cases, each bank may classify the advance given by it according to its own
experience of recovery & other factors. Since in the last two quarters, the amount remains outstanding &, thus,
interest amount should be reversed. This is despite the certificate of lead bank to classify that the account as
performing. Accordingly, the amount should be shown as non-performing asset.
Q.6: You have been appointed as an auditor of LCO Bank, a nationalized bank. LCO Bank also deals in
providing credit card facilities to its account holder. The bank is aware of the fact that there should be strict

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control over storage & issue of credit cards. How will you evaluate the Internal Control System in the area of
Credit Card operations of a Bank?
Credit Card • There should be effective screening of applications with reasonably good credit
Operations assessments.
• There should be strict control over storage & issue of cards.
• There should be a system whereby a merchant confirms the status of unutilised limit of
a credit-card holder from the bank before accepting the settlement, in case the amount
to be settled exceeds a specified percentage of the total limit of the card holder.
• There should be a system of prompt reporting by the merchants of all settlements
accepted by them through credit cards.
• Reimbursement to merchants should be made only after verification of the validity of
merchant’s acceptance of cards.
• All the reimbursement (gross of commission) should be immediately charged to the
customer’s account.
• There should be a system to ensure that statements are sent regularly & promptly to
the customer.
• There should be a system to monitor & follow-up customers’ payments.
• Payments overdue beyond a reasonable period should be identified & attended to
carefully. For defaulting customers, credit should be stopped by informing the
merchants through periodic bulletins, as early as possible, to avoid increased losses.
• There should be a system of periodic review of credit card holders’ accounts. On this
basis, the limits of customers may be revised, if necessary. The review should also
include determination of doubtful amounts & the provisioning in respect thereof.
Q.7: You have been appointed as Concurrent Auditor of a nationalized bank branch. The main business at the
branch is dealing in foreign exchange. Suggest the main areas of coverage with regard to foreign exchange
transactions of the said branch under concurrent audit.
Area of Suggested Audit Procedures
Focus
Foreign • Check foreign bills negotiated under letters of credit.
Exchange • Check FCNR & other non-resident accounts whether the debits & credits are permissible
under rules.
• Check whether inward/outward remittance have been properly accounted for.
• Examine extension & cancellation of forward contracts for purchase & sale of foreign
currency. Ensure that they are duly authorised & necessary charges have been
recovered.
• Ensure that balances in Nostro accounts in different foreign currencies are within the
limit as prescribed by the bank.
• Ensure that the overbought/oversold position maintained in different currencies is
reasonable, considering the foreign exchange operations.
• Ensure adherence to the guidelines issued by RBI/HO of the bank about dealing room
operations.
• Ensure verification/reconciliation of Nostro & Vostro account transactions/balances.
Q.8: While auditing FAIR Bank, you observed that a lump sum amount has been disclosed as contingent
liability collectively. You are, therefore, requested by the management to guide them about the disclosure
requirement of Contingent Liabilities for Banks. Kindly guide.
✓ Claims against the bank not acknowledged as debts
✓ Liability for partly paid investments
✓ Liability on account of outstanding forward exchange contracts.
✓ Guarantees given on behalf of constituents (within India; outside India)

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✓ Acceptances, endorsements and other obligations

✓ Other items for which the bank is contingently liable
✓ Bills for Collection
Q.9: ABC Chartered Accountants have been appointed as concurrent auditors for the branches of Effective
Bank Ltd. for the year 2019-20. You are part of the audit team for Agra branch of the bank & have been
instructed by your senior to verify the advances of the audit period. You are required to guide your assistant
about the areas to be taken care while doing verification during the concurrent audit.
Advances • Ensure that loans & advances have been sanctioned properly in accordance with delegated
authority.
• Ensure that securities & documents have been received & properly charged/ registered.
• Ensure that post disbursement supervision & follow-up is proper, such as receipt of stock
statements, instalments, recovery/ renewal of sanction limits, etc.
• Verify whether there is any misutilisation of the loans & whether there are instances
indicative of diversion of funds.
• Check whether the letters of credit issued by the branch are within the delegated power &
ensure that they are for genuine trade transactions.
• Check the bank guarantees issued, whether they have been properly worded & recorded in
the register of the bank. Whether they have been promptly renewed on the due dates.
• Ensure proper follow-up of overdue bills of exchange.
• Verify whether the classification of advances has been done as per RBI guidelines.
• Verify whether the claims to DICGC & ECGC is submitted in time.
• Verify that instances of exceeding delegated powers have been promptly reported to
controlling/Head Office by the branch & have been confirmed or ratified at the required
level.
Q.10: In the course of audit of Skip Bank Ltd., you found that the Bank had sold certain of its non-performing
assets. Draft the points of audit check that are very relevant to this area of checking.
In case of Sale/Purchase of NPA by Bank:
✓ the auditor should examine the policy laid down by the Board of Directors in this regard relating to
procedures, valuation and delegation of powers. only such NPA has been sold which has remained NPA in the
books of the bank for at least 2 years.
✓ the assets have been sold/ purchased "without recourse' only. subsequent to the sale of the NPA, the
bank
✓ does not assume any legal, operational or any other type of risk relating to the sold NPAs.
✓ the NPA has been sold at cash basis only.
✓ the bank has not purchased an NPA which it had originally sold.
In case of sale of an NPA, the auditor should also ensure that:
✓ on the sale of the NPA, the same has been removed from the books of the account.
✓ the short fall in the net book value has been charged to the profit and loss account.
✓ where the sale is for a value higher than the NBV, no profit is recognised and the excess provision has
not been reversed but retained to meet the shortfall/ loss that may arise because of sale of other non-
performing financial assets.
Q.11: Banks, because of certain characteristics, are distinguished from other commercial enterprises & hence
it needs special audit consideration. As an auditor of a bank, specify the various peculiarities which may
necessitate special audit consideration to be taken care by you?
The banking industry is the pivot of any economy & its financial system. Banks are one of the foremost agents
of financial intermediation in an economy like India &, therefore, development of a strong & resilient banking
system is of utmost importance. The banking institutions in the country are working in a competitive
environment & their regulatory framework is aligned with the international best practices. Thus, financial
deepening has taken place in India & continues to be in progress with a focus on orderly conditions in financial
markets while sustaining the growth momentum. Banks have certain characteristics distinguishing them from

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most other commercial enterprises.

Special audit considerations arise in the audit of banks because of:
• the particular nature of risks associated with the transactions undertaken;
• the scale of banking operations & the resultant significant exposures which can arise within short period of
time;
• the extensive dependence on IT to process transactions;
• the effect of the statutory & regulatory requirements;
• the continuing development of new products & services & banking practices which may not be matched by
the concurrent development of accounting principles & auditing practices.
Evolution of technology & providing services through Net Banking & Mobiles has exposed banks to huge
operational & financial risk. The auditor should consider the effect of the above factors in designing his audit
approach. It is imperative for Branch Auditors & SCAs (Statutory Central Auditors) to have detailed knowledge
of the products offered & risks associated with them, & appropriately address them in their audit plan to the
extent they give rise to the risk of material misstatements in the financial statements. In today’s environment,
the banks use different applications to carry out different transactions which may include data flow from one
application to other application; the auditor while designing his plans should also understand interface controls
between the various applications.
Q.12: ABC Bank had sanctioned credit limits of Rs.100 lakh to M/s Volkart Ltd on 1st September 2018. The
renewal of limits was due on 1st September 2019. While doing the statutory branch audit for the year ended
31st March 2020, you find that the renewal has not been done even though 180 days are over. The bank
says that the renewal process has been initiated on time & most of the document are received. The account
is operated regularly & is in order; balance is maintained within drawing power. It also shows a letter from
Volkart stating that due to a sudden death of their auditor, a new auditor had to be appointed. Procedure for
appointment took some time & the new auditor was doing the audit all over again. The limit was not
renewed till 31/3/2020. However, the audited financials are received on 10th April 2020 & the renewal letter
was issued immediately. Your assistant is insisting that the account must be classified as NPA since the limit
was not renewed as on 31/3/2020. What is your opinion?
As per Guidelines of Reserve Bank of India the account should be classified as NPA if renewal is not done in 180
days. However, in the present case, operations in the account are excellent. The bank has shown a letter from
that company that due to certain reasons the audited financial statements are delayed. Further, the limit has
been renewed before signing the audit report.
Thus, even if the sanction was issued after the balance sheet date, it relates to the position as on the balance
sheet date. Therefore, it is an adjusting event under AS 4, Contingencies & Events Occurring After the Balance
Sheet Date. It is also a matter of substance over form.
The auditor would consider classifying the account as a standard asset.
Q.13: You are auditing a small bank branch with staff strength of the manager, cashier & three other staff S1
,S2 & S3. Among allocation of work for other areas, S1 who is a peon also opens all the mail & forwards it to
the concerned person. He does not have a signature book so as to check the signatures on important
communications. S2 has possession of all bank forms (e.g. Cheque books, demand draft/pay order books,
travelers’ cheques, foreign currency cards etc.). He maintains a record meticulously which you have test
checked also. However, no one among staff regularly checks that. You are informed that being a small branch
with shortage of manpower, it is not possible to always check the work & records. Give your comments.
Banks are required to implement & maintain a system of internal controls for mitigating risks, maintain good
governance & to meet the regulatory requirements. Given below are examples of internal controls that are
violated in the given situation:
In the instant case, S1 who is a peon opens all the mail & forwards it to the concerned person. Further, he does
not have a signature book so as to check the signatures on important communications is not in accordance with
implementation & maintenance of general internal control. As the mail should be opened by a responsible
officer. Signatures on all the letters & advices received from other branches of the bank or its correspondence

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should be checked by an officer with the signature book.

All bank forms (e.g. Cheque books, demand draft/pay order books, travelers’ cheques, foreign currency cards
etc.) should be kept in the possession of an officer, & another responsible officer should verify the issuance &
stock of such stationery. In the given case, S2 has possession of all bank forms (e.g. cheque books, demand
draft/pay order books, travelers’ cheques, foreign currency cards etc.). He maintains a record meticulously
which were also verified on test check basis.
Further, contention of bank that being a small branch with shortage of manpower they are not able to check
the work & records on regular basis, is not tenable as such lapses in internal control pose risk of fraud.
The auditor should report the same in his report accordingly.

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CH - 10 AUDIT OF INSURANCE COMPANIES

Q.1: What are the steps to be taken while verifying the Premium of (a) General Insurance Company; & (b)
Life Insurance Company?
(a) PREMIUM – GENERAL INSURANCE COMPANIES
Premium: Premium is the consideration received by an insurer from the insured under an insurance contract,
whereby the insurer agrees to undertake certain sum of risk on behalf of the insured. The objectives of internal
controls over premium is to ensure that correct premium is calculated & collected before acceptance of any
risk, that premium is accounted for in an appropriate manner & that the premium is collected only in respect of
such risks which are assumed by the company.
No Risk Assumption without Premium – Section 64VB of the Insurance Act, 1938
No insurer should assume any risk in India in respect of any insurance business on which premium is ordinarily
payable in India unless & until the premium payable is received or is guaranteed to be paid by such person in
such manner & within such time, as may be prescribed, or unless & until deposit of such amount, as may be
prescribed, is made in advance in the prescribed manner.
Premium Revenue Recognition:
According to the IRDA (Preparations & Presentations of the Financial Statements & Auditor’s Report),
Regulations 2000, Premium Revenue Recognition is based on the pattern of Risk to which the insurer is
exposed. These Regulations envisage that an Insurer based on the past experience, can reliably estimate the
pattern of Risk for a particular type of business.
Verification of Premiums – Verification of premium is of utmost importance to an auditor. The auditor should
apply, inter alia, the following procedures for verification of premium –
Insurance premium is collected upon issuing policies. It is the consideration for bearing the risk by the
insurance company. The assumption of the risk starts on the issue of a policy document or any equivalent
document that evidences risk has been accepted by the company on the acceptance of proposal form or cover
note by the respective underwriting department. This receipt is recorded as the premium income in the books
of the insurance company only when the risk is accepted by the company Money received against which the
company has not issued a policy document, cover note or any other document that evidences acceptance of
risk is recorded as a liability. It is recorded as premium income only after the company has accepted risk.
Premium may be accepted either in cash/cheque/Demand Draft/pay order, bank guarantee, cash deposit, etc.
The premium collections are credited to a separate bank account. As per the policy of the insurance company,
the collections are transferred to the Regional Office or Head Office. As soon as the insurance policy is issued,
an entry is made in the Register of Policies showing all the relevant details.
No Risk Assumption without Premium -No risk can be assumed by the insurer unless the premium is received.
According to section 64VB of the Insurance Act, 1938, no insurer should assume any risk in India in respect of
any insurance business on which premium is ordinarily payable in India unless & until the premium payable is
received or is guaranteed to be paid by such person in such manner & within such time, as may be prescribed,
or unless & until deposit of such amount, as may be prescribed, is made in advance in the prescribed manner.
The premium receipt of insurance companies carrying on general insurance business normally arise out of
three sources, viz., premium received from direct business, premium received from reinsurance business & the
share of co-insurance premium.
Verification of Premiums -Verification of premium is of utmost importance to an auditor. The auditor should
apply, inter alia, the following procedures for verification of premium –
(i) Before commencing verification of premium income, the auditor should look into the internal controls &
compliance thereof as laid down for collection & recording of the premiums.
(ii) The auditor should broadly review the systems used by the company to collect money, underwrite &
issue the policy. Insurance companies use varied & complex IT systems for risk assessment, policy
issuance, premium receipting & accounting. Hence, it is essential for the auditor to understand the
overall system architecture & specifically the data flow from one system to the other.

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(iii) The auditor should ascertain that all the cover notes (for motor business) relating to the risks assumed
have been serially numbered for each class of business. The auditor should also verify that there is an
adequate internal check on the issue of stationery comprising of cover notes, policy documents, stamps,
etc. The auditor may apply sampling techniques for verification of larger volume of transactions.
(iv) The auditor should ensure that premium in respect of risks incepting during the relevant accounting year
has been accounted as premium income of that year on the basis of premium revenue recognition. The
auditor, as part of his audit procedures, should make an assessment of the reasonability of the risk
pattern established by the management. The auditor should also see whether the premium received
during the year but pertaining to risk commencing in the following year has been accounted for under
the head ‘Premium Received in Advance’ & has been disclosed separately. Normally, such instances
relate to the issue of cover notes & certificates at the end of the accounting year relating to risks
commencing in the next accounting period. Generally, there is a column in the Premium Register called
“Commencement of Risk”, indicating the date & time from which the risk under the policy issued has
commenced. The auditor should verify that policy documents have not been issued, in case:
(a) premium had not been collected at all;
(b) premium had been collected but the relevant cheques have been dishonoured; (refer Cheque
Dishonoured Book);
(c) premium had not immediately been collected due to furnishing of a bank guarantee or cash
deposit but either the deposit or guarantee had fallen short or has expired or the premium had
been collected beyond the stipulated time limit (i.e., there is a shortfall in bank guarantee account
or cash deposit account of the insured);
(d) premium had not been collected due to risk cover being increased or where stipulated limits have
been exhausted in respect of open declaration policies (i.e., where premium has accrued but has
not been received); &
(e) instalments of premium have not been collected in time in respect of certain categories of policies,
e.g., marine-cum-erection policies where facility has been granted for premium being paid in
instalments (such facility is normally available subject to certain conditions, e.g., that the first
equated instalment is more by 5 per cent of the total premium payable by instalments).
(f) Premium collected but policies not issued for long periods of time.
(v) The auditor should examine whether the reinsurance company is not under a risk in respect of amount
lying at credit & outstanding as at the year-end in the following accounts:
(vi) The auditor should verify the collections lodged by agents after the balance sheet date to see whether
any collection pertains to risk commencing for the year under audit. The auditor should also check that
the premium has been recorded originally at the gross figure, i.e., without providing for unexpired risks
& reinsurances.
(vii) In case of co-insurance business, where the company is not the leader, because of the non-availability of
the relevant information in many cases the premium is not booked even though the risk has
commenced during the relevant accounting year. The auditor should see that the company’ s share of
the premium has been accounted for on the basis of the available information on nature of risk & the
provisional premium charged by the leading insurer. The auditor should examine the communications
issued to the company by the leading insurers advising them of the company’s share of premium
income. Such communications should be seen even in respect of the post - audit period. Where the
company is the leader, the auditor should obtain a reasonable assurance that only the company’s own
share of premium has been shown as income & accounts of the other companies have been credited
with their share of the premium collected.
(viii) The auditor should check whether Premium Registers have been maintained chronologically, for each
underwriting department, giving full particulars including service tax charged as per acceptance advice
on a day-to-day basis. The auditor should verify whether the figures of premium mentioned in the
register tally with those in General Ledger.
(ix) Where policies have been issued with a provision to collect premium periodically (i.e., under instalment
clause, special declaration policy or periodical declaration under open policies in marine insurance), the

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auditor should check whether premium are collect ed as & when they become due.
(x) The auditor should verify whether instalments falling due on or before the balance sheet date, whether
received or not, have been accounted for as premium income as for the year under audit. Also examine
whether instalments of premium falling due in the subsequent year have not been recognised in the
accounts as outstanding premium.
(xi) The auditor should verify the year end transactions to check that amounts received during the year in
respect of risks commencing/ instalments falling due on or after the first day of next financial year are
not credited to premium account but credited to Premium Received in Advance Account.
(xii) The auditor should verify the collections remitted by agents immediately after the cut-off date to verify
the risk assumed during the year under audit on those collections.
(xiii) The auditor should also check that in case of cancellation of policies/cover notes issued, no risk has been
assumed between the date of issue & subsequent cancellation thereof.
(xiv) Where premium originally received has been refunded, the auditor should verify whether the agency
commission paid on such premium has been recovered.
(xv) The auditor should verify whether GST has been charged from the insured, at the rates in force, on the
total premium for all classes of business other than those exempted under service tax laws. Check
whether GST so collected is disclosed under ‘Current Liabilities’ to the extent not deposited in
Government’s Account.
(xvi) In the case of co-insurance business, the auditor should verify whether GST at the rates in force, based
on the place of business & place of delivery on the whole premium has been charged or collected from
the insured by the company in case it is the leader. Check that GST/service tax so collected on premium
charged from the insured by the company have been regularly deposited in the Government’s Account.
(xvii) The auditor should also check that money collected by the agents from the policyholders have been
received by the company as quickly as possible.
(xviii) The auditor should also check whether the bank guarantees against which policies are issued are valid
& there is a tracking mechanism of the amounts of policies issued against the guarantees.
(b) PREMIUM – LIFE INSURANCE COMPANIES
Premium Collection, Accounting & reconciliation: Premium accounting refers to recognizing the premium
earned by the insurer as income in the accounting system.
Income is recognized as:
i. New business premium – premium received for the first policy year &
ii. Renewal premium – premium received for subsequent policy years.
Premium received but not identifiable against any policy would be treated as ‘unallocated premium’/ ‘suspense
amount’.
Further following points should be noted while recognizing the premium:
(2) When the new policy is issued by the Insurer, new business premium is recognised on the realisation of
premium. Generally, Policy is underwritten only after the receipt of the first premium. However, in certain
cases, policies are issued awaiting realisation of premiums, for e.g. policies are issued subject to realisation
of cheques issued by the Insured. Auditors are required to check these cases & ensure proper accounting
of the same.
(3) Renewal income is recognized (1) on realization of the premium amount or (2) when premium is due but
not received up to the end of grace period.
(4) Auditors should also evaluate various sub-processes, employed by the Insurance Companies in accounting
of premiums like collection of premium from the policy holders, booking of premium, banking, accounting
& reconciliation of the same.
Following are the certain illustrative points, Auditors are required to follow during the Audit of
Accounting of Premiums:
I. Collection of Premium:
• The premium collections are credited to separate bank account & no withdrawals are normally
permitted from that account for meeting general expenditure.

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• Check whether there is daily reconciliation process to reconcile the amounts collected, entered
into the system & deposited into the bank.
• Check that there is appropriate mechanism to ensure all the collections are deposited into the
Bank on timely basis.
II. Calculation of Premium:
• Check that Accounting system, employed by the Company, calculates premium amounts & its
respective due dates correctly.
• Check that system employed as such is equipped to calculate all types of premium modes
correctly.
III. Recognition of Income:
• Check that premium is recognised only on the basis of ‘Issued Policies’ & not on underwriting
dates.
• Check that there is inbuilt mechanism the system all the premium collected are correctly
allocated all various components of the Policies.
• Check that there is appropriate mechanism in place to conduct reconciliation on daily basis &
reconciling items, if any, are rectified/ followed up.
IV. Accounting of ‘Advance Premium’:
• Check, whether system has capability to identify regular & advance premium.
• Check whether there is a process of applying advance premium to a contract when premium is
due.
V. Reporting of Premium figures to IRDA/ Management:
• Check the methodology for generation of MIS from the system & there is no manual intervention.
• Check the procedure for Maker/ Checker before finalising the MIS.
• Check whether there is a reconciliation process between premium Income as per financials & as
reported.
VI. Other Areas:
• Check whether there are appropriate SOPs developed by the Companies & are strictly followed
by all the departments/ branches of the Company.
• Ensure duly approved Delegation of Authority parameters matrix already in place for
authorisation limits.
• Premium recognition & refund of premium are independent processes with adequate
segregation of duties amongst the personnel.
• Check that the Company conducts premium reconciliation on daily basis.
• Check the robustness of interface between administration & accounting system.
• Auditors may also refer to IRDA (Preparation of Financial Statements & Auditors Report of
Insurance Companies) Regulations, 2000 for premium accounting.
Q.2: Enumerate the steps to be taken by an auditor for the verification of Re-insurance outward by a General
Insurance Company.
Reinsurance: A reinsurance transaction may be defined as an agreement between a ‘ceding company’ & a
‘reinsurer’ whereby the former agrees to ‘cede’ & the latter agrees to accept a certain specified share of risk or
liability upon terms as set out in the agreement. A ‘ceding company’ is the original insurance company which
has accepted the risk & has agreed to ‘cede’ or pass on that risk to another insurance company or the
reinsurance company. It may, however, be emphasised that the insured does not acquire any right under a
reinsurance contract. In the event of loss, the insured’s claim for full amount is against the original insurer only.
The original insurer in turn, lodges a claim with the reinsurer.
Verification of Re-insurance Outward
The following steps may be taken by the auditor in the verification of re-insurance outward:
(i) The auditor should verify that re-insurance underwriting returns received from the operating units
regarding premium, claims paid, outstanding claims tally with the audited figures of premium, claims

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paid & outstanding claims

(ii) The auditor should check whether the pattern of re-insurance underwriting for outward cessions fits
within the parameters & guidelines applicable to the relevant year.
(iii) The auditor should also check whether the cessions have been made as per the stipulation applicable to
various categories of risk.
(iv) The auditor should verify whether the cessions have been made as per the agreements entered into with
various companies.
(v) It should also be seen whether the outward remittances to foreign re-insurers have been done as per the
foreign exchange regulations.
(vi) It should also be seen whether the commission on cession has been calculated as per the terms of the
agreement with the re-insurers.
(vii) The auditor should verify the computation of profit commission for various automatic treaty
arrangements in the light of the periodical accounts rendered & in relation to outstanding loss pertaining
to the treaty.
(viii) The auditor should examine whether the cash loss recoveries have been claimed & accounted on a
regular basis.
(ix) The auditor should also verify whether the Claims Paid item appears in Outstanding Claims list by error.
This can be verified at least in respect of major claims.
(x) He should see whether provisioning for outstanding losses recoverable on cessions have been confirmed
by the re-insurers & in the case of major claims, documentary support should be insisted & verified.
(xi) Accounting aspects of the re-insurance cession premium, commission receivable, paid claims recovered,
& outstanding losses recoverable on cessions have to be checked.
(xii) The auditor should check percentage pattern of gross to net premium, claims paid & outstanding claims
to ensure comparative justification.
(xiii) The auditor should also check that the re-insurers balance on cessions & whether the sub ledger
balances tallies with the general ledger balances.
(xiv) The auditor should review the individual accounts to find out whether any balance requires provisioning
/ write off or write back.
(xv) He should verify whether the balances with re-insurers are supported by necessary confirmation
obtained from them.
(xvi) He should verify whether opening outstanding claims not paid during the year find place in the closing
outstanding claims vis-a-vis the reinsurance inwards outstanding losses recoverable on cessions appears
in both opening & closing list. If not, the reason for the same should be analysed.
(xvii) Any major event after the Balance Sheet date which might have wider impact with reference to
subsequent changes regarding the claim recovery both paid & outstanding & also re-insurance balances
will need to be brought out suitably.
Q.3: State the procedure for verification of Agents’ Balances in the course of audit of a General Insurance
Company.
Outstanding Premium & Agents’ Balances: The following are the audit procedures to be followed for
verification of outstanding premium & agents’ balances:
(i) Inquire reasons for long outstanding credit balances in outstanding premium accounts & examine the
reasons for policies not being issued or the outstanding premium not adjusted against amounts due.
(ii) Scrutinise & review control account debit balances & their nature should be enquired into.
(iii) Examine inoperative balances & treatment given for old balances with reference to company rules.
(iv) Enquire into the reasons for retaining the old balances.
(v) Verify old debit balances which may require provision or adjustment. Notes of explanation may be
obtained from the management in this regard.
(vi) Check age-wise, sector-wise analysis of outstanding premium.
(vii) Verify whether outstanding premiums have since been collected.

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(viii) Check the availability of adequate bank guarantee or premium deposit for outstanding premium.
Q.4: As at 31st March 2020 while auditing Safe Insurance Ltd, you observed that a policy has been issued on
25th March 2020 for fire risk favouring one of the leading corporate houses in the country without the actual
receipt of premium & it was reflected as premium receivable. The company maintained that it is a usual
practice in respect of big customers & the money was collected on 5th April, 2020. You further noticed that
there was a fire accident in the premises of the insured on 31st March 2020 & a claim was lodged for the
same. The insurance company also made a provision for claim. Please respond.
Provision for Claim: No risk can be assumed by the insurer unless the premium is received. According to
section 64VB of the Insurance Act, 1938, no insurer should assume any risk in India in respect of any insurance
business on which premium is ordinarily payable in India unless & until the premium payable is received or is
guaranteed to be paid by such person in such manner & within such time, as may be prescribed, or unless &
until deposit of such amount, as may be prescribed, is made in advance in the prescribed manner. The premium
receipt of insurance companies carrying on general insurance business normally arise out of three sources, viz.,
premium received from direct business, premium received from reinsurance business & the share of co-
insurance premium. In view of the above, the insurance company is not liable to pay the claim & hence no
provision for claim is required.
Q.5: ABC & Co., Chartered Accountants are the Auditors of Just Care Life Insurance Company Limited.
Enumerate the steps to be taken by the auditor while verifying the "Investment".
Investments: The Investment portfolio of Life Insurance companies comprise of Shareholders’ funds &
Policyholders’ funds. Policyholders’ funds can further be segregated as linked & non-linked. Investment
regulations are however prescribed separately for the following investment categories:
As Insurers essentially manage the funds for policyholders it becomes imperative for the insurer to have
adequate systems & processes that should not only ensure robust internal controls, financial transparency &
equity but also bring effective governance so as to serve the interests of the management, stakeholders,
consumers & the society, at large. IRDA (Investment) regulations, 2000 gives details of the pattern in which
Funds of the Life Insurance business, should be kept invested at any given point of time.
The overall functioning of the Investment function should include the following
independent functions:
• Investments front office / dealing desk
• Investments mid office – Compliance, Risk Management, Reporting, Reconciliations
• Treasury – Cash Management, Deal settlement, Broker empanelment, Custody
• Investment accounting – Fund accounting, NAV computation & declaration.
Role of Auditor: The Auditor during his review of Investment Department should mainly consider the following:
 Review the Investment management structure to ensure adequate segregation of duties between
Investment Front office, Mid Office & Back office;
 Review of insurer’s Standard Operating Procedures which are prescribed by the IRDA Regulations & are
required to cover the entire gamut of investment related processes & policies;
 Review of insurer’s Investment policy;
 Review of functioning & scope & minutes of Investment Committee;
 Compliance of all Investment regulations, various other circulars specified by IRDAI & other regulations
specified in the Insurance Act, 1938;
 Review of insurer’s Disaster Recovery, Backup & Contingency Plan ;
 Review of access Controls, authorization process for Orders & Deal execution, etc.;
 Review of insurer’s Cash Management System to track funds available for Investment considering the
settlement obligations & subscription & redemption of units, etc. The system should be validated not to
accept any commitment beyond availability of funds & restrict Short Sales at the time of placing the order.

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Further insurer’s system should be able to determine the amount of Investible surplus;

 Ensure that the system is be able to automatically monitor various Regulatory limits on Exposure & Rating
of debt instruments;

 Review of fund wise reconciliation with Investment Accounts, Bank, & Custodian records ;

 Ensure that there is split between Shareholders’ & Policyholders ’ funds, & earmarking of securities
between various funds namely Life (Participating & Non-Participating), Pension & Group (Participating &
Non-Participating) & Unit Linked Fund;

 Review the arrangements & reconciliations of holdings with the insurer ’s custodian;

 Review & check insurer’s Investment Accounting & valuation policy & the controls around this process;

 insurer’s risk management policies & processes to manage investment risk such as Market risk, Liquidity
risk, Settlement risks, etc.;

 Determine the extent of activities outsourced & the controls over such activities;

 Controls over NAV computation & declaration;

 Controls over various system interfaces such as Seamless integration of data, between front office & back
office, in the Investments accounting system;

 Flow of data from PMS to the Investment Accounting system;

 Controls around personal dealings, insider trading & front running.
Q.6: Briefly explain the term policy lapse & revival in case of Life Insurance Company & role of auditor in
verifying the same.
Policy Lapse & Revival: “Lapse” is the discontinuance of the policy owing to non-payment of premium dues.
The term “lapse” is not defined in the insurance legislation, except stating that “a policy which has acquired a
surrender value shall be kept alive to the extent of the paid-up sum assured” - vide section 113(2) of the
Insurance Act,1938.
In order to keep a life insurance policy “in force” the policy holder is required to pay premiums when due
(either monthly/ quarterly/annual/bi-annual). If payment is missed, the insurer allows a period of 15/30 days
from the premium due date for making the payment. This period is termed as “grace period”. If the policy
holder does not make the payment within the grace period, the policy gets “lapsed”. Thus, a payment within
the grace period is deemed to be a payment on the due date.
Lapsation affects all the stakeholders – the policy holder, agents & the insurer. A lapsed policy ceases to
provide insurance protection to the insured. It forfeits the benefits under the policy & cost of new policy is
higher. Agents do not get renewal premium commission if the policy is lapsed.
The terms & conditions of the policy stipulate, that where the premium is not paid within the grace period, the
policy lapses but may be revived during the life time of the life assured. Some insurers do not allow revival, if
the policy has remained in lapsed condition for more than five years. This is because of the possibility that the
arrears of premiums on such a policy would be too heavy & that it would be better to take out a fresh policy.
The insurer should have taken persistent measures for monitoring receipt of renewal premium within the due
dates. In case of most of insurers, policy lapsation is tracked over the PMS, wherein premium due dates are
monitored by the system once initial data of the policy is entered in the system.
Role of Auditor: The primary objective of the audit is to check & confirm that due dates are recorded &
monitored properly & polices are marked as “lapsed” on non-receipt of renewal premium within due
dates/grace period. In case of revival request, whether adequate checks are in place for receipt of outstanding
amounts & adequate documents are obtained before reviving the policy.
Q.7: You have been appointed to carry out the audit of Sky Insurance Company Ltd. for the year 2019-20. In
the course of your audit, you observed that the commission paid to agents constituted a major expense in
operating expenses of the Company. Enumerate the audit concerns that address to the assertions required
for the Auditor to ensure the continued existence of internal control as well as fairness of the amounts in
accounting of commission paid to agents.

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Commission/Brokerage
The commission is the consideration payable for getting the insurance business. The term ‘commission’ is used
for the payment of consideration to get Direct business. Commission received on amount of premium paid to a
re-insurer is termed ‘Commission on reinsurance accepted’ & is reduced from the amount of commission
expenditure. The internal control with regard to commission is aimed at ensuring that commission is paid in
accordance with the rules & regulations of the company & in accordance with the agreement with the agent,
commission is paid to the agent who brought the business & the legal compliances, for example, tax deduction
at sources, GST on reverse charge mechanism & provisions of the Insurance Act, 1938 have been complied
with.
✓ It is a well-known fact that insurance business is solicited by insurance agents. The remuneration of an agent
is paid by way of commission which is calculated by applying a percentage to the premium collected by him.
Commission is payable to the agents for the business procured through them & is debited to Commission on
Direct Business Account. There is a separate head for commission on reinsurance accepted which usually arise
in case of Head Office. It may be noted that u/s 40 of Insurance Act, 1938, no commission can be paid to a
person who is not an agent of the insurance company. Commission cannot be paid in excess of the maximum
rates of commission as framed by IRDAI. The rates of commission/brokerage are agreed & documented with
the agent & filed with IRDAI.
Role of Auditor: The auditor should, inter alia, do the following for verification of commission:
✓ Ensure that commission/brokerage is not paid in excess of the limits specified by IRDAI
✓ Ensure that commission/brokerage is paid as per rates with the agent & rates filed with IRDAI
✓ Ensure that commission/brokerage is paid to the agent/broker who has solicited the business
✓ Ensure that the agent/broker is not blacklisted by IRDAI & is not terminated for fraud etc.
✓ Vouch disbursement entries with reference to the disbursement vouchers with copies of commission bills
& commission statements.
✓ Check whether the vouchers are authorised by the officers-in–charge as per rules in force & income tax is
deducted at source, as applicable.
✓ Test check correctness of amounts of commission allowed.
✓ Scrutinise agents’ ledger & the balances, examine accounts having debit balances, if any, & obtain
information on the same. Necessary rectification of accounts & other remedial actions have to be
considered.
✓ Check whether commission outgo for the period under audit been duly accounted.
Q.8: You are the auditor of Good Luck General Insurance Company. You want to ensure that there exists
good system that effectively serves the requirements of true & fair accounting of claim-related expenses &
liabilities. Suggest how this can be ensured.
Verification of Claims
Claims Provisions -The auditor should obtain from the divisions/branches, the information for each class of
business, categorizing the claims value-wise before commencing verification of the claims provisions, so that
appropriate statistical sampling techniques may be applied, to ensure that representative volume of claims is
verified for each class of business. The auditor should determine the total number of documents to be checked
giving due importance to claim provisions of higher value.
The outstanding liability at the year-end is determined at the divisions/branches where the liability originates
for outstanding claims. Thereafter, based on the total consolidated figure for all the divisions/branches, the
Head Office considers a further provision in respect of outstanding claims. The auditor should satisfy himself
that the estimated liability provided for by the management is adequate with reference to the relevant claim
files/dockets, keeping in view the following:
(i) that provision has been made for all unsettled claims as at the year-end on the basis of claims
lodged/communicated by the parties against the company. The date of loss (& not the date of
communication thereof) is important for recording/ recognizing the claim as attributable to a particular
year.

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(iii) Insurance companies normally have an ‘initial provision’ or ‘default provision’ based on a pre-
determined formula or on a primary assessment of the damage by a surveyor. The auditor would need to
review the pre-determined formula to ensure that initial reserving made is adequate. This pre-defined
formula is based on past trends & is normally certified by the Claims Head or the appointed Actuary
In certain circumstances, the claims are incurred by the insurance company but are not reported at the
balance sheet date by the insured. Such claims are known as claims incurred but not reported (IBNR) or
claims incurred but not enough reported(IBNER). The auditor should check the records for subsequent
periods to ascertain that adequate provision has been created for such claims also. Calculation of IBNR &
IBNER is done by the Appointed Actuary of the insurance company based on probability weighted
estimations & statistical models approved by the Actuarial Standards.
(iii) that provision has been made for only such claims for which the company is legally liable, considering
particularly, (a) that the risk was covered by the policy, if in force, & the claims arose during the currency
of the policy; & (b) that claim did not arise during the period the company was not supposed to cover the
risk or where cheques covering premium have been dishonoured (refer section 64VB of the Insurance
Act, 1938) or where a total loss under a policy has already been met/settled. (c) the loss event or the
nature of loss is not excluded from the policy coverage (d) the person who has incurred the loss is the
policyholder
(iv) that the provision made is normally not in excess of the amount insured except in some categories of
claims where matters may be sub-judice in legal proceedings which will determine the quantum of claim,
the amount of provision should also include survey fee & other direct expenses.
(v) that in determining the amount of provision, events after the balance sheet date have been considered,
e.g., (a) claims settled for a materially higher/lower amount in the post-audit period; (b) claims paid by
other insurance companies during the year under audit & communicated to company after the balance
sheet date where other companies are the leaders in co-insurance arrangements; & (c) further reports
by surveyors or assessors & (d), re-insurance cover available is considered.
(vi) that the claims status reports recommended to be prepared by the Divisional Manager on large claims
outstanding at the year-end have been reviewed with the contents of relevant files or dockets for
determining excess/short provisions. The said report should be complete as to material facts to enable
the auditor to take a fair view of the provision made.
(vii) that in determining the amount of provision, the ‘average clause’ has been applied in case of under-
insurance by parties.
(viii) that the provision made is net of payments made ‘on account’ to the parties wherever such payments
have been booked to claims.
(ix) that in case of co-insurance arrangements, the company has made provisions only in respect of its own
share of anticipated liability.
(x) that wherever an unduly long time has elapsed after the filing of the claim & there has been no further
communication & no litigation or arbitration dispute is involved, the reasons for carrying the provision
have been ascertained.
(xi) that wherever legal advice has been sought or the claim is under litigation, the provision is made
according to the legal advisor’s view & differences, if any, are explained.
(xii) that in the case of amounts purely in the nature of deposits with courts or other authorities, adequate
provision is made & deposits are stated separately as assets & provisions are not made net of such
deposits.
(xiii) that no contingent liability is carried in respect of any claim intimated in respect of policies issued.
(xiv) that the claims are provided for net of estimated salvage, wherever applicable.
(xv) that intimation of loss is received within a reasonable time & reasons for undue delay in intimation are
looked into.
(xvi) that provisions have been retained as at the yearend in respect of guarantees given by company to
various Courts for claims under litigation.
(xvii) that due provision has been made in respect of claims lodged at any office of the company other than
the one from where the policy was taken,

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3. A vehicle insured at Mumbai having met with an accident at Chennai necessitating claim intimation
at one of the offices of the company at Chennai.
(xviii) that provisions are made or Contingent Liabilities disclosed for all claims that are in litigation at various
judicial forums such as Insurance Ombudsman, Motor Accident Compensation Tribunal (MACT), District
Magistrate Courts, High Court & Supreme Court.
In cases of material differences in the liability estimated by the management & that which ought to be provided
in the opinion of the auditor, the same must be brought out in the auditor’s report after obtaining further
information or explanation from the management. For determining theadequacy of the provisions in respect of
any category of business, the auditor may resort to the method of testing the actual payments, wherever
made, with the provisions made earlier for that category of business. Whether such liability has been estimated
in the past on a fair & realistic basis can, thus, be examined by looking into current year’s payments against
provisions of the earlier year.
Claims Paid - The auditor may determine the extent of checking of claims paid on the same line as suggested
for outstanding claims. Other aspects in respect of claims paid to be examined by the auditors are as follows:
(i) that in case of co-insurance arrangements, claims paid have been booked only in respect of company’s
share & the balance has been debited to other insurance companies;
(ii) that claims are not paid if the premiums are not received as per Section 64 (VB) of the Insurance Act.
(iii) that in case of claims paid on the basis of advices from other insurance companies (where the company
is not the leader in co-insurance arrangements), whether share of premium was also received by the
company. Such claims which have been communicated after the year-end for losses which occurred prior
to the year-end must be accounted for in the year of audit;
(iv) that the claims payments have been duly sanctioned by the authority concerned & the payments of the
amounts are duly acknowledged by the claimants;
(v) that the salvage recovered has been duly accounted for in accordance with the procedure applicable to
the company & a letter of subrogation has been obtained in accordance with the laid down procedure;
(vi) that the amounts of the nature of pure advances/deposits with Courts, etc., in matters under
litigation/arbitration have not been treated as claims paid but are held as assets till final disposal of such
claims. In such cases, full provision should be made for outstanding claims;
(vii) that payment made against claims partially settled have been duly vouched. In such cases, the
sanctioning authority should be the same as the one which has powers in respect of the total claimed
amount;
(viii) that in case of final settlement of claims, the claimant has given an unqualified discharge note, not
involving the company in any further liability in respect of the claim; &
(ix) that the figures of claims, wherever communicated for the year by the Division to the Head Office for
purposes of reinsurance claims, have been reconciled with the trial balance-figure.
(x) that payments have been made within 30 days of the receipt of the last document received. In case,
there are delays, interest on such delays have to be paid as per IRDAI regulations.
(xi) that the salvage recovered has been duly accounted for in accordance with the procedure applicable to
the company & a letter of subrogation has been obtained in accordance with the laid down procedure.
(xii) that necessary claims have been made to the re-insurer for all such claims paid. In certain facultative
re-insurance arrangements, prior approval of the re-insurer has been obtained before the claim has
been paid.
Q.9: Your audit assistant seeks your help in checking the claim liability of Bharat Insurance Co. Ltd. & wants
to know the registers & records which they should obtain & review in this regard.
Registers & Records -The following register & records are generally prepared in respect of claims:
(i) Claims Intimation Register;
(ii) Claims Paid Register;
(iii) Claims Disbursement Bank Book;
(iv) Claims Dockets, normally containing the following records:
Claim intimation, claim form, particulars of policy, survey report, Photograph showing damage, repairer’s

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bills, letter of subrogation, police report (in case of theft), fire service report, claim settlement note, claim
satisfaction note, salvage report, salvage disposal note, claims discharge voucher, etc.;
(v) Report of quality assurance team; &
(vi) Salvage register.
The Claim Account is debited with all the payments including repair charges, fire-fighting expenses, police
report fees, survey fees, amount decreed by the Courts, travel expenses, photograph charges, etc.
Q.10: As an auditor of Life Insurance Company, how will you verify the ‘Commission Payable’ to its Agents?
Commission payable to Agent: Insurance business is generally solicited by the Insurance agents. The
remuneration of agent is paid by way of commission which is calculated by applying percentage to premium
collected by him. Agency commission contributes towards significant portion of expenses incurred by the
Insurance Commission. Commission is payable towards generation of new business and towards settlement of
renewal premium
Role of Auditor: The Auditor during his review of Commission paid to Agents should mainly consider the
following:
1. Review the system established by the Insurer with respect to calculation of commission to eligible
agents accurately and processing the same in timely manner.
2. Review the commission payment system is in sync with the premium collection system.
3. Check whether commission paid is within the limit prescribed under Insurance Act.
4. Check whether commission is clawed-back on the cancelled policies.
5. Check the completeness of commission processing system.
What is the ‘Actuarial Process’ in Life Insurance Business & what is the role of Auditor with respect to the
same?
Actuarial Process: Actuaries in Life Insurance business have gained tremendous importance. The role of
Actuary in life insurance has shifted from supervising compliance to certify whether products & financial
reports are in accordance with the general regulatory guidelines.
The job of actuary or actuarial department in any Life Insurance Company involves, detailed analysis of data to
quantify risk. The actuarial department is calculating & modelling hub of the Company. Within the department
fundamentals of Insurance business is determined from pricing to policy valuations techniques.
Role of Auditor: Auditors in the Audit report are required to certify, whether the actuarial valuation of
liabilities is duly certified by the appointed actuary, including to the effect that the assumptions for such
valuation are in accordance with the guidelines & norms, if any, issued by the authority &/or the Actuarial
Society of India in concurrence with the IRDA.
Hence, Auditors generally rely on the Certificate issued by the Appointed Actuary, certifying the Policy
liabilities. However, Auditor may discuss with the Actuaries with respect to process followed & assumptions
made by him before certifying the Policy liabilities.
Actuarial department broadly concentrates following key areas of Insurance business:
• Product Development/ Pricing & Experience analysis.
• Model Development.
• Statutory Valuations & reserving.
• Business Planning.
• Solvency management.
• Management reporting on various business valuations & profitability models of the Life Insurance
business.

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CH – 11
AUDIT OF NON-BANKING FINANCIAL
COMPANIES
Q. 1 Define NBFC. Also give a brief description about types of NBFCs covering any five NBFCs.
Definition of NBFC:
45 I(f) of Reserve Bank of India (Amendment) Act, 1997 defines a non-banking financial company as:
(i) A financial institution which is a company;
(ii) A non-banking institution which is a company a non-banking institution which is a company & which has
as its principal business the receiving of deposits, under any scheme or arrangement or in any other
manner, or lending in any manner;
(iii) Such other non-banking institution or class of such institutions, as the as the Bank may, with the
previous approval of the Central Government & by notification in the Official Gazette, specify;”
Further, in order to identify a particular company as Non-Banking Financial Company (NBFC), it will
consider both assets & income pattern as evidenced from the last audited balance sheet of the company to
decide its principal business. The company will be treated as NBFC when a company's financial assets
constitute more than 50 per cent of the total assets (netted off by intangible assets) & income from
financial assets constitute more than 50 per cent of the gross income. A company which fulfils both these
criteria shall qualify as an NBFC & would require to be registered as NBFC by RBI.
NBFCS MANDATED TO REGISTER UNDER RBI
NBFCs registered with RBI are categorized as follows:
a. in terms deposit acceptance or otherwise into Deposit & Non-Deposit accepting NBFCs;
b. non deposit taking NBFCs by their size into systemically important & non-systemically important (NBFC-
NDSI & NBFC-ND); &
c. by the kind of activities, they conduct.
Within the categorization mentioned in (c) above, (i.e. by the kind of activity they conduct) the different
types of NBFCs are as follows:
✓ Investment & Credit Company (ICC)
✓ Infrastructure Finance Company (IFC)
✓ Systematically Important Core Investment Company (CIC-ND-SI)
✓ Infrastructure Debt Fund- Non- Banking Financial Company (IDF-NBFC)
✓ Non-Banking Financial Company - Micro Finance Institution (NBFC-MFI)
✓ Non-Banking Financial Company - Factors (NBFC- Factors)
✓ NBFC- Non Operative Financial Holding Company (NOFHC)
All NBFCs are either deposit taking or non-deposit taking. If they are non-deposit taking, ND is suffixed to
their name (NBFC-ND).
COMPANIES EXEMPTED FROM REGISTRATION UNDER RBI
Companies that do financial business but are regulated by other regulators are given specific exemption by
the Reserve Bank from its regulatory requirements for avoiding duality of regulation. Following NBFCs have
been exempted from the requirement of registration u/s 45-IA of the RBI Act, 1934 subject to certain
conditions.
✓ Housing Finance Institutions (regulated by National Housing Bank);
✓ Merchant Banking Companies (regulated by SEBI);
✓ Stock Exchanges (regulated by SEBI);
✓ Companies engaged in the business of stock-broking/sub-broking (regulated by SEBI);

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✓ Venture Capital Fund Companies (regulated by SEBI);

✓ Nidhi Companies (regulated by MCA, Government of India);
✓ Insurance companies (regulated by IRDA); &
✓ Chit Companies (as defined in clause (b) of section 2 of the Chit Funds Act, 1982 (Act 40 of 1982)).
✓ Micro Finance Companies
✓ Securitisation & Reconstruction Companies
✓ Mutual Benefit Companies
✓ Mortgage Guarantee Companies
✓ Core Investment Companies i.e. a NBFC being a Core Investment Company referred to in the Core
Investment Companies (Reserve Bank) Directions, 2016, which is not a Systemically Important Core
Investment Company, as defined in subparagraph (xxv) of paragraph 3 of the Core Investment Companies
(Reserve Bank) Directions, 2016.
✓ Alternative Investment Fund (AIF) Companies
Q. 2 : Shubham & Associates are going to start the audit of NBFCs. They have not performed much work
for the NBFCs in the past years. You are required to explain the requirements related to registration &
regulation of NBFCs which an auditor needs to keep in his mind while planning the audit of NBFC which
would help this firm.
An auditor should know following points regarding registration & regulation of NBFCs: U/s 45–IA of the RBI
Act, 1934, no NBFC shall commence or carry on the business of a non-banking financial institution without
▪ obtaining a certificate of registration issued by the RBI; &
▪ having a net owned fund (NOF) of ` 25 lakhs (₹ Two crore since April 1999) not exceeding two hundred
lakhs rupees, as the RBI may, by notification in the Official Gazette, specify.
(The RBI (Amendment) Act (1997) provided an entry point norm of ` 25 lakh as the minimum NOF which was
revised upwards to ` 2 crore for new NBFCs seeking grant of certificate of registration (CoR) on or after 21
April 1999).
A company incorporated under the Companies Act & desirous of commencing business of non-banking
financial institution as defined u/s 45–IA of the RBI Act, 1934 can apply to the RBI in prescribed form along
with necessary documents for registration. The RBI issues CoR after satisfying itself that the conditions as
enumerated in Section 45-IA of the RBI Act, 1934 are satisfied.
However, to obviate dual regulation, certain categories of NBFCs which are regulated by other regulators are
exempted from the requirement of registration with RBI viz. Venture Capital Fund/Merchant Banking
companies/Stock Broking Companies registered with SEBI,
Insurance Company holding a valid CoR issued by IRDA, Nidhi Companies as notified u/s 406 of the
Companies Act, 2013, Chit Companies as defined in clause (b) of Section 2 of the Chit Funds Act, 1982 or
Housing Finance Companies regulated by National Housing Bank.
The RBI has issued directions to NBFCs on acceptance of public deposits, prudential norms like capital
adequacy, income recognition, asset classification, provision for bad & doubtful debts, risk exposure norms &
other measures to monitor the financial solvency & reporting by NBFCs.
Directions were also issued to auditors to report non-compliance with the RBI Act & regulations to the
Reserve Bank, Board of Directors & shareholders.
Q. 3 : Satyam Pvt Ltd is a company engaged in trading activities, it also has made investments in shares of
other Companies & advanced loans to group companies amounting to more than 50% of its total assets.
However, trading income constitutes majority of its total income. Whether the Company is an NBFC?
In order to identify a particular company as Non-Banking Financial Company (NBFC), it will consider both
assets & income pattern as evidenced from the last audited balance sheet of the company to decide its
principal business. The company will be treated as NBFC when a company's financial assets constitute more

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than 50 per cent of the total assets (netted off by intangible assets) & income from financial assets constitute
more than 50 per cent of the gross income. A company which fulfils both these criteria shall qualify as an
NBFC & would require to be registered as NBFC by Reserve Bank of India. In the given case, though Satyam
Pvt Ltd is fulfilling the criteria on the asset side, but however is not fulfilling the criteria on the income side,
the company cannot be classified as a deemed NBFC.
Q. 4 : Shivam & Co LLP are the auditors of NBFC (Investment & Credit Company). Some of the team
members of the audit team who audited this NBFC have left the firm & the new team members are in
discussion with the previous team members who are still continuing with the firm regarding the
verification procedures to be performed. In this context, please explain what verification procedures
should be performed in relation to audit of NBFC - Investment & Credit Company (NBFC-ICC).
AUDIT CHECK-LIST
Some important points that may be covered in the audit of NBFCs, in addition to the audit points that may be
covered for companies in general, are given below:
(eg. NBFC - Investment & Credit Company (NBFC-ICC)
i Physically verify all the shares & securities held by a NBFC. Where any security is lodged with an
institution or a bank, a certificate from the bank/institution to that effect must be verified.
ii Verify whether the NBFC has not advanced any loans against the security of its own shares.
iii Verify that dividend income wherever declared by a company, has been duly received by an NBFC &
interest wherever due [except in case of NPAs] has been duly accounted for. NBFC Prudential Norms
require dividend income on shares of companies & units of mutual funds to be recognised on cash basis.
However, the NBFC has an option to account for dividend income on accrual basis, if the same has been
declared by the body corporate in its Annual General Meeting & its right to receive the payment has
been established. Income from bonds/debentures of corporate bodies is to be accounted on accrual
basis only if the interest rate on these instruments is predetermined & interest is serviced regularly &
not in arrears.
iv Test check bills/contract notes received from brokers with reference to the prices vis-à-vis the stock
market quotations on the respective dates.
v Verify the Board Minutes for purchase & sale of investments. Ascertain from the Board resolution or
obtain a management certificate to the effect that the investments so acquired are current investments
or Long-Term Investments.
vi Check whether the investments have been valued in accordance with the NBFC Prudential Norms &
adequate provision for fall in the market value of securities, wherever applicable, have been made there
against, as required by the Directions.
vii Obtain a list of subsidiary/group companies from the management & verify the investments made in
subsidiary/group companies during the year. Ascertain the basis for arriving at the price paid for the
acquisition of such shares & whether the Valuation is as per Prudential norms.
viii Check whether investments in unquoted debentures/bonds have not been treated as investments but as
term loans or other credit facilities for the purposes of income recognition & asset classification.
ix An auditor will have to ascertain whether the requirements of AS 13 “Accounting for Investments” or
other accounting standard, as applicable, (to the extent they are not inconsistent with the Directions)
have been duly complied with by the NBFC.
x In respect of shares/securities held through a depository, obtain a confirmation from the depository
regarding the shares/securities held by it on behalf of the NBFC.
xi Verify that securities of the same type or class are received back by the lender/paid by the borrower at
the end of the specified period together with all corporate benefits thereof (i.e. dividends, rights, bonus,
interest or any other rights or benefit accruing thereon).
xii Verify charges received or paid in respect of securities lend/borrowed.
xiii Obtain a confirmation from the approved intermediary regarding securities deposited with/borrowed
from it as at the year end.
xiv An auditor should examine whether each loan or advance has been properly sanctioned. He should

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verify the conditions attached to the sanction of each loan or advance i.e. limit on borrowings, nature of
security, interest, terms of repayment, etc.
xv An auditor should verify the security obtained & the agreements entered into, if any, with the concerned
parties in respect of the advances given. He must ascertain the nature & value of security & the net
worth of the borrower/guarantor to determine the extent to which an advance could be considered
realisable.
xvi Obtain balance confirmations from the concerned parties.
xvii As regards bill discounting, verify that proper records/documents have been maintained for every bill
discounted/rediscounted by the NBFC. Test check some transactions with reference to the documents
maintained & ascertain whether the discounting charges, wherever, due, have been duly accounted for
by the NBFC.
xviii Check whether the NBFC has not lent/invested in excess of the specified limits to any single borrower or
group of borrowers as per NBFC Prudential Norms.
xix An auditor should verify whether the NBFC has an adequate system of proper appraisal & follow up of
loans & advances. In addition, he may analyse the trend of its recovery performance to ascertain that
the NBFC does not have an unduly high level of NPAs.
xx Check the classification of loans & advances (including bills purchased & discounted) made by a NBFC
into Standard Assets, Sub-Standard Assets, Doubtful Assets & Loss Assets & the adequacy of provision
for bad & doubtful debts as required by NBFC Prudential Norms.
Q. 5 : You are appointed as the auditor of a NBFC registered with the RBI & which is accepting & holding
public deposits. You are considering your reporting requirement in addition to your report made u/s 143 of
the Companies Act, 2013 on the accounts of this NBFC as per the prescribed Directions. Please explain what
points are required to be known in respect of separate report to be given by you to the Board of Directors
of this NBFC.
Material to be included in the Auditor’s report to the Board of Directors: The auditor’s report on the
accounts of a non-banking financial company shall include a statement on the following matters, namely –
(A) In the case of all non-banking financial companies:
I. Conducting Non-Banking Financial Activity without a valid Certificate of Registration (CoR) granted
by the RBI is an offence under chapter V of the RBI Act, 1934. Therefore, if the company is engaged
in the business of non-banking financial institution as defined in section 45-I (a) of the RBI Act &
meeting the Principal Business Criteria (Financial asset/income pattern) as laid down vide the RBI’s
press release dated April 08, 1999, & directions issued by DNBR, auditor shall examine whether the
company has obtained a Certificate of Registration (CoR) from the RBI.
II. In case of a company holding CoR issued by the RBI, whether that company is entitled to continue to
hold such CoR in terms of its Principal Business Criteria (Financial asset/income pattern) as on
March 31 of the applicable year.
III. Whether the non-banking financial company is meeting the required net owned fund requirement
as laid down in Master Direction - Non-Banking Financial Company – Non-Systemically Important
Non-Deposit taking Company (Reserve Bank) Directions, 2016 & Master Direction - Non-Banking
Financial Company - Systemically Important Non-Deposit taking Company & Deposit taking
Company (Reserve Bank) Directions, 2016.
Note: Every non-banking financial company shall submit a Certificate from its Statutory Auditor that it is
engaged in the business of non-banking financial institution requiring it to hold a Certificate of
Registration u/s 45-IA of the RBI Act & is eligible to hold it. A certificate from the Statutory Auditor in this
regard with reference to the position of the company as at end of the financial year ended March 31 may
be submitted to the Regional Office of the Department of Non-Banking Supervision under whose
jurisdiction the non-banking financial company is registered, within one month from the date of
finalization of the balance sheet & in any case not later than December 30th of that year.
The format of Statutory Auditor’s Certificate (SAC) to be submitted by NBFCs has been issued vide DNBS.
PPD.02/66.15.001/2016-17 Master Direction- Non-Banking Financial Company Returns (Reserve Bank)

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Directions, 2016.
(B) In the case of a non-banking financial companies accepting/holding public deposits
Apart from the matters enumerated in (A) above, the auditor shall include a statement on the following
matters, namely-
(i) Whether the public deposits accepted by the company together with other borrowings indicated
below viz.
a) from public by issue of unsecured non-convertible debentures/bonds;
b) from its shareholders (if it is a public limited company); &
c) which are not excluded from the definition of ‘public deposit’ in the Non-Banking Financial
Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016, are within the limits
admissible to the company as per the provisions of the Non-Banking Financial Companies
Acceptance of Public Deposits (Reserve Bank) Directions, 2016;
(ii) Whether the public deposits held by the company in excess of the quantum of such deposits
permissible to it under the provisions of Non-Banking Financial Companies Acceptance of Public
Deposits (Reserve Bank) Directions, 2016 are regularised in the manner provided in the said
Directions;
(iii) Whether the non-banking financial company is accepting "public deposit” without minimum
investment grade credit rating from an approved credit rating agency as per the provisions of Non-
Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016;
(iv) Whether the capital adequacy ratio as disclosed in the return submitted to the Bank in terms of the
Non-Banking Financial Company - Systemically Important Non-Deposit taking Company & Deposit
taking Company (Reserve Bank) Directions, 2016 has been correctly determined & whether such
ratio is in compliance with the minimum CRAR prescribed therein;
(v) In respect of non-banking financial companies referred to in clause (iii) above,
a) whether the credit rating, for each of the fixed deposits schemes that has been assigned by one
of the Credit Rating Agencies listed in Non-Banking Financial Companies Acceptance of Public
Deposits (Reserve Bank) Directions, 2016 is in force; &
b) whether the aggregate amount of deposits outstanding as at any point during the year has
exceeded the limit specified by the such Credit Rating Agency;
(vi) Whether the company has violated any restriction on acceptance of public deposit as provided in
Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016;
(vii) Whether the company has defaulted in paying to its depositors the interest & /or principal amount
of the deposits after such interest &/or principal became due;
(viii) Whether the company has complied with the prudential norms on income recognition, accounting
standards, asset classification, provisioning for bad & doubtful debts, & concentration of
credit/investments as specified in the Directions issued by the Bank in terms of the Master Direction
- Non-Banking Financial Company - Systemically Important Non-Deposit taking Company & Deposit
taking Company (Reserve Bank) Directions, 2016;
(ix) Whether the company has complied with the liquid assets requirement as prescribed by the Bank in
exercise of powers u/s 45-IB of the RBI Act & whether the details of the designated bank in which
the approved securities are held is communicated to the office concerned of the RBI in terms of NBS
3; Non-Banking Financial Company Returns (Reserve Bank) Directions, 2016;
(x) Whether the company has furnished to the RBI within the stipulated period the return on deposits
as specified in the NBS 1 to – Non- Banking Financial Company Returns (Reserve Bank) Directions,
2016;
(xi) Whether the company has furnished to the RBI within the stipulated period the quarterly return on
prudential norms as specified in the Non-Banking Financial Company Returns (Reserve Bank)
Directions, 2016;
(xii) Whether, in the case of opening of new branches or offices to collect deposits or in the case of
closure of existing branches/offices or in the case of appointment of agent, the company has
complied with the requirements contained in the Non-Banking Financial Companies Acceptance of

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Public Deposits (Reserve Bank) Directions, 2016.

(C) In the case of a non-banking financial company not accepting public deposits
Apart from the aspects enumerated in (A) above, the auditor shall include a statement on the following
matters, namely: -
(i) Whether the Board of Directors has passed a resolution for non- acceptance of any public deposits;
(ii) Whether the company has accepted any public deposits during the relevant period/year;
(iii) Whether the company has complied with the prudential norms relating to income recognition,
accounting standards, asset classification & provisioning for bad & doubtful debts as applicable to it
in terms of Non- Banking Financial Company – Non-Systemically Important Non-Deposit taking
Company (Reserve Bank) Directions, 2016 & Non-Banking Financial Company - Systemically
Important Non-Deposit taking Company & Deposit taking Company (Reserve Bank) Directions, 2016;
(iv) In respect of Systemically Important Non-deposit taking NBFCs as defined in Non-Banking Financial
Company - Systemically Important Non-Deposit taking Company & Deposit taking Company
(Reserve Bank) Directions, 2016:
a) Whether the capital adequacy ratio as disclosed in the return submitted to the RBI in form NBS
- 7, has been correctly arrived at & whether such ratio is in compliance with the minimum CRAR
prescribed by the RBI;
b) Whether the company has furnished to the RBI the annual statement of capital funds, risk
assets/exposures & risk asset ratio (NBS-7) within the stipulated period.
(v) whether the non-banking financial company has been correctly classified as NBFC Micro Finance
Institutions (MFI) as defined in the Non-Banking Financial Company – Non-Systemically Important
Non-Deposit taking Company (Reserve Bank) Directions, 2016 & Non-Banking Financial Company -
Systemically Important Non-Deposit taking Company & Deposit taking Company (Reserve Bank)
Directions, 2016.
(D) In the case of a company engaged in the business of non-banking financial institution not required to
hold CoR subject to certain conditions
Apart from the matters enumerated in (A)(I) above where a company has obtained a specific advice from
the RBI that it is not required to hold CoR from the RBI, the auditor shall include a statement that the
company is complying with the conditions stipulated as advised by the RBI.
Reasons to be stated for unfavourable or qualified statements:
Where, in the auditor’s report, the statement regarding any of the items referred to in paragraph 3 above is
unfavourable or qualified, the auditor’s report shall also state the reasons for such unfavourable or qualified
statement, as the case may be. Where the auditor is unable to express any opinion on any of the items
referred to in paragraph 3 above, his report shall indicate such fact together with reasons therefor.
Q. 6 : Kamna & Co LLP, a firm of Chartered Accountants, was appointed as auditor of an NBFC. The audit
work has been completed. The audit team which was involved in the fieldwork came across various
observations during the course of audit of this NBFC & have also limited understanding about the
exceptions which are required to be reported in the audit report. They would like to understand in detail
regarding the obligations on the part of an auditor in respect of exceptions in his report so that they can
conclude their work. Please explain.
Obligation of auditor to submit an exception report to the RBI
(i) Where, in the case of a non-banking financial company, the statement regarding any of the items
referred to in paragraph 3 above, is unfavourable or qualified, or in the opinion of the auditor the
company has not complied with:
a) the provisions of Chapter III B of RBI Act (Act 2 of 1934); or
b) Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016; or
c) Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company
(Reserve Bank) Directions, 2016 & Non-Banking Financial Company - Systemically Important Non-
Deposit taking Company & Deposit taking Company (Reserve Bank) Directions, 2016.
It shall be the obligation of the auditor to make a report containing the details of such unfavourable

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or qualified statements &/or about the non-compliance, as the case may be, in respect of the
company to the concerned Regional Office of the Department of Non-Banking Supervision of the RBI
under whose jurisdiction the registered office of the company is located as per first Schedule to the
Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016.
(ii) The duty of the Auditor under sub-paragraph (I) shall be to report only the contraventions of the
provisions of RBI Act, 1934, & Directions, Guidelines, instructions referred to in sub-paragraph (1) & such
report shall not contain any statement with respect to compliance of any of those provisions.
Q. 7 : Karma Pvt Ltd is a Non-Deposit Taking Non-Systemically Important NBFC registered with Reserve
Bank of India. The Statutory Auditor of the company is required to give a report to the Board of Directors.
What shall be the content of the Auditor’s Report to the Board.
The statutory auditor of Karma Pvt Ltd, being a Non-Deposit Taking Non-Systemically Important NBFC is
required to submit separate report to the Board of Directors on the matters as specified as below:
(i) Conducting Non-Banking Financial Activity without a valid Certificate of Registration (CoR) granted by
the RBI is an offence under chapter V of the RBI Act, 1934. Therefore, if the company is engaged in the
business of non-banking financial institution as defined in section 45-I (a) of the RBI Act & meeting the
Principal Business Criteria (Financial asset/income pattern) as laid down vide the RBI’s press release
dated April 08, 1999, & directions issued by DNBR, auditor shall examine whether the company has
obtained a Certificate of Registration (CoR) from the RBI.
(ii) In case of a company holding CoR issued by the RBI, whether that company is entitled to continue to
hold such CoR in terms of its Principal Business Criteria (Financial asset/income pattern) as on March 31
of the applicable year.
(iii) Whether the non-banking financial company is meeting the required net owned fund requirement as
laid down in Master Direction - Non-Banking Financial Company – Non-Systemically Important Non-
Deposit taking Company (Reserve Bank) Directions, 2016 & Master Direction - Non-Banking Financial
Company - Systemically Important Non-Deposit taking Company & Deposit taking Company (Reserve
Bank) Directions, 2016.
Apart from the aspects enumerated above, the auditor shall include a statement on the following matters,
namely: -
(i) Whether the Board of Directors has passed a resolution for non- acceptance of any public deposits;
(ii) Whether the company has accepted any public deposits during the relevant period/year;
(iii) Whether the company has complied with the prudential norms relating to income recognition,
accounting standards, asset classification & provisioning for bad & doubtful debts as applicable to it in
terms of Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company
(Reserve Bank) Directions, 2016;
Where, in the auditor’s report, the statement regarding any of the items referred to matters specified above
is unfavourable or qualified, the auditor’s report shall also state the reasons for such unfavourable or
qualified statement, as the case may be. Where the auditor is unable to express any opinion on any of the
items referred above, his report shall indicate such fact together with reasons thereof.
Q. 8 : Krishna Pvt Ltd is primarily into the business of selling computer parts. However, the company is
fulfilling the Principal Business Criteria as at the balance sheet date i.e. Financial Assets are more than 50 %
of total assets & Financial Income is more than 50% of Gross Income. What shall be the obligation of the
Statutory Auditor in such a scenario?
In the given case, Krishna Pvt Ltd is fulfilling the Principal Business Criteria i.e. Financial Assets are more than
50 % of total assets & Financial Income is more than 50 % of Gross Income. The company which fulfils both
these criteria shall qualify as an NBFC & hence is required to obtain Certificate of Registration (CoR) with
Reserve Bank of India. In such a scenario, the statutory auditor has an obligation to submit exception report
to the RBI on the following matters :
Where, in the case of a non-banking financial company, the statement regarding any of the items referred to
in paragraph 3 of the Non-Banking Financial Companies Auditor’s Report (Reserve Bank) Directions, 2016, is

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unfavourable or qualified, or in the opinion of the auditor the company has not complied with:
a) the provisions of Chapter III B of RBI Act (Act 2 of 1934); or
b) Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 2016; or
c) Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company (Reserve
Bank) Directions, 2016 & Non-Banking Financial Company - Systemically Important Non-Deposit taking
Company & Deposit taking Company (Reserve Bank) Directions, 2016. It shall be the obligation of the
auditor to make a report containing the details of such unfavourable or qualified statements &/or about
the non-compliance, as the case may be, in respect of the company to the concerned Regional Office of
the Department of Non-Banking Supervision of the RBI under whose jurisdiction the registered office of
the company is located as per first Schedule to the Non-Banking Financial Companies Acceptance of
Public Deposits (Reserve Bank) Directions, 2016.
The duty of the Auditor under sub-paragraph (I) shall be to report only the contraventions of the provisions of
RBI Act, 1934, & Directions, Guidelines, instructions referred to in sub-paragraph (1) & such report shall not
contain any statement with respect to compliance of any of those provisions.
Q. 9 : Mr. G. has been appointed as an auditor of LMP Ltd., a NBFC company registered with RBI. Mr. G is
concerned about whether the format of financial statements prepared by LMP Ltd. is as per notification
issued by the Ministry of Corporate Affairs (MCA) dated October 11, 2018. The notification prescribed the·
format in Division III under Schedule III of the Companies Act, 2013 applicable to NBFCs complying with Ind-
AS. Mr. G wants to know the differences in the presentation requirements between Division II & Division III
of Schedule III of the Companies Act, 2013. Help Mr. G.
Differences between Division II (Ind- AS- Other than NBFCs) & Division III (Ind- AS- NBFCs) of Schedule III
The presentation requirements under Division III for NBFCs are similar to Division II (Non NBFC) to a large
extent except for the following:
(a) NBFCs have been allowed to present the items of the balance sheet in order of their liquidity which is
not allowed to companies required to follow Division II. Additionally, NBFCs are required to classify
items of the balance sheet into financial & non-financial whereas other companies are required to
classify the items into current & non-current.
(b) An NBFC is required to separately disclose by way of a note any item of ‘other income’ or ‘other
expenditure’ which exceeds 1 per cent of the total income. Division II, on the other hand, requires
disclosure for any item of income or expenditure which exceeds 1 per cent of the revenue from
operations or `10 lakhs, whichever is higher.
(c) NBFCs are required to separately disclose under ‘receivables’, the debts due from any Limited Liability
Partnership (LLP) in which its director is a partner or member.
(d) NBFCs are also required to disclose items comprising ‘revenue from operations’ & ‘other
comprehensive income’ on the face of the Statement of profit & loss instead of showing those only as
part of the notes.
(e) Separate disclosure of trade receivable which have significant increase in credit risk & credit impaired
(f) The conditions or restrictions for distribution attached to statutory reserves have to be separately
disclose in the notes as stipulated by the relevant statute.
Q. 10 : Abhimanyu Finance Ltd. is a Non Banking Finance Company & was in the business of accepting
public deposits & giving loans since 2015. The company was having net owned funds of ` 1,50,00,000/-(one
crore fifty lakhs) & was not having registration certificate from RBI & applied for it on 30th March 2021.
The company appointed Mr. Kabra as its statutory auditors for the year 2020-21. Advise the auditor with
reference to auditor procedures to be taken & reporting requirements on the same in view of CARO 2020?
As per Clause (xvi) of Paragraph 3 of CARO 2020, the auditor is required to report that “whether the company
is required to be registered u/s 45-IA of the Reserve Bank of India Act, 1934 & if so, whether the registration
has been obtained.”
The auditor is required to examine whether the company is engaged in the business which attract the
requirements of the registration. The registration is required where the financing activity is a principal
business of the company. The RBI restrict companies from carrying on the business of a non-banking financial

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institution without obtaining the certificate of registration.

Audit Procedures & Reporting:
(i) The auditor should examine the transactions of the company with relation to the activities covered
under the RBI Act & directions related to the Non-Banking Financial Companies.
(ii) The financial statements should be examined to ascertain whether company’s financial assets
constitute more than 50 per cent of the total assets & income from financial assets constitute more
than 50 per cent of the gross income.
(iii) Whether the company has net owned funds as required for the registration as NBFC.
(iv) Whether the company has obtained the registration as NBFC, if not, the reasons should be sought from
the management & documented.
(v) The auditor should report incorporating the following:-
1) Whether the registration is required u/s 45-IA of the RBI Act, 1934.
2) If so, whether it has obtained the registration.
3) If the registration not obtained, reasons thereof.
In the instant case Abhimanyu Finance Ltd. is a Non Banking Finance Company & was in the business of
accepting public deposits & giving loans since 2015. The company was having net owned funds of `
1,50,00,000/-(one crore fifty lakhs) which is less in comparison to the prescribed limit i.e. 2 crore rupees &
was also not having registration certificate from RBI (though applied for it on 30th March 2021). The auditor
is required to report on the same as per Clause (xvi) of Paragraph 3 of CARO 2020.

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CH – 12 AUDIT UNDER FISCAL LAWS

EXAMPLE 1.
DB Pvt. Ltd. has total turnover of ` 525 lacs for the FY 2020-21.
✓ DB Pvt. Ltd has to conduct the Audit of Books of Accounts u/s 44AB of the Act for the FY 2020-21 as the
turnover exceeds ` 5 crores.
EXAMPLE 2.
ABC & Co. (a partnership firm) engaged in trading of electronic goods is expecting a turnover of ` 165 lacs for
the FY 2020-21. (Assume the partnership firm would not be able to ensure that the aggregate of all amounts
received including amount received for sales, turnover or gross receipts during the previous year, in cash,
does not exceed five per cent of the said amount & aggregate of all payments made including amount
incurred for expenditure, in cash, during the previous year does not exceed five per cent of the said payment).
✓ Section 44AD would be applicable to Partnership Firm. Thus, ABC & Co. can declare the minimum profit @
8% of the turnover as its turnover during the PY 2020-21 is not expected to exceed ` 2 crores. If the firm do
not opt for presumptive income scheme u/s 44AD, it has to get books of accounts audited u/s 44AB of the
Act.
EXAMPLE 3.
Mr. Anand Khater, a Commission Agent is expecting commission receipts of ` 137 lacs during the FY 2020-21
(Assume he would not be able to ensure that the aggregate of all amounts received including amount
received for sales, turnover or gross receipts during the previous year, in cash, does not exceed five per cent
of the said amount & aggregate of all payments made including amount incurred for expenditure, in cash,
during the previous year does not exceed five per cent of the said payment).
✓ Though Section 44AD is applicable to an Individual, it is not applicable to Commission income. In the given
case, since, Mr. Anand earns the commission income, he cannot take the benefit of section 44AD. His total
turnover during the FY 2020-21 in respect of commission income is expected to exceed ` 1 crore, he would
have to get his books of accounts audited u/s 44AB of the Act.
EXAMPLE 4.
Mr. Vishal Raka, owning an Agency of Samsung Mobile for the city of Pune & expects the turnover of ` 87 lacs
during the FY 2020-21.
✓ Though Section 44AD is applicable to an Individual, it is not applicable to Commission income. In the given
case, since, Mr. Vishal earns the commission income, he cannot take the benefit of section 44AD. His total
turnover during the FY 2020-21 in respect of commission income is not expected to exceed ` 1 crore,
therefore, he need not get his books of accounts audited u/s 44AB of the Act.
EXAMPLE 5 :
While writing the audit program for tax audit in respect of A Ltd., you wish to include possible instances of
capital receipt if not credited to Profit &Loss Account which needs to be reported under clause 16(e) of
form 3CD. Please elucidate possible instances.
The following is an illustrative list of capital receipts which, if not credited to the profit & loss account, are
to be stated under clause 16(e) of Form 3CD-
(a) Capital subsidy received in the form of Government grants, which are in the nature of promoters’
contribution i.e., they are given with reference to the total investment of the undertaking or by way of
contribution to its total capital outlay. For e.g., Capital Investment Subsidy Scheme.
(b) Government grant in relation to a specific fixed asset where such grant is shown as a deduction from
the gross value of the asset by the concern in arriving at its book value.
(c) Compensation for surrendering certain rights.
(d) Profit on sale of fixed assets/investments to the extent not credited to the profit & loss account.

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EXAMPLE 6:
Company has received an advance for capital asset & the same is outstanding for 5 years & expected to
remain outstanding as at 31 March 2021. What would be tax auditor reporting responsibility?
The requirement of reporting arises only on forfeiture of such amount. If an advance has been received & has
been outstanding for a considerable period of time, there is no requirement to report such amount unless &
until it is forfeited by an act of the assessee under clause 29A.
EXAMPLE 7:
If an assessee has forfeited the amount without right of forfeiture as per agreement, then can it become
income u/s 56(2)(ix) & reportable under clause 29A?
If the assessee has forfeited the amount without right to forfeit & in case there is no action by the other
party, the amount so forfeited may become income under sub clause (ix) & the tax auditor should report such
forfeiture with appropriate note under clause 29A.
EXAMPLE 8:
If an assessee has not forfeited the amount even though the conditions of forfeiture is applicable as per
contractual terms, will it become income u/s 56(2)(ix) & reportable under clause 29A?
If the assessee contends that the amount has not been forfeited, the tax auditor needs to look at all facts of
the case & may obtain a management representation that even though the contract permits forfeiture on
some conditions & even though such conditions have occurred, the assessee has not yet forfeited the
advance & other sums received.
ILLUSTRATION 1:
Concession Ltd. is engaged in the business of manufacturing of threads. The company is expecting to record
turnover of ` 8.13 crores during the financial year 2020-21 before adjusting the following:
Cash discount (other than allowed in Cash memo/ sales invoice) ` 9,20,000
Trade discount ` 2,90,000
Commission on Sales ` 6,00,000
Sales Return (F.Y. 2018-19) ` 1,60,000
Sale of Investment ` 6,60,000
Discount allowed in the Sales Invoice ` 8,20,000
You are required to ascertain the effective turnover to be considered for the prescribed limit of tax audit
under the relevant Act & guide the company whether the provisions relating to tax audit applies.
The provisions relating to tax audit u/s 44AB of the Income Tax Act, 1961 applies to every person carrying on
business, if his total sales, turnover or gross receipts in business exceed the prescribed limit of ' 1 crore
(Provided that in the case of a person whose aggregate of all amounts received including amount received for
sales, turnover or gross receipts during the previous year, in cash, does not exceed five per cent of the said
amount & aggregate of all payments made including amount incurred for expenditure, in cash, during the
previous year does not exceed five per cent of the said payment, the limit of one crore rupees shall change to
five crore rupees) & to a person carrying on a profession, if his gross receipts from profession exceed the
prescribed limit of ' 50 lakhs in any previous year. However, the term "sales", "turnover" or "gross receipts"
are not defined in the Act, & therefore the meaning of the aforesaid terms has to be considered for the
applicability of the section.
Some of the points for merit consideration in this regard as discussed in the Guidance Note issued by the
Institute are given below-
(i) Discount allowed in the sales invoice will reduce the sale price &, therefore, the same can be deducted
from the turnover.
(ii) Cash discount otherwise than that allowed in a cash memo/sales invoice is in the nature of a financing
charge & is not related to turnover. Therefore, should not be deducted from the turnover.

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(iii) Turnover discount is normally allowed to a customer if the sales made to him exceed a particular
quantity. As per trade practice, it is in the nature of trade discount & should be deducted from the
figure.
(iv) Special rebate allowed to a customer can be deducted from the sales if it is in the nature of trade
discount. If it is in the nature of commission on sales, the same cannot be deducted from the figure of
turnover.
(v) Price of goods returned should be deducted from the turnover even if the returns are from the sales
made in the earlier year/s.
(vi) Sale proceeds of any shares, securities, debentures, etc., held as investment will not form part of
turnover. However, if the shares, securities, debentures etc., are held as stock-in-trade, the sale
proceeds thereof will form part of turnover.
In the given case, Concession Ltd. is engaged in manufacturing business. Therefore, the tax audit would be
applicable if the turnover exceeds ' 5 crores during the financial year 2020-21. The calculation of effective
turnover for the prescribed limit purpose, in accordance with abovementioned conditions, is given below:
Expected turnover during the year ` 8,13,00,000
Less: (i) Discount allowed in the Sales Invoice (` 8,20,000)
(i) Trade discount (` 2,90,000)
(ii) Sales Return (` 1,60,000)
Effective turnover ` 8,00,30,000
Conclusion: The expected effective turnover of Concession Ltd. is Rupees Eight Crores & Thirty Thousand only
which is over & above the prescribed limit for tax audit u/s 44AB of the Income Tax Act, 1961. Thus, the
provisions related to tax audit would be applicable to the company & would therefore be liable for tax audit.
ILLUSTRATION 2:
V Pvt Ltd is engaged in the business of providing corporate/professional training programs. It has an annual
turnover of INR 69 crores. The company is subject to tax audit for which the work has been started by the
tax auditor. For the financial year ending 31 March 2021, the company applied for GST registration for 2
new locations for which registration certificates have not yet been received by the company. However, the
registration number is available on the portal of relevant authority which can be verified by checking the
details of the company. In this case what should be the audit procedures to verify this registration number?
The tax auditor should verify the registration number for the locations for which registration certificates have
not been received from online portal of the relevant authority. The auditor should also ensure that the details
furnished while checking the registration number pertains to the company only. If the company has filed any
returns for these locations, the auditor should enquire for the same from the management & should check
those returns to verify the correctness of the registration numbers. In addition, the auditor should also obtain
specific representation in respect of this point from the management.
ILLUSTRATION 3.
Ploy Ltd., engaged in the leasing of goods carriage, appointed you as the tax auditor for the financial year
2020-21. How would you deal with the following payments to Mr. X, Mr. Y & Mr. Z (engaged in leasing of
goods carriage) relating to the leasing transactions in your tax audit report:
(i) Payments of 6 invoices of ` 5,000 each made in cash to Mr. X on 4th July, 2020.
(ii) Payments of 2 invoices of ` 18,000 each made in cash to Mr. Y on 5th July, 2020 & 6th July, 2020
respectively.
(iii) Payment of ` 40,000 made in cash to Mr. Z on 7th July, 2020 against an invoice for expenses booked in
2019-20.
Reporting of Payments Exceeding ` 35,000 in Cash: Disallowance u/s 40A(3) of the Income Tax Act, 1961 is
attracted if the assessee incurs any expenses in respect of which payment or aggregate of payments made to
a person in a day, otherwise than by an account payee cheque drawn on bank or account payee draft,
exceeds ` 10,000. However, in case of payment made for plying, hiring or leasing of goods carriage, limit is `

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35,000 instead of ` 10,000. Further, as per section 40A(3A) of the Income Tax Act, 1961, where an allowance
has been made in the assessment for any year in respect of any liability incurred by the assessee for any
expenditure & subsequently during any previous year the assessee makes payment in respect thereof,
otherwise than by an account payee cheque drawn on a bank or account payee bank draft, the payment so
made shall be deemed to be the profits & gains of business or profession & accordingly chargeable to income-
tax as income of the subsequent year if the payments made to a person in a day, exceeds ` 10,000 (` 35,000 in
case of plying, hiring or leasing of goods carriages). However, exemption is provided under Rule 6DD having
regard to nature & extent of banking facilities available & other relevant factors. Subsequently, under clause
21(d)(A) & 21(d)(B) of Form 3CD, the tax auditor has to scrutinize on the basis of the examination of books of
account & other relevant documents/evidence, whether the expenditure covered u/s 40A(3) & 40A(3A)
respectively read with rule 6DD were made by account payee cheque drawn on a bank or account payee bank
draft. If not, the same has to be reported under abovementioned clauses. Therefore, as per the provisions &
explanations discussed above, the given cases are dealt as under-
(i) Payments of 6 invoices of ` 5,000 each aggregating ` 30,000 made in cash on 4th July, 2020 need not be
reported as the aggregate of payments do not exceed ` 35,000.
(ii) Payments of 2 invoices of ` 18,000 each made in cash on 5th July, 2020 & 6th July, 2020 respectively
aggregating ` 36,000 need not be reported as the payment do not exceed ` 35,000 in a day.
Payment of ` 40,000 made in cash against an invoice for expenses booked in 2019-20 is likely to be deemed to
be the profits & gains of business or profession u/s 40A(3A) of the Income Tax Act, 1961. Thus, the details of
such amount needs to be furnished under clause 21(d)(B) of Form 3CD.
ILLUSTRATION 4.
An assesses has paid Rent to his brother ` 2,50,000/- & paid interest to his sister ` 4,00,000. State the
reporting requirements in the Tax Audit Report.
Payment of Rent & Interest: A tax auditor has to report under Clause 23 of Form 3CD which deals with the
particulars of payments made to persons specified u/s 40A(2)(b) of the Income Tax Act, 1961. Where the
assessee is an individual, the specified persons include any relative of the assessee (i.e. Husband, Wife,
Brother, Sister or any other Lineal Ascendant or Descendant). In the present case, an assessee has paid rent to
his brother ` 2,50,000 & interest to his sister of ` 4,00,000 which may be disallowed if, in the opinion of the
Assessing Officer, such expenditure is excessive or unreasonable having regard to:
1) the fair market value of the goods, services or facilities for which the payment is made; or
2) for the legitimate needs of business or profession of the assessee; or
the benefit derived by or accruing to the assessee from such expenditure. Hence this fact needs to be
reported in the Tax Audit Report accordingly.
CH – 12 UNIT 2: AUIDT UNDER INDIRECT TAX LAWS
ILLUSTRATION 1.
M/s. Mehtab & Co. a registered person received notice of audit in FORM GST ADT-01 on 15-Nov-2020,
stating therein that the audit team from the department will visit their office on 21-Nov-2020 to conduct
audit. The RP is expected the specified documents must be kept ready for audit. As a consultant of M/s.
Mehtab & Co. what advise you will give to your client?
As a consultant of M/s. Mehtab & Co. we will advise that notice for audit by tax authorities shall be given for
not less than 15 working days prior to the conduct of audit in FORM GST ADT-01. Therefore, the RP must
intimate to the tax authorities that he may be given appropriate time before the necessary books of accounts
& other records may be kept ready for the purposes of audit.
ILLUSTRATION 2.
M/s. Ramaya Bhola (P) Ltd., a registered person is issued a notice in FORM GST ADT-03 for conduct of a
special audit by M/s. Rohit & Associates, Chartered Accountants. The company claims that he is already
subject to statutory audit by his regular CA under the Companies Act as well as tax audit under the Income
Tax Act. Whether the special audit is still applicable on the company?

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Considering the special nature of GST audit u/s 66 the audit having been conducted under other proceedings
or under other laws; do not preclude the proper officer from exercising option u/s 66.
ILLUSTRATION 3.
Mr. X, an articled trainee in JSA Associates, is assigned a GST Audit of Flex Industries, a branch in Delhi. He
is confused with the applicability of GST audit on Flex Industries considering the definition of turnover in
section 35(5). Flex Industries is a company with operations spread across India with aggregate turnover
amounting to ` 8 crores (this turnover is spread across various cities) during the FY ended 31 March, 2019.
Will GST audit be applicable on Flex Industries? If yes, substantiate section 35(5) in context of rule 80(3).
GST Audit will be applicable on Flex Industries. As per section 35(5) read with rule 80(3), the total turnover
calculation for the applicability of GST audit must be done on a PAN India basis, which means that once the
turnover under the PAN India level is more than ` 5 crores, all business entities registered under GST for that
PAN will be liable for GST audit for the FY.
ILLUSTRATION 4.
Krishna Enterprises, a textile shop with registered GST premises in Delhi, is having turnover of ` 1.55 crores,
` 1.45 crores & ` 1.50 crores for the quarters 2, 3 & 4 respectively of the FY 2018-19. He did not have good
fortune in quarter 1 of 2018-19 for which his turnover was ` 70 lakhs. Mr. Vasudev, a chartered accountant,
is appointed as tax consultant of Krishna Enterprises. He is perplexed whether GST audit is applicable for
his client. If so, substantiate with relevant section.
GST audit will be applicable to Krishna Enterprises. As per section 35(5) read with rule 80(3), if the annual
turnover of a registered taxpayer is more than ` 5 crores during the year ended 31 March, 2019, he is
required to get his accounts audited by a chartered accountant or cost accountant.
In the given case, the aggregate turnover during the year ended 31 March, 2019 was above ` 5 crores, hence,
GST audit would be applicable to Krishna Enterprises.
ILLUSTRATION 5.
SSM & Co. is a leading electronics company having multiple branches registered under GST in different
States. The aggregate turnover of all such branches exceeded ` 5 crores during the FY ended 31 March,
2019. However, the Delhi branch had a turnover of ` 3.75 crores. Pankaj Gupta, Finance Officer of Delhi
branch, contended that GST audit would not be applicable on Delhi branch as the turnover for that branch
did not surpass the threshold. Whether the contention of Mr. Pankaj Gupta was correct or not.
Substantiate.
GST audit would be applicable on Delhi branch. As per section 35(5) read with rule 80(3), the aggregate
turnover calculation must be PAN based, which means that once the turnover under the PAN is more than ` 5
crores, all business entities registered under GST for that PAN will be liable for GST audit for that FY.
Contention of Mr. Pankaj, Finance Officer, was incorrect.
ILLUSTRATION 6.
Mr. Anuj, a Chartered Accountant by profession, has been appointed as GST auditor for ABC Ltd. The
management has asked Mr. Anuj for GST audit & to file GSTR-3B for the months of July & August 2019 &
filing of annual return in FORM GSTR-9. Mr. Anuj contended that he has been appointed only for GST audit
& the above are his scope limitations & cannot be conducted as the compliances & returns are to be filed
by the management. In context of above dispute, you have to suggest whether the contention of Mr. Anuj
is correct or not. Justify.
GST auditor’s prime responsibility on this engagement is limited to GST audit, audit of reconciliation
statement between books of accounts vis-a-vis GST returns prepared by the Company. The GST auditor is,
however, not responsible for any compliances like uploading GST periodic returns for the relevant audit
period. Since, in the given situation, Management has asked the auditor Mr. Anuj to conduct besides GST
Audit filing of GSTR-3B for the months of July & August 2019 & filing of annual return in FORM GSTR-9.
Accordingly, Mr. Anuj has rightly refused that his scope is limited to GST Audit & the scope does not cover any
of the management functions. In view of above, Contention of Management to Anuj is not tenable as

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preparation of annual returns & its filing was the responsibility of management.
ILLUSTRATION 7.
Advance received during the composition scheme, but supplies effected after opting out. Time of supply for
the composition scheme includes advance received on supply of goods but under the regular scheme
advance received is excluded from time of supply. e.g. Advance received ` 50,000/- under the composition
scheme & tax paid on advance @ 1% i.e.,` 500/- whereas the supply value after he exits the composition
scheme aggregates ` 1,00,000/¬In terms of Section 12 of the CGST Act to the extent of advance of ` 50,000/-
supply is deemed to have been already effected. Hence, tax under the composition scheme is required to
be paid only on ` 50,000/- & the balance of ` 50,000/- would be subject to tax at the applicable rates of a
normal supply.
ILLUSTRATION 8.
PQR Limited has exported goods to XYZ Limited located in USA. The value of goods is $100,000. The
exchange rate (Rs/$) on the date of filing Shipping Bill is-
CBEC notified rate ` 65
RBI reference rate ` 68
At the time of receiving money, the bank exchanged the foreign currency at ` 70.
For the purpose of GST returns, the exchange rate would be ` 65 & the exports to be disclosed in the GST
returns would be ` 65,00,000. For the purpose of accounting records, the exchange rate would be ` 68 & the
exports recorded in the books would be ` 68,00,000. The difference in revenue being ` 3,00,000 would have
to be reduced from the annual turnover as per the financials to arrive at the turnover as per FORM GSTR-9.
Additionally, difference in the amount booked in the accounts & actual amount received being ` 70 - ` 68 = 2 x
$1,00,000 = ` 2,00,000 would be credited to the Profit & Loss account as forex gain which again needs to be
reduced from the annual turnover as per the financials to arrive at the turnover as per FORM GSTR-9.
EXAMPLE 1.
if the aggregate turnover (PAN based) is at ` 5.50 crores & the registered person is carrying on business in
two different States having a turnover of ` 4.75 crores & 0.75 crores respectively, the law mandates that
audit is required to be carried out in both the States.
EXAMPLE 2.
Indigo” could be a trade name while the legal name is "InterGlobe Aviation Limited”.
EXAMPLE 3.
a proprietary concern could be subject to audit under the Income Tax Act, 1961 & a private limited
company could be subject to the statutory audit under the Companies Act, 2013 as well as under the
Income Tax Act, 1961. Similarly, a society registered under the Societies Registration Act may be subject to
audit under that Act as well as under the Income Tax Act, 1961. This fact must be specified in S. No. 4. The
response to this question is in Yes/ No & the name of the Act is to be specified under which the tax payer
has been subjected to audit.
EXAMPLE 4.
If ` 10 crore of unbilled revenue existed for the FY 2018-19, & during the current FY(2019-20), GST was paid
on ` 4 crore of such revenue, then value of ` 4 crore shall be declared here.
EXAMPLE 5.
M&A Co. receives ` 10 crore advances in FY 2018-19 for the supply of services to be made in FY 2019-20.
This amount will be shown as current liability in balance sheet as on 31st March, 2019. However, in terms
of section 13(2) of the CGST Act, GST shall be paid on such advances. Thus, the value of ` 10 crore shall be
declared in this Table.
EXAMPLE 6.
In respect of FY 2019-20, the closing balance of unbilled revenue stands at ` 5 crore. This means that ` 5
crore is the part of the turnover for the FY 2019-20 of the entity & will not be reflected in GST annual return

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since invoice under GST has not been issued. Thus, the value of ` 5 crore is to be declared in this Table &
deducted from the annual turnover to arrive at the turnover as per GST law.
EXAMPLE 7.
M/s ABC & Co. supplies goods on credit to the customer Mr. A for ` 100,000 [applicable GST 18%]. Mr. A
pays the supply value much before the credit period & in turn requests the supplier to extend a cash
discount of 2%. Cash discount extended at 2% shall be a Non-GST Credit note which should be considered
for disclosure in Part II at Table 5J.
EXAMPLE 8.
Mr. A has supplied goods for ` 20,000/- [applicable GST 12%] along with transport charges for ` 2,000/- to
M/s ABC & Co., On receipt of the goods, the customer complains that the goods are damaged. Mr. A
extends a discount of ` 2,500/- to the customer & issues a Credit Note without giving effect to the GST for
the damage. This adjustment to the amount receivable from the customer shall be accommodated by way
of a Credit Note & the same shall call for adjustment to the turnovers.
EXAMPLE 9.
For supplies made in FY 2019-20-19, the last date of issuance of credit note is September following the end
of the FY, i.e. September, 2020. Any credit note issued beyond this period will not be accounted for in the
GST returns. However, it may have an effect of reducing the turnover in the financial statements & thus,
calls for reconciliation.
EXAMPLE 10.
XYZ Limited, SEZ unit supplied goods to a DTA unit & the relevant bill of entry is filed by the DTA unit This
transaction would be a `sale’ for the purpose of financial statements of the SEZ unit but would not be
considered as supply for GST purposes & hence needs to be deducted from the turnovers of financial
statements for the purpose of arriving at the turnover as per GSTR 9. In respect of the inward supply in the
hands of the DTA, this transaction would be treated as import of goods.
EXAMPLE 11.
XYZ Limited, a SEZ unit, supplied goods to a DTA unit & the bill of entry was filed by the SEZ unit based on
authorization by the DTA unit This transaction would be outward supply or `sale’ for the purpose of
financial statements of the SEZ unit & inward supply for GST purposes. Accordingly, it would not require
any disclosure in the aforementioned table.
EXAMPLE 12.
Incidental expenses like transportation, packing, handling charges paid by the supplier before delivery &
recovered from the customer may be netted off in respective head of expenditure/ income in Profit & Loss
account but it will be shown as GST turnover in terms of valuation provisions as per section 15.
Q.1 Mr. A engaged in business as a sole proprietor presented the following information to you for the FY
2020-21. Turnover expected to be made during the year ` 624 lacs. Goods returned in respect of sales made
during FY 2019-20 is ` 20 lacs not included in the above. Cash discount allowed to his customers ` 1 lac for
prompt payment. Special rebate allowed to customer in the nature of trade discount ` 5 lacs. Kindly advise
him whether he has to get his accounts audited u/s 44AB of the Income Tax Act, 1961.
Turnover limit for the purpose of Tax Audit: The following points merit consideration as stated in the
Guidance note on Tax Audit issued by the ICAI-
(i) Price of goods returned should be deducted from the figure of turnover even if the return are from the
sales made in the earlier years.
(ii) Cash discount otherwise than that allowed in a cash memo/sales invoice is in the nature of a financing
charge & is not related to turnover. The same should not be deducted from the figure of turnover.
(iii) Special rebate allowed to a customer can be deducted from the sales if it is in the nature of trade
discount.
Applying the above stated points to the given problem,

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1. Total Turnover 624 Lacs

2. Less – (i) Goods Returned 20 Lacs 20 Lacs
(ii) Special rebate allowed to customer in the nature of trade discount
5 Lacs
would be deducted 5 Lacs
Balance 599 Lacs
As the limit for tax audit is ` five crores (assuming the aggregate of all amounts received including amount
received for sales, turnover or gross receipts during the previous year, in cash, does not exceed five per cent
of the said amount & aggregate of all payments made including amount incurred for expenditure, in cash,
during the previous year does not exceed five per cent of the said payment), he would be required to get his
accounts audited u/s 44AB of the Income Tax Act, 1961.
Q.2 Comment with respect to computation of total sales, turnover or gross receipts in business exceeding
the prescribed limit u/s 44 AB of Income Tax Act, 1961.
(i) Discount allowed in the sales invoice
(ii) Cash discount
(iii) Price of goods returned related to earlier year
(iv) Sale proceeds of fixed assets.
Computation of Sales, Turnover or Gross Receipts: In the context of section 44AB of the Income Tax Act,
1961, following considerations are required with regard to computation of sales, turnover or gross receipts in
business exceeding the prescribed limit u/s 44AB of the Income Tax Act, 1961-
(i) Discount allowed in the sales invoice will reduce the sale price &, therefore, the same can be deducted
from the turnover.
(ii) Cash discount otherwise than that allowed in a cash memo/sales invoice is in the nature of a financing
charge & is not related to turnover. Therefore, should not be deducted from the turnover.
(iii) Price of goods returned should be deducted from the turnover even if the returns are from the sales
made in the earlier year/s.
(iv) Sale proceeds of fixed assets would not form part of turnover since these are not held for resale.
Q.3 Write a short note on - Method of accounting in Form No. 3CD of Tax Audit.
Method of accounting in Form No. 3CD of Tax Audit: Clause 13 of Form No. 3CD of the tax audit requires to
state method of accounting employed in the previous year. It also requires to state the change in method of
accounting vis-à-vis the preceding year. If so, details of change & the effect on the profit or loss are to be
stated. Also details of deviation thereof, if any, from accounting standards prescribed u/s 145 & the effect
there of on the profit or loss are stated. Section 145 provides that method of accounting be either cash or
mercantile. Hybrid system is not permitted.
Q.4 ABC Printing Press, a proprietary concern, is expecting to make a turnover more than ` 7.03 crore for
the year ending 31.03.2021. The Management explained its auditor Mr. Z, that it undertakes different job
work orders from various customers. The raw materials required for each job are dissimilar. It purchases
the raw materials as per specification/ requirements of each customer & there is hardly any balance of raw
materials remaining in the stock except pending work-in-progress at the year end. Because of variety &
complexity of materials, it is impossible to maintain a stock-register. Give your comments.
Non-maintenance of stock register: The explanation of the entity for the use of varieties of raw materials for
different jobs undertaken may be valid. But the auditor needs to verify the specified job-orders received &
the different raw materials purchased for each job separately. The use of different papers (quality, quantity &
size) ink, colour etc. may be examined. If possible, the auditor may also enquire with the other similar printers
in the locality to ensure the prevailing custom. At the same time, he has to report & certify under clause 35(b)
& clause 11(b) of Form 3CD read with the Rule 6G(2) of the Income-tax Act, 1961, about the details of stock &
account books (including stock register) maintained. He must verify the closing stock of raw materials, work-

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in-progress & finished goods of the concern, at least on the date of its balance sheet. In case the said details
are not properly maintained, he has to specifically mention the same with reasons for non-maintenance of
stock register by the entity.
Q.5 Draft an audit programme for conducting the audit of a Public Trust registered u/s 12A of the Income-
tax Act, 1961.
An auditor should conduct routine checking during the course of audit of a public trust, in the following
manner:
(i) Check the books of account & other records having regard to the system of accounting & internal
control;
(ii) Vouch the transactions of the trust to ensure that:
▪ the transaction falls within the ambit of the trust;
▪ the transaction is properly authorized by the trustees or other delegated authority as may be
permissible in law;
▪ all incomes due to the trust have been properly accounted for on the basis of the system of
accounting followed by the trust;
▪ all expenses & outgoings appertaining to the trust have been recorded on the basis of the system of
accounting followed by the trust;
▪ amounts shown as applied towards the object of the trust are covered by the objects of trust as
specified in the document governing the trust.
(iii) Obtain trial balance on the closing date duly certified by the trustee;
(iv) Obtain Balance Sheet & Profit & Loss Account of the trust authenticated by the trustees & check the
same with the trial balance with which they should agree.
Q.6 State whether a Tax audit report can be revised & if so, state those circumstances.
Revision of Tax Audit Report: Normally, the report of the tax auditor cannot be revised later. However, when
the accounts are revised in the following circumstances, the tax auditor may have to revise his tax audit
report also.
(i) Revision of accounts of a company after its adoption in the annual general meeting.
(ii) Change in law with retrospective effect.
(iii) Change in interpretation of law (e.g.) CBDT Circular, Notifications, Judgments, etc.
The Tax Auditor should state it is a revised report, clearly specifying the reasons for such revision with a
reference to the earlier report.
Q.7 Mr. PK would be conducting the Tax audit u/s 44 AB of the Income Tax Act, 1961 of MG Ltd. for the
year ending 31st March 2021. There is a difference of opinion between Mr. PK & the Management in
respect of certain information to be furnished in Form No. 3CD. As a tax auditor, Mr. PK has to report
whether the statement of particulars in Form 3CD are true & correct & the same is to be annexed to the
report in Form No. 3CA. Advise on the matters to be considered by Mr. PK while furnishing the particulars
in Form No. 3CD.
Form No. 3CD
The statement of particulars given in Form No. 3CD as annexure to the audit report contains forty-four
clauses. The tax auditor has to report whether the particulars are true & correct. This Form is a statement of
particulars required to be furnished u/s 44AB. The same is to be annexed to the reports in Form No. 3CA or
3CB in respect of a person who carries on business or profession
i. If a particular item of income/expenditure is covered in more than one of the specified clauses in the
statement of particulars, care should be taken to make a suitable cross reference to such items at the
appropriate places.

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ii. ii. If there is any difference in the opinion of the tax auditor & that of the assessee in respect of any
information furnished in Form No. 3CD, the tax auditor should state both the view points & also the
relevant information in order to enable the tax authority to take a decision in the matter.
iii. If any particular clause in Form No. 3CD is not applicable, he should state that the same is not applicable.
iv. In computing the allowance or disallowance, he should keep in view the law applicable in the relevant
year, even though the form of audit report may not have been amended to bring it in conformity with
the amended law.
v. In case the prescribed particulars are given in part or piecemeal to the tax auditor or relevant form is
incomplete & the assessee does not give the information against all or any of the clauses, the auditor
should not withhold the entire audit report. In such a case, he can qualify his report on matters in
respect of which information is not furnished to him. In the absence of relevant information, the tax
auditor would have no option but to state in his report that the relevant information has not been
furnished by the assessee.
vi. The information in Form No. 3CD should be based on the books of accounts, records, documents,
information & explanations made available to the tax auditor for his examination. vii. In case the auditor
relies on a judicial pronouncement, he may mention the fact as his observations in clause (3) of Form No.
3CA or clause (5) provided in Form No. 3CB, as the case may be
Q.8 A is the proprietor of a firm M/s ABC & Co. The firm is expecting a turnover of ` 900 lakhs during the
financial year ending 31/03/2021. The firm sold land & building during the year for a consideration of ` 15
lakhs, whose value for stamp duty purposes was ` 16 lakhs. As’ the Tax Auditor of the said firm, is the above
required to be reported? If yes, how will you report the same?
Reporting Requirement Under Clause (17) & (29B) of Form 3CD: As per Clause 17 of Form 3CD, the tax auditor
is required to furnish detailed information in case if any land or building or both is transferred during the
previous year for a consideration less than value adopted or assessed or assessable by any authority of a State
Government referred to in section 43CA or 50C, as under:
Details of property Consideration received or accrued Value adopted or assessed or assessable

The auditor should obtain a list of all properties transferred by the assessee during the previous year. He may
also verify the same from the statement of profit & loss or balance sheet, as the case may be. Further, the
auditor has to furnish the amount of consideration received or accrued, during the relevant previous year of
audit, in respect of land/building transferred during the year as disclosed in the books of account of the
assessee.
For reporting the value adopted or assessed or assessable, the auditor should obtain from the assessee a copy
of the registered sale deed in case, the property is registered. In case the property is not registered, the
auditor may verify relevant documents from relevant authorities or obtain third party expert like lawyer,
solicitor representation to satisfy the compliance of section 43CA / section 50C of the Act. In exceptional
cases where the auditor is not able to obtain relevant documents, he may state the same through an
observation in his report 3CA/CB.
In addition, as per clause 29(B) (w.e.f. assessment year 2019-20), in case of an immovable property, where
the stamp duty value exceeds the consideration by less than the higher of (i) rupees 50,000 or (ii) 5% of the
consideration, the difference is not chargeable to tax. Therefore, for any immovable property, where the
stamp duty value is up to 105% of the sale consideration, no addition can be made u/s 56(2)(x).
In the given case, M/s. ABC & Co., has sold land & building during the year for a consideration of rupees 15
lakhs which is less than stamp duty value i.e. rupees 16 lakhs. Further, it is also more than the higher of, 5% of
consideration 15 lakhs i.e. 75,000 rupees or 50,000 rupees. Hence, tax auditor is required to report on the
same under Clause 17 & clause 29(B) of Form 3CD.
Q.9 How will you verify the income & expenditure of earlier years credited/debited in the current year for

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reporting under clause 27(b) of Form 3CD while carrying out Tax Audit u/s 44AB of the Income Tax Act,
1961?
Clause 27(a): Amount of Central Value Added Tax/GST credits availed of or utilized during the previous year
& its treatment in the profit & loss account & treatment of outstanding Central Value Added Tax/GST
credits in the accounts.
The amount of CENVAT/GST availed & utilised should be reported under this sub-clause. In some cases,
CENVAT/GST availed may be lesser than the CENVAT /GST credit utilised during the year on account of
opening balance in CENVAT/GST account or vice-versa & as such it would be advisable, in order to avoid any
misleading conclusion & inferences, to report the opening & closing balances of CENVAT/GST. Further the
sub-clause requires reporting of the credits availed of or utilized during the previous year, it is desirable to
report both the credits availed & the credits utilized.
In so far as the reporting of accounting treatment of CENVAT/GST credit is concerned the clause requires that
its treatment in profit & loss account & the treatment of outstanding CENVAT/GST credit in the account have
to be reported upon.
The tax auditor should verify & maintain the following information in his working papers for the purpose of
reporting in the format provided in the e-filing utility:
Treatment in Profit & Loss
CENVAT/GST Amount
Accounts
Opening balance
CENVAT/GST Availed
CENVAT/GST utilized
Closing / outstanding Balance

Clause 27(b): Particulars of income or expenditure of prior period credited or debited to the profit & loss
account.
It may be noted that information under this clause would be relevant only in those cases where the assessee
follows mercantile system of accounting.
Under cash system of accounting, expenses debited/ income credited to the profit & loss account would be
current year’s expenses/income even though they may relate to earlier years.
The tax auditor should maintain the following information in his working papers file for the purpose of
reporting in the format provided in the e-filing utility:
Sr. No. Type Particulars Amount Prior Period to which it relates (Year in yyyy-yy format)
1 2 3 4 5
Audit checklist for practical understanding :
(I) CENVAT Credits [Clause 27(a)]
▪ The auditor should check records related to CENVAT/GST.
▪ The auditor shall go through relevant records to find out details regarding CENVAT/GST credit
available/receivable, treatment of CENVAT/GST credit availed during the year & the CENVAT/GST
credit outstanding at the year end.
▪ Check the CENVAT/GST receivable account & collect the following information therefrom--

 Opening balance;

 CENVAT/GST credit availed of during the year;

 CENVAT/GST credit utilised during the year;

 Treatment of both the above in the profit & loss account & also the treatment of CENVAT/GST
credit outstanding at the year end.
▪ Ask the assessee to furnish details as to accounting policy followed in respect of CENVAT/GST. See
that such policy is in consonance with the Guidance Note issued by the ICAI on Accounting for
CENVAT/GST.
(ii) Expenditure/Income of Earlier Years Debited/ Credited in Current Year [Clause 27(b)]

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▪ Ask the assessee to furnish a schedule indicating particulars of expenditure/ income of any earlier
year debited/credited to the Profit & Loss account of the relevant previous year.
▪ Verify various expenses account to see whether any expenditure pertaining to any earlier year has
been debited to the profit & loss account. For example, an assessee might have paid some
certification fee etc., for four years in the year under audit. In that case payment of expenses for
previous three years would be prior period payment.
▪ Also see that all such items are properly disclosed.
▪ Check while conducting the routine audit, that there is no expenditure/ income relating to earlier
years that has not been mentioned in the particulars furnished by the assessee.
▪ In case of cash system of accounting, there will be no amount to be disclosed under this head.
UNIT - II
Q.1 MM & Co., a footwear manufacturer is registered with GST in Delhi & its branches registered in Punjab
& Haryana. Its turnover for the FY ended 31st March, 2019 is: Delhi: ` 1.8 crore, Punjab: ` 1.2 crore &
Haryana: ` 2.7 crore. However, the branch registered in Punjab is making only exempt supplies. The
management of the company is of the view that GST audit is not applicable on them. Whether, their
contention is correct or not. Substantiate.
GST audit will be applicable on MM & Co. As per section 35(5) read with rule 80(3), the aggregate turnover
calculation for the applicability of GST audit must be done on a PAN India basis, which means that once the
turnover under the PAN India level is more than ` 5 crores, all business entities registered under GST for that
PAN will be liable for GST audit for the FY. Further, aggregate turnover includes exempted supplies. Therefore,
any person making exempt supplies which is registered under GST will also be liable for GST audit.
Thus, in the given case, the contention of the management is not correct. The aggregate turnover of the
company is ` 5.7 crore. Thus, each branch is liable for GST audit.
Q.2 Write a short note on Special Audit under GST.
SPECIAL AUDIT U/S 66
Special audit wherein the registered person can be directed to get his records including books of account
examined & audited by a chartered accountant or a cost accountant during any stage of scrutiny, inquiry,
investigation or any other proceedings; depending upon the nature & complexity of the case [Section 66
read with rule 102] on order of Assistant Commissioner or above with prior approval of the Commissioner.
Procedure of Special Audit [S. 66]
Availing the services of experts is an age old practice & is the process of law. These experts have done
yeoman service to the process of delivering justice. One such facility extended by the Act is u/s 66 where an
officer not below the rank of Assistant Commissioner, duly approved, may avail the services of a chartered
accountant or cost accountant to conduct a detailed examination of specific areas of operations of a
registered person. Availing the services of the expert be it a chartered accountant or cost accountant is
permitted by this section only when the officer considering the nature & complexity of the business & in the
interest of revenue is of the opinion that:
▪ Value has not been correctly declared; or
▪ Credit availed is not within the normal limits.
It would be interesting to know how these ‘subjective’ conclusions will be drawn & how the proper officer
determines what is the normal limit of input credit availed.
Circumstances for Notice for Special Audit: An Assistant Commissioner who frames an opinion on the above
two aspects, after commencement & before completion of any scrutiny, inquiry, investigation or any other
proceedings under the Act, may direct a registered person to get his books of accounts audited by an expert.
Such direction is to be issued in accordance with the provision of Rule 102 (1) FORM GST ADT-03.
The Assistant Commissioner needs to obtain prior permission of the Commissioner to issue such direction to

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the registered person.

Identifying the expert is not left to the registered person whose audit is to be conducted but the expert is to
be nominated by the Commissioner.
Opportunity of being heard shall be given to registered person: As per section 66(4) of the CGST, SGST/
UTGST Acts, 2017, the registered person shall be given an opportunity of being heard in respect of any
material gathered on the basis of special audit which is proposed to be used in any proceedings against him
under this Act or the rules made thereunder.
Time Limit to Submit the Audit Report: The Chartered Accountant or the Cost Accountant so appointed shall
submit the audit report, mentioning the specified particulars therein, within a period of 90 days, to the
Assistant Commissioner in accordance with provision of Rule 102(2) FORM GST ADT-04.
Extension in Submission of Audit Report: In the event of an application to the Assistant Commissioner by
Chartered Accountant or the Cost Accountant or the registered person seeking an extension, or for any
material or sufficient reason, the due date of submission of audit report may be extended by another 90 days.
Special Audit shall have overriding effect: Considering the special nature of this audit, i.e. audit having been
conducted under other proceedings or under other laws; this does not preclude the proper officer from
exercising option u/s 66.
While the report in respect of the special audit under this section is to be submitted directly to the Assistant
Commissioner, the registered person is to be provided an opportunity of being heard in respect of any
material gathered in the special audit which is proposed to be used in any proceedings under this Act. This
provision does not appear to clearly state whether the registered person is entitled to receive a copy of the
entire audit report or only extracts or merely inferences from the audit. However, the observance of the
principles of natural justice in the proceedings arising from this audit would fail if the taxable person is not
provided the copy of the special audit report.
Expenses for Examination & Remuneration for Audit: The expenses for examination & audit including the
remuneration payable to the auditor will be determined & borne by the Commissioner.
As in the case of audit u/s 65, no demand of tax, even ad interim, is permitted on completion of the special
audit under this section. In case any possible tax liability is identified during the audit, procedure u/s 73 or 74,
as the case may be, is to be followed.
Q.3 Mr. A was appointed as an auditor of M/s. XYZ Co. During the course of audit he finds that the
company has availed an excess ITC of ` 50 lakh. Accordingly, he made recommendations in Part V of GSTR-
9C, the management of the company refused to pay the excess ITC & argued that auditors
recommendations are not binding. Comment.
The management contention is correct. The auditor has only a recommendatory power, for recommendations
given by the auditor may or may not be acceptable to the registered person. The registered person has the
option to accept, reject or partially accept the recommended additional tax liability. In line with such
recommendations, though not explicitly stated anywhere in the relevant Form or GST law –
(i) the registered person can choose to make the payment of the additional tax liability in full or in part;
(ii) the registered person can even choose to reject the complete recommendations of the auditor & not
make the payment at all.
Q.4 Mr. John, made an outward supply of ` 4.00 lakhs to M/s. Taj Enterprises on 30th April, 2020 on a
credit period of 15 days. However, M/s. Taj Enterprises made the payment to Mr. John after 45 days along
with interest for 30 days delayed payment @ 12%. As such, Mr. John received total payment of ` 4,04,000/-
along with interest. However, while filing Form GSTR-3B/ Form GSTR-1, Mr. John declared his outward
supplies at ` 4.00 lakhs. Even while filing Form GSTR-9, Mr. John did not discharge his tax liability. As a GST
auditor in Form GSTR-9C, what action is recommended by the auditors. Comment.
In terms of section 15(2)(d) while computing value of taxable supply the transaction value shall include

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interest or late fee or penalty for delayed payment of any consideration for any supply. Since, Mr. John did
not pay tax on interest component, he made violation of valuation provisions. Mr. John was having option to
discharge such liability at the time of filing of Form GSTR-9, which he did not avail. Therefore, the GST auditor
may recommend him to discharge such liability at the time of making reconciliation statement in Form GSTR-
9C.
Q.5 CA Natraj, proprietor of Satyam & Co., Chartered Accountants, while doing GST audit in Form GSTR-9C,
recommended additional liability of ` 1.5 crore to be paid by PQR Co. Ltd. on account of supplies not
declared in regular returns in Form GSTR-3B/ Form GSTR-1 & also in annual return in Form GSTR-9. The
company agreed to pay the liability. On the date of payment, it had ITC of ` 1 crore in its electronic credit
ledger which the company wants to use for making the payment & balance amount to be paid in cash.
Comment.
The management is not correct in doing so. If the registered person chooses to make the payment of any
additional liability as recommended by the auditor, the company may make such payment through FORM
DRC-03. However, such liability shall be paid through electronic cash ledger only.
Q.6 M/s. Ramo & Co (P) Ltd. while appointing M/s. Jatin Prasad & Associates, a CA firm, as their GST
auditors for the FY 2020-21 claims that only a GST Practitioner CA firm is eligible for doing audit under GST
law in terms of section 35(5) of the Act. Comment.
The GST Act/ Rules do not vest a GST practitioner with the power to audit u/s 35(5). The power to audit is
granted only to a chartered accountant or cost accountant who is in practice. Therefore, a chartered
accountant is not required to be registered as a GST practitioner for the purpose of certifying FORM GSTR-9C.
Therefore, the contention of the company that only a GST Practitioner CA is eligible for GST audit is not
correct.
Q.7 State the consequences of not filing of Annual Return in Form GSTR-9 & not getting the GST Audit done
u/s. 35(5) of the Act, in Form GSTR-9C?
Section 47(2) provides that in case of failure to submit the annual return within the specified time, a late fee
shall be levied. The said late fee would be ` 100 per day during which such failure continues subject to a
maximum of a quarter percent of the turnover in the State/UT. There would be an equal amount of late fee
under the respective SGST/ UTGST Act.
However, there is no specific penalty prescribed in the GST Law for not getting the accounts audited by a
chartered accountant or a cost accountant. Therefore, in terms of section 125 of the CGST Act, the registered
person may be subjected to a penalty of up to ` 25,000/-. This section deals with the general penalty that gets
attracted where any person, who contravenes any of the provisions of this Act, or any rules made thereunder
for which no penalty is separately provided. Similar provision also exists under the SGST/ UTGST Act as well.
As such, penalty of up to ` 25,000/- shall be imposed under the SGST/ UTGST Act. It is possible that since the
annual return in FORM GSTR-9 is to be accompanied with the auditor’s report in FORM GSTR-9C, if not done it
may amount to non-filing of annual return & late fee also may be levied.
Q.8 What are the objectives of Special Audit u/s 66 of the CGST Act. Can it be invoked in a routine manner
by proper officer?
The objectives of Special Audit u/s 66 of the CGST Act is that if at any stage of scrutiny, inquiry, investigation
or any other proceedings before him, any officer not below the rank of Assistant Commissioner, having regard
to the nature & complexity of the case & the interest of revenue, is of the opinion that the value has not been
correctly declared or the credit availed is not within the normal limits, he may, with the prior approval of the
Commissioner, direct such registered person by a communication in writing to get his records including books
of account examined & audited by a chartered accountant or a cost accountant as may be nominated by the
Commissioner. Therefore, it cannot be invoked in a routine manner by proper officer.
Q.9 Write a short note on differences in Audit by Tax Authorities & the Special Audit?
There are differences in Audit by Tax Authorities & the Special Audit. Such differences can be analysed as

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under-
i. The audit by tax authorities is conducted by the revenue officers whereas special audit is conducted by
the CA/ Cost Accountants on the penal of the department.
ii. The audit by tax authorities is conducted by the revenue officers either the taxpayer’s office or at their
own office whereas special audit is conducted by the CA/ Cost Accountants at the taxpayer’s office.
iii. The audit by tax authorities can be invoked in a routine manner by the revenue officers whereas special
audit is invoked with the prior approval of the Commissioner if the nature of business of the auditee is
found to be complex.
iv. The audit by tax authorities is to be completed within 3 months which is further extendable by another 6
months, whereas special audit is to be completed within 90 days which is further extendable by another
90 days.
Q.10 State the scope of audit under GST, whether inspection or fait accompli?
The scope of inspection by the tax authorities is much wider which may entail inspection, search & seizure at
the business premises & the vehicles of the taxable person. Such powers are used by the authorities in special
circumstances when the proper officer not below the rank of Joint Commissioner has reason to believe that
there is evasion of tax by the taxpayer.
As compared to inspection, the scope of audit is very limited up to fait accompli in the case of registered
person. Fait accompli is a thing that has already happened or has been decided before those affected about it,
leaving them with no option but to accept or reject it. E.g. the results were presented to shareholders as a fait
accompli. Therefore, the auditors are not having powers to inspect the premises or vehicles of the registered
person but to make the checking of the records, books of accounts, audited financial statements or the
returns etc. filed by him.
Q.11 The GST department endeavours to collect legitimate taxes while requiring the taxpayers to file
FORM GSTR-9 & FORM GSTR-9C. Can you draw a comparative view of these two forms?
COMPARATIVE VIEW OF FORM GSTR-9 & GSTR-9C
S. FORM GSTR-9 FORM GSTR-9C
No.
1. It is annual report of a formal or official It is auditor’s report reconciling audited financial
character giving information statements with FORM GSTR-9
2. Enacted u/s 44 read with rule 80 Enacted u/s 35(5)/ 44 read with rule 80
3. Filing of FORM GSTR-9 is mandatory for all To be filed only if the aggregate turnover in a FY
registered persons without any threshold limit.
exceeds the prescribed limit which 5.00 crore at
[Upto 2.00 crore optional] present.
4. Not required to be filed by a Casual Taxable Not required to be filed by a Casual Taxable
Person, Non-Resident Taxable Person, Input Person, Non-Resident Taxable Person, Input
Service Distributor, Unique Identification Service Distributor, Unique Identification Number
Number Holders, Online Information & Holders, Online Information & Database Access
Database Access Retrieval Service, Composition
Retrieval Service, Composition Dealers, persons
Dealers, persons required to deduct taxes u/srequired to deduct taxes u/s 51, persons required
51 & persons required to collect taxes u/s 52.
to collect taxes u/s 52, Government Department
subject to CAG audit & foreign airline company.
5. No need to annex financials Financials to be annexed
6. The annual return is to be filed by the Reconciliation statement in FORM GSTR-9C is to be
registered person. given by auditors & to be filed by the registered
person.
7. The annual return is to be prepared based on The reconciliation statement is to be prepared for
consolidated information from periodical reconciling the information in the annual return

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returns like FORM GSTR-3B/ FORM GSTR-1. viz. a viz. the audited annual financial statement.
8. The annual return is to be verified by the The reconciliation statement is to be certified by
registered person. the auditors.
Q.12 Whether filing of Annual Return in Form GSTR-9 is mandatory for all registered persons? If not then
what are the exceptions?
Filing of Annual Return in Form GSTR-9 is mandatory for all registered persons except the following-
▪ Casual taxable persons
▪ Input service distributors
▪ Non-resident taxable persons
▪ Persons paying TDS/ TCS u/s 51/ 52 of the Act
▪ Person supplying online information & database access retrieval services
▪ Persons having GTO<2.00 crore are having option to file & not to file the Annual Return

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CH – 13
AUDIT OF PUBLIC SECTOR
UNDERTAKINGS
Q. 1 What are the principles involved regarding “Propriety audit’ in the case of Public Sector Undertaking?
Companies Act, lays down special provisions regarding audit of accounts of public sector undertakings
registered Some general principles have been laid down in the Audit Code, which have for long been
recognised as standards of financial propriety. Audit against propriety seeks to ensure that expenditure
conforms to these principles which have been stated as follows:

i. The expenditure should not be prima facie more than the occasion demands. Every public officer is
expected to exercise the same vigilance in respect of expenditure incurred from public moneys as a
person of ordinary prudence would exercise in respect of expenditure of his own money.
ii. No authority should exercise its powers of sanctioning expenditure to pass an order which will be
directly or indirectly to its own advantage.
iii. Public moneys should not be utilised for the benefit of a particular person or section of the
community.
iv. Apart from the agreed remuneration or reward, no other avenue is kept open to indirectly benefit the
management personnel, employees & others.
It may be stated that it is the responsibility of the executive departments to enforce economy in public
expenditure. The aim of propriety audit is to bring to the notice of the proper authorities of wastefulness in
public administration & cases of improper; avoidable & infructuous expenditure.
Q. 2 Write a short explanatory note on –
(a) Areas of propriety audit u/s 143(1) of the Companies Act, 2013.
(b) Role of C&AG in the Audit of a Government company.
(a) Areas of Propriety Audit u/s 143(1): Section 143(1) of the Companies Act, 2013 requires the auditor to
make an enquiry into certain specific areas. In some of the areas, the auditor has to examine the same
from propriety angle as to -
(i) whether loans & advances made by the company on the basis of security have been properly
secured & whether the terms on which they have been made are prejudicial to the interests of the
company or its members;
(ii) whether transactions of the company which are represented merely by book entries are
prejudicial to the interests of the company;
(iii) where the company not being an investment company or a banking company, whether so much of
the assets of the company as consist of shares, debentures & other securities have been sold at a
price less than that at which they were purchased by the company;
(iv) whether loans & advances made by the company have been shown as deposits;
(v) whether personal expenses have been charged to revenue account;
(vi) where it is stated in the books & documents of the company that any shares have been allotted for
cash, whether cash has actually been received in respect of such allotment, & if no cash has
actually been so received, whether the position as stated in the account books & the balance sheet
is correct, regular & not misleading.
A control has been set up to verify the receipt of cash in case of allotment of shares for cash. Further, if
cash is not received, whether the books of accounts & statement of affairs shows the true picture.
(b) Role of C&AG in the Audit of a Government company: Role of C&AG is prescribed under sub section (5),
(6) & (7) of section 143 of the Companies Act, 2013. In the case of a Government company, the
comptroller & Auditor-General of India shall appoint the auditor under sub-section (5) or sub-section (7)

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of section 139 i.e. appointment of First Auditor or Subsequent Auditor & direct such auditor the manner
in which the accounts of the Government company are required to be audited & thereupon the auditor
so appointed shall submit a copy of the audit report to the Comptroller & Auditor-General of India which,
among other things, include the directions, if any, issued by the Comptroller & Auditor-General of India,
the action taken thereon & its impact on the accounts & financial statement of the company. The
Comptroller & Auditor-General of India shall within sixty days from the date of receipt of the audit report
have a right to:
(i) conduct a supplementary audit of the financial statement of the company by such person or
persons as he may authorize in this behalf; & for the purposes of such audit, require information or
additional information to be furnished to any person or persons, so authorised, on such matters, by
such person or persons, & in such form, as the Comptroller & Auditor-General of India may direct; &
(ii) comment upon or supplement such audit report. It may be noted that any comments given by the
Comptroller & Auditor-General of India upon, or supplement to, the audit report shall be sent by the
company to every person entitled to copies of audited financial statements under sub-section (1) of
section 136 i.e. every member of the company, to every trustee for the debenture-holder of any
debentures issued by the company, & to all persons other than such member or trustee, being the
person so entitled & also be placed before the annual general meeting of the company at the same
time & in the same manner as the audit report.
Test Audit: Further, without prejudice to the provisions relating to audit & auditor, the Comptroller &
Auditor- General of India may, in case of any company covered under sub-section (5) or sub-section (7) of
section 139, if he considers necessary, by an order, cause test audit to be conducted of the accounts of such
company & the provisions of section 19A of the Comptroller & Auditor-General's (Duties, Powers &
Conditions of Service) Act, 1971, shall apply to the report of such test audit.
Q. 3 ABG & Co., a Chartered Accountant firm has been appointed by C & AG for performance audit of a
Sugar Industry. What factors should be considered by ABG & Co., while planning a performance audit of
Sugar Industry?
Planning for Performance Audit
The following steps are suggested to the auditors for planning while conducting the performance audit:
(A) Understanding the Entity/Programme - It is the starting point for planning individual performance audit.
The auditor may use the following sources for understanding the entity:
(i) Documents of the entity: Documents on administration and functions of the entity, policy files,
annual reports, budget documents, accounts, minutes of meetings, information on the website,
internal audit reports, electronic databases & MIS reports, RTI material etc.
(ii) Legislative documents: Legislation, parliamentary questions & debates, reports of the Public
Accounts Committee, the Committee on Public Undertakings, the Estimates Committee & letters
from Members of Parliament.
(iii) Policy documents: Documents of Planning Commission, Ministry of Finance etc.
(iv) Academic or special research: Independent evaluations on the entity, academic research & similar
work done by other governments & other SAIs.
(v) Past audits: Past financial & performance audits of the entity provide a major source of
information & understanding.
(vi) Media coverage: Print & electronic media - their systematic documentation on regular basis in a
transparent manner.
(vii) Special focus groups: Audit Advisory Committee concerns, annual & special reports of World Bank,
Reserve Bank of India, reports by special interest groups, NGOs, etc.
(B) Defining the Objectives & the Scope of Audit - The audit objectives should be defined in a succinct
manner as they will impact the nature of the audit, govern its conduct & affect audit conclusions. Setting

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audit objectives ensures good quality performance audits. It facilitates clarity, demonstrates consistent
quality of audit & serves as a measure of quality assurance of the audit.
Defining the scope constricts the audit to significant issues that relate to the audit objectives. It mainly
focuses the extent, timing & nature of the audit.
(C) Determining Audit Criteria - Audit criteria are the standards used to determine whether a program
meets or exceeds expectations. It provides a context for understanding the results of the audit. Audit
criteria are reasonable & attainable standards of performance against which economy, efficiency &
effectiveness of programmes & activities can be assessed.
The audit criteria may be sought to be obtained from the following sources:
(i) procedure manuals of the entity.
(ii) policies, standards, directives & guidelines.
(iii) criteria used by the same entity or other entities in similar activities or programmes. ‘
(iv) independent expert opinion & know how.
(v) new or established scientific knowledge & other reliable information. (vi) general management &
subject matter literature & research papers.
(D) Deciding Audit Approach - There is no uniform audit approach prescribed that can be applicable to all
types of subjects of performance audits. Selection of approach also determine methods & means used
for conducting the audit. Some of the methods which could be used in conducting performance audits
include:
(i) Analysis of procedures: It involves review of the systems in place for planning, conducting, checking
& monitoring the activity. This would consist of examination of documents such as financial reports,
budgets, programme guidelines, procedure manuals, etc.
(ii) Case studies: A case study is a descriptive analysis of an entity, scheme or a programme. It involves
analysis of a particular issue within the context of the whole area under review.
(iii) Use of existing data: The audit staff should investigate the data held by entity management & by
other relevant sources. Audit conclusions based on testing of available data for correctness &
completeness enhances the assurance level.
(iv) Surveys: Survey is a method of collecting information from members of a population to assess the
interrelation of events & conditions. Surveys on predetermined parameters can supplement the
audit findings & conclusions adding value to the performance audits.
(v) Analysis of results: It requires the auditor to carry out actual output-input analysis to determine the
efficiency of the programme.
(vi) Quantitative analysis: It involves examination of available data relating to financials like earnings,
revenue, or data relating to programme implementation like details of beneficiaries etc. However, it
may not be possible for the auditor to work with complete data due to its high volume. In such
cases, sampling techniques are required to be used.
(E) Developing Audit Questions - Subsequent to designing of audit objectives & determination of audit
criteria, the audit team is required to prepare a list of questions to whichthey would seek answers. The
questions should be framed in comprehensive manner involving detailed hierarchy of questions
(F) Assessing Audit Team Skills & whether Outside Expertise required - It is essential that the performance
auditors possess special aptitude & knowledge. The Auditing Standards of C&AG of India provide that
the audit institution should develop & train the auditors to enable them to perform their tasks
effectively & efficiently & should prepare manuals & other written guidance notes & instructions
concerning conduct of audits.
Given the diverse range of subjects of performance auditing, the audit team needs to develop sound

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understanding of the programme or entity proposed to be audited.

The audit team needs to decide at the planning stage on which aspect expertise is required. Though, the
Accountant General may use the work of an expert, he retains full responsibility for the expression of
opinion in the auditor’s report.
(G) Preparing Audit Design Matrix (ADM) - Having determined the audit objective, audit criteria, audit
approach, data collection etc., audit team should prepare an Audit Design Matrix. It is a structured &
highly focused approach to designing a performance audit study.
The ADM highlights the data collection & analysis method as well as the type & sources of evidence
required to support audit opinion/findings.
A specimen of ADM is given as under:
Audit Objective Audit Questions Audit Criteria Evidence Data Collection &
(1) (2) (3) (4) Analysis Method
(5)

An ADM is prepared on the basis of information & knowledge obtained during the planning stage. A
well-designed ADM leads to effective audits thus providing highest assurances to the auditing entities. It
is desirable to prepare ADM for each of the audit objectives.
(H) Establishing Time Table & Resources - It is significant to determine the timetable & desirable resources.
Selection of appropriate audit team is the most vital component in planning an audit. Considerations for
selection of an appropriate audit team should be recorded along with the proposed timelines for various
activities to be undertaken as a part of audit process. The progress should also be monitored against
these timelines. The Accountant General would be liable for ensuring that the performance audit is
completed on time. The variations between the required & actual time spent should be compared &
approved from the competent authority.
The team should build time for translation, approval & possible delays in their own schedule in order to
meet the targets.
(I) Intimation of Audit Programme to Audit Entities - Audited entities must be intimated about the
intention of taking up planned performance audit with the scope & extent of audit including the
constitution of audit team & the tentative time schedule, well before the commencement of Audit.
Acknowledgement of this may be requested & placed on record.
It may be required to refine an audit's objectives as the audit progresses for gathering the requisite
information to fulfil the audit. The reasons for such changes in the objectives should also be recorded &
approved from the competent authority.
The audit programme should be flexible & reviewed from time to time as it is not possible to anticipate
all the contingencies at the early stage.
The Accountant General should share all significant refinements in the approach & additional tests & findings,
concurrently with other audit teams when different persons conduct the audit at different locations. The
system of sharing of the significant field audit experience should be documented & reviewed.
Q. 4 Sunlight Limited is a public sector undertaking engaged in production of electricity from solar power. It
had commissioned a new project near Goa with a new technology for a cost of ` 5,750 crore. The project
had seen delay in commencement & cost overrun. State the matters that a Comprehensive Audit by C&AG
may cover in reporting on the performance & efficiency of this project.
COMPREHENSIVE AUDIT
The Comptroller & Auditor General assists the legislature in reviewing the performance of public
undertakings. He conducts an efficiency-cum-performance audit other than the field which has already been
covered either by the internal audit of the individual concerns or by the professional auditors. He locates the

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area of weakness & extravagance for managements’ information.

The areas covered in comprehensive audit naturally vary from enterprise to enterprise depending on the
nature of the enterprise, its objectives & operations. However, in general, the covered areas are those of
investment decisions, project formulation, organisational effectiveness, capacity utilisation, management of
equipment, plant & machinery, production performance, use of materials, productivity of labour, idle
capacity, costs & prices, materials management, sales & credit control, budgetary & internal control systems,
etc.
Some of the issues examined in comprehensive audit are:
(a) How does the overall capital cost of the project compare with the approved planned costs? Were there
any substantial increases &, if so, what are these & whether there is evidence of extravagance or
unnecessary expenditure?
(b) Have the planned production or operational outputs been achieved? Has there been under-utilisation of
installed capacity or shortfall in performance &, if so, what has caused it?
(c) Has the planned rate of return been achieved?
(d) Are the systems of project formulation & execution sound? Are there inadequacies? What has been the
effect on the gestation period & capital cost?
(e) Are cost control measures adequate & are there inefficiencies, wastages in raw materials consumption,
etc.?
(f) Are the purchase policies adequate? Or have they led to piling up of inventory resulting in redundancy in
stores & spares?
(g) Does the enterprise have research & development programmes? What has been the performance in
adopting new processes, technologies, improving profits & in reducing costs through technological
progress?
(h) If the enterprise has an adequate system of repairs & maintenance?
(i) Are procedures effective & economical?
(j) Is there any poor or insufficient or inefficient project planning?
The Bureau of Public Enterprises has issued guidelines to be followed by the public sector enterprises in
respect of general management, financial management, materials management, production management,
construction management, etc. & these guidelines provide another basis for appraising enterprise
performance & its systems. Another source of criteria is industrial engineering & other technical studies by
internal & external experts & the standards given in these. Then there are standards of financial propriety.
The starting point of a comprehensive appraisal of a public enterprise, which covers aspects of economy,
efficiency & effectiveness, is the preparation of an audit programme based on the study of decisions relating
to the setting up of the enterprise, its objectives, the areas of operation, organisation, financial & operational
details available in the annual reports & accounts, capital & operational budgets, deliberations of the board
of directors, material in the earlier audit inspection reports on the enterprise & other relevant available
papers. These audit programmes (or guidelines) identify the areas/aspects which require further detailed
audit analysis & criteria, the data required for such analysis & the sources of such data, the extent of the
audit analysis including the test checks to be applied & the instructions to the audit parties assigned to the
work.
Q. 5 Ceta Ltd. is a company in which 54% of the paid up share capital is held by Rajasthan Government. The
company is engaged in the business of providing consultancy services in relation to construction projects.
The audit of the financial statements of Ceta Ltd. for the financial year ended 31 March 2020 got completed
with lot of intervention of Comptroller & Auditor General of India, wherein C&AG was giving directions to
the auditors on the manner in which audit should be conducted in respect of certain areas. Further, it also
received comments from C&AG on the audit report of the auditors. Ceta Ltd is seeking advice to go against

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C&AG so that they can avoid unnecessary interference of C&AG. You are required to advise Ceta Ltd. with
respect to role of C&AG in the audit of a Government company.
AUDIT OF GOVERNMENT COMPANIES The following steps are involved in the audit of government
companies:
(a) Appointment of Auditors u/s 139(5) & 139(7) read with section 143(5) of the Companies Act, 2013 -
Statutory auditors of Government Companies are appointed or re-appointed by the C&AG. There is thus,
a departure from the practice in vogue in the case of private sector companies where appointment or re-
appointment of the auditors & their remuneration are decided by the members at the annual general
meetings. In the case of government companies, though the appointment of statutory auditors is done
by the C&AG, the remuneration is left to the individual companies to decide based on certain guidelines
given by the C&AG in this regard.
The C&AG may direct the appointed auditor on the manner in which the accounts of the Government
company are required to be audited & the auditor so appointed has to submit a copy of the audit report
to the Comptroller & Auditor-General of India. The report, among other things, includes the directions, if
any, issued by the C&AG, the action taken thereon & its impact on the accounts & financial statement of
the company. The report u/s 143(5) is in addition to the reports issued by the Statutory Auditors under
various other clauses of section 143.
(b) Supplementary audit u/s 143(6)(a) of the Companies Act, 2013 - The Comptroller & Auditor-General of
India shall within 60 days from the date of receipt of the audit report have a right to conduct a
supplementary audit of the financial statement s of the government company by such person or persons
as he may authorize in this behalf & for the purposes of such audit, require information or additional
information to be furnished to any person or persons, so authorised, on such matters, by such person or
persons, & in such form, as the C&AG may direct.
(c) Comment upon or supplement such Audit Report u/s 143(6)(b) of the Companies Act, 2013 - Any
comments given by the C&AG upon, or in supplement to, the audit report issued by the statutory
auditors shall be sent by the company to every person entitled to copies of audited financial statements
under sub-section (1) of section 136 of the said Act i.e. every member of the company, to every trustee
for the debenture-holder of any debentures issued by the company, & to all persons other than such
member or trustee, being the person so entitled & also be placed before the annual general meeting of
the company at the same time & in the same manner as the audit report.
(d) Test audit u/s 143(7) of the Companies Act, 2013 - Without prejudice to the provisions relating to audit
& auditor, the C&AG may, in case of any company covered under sub-section (5) or sub-section (7) of
section 139 of the said Act, if he considers necessary, by an order, cause test audit to be conducted of
the accounts of such company & the provisions of section 19A of the Comptroller & Auditor-General's
(Duties, Powers & Conditions of Service) Act, 1971, shall apply to the report of such test audit.
Q. 6 “A performance audit is an objective & systematic examination of evidence for the purpose of
providing an independent assessment of the performance of a government organization, program, activity,
or function in order to provide information to improve public accountability & facilitate decision-making by
parties with responsibility to oversee or initiate corrective action.” Briefly discuss the issues addressed by
Performance Audits conducted in accordance with the guidelines issued by C&AG.
PERFORMANCE AUDIT
A performance audit is an objective & systematic examination of evidence for the purpose of providing an
independent assessment of the performance of a government organization, program, activity, or function
in order to provide information to improve public accountability & facilitate decision-making by parties
with responsibility to oversee or initiate corrective action.
Performance audit in PSUs is conducted by the C&AG (Supreme Audit Institutions) through various

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subordinate offices of Indian Audit & Accounts Department (IAAD).

In conducting performance audit, the subordinate offices are guided by manual & auditing standards
prescribed by C&AG.
This audit promotes accountability by assisting those charged with governance & oversight responsibilities to
improve performance through an examination of whether:
(a) decisions by the legislature or the executive are efficiently & effectively prepared & implemented; &
(b) tax payers or citizens have received value for money. According to the guidelines issued by the C&AG,
Performance Audits usually address the issues of:
(i) Economy- It is minimising the cost of resources used for an activity, having regard to appropriate
quantity, quality & at the best price.
Judging economy implies forming an opinion on the resources (e.g. human, financial & material)
deployed. This requires assessing whether the given resources have been used economically &
acquired in due time, in appropriate quantity & quality at the best price.
(ii) Efficiency- It is the input-output ratio. In the case of public spending, efficiency is achieved when
the output is maximised at the minimum of inputs, or input is minimised for any given quantity &
quality of output.
Auditing efficiency embraces aspects such as whether:
(a) sound procurement practices are followed;
(b) resources are properly protected & maintained;
(c) human, financial & other resources are efficiently used;
(d) optimum amount of resources (staff, equipment, & facilities) are used in producing or
delivering the appropriate quantity & quality of goods or services in a timely manner;
(e) public sector programmes, entities & activities are efficiently managed, regulated, organised
& executed;
(f) efficient operating procedures are used; &
(g) the objectives of public sector programmes are met cost-effectively.
(iii) Effectiveness- It is the extent to which objectives are achieved & the relationship between the
intended impact & the actual impact of an activity.
In auditing effectiveness, performance audit may, for instance:
(a) assess whether the objectives of & the means provided (legal, financial, etc.) for a new or ongoing public
sector programme are proper, consistent, suitable or relevant to the policy;
(b) determine the extent to which a program achieves a desired level of program results;
(c) assess & establish with evidence whether the observed direct or indirect social & economic impacts of a
policy are due to implementation of the policy or to other causes;
(d) identify factors inhibiting satisfactory performance or goal-fulfilment;
(e) assess whether the programme complements, duplicates, overlaps or counteracts other related
programmes;
(f) assess the effectiveness of the program &/or of individual program components;
(g) determine whether management has considered alternatives for carrying out the program that might
yield desired results more effectively or at a lower cost;
(h) assess the adequacy of the management control system for measuring, monitoring & reporting a
programme's effectiveness;
(i) assess compliance with laws & regulations applicable to the program; &

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(j) identify ways of making programmes work more effectively.

Q. 7 BT Ltd , a company wholly owned by central government was disinvested during the previous year,
resulting in 40% of the shares being held by public. The shares were also listed on the BSE. Since the shares
were listed, all the listing requirements were applicable, including publication of quarterly results,
submission of information to the BSE etc. Sam, the FM of the company is of the opinion that now the
company is subject to stringent control by BSE & the markets, therefore the auditing requirements of a
limited company in private sector under the Companies Act 2013 would be applicable to the company &
the C&AG will not have any role to play. Comment.
Section 2(45) of the Companies Act, 2013, defines a “Government Company” as a company in which not less
than 51% of the paid-up share capital is held by the Central Government or by any State Government or
Governments or partly by the Central Government & partly by one or more State Governments, & includes a
company which is a subsidiary company of such a Government company. The auditors of these government
companies are firms of Chartered Accountants, appointed by the Comptroller & Auditor General, who gives
the auditor directions on the manner in which the audit should be conducted by them. The listing of
company’s shares on a stock exchange is irrelevant for this purpose & hence Sam’s opinion is not correct.
Q. 8 You have been appointed as auditor of a AKY Ltd. After having determined the audit objectives, now
you have been requested to draft audit criteria. What are the sources that you will use while doing the
task?
Determining Audit Criteria - Audit criteria are the standards used to determine whether a program meets or
exceeds expectations. It provides a context for understanding the results of the audit. Audit criteria are
reasonable & attainable standards of performance against which economy, efficiency & effectiveness of
programmes & activities can be assessed.
The audit criteria may be sought to be obtained from the following sources:
i. procedure manuals of the entity.
ii. policies, standards, directives & guidelines.
iii. criteria used by the same entity or other entities in similar activities or programmes. ‘
iv. independent expert opinion & know how.
v. new or established scientific knowledge & other reliable information.
vi. general management & subject matter literature & research papers.

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CH – 14 LIABILITIES OF AUDITOR
Q. 1 Indicate the precise nature of auditor's liability in the following situations & support your views with
authority, if any:
(i) A misstatement had occurred in the prospectus issued by the company.
(ii) Certain weaknesses in the internal control procedure in the payment of wages in a large
construction company were noticed by the statutory auditor who in turn brought the same to
the knowledge of the Managing Director of the company. In the subsequent year huge
defalcation came to the notice of the management. The origin of the same was traced to the
earlier year. The management wants to sue the auditor for negligence & also plans to file a
complaint with the Institute.
(iii) Based upon the legal opinion of a leading advocate, X Ltd. made a provision of ` 3 crores towards
Income Tax liability. The assessing authority has worked out the liability at ` 5 crores. It is
observed that the opinion of the advocate was inconsistent with legal position with regard to
certain revenue items.
(i) A misstatement had occurred in the prospectus issued by the company.
Damages for negligence: Civil liability for mis-statement in prospectus under section 35 of the
Companies Act, 2013, are:
(i) Where a person has subscribed for securities of a company acting on any statement
included, or the inclusion or omission of any matter, in the prospectus whic h is misleading
and has sustained any loss or damage as a consequence thereof, the company and every
person who—
(a) is a director of the company at the time of the issue of the prospectus;
(b) has authorized himself to be named and is named in the prospectus as a director of the
company or has agreed to become such director either immediately or after an interval of
time;
(c) is a promoter of the company;
(d) has authorised the issue of the prospectus; and
(e) is an expert referred to in sub-section (5) of section 26,

shall, without prejudice to any punishment to which any person may be liable under section 36, be
liable to pay compensation to every person who has sustained such loss or damage.
No person shall be liable under sub-section (1), if he proves—
✓ that, having consented to become a director of the company, he withdrew his consent
before the issue of the prospectus, and that it was issued without his authority or
consent; or
✓ that the prospectus was issued without his knowledge or consent, and that on
becoming aware of its issue, he forthwith gave a reasonable public notice that it was
issued without his knowledge or consent.
✓ that, as regards every misleading statement purported to be made by an expert or
contained in what purports to be a copy of or an extract from a report or valuation of
an expert, it was a correct and fair representation of the statement, or a correct copy
of, or a correct and fair extract from, the report or valuation; and he had reaso nable
ground to believe and did up to the time of the issue of the prospectus believe, that the
person making the statement was competent to make it and that the said person had
given the consent required by subsection (5) of section 26 to the issue of the
prospectus and had not withdrawn that consent before delivery of a copy of the
prospectus for registration or, to the defendant's knowledge, before allotment
thereunder.
Notwithstanding anything contained in this section, where it is proved that a prospectus has been
issued with intent to defraud the applicants for the securities of a company or any other person or for
any fraudulent purpose, every person referred to in subsection (1) shall be per sonally responsible,
without any limitation of liability, for all or any of the losses or damages that may have been incurred

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by any person who subscribed to the securities on the basis of such prospectus.
It may be noted that the term "expert” as defined in Section 2(38) of the Companies Act, 2013
includes an engineer, a valuer, a chartered accountant, a company secretary, a cost accountant and
any other person who has the power or authority to issue a certificate in pursuance of any law for the
time being in force. Also, under Section 26 of the Act a statement may be considered to be untrue,
not only because it is so but also if it is misleading in the form and context in which it is included.
The liability would arise if the written consent of the auditor to the issue of the prospectus, including
the report purporting to have been made by him as an "expert” has been obtained.
Criminal liability for Misstatement in Prospectus - As per Section 34 of the Companies Act, 2013,
where a prospectus issued, circulated or distributed includes any statement which is untrue or
misleading in form or context in which it is included or where any inclusion or omission of any matter
is likely to mislead, every person who authorises the issue of such prospectus shall be liable under
section 447.
This section shall not apply to a person if he proves that such statement or omission was immaterial
or that he had reasonable grounds to believe, and did up to the time of issu e of the prospectus
believe, that the statement was true or the inclusion or omission was necessary.

(ii) In the given case, certain weaknesses in the internal control procedure in the payment of wages in a
large construction company were noticed by the statutory auditor & brought the same to the knowledge
of the Managing Director of the company. In the subsequent year, a huge defalcation took place, the
ramification of which stretched to the earlier year. The management of the company desires to sue the
statutory auditor for negligence. The precise nature of auditor's liability in the case can be ascertained on
the basis of the under noted considerations:
(a) Whether the defalcation emanated from the weaknesses noticed by the statutory auditor, the
information regarding which was passed on to the management; &
(b) Whether the statutory auditor properly & adequately extended the audit programme of the previous
year having regard to the weaknesses noticed.
SA 265 on “Communicating Deficiencies in Internal Control to Those Charged with Governance &
Management” clearly mentions that, “The auditor shall determine whether, on the basis of the audit work
performed, the auditor has identified one or more deficiencies in internal control. If the auditor has identified
one or more deficiencies in internal control, the auditor shall determine, on the basis of the audit work
performed, whether, individually or in combination, they constitute significant deficiencies. The auditor shall
communicate in writing significant deficiencies in internal control identified during the audit to those charged
with governance on a timely basis. The auditor shall also communicate to management at an appropriate
level of responsibility on a timely basis”. The fact, however, remains that, weaknesses in the design of the
internal control system & non-compliance with identified control procedures increase the risk of fraud or
error. If circumstances indicate the possible existence of fraud or error, the auditor should consider the
potential effect of the suspected fraud or error on the financial information. If the auditor believes the
suspected fraud or error could have a material effect on the financial information, he should perform such
modified or additional procedures as he determines to be appropriate. Thus, normally speaking, as long as
the auditor took due care in performing the audit work, he cannot be held liable.
The fact that the matter was brought to the notice of the managing director may be a good defence
for the auditor as well. According to the judgement of the classic case in re Kingston Cotton Mills Ltd.,
(1896) it is the duty of the auditor to probe into the depth only when his suspicion is aroused. The
statutory auditor, by bringing the weakness to the notice of the managing director had alerted the
management which is judicially held to be primarily responsible for protection of the assets of the
company & can put forth this as defence against any claim arising subsequent to passing of the
information to the management. In a similar case S.P. Catterson & Sons Ltd. (81 Acct. L. R.68), the
auditor was acquitted of the charge.

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(iii) SA 500 on "Audit Evidence" discusses the auditor's responsibility in relation to & the procedures the
auditor should consider in, using the work of an expert as audit evidence. During the audit, the
auditor may seek to obtain, in conjunction with the client or independently, audit evidence in the
form of reports, opinions, valuations & statements of an expert, e.g., legal opinions concerning
interpretations of agreements, statutes, regulations, notifications, circulars, etc. Before relying on
advocate's opinion, the auditor should have seen that opinion given by the expert is prima facie
dependable. The question states very clearly that the opinion of the advocate was inconsistent with
legal position with regard to certain items. It is, perhaps, quite possible that auditor did not seek
reasonable assurance as to the appropriateness of the source data, assumptions & methods used by
the expert properly.
In fact, SA 500 makes it incumbent upon the part of the auditor to resolve the inconsistency by
discussion with the management & the expert. In case, the experts' work does not support the related
representation in the financial information the inconsistency in legal opinions could have been
detected by the auditor if he had gone through the same. This seems apparent having regard to wide
difference in the liability worked out by the assessing authority. Under the circumstance, the auditor
should have rejected the opinion & insisted upon making proper provision.
Q. 2 Write a short note on - Auditor’s liability in case of unlawful acts or defaults by clients.
Auditor's liability in case of unlawful Acts or defaults by clients: The auditor's basic responsibility is to report
whether in his opinion the accounts show a true & fair view & in discharging his responsibility he has to see as
to how the particular situations affected his position. The general thinking with regard to unlawful acts or
defaults by clients appears to be that the auditor should not 'aid or abet' but he is apparently not under any
legal obligation to disclose the offence. A professional accountant would himself be guilty of a criminal
offence if he advises his client to commit any criminal offence or helps or encourages in planning or execution
of the same or conceals or destroys evidence to obstruct the course of public justice or positively assists his
client in evading prosecution. A professional accountant in his capacity as auditor, accountant, or tax
representative has access to a variety of information concerning his clients. On some occasions, he may
acquire knowledge that his client has been guilty of some unlawful act, default, fraud, or other criminal
offence. The duty of the professional accountant in such a case would depend upon the actual circumstances
of the situation. Due consideration should be given to the exact nature of services that a professional
accountant is rendering to his client, i.e. is he representing the client in income-tax proceedings or is he acting
in the capacity of an auditor or an accountant or a consultant.
The ICAI has considered the role of chartered accountants in relation to taxation frauds by an assessee &
has made the following major recommendations:
(i) A professional accountant should keep in mind the provisions of Section 126 of the Evidence Act
whereby a barrister, an attorney, a pleader or a Vakil is barred from disclosing any communication made
to him in the course of & for the purpose of his employment.
(ii) If the fraud relates to past years when the accountant did not represent the client, the client should be
advised to make a disclosure. The accountant should also be careful that the past fraud does not in any
way affect the current tax matters.
(iii) In case of fraud relating to accounts examined & reported upon by the professional accountant himself,
he should advise the client to make a complete disclosure. In case the client refuses to do so, the
accountant should inform him that he is entitled to dissociate himself from the case & that he would
make a report to the authorities that the accounts prepared or examined by him are unreliable on
account of certain information obtained later. In making such a report, the contents of the information
as such should not be communicated unless the client consents in writing.
(iv) In case of suppression in current accounts, the client should be asked to make a full disclosure. If he
refuses to do so, the accountant should make a complete reservation in his report & should not associate
himself with the return.
However, it can be argued that the auditor has a professional obligation to ensure that the client is fully

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aware of the seriousness of the offence & to seriously consider full disclosure of the matter.
It has been clearly established in various case laws that the auditor is expected to know the contents of
documents & records & ascertain whether the affairs of the client are being conducted in an unlawful
manner. It is in the course of the work, he comes across any unlawful acts, it is his duty to bring it to the
notice of the client as also to make a disclosure in his report in appropriate cases. In this regard, one has to
bear in mind the consequence of the act in relation to the professional code to which an auditor is subjected.
Under the code, an auditor cannot disclose confidential information unless permitted by the client or unless
required by law. Each case has to be judged on its circumstances. However, in every case he has to assess the
implications of the unlawful act or default on the true & fair character of the accounting statements.
The question of liability of an auditor for unlawful acts or defaults by clients should be considered in the light
of the broad parameters given above. However, it appears that if an auditor was aware of any unlawful act
having been committed by client in respect of accounts audited by him & the unlawfulness was not rectified
by proper disclosure or any other appropriate means, the auditor owes a duty to make a suitable report. If he
does not, he may be held liable, if the true & fair character of the accounts has been vitiated.
Q. 3 Explain briefly duties & responsibilities of an auditor in case of material misstatement resulting from
Management Fraud.
Duties & Responsibilities of an Auditor in case of Material Misstatement resulting from Management
Fraud: Misstatement in the financial statements can arise from fraud or error. The term fraud refers to an
‘Intentional Act’ by one or more individuals among management, those charged with governance. The auditor
is concerned with fraudulent acts that cause a material misstatement in the financial statements.
As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”,
fraud can be committed by management overriding controls using such techniques as engaging in complex
transactions that are structured to misrepresent the financial position or financial performance of the entity.
Fraud involving one or more members of management or those charged with the governance is referred to as
“management fraud”. The primary responsibility for the prevention & detection of fraud rests with those
charged with the governance & the management of the entity.
Further, an auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable
assurance that the financial statements taken as a whole are free from material misstatement, whether
caused by fraud or error. Owing to the inherent limitations of an audit, there is an unavoidable risk that some
material misstatements of the financial statements may not be detected, even though the audit is properly
planned & performed in accordance with the SAs.
The risk of the auditor not detecting a material misstatement resulting from management fraud is greater
than for employee fraud, because management is frequently in a position to directly or indirectly manipulate
accounting records, present fraudulent financial information or override control procedures designed to
prevent similar frauds by other employees
Auditor’s opinion on the financial statements is based on the concept of obtaining reasonable assurance,
hence in an audit, the auditor does not guarantee that material misstatements will be detected.
Further, as per section 143(12) of the Companies Act, 2013, if an auditor of a company, in the course of the
performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount(s)
as may be prescribed, is being or has been committed in the co. by its officers or employees, the auditor shall
report the matter to the Central Government (in case amount of fraud is ` 1 crore or above)or Audit
Committee or Board in other cases (in case the amount of fraud involved is less than ` 1 crore) within such
time & in such manner as may be prescribed.
The auditor is also required to report as per Clause (xi) of Paragraph 3 of CARO, 2020, Whether any fraud by
the company or any fraud on the company has been noticed or reported during the year; If yes, the nature &
the amount involved is to be indicated.
If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters exceptional
circumstances that bring into question the auditor’s ability to continue performing the audit, the auditor
shall:
(i) Determine the professional & legal responsibilities applicable in the circumstances, including whether

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there is a requirement for the auditor to report to the person or persons who made the audit
appointment or, in some cases, to regulatory authorities;
(ii) Consider whether it is appropriate to withdraw from the engagement, where withdrawal from the
engagement is legally permitted; &
(iii) If the auditor withdraws:
(1) Discuss with the appropriate level of management & those charged with governance, the auditor’s
withdrawal from the engagement & the reasons for the withdrawal; &
(2) Determine whether there is a professional or legal requirement to report to the person or persons
who made the audit appointment or, in some cases, to regulatory authorities, the auditor’s
withdrawal from the engagement & the reasons for the withdrawal.
Q. 4 In assessment procedure of M/s Cloud Ltd., Income Tax Officer observed some irregularities.
Therefore, he started investigation of Books of Accounts audited & signed by Mr. Old, a practicing
Chartered Accountant. While going through books he found that M/s Cloud Ltd. used to maintain two sets
of Books of Accounts, one is the official set & other is covering all the transactions. Income Tax Department
filed a complaint with the ICAI saying Mr. Old had negligently performed his duties. Comment.
Liability of Auditor: “It is the auditor’s responsibility to audit the statement of accounts & prepare tax returns
on the basis of books of accounts produced before him. Also if he is satisfied with the books & documents
produced to him, he can give his opinion on the basis of those documents only by exercising requisite skill &
care & observing the laid down audit procedure.
In the instant case, Income tax Officer observed some irregularities during the assessment proceeding of M/s
Cloud Ltd. Therefore, he started investigation of books of accounts audited & signed by Mr. Old, a practicing
Chartered Accountant. While going through the books, he found that M/s Cloud Ltd. Used to maintain two
sets of Books of Accounts, one is the official set & other is covering all the transactions. Income Tax
Department filed a complaint with the ICAI saying Mr. Old had negligently performed his duties.
Mr. Old, the auditor was not under a duty to prepare books of accounts of assessee & he should, of course,
neither suggest nor assist in the preparations of false accounts. He is responsible for the books produced
before him for audit. He completed his audit work with official set of books only.
In this situation, as Mr. Old, performed the auditing with due skill & diligence; &, therefore, no question of
negligence arises. It is the duty of the Department to himself investigate the truth & correctness of the
accounts of the assessee.
Q. 5 Mr. Fresh, a newly qualified chartered accountant, wants to start practice & he requires your advice,
among other things, on criminal liabilities of an auditor under the Companies Act, 2013. Kindly guide him.
CRIMINAL LIABILITY UNDER THE COMPANIES ACT
The circumstances in which an auditor can be prosecuted under the Companies Act, & the penalties to which
he may be subjected are briefly stated below:
(i) Criminal liability for Misstatement in Prospectus - As per Section 34 of the Companies Act, 2013, where
a prospectus issued, circulated or distributed includes any statement which is untrue or misleading in
form or context in which it is included or where any inclusion or omission of any matter is likely to
mislead, every person who authorises the issue of such prospectus shall be liable u/s 447.
This section shall not apply to a person if he proves that such statement or omission was immaterial or
that he had reasonable grounds to believe, & did up to the time of issue of the prospectus believe, that
the statement was true or the inclusion or omission was necessary.
(ii) Punishment for false statement - According to Section 448 of the Companies Act, 2013 if in any return,
report, certificate, financial statement, prospectus, statement or other document required by, or for, the
purposes of any of the provisions of this Act or the rules made thereunder, any person makes a
statement —
(a) which is false in any material particulars, knowing it to be false; or
(b) which omits any material fact, knowing it to be material,
he shall be liable u/s 447.

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Punishment for Fraud- As per Section 447 of the Companies Act, 2013, without prejudice to any liability
including repayment of any debt under this Act or any other law for the time being in force, any person who
is found to be guilty of fraud [involving an amount of at least ten lakh rupees or one percent of the turnover
of the company, whichever is lower] shall be punishable with imprisonment for a term which shall not be less
than six months but which may extend to ten years & shall also be liable to fine which shall not be less than
the amount involved in the fraud, but which may extend to three times the amount involved in the fraud:
It may be noted that where the fraud in question involves public interest, the term of imprisonment shall not
be less than three years.
It may also be noted that where the fraud involves an amount less than ten lakh rupees or one percent of the
turnover of the company, whichever is lower, & does not involve public interest, any person guilty of such
fraud shall be punishable with imprisonment for a term which may extend to five years or with fine which
may extend to fifty lakh rupees or with both.]
Explanation — For the purposes of this section—
(i) “fraud” in relation to affairs of a company or any body corporate, includes any act, omission,
concealment of any fact or abuse of position committed by any person or any other person with the
connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the
interests of, the company or its shareholders or its creditors or any other person, whether or not there is
any wrongful gain or wrongful loss;
(ii) “wrongful gain” means the gain by unlawful means of property to which the person gaining is not legally
entitled;
(iii) “wrongful loss” means the loss by unlawful means of property to which the person losing is legally
entitled.
Direction by Tribunal in case auditor acted in a fraudulent manner: As per sub-section (5) of the section 140,
the Tribunal either suo motu or on an application made to it by the Central Government or by any person
concerned, if it is satisfied that the auditor of a company has, whether directly or indirectly, acted in a
fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or
officers, it may, by order, direct the company to change its auditors.
However, if the application is made by the Central Government & the Tribunal is satisfied that any change of
the auditor is required, it shall within fifteen days of receipt of such application, make an order that he shall
not function as an auditor & the Central Government may appoint another auditor in his place.
It may be noted that an auditor, whether individual or firm, against whom final order has been passed by the
Tribunal under this section shall not be eligible to be appointed as an auditor of any company for a period of
five years from the date of passing of the order & the auditor shall also be liable for action u/s 447.
It is hereby clarified that the case of a firm, the liability shall be of the firm & that of every partner or partners
who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its
director or officers.
Q. 6 On the advice of Management of Quick Ltd., the auditor of the Company overlooked & did not report
on shifting of certain current year's sales transactions to the next year. The National Company Law Tribunal
(NCLT) wants to take action against the auditor. Describe the powers of the NCLT u/s 140(5) of the
Companies Act, 2013 for such action & consequences for the auditor.
Direction by Tribunal in case auditor acted in a fraudulent manner: As per sub-section (5) of the section 140,
the Tribunal either suo motu or on an application made to it by the Central Government or by any person
concerned, if it is satisfied that the auditor of a company has, whether directly or indirectly, acted in a
fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or
officers, it may, by order, direct the company to change its auditors.
However, if the application is made by the Central Government & the Tribunal is satisfied that any change of
the auditor is required, it shall within fifteen days of receipt of such application, make an order that he shall
not function as an auditor & the Central Government may appoint another auditor in his place.
It may be noted that an auditor, whether individual or firm, against whom final order has been passed by the
Tribunal under this section shall not be eligible to be appointed as an auditor of any company for a period of

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five years from the date of passing of the order & the auditor shall also be liable for action u/s 447.
It is hereby clarified that the case of a firm, the liability shall be of the firm & that of every partner or partners
who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its
director or officers.
Q. 7 State the nature of liability as provided in the Companies Act, 2013 for an auditor for not appropriately
dealing with a misstatement appearing in audited financial statements or a false statement in Audit
Report.
U/s 448 of the Companies Act, 2013, an auditor is liable for criminal prosecution, if he, in any return, report,
certificate, financial statement, prospectus, statement or other document required by, or for, the purposes of
any of the provisions of this Act or the rules made thereunder, makes a statement (a) which is false in any
material particular knowing it to be false; or (b) which omits any material fact knowing it to be material.
If convicted, he can be punished with imprisonment & also with fine as provided u/s 447 of the said Act.
Thus, in view of above, an auditor will be held liable for criminal prosecution for not appropriately dealing
with a misstatement appearing in audited financial statements or a false statement in Audit Report assuming
that it was known to auditor.
Q. 8 The Auditor of M/s Quick Limited succumbed to the pressure of the management in Certifying the
Financials with an over stated figure of turnover by not adhering to the cut-off principles of the time scale
for the transactions of the year. On taking cognizance of this act of the Auditor, the Tribunal under the
Companies Act, 2013 initiated the proceedings against him. Briefly list the powers of the Tribunal in this
respect including those relating to making orders against the Auditor found to be guilty.
Direction by Tribunal in case auditor acted in a fraudulent manner: As per section 140(5), the Tribunal either
suo motu or on an application made to it by the CG or by any person concerned, if it is satisfied that the
auditor of a company has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded
in any fraud by, or in relation to, the company or its directors or officers, it may, by order, direct the company
to change its auditors.
However, if the application is made by the Central Government & the Tribunal is satisfied that any change of
the auditor is required, it shall within fifteen days of receipt of such application, make an order that he shall
not function as an auditor & the Central Government may appoint another auditor in his place.
It may be noted that an auditor, whether individual or firm, against whom final order has been passed by the
Tribunal under this section shall not be eligible to be appointed as an auditor of any company for a period of
five years from the date of passing of the order & the auditor shall also be liable for action u/s 447.
It is hereby clarified that the case of a firm, the liability shall be of the firm & that of every partner or partners
who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its
director or officers.
Q. 9 CA Prince, a Chartered Accountant has appeared before the Income Tax Authorities as the authorized
representative of his client & delivers to the Income Tax Authorities a false declaration. What are the
liabilities of CA. Prince under Income Tax Act, 1961?
False Declaration as Authorized Representative: In connection with proceedings under the Income Tax Act
1961, a Chartered Accountant often acts as the authorised representative of his clients & attends before an
Income Tax Authority or the appellate tribunal.
Any person who acts or induces, in any manner another person to make & deliver to the Income Tax
Authorities a false account, statement, or declaration, relating to any income chargeable to tax which he
knows to be false or does not believe to be true will be liable u/s 278 of the Income Tax Act 1961.
Further, in case of submission of any information which is false & which the Chartered Accountant either
knows or believes to be false or untrue, he would be liable to rigorous imprisonment which may extend to
seven years (in other cases two years) &/or to a fine.
In the instant case, Mr. Prince, a chartered accountant has appeared before the Income Tax Authorities as the
authorized representative of his client & delivered a false declaration, thus, he would be liable u/s 278 of the
Income Tax Act, 1961.

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CH – 15
INTERNAL AUDIT, MANAGEMENT
AUDIT & OPERATIONAL AUDIT
Q. 11 The Managing Director of X Ltd is concerned about high employee attrition rate in his company. As the
internal auditor of the company he requests you to analyze the causes for the same. What factors would you
consider in such analysis?
The factors responsible for high employee attrition rate are as under:
(i) Job Stress & work life imbalance;
(ii) Wrong policies of the Management;
(iii) Unbearable behaviour of Senior Staff;
(iv) Safety factors;
(v) Limited opportunities for promotion;
(vi) Low monetary benefits;
(vii) Lack of labour welfare schemes;
(viii) Whether the organization has properly qualified & experienced personnel for the various levels of
works?
(ix) Is the number of people employed at various work centres excessive or inadequate?
(x) Does the organization provide facilities for staff training so that employees & workers keep themselves
abreast of current techniques & practices?
Q. 2 XYZ, a manufacturing unit does not accept the recommendations for improvements made by the
Operational Auditor. Suggest an alternative way to tackle hostile management.
Alternative Way to Tackle the Hostile Management: While conducting the operational audit the auditor has to
come across many irregularities & areas where improvement can be made & therefore he gives his suggestions
& recommendations.
These suggestions & recommendations for improvements may not be accepted by the hostile managers & in
effect there may be cold war between the operational auditor & the managers.
This would defeat the very purpose of the operational audit.
The Participative Approach comes to the help of the auditor. In this approach the auditor discusses the ideas
for improvements with those managers that have to implement them & make them feel that they have
participated in the recommendations made for improvements. By soliciting the views of the operating
personnel, the operational audit becomes a co-operative enterprise.
This participative approach encourages the auditee to develop a friendly attitude towards the auditors & look
forward to their guidance in a more receptive fashion. When the participative
method is adopted then the resistance to change becomes minimal, feelings of hostility disappear & gives room
for feelings of mutual trust. Team spirit is developed. The auditors & the auditee together try to achieve the
common goal. The proposed recommendations are discussed with the auditee & modifications as may be
agreed upon are incorporated in the operational audit report.
With this attitude of the auditor, it becomes absolutely easy to implement the proposed suggestions as the
auditee themselves take initiative for implementing & the auditor does not have to force any change on the
auditee.
Hence, the Operational Auditor of XYZ manufacturing unit should adopt the above mentioned participative
approach to tackle the hostile management of XYZ.
Q. 3 Write a short note on Summary Written Report.
Summary written reports - These summary reports are also referred to as ‘flash’ reports’. In a number of
companies, the practice has developed of issuing an annual (or sometimes more frequent) report summarising
the various individual reports issued & describing the range of their content. These summary reports in some

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cases are primarily for audit committees of Boards of Directors, but in other cases for higher level
management. They are especially useful to top level managers who do not actively review the individual
reports. They are also useful to the general auditor in seeing his total reporting effort with more perspective &
on an integrated basis.
Q. 4 State the important aspects to be considered by the External auditor in the evaluation of the Internal
Audit Function.
Evaluation of Internal Audit Functions by External Auditor: The external auditor’s general evaluation of the
internal audit function will assist him in determining the extent to which he can place reliance upon the work of
the internal auditor. The external auditor should document his evaluation & conclusions in this respect. The
important aspects to be considered in this context are:
a) Organisational Status - Whether internal audit is undertaken by an outside agency or by an internal audit
department within the entity itself, the internal auditor reports to the management. In an ideal situation,
his reports to the highest level of management & are free of any other operating responsibility. Any
constraints or restrictions placed upon his work by management should be carefully evaluated. In
particular, the internal auditor should be free to communicate fully with the external auditor.
b) Scope of Function - The external auditor should ascertain the nature & depth of coverage of the assignment
which the internal auditor discharges for management. He should also ascertain to what extent the
management considers, & where appropriate, acts upon internal audit recommendations.
c) Technical Competence - The external auditor should ascertain that internal audit work is performed by
persons having adequate technical training & proficiency. This may be accomplished by reviewing the
experience & professional qualifications of the persons undertaking the internal audit work.
d) Due Professional Care - The external auditor should ascertain whether internal audit work appears to be
properly planned, supervised, reviewed & documented. An example of the exercise of due professional care
by the internal auditor is the existence of adequate audit manuals, audit programmes & working papers.
Q. 5 AB Pvt. Ltd. company has outstanding loans or borrowings from banks exceeding one hundred crore
rupees wants to appoint an internal auditor. Please guide him for the applicability of the same & who can be
appointed as an internal auditor & what work would be reviewed by him.
Applicability of Internal Audit: Section 138 of the Companies Act, 2013 states that every private limited
company is required to conduct internal audit if its outstanding loans or borrowings from banks or public
financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding
financial year. In view of above provisions, AB Pvt. Ltd. is under compulsion to conduct internal audit as its
loans or borrowings are falling under the prescribed limit.
Who can be appointed as Internal Auditor- The internal auditor shall either be a chartered accountant or a
cost accountant, whether engaged in practice or not, or such other professional as may be decided by the
Board to conduct internal audit of the functions & activities of the companies. The internal auditor may or may
not be an employee of the company.
Work to be reviewed by Internal Auditor-
✓ to maintain an adequate system of internal control by a continuous examination of accounting procedures,
receipts and disbursements, and to provide adequate safeguards against misappropriation of assets.
✓ to operate independently of the accounting staff and must not in any way divest with any of the
responsibilities placed upon him.
✓ Not to involve in the performance of executive functions in order that the objective outlook does not get
obscured by the creation of the vested interest.
✓ to observe facts and situations and bring them to notice of authorities who would otherwise never know
them; also, critically appraise various policies of the management and draw its attention to any deficiencies,
wherever these require to be corrected.
✓ to associate closely with management and keep knowledge up to date by being informed about all
important occurrences and events affecting the business, as well as the changes that are made in business
policies.

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✓ At all times, the internal auditor must enjoy an independent status.

Q. 6 The main objective of operational auditing is to verify the fulfillment of plans, & sound business
requirements while in financial auditing, the concentration is more in the financial & accounting areas to
ensure that possibilities of loss, wastage & fraud are minimized or removed. Analyze & explain stating clearly
major differences between Financial & Operational Auditing.
Differences between Financial & Operational Auditing - The major differences between financial & operational
auditing can be described as follows:
(i) Purpose - The financial auditing is concerned with the opinion that whether the historical information
recorded is correct or not, whereas the operational auditing emphasizes on effectiveness & efficiency of
operations for future performance.
(ii) Area - Financial audits are restricted to the matters directly affecting the appropriateness of the presented
financial statements but the operational auditing covers all the activities that are related to the efficiency &
effectiveness of operations directed towards accomplishment of objectives of organization.
(iii) Reporting -The financial audit report is sent to all stockholders, bankers & other persons having a stake in
the Organisation. However, the operational audit report is primarily for the management.
(iv) End Task - The financial audit has to report the findings to the persons getting the report as its end
objective, however, the operational auditing is not limited to reporting only but includes suggestions for
improvement also.
Q. 7 Moon Ltd. of which you are the Statutory Auditor, have an internal audit being conducted by an outside
agency. State the factors that weigh considerations in opting to make use of direct assistance of the internal
auditors for the purpose of statutory audit.
Determining the Nature & Extent of Work of the Internal Audit Function that Can Be Used The external
auditor shall not use the work of the internal audit function if the external auditor determines that the
function’s organizational status & relevant policies & procedures do not adequately support the objectivity of
internal auditors; the function lacks sufficient competence or the function does not apply a systematic &
disciplined approach, including quality control.

Q. 8 The Operational Audit is carried out effectively when the Operational Auditor responds with positive
traits in a scenario that is blended with behavioural issues. Explain a few positive traits that help to conclude
an Operational Audit, a success
Positive Traits that help to conclude an Operation Audit A success:
Qualities of Operational Auditor
The operational auditor should possess some very essential personal qualities to be effective in his work:
1. In areas beyond accounting & finance, his knowledge ordinarily would be rather scanty & this is a reason
which should make him even more inquisitive.
2. He should ask the who, why, how of everything. He should try to visualise whether simpler alternative

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means are available to do a particular work.

3. He should try to see everything as to whether that properly fits in the business frame & organisational
policy. He should be persistent & should possess an attitude of skepticism.
4. He should imbibe a collaborative & constructive approach rather than a fault-finding approach & should
give a feeling that his efforts are to help to attain an improved operation & not merely fault finding.
5. If the auditor succeeds in giving a feeling of help & assistance through constructive criticism, he will be able
to obtain the co-operation of the persons who are involved in the operations. This will itself be a
tremendous achievement of the operational auditor. He should try to develop a team comprised of people
of different backgrounds. The involvement of technical people in operational auditing is generally helpful.
Q. 9
a) Perfect Steel Ltd. has reported a higher turnover of ` 560 crores in the year 2019- as compared to earlier
years but its sales return has also increased to 10% from only 4% up to the last year. The management is
concerned about the high sales returns & feels a need to get the operational audit done for sales &
production department of the company. The company is also having an internal audit department in the
company. Elaborate the possible reason/s, why management is getting the operational audit done when
an internal audit has already been done for both the departments?
b) You are also required to discuss the difference in the approach of both these audits.
(a) Why Operational Audit?:
Why Operational Audit?
The need for operational auditing has arisen due to the inadequacy of traditional sources of information for
effective management of the company where the management is at a distance from actual operations due to
layers of the delegation of responsibility, separating it from actualities in the organisation.
An operational audit is considered as a specialised management information tool to fill the void that
conventional information sources fail to fill. Conventional sources of management information are
departmental managers, routine performance reports, internal audit reports, & periodic special investigation &
survey. These conventional sources fail to provide information for the best direction of the departments all of
whose activities do not come under direct observation of managers.
The shortcomings of these sources can be stated as under:
(i) Executives & managers are too preoccupied with the implementation of plans & achieving of targets &
may be out of touch with the bigger picture including the inter-connectedness of their tasks with the
overall objectives of the organisation. Further, they may be left with very little time to collect information
& locate problems. They may even come across problems that have come to surface but hardly aware of
the problems that are brewing & potential while actually performing their day-to-day activities.
(ii) Managers or their aides are generally relied upon for transmitting information rather than for booking for
information or for analysing the situations.
(iii) The information that is transmitted by managers is not necessarily objective - often it may be biased for
various reasons.
(iv) Conventional internal audit reports are often routine & mechanical in character & have a definite leaning
towards accounting & financial information. They are also historical in nature.
(v) Other performance reports contained in the annual audited accounts & the routine reports prepared by
the operating departments have their own limitations. The annual audited accounts are good as far as an
overall true & fair evaluation of the financial statements are concerned.
Another important point may be noticed in the matter of routine departmental reports. The busy
management people, who can afford time only to glance over the performance reports, cannot be
expected to make an integrated reading of several reports or to undertake an analysis of such reports.
What they need is a reliable, unmanipulated & objective report which they would like to look into to

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understand the situation.

(vi) Operations of controls in a satisfactory manner cannot be relied upon to bring to light the environmental
conditions. Controls are specific & their satisfactory operation is related to the specific situation under
control. Also, monitoring the breakdown or non-operation of controls is a periodic activity.
(vii) Surveys & special investigations, no doubt, are very useful but these are occasional in character. Also, they
are costly, time consuming & keep the departmental key personnel busy during the period the operations
are on. These are basically an attempt to carry out a post-mortem rather than continuous improvement
efforts or a system to give signals for potential risks (dangers & disasters to come).
(b) Relationship between Internal Auditing & Operational Auditing
Internal auditing is an independent appraisal activity within an organisation for the review of operations as a
service to organisation. When an auditor is concerned with the appraisal of operations, he becomes an
operational auditor. According to the Institute of Internal Auditors, “the overall objective of internal auditing is
to assist all members of management in the objective discharge of their responsibilities, by furnishing them
with objective analysis, appraisals, recommendations & pertinent comments, concerning the activities
reviewed.”
Internal auditors may act as operational auditors when the objective is the deep-dive analysis of operations
only.
Difference between Internal & Operational Audit: There probably may not be much difference in
viewing operational audit as a review & appraisal of operations of an organisation carried on by a competent
independent person. Auditing whether carried on by internal staff or by an external person should necessarily
be an independent activity to maintain its objectivity & usefulness.
The difference in the approach of both these audits is illustrated below:
1. Perception - Traditionally, internal auditors have been engaged in a sort of protective function, deriving
their authority from the management. They view & examine internal controls in the financial & accounting
areas to ensure that possibilities of loss, wastage & fraud are not there; they check the accounting books &
records to see, whether the internal checks are properly working & the resulting accounting data are
reliable.
Also, the internal auditor will review the operational control on cash to determine whether maximum
possible protection has been given to cash. Similarly, in the audit of stocks, matters such as reorder policy,
obsolescence policy & the overall inventory management policy will be considered. In pure administrative
areas on stock, whether the adequate security & insurance arrangements exist for the protection of stocks
would also be considered.
2. Issues - The basic difference that exists in conceptualisation of the technique of operational auditing is in
the auditor’s role in recommending corrections or in installing systems & controls. According to the IIA, “the
internal auditor should be free to review & appraise policies, plans, procedures & records; but his review &
appraisal does not in any way relieve other persons in the organisation of the responsibilities assigned to
them. ” However, a further distinction should be observed between traditional internal auditing &
operational auditing - this lies in the attitude & approach to the whole auditing proposition. Every aspect of
the operational auditing programme should be geared to management policies, management objectives &
management goals.
3. Objectives - The main objective of operational auditing is to verify the fulfillment of plans & sound business
requirements as also to focus on objectives & their achievement objectives; the operational auditor should
not only have a proper business sense, he should also be equipped with a thorough knowledge of policies,
procedures, systems & controls, he should be intimately familiar with the business, its nature & problems &
prospects & its environment. Above all, his mind should be open & active so as to be able to perceive
problems & prospects & grasp technical matters. In carrying out his work probably at every step he will
have to exercise judgement to evaluate evidence in connection with the situations & issues. The norms &
standards should be such as are generally acceptable or developed by the company itself. Performance
yardsticks can be found in the management objectives, goals & plans, budgets, records of past
performance, policies & procedures. Industry standards can be obtained from the statistics provided by the

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industry associations & government sources. It should be appreciated that the standards may be relative
depending upon the situation & circumstances; the operational auditor may have to apply them with
suitable adjustments.
Today, however, the concept of modern internal auditing suggests that there is no difference in internal &
operational auditing. In fact, the scope of internal auditing is broad enough to embrace the areas covered
by operational auditing as well. The modern internal auditing performs both protective as well as
constructive functions.
Q. 10 Mr. A is appointed as a statutory auditor of XYZ Ltd. XYZ Ltd is required to appoint an internal auditor
as per statutory provisions given in the Companies Act, 2013 & appointed Mr. B as its internal auditor. The
external auditor Mr. A asked internal auditor to provide direct assistance to him regarding evaluating
significant accounting estimates by the management & assessing the risk of material misstatements.
a) Discuss whether Mr. A, statutory auditor, can ask direct assistance from Mr. B, internal auditor as stated
above in view of auditing standards.
b) Will your answer be different if Mr. A asks direct assistance from Mr. B, internal auditor with respect to
external confirmation requests & evaluation of the results of external confirmation procedures?
(a) Direct Assistance from Internal Auditor: As per SA 610 “Using the Work of Internal Auditor”, the external
auditor shall not use internal auditors to provide direct assistance to perform procedures that Involve
making significant judgments in the audit. Since the external auditor has sole responsibility for the audit
opinion expressed, the external auditor needs to make the significant judgments in the audit engagement.
Significant judgments include the following:
▪ Assessing the risks of material misstatement;
▪ Evaluating the sufficiency of tests performed;
▪ Evaluating the appropriateness of management’s use of the going concern assumption;
▪ Evaluating significant accounting estimates; &
▪ Evaluating the adequacy of disclosures in the financial statements, & other matters affecting the
auditor’s report.
In view of above, Mr. A cannot ask direct assistance from internal auditors regarding evaluating significant
accounting estimates & assessing the risk of material misstatements.
(b) Direct Assistance from Internal Auditor in case of External Confirmation Procedures: SA 610 “Using the
Work of Internal Auditor”, provide relevant guidance in determining the nature & extent of work that may
be assigned to internal auditors. In determining the nature of work that may be assigned to internal
auditors, the external auditor is careful to limit such work to those areas that would be appropriate to be
assigned. Further, in accordance with SA 505, “External Confirmation” the external auditor is required to
maintain control over external confirmation requests & evaluate the results of external confirmation
procedures, it would not be appropriate to assign these responsibilities to internal auditors. However,
internal auditors may assist in assembling information necessary for the external auditor to resolve
exceptions in confirmation responses.
Q. 11 M/s ABC & Co., Chartered Accountants have been approached by PQR Ltd., a company engaged in iron
& steel manufacturing industry. The company has been facing following operational issues:
(a) Penal interest for delayed payments to the overseas vendors despite having enough cash flows; &
(b) Despite having regular production & enough inventory, delays in shipping the final goods to the
customers leading to its deteriorating vendor rating.
As a partner of M/s ABC & Co., through detailed discussion with the Senior Manager of PQR Ltd., you have
concluded that all these delays are because of long decision-making cycles in the company. As a consultant to
the Company, would you recommend Management Audit or Operational Audit?
A comparison between the Management Audit & the Operational Audit is as follows:
Management audit is concerned with the “Quality of managing”, whereas operational audit focuses on the
“Quality of operations”.
Management audit is the “Audit of management” while the operational audit is the “Audit for the

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management”. The focus of Management Audit is on “Quality of Decision Making” rather than the
effectiveness or efficiency of operations.
The basic difference between the two audits, then, is not in method, but in the level of appraisal. In a
management audit, the auditor is to make his tests to the level of top management, its formulation of
objectives, plans & policies & its decision making. It is not that he just verifies the operations of control &
procedures & fulfillment of plans in conformity with the prescribed policies.
Since, the delays in payments & consequent penal interest payments & the delays in shipping & the consequent
deteriorating vendor ratings are happening because of the delays in decision-making process of the
management. Therefore, it appears that this is not just an internal control or operational issue but an issue of
management process.
Therefore, management audit would be recommended in this case.
Q. 12 The PQR Ltd. has come across many instances where it could buy products at lesser cost than the actual
procurement price it paid. The management believes that the adequate purchase policy is in place including
the requirements of three quotations from registered vendors, appropriate vendor vetting & rating
mechanism, however, the on-ground implementation of the purchase policy might be defective. Further, it
has observed that there might be some employees involved in choosing the higher cost vendors as well. The
company approaches you to advise the type of audit it should get done: Management or Operational. Please
advise through a comparison between both the audits.
Since it is not the Management’s Decisions that are creating the operational bottlenecks. The Purchase Policy &
Procedure seem to be in place, the missing part is the operational implementation by the process employees.
Therefore, the Operational Audit is recommended in this case.
Q. 13 The Marketing Department of XYZ Ltd. has been consistently showing a lower performance whereas
the cost of the department is increasing in spurts over the years. The management believes that since the
marketing department is under a regular radar of the CFO, an audit might result in the employee hostility.
Also, an operational audit of Marketing Department was done two years back however, the
recommendations of the previous audit were not followed by the concerned employees. Please advise the
management if another audit is the solution & whether only one-time operational audit is enough? Further,
advise on the ways to deal with the employee hostility.
The Operational Audit is not one-time activity. It should be viewed as a continuous improvement cycle:

The continuous improvement cycle of Operational Audit can be depicted through Plan, Do, Check & Act
diagram.
All the significant operations must be subjected to the scrutiny of operational audit, at least, once in three
years. Therefore, the operational audit should be done in the current scenario. However, to deal with the
employee hostility the participative approach of the audit should be adopted:
In this approach the auditor discusses the ideas for improvements with those managers that have to implement
them & make them feel that they have participated in the recommendations made for improvements. By
soliciting the views of the operating personnel, the operational audit becomes a co-operative enterprise. This
participative approach encourages the auditee to develop a friendly attitude towards the auditors & look
forward to their guidance in a more receptive fashion. When the participative method is adopted then the

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resistance to change becomes minimal, feelings of hostility disappear & gives room for feelings of mutual trust.
Team spirit is developed. The auditors & the auditee together try to achieve the common goal. The proposed
recommendations are discussed with the auditee & modifications as may be agreed upon are incorporated in
the operational audit report. With this attitude of the auditor, it becomes absolutely easy to implement the
proposed suggestions as the auditee themselves take initiative for implementing & the auditor does not have
to force any change on the auditee.

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CH – 16
DUE DILIGENCE, INVESTIGATION
& FORENSIC AUDIT
Q. 1 : Sri Rajan is above 80 years old & wishes to sell his proprietary business of manufacture of specialty
chemicals. Ceta Ltd. wants to buy the business & appoints you to carry out a due diligence audit to decide
whether it would be worthwhile to acquire the business.
What procedures you would adopt before you could render any advice to Ceta Ltd.?
CLASSIFICATION OF DUE-DILIGENCE
Due Diligence can be sub-classified into discipline-wise exercises in following manner:
(i) Commercial/Operational Due Diligence: It is generally performed by the concerned acquire enterprise
involving an evaluation from commercial, strategic & operational perspectives. For example, whether
proposed merger would create operational synergies.
(ii) Financial Due Diligence: It involves analysis of the books of accounts & other information pertaining to
financial matters of the entity. It should be performed after completion of commercial due diligence.
(iii) Tax Due Diligence: It is a separate due diligence exercise but since it is an integral component of the
financial status of a company, it is generally included in the financial due diligence. The accountant has to
look at the tax effect of the merger or acquisition.
(v) Information Systems Due Diligence: It pertains to all computer systems & related matter of the entity.
(vi) Legal Due Diligence: This may be required where legal aspects of functioning of the entity are reviewed.
(vii) Environmental Due Diligence: It is carried out in order to study the entity’s environment, its flexibility &
adaptiveness to the acquirer entity.
(viii) Personnel Due Diligence: It is carried out to ascertain that the entity’s personnel policies are in line or
can be changed to suit the requirements of the restructuring.
FINANCIAL DUE DILIGENCE
At times, the financial due diligence review is interpreted as complete due diligence review since it is supposed
to ascertain the financial implications of all the other due diligence reviews. This is, however, not appropriate.
The term 'financial due diligence' should be used with caution. Unless the scope of financial due diligence to be
performed is wide enough to cover all the aspects, it should not be confused with overall due diligence review.
It can be understood from the foregoing that the role of financial due diligence commences only after a price
has been agreed for the business or a restructuring plan is framed. The initial price & other decisions are taken
on the basis of net worth as well as trend of profitability of the target company, with an assumption that all
contingent liabilities that may impact the future of the business have been recorded. The principal objective of
financial due diligence, therefore, is usually to look behind the veil of initial information provided by the
company & to assess the benefits & costs of the proposed acquisition/merger by inquiring into all relevant
aspects of the past, present & future of the business to be acquired/merged with.
In order to achieve its objective, the due diligence process can include any or all of the following objectives
for individual areas of the verification:
▪ Brief description of the history of business
▪ The background & standing of promoters
▪ Accounting policies & practices followed by the organization
▪ Management information systems
▪ Details of management structure
▪ Trading results both past & the recent past
▪ Assets & liabilities as per latest balance sheet
▪ Current status of Income tax assessments including appeals pending against tax liabilities assessed by tax
authority.

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▪ Cash flow patterns

▪ Brief description of commercial &/or other activities carried out by the organization
▪ The projection of future profitability
If a full-fledged financial due diligence is conducted, it would include the following matters, inter alia, in its
scope:
(a) Brief history of the target company & background (b) Accounting policies;
of its promoter;
(c) Review of financial statements; (d) Taxation;
(e) Cash flow; (f) Financial Projection;
(g) Management & employees; (h) Statutory Compliance.
i. Brief history of the target company & background of its promoters - The accountant should begin the
financial due diligence review by looking into the history of the company & the background of the
promoters.
The details of how the company was set up & who were the original promoters has to be gone into, before
verification of financial data in detail. An eye into the history of the target company may reveal its turning
points, survival strategies adopted by the target company from time to time, the market share enjoyed by
the target company & changes therein, product life cycle & adequacy of resources. It could also help the
accountant in determining whether, in the past, any regulatory requirements have had an impact on the
business of the target company. Broadly, the accountant should make relevant enquiries about the history
of target's business products, markets, suppliers, expenses, operations. This could, inter alia, include the
following:
▪ Nature of business(es)
▪ Location of production facilities, warehouses, offices.
▪ Employment
▪ Products or services & markets
▪ History of the business with important suppliers of goods & services
▪ Inventories
▪ Franchises, licenses, patents.
▪ Important expense categories.
▪ Research & development.
▪ Foreign currency assets, liabilities & transactions.
▪ Legislation & regulation that significantly affect the entity.
▪ Information systems.
ii. Accounting policies - The accountant should study the accounting policies being followed by the target
company & ascertain whether any accounting policy is inappropriate.
The accountant should also see the effects of the recent changes in the accounting policies. The target
company might have changed its accounting policies in the recent past keeping in view its intention of
offering itself for sale.
The overall scope has to be based on the accounting policies adopted by the management. The accountant
has to look at any material effect of accounting policies on the overall profitability & their correctness. It is
reiterated that the accountant should have a detailed look at all material changes in Accounting Policies in
the period subjected to review very carefully.
The accountant's report should include a summary of significant accounting policies used by the target
company, that changes that have been made to the accounting policies in the recent past, the areas in
which accounting policies followed by the target company are different from those adopted by the
acquiring enterprise, the effect of such differences.
iii. Review of Financial Statements - Before commencing the review of each of the aspect covered by the
financial statements, the accountant should examine whether the financial statements of the target

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company have been prepared in accordance with the Statute governing the target company, Framework
for Preparation & Presentation of the Financial Statements & the relevant Accounting Standards. If not,
the accountant should record the deviations from the above & consider whether it warrant an inclusion
in the final report on due diligence.
After having an overall view of the financial statements, as mentioned in the above paragraphs, the
accountant should review the operating results of the target company in great detail. It is important to
make an evaluation of the profit reported by the target company. The reason being that the price of the
target company would be largely based upon its operating results.
The accountant should consider the presence of an extraordinary item of income or expense that might
have affected the operating results of the target company.
It is advisable to compare the actual figures with the budgeted figures for the period under review & those
of the previous accounting period. This comparison could lead the accountant to the reasons behind the
variations. It is important that the trading results for the past four to five years are compared & the trend
of normal operating profit arrived at.
The normal operating profits should further be benchmarked against other similar companies. Besides the
above, & based on the trend of operating results, the accountant has to advise the acquiring enterprise,
through due diligence report, on the indicative valuation of the business.
In the case of many enterprises, the valuation is mainly based on the value of net worth only. For valuation
of immovable properties & plant, if required, the assistance of expert valuers could also to be taken. The
exercise to evaluate the balance sheet of the target company has to take into consideration the basis upon
which assets have been valued & liabilities have been recognised. The net worth of the business has to be
arrived at by taking into account the impact of over/under valuation of assets & liabilities. The accountant
should pay particular attention to the valuation of intangible assets.
The objective of the Due Diligence exercise will be to look specifically for any hidden liabilities or over-
valued assets.
iv. Taxation - Tax due diligence is a separate due diligence exercise but since it is an integral component of
the financial status of a company, it is generally included in the financial due diligence. It is important to
check if the company is regular in paying various taxes to the Government. The accountant has to also
look at the tax effects of the merger or acquisition.
v. Cash Flow - A review of historical cash flows & their pattern would reflect the cash generating abilities of
the target company & should highlight the major trends. It is important to know if the company is able to
meet its cash requirements through internal accruals or does it have to seek external help from time to
time.
It is necessary to check that:
a) Is the company able to honor its commitments to its trade payables, to the banks, to government &
other stakeholders?
b) How well is the company able to turn its trade receivables & inventories?
c) How well does it deploy its funds?
d) Are there any funds lying idle or is the company able to reap maximum benefits out of the available
funds?
e) What is the investment pattern of the company & are they easily realisable?
vi. Financial Projections - The accountant should obtain from the target company the projections for the
next five years with detailed assumptions & workings. He should ask the target company to give
projections on optimistic, pessimistic & most likely bases.
vii. Management & Employees - In most of the companies which are available for take over the problem of
excess work force is often witnessed. It is important to work out how much of the labour force has to be
retained. It is also important to judge the job profile of the administrative & managerial staff to gauge
which of these matches the requirements of the new incumbents. Due to complex set of labour laws
applicable to them, companies often have to face protracted litigation from its workforce & it is
important to gauge the likely impact of such litigation.

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The assumptions regarding increase in salaries, interest rate, retirement etc. have to be gone into to see if
they are reasonable. It is also necessary to see if the basic salary /wage considered for the valuation is
correct & includes all elements subject to payment of Gratuity. In the case of PF, ESI etc. the accountant
has to see if all eligible employees have been covered.
It is very important to consider the pay packages of the key employees as this can be a crucial factor in
future costs. One has to carefully look at Employees Stock Option Plans; deferred compensation plans;
Economic Value Addition & other performance linked pay; sales incentives that have been promised etc. It
is also important to identify the key employees who will not continue after the acquisition either because
they are not willing to continue or because they are to be transferred to another company within the
'group' of the target company.
viii. Statutory Compliance - During a due diligence this is one aspect that has to be investigated in detail. It is
important therefore, to make a list of laws/ statues that are applicable to the entity as well as to make a
checklist of compliance required from the company under those laws. If the company has not been
regular in its legal compliance it could lead to punitive charges under the law. These may have to be
quantified & factored into the financial results of the company.
Q. 2 :An American Company engaged in the business of manufacturing & distribution of industrial gases, is
interested in acquiring a listed Indian Company having a market share of more than 65% of the industrial gas
business in India. It requests you to conduct a “Due Diligence” of this Indian Company & submit your Report.
List out the contents of your Due Diligence Review Report that you will submit to your USA based Client.
CONTENTS OF A DUE DILIGENCE REPORT
The contents of a due diligence report will always vary with individual circumstances. Following headings are
illustrative:
Example of Headings of a Due Diligence Report
▪ Executive Summary
▪ Introduction
▪ Background of Target company
▪ Objective of due diligence
▪ Terms of reference & scope of verification
▪ Brief history of the company
▪ Share holding pattern
▪ Observations on the review
▪ Assessment of management structure
▪ Assessment of financial liabilities
▪ Assessment of valuation of assets
▪ Comments on properties, terms of leases, lien & encumbrances.
▪ Assessment of operating results
▪ Assessment of taxation & statutory liabilities
▪ Assessment of possible liabilities on account of litigation & legal proceedings against the company
▪ Assessment of net worth
▪ Interlocking investments & financial obligations with group / associates companies, amounts receivables
subject to litigation, any other likely liability which is not provided for in the books of account
▪ SWOT Analysis
▪ Comments on future projections
▪ Status of charges, liens, mortgages, assets & properties of the company
▪ Suggestion on ways & means including affidavits, indemnities, to be executed to cover unforeseen &
undetected contingent liabilities
▪ Suggestions on various aspects to be taken care of before & after the proposed merger/acquisition.
Q. 3 :KDK Bank Ltd., received an application from a pharmaceutical company for takeover of their
outstanding term loans secured on its assets, availed from & outstanding with a nationalised bank. KDK Bank

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Ltd., requires you to make a due diligence audit in the areas of assets of pharmaceutical company especially
with reference to valuation aspect of assets. State what may be your areas of analysis in order to ensure that
the assets are not stated at overvalued amounts.
Over-Valued Assets:
✓ Uncollected/uncollectable receivables.
✓ Obsolete, slow non-moving inventories or inventories valued above NRV; huge inventories of packing
materials etc. with name of company.
✓ Underused or obsolete Plant and Machinery and their spares; asset values which have been impaired due to
sudden fall in market value etc.
✓ Assets carried at much more than current market value due to capitalization of expenditure/foreign
exchange fluctuation, or capitalization of expenditure mainly in the nature of revenue.
✓ Litigated assets and property.
✓ Investments carried at cost though realizable value is much lower.
✓ Investments carrying a very low rate of income / return.
Q. 4 :“Due diligence is different from audit” – Explain the difference between due diligence & audit.
DIFFERENCE BETWEEN DUE DILIGENCE & AUDIT
It needs be underlined that due diligence is different from audit. Audit is an independent examination &
evaluation of the financial statements on an organization with a view to express an opinion thereon. Whereas,
due diligence refers to an examination of a potential investment to confirms all material facts of the
prospective business opportunity. It involves review of financial & non-financial records as deemed relevant &
material. Simply put, due diligence aims to take the care that a reasonable person should take before entering
into an agreement or a transaction with another party.
Q. 5 :PB Ltd. entered into a deal with SV Ltd. for buying its business of manufacturing wooden products/
goods. PB Ltd. has appointed your firm for conducting due diligence review & they want to know the cash
generating abilities of SV Ltd. What points will you check in order to ensure that the manufacturing unit of SV
Ltd. will be able to meet the cash requirements internally?
In order to ensure that the manufacturing unit of SV Ltd. will be able to meet the cash requirements internally,
one is required to verify:
i. Is the company able to honor its commitments to its trade payables, to the banks, to the
government & other stakeholders?
ii. How well is the company able to convert its trade receivables & inventories?
iii. How well the Company deploys its funds?
iv. Are there any funds lying idle or is the company able to reap maximum benefits out of the available
funds?
v. What is the investment pattern of the company & are they easily realizable?
Q. 6 :A nationalised bank received an application from an export company seeking sanction of a term loan to
expand the existing sea food processing plant. In this connection, the General Manager, who is in charge of
Advances, approaches you to conduct a thorough investigation of this limited company & submit a
confidential report based on which he will decide whether to sanction this loan or not. List out the points you
will cover in your investigation before submitting your report to the General Manager.
Investigation on behalf of a Bank/ Financial Institution Proposing to Advance Loan to a Company
A bank is primarily interested in knowing the purpose for which a loan is required, the sources from which it
would be repaid & the security that would be available to it, if the borrower fails to pay back the loan. On these
considerations, the investigating accountant, in the course of his enquiry, should attempt to collect
information on the under-mentioned points:
(i) The purpose for which the loan is required & the manner in which the borrower proposes to invest the
amount of the loan.
(ii) The schedule of repayment of loan submitted by the borrower, particularly the assumptions made therein
as regards amounts of profits that will be earned in cash & the amount of cash that would be available for

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the repayment of loan to confirm that they are reasonable & valid in the circumstances of the case.
Institutional lenders now-a-days rely more, for repayment of loans, on the annual profits & loss, & on the
values of assets mortgaged to them.
(iii) The financial standing & reputation for business integrity enjoyed by directors & officers of the company.
(iv) Whether the company is authorised by the Memorandum or the Articles of Association to borrow money
for the purpose for which the loan will be used.
(v) The history of growth & development of the company & its performance during the past 5 years.
(vi) How the economic position of the company would be affected by economic, political & social changes that
are likely to take place during the period of loan.
(vii) Whether any loan application to any other Bank or Financial Institution was made, & if so, the reasons for
rejection thereof.
To investigate the profitability of the business for judging the accuracy of the schedule of repayment
furnished by the borrower, as well as the value of the security in the form of assets of the business already
possessed & those which will be created out of the loan, the investigating accountant should take the under-
mentioned steps:
(a) Prepare a condensed income statement from the Statement of Profit & Loss for the previous five years,
showing separately therein various items of income & expenses, the amounts of gross & net profits
earned & taxes paid annually during each of the five years. The amount of maintainable profits
determined on the basis of foregoing statement should be increased by the amount by which these
would increase on the investment of borrowed funds.
(b) Compute the under-mentioned ratios separately & then include them in the statement to show the
trend as well as changes that have taken place in the financial position of the company:
(i) Sales to Average Inventories held.
(ii) Sales to Fixed Assets.
(iii) Equity to Fixed Assets.
(iv) Current Assets to Current Liabilities.
(v) Quick Assets (the current assets that are readily realisable) to Quick Liabilities.
(vi) Equity to Long Term Loans.
(vii) Sales to Book Debts.
(viii) Return on Capital Employed.
(c) Enter in a separate part of the statement the break-up of annual sales product-wise to show their trend.
Steps involved in the verification of assets & liabilities included in the Balance Sheet of the borrower
company which has been furnished to the Bank - The investigating accountant should prepare schedules of
assets & liabilities of the borrower & include in the particulars stated below:
(a) Fixed assets - A full description of each asset its gross value, the rate at which depreciation has been
charged & the total depreciation written off. In case the rate at which depreciation has been adjusted is
inadequate, the fact should be stated. In case any asset is encumbered, the amount of the charge & its
nature should be disclosed. In case an asset has been revalued recently, the amount by which the value
of the asset has been decreased or increased on revaluation should be stated along with the date of
revaluation. If considered necessary, he may also comment on the revaluation & its basis.
(b) Inventory - The value of different types of inventories held (raw materials, work-in-progress & finished
goods) & the basis on which these have been valued.
Details as regards the nature & composition of finished goods should be disclosed. Slow-moving or
obsolete items should be separately stated along with the amounts of allowances, if any, made in their
valuation. For assessing redundancy, the changes that have occurred in important items of inventory
subsequent to the date of the Balance Sheet, either due to conversion into finished goods or sale, should
be considered.
If any inventory has been pledged as a security for a loan the amount of loan should be disclosed.
(c) Trade Receivables, including bills receivable - Their composition should be disclosed to indicate the
nature of different types of debts that are outstanding for recovery; also whether the debts were being
collected within the period of credit as well as the fact whether any debts are considered bad or doubtful
& the provision if any, that has been made against them.

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Further, the total amount outstanding at the close of the period should be segregated as follows:
(i) debts due in respect of which the period of credit has not expired;
(ii) debts due within six months; &
(iii) debts due but not recovered for over six months
If any debts are due from directors or other officers or employees of the company, the particulars
thereof should be stated. Amounts due from subsidiary & affiliated concerns, as well as those considered
abnormal should be disclosed. The recoveries out of various debts subsequent to the date of the Balance
sheet should be stated.
(d) Investments - The schedule of investments should be prepared. It should disclose the date of purchase,
cost & the nominal & market value of each investment. If any investment is pledged as security for a
loan, full particulars of the loan should be given.
(e) Secured & Unsecured Loans - Debentures & other secured loans should be included together in a
separate schedule. Against the debentures & each secured loan, the amounts outstanding for payments
along with due dates of payment should be shown. In case any debentures have been issued as a
collateral security, the fact should be stated. Particulars of assets pledged or those on which a charge has
been created for re-payment of a liability should be disclosed. Details of loans proposed to be obtained
from Promoters/ Directors/ Related Parties should be stated separately. In case any unsecured loan is to
be repaid prior to repayment of Bank loan, its terms & conditions should be verified.
(f) Provision of Taxation - The previous year’s up to which taxes have been assessed or assessment order
received should be ascertained. If provision for taxes not assessed appears to be inadequate, the fact
should be stated along with the extent of the shortfall.
(g) Other Liabilities - It should be stated whether all the liabilities, actual & contingent, are correctly
disclosed. Also, an analysis according to ages of trade payables should be given to show that the
company has been meeting its obligations in time & has not been depending on trade credit for its
working capital requirements.
(h) Insurance - A schedule of insurance policies giving details of risks covered, the date of payment of last
premiums & their value should be attached as an annexure to the statements of assets, together with a
report as to whether or not the insurance-cover appears to be adequate, having regard to the value of
assets.
(i) Contingent Liabilities - By making direct enquiries from the borrower company, from members of its
staff, perusal of the files of parties to whom any loan has been advanced for example, those of
machinery suppliers & the legal adviser. The investigating accountant should ascertain particulars of any
contingent liabilities which have not been disclosed. In case, there are any, these should be included in a
schedule & attached to the report.
Q. 7:What are the important steps involved while conducting Investigation on behalf of an Incoming Partner?
Investigation on behalf of an Incoming Partner
The general approach of the investigating accountant in this type of investigation would be more or less similar,
irrespective of the nature of business of the firm-manufacturing, trading or rendering a service.
Primarily, an incoming partner would be interested to know whether the terms offered to him are reasonable
having regard to the nature of the business, profit records, capital contribution, personal capability of the
existing partners, socio-economic setting, etc., & whether he would be capable of deriving continuing benefit
by the way of return on capital to be contributed & remuneration for services to be rendered, which can be
justified by the overall economic conditions prevailing & other considerations considering his own personality &
achievements. In addition, he would be interested to ascertain whether the capital to be contributed by him
would be safe & applied usefully.
Broadly, the steps involved are the following:
(a) Ascertainment of the history of the inception & growth of the firm.
(b) Study of the provisions of the deed of partnership, particularly for composition of partners, their capital

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contribution, drawing rights, retirement benefits, job allocation, financial management, goodwill, etc.
(c) Scrutiny of the record of profitability of the firm’s business over a suitable number of years, with usual
adjustments that are necessary in ascertaining the true record of business profits. Particular attention
should, however, be paid to the nature of partners’ remuneration, which may be excessive or inadequate
in relation to the nature & profitability of the business, qualification & expertise of the partners & such
other factors as may be relevant.
(d) Examination of the asset & liability position to determine the tangible asset backing for the partner’s
investment, appraisal of the value of intangibles like goodwill, know how, patents, etc. impending
liabilities including contingent liabilities & those pending for tax assessment. In case of firms rendering
services, the question of tangible asset backing usually is not important, provided the firm’s profit record,
business coverage & standing of the partners are of the acceptable order.
(e) Position of orders at hand & the range & quality of clientele should be thoroughly examined, which the
firm is presently operating.
(f) Position & terms of loan finance would call for careful scrutiny to assess its usefulness & implication for
the overall financial position; reason for its absence or negative impact should be studied.
(g) It would be interesting to study the composition & quality of key personnel employed by the firm & any
likelihood of their leaving the organisation in the near future.
(h) Various important contractual & legal obligations should be ascertained & their nature studied. It may be
the case that the firm has standing agreement with the employees as regards salary & wages, bonus,
gratuity & other incidental benefits. Full impact of such standing agreements would be gauged before a
final decision is reached.
(i) Reasons for the offer of admission to a new partner should be ascertained & it should be determined
whether the same synchronises with the retirement of any senior partner whose association may have
had considerable bearing on the firm’s success.
(j) Appraisal of the record of capital employed & the rate of return. It is necessary to have a comparison with
alternative business avenues for investments & evaluation of possible results on a changed capital &
organisation structure, if any, envisaged along with the admission of the partner.
(k) It would be useful to have a first hand knowledge about the specialisation, if any, attained by the firm in
any of its activities.
(l) Manner of computation of goodwill on admission as also on retirement, if any, should be ascertained.
(m) Whether any special clause exists in the deed of partnership to allow admission in future of a new partner,
who may be specified, on concessional terms.
(n) Whether the incomplete contracts which will be transferred to the reconstituted firm will be a liability or a
loss.
It would always be worthwhile to remember that, in a partnership, personal considerations count
predominantly over other considerations & assessment of standing of the firm, standing & reliability of other
partners, their personal reputation & the goodwill enjoyed by the products/services of the firm are important.
On the basis of the broad frame of considerations as given above, the investigating accountant should devise
his own considerations in each case which may be quite diverse. Additional considerations may come up in the
case of service-rendering firms where profit & business record, goodwill of the firm & of individual partners
would assume greater significance.
Again, in the case of industrial firms, the network of customers, their scatter, size, etc., would be relevant for
consideration.
Q. 8 :Mr. Clean who proposes to buy the proprietary business of Mr. Perfect, engages you as investigating
accountant. Specify the areas which you will cover in your investigation.

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SPECIAL ASPECTS IN CONNECTION WITH BUSINESS INVESTIGATIONS

We discuss below the factors to be considered by a professional accountant while carrying out the investigation
for attaining satisfactory results:
(a) Studying the overall picture - In such a business investigation, it is of utmost importance firstto have an
overall picture of the position of the business which is being investigated before the details are gone into.
This is because figures are only symbols; & it is impossible to interpret them intelligently without
knowledge of the background in which they have emerged.
At times, political or economic factors also may affect the fortunes of a business; for example, labour
disturbances, changes in government policies in the matter of levy of excise & custom duties, imports, etc.
It is, therefore necessary that the impact of all these factors should be studied & their effect on the
business judged on a consideration of the profits in the past. For studying the economic & financial
position of the business, the following should be considered:
(i) The adequacy or otherwise of fixed & working capital. Are these sufficient for the growth of the
business?
(ii) What will be the trend of the sales & profits in the future? Establishing the trend of sales, product-
wise & area-wise will ordinarily help in drawing a conclusion on whether the trend will be
maintained in the future.
(iii) Whether the profit which the business could be expected to maintain in the future would yield an
adequate return on the capital employed?
(iv) Whether the business is operating at its 100 percent capacity or improvements can be made to
reach at full productivity?
(b) Statement of Profit & Loss - To study the Statement of Profit & Loss of a concern, it is necessary to
consider each item, included therein, in relation to the corresponding items in the Statement of Profit &
Loss of the previous years. It is therefore, necessary that a summary, in a columnar form, should be
prepared of the balances included in the Statement of Profit & Loss of the business for a period, say of 5 to
7 years.
In the foregoing summary, in the place of figures of opening & closing inventories, the figures of inventory
consumed, for each product, in different years should be entered. It should also be verified that the
inventories have been valued on a consistent basis throughout the period under review. If there has been
a change, the values of inventories should be adjusted. Further, in the summary, the gross profit ratios &
the ratios showing the relationship between various items of expenses & sales should be entered. The
trend of these ratios should be examined &, if there is a wide divergence in them, an explanation for the
same should be sought. In the preparation of the summary attention should also be paid to the following
matters:
Turnover - The figures of sales should be broken down between the various products sold to show
variations in turnover of individual products from year to year. In this way, it would be possible to find out
the products the sales of which have been increasing & those the sales of which have been falling.
By reference to the list of customers, in the Order Books, it should be ascertained whether the business
has a very large turnover with a few customers or a small turnover with several customers.
The Order Books should also be examined to find out if fictitious sales have been entered in any year to
boost up profits. If so, the figures of sales of the year or years should be adjusted.
If the business consists of activities which are dissimilar in operation, like manufacturing & agency, then
apart from splitting the income between the two sources, expenses should also be apportioned between
them to separately arrive at the figures of profit from each of the activities.
Wage structure - The method of computing wages & the rates of wages should be examined. On occasions
a business may have to pay higher wages than those prevailing in other business in the same
neighbourhood in pursuance of an industrial award. Another factor which is important to consider in this
connection is the relationship of the business with its workers/ labour unions. A business which has
suffered several industrial disputes, strikes, etc. & has had its working interrupted by them frequently
cannot be expected to prosper unless a proper settlement is reached with workers’ unions.

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Depreciation & Maintenance - The charge on account of depreciation & maintenance of machinery &
other assets included in the accounts of different years should be compared to verify that depreciation has
been provided from year to year on a consistent basis & that it is adequate. Also, the necessary
adjustment in the depreciation charge should be made if it is the practice of the company to write off the
assets on a renewal basis.
Further, if assets have been revalued, it should be confirmed that depreciation on the increased valuation
has been adjusted. Generally, with age, the cost of maintenance of assets should increase. If it has not, the
reason thereof should be ascertained.
In case of leasehold property, it should be ascertained whether an adequate provision has been made for
the dilapidation charge which may be payable at the end of the lease.
Further, compliance of relevant AS should also be verified.
Managerial Remuneration - It should be verified that the remuneration payable to various members of
managerial personnel is not excessive in relation to the profits of the business after taking into account the
time devoted by each of them. However, it could also be that no or only a nominal remuneration has been
charged in the accounts. In either case, an adjustment should be made to arrive at true profitability of the
concern. Further, in case of company, requirement of relevant section of Companies Act, 2013 is to be
seen. It has to be assured that calculation of profit for arriving at the remuneration is correct.
Exceptional & non-recurring items - It is customary to adjust exceptional items in the summary of
Statement of Profit & Loss in order that they may not obscure the trend of the profits. In the matter of
non-recurring items, it is necessary to remember that adjustments are to be made in respect of
exceptional items which do not recur from year to year or can be considered exceptional having regard to
their materiality or periodicity.
In this connection, it is worthwhile to examine the income tax assessment orders of the business to find
out the items which have been treated as revenue but have been considered inadmissible by the taxing
authority. Where the effect of these has been abnormal on the tax paid by the company from year to year,
suitable adjustments should be made in the figures of taxes paid, as well as in the assets amounts.
Likewise, adjustments should be made in respect of exceptional profits & losses like, profit or loss on sale
of obsolete asset.
Repairs & maintenance - It is one of the recurring expenses of a business. Occasionally it is noticed that
this expenditure is unduly heavy in some of the years, while quite low in some others. Generally,
companies, as a matter of routine undertake major repairs, overhauls & maintenance programme at an
interval of 3 or 4 years while running repairs & maintenance continue in the usual manner which gives rise
to fluctuating charges in the accounts unless periodic major expenses are treated as deferred expenditure.
Besides, due to wrong allocation of expenses between capital & revenue, repair charges may appear to be
heavy or low. If fluctuating & abnormal charges for repairs is noticed, it would be the duty of the
investigating accountant to scrutinise this head thoroughly to establish correct & normal charge for
repairs.
Unusual year - A company’s record of profitability may show a trend of increasing or decreasing profit or
loss or it may be highly erratic & fluctuating. Where a definite trend is discernible, the job of the
investigating accountant is somewhat simplified. He can adopt recent years’ record of profitability as the
basis for estimating future maintainable profit having regard to the inflationary state in the economy. But
if the same is fluctuating, there would be more demand on judgement of the accountant in selecting the
period to be covered for estimation of profitability. In such cases it may even be necessary to take into
consideration results of past 9 to 10 years with a view to iron out the fluctuation. If, however, it is noticed
that results of one or more years under scrutiny were materially vitiated by exceptional factors like a long-
term industrial dispute, natural calamities, pandemic, fire, war, ravage etc., the investigating accountant
should eliminate such year / years from consideration altogether since they do not reflect the results
obtained through normal business.
(c) Balance Sheet - Fixed Assets - Fixed assets, usually, are shown in accounts at cost less depreciation but
the accounts do not show the ages of different assets. It is desirable, therefore, to obtain age analysis of

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various items of fixed assets. Assets which are old or are obsolete would naturally have to be replaced. It
should be seen that their values are not in excess of the value of service that they could be expected to
render to the business during the balance period of their active life & the amount they would fetch on sale
as scrap. Title deeds should be verified to ascertain the extent of enterprise’s ownership in such assets,
like land & building jointly owned by two or more companies or their subsidiaries.
In addition, from a study of the maintenance expenses incurred from year to year, it should be judged
whether the assets have been properly maintained. If not, it might be necessary to incur heavy
expenditure on repairs to put them in a proper working order. In such a case, an allowance for this factor
should be made in the value of assets. More particularly, it should be seen that if assets have been
revalued, the increased depreciation charge has been adjusted against profit. Further, investigator has to
assure whether assets whose recoverable amount is less than carrying amount are impaired &
requirement of AS 28, “Impairment of Asset”, has been complied.
Investments -Investments should be broadly classified into long term investments & current investments.
A current investment is by its nature readily realisable & is intended to be held for not more than one
year. All other investments are long term investments.
Current investments are valued on the basis of lower of cost & fair value determined either on an
individual investment basis or by category of investment but not on an overall basis.
Long-term investments are usually carried at cost. However, when there is a permanent decline in the
value of long-term investments, the carrying amount should be reduced to recognise the decline. The
carrying amount of long-term investments is determined on an individual investment basis. Interest,
dividends & rentals receivable in connection with investment are generally regarded as income. However,
in some cases, such receipts represent recovery of cost & should therefore be reduced from, the cost of
investment (e.g. dividend out of pre-acquisition profits).
Inventories - It should be seen that inventories have been valued consistently & that the basis of valuation
was such that the value placed on inventories did not include any element of profit. Also, there should be
due allowance for damaged, obsolete & slow-moving inventories. In some cases, physical verification of
inventories is necessary where the inventories belonging to the entity are held by other parties. Examine
the appropriateness of valuation of work in progress as disclosed in the books.
Trade Receivables - In assessing their value, the following should be taken into account:
(i) Whether provision for bad debts have been made in the years in which the relevant sales took place
instead of in the year in which they have been written off, except when debts have had to be written
off on account of a slump or a fall in international prices, during a period subsequent to the period in
which sales had taken place.
(ii) The length of the credit period allowed or any excessive discounts allowed throughout the period
under investigation, to determine whether it has been necessary to increase continually the credit
period in order to affect the sales. If it has been so, it would indicate that the demand for the goods
manufactured by the concern in the market has been diminishing gradually.
(iii) Debts should be classified according to their age. This would disclose the character of the parties
with whom the company trades & the amount of working capital that will be necessarily blocked on
this account in the course of business. Determine Debtors to Sales Ratio.
Other liquid assets - It should be ascertained that the assets so described are readily realisable. Money
with a bank in liquidation should be taken only to the extent guaranteed by Deposit Insurance Scheme.
Idle assets -On a scrutiny, it may appear that certain assets are remaining idle & are not being properly
applied in the business. These may come from all sections of assets. For example, certain plant &
machinery may have been put to use after a considerable period of time after acquisition. Some of the
fixed assets may be awaiting installation even at the valuation time. The company may hold large cash &
bank balances, not warranted by the need of the business. Then again, there may be instances of obsolete
& slow-moving inventories of large value in the accounts of the company. It would be the duty of the
investigating accountant to eliminate these idle assets, if any, after proper identification from the net
worth of the business. However, proper value of these assets may be separately added to the value of the

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business.
Liabilities - The important matter to investigate in this regard is whether those are stated fully or
understated or overstated. In other words, whether the profits of the business have been inflated by
suppression of liabilities or there are any free reserves included in the liabilities. In either case, an
adjustment would be necessary. Secondly, it should be ascertained that liabilities are not unduly large or
are not outstanding for a long time, in such cases, it would be necessary to pay off some of them which
would cause a drain on the liquid resources of the concern. The fact should be stated in the report.
Taxation - Orders in respect of assessments completed should be studied & it should be verified that an
adequate provision has been made in respect of liabilities for taxes which have not been assessed. Also, it
should be seen that in the past there has been no reopening of assessments. If so, the company may be
liable for an undisclosed sum of taxes plus penalties. Any temporary tax benefit should also be
disregarded.
Capital - In this regard, it is necessary to ascertain:
(i) Whether the capital is well balanced. This would not be the case if the number of debentures &
preference share capital are disproportionately large as compared to the equity capital. Low equity
capital would handicap the company in raising further equity capital, on favourable terms for
financing the business or to pay off capital commitment. Further, when the capital is highly geared, it
would affect the value of the equity capital;
(ii) That the amount of capital is reasonable compared to the value of fixed assets & the amount of
working capital required. The terms associated with the issue of the capital should also be studied;
restriction on transferability of shares usually depresses the value of share & of the business.
(d) Interpretation of figures - Fixed Assets - The amount of capital expenditure which would be necessary in
the future for the continuation of the business, in its existing stage, should be assessed having regard to
the under-mentioned factors:
(i) the amount required for the replacement of assets when these would become worn out or
obsolete;
(ii) the expenditure which will be necessary to replace obsolete machinery by more sophisticated
machinery for manufacturing different types of goods for which there is demand.
Turnover - In assessing the turnover which the business would be able to maintain in the future, the
following factors should be taken into account:
(i) Trend: Whether in the past sales have been increasing consistently or they have been fluctuating.
A proper study of this phenomenon should be made.
(ii) Marketability: Is it possible to extend the sales into new markets or that these have been fully
exploited? Product wise estimation should be made.
(iii) Political & economic considerations: Are the policies pursued by the Government likely to
promote the extension of the market for goods to other countries? Whether the sales in the home
market are likely to increase or decrease as a result of various emerging economic trends?
(iv) Competition: What is the likely effect on the business if other manufacturers enter the same field
or if products which would sell in competition are placed on the market at cheaper price?
Is the demand for competing products increasing? Is the company’s share in the total trade constant or
has it been fluctuating?
Working Capital - In making assessment of the working capital requirements in the future, the
following matters should be taken into account:
(i) Has the ratio of inventory to turnover been increasing & if so, is it a continuing or only a temporary
trend?
(ii) Are the trade payables being paid promptly or is there a backlog which will have to be dealt with?
(iii) What will be the effect on inventory, trade receivables & trade payables, if the turnover is
increased or if new products are introduced?
Estimating Future Maintainable Profits - Fluctuations in profits during the years under review should

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be examined after adjusting the profits for extraneous factors, if any, that had given rise to fluctuations
to determine whether the factors responsible for the fluctuations were temporary or was likely to recur
in future. A statement should be prepared showing separately the profits after depreciation earned in
each of the years during the period under review, after making adjustments therein, if considered
necessary, as regards factors which have been responsible for any extraordinary increase in profits. If
the percentage of profits before taxation to capital has been stable or has been increasing, it would
indicate that the business would continue to earn the same rate of profit as it has done in the past. If,
on the other hand, the percentage has been falling, & there is no evidence that the factors responsible
therefore have ceased to operate, investment of further capital in the business would not be
commercially advisable.
Q. 9 :In a Company, it is suspected that there has been embezzlement in cash receipts. As an investigator,
what are the areas that you would verify?
Cash receipts - In cases like holding back cash sales, collections by travelling salesmen, V.P.P receipts, or casual
receipts, e.g., sales of scrap, recoveries out of debts written off earlier, etc., the amount or amounts of receipts
embezzled may be subsequently covered up by the perpetrator adopting one or other of the under-mentioned
devices:
(i) Issuing a receipt to the payee for the full amount collected & entering only a part of the amount on
the counterfoil.
(ii) Showing a larger cash discount than actually allowed.
(iii) Adjusting a fictitious credit in the account of a customer for the value of goods returned by him.
(iv) Adjusting a cash sale as a credit sale, & raising a debit in the account of the customer.
(v) Writing off a good debt as bad & irrecoverable to cover up the amount collected which has been
misappropriated.
(vi) Short-debiting the customer’s account in the ledger with an intention to withdraw the difference
when the full amount payable by him is collected.
(vii) Under-casting the receipts side of the Cash Book or over-casting the payment side.
(viii) Carrying over a shorter total of the receipts from one page of the Cash Book to the next or over-
carrying the total of the payment from one page of the Cash Book to the next with a view to
covering up misappropriation; either short banking of cash collection or a part of the amount of
withdrawal from the bank.
Verification of Cash Receipts: On the assumption that some of these may have been diverted before being
entered in the books, evidence as regards income received from different sources should be scrutinised, e.g.,
inventory, sales summaries, rental registers,
correspondence with customers, advices of travelling salesmen & counterfoils or receipts. Carbon copies of
receipts marked ‘duplicate’, should be scrutinised to confirm that they are in fact copies of receipts issued
earlier. In addition, by recalling paying-in-slips from the bank the details of cash deposited on each day should
be compared with those shown in the Cash Book. The record of sales of scrap of waste paper, that of collection
of rents from labourers temporarily accommodated in the company’s quarters, that of refunds of amounts
deposited with the electric supply co., or any other Government authorities should be examined for finding out
if any of these amounts have been misappropriated. Cash sales should be vouched in detail. Recoveries from
customers & sundry parties should be checked with the copies of receipts issued to them; deductions made on
account of cash discounts should be reviewed. All withdrawals from the bank should be checked by reference
to corresponding entries in the bank pass book.
Q. 10: J Ltd. is interested in acquiring S Ltd. The valuation of S Ltd. is dependent on future maintainable sales.
As the person entrusted to value S Ltd., what factors would you consider in assessing the future maintainable
turnover?
In assessing the turnover which the business would be able to maintain in the future, the following factors
should be taken into account:
(i) Trend: Whether in the past, sales have been increasing consistently or they have been fluctuating. A

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proper study of this phenomenon should be made.

(ii) Marketability: Is it possible to extend the sales into new markets or that these have been fully exploited?
Product wise estimation should be made.
(iii) Political & economic considerations: Are the policies pursued by the Government likely to promote the
extension of the market for goods to other countries? Whether the sales in the home market are likely to
increase or decrease as a result of various emerging economic trends?
(iv) Competition: What is the likely effect on the business if other manufacturers enter the same field or if
products which would sell in competition are placed on the market at cheaper price? Is the demand for
competing products increasing? Is the company’s share in the total trade constant or has it been
fluctuating?
Q. 11 :MF. Ltd., engaged in the manufacturing of various products in its factory, is concerned with shortage in
production & there arose suspicion of inventory fraud. You are appointed by MF Ltd. To evaluate the options
for verifying the process to reveal fraud & the corrective action to be taken. As an investigating accountant
what will be your areas of verification & the procedure to be followed for verification of defalcation of
inventory?
Inventory Frauds-Inventory frauds are many & varied but here we are concerned with misappropriation of
goods & their concealment.
(i) Employees may simply remove goods from the premises.
(ii) Theft of goods may be concealed by writing them off as damaged goods, etc.
(iii) Inventory records may be manipulated by employees who have committed theft so that book quantities
tally with the actual quantities of inventories in hand.
(iv) Inflating the quantities issued for production is another way of defalcating raw materials & store items.
(v) Stocks actually dispatched but not entered in sales/ debtor’s account.
Verification Procedure for Defalcation of inventory - It may be of trading stock, raw materials, manufacturing
stores, tools or of other similar items (readily) capable of conversion into cash. The loss may be the result of a
theft by an employee once or repeatedly over a long period, when the same have not been detected. Such
thefts usually are possible through collusion among a number of persons. Therefore, for their detection, the
entire system of receipts, storage & dispatch of all goods, etc. should be reviewed to localise the weakness in
the system.
The determination of factors which have been responsible for the theft & the establishment of guilt would be
difficult in the absence of: (a) a system of inventory control, & existence of detailed record of the movement of
inventory, or (b) availability of sufficient data from which such a record can be constructed. The first step in
such an investigation is to establish the different items of inventory defalcated & their quantities by checking
physically the quantities in inventory held & those shown by the Inventory Book. Investigating accountant
should ascertain the exact duties of persons handling the stocks received in & issued from store for production/
sale or any other purpose. Identify the excessive control in the hands of a single person, without any
supervision as it will widen the scope of investigation.
Afterwards, all the receipts & issues of inventory recorded in the Inventory Book should be verified by
reference to entries in the Goods Inward & Outward Registers & the documentary evidence as regards
purchases & sales. This would reveal the particulars of inventory not received but paid for as well as that issued
but not charged to customers. Further, entries in respect of returns, both inward & outward, recorded in the
financial books should be checked with corresponding entries in the Inventory Book. Also, the totals of the
Inventory Book should be checked. Finally, the shortages observed on physical verification of inventory should
be reconciled with the discrepancies observed on checking the books in the manner mentioned above. In the
case of an industrial concern, issue of raw materials, stores & tools to the factory & receipts of manufactured
goods in the godown also should be verified with relative source documents.
Defalcations of inventory, sometimes, also are committed by the management, by diverting a part of
production & the consequent shortages in production being adjusted by inflating the wastage in production;
similar defalcations of inventories & stores are covered up by inflating quantities issued for production. For
detecting such shortages, the investigating accountant should take assistance of an engineer. For that he will be

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more conversant with factors which are responsible for shortage in production & thus will be able to correctly
determine the extent to which the shortage in production has been inflated. In this regard, guidance can also
be taken from past records showing the extent of wastage in production in the past. Similarly, he would be able
to better judge whether the material issued for production was excessive &, if so to what extent. The per hour
capacity of the machine & the time that it took to complete one cycle of production, also would show whether
the issues have been larger than those required
Q. 12:In a Public Limited Company, it is suspected by the Management that there has been embezzlement in
supplier's ledger. As an auditor of the Company, you have been asked to investigate the matter. What are
the major areas that you would verify in this regard?
Frauds through suppliers’ ledger -
(i) Adjusting fictitious or duplicate invoices as purchases in the accounts of suppliers & subsequently
misappropriating the amounts when payments are made to the suppliers in respect of these invoices.
(ii) Suppressing the Credit Notes issued by suppliers & withdrawing the corresponding amounts not claimed by
them.
(iii) Withdrawing amounts unclaimed by suppliers, for one reason or another by showing that the same have
been paid to them
(iv) Accepting purchase invoices at prices considerably higher than their market prices & collecting the excess
amount, paid in cash, from the suppliers.
Verification of balances in suppliers’ ledger - The Purchase Journal should be vouched by reference to entries
in the Goods Inward Book & the suppliers’ invoices to confirm that amounts credited to the accounts of
suppliers were in respect of goods, which were duly received & the suppliers’ accounts had been credited
correctly. All the suppliers should be requested to furnish statements of their accounts to see whether or not
any balance is outstanding or due so as to confirm that allowances & rebates given by them have been
correctly adjusted & were duly authorized by the authorized person/ officer. Examine the system of internal
control in relation to purchase orders issued & identify possibilities of collusion with suppliers.
Q. 13 :General objective of an audit is to find out whether the financial statements show true & fair view. On
the other hand, investigation implies systematic, critical & special examination of the records of a business
for a specific purpose.
In view of the above, you are required to brief out the difference between Audit & Investigation.
AUDIT VERSUS INVESTIGATION Investigation differs substantially from an audit assignment. Audit aims at
collection of sufficient appropriate audit evidence to enable the auditor to form a judgement & express an
opinion on the financial statements or other data under examination. An investigation, on the other hand,
requires special in-depth examination of the particular records or transaction with the objective of establishing
a part or happening or assessing a particular situation. The scope of audit is broad based & general in nature
whereas investigation is narrow & specific.
The difference is tabulated below:
Basis of Difference Investigation Audit
(i) Objective An investigation aims at establishing a The main objective of an audit is to verify
fact or a happening or at assessing a whether the financial statements display
particular situation. a true & fair view of the state of affairs &
the working results of an entity.
(ii) Scope The scope of investigation may be The scope of audit is wide & in case of
governed by statute or it may be non- statutory audit the scope of work is
statutory. determined by the provisions of relevant
law.
(iii) Periodicity The work is not limited by rigid time The audit is carried on either quarterly,
frame. It may cover several years, as the half-yearly or yearly.
outcome of the same is not certain.
(iv) Nature Requires a detailed study & examination Involves tests checking or sample

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of facts & figures. Investigation is technique to draw evidences for forming

voluntary in nature. a judgement & expression of opinion. It is
mandatory for companies.
(v) Inherent No inherent limitation owing to its nature Audit suffers from inherent limitation.
Limitations of engagement.
(vi) Evidence It seeks conclusive evidence. Audit is mainly concerned with prima-
facie evidence.
(vii) Observance of It is analytical in nature & requires a Is governed by compliance with generally
Accounting thorough mind, capable of observing, accepted accounting principles, audit
Principles collecting & evaluating facts. procedures & disclosure requirements.
(viii) Appointing Even third party can appoint Investigator Auditor is appointed by owner/
Agency shareholders of company/ enterprise
(ix) Reporting The outcome is reported to the person(s) The outcome is reported to the owners of
on whose behalf investigation is carried the business entity.
out.
The approach to an investigation is different from that followed in an audit. An investigation involves a more
detailed examination of the selected areas than what is required in an audit. An investigation seeks substantive
&, in some case, even conclusive evidence as compared to audit which mainly relies on persuasive evidence.
An investigator does not accept a stated fact as correct until it is substantiated. An auditor, in the absence of
suspicious circumstances, relies on stated facts or figures. An auditor has to see whether the method of
valuation & other accounting policies have been properly made in the financial statements or not. An
investigator, however, is not bound by accounting conventions, policies & disclosure requirements. An auditor
does not suspect unless circumstances are there to arouse suspicion, while an investigator approaches the
work with a frame of mind to suspect, verify & satisfy.
The auditor seeks to report what he finds in the normal course of examination of the accounts adopting
generally followed techniques unless circumstances call for a special probe: fraud, error, irregularity, whatever
comes to the auditor's notice in the usual course of checking, are all looked into in depth & sometimes
investigation results from the prima facie findings of the auditor.
Q. 14:XYZ Ltd. has bought a land in Nagpur for setting up a manufacturing unit in the year 2018 at a price of
Rs. 10 crores. In the year 2019, one of the directors of company raised suspicion on the price & transactions
related to purchase of land. Therefore, an investigation was ordered by the management & PV Associates
were appointed to investigate the matter & submit their report accordingly. PV Associates were of the view
that they need to take an expert’s opinion on the price of land. Whether PV Associates is authorized to take
assistance of expert? If yes, what is the process they need to follow?
If PV Associates feels the necessity of obtaining views & opinions of experts in various fields to properly
conduct the investigation, they are allowed to do so.
It would be therefore, proper for the investigator to get the written general consent of his client, to refer
special matters for views of different experts at the beginning of investigation & he should settle the question
of costs for obtaining the views & other related implications.
Q. 15 :Briefly mention the forensic audit techniques.
FORENSIC AUDIT TECHNIQUES
Detecting fraud is difficult, especially frauds involving material financial statement misstatements, which occur
only in about 2 percent of all financial statements. Fraud is generally concealed & often occurs through
collusion. Normally, the documents supporting omitted transactions are not kept in company files. False
documentation is often created or legitimate documents are altered to support fictitious transactions. While
fraud detection techniques will not identify all fraud, the use of sound techniques can increase the likelihood
that misstatements or defalcations will be discovered on a timely basis.
Some of the techniques that a forensic auditor may use are listed below:
(i) General Audit Techniques:

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▪ Testing defenses: A good initial forensic audit technique is to attempt to circumvent these defenses
yourself. The weaknesses you find within the organizations control will most probably guide you down
the sea path taken by suspected perpetrators. This technique requires you to attempt to put yourself
in the shoes & think like your suspect.
(ii) Statistical & Mathematical Techniques:
▪ Trend Analysis: Businesses have cycles & seasons much akin to nature itself. An expense or event
within a business that would be analogous to a snowy day in the middle of summer is worth
investigating. Careful review of your subject organization's historical norms is necessary in order for
you to be able to discern the outlier event should it arise within your investigation.
▪ Ratio Analysis: Another useful fraud detection technique is the calculation of data analysis ratios for
key numeric fields. Like financial ratios that give indications of the financial health of a company, data
analysis ratios report on the fraud health by identifying possible symptoms of fraud.
(iii) Technology based /Digital Forensics Techniques: Every transaction leaves a digital footprint in today's
computer-driven society. Close scrutiny of relevant emails, accounting records, phone logs & target
company hard drives is a requisite facet of any modern forensic audit. Before taking steps such as
obtaining data from email etc. the forensic auditor should take appropriate legal advice so that it doesn’t
amount to invasion of privacy. Digital investigations can become quite complex & require support from
trained digital investigators. However, many open-source digital forensics tools are now available to assist
you in this phase of the investigation.
• Cross Drive Analysis • EnCase
• Live Analysis • MD5
• Deleted Files • Tracking Log Files
• Stochastic Forensics • PC System Log
• Steganography • Free Log Tools
(iv) Computer Assisted Auditing Techniques (CAATs): Changing patterns of businesses, regulatory framework,
scarcity of resources at auditors’ disposal on one side & the ever-increasing mountainous data on other
hand is making audit a complex process. Use of CAATs is, thus, indispensable to the Auditors & forensic
auditors. Computer-assisted audit techniques (CAATs) or computer-assisted audit tools & techniques
(CAATs) are computer programs that the auditors use as part of the audit procedures to process data of
audit significance contained in a client’s information systems, without depending on him.
(v) Generalised Audit Software (GAS): Generalized Audit Software (GAS) is a class of CAATs that allows
auditors to undertake data extraction, querying, manipulation, summarization & analytical tasks. GAS
focuses on the fully exploiting the data available in the entity’s application systems in the pursuit of audit
objectives. GAS support auditors by allowing them to examine the entity’s data easily, flexibly,
independently & interactively in data-based auditing.
Using GAS, an auditor can formulate a range of alternative hypotheses for a particular potential
misstatement in the subject matter & then test those hypotheses immediately. “What if” scenarios can be
developed with the results & the auditors can examine the generated report rapidly. Currently, the latest
versions of GAS include the Audit Command Language (ACL), Interactive Data Extraction & Analysis (IDEA)
& Panaudit.
(vi) Common Software Tool (CST): Due to shortcomings of GASs, CSTs have become popular over a period.
Spreadsheets (like MS Excel, Lotus, etc.), RDBMS (like MS Access, etc.) & Report writers (like Crystal
reports, etc.) are few examples of CSTs. Their widespread acceptability is due to its instant availability &
lower costs. While spreadsheets may be extremely easy to use due to its simplicity & versatility, other CSTs
may need some practice.
Whether one uses GAS or CST, it is imperative that the auditor is aware about the manner & processes
that have led to the data generation, the control environment revolving around the data & the source
from where the data samples are imported into the GAS/CST.
(vii) Data Mining Techniques: It is a set of assisted techniques designed to automatically mine large volumes of
data for new, hidden or unexpected information or patterns.

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Data mining techniques are categorized in three ways: Discovery, Predictive modeling & Deviation & Link
analysis. It discovers the usual knowledge or patterns in data, without a predefined idea or hypothesis
about what the pattern may be, i.e. without any prior knowledge of fraud. It explains various affinities,
association, trends & variations in the form of conditional logic.
(viii) Laboratory Analysis of Physical & Electronic Evidences:
Computer Forensics Protection/Validation of Evidence

 hard disk imaging 
 Federal Rules of Evidence

 E-mail analysis 
 Chain of Custody

 search for erased files 
 Altered & Fictitious Documents

 analyse use & possible misuse of data 
 physical examination

 computer software to analyze data 
 fingerprint analysis

 forgeries

 ink sampling

 document dating
Q. 16 :What are the areas where the services of forensic accountants/ auditors are generally required?
Services rendered by Forensic Auditors
• Crafting questions to be posed
• Responding to questions posed
• Identifying documents to be requested &/or subpoenaed
• Identifying individuals to be most knowledgeable of facts
• Conducting research relevant to facts of the case
• Identifying & preserving key evidence
• Evaluating produced documentation & information for completeness
• Analysing produced records & other information for facts
• Identifying alternative means to obtain key facts & information
• Providing questions for deposition & cross examination of fact & expert witnesses
The services rendered by the forensic accountants are in great demand in the following areas:
Criminal Investigation : 
 Matters relating to financial implications the services of the forensic
accountants are availed of. The report of the accountants is
considered in preparing & presentation as evidence
Professional Negligence Cases : 
 Professional negligence cases are taken up by the forensic
accountants. Non- conformation to Generally Accepted Accounting
Standards (GAAS) or noncompliance to auditing practices or ethical
codes of any profession, Forensic Auditors are needed to measure the
loss due to such professional negligence or shortage in services.
Arbitration service: 
 Forensic accountants render arbitration & mediation services for the
business community. Their expertise in data collection & evidence
presentation makes them sought after in this specialized practice
area.
Fraud Investigation & 
 Forensic accountants render such services both when called upon to
Risk/Control Reviews: investigate specific cases as well for a review of or for implementation
of Internal Controls. Another area of significance is Risk Assessment &
Risk Mitigation
Settlement of insurance claims: 
 Insurance companies engage forensic accountants to have an accurate
assessment of claims to be settled.

 In case of policy holders seek the help of a forensic accountant when
they need to challenge the claim settlement as worked out by the

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insurance companies. A forensic accountant handles the claims

relating to consequential loss policy, property loss due to various risks,
fidelity insurance & other types of insurance claims.
Dispute settlement: Business firms engage forensic accountants to handle contract disputes,
construction claims, product liability claims, infringement of patent &
trade marks cases, liability arising from breach of contracts & so on
Characteristics- Forensic Auditor Skills - Forensic Auditor should possess

 Out of the Box Thinking  Auditing standards, procedures & related

 Strong Visualization & Imagination methodologies

 Curiosity  Accounting & Business reporting systems

 Persistence  Information Technology

 Detail-oriented  Data Analytics

 Inquisitiveness  Criminology

 Creativity  Legal Framework

 Discretion  Litigation processes & procedures

 Skepticism  Investigative Techniques

 Confidence &  Evidence gathering

 Sound professional judgement  Network of professional contacts in related
 fields' viz. enforcement, regulatory bodies, law,
 Objectivity & credibility
industry, peers etc.
A forensic accountant should possess not only the broad knowledge of accounting principles, practice &
standards but also the knowledge of insurance, banking civil & criminal law & human psychology.
A Forensic Auditor must be open to consider all alternatives, scrutinize the details & act as an expert witness. In
addition, a Forensic Auditor must be able to listen effectively & communicate clearly & concisely in a timely
manner.
Q. 17 :Enumerate the steps to be undertaken in case of forensic audit process.
PROCESS OF FORENSIC ACCOUNTING
Each Forensic Accounting assignment is unique. Accordingly, the actual approach adopted & the procedures
performed will be specific to it. However, in general, many Forensic Accounting assignments will include the
steps detailed below.
Step 1. Initialization
It is vital to clarify & remove all doubts as to the real motive, purpose & utility of the assignment. It is helpful to
meet the client to obtain an understanding of the important facts, players & issues at hand. A conflict check
should be carried out as soon as the relevant parties are established. It is often useful to carry out a preliminary
investigation prior to the development of a detailed plan of action. This will allow subsequent planning to be
based upon a more complete understanding of the issues.
Step 2. Develop Plan
This plan will take into account the knowledge gained by meeting with the client & carrying out the initial
investigation & will set out the objectives to be achieved & the methodology to be utilized to accomplish them.
Step 3. Obtain Relevant Evidence
Depending on the nature of the case, this may involve locating documents, economic information, assets, a
person or company, another expert or proof of the occurrence of an event. In order to gather detailed
evidence, the investigator must understand the specific type of fraud that has been carried out, & how the
fraud has been committed. The evidence should be sufficient to ultimately prove the identity of the
fraudster(s), the mechanics of the fraud scheme, & the amount of financial loss suffered. It is important that
the investigating team is skilled in collecting evidence that can be used in a court case within the stipulated
time period, & in keeping a clear chain of custody until the evidence is presented in court. If any evidence is
inconclusive or there are gaps in the chain of custody, then the evidence may be challenged in court, or even

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become inadmissible. Investigators must be alert to documents being falsified, damaged or destroyed by the
suspect(s).
Step 4. Perform the analysis
The actual analysis performed will be dependent upon the nature of the assignment & may involve:
 calculating economic damages;
 summarizing a large number of transactions;
 performing a tracing of assets;
 performing present value calculations utilizing appropriate discount rates;
 performing a regression or sensitivity analysis;
 utilizing a computerized application such as a spread sheet, data base or computer model; &
 utilizing charts & graphics to explain the analysis.
Step 5. Reporting
Issuing an audit report is the final step of a fraud audit. Auditors will include information detailing the
fraudulent activity, if any has been found. The client will expect a report containing the findings of the
investigation, including a summary of evidence, a conclusion as to the amount of loss suffered as a result of the
fraud & to identify those involved in fraud. The report may include sections on the nature of the assignment,
scope of the investigation, approach utilized, limitations of scope & findings &/or opinions. The report will
include schedules & graphics necessary to properly support & explain the findings.
The report will also discuss how the fraudster set up the fraud scheme, & which controls, if any, were
circumvented. It is also likely that the investigative team will recommend improvements to controls within the
organization to prevent any similar frauds occurring in the future.
The forensic auditor should have active listening skills which will enable him to summarize the facts in the
report. It should be kept in mind that the report should be based on the facts assimilated during the process &
not on the opinion of the person writing the report.
Step 6. Court proceedings
The investigation is likely to lead to legal proceedings against the suspect, & members of the investigative team
will probably be involved in any resultant court case. The evidence gathered during the investigation will need
to be presented at court, & team members may be called to court to describe the evidence they have gathered
& to explain how the suspect was identified.
Q. 18 :ABC Ltd. is a listed company having turnover of ` 50 crores & plans expansion by installation of new
machines at new building-having total additional project cost of ` 20 crore.
Rupees (In crore) Purpose
10.0 - for Building
8.5 - for Machinery
1.5 - for Working Capital
20 Crore Total
Project gets implemented in 2019-20 & one of the accountants report to the Managing Director that some
suspicious transactions are noticed in the purchase of building material. But the Management is confused as
to whether they should get an audit or Forensic Audit done for the same. Advise Management about the
difference in forensic accounting & audit.
AUDIT V/S. FORENSIC ACCOUNTING/FORENSIC AUDIT
How is a forensic accounting analysis different from an audit?
The general public believes that a financial auditor would detect a fraud if one were being perpetrated during
the financial auditor's audit. The truth, however, is that the procedures for financial audits are designed to
detect material misstatements, not immaterial frauds. While it is true that many of the financial statements &
frauds could have, perhaps should have, been detected by financial auditors, the vast majority of frauds could
not be detected with the use of financial audits. Reasons include the dependence of financial auditors on a
sample & the auditors' reliance on examining the audit trail versus examining the events' & activities behind
the documents. The latter is simply resource prohibitive in terms of costs & time.

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There are some basic differences today between the procedures of forensic auditors & those of financial
auditors. In comparison, forensic accounting & audit differ in specific ways, as shown below:

A forensic accountant will often look for indications of fraud that are not subject to the scope of a financial
statement audit. Forensic Accounting has Investigative mentality" however auditing is done with
"professional skepticism". A forensic accountant will often require more extensive corroboration. A forensic
accountant may focus more on seemingly immaterial transactions.
S. N. Particulars Other Audits Forensic Audit
1. Objectives Express an opinion as to ‘True & Whether fraud has actually taken
Fair’ presentation place in books
2. Techniques Substantive & Compliance. Sample Investigative, substantive or in-depth
based checking
3. Period Normally for a particulars No such limitations
accounting period.
4. Verification of stock, Relies on the management Independent/verification of
Estimation realisable certificate/Management suspected/selected items where
value of assets, Representation misappropriation in suspected
provisions, liability etc.
5. Off balance sheet items Used to vouch the arithmetic Regulatory & propriety of these
(like contracts etc.) accuracy & compliance with transactions/contracts are examined.
procedures.
6. Adverse findings if any Negative opinion or qualified Legal determination of fraud impact &
opinion expressed with/without identification of perpetrators
quantification depending on scope.
Q. 19 :What do you understand by the word “Forensic” & why the need for forensic audit arises?
Forensic” means “suitable for use in the court of law”. Bologna said that it is the application of financial skills
& investigative mentality to unresolved issues, conducted within the context of the rules of evidence. As an
emerging discipline, it encompasses financial expertise, fraud knowledge & a sound knowledge &
understanding of business reality & the working of legal system.
However, the definition of Forensic Auditing keeps on changing in response to the growing needs of
corporations. Simply stated, Forensic Auditing includes the use of accounting, auditing & investigative skills to
assist in legal matters.
Important Definitions:

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Forensic: The word forensic comes from the Latin word forensis, meaning "of or before the forum." It is -

 Relating to, used in, or appropriate for courts of law or for public discussion or argumentation.

 Relating to the use of science or technology in the investigation & establishment of facts or evidence in a
court of law.
Forensic Accounting: The integration of accounting, auditing & investigative skills yields the specialty known
as Forensic Accounting. It is the study & interpretation of accounting evidence. It is the application of
accounting methods to the tracking & collection of forensic evidence, usually for investigation & prosecution
of criminal acts such as embezzlement or fraud.
Forensic Accounting can sometimes be referred to as Forensic Auditing.
Forensic Investigation: Also known as forensic audit is the examination of documents & the interviewing of
people to extract evidence. Forensic Accounting examines individual or company financial records as an
investigative measure that attempts to derive evidence suitable for use in litigation.
Fraud Auditing: In a fraud audit one searches for the point where the numbers &/or financial statements to
do mesh. It is a meticulous review of financial documents conducted when fraud is suspected. Some entities
do them as a precaution to prevent fraud from happening & to catch it before the loss magnifies. A Fraud
Audit however is not an Investigation. Fraud auditing is used to identify fraudulent transactions, not to figure
out how they were created. Fraud auditors often go outside the books of accounts to find fraudulent
transactions.
Red Flag: Red flags are indicators or warning of any impending danger or inappropriate behaviour. Red flag
does not necessarily indicate the existence of fraud however are indicators that caution needs to be
exercised while investigating the situations. Red flags are classified in categories such as financial
performance red flag, accounting system red flags, operational red flags & behavioural red flags.
Forensic audit can be conducted in order to prosecute a party for fraud, embezzlement or other financial
claims. In addition, an audit may be conducted to determine negligence in addition, an audit may be conducted
to determine negligence.

In order to properly perform these services a Forensic Auditor must be familiar with legal concepts &
procedures & have expertise in the use of IT tools & techniques that facilitate data recovery & analysis. In
addition, a Forensic Auditor must be able to identify substance over form when dealing with an issue.
Q. 20 :BR Construction was into the business of building roads & other infrastructure facilities for
government contracts. Mr. Tiwari, one of the senior official, was looking after the procurement of cement
required at the construction sites. There was a substantial increase in the price of cement bags bought as
compared to those bought prior to the appointment of Mr. Tiwari. The management of the company decides
to get a forensic audit done for the transactions handled by Mr. Tiwari. What points should be kept in mind

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by the management while appointing a forensic auditor?

While appointing a forensic auditor, the Management of BR Construction must initially consider whether the
firm has the necessary skills & experience to accept the work.
Characteristics- Forensic Auditor Skills - Forensic Auditor should possess

 Out of the Box Thinking 
 Auditing standards, procedures & related

 Strong Visualization & Imagination methodologies

 Curiosity 
 Accounting & Business reporting systems

 Persistence 
 Information Technology

 Detail-oriented 
 Data Analytics

 Inquisitiveness 
 Criminology

 Creativity 
 Legal Framework

 Discretion 
 Litigation processes & procedures

 Skepticism 
 Investigative Techniques

 Confidence & 
 Evidence gathering

 Sound professional judgement 
 Network of professional contacts in related
 fields' viz. enforcement, regulatory bodies, law,
 Objectivity & credibility
industry, peers etc.
A forensic accountant should possess not only the broad knowledge of accounting principles, practice &
standards but also the knowledge of insurance, banking civil & criminal law & human psychology.
A Forensic Auditor must be open to consider all alternatives, scrutinize the details & act as an expert witness. In
addition, a Forensic Auditor must be able to listen effectively & communicate clearly & concisely in a timely
manner.

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CH – 17 PEER REVIEW & QUALITY REVIEW

Q. 1 :Anand, a practicing Chartered Accountant is appointed to conduct the peer review of another practicing
unit. What areas Anand should review in the assessment of independence of the practicing unit?
Review in the Assessment of Independence of the Practicing Unit – The reviewer should carry out the
compliance review of the five general controls, i.e., independence, maintenance of professional skills &
standards, outside consultation, staff supervision & development & office administration & evaluate the
degree of reliance to be placed upon them. The degree of reliance will, ultimately, affect the attestation service
engagements to be reviewed.
Independence is the main quality expected of an auditor. That is the very basis for the existence of the
profession of auditing. Independence is a condition of mind as well a personal character of a person. It is
difficult to define but very easy to perceive. Guidance Note on Independence of Auditors clarifies that
independence is of two types, viz. independence of mind & independence of appearance. The Guidance Note
further states that there are certain threats to independence which are classified as self-interest threats, self-
review threats, advocacy threats, familiarity threats & intimidation threats.
The responsibility of the Peer Reviewer, therefore, is to ascertain the existence of independence & the absence
of threats to independence.
The reviewer should , therefore, check the following aspects in respect of assessment of independence of the
practicing unit:
(i) Does the practice unit have a policy to ensure independence, objectivity & integrity, on the part of
partners & staff? Who is responsible for this policy?
(ii) Does the practice unit communicate these policies & the expected standards of professional behaviour to
all staff?
(iii) Does the practice unit monitor compliance with policies & procedures relating to independence?
(iv) Does the practice unit periodically review the practice unit's association with clients to ensure objectivity
& independence?
(v) How does the practice unit deal with the threats to independence ?
Q. 2 :What are the areas excluded from the scope of peer reviewer?
Engagement means an engagement in which a practitioner expresses a conclusion designed to enhance the
degree of confidence of the intended users other than the responsible party about the outcome of the
evaluation or measurement of a subject matter against criteria but does not include:
i. Management Consultancy Engagements;
ii. Representation before various Authorities;
iii. Engagements to prepare tax returns or advising clients in taxation matters;
iv. Engagements for the compilation of financial statements;
v. Engagements solely to assist the client in preparing, compiling or collating information other than financial
statements;
vi. Testifying as an expert witness;
vii. Providing expert opinion on points of principle, such as Accounting Standards or the applicability of certain
laws, on the basis of facts provided by the client; &
viii. Engagement for Due diligence.
Q. 3 :Write short notes on the following:
(a) Scope of Peer Review.

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(b) Technical, ethical & professional standards as per Statement on Peer Review.
(a) SCOPE OF PEER REVIEW
The Statement on Peer Review lays down the scope of review to be conducted as under:
The Peer Review process shall apply to all the assurance services provided by a Practice Unit.
1. Once a Practice Unit is selected for Review, its assurance engagement records pertaining to the Peer
Review Period shall be subjected to Review.
2. The Review shall cover:
(i) Compliance with Technical, Professional & Ethical Standards.
(ii) Quality of reporting.
(iii) Systems & procedures for carrying out assurance services.
(iv) Training programmes for staff (including articled & audit assistants) concerned with assurance
functions, including availability of appropriate infrastructure.
(v) Compliance with directions & / or guidelines issued by the Council to the Members, including Fees to
be charged, Number of audits undertaken, register for Assurance Engagements conducted during the
year & such other related records.
(vi) Compliance with directions & / or guidelines issued by the Council in relating to article assistants & / or
audit assistants, including attendance register, work diaries, stipend payments, & such other related
records.
As it is clear from the above, that the Statement of Peer Review aims to confine the scope of review to
preceding three years since this would establish the consistency or deviations, if any, in respect of procedures
followed by the practice unit.

(b) TECHNICAL, ETHICAL & PROFESSIONAL STANDARDS AS PER STATEMENT ON PEER REVIEW.
The Statement defines the scope of peer review which revolves around compliance with technical, ethical &
professional standards; quality of reporting; office systems & procedures with regard to compliance of
assurance engagements; &, training programmes for staff including articled & audit assistants involved in
assurance engagements. The entire peer review process is directed at the assurance services. Assurance
Services means assurance engagements services as specified in the “Framework for Assurance Engagements”
issued by the ICAI & as may be amended from time to time.
As per the Statement, Technical, Professional & Ethical Standards – means
(i) Accounting Standards issued by ICAI that are applicable for entities other than companies under the
Companies Act, 2013;
(ii) Accounting Standards prescribed u/s 133 of the Companies Act; 2013 by the Central Government based
on the recommendation of ICAI & in consultation with the National Financial Reporting Authority (NFRA)
& notified as Accounting Standards Rules 2006, as amended from to time;
(iii) Indian Accounting Standards prescribed u/s 133 of the Companies Act 2013 by the Central Government
based on the recommendation of ICAI & in consultation with NFRA & notified as Companies (Indian
Accounting Standards) Rules, 2015, as amended from time to time;
(iv) Standards :
Standards issued by the ICAI including-
(a) Engagement standards (d) Standards on Internal Audit.
(b) Statements (e)Guidelines/ Notifications / Directions / Announcements /
(c) Guidance notes Pronouncements / Professional Standards issued from time to time by
the Council or any of its Committees.

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(v) Framework for the preparation & presentation of financial statements, Preface to the Standards on Quality
Control, Auditing, Review, Other Assurance & Related Services & Framework for Assurance engagements;
Provisions of the relevant statutes & / or rules or regulations which are applicable in the context of the specific
engagements being reviewed including instructions, guidelines, notifications, directions issued by regulatory
bodies as covered in the scope of assurance engagements.
Q. 4 :The elements of skill, experience & independence of reviewers are ensured before initiating them in
Peer Review process. In the above light, state few eligibility criteria fixed for a person to be empaneled &
also for being appointed as a Peer Reviewer.
Eligibility to be a Reviewer
1. A Peer Reviewer shall: -
(a) Shall be a member in practice with at least 10 years of experience for Level I entities & 7 years of
experience for Level II entities.
(b) In case a member has moved from industry to practice & is currently in practice he should have at
least 15 years of experience in industry & at least 5 years’ experience in practice for Level I entities &
an experience of at least 10 years in industry & at least 3 years’ experience in practice, for Level II
entities.
(c) Should have undergone the requisite training & cleared the requisite test for Peer Review as
prescribed by the Board.
(d) Should have conducted audit of Level I Entities for at least 7 years or got his entity audited for at least
7 years which should be a Level I entity to be eligible for conducting Peer Review of Level I Entities.
2. A member on being appointed as a Reviewer shall be required to -
(a) furnish a declaration as prescribed by the Board, at the time of acceptance of Peer Review
appointment.
(b) sign a Declaration of Confidentiality as per Annexure A to this Statement .
3. A member shall not be eligible for being appointed as a Reviewer, if -
(i) any disciplinary action / proceeding is pending against him
(ii) he has been found guilty of professional or other misconduct by the Council or the Board of Discipline
or the Disciplinary Committee at any time
(iii) he has been convicted by a competent court whether within or outside India, of an offence involving
moral turpitude & punishable with imprisonment
(iv) he or his partners or personnel has any obligation or conflict of interest in the Practice Unit.
4. A Reviewer shall not accept any professional assignment from the Practice Unit for a period two years from
the date of appointment. Further, he should not have accepted any professional assignment from the
Practice Unit for a period of two years before the date of appointment as reviewer of that Practice Unit.
Q. 5 :What are the inherent limitations of Peer Review?
INHERENT LIMITATIONS OF REVIEW
The reviewer conducts the review in accordance with the Statement on Peer Review. The review would not
necessarily disclose all weaknesses in compliance of technical standards & maintenance of quality of assurance
services since it would be based on selective tests. As there are inherent limitations in the effectiveness of any
system of quality control which happens to be subject-matter of review, departure from the system may occur
& may not be detected.
Q. 6 :What are the objectives of the Quality review?
SCOPE & OBJECTIVES OF QUALITY REVIEW
Quality review is directed towards evaluation of audit quality & adherence to various statutory & other
regulatory requirements. They are designed to identify & address weaknesses & deficiencies related to how the
audits were performed by the audit firms. To achieve that goal, quality reviews included reviews of certain
aspects of selected statutory audits performed by the firm & reviews of other matters related to the firm’s

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quality control system.

In the course of reviewing aspects of selected audits, a review may identify ways in which a particular audit is
deficient, including failures by the firm to identify, or to address appropriately, aspects in which an entity’s
financial statements do not present fairly the financial position or the results of operations in conformity with
the applicable Generally Accepted Accounting Principles (GAAP) & other technical standards. It is not the
purpose of a review, however, to review all of a firm’s audits or to identify every aspect in which a reviewed
audit is deficient. Accordingly, a review should not be understood to provide any assurance that the firm’s
audits, or its clients’ financial statements or reporting thereon, are free of any deficiencies.
The scope & objective of the quality review includes:
(a) Examining whether the Statutory Auditor has ensured compliance with the applicable technical standards
in India & other applicable professional & ethical standards & other relevant guidance.
(b) Examining whether the Statutory Auditor has ensured compliance with the relevant laws & regulations as
required under applicable auditing standard.
(c) Examining whether the Audit firm under review (AFUR) has implemented a system of quality control with
reference to the applicable quality control standards.
(d) Examining whether there is no material misstatement of assets & liabilities as at the reporting date in
respect to the selected entity.
The major focus of the reviews is on compliance with technical standards, other relevant guidance, relevant
laws & regulations as required under applicable auditing standard, quality of reporting & firm’s quality control
framework. The focus areas for quality reviews for any particular class or classes of Audit firms / entities may
be such as specified by the Board, from time to time.
The review would encompass AFUR’s working papers of selected audit file/s to assess quality of their audit & to
ensure that financial statements are free of material mis-statement/s; internal quality controls placed within
AFUR, including assessment of how internal controls impact audit quality; AFUR’s independence; compliance
with technical standards, other relevant guidance & relevant laws & regulations; on-site-inspections; &
discussion of findings with senior management of AFUR.
Q. 7 :What are the reporting responsibilities of the technical reviewer while carrying out a Quality review
assignment?
The Technical Reviewers expresses an opinion on whether the system of quality control for the attestation
services of the firm under review has been designed so as to carry out professional attestation services
assignments in a manner that ensures compliance with the applicable Technical standards & maintenance of
the quality of attestation service work they perform. The Technical Reviewer’s review would not necessarily
disclose all weaknesses in the quality of attestation work or all instances of lack of compliance with applicable
Technical Standards. As there are inherent limitations in the effectiveness of any system of quality control,
departure from the system may occur & not be detected. Also, projection of any evaluation of system of
quality control to future periods is subject to the risk that the system of quality controls may become
inadequate because of changes in conditions, or that the degree of compliance with the policies & procedures
may deteriorate. In the process, the Technical Reviewers also identified what they considered to be
deficiencies & any defects in, or criticisms of the firm’s quality control system.
Q. 8 :Give examples of areas on which the reviewer may qualify the report?
A reviewer may qualify the report due to one or more of the following:

 non-compliance with technical standards & other relevant guidance;

 non-compliance with relevant laws & regulations as required under applicable auditing standard;

 quality control system design deficiency; or

 non-compliance with quality control policies & procedures.
Q. 9 :What are the consequences if the Quality review board notices major non-compliances with the
requirements of the Standards on quality control or standards on auditing or accounting standards?
ACTIONS THAT MAY BE RECOMMENDED BY THE QUALITY REVIEW BOARD

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The actions that the Board may take, based upon consideration of recommendations of the QRG, include one
or more of the following:-
(a) Make recommendations to the Council of ICAI u/s 28B(a) of Chartered Accountants Act, 1949 for referring
the case to the Director (Discipline) of the Institute for consideration & necessary action under the
Chartered Accountants Act, 1949.
(b) Issue advisory & guidance to the AFUR u/s 28B(c) of Chartered Accountants Act, 1949 for improvement in
the quality of services & adherence to various statutory & other regulatory requirements. A copy of such
advisory may also be sent to the ICAI for information.
(c) Inform the details of the non-compliance to the regulatory bod(y)/ies relevant to the entity as may be
decided by the Board.
(d) Intimate the AFUR as to the findings of the Report as well as action initiated as above.
(e) In case of review arising out of a reference received from a regulatory body, inform the results of review &
the details of action taken to the concerned regulatory body.
(f) Consider the matter complete & inform the AFUR accordingly.
Q 10 :Briefly discuss the various stages involved in the conduct of the quality review assignments.
The following points describes the various stages generally involved in the conduct of the quality review
assignments:
✓ QRB selects Audit Firm & the audit file for review & identifies TR to conduct Quality Review.
✓ QRB sends Offer Letter of Engagement to TR.
✓ TR conveys his acceptance of Letter of Engagement to QRB by sending necessary declarations for
meeting eligibility conditions & furnishing statement of confidentiality by himself & his assistant/s, if any.
✓ QRB intimates AFUR about the proposed Quality Review. QRB also sends a copy of this intimation letter
to TR & provides them contact details of each other for further communication.
✓ TR sends the specified Quality Review Questionnaire to the AFUR for filling-up. He also calls for additional
information from the AFUR, if required.
✓ TR & his team carry out the Quality Review by starting their off-site review by making proper planning for
the review & then on-site visiting the office of the AFUR by fixing the date as per mutual consent
ensuring that review exercise gets completed within specified time frame.
✓ On completion of on-site review, TR to send the preliminary report to AFUR. TR shall send a copy of
preliminary report to QRB as well.
✓ AFUR to submit representation on the preliminary report to the TR & TR to immediately send the reply of
the AFUR to QRB.
✓ TR to submit final report along with a copy of Annual report of the entity for the year under review, to
the QRB in the specified format, on his (individual) letterhead, duly signed & dated within specified time
frame or as extended by the QRB. In addition, he shall also send a copy of the final report to the AFUR,
requesting them to send their final reply thereon to the QRB within 7 days of receipt of the final report.
AFUR shall also send a copy of their final reply to TR.
✓ AFUR to submit to QRB their reply on the final report & feedback, in prescribed format, regarding their
experience of the quality review.
✓ Upon receipt of the final reply from the AFUR, TR shall submit to QRB within next 7 days a summary of
his findings, in the specified format, containing his findings, technical requirements, final reply of the
AFUR & his final comments thereon.
✓ QRG to consider the report of the TR & responses of AFUR & make recommendations to QRB. QRG may
also call for additional details/information/explanations, if required, from TR/AFUR or issue such
directions to TR, as it may deem appropriate, enabling it to assess the quality of audit & reporting by the
AFUR.
✓ QRB to consider report & recommendations of QRG & decide further course of action.

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Q. 11 : What are the important areas for evaluation while conducting quality reviews in terms of SQC -1
Standard on Quality Control?
IMPORTANT AREAS for evaluation IN ACCORDANCE WITH SQC-1
✓ Whether the audit firm establishes & implements policies & procedure on all the element of system of
quality control.
✓ Whether the engagement quality control reviewer review at an appropriate time for the planning of an
audit, significant audit judgement, & expressions of an audit opinion.
✓ Whether the audit firm assigns as the person responsible for the monitoring of the system of quality
control a person with appropriate experience for the role, vest the assigned person with sufficient &
appropriate authority.
✓ Whether the audit firm obtain, at least annually, a confirmation letter concerning compliance with policies
& procedure for the maintenance of independence from all person required to maintain independence.
✓ Whether the audit firm perform the independence confirmation procedure set forth in its internal rules
before acceptance & continuance of an audit engagement, & when issuing the auditor’s report
appropriately confirms that there was no change in the status of independence.
✓ Whether the audit firm develop & provides education/ training program that fully take into account the
knowledge, experience, competence & capabilities of the professional staff.

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CH – 18 PROFESSIONAL ETHICS
Q. 1: A Chartered Accountant in practice has been suspended from practice for a period of months & he had
surrendered his Certificate of Practice for the said period. During the said period of suspension, though the
member did not undertake any audit assignments, he undertook representation assignments for income tax
whereby he would appear before the tax authorities in his capacity as a Chartered Accountant.
Undertaking Tax Representation Work: A chartered accountant not holding certificate of practice cannot take
up any other work because it would be violation of the relevant provisions of the Chartered Accountants Act,
1949.
In case a member is suspended & is not holding Certificate of Practice, he cannot in any other capacity take up
any practice separable from his capacity to practice as a member of the Institute. This is because once a person
becomes a member of the Institute; he is bound by the provisions of the Chartered Accountants Act, 1949 & its
Regulations.
If he appears before the income tax authorities, he is only doing so in his capacity as a chartered accountant &
a member of the Institute. Having bound himself by the said Act & its Regulations made there under, he cannot
then set the Regulations at naught by contending that even though he continues to be a member & has been
punished by suspension, he would be entitled to practice in some other capacity.
Conclusion: Thus, in the instant case, a chartered accountant would not be allowed to represent before the
income tax authorities for the period he remains suspended. Accordingly, in the present case he is guilty of
professional misconduct.
Q. 2: Mr. A, a practicing Chartered Accountant agreed to select & recruit personnel, conduct training
programmes for & on behalf of a client. Is this a professional misconduct?
Providing Management Consultancy & Other Services: U/s 2(2)(iv) of the Chartered Accountants Act, 1949, a
member of the Institute shall be deemed “to be in practice” when individually or in partnership with Chartered
Accountants in practice, he, in consideration of remuneration received or to be received renders such other
services as, in the opinion of the Council, are or may be rendered by a Chartered Accountant in practice.
Pursuant to Section 2(2)(iv) above, the Council has passed a resolution permitting a Chartered Accountant in
practice to render entire range of “Management Consultancy & other Services”.
The definition of the expression “Management Consultancy & other Services” includes Personnel recruitment &
selection. Personnel Recruitment & selection includes, development of human resources including designing &
conduct of training programmes, work study, job description, job evaluation & evaluations of workloads.
Conclusion: Therefore, Mr. A is not guilty of professional misconduct.
Q. 3: Mr. X & Mr. Y, partners of a Chartered Accountant Firm, one in-charge of Head Office & another in-
charge of Branch at a distance of 80 km. from the municipal limits, puts up a name-board of the firm in both
premises & also in their respective residences.
Putting Name Board of the Firm at Residence: The council of the Institute has decided that with regard to the
use of the name-board, there will be no bar to the putting up of a name-board in the place of residence of a
member with the designation of chartered accountant, provided, it is a name-plate or board of an individual
member & not of the firm.
In the given case, partners of XY & Co., put up a name board of the firm in both offices but not in their
respective residences.
Conclusion: Thus, the chartered accountants are guilty of misconduct. Distance given in the question is not
relevant for deciding.
Q. 4: Mr. K, Chartered Accountant practicing as a sole proprietor has an office in the suburbs of Chennai. Due
to increase in the income tax assessment work, he opens another office near the income tax office, which is
within the city & at a distance of 30 km. from his office in the suburb. For running the new office, he has
employed a retired Income Tax Commissioner who is not a Chartered Accountant.

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Maintenance of Branch Office in the Same City: As per section 27 of the Chartered Accountants Act, 1949 if a
chartered accountant in practice has more than one office in India, each one of these offices should be in the
separate charge of a member of the Institute. However, a member can be in charge of two offices if the second
office is located in the same premises or in the same city, in which the first office is located; or the second
office is located within a distance of 50 km. from the municipal limits of a city, in which the first office is
located.
In the given case, Mr. K, Chartered Accountant in practice as a sole proprietor at Chennai has an office in
suburbs of Chennai, & due to increase in the work he opened another branch within the city near the income
tax office. He also employed a retired income tax commissioner to run the new office & the second office is
situated within a distance of 30 kilometers from his office in the suburb.
Conclusion: In view of above provisions, there will be no misconduct if Mr. K will be in charge of both the
offices. However, he is bound to declare which of the two offices is the main office.
Q. 5: Mr. Qureshi, Chartered Accountant, in practice died in a road accident. His widow proposes to sell the
practice of her husband to Mr. Pardeshi, Chartered Accountant, for ` 5 lakhs. The price
also includes right to use the firm name - Qureshi & Associates. Can widow of Qureshi sell the practice & can
Mr. Pardeshi continue to practice in that name as a proprietor?
Sale of Goodwill: With reference to Clause (2) of Part I to the First Schedule to Chartered Accountants’ Act,
1949, the Council of the ICAI considered whether the goodwill of a proprietary concern of chartered accountant
can be sold to another member who is otherwise eligible, after the death of the proprietor.
It lays down that the sale is permitted subject to certain conditions discussed in the above flowchart. It further
resolved that the legal heir of the deceased member has to obtain the permission of the Council within a year
of the death of the proprietor concerned.
Conclusion: Thus, in a given case, the widow of Mr. Qureshi, who has proposed to sell the practice for ` 5 lakhs
is in effect proposing the sale of goodwill. Thus, the act of Mrs. Qureshi is permissible & Mr. Pardeshi can
continue to practice in that name as a proprietor.
Q. 6: Mr. S, a Chartered Accountant published a book & gave his personal details as the author. These details
also mentioned his professional experience & his present association as partner with M/s RST, a firm.
Soliciting Professional Work: Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949
refers to professional misconduct of a member in practice if he solicits client or professional work either
directly or indirectly, by circular, advertisement, personal communication or interview or by any other means.
Therefore, members should not adopt any indirect methods to advertise their professional practice with a view
to gain publicity & thereby solicit clients or professional work. Such a restraint must be practiced so that
members may maintain their independence of judgement & may be able to command the respect of their
prospective clients. While elaborating forms of soliciting work, the Council has specified that a member is not
permitted to indicate in a book or an article, published by him, his association with any firm of chartered
accountants. In this case, Mr. S, a Chartered Accountant published the book & mentioned his professional
experience & his association as a partner with M/s RST, a firm of chartered accountants. Conclusion: Mr. S
being a chartered accountant in practice has committed the professional misconduct by mentioning that at
present he is a partner in M/s. RST, a chartered accountants firm.
Q. 7: M/s XYZ, a firm of Chartered Accountants created a website “www.xyzindia.com”. The website besides
containing details of the firm & bio-data of the partners also contains the passport size photographs of all the
partners of the firm.
Hosting Details on Website: As per detailed guidelines of the ICAI laid down in Clause (6) of Part I of the First
Schedule to the Chartered Accountants Act, 1949, a chartered accountant of the firm can create its own
website using any format subject to guidelines. However, the website should be so designed that it does not
solicit clients or professional work & should not amount to direct or indirect advertisement. The guidelines of
the ICAI to allow a firm to put up the details of the firm, bio-data of partners & display of a passport size
photograph.

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Conclusion: In the case of M/s XYZ, all the guidelines seem to have been complied & there appears to be no
violation of the Chartered Accountants Act, 1949 & its Regulations.
Q. 8: M/s LMN, a firm of Chartered Accountants responded to a tender from a State Government for
computerization of land revenue records. For this purpose, the firm also paid ` 50,000 as earnest deposit as
part of the terms of the tender.
Responding to Tenders: Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949 lays
down guidelines for responding to tenders, etc. As per the guidelines if a matter relates to any services other
than audit, members can respond to any tender. Further, in respect of a non-exclusive area, members are
permitted to pay reasonable amount towards earnest money/security deposits.
Conclusion: In the instance case, since computerization of land revenue records does not fall within exclusive
areas for chartered accountants, M/s LMN can respond to tender as well as deposit ` 50,000 as earnest deposit
& shall not have committed any professional misconduct.
Q. 9: Mr. Honest, a Chartered Accountant in practice, wrote two letters to M/s XY Chartered Accountants a
firm of CAs; requesting them to allot him some professional work. As he did not have a significant practice or
clients he also wrote a letter to M/s ABC, a firm of Chartered Accountants for securing professional work. Mr.
Clever, another CA, informed ICAI regarding Mr. Honest's approach to secure the professional work. Is Mr.
Honest wrong in soliciting professional work?
Securing Professional Work: Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949
states that a Chartered Accountant in practice shall be deemed to be guilty of misconduct if he solicits clients or
professional work either directly or indirectly by a circular, advertisement, personal communication or
interview or by any other means. Provided that nothing herein contained shall be construed as preventing or
prohibiting any Chartered Accountant from applying or requesting for or inviting or securing professional work
from another chartered accountant in practice.
Such a restraint has been put so that the members maintain their independence of judgment & may be able to
command respect from their prospective clients.
Conclusion: In the given case, Mr. Honest wrote letters only to other Chartered Accountants, M/s XY & M/s
ABC requesting them to allot some professional work to him, which is not prohibited under Clause (6) as
explained above. Thus, Mr. Honest has not committed any professional misconduct by soliciting professional
work.
Q. 10: A practising Chartered Accountant uses a visiting card in which he designates himself, besides as
Chartered Accountant, as a Tax Consultant.
Tax Consultant: Section 7 of the Chartered Accountants Act, 1949 read with Clause (7) of Part I of the First
Schedule to the said Act prohibits advertising of professional attainments or services of a member. It also
restrains a member from using any designation or expression other than that of a chartered accountant in
documents through which the professional attainments of the member would come to the notice of the public.
Under the clause, use of any designation or expression other than chartered accountant for a chartered
accountant in practice, on professional documents, visiting cards, etc. amounts to a misconduct unless it be a
degree of a university or a title indicating membership of any other professional body recognised by the Central
Government or the Council.
Conclusion: Thus, it is improper to use designation "Tax Consultant" since neither it is a degree of a University
established by law in India or recognised by the Central Government nor it is a recognised professional
membership by the Central Government or the Council.
Q. 11: B, a Chartered Accountant in practice is a partner in 3 firms. While printing his personal letter heads, B
gave the names of all the firms in which he is a partner.
Advertisement of Professional Attainments: Clause (7) of Part I of the First Schedule to the Chartered
Accountants Act, 1949 prohibits advertising of professional attainments or services of a member. It also
restrains a member from using any designation or expression other than that of a Chartered Accountant in

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documents through which the professional attainments of the member would come to the notice of the public.
Even a member is not permitted to specify the date of setting up of practice or establishment of firm on
letterheads. However, there is no prohibition for printing names of all the three firms on the personal
letterheads in which a member holding Certificate of Practice is a partner.
Conclusion: Thus, B is not guilty of any misconduct under the Chartered Accountants Act, 1949.
Q. 12: The offer document of a listed company in which Mr. D, a practising Chartered Accountant is a director
mentions the name of Mr. D as a director along with his various professional attainments & spheres of
specialisation.
The Council of the ICAI has in a communication to members stated that if a public company, in which a
chartered accountant in practice is a director, issues a prospectus or gives any announcement that gives
descriptions about the Chartered Accountant’s expertise, specialisation & knowledge in any particular field, it
shall constitute a misconduct under Clauses (6) & (7) of Part I of the First Schedule to the Chartered
Accountants Act, 1949. The Council has further stated that in such cases the member concerned has to take
necessary steps to ensure that such prospectus or public announcements or public communications do not
advertise his professional attainments & also that such prospectus or public announcements or public
communications do not directly or indirectly amount to solicitation of clients for professional work by the
members.
Conclusion: Thus, in the instant case, Mr. D would be held to be guilty of professional mis-conduct & liable for
disciplinary action.
Q. 13: Mr. X, a Chartered Accountant accepted his appointment as tax auditor of a firm u/s 44AB, of the
Income-tax Act, & commenced the tax audit within two days of his appointment since the client was in a
hurry to file Return of Income before the due date. After commencing the audit, Mr. X realised his mistake of
accepting this tax audit without sending any communication to the previous tax auditor. In order to rectify
his mistake, before signing the tax audit report, he sent a registered post to the previous auditor & obtained
the postal acknowledgement. Will Mr. X be held guilty under the Chartered Accountants Act?
Communication with the Previous Auditor: As per Clause (8) of Part I of First Schedule to the Chartered
Accountants Act, 1949, Mr. X will be held guilty since he has accepted the tax audit, without first
communicating with the previous auditor in writing. The object of the incoming auditor communicating in
writing with the retiring auditor is to ascertain whether there are any circumstances which warrant him not to
accept the appointment, for example, whether the previous auditor has been changed on account of having
qualified the report or he had expressed a wish not to continue on account of something inherently wrong with
the administration of the business. The retiring auditor may even give out information regarding the condition
of the accounts of the client or the reason that impelled him to qualify his report. Under all circumstances, it
would be essential for the incoming auditor to carefully consider the facts before deciding whether or not he
should accept the audit. As a matter of professional courtesy & professional obligation it is necessary for the
new auditor appointed to communicate with such earlier auditor.
Conclusion: Therefore, Mr. X will be held guilty of professional misconduct.
Q. 14: W, a Chartered Accountant has sent letters under certificate of posting to the previous auditor
informing him his appointment as an auditor before the commencement of audit by him.
Communication with the Previous Auditor: Clause (8) of Part I of the First Schedule to the Chartered
Accountants Act, 1949 requires communication by the incoming auditor with the previous auditor before
accepting a position by him. The Council of the Institute has taken the view that a mere posting of a letter
“under certificate of posting” is not sufficient to establish communication with the retiring auditor unless there
is some evidence to show that the letter has in fact reached the person communicated with. A Chartered
Accountant who relies solely upon a letter posted “under certificate of posting” therefore does so at his own
risk. Since the letters were sent by “W” to the previous auditor informing him of his appointment as an auditor
before the commencement of audit by him under Certificate of Posting is not sufficient to prove
communication with the retiring auditor. In the opinion of the Council, communication by a letter sent

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“Registered Acknowledgement Due” or by hand against a written acknowledgement would in the normal
course provide positive evidence.
Conclusion: Hence “W” was guilty of professional misconduct under Clause (8) of Part I of First Schedule to the
Chartered Accountants Act, 1949.
Q. 15: CA Raja was appointed as the Auditor of Castle Ltd. for the year 2019-20. Since he declined to accept
the appointment, the Board of Directors appointed CA Rani as the auditor in the place of CA Raja, which was
also accepted by CA Rani.
Board can appoint the auditor in the case of casual vacancy u/s 139(8) of the Companies Act, 2013. The non-
acceptance of appointment by CA. Raja does not constitute a casual vacancy to be filled by the Board. In this
case, it will be deemed that no auditor was appointed in the AGM.
Further, as per Section 139(10) of the Companies Act, 2013 when at any annual general meeting, no auditor is
appointed or re-appointed, the existing auditor shall continue to be the auditor of the company. The
appointment of the auditor by the Board is defective in law.
Clause (9) of Part I of First Schedule to the Chartered Accountants Act, 1949 states that a chartered accountant
is deemed to be guilty of professional misconduct if he accepts an appointment as auditor of a company
without first ascertaining from it whether the requirements of section 225 of the Companies Act, 1956 (now
Section 139, 140 & 142 read with Section 141 of the Companies Act, 2013), in respect of such appointment
have been fully complied with.
Conclusion: Hence, CA. Rani is guilty of professional misconduct since she accepted the appointment without
verification of statutory requirements.
Q. 16: Mrs. X is a Director of ABC Pvt. Ltd. During the year 2020-21, the company appointed CA Mr. Y, Mrs.
X's spouse, as its statutory auditor. Mr. Y used to deliver audit report without any comments or disclosures,
thereupon.
As per Section 141(3)(f) of the Companies Act, 2013, a person shall not be eligible for appointment as an
auditor of a company whose relative is a director or is in the employment of the company as a director or key
managerial personnel.
The definition of ‘Relative’ includes husband & wife. Clause (9) of Part I of the First Schedule to the Chartered
Accountants Act, 1949, provides that a member in practice shall be deemed to be guilty of professional
misconduct if he accepts an appointment as auditor of a company without first ascertaining from it whether
the requirements of Section 225 of the Companies Act, 1956 (now Section 139, 140 & 142 read with Section
141 of the Companies Act, 2013), in respect of such appointment have been duly complied with.
In this case Mrs. X is a Director of ABC Pvt. Ltd. & the company has appointed Mr. Y, Chartered Accountant,
Mrs. X's spouse, as its statutory auditor. Mr. Y should not accept the appointment as statutory auditor of the
company, where his wife Mrs. X is a director. This is contravention of section 141 of the Companies Act, 2013.
Conclusion: Therefore, Mr. Y is liable for misconduct under the said clause since he accepted the appointment
without first verifying the compliance of statutory requirements.
Q. 17: A chartered accountant holding certificate of practice & having four articled clerks registered under
him accepts appointment as a full-time lecturer in a college. Also, he becomes a partner with his brother in a
business. Examine his conduct in the light of Chartered Accountants Act, 1949 & the regulations thereunder.
Clause (11) of Part I of the First Schedule to the Chartered Accountants Act, 1949 debars a chartered
accountant in practice from engaging in any business or occupation other than the profession of chartered
accountancy unless permitted by the Council of the Institute so to engage. This clause, in effect, has
empowered the Council of the Institute to permit chartered accountants in practice to engage in any other
business or occupation considered fit & proper. Accordingly, the Council had formulated Regulations 190A &
191 to the Chartered Accountants Regulations, 1988 to provide a basis for considering applications of chartered
accountants seeking permission to engage in other business or occupation. A member can accept full- time
lecturer-ship in a college only after obtaining the specific & prior approval of the Council as also becoming a

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partner in a business with his brother would require specific permission.

Conclusion: Thus, the chartered accountant is liable for professional misconduct since he failed to obtain
specific & prior approval of the Council in each case.
Q. 18: Mr. A, a practicing Chartered Accountant, took over as the executive chairman of Software Company
on 1.4.2019. On 10.4.2019 he applied to the Council for permission.
Specific Permission to be Obtained: As per Clause (11) of Part I of First Schedule to the Chartered Accountants
Act, 1949, a Chartered Accountant in practice will be deemed to be guilty of professional misconduct if he
engages in any business or occupation other than the profession of Chartered Accountant unless permitted by
the Council so to engage.
In the instant case, Mr. A took over as the executive chairman on 01.04.2019 & applied for permission on
10.04.2019. On the basis of these facts, he was engaged in other occupation between the period 01.04.2019 &
10.04.2019, without the permission of the Council.
Conclusion: Therefore, Mr. A is guilty of professional misconduct in terms of Clause (11) of Part I of First
Schedule to the Chartered Accountants Act, 1949.
Q. 19: C.A. Prabhu is a leading income tax practitioner & consultant for derivative products. He resides in
Mumbai near to the ABC commodity stock exchange & does trading in commodity derivatives. Every day, he
invests nearly 50% of his time to settle the commodity transactions. Is C.A. Prabhu liable for professional
misconduct?
Engaging into a Business: As per Clause (11) of Part I of First Schedule of Chartered Accountants Act, 1949, a
Chartered Accountant in practice is deemed to be guilty of professional misconduct if he engages in any
business or occupation other than the profession of Chartered Accountant unless permitted by the Council so
to engage.
However, the Council has granted general permission to the members to engage in certain specific occupation.
In respect of all other occupations specific permission of the Institute is necessary.
In this case, CA. Prabhu is engaged in the occupation of trading in commodity derivatives which is not covered
under the general permission.
Conclusion: Hence, specific permission of the Institute has to be obtained otherwise he will be deemed to be
guilty of professional misconduct under Clause (11) of Part I of First Schedule of Chartered Accountants Act,
1949.
Q. 20: S, a practicing chartered accountant gives power of attorney to an employee chartered accountant to
sign reports & financial statements on his behalf.
Power of Signing Reports & Financial Statements: Under Clause (12) of Part I of First Schedule to the Chartered
Accountants Act, 1949, a Chartered Accountant in practice is deemed to be guilty of professional misconduct if
he allows a person not being a member of the Institute in practice or a member not being his partner to sign on
his behalf or on behalf of his firm, any balance sheet, profit & loss account, report or financial statements. This
clause read in conjunction with Section 26 of the Chartered Accountants Act, 1949 stipulates that no person
other than the member of the institute shall sign any document on behalf of a Chartered Accountant in practice
or a firm of Chartered Accountants in his or its professional capacity.
The term ‘Financial Statement’ for this purpose would cover an examination of the accounts or financial
statements given under a statutory enactment or otherwise. Further, Clause (1) of Part II of the Second
Schedule to the Chartered Accountants Act, 1949 states that a member of the Institute, whether in practice or
not, shall be deemed to be guilty of professional misconduct, if he contravenes any of the provisions of this Act
or the regulations made there under or any guidelines issued by the Council.
Conclusion: Accordingly, S is guilty of professional misconduct under Clause (12) of Part I of First Schedule &
also under Clause (1) of Part II of Second Schedule for contravening Section 26.
Q. 21: CA. Smart, a practicing Chartered Accountant was on Europe tour between 15-9-20 & 25-9-20. On 18-
9-20 a message was received from one of his clients requesting for a stock certificate to be produced to the

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bank on or before 20-9-20. Due to urgency, CA. Smart directed his assistant, who is also a Chartered
Accountant, to sign & issue the stock certificate after due verification, on his behalf.
Allowing a Member Not Being a Partner to Sign Certificate: As per Clause (12) of Part I of the First Schedule to
the Chartered Accountants Act, 1949, a Chartered Accountant in practice is deemed to be guilty of professional
misconduct “if he allows a person not being a member of the Institute in practice or a member not being his
partner to sign on his behalf or on behalf of his firm, any balance sheet, profit & loss account, report or financial
statements”.
In this case, CA. Smart allowed his assistant who is not a partner but a member of the ICAI to sign stock
certificate on his behalf & thereby commits misconduct.
Conclusion : Thus, CA. Smart is guilty of professional misconduct under Clause (12) of Part I of First Schedule to
the Chartered Accountants Act, 1949.
Q. 22: Mr. 'C', a Chartered Accountant holds a certificate of practice while in employment also, recommends
a particular lawyer to his employer in respect of a case. The lawyer, out of the professional fee received from
employer paid a particular sum as referral fee to Mr. 'C'.
Referral Fee from Lawyer: According to Clause (2) of Part II of First Schedule of the Chartered Accountant Act,
1949, a member of the Institute(other than a member in practice) shall be guilty of professional misconduct, if
he being an employee of any company, firm or person accepts or agrees to accept any part of fee, profits or
gains from a lawyer, a chartered accountant or broker engaged by such company, firm or person or agent or
customer of such company, firm or person by way of commission or gratification.
In the present case, Mr. C who beside holding a certificate of practice, is also an employee & by referring a
lawyer to the company in respect of a case, he receives a particular sum as referral fee from the lawyer out of
his professional fee.
Conclusion: Therefore, Mr. C is guilty of professional misconduct by virtue of Clause (2) of Part II of First
schedule.
Q. 23: Mr. 'G', while applying for a certificate of practice, did not fill in the columns which solicit information
about his engagement in other occupation or business, while he was indeed engaged in a business.
Disclosure of Information: As per Clause (2) of Part III of First Schedule to the Chartered Accountants Act, 1949
a member shall be held guilty if a Chartered Accountant, in practice or not, does not supply the information
called for, or does not comply with the requirements asked for, by the Institute, Council or any of its
Committees, Director (Discipline), Board of Discipline, Disciplinary Committee, Quality Review Board or the
Appellate Authority;
In the given case, Mr. “G”, a Chartered Accountant while applying for a certificate of practice, did not fill in the
columns which solicit information about his engagement in other occupation or business, while he was indeed
engaged in a business. Details of engagement in business need to be disclosed while applying for the certificate
of practice as it was the information called for in the application, by the Institute.
Conclusion: Thus, Mr. G will be held guilty for professional misconduct under the Clause (2) of Part III of First
Schedule of the Chartered Accountants Act, 1949.
Q. 24: Mr. X, a Chartered Accountant, employed as a paid Assistant with a Chartered Accountant firm, leaves
the services of the firm on 31st December, 2019. Despite many reminders from ICAI he fails to reply
regarding the date of leaving the services of the firm.
Failed to Supply Information Called For: As per Clause (2) of Part III of the First Schedule to the Chartered
Accountants Act, 1949, a member, whether in practice or not, will be deemed to be guilty of professional
misconduct if he does not supply the information called for, or does not comply with the requirements asked
for, by the Institute, Council or any of its Committees, Director (Discipline), Board of Discipline, Disciplinary
Committee, Quality Review Board or the Appellate authority.
Conclusion: Thus, in the given case, Mr. X has failed to reply to the letters of the Institute asking him to confirm
the date of leaving the service as a paid assistant. Therefore, he is held guilty of professional misconduct as per

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Clause (2) of Part III of the First Schedule to the Chartered Accountants Act, 1949.
Q. 25: YKS & Co., a proprietary firm of Chartered Accountants was appointed as a concurrent auditor of a
bank. YKS, the proprietor, used his influence to get a loan & thereafter failed to repay the loan.
This is a case which is covered under the expression in other misconduct of the Chartered Accountants Act,
1949. As per Clause (2) of Part IV of First Schedule to the Chartered Accountants Act, 1949, a member of the
Institute, whether in practice or not, shall be deemed to be guilty of other misconduct, if he, in the opinion of
the Council, brings disrepute to the profession or the Institute as a result of his action whether or not related to
his professional work. Here the Chartered Accountant is expected to maintain the highest standards of integrity
even in his personal affairs & any deviation from these standards calls for disciplinary action.
In the present case, YKS & Co, being a concurrent auditor used his position to obtain the funds & failed to repay
the same to the bank. This brings disrepute to the profession of a Chartered Accountant. This act of YKS & Co is
not pardonable.
Conclusion: Therefore, YKS & Co will be held guilty of other misconduct under Clause (2) of Part IV of First
Schedule to the Chartered Accountants Act, 1949.
Q. 26: Mr. Parekh, a Chartered Accountant was invited by the Chamber of Commerce to present a paper in a
symposium on the issues facing Indian Leather Industry. During the course of his presentation he shared
some of the vital information of his client’s business under the impression that it will help the Nation to
compete with other countries at international level.
Disclosure of Client’s Information: Clause (1) of Part I of the Second Schedule to the Chartered Accountants
Act, 1949 deals with the professional misconduct relating to the disclosure of information by a chartered
accountant in practice relating to the business of his clients to any person other than his client without the
consent of his client or otherwise than as required by any law for the time being in force would amount to
breach of conduct. The Code of Ethics further clarifies that such a duty continues even after completion of the
assignment. The Chartered Accountant may however, disclose the information in case it is required as a part of
performance of his professional duties. In the given case, Mr. Parekh has disclosed vital information of his
client’s business without the consent of the client under the impression that it will help the nation to compete
with other countries at International level.
Conclusion: Thus, it is a professional misconduct covered by Clause (1) of Part I of Second Schedule to the
Chartered Accountants Act, 1949.
Q. 27: Mr. A, a Chartered Accountant was the auditor of 'A Limited'. During the financial year 2019-20, the
investment appeared in the Balance Sheet of the company of ` 10 lakhs & was the same amount as in the last
year. Later on, it was found that the company's investments were only ` 25,000, but the value of investments
was inflated for the purpose of obtaining higher amount of Bank loan.
Grossly Negligent in Conduct of Duties: As per Part I of Second Schedule to the Chartered Accountants Act,
1949, a Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he,
certifies or submits in his name or in the name of his firm, a report of an examination of financial statements
unless the examination of such statements & the related records has been made by him or by a partner or an
employee in his firm or by another chartered accountant in practice, under Clause (2); does not exercise due
diligence, or is grossly negligent in the conduct of his professional duties, under Clause (7); or fails to obtain
sufficient information which is necessary for expression of an opinion or its exceptions are sufficiently material
to negate the expression of an opinion, under Clause (8).
The primary duty of physical verification & valuation of investments is of the management. However, the
auditor’s duty is also to verify the physical existence & valuation of investments placed, at least on the last day
of the accounting year. The auditor should verify the documentary evidence for the cost/value & physical
existence of the investments at the end of the year. He should not blindly rely upon the Management’s
representation. In the instant case, such non-verification happened for two years. It also appears that auditors
failed to confirm the value of investments from any proper source. In case auditor has simply relied on the
management’s representation, the auditor has failed to perform his duty.

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Conclusion: Accordingly, Mr. A, will be held liable for professional misconduct under Clauses (2), (7) & (8) of
Part I of the Second Schedule to the Chartered Accountants Act, 1949.
Q. 28: Mr. Joe, a Chartered Accountant during the course of audit of M/s XYZ Ltd. came to know that the
company has taken a loan of ` 10 lakhs from Employees Provident Fund. The said loan was not reflected in
the books of account. However, the auditor ignored this information in his report.
Failure to Disclose Material Facts: As per Clause (5) of Part I of Second Schedule to the Chartered Accountants
Act, 1949, a chartered Accountant in practice will be held liable for misconduct if he fails to disclose a material
fact known to him, which is not disclosed in the financial statements but disclosure of which is necessary to
make the financial statements not misleading. In this case, Mr. Joe has come across information that a loan of `
10 lakhs has been taken by the company from Employees Provident Fund. This is contravention of Rules & the
said loan has not been reflected in the books of accounts. Further, this material fact has also to be disclosed in
the financial statements. The very fact that Mr. Joe has failed to disclose this fact in his report, he is attracted
by the provisions of professional misconduct under Clause (5) of Part I of Second Schedule to the Chartered
Accountants Act, 1949.
Q. 29: A practicing Chartered Accountant was appointed to represent a company before the tax authorities.
He submitted on behalf of his clients certain information & explanations to the authorities, which were
found to be false & misleading.
Submitting Information as Authorised Representative: As per Clause (5) of Part I of Second Schedule to the
Chartered Accountant Act, 1949, if a member in practice fails to disclose a material fact known to him which is
not disclosed in a financial statement, but disclosure of which is necessary to make the financial statement not
misleading, where he is concerned with that financial statement in a professional capacity, he will be held guilty
under Clause (5). As per Clause (6) of Part I of Second Schedule if he fails to report a material misstatement
known to him to appear in a financial statement with which he is concerned in a professional capacity, he will
be held guilty under Clause (6).
In given case, the Chartered Accountant had submitted the statements before the taxation authorities. These
statements are based on the data provided by the management of the company. Although the statements
prepared were based on incorrect facts & misleading, the Chartered Accountant had only submitted them
acting on the instructions of his client as his authorized representative.
Conclusion: Hence the Chartered Accountant would not be held liable for professional misconduct.
Q. 30: CA Chiranjiv who conducted ABC audit of a Haryana daily ‘New Era’ certified the circulation figures
based on Management Information System Report (M.I.S Report) without examining the books of Account.
According to Clause (7) of Part I of Second Schedule of Chartered Accountants Act, 1949, a Chartered
Accountant in practice is deemed to be guilty of professional misconduct if he “does not exercise due diligence
or is grossly negligent in the conduct of his professional duties”.
In the instant case, CA Chiranjiv did not exercise due diligence & is grossly negligent in the conduct of his
professional duties since he certified the circulation figures without examining the books of accounts.
To ascertain the number of paid copies verification of remittances from the agents, credit allowed to the agents
for unsold copies returned, examination of books of account is essential. Further certification of circulation
figures based on statistical information without cross verification with financial records amounts to gross
negligence & failure to exercise due diligence.
Conclusion: Hence, CA Chiranjiv is guilty of professional misconduct as per Clause (7) of Part I of Second
Schedule of Chartered Accountants Act, 1949.
Q. 31: Mr. D, a practicing Chartered Accountant, did not complete his work relating to the audit of the
accounts of a company & had not submitted his audit report in due time to enable the company to comply
with the statutory requirements.
Not Exercising Due Diligence: According to Clause (7) of Part I of Second Schedule of Chartered Accountants
Act, 1949, a Chartered Accountant in practice is deemed to be guilty of professional misconduct if he does not

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exercise due diligence or is grossly negligent in the conduct of his professional duties.
It is a vital clause which unusually gets attracted whenever it is necessary to judge whether the accountant has
honestly & reasonably discharged his duties. The expression negligence covers a wide field & extends from the
frontiers of fraud to collateral minor negligence.
Where a Chartered Accountant had not completed his work relating to the audit of the accounts a company &
had not submitted his audit report in due time to enable the company to comply with the statutory
requirement in this regard. He was guilty of professional misconduct under Clause (7). Since Mr. D has not
completed his audit work in time & consequently could not submit audit report in due time & consequently,
company could not comply with the statutory requirements, therefore, the auditor is guilty of professional
misconduct under Clause (7) of Part I of the Second Schedule to the Chartered Accountants Act, 1949.
Q. 32: Z, a practicing Chartered Accountant issued a certificate of circulation of a periodical without going
into the most elementary details of how the circulation of a periodical was being maintained i.e. by not
looking into the financial records, bank statements or bank pass books, by not examining evidence of actual
payment of printer’s bills & by not caring to ascertain how many copies were sold & paid for.
Failure to Obtain Information: Clause (8) of Part I of Second Schedule to the Chartered Accountants Act, 1949
states that if a Chartered Accountant in practice fails to obtain sufficient information to warrant the expression
of an opinion or his exceptions are sufficient material to negate the expression of an opinion, the chartered
accountant shall be deemed to be guilty of a professional misconduct.
In the instant case Mr. Z, a practicing Chartered Accountant issued a certificate of circulation of a periodical
without going into the most elementary details of how the circulation of a periodical was being maintained i.e.,
by not looking into the financial records, bank statements or bank pass books, by not examining evidence of
actual payment of printer’s bills & by not caring to ascertain how many copies were sold & paid for.
The chartered accountant should not express his opinion before obtaining the required data & information. As
an auditor, Mr. Z ought to have verified the basic records to ensure the correctness of circulation figures.
Conclusion: Thus, in the present case Mr. Z will be held guilty of professional misconduct as per Clause (8) of
Part I of Second Schedule to the Chartered Accountants Act, 1949.
Q. 33: A charitable institution entrusted ` 10 lakhs with its auditors M/s Ram & Co., a Chartered Accountant
firm, to invest in a specified securities. The auditors pending investment of the money, deposited it in their
Savings bank account & no investment was made in the next three months.
Failure to Keep Money in Separate Bank Account: If a Chartered Accountant in practice fails to keep moneys of
his clients in a separate bank account or fails to use such moneys for purposes for which they are intended then
his action would amount to professional misconduct under Clause (10) of Part I of Second Schedule to the
Chartered Accountants Act, 1949. In the course of his engagement as a professional accountant, a member may
be entrusted with moneys belonging to his client. If he should receive such funds, it would be his duty to
deposit them in a separate banking account, & to utilise such funds only in accordance with the instructions of
the client or for the purposes intended by the client.
Conclusion: In the given case by depositing the client’s money by M/s Ram & Co., a firm of Chartered
Accountants, in their own savings bank account, the auditors have committed a professional misconduct.
Hence in the given case, M/s Ram & Co. will be held guilty of professional misconduct.
Q. 34: L, a chartered accountant did not maintain books of account for his professional earnings on the
ground that his income is less than the limits prescribed u/s 44AA of the Income Tax Act, 1961.
Maintenance of Books of Account: As per the Council General Guidelines 2008, under Chapter 5 on
maintenance of books of accounts, it is specified that if a chartered accountant in practice or the firm of
Chartered Accountants of which he is a partner fails to maintain & keep in respect of his/its professional
practice, proper books of account including the Cash Book & Ledger, he is deemed to be guilty of professional
misconduct. Accordingly, it does not matter whether section 44AA of the Income Tax Act, 1961 applies or not.
Conclusion: Hence, Mr. L is guilty of professional misconduct.

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Q. 35: A member of the institute shall not accept in a year more than the specified number of tax audits u/s
44AB of the Income Tax Act.
Mr. Gaurav is a partner in M/s. XYZ & Co., a firm of Chartered Accountants with 6 partners.
During the assessment year 2020-21, Mr. Gaurav alone had signed 290 tax audit reports consisting of both
corporate & non-corporate assesses.
Ceiling limit for signing the Tax Audit Reports: As per Council General Guidelines 2008, a member of the
Institute in practice shall not accept, in a financial year, more than the “specified number of tax audit
assignments” u/s 44AB of the Income-tax Act, 1961. It is also provided further that where any partner of a firm
of Chartered Accountants in practice accepts one or more tax audit assignments in his individual capacity, the
total number of such assignments which may be accepted by him shall not exceed the “specified number of tax
audit assignments” in the aggregate.
In the case of firm of Chartered Accountants in practice “the specified number of tax audit assignments”
means, 60 tax audit assignments per partner in the firm, in a financial year, whether in respect of corporate or
non-corporate assesses.
Further, as per clarification issued by the Institute on Tax Audit Assignments, tax audit reports may be signed by
the partners in any manner whosoever in accordance with specified audit limits. Thus, one partner can
individually sign all the tax audit reports subject to specified tax audit assignment limits on behalf of all the
partners in the firm of Chartered Accountants in practice or all the partners of the firm can collectively sign the
tax audit reports.
In the instant case, there are 6 partners in M/s XYZ & Co., a Chartered Accountants firm, accordingly specified
ceiling limit for the firm will be (60 tax audit assignments per partner X 6 partners) = 360. Therefore, all the 6
partners of the firm can collectively sign 360 tax audit reports. This maximum limit of 360 tax audit assignments
may be distributed between the partners in any manner whatsoever. For instance, 1 partner can individually
sign 360 tax audit reports in case remaining 5 partners are not signing any tax audit report.
Assuming Mr. Gaurav has signed 290 tax audit reports consisting of both corporate & non-corporate assessee
on behalf of firm & remaining partners are signing audit reports within the specified number of tax audit
assignments u/s 44AB i.e. upto 70.
Conclusion: Hence, Mr. Gaurav shall not be deemed to guilty of professional misconduct provided total number
of tax audit reports on behalf of firm do not exceeds 360.
Q. 36: Mr. C accepted the statutory audit of M/s PSU Ltd., whose net worth is negative for the year 2019-20.
The audit was to be conducted for the year 2020-21. The audited accounts for the year 2020-21 showed
liability for payment of tax audit fees of ` 15,000 in favour of Mr. E, the previous auditor.
Accepting Appointment as an Auditor: As per Chapter 7 of Council General Guidelines 2008, a member of the
ICAI in practice shall be deemed to be guilty of professional misconduct if he accepts appointment as auditor of
an entity in case the undisputed audit fee of another chartered accountant for carrying out the statutory audit
under Companies Act or various other statutes has not been paid.
As per the proviso, such prohibition shall not apply in case of a sick unit where a sick unit is defined to mean
“where the net worth is negative”.
Conclusion: In the instant case, though the undisputed fees are unpaid, Mr. C would still not be guilty of
professional misconduct since the M/s PSU Ltd. is a sick unit having negative net worth for the year 2019-20.
Q. 37: A is the auditor of Z Ltd., which has a turnover of ` 200 crore. The audit fee for the year is fixed at ` 50
lakhs. During the year, the company offers A an assignment of management consultancy within the meaning
of Section 2(2)(iv) of the CA Act, 1949 for a remuneration of ` 1 crore. A seeks your advice on accepting the
assignment.
Appointment as a Statutory Auditor of a PSUs’/Govt Company(ies)/Listed Company(ies) & Other Public
Company(ies): As per the Council General Guidelines 2008, under Chapter IX on appointment as statutory
auditor a member of the Institute in practice shall not accepts the appointment as a statutory auditor of a

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PSUs’/Govt company(ies)/Listed company(ies) & other public company(ies) having a turnover of ` 50 crores or
more in a year & where he accepts any other work(s) or assignment(s) or service(s) in regard to same
undertaking(s) on a remuneration which in total exceeds the fee payable for carrying out the statutory audit of
the same undertaking. For this purpose, the other work/services include Management Consultancy & all other
professional services permitted by Council excluding audit under any other statute, Certification work required
to be done by the statutory auditor & any representation before an authority.
Conclusion: In view of the above position it would be a misconduct on A’s part if he accepts the management
consultancy assignment for a fee of ` 1 crore.
Q. 38: D, who conducts the tax audit u/s 44AB of the Income Tax Act, 1961 of M/s ABC, a partnership firm,
has received the audit fees of ` 2,50,000 on progressive basis in respect of the tax audit for the year ended
31.3.2020. The audit report was, however, signed on 25.5.2020.
Entire Audit Fees Received in Advance: As per Chapter X of Council General Guidelines, 2008 a member of the
Institute in practice or a partner of a firm in practice or a firm shall not accept appointment as auditor of a
concern while indebted to the concern or given any guarantee or provided any security in connection with the
indebtedness of any third person to the concern, for limits fixed in the statute & in other cases for amount
exceeding ` 1,00,000/-.
However, the Research Committee of the ICAI has expressed the opinion that where in accordance with the
terms of engagement of auditor by a client, the auditor recovers his fees on a progressive basis as & when a
part of the work is done without waiting for the completion of the whole job, he cannot be said to be indebted
to the company at any stage.
Conclusion: In the instant case, Mr. D is appointed to conduct a tax audit u/s 44AB of the Income Tax Act, 1961.
He has received the audit fees of ` 2,50,000 in respect of the tax audit for the year ended 31.3.2020 which is on
progressive basis. Therefore, Mr. D will not be held guilty for misconduct.
Q. 39: P, a Chartered Accountant in practice provides management consultancy & other services to his
clients. During 2020, looking to the growing needs of his clients to invest in the stock markets, he also
advised them on Portfolio Management Services whereby he managed portfolios of some of his clients. Is P
guilty of professional misconduct?
Advising on Portfolio Management Services : The Council of the ICAI pursuant to Section 2(2)(iv) of the
Chartered Accountants Act, 1949 has passed a resolution permitting “Management Consultancy & other
Services” by a Chartered Accountant in practice. A clause of the aforesaid resolution allows Chartered
Accountants in practice to act as advisor or consultant to an issue of securities including such matters as
drafting of prospectus, filing of documents with SEBI, preparation of publicity budgets, advice regarding
selection of brokers, etc. It is, however, specifically stated that Chartered Accountants in practice are not
permitted to undertake the activities of broking, underwriting & portfolio management services. Thus, a
chartered accountant in practice is not permitted to manage portfolios of his clients.
In view of this, P would be guilty of misconduct under the Chartered Accountants Act, 1949.
Q. 40:Mr. G, a Chartered Accountant in practice as a sole proprietor has an office in Mumbai near Church
Gate. Due to increase in professional work, he opens another office in a suburb of Mumbai which is
approximately 80 kilometers away from the municipal limits of the city. For running the new office, he
employs three retired Income-tax Officers. Is Mr. G guilty of professional misconduct?
In terms of section 27 of the Chartered Accountants Act, 1949, if a chartered accountant in practice has more
than one office in India, each one of these offices should be in the separate charge of a member of the
Institute. There is however an exemption for the above if the second office is located in the same premises, in
which the first office is located; or the second office is located in the same city, in which the first office is
located; or the second office is located within a distance of 50 kms from the municipal limits of a city, in which
the first office is located. Since the second office is situated beyond 50 kms of municipal limits of Mumbai city,
he would be liable for committing a professional misconduct.
Q. 41: Write a short note on Other Misconduct.

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Other Misconduct
Other misconduct has been defined in part IV of the First Schedule & part III of the Second Schedule. These
provisions empower the Council to inquire into any misconduct of a member even it does not arise out of his
professional work. This is considered necessary because a chartered accountant is expected to maintain the
highest standards of integrity even in his personal affairs & any deviation from these standards, even in his non-
professional work, would expose him to disciplinary action.
Other misconduct would also relate to conviction by a competent court for an offence involving moral
turpitude punishable with transportation or imprisonment to an offence not of a technical nature committed
by the member in his professional capacity. [See section 8(v) of the Act].
Q. 42: Mr. K, a practicing Chartered Accountant gave 50% of the audit fees received by him to a non-
Chartered Accountant, Mr. L, under the nomenclature of office allowance & such an arrangement continued
for a number of years. Discuss this in the light of Professional Ethics issued by ICAI.
Sharing of Audit Fees with Non-Member: As per Clause (2) of Part I of First Schedule to the Chartered
Accountants Act, 1949 a member shall be held guilty if a Chartered Accountant in practice pays or allows or
agrees to pay or allow, directly or indirectly, any share, commission or brokerage in the fees or profits of his
professional business, to any person other than a member of the Institute or a partner or a retired partner or
the legal representative of a deceased partner, or a member of any other professional body or with such other
persons having such qualification as may be prescribed, for the purpose of rendering such professional services
from time to time in or outside India.
In the instant case, Mr. K, a practising Chartered Accountant gave 50% of the audit fees received by him to a
non-Chartered Accountant, Mr. L, under the nomenclature of office allowance & such an arrangement
continued for a number of years. In this case, it is not the nomenclature to a transaction that is material but it is
the substance of the transaction, which has to be looked into.
The Chartered Accountant had shared his profits &, therefore, Mr. K will be held guilty of professional
misconduct under the Clause (2) of Part I of First Schedule to the Chartered Accountants Act, 1949.
Q. 43:Mr. X who passed his CA examination of ICAI on 18th July, 2020 & started his practice from August 15,
2020. On 16th August 2020, one female candidate approached him for articleship. In addition to monthly
stipend, Mr. X also offered her 1 % profits of his CA firm. She agreed to take both 1 % profits of the CA firm &
stipend as per the rate prescribed by the ICAI. The ICAI sent a letter to Mr. X objecting the payment of 1 %
profits. Mr. X replies to the ICAI stating that he is paying 1 % profits of his firm over & above the stipend to
help the articled clerk as the financial position of the articled clerk is very weak. Is Mr. X liable to professional
misconduct?
Sharing Fees with an Articled Clerk: As per Clause (2) of Part I of First Schedule to the Chartered Accountants
Act 1949, a Chartered Accountant in practice shall be deemed to be guilty of professional misconduct if he pays
or allows or agrees to pay or allow, directly or indirectly, any share, commission or brokerage in the fees or
profits of his professional business, to any person other than a member of the Institute or a partner or a retired
partner or the legal representative of a deceased partner, or a member of any other professional body or with
such other persons having such qualification as may be prescribed, for the purpose of rendering such
professional services from time to time in or outside India.
In view of the above, the objections of the ICAI, as given in the case, are correct & reply of Mr. X, stating that he
is paying 1 % profits of his firm over & above the stipend to help the articled clerk as the position of the articled
clerk is weak is not tenable. Hence, Mr. X is guilty of professional misconduct in terms of Clause (2) of Part I of
First Schedule to the Chartered Accountants Act 1949.
Q. 44: M/s XYZ, a firm in practice, develops a website “xyz.com”. The colour chosen for the website was a
very bright green & the web-site was to run on a “push” technology where the names of the partners of the
firm & the major clients were to be displayed on the web-site without any disclosure obligation from any
regulator. Is this website in compliance with guidelines issued by ICAI in this regard?
Posting of Particulars on Website: The Council of the Institute had approved posting of particulars on website
by Chartered Accountants in practice under Clause (6) of Part I of First Schedule to the Chartered Accountants

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Act, 1949 subject to the prescribed guidelines. The relevant guidelines in the context of the website hosted by
M/s XYZ are:
▪ No restriction on the colours used in the website;
▪ The websites are run on a “pull” technology & not a “push” technology;
▪ Names of clients & fees charged not to be given.
However, disclosure of names of clients &/or fees charged, on the website is permissible only where it is
required by a regulator, whether or not constituted under a statute, in India or outside India, provided that
such disclosure is only to the extent of requirement of the regulator. Where such disclosure of names of clients
&/or fees charged is made on the website, the member/ firm shall ensure that it is mentioned on the website
[in italics], below such disclosure itself, that “This disclosure is in terms of the requirement of [name of the
regulator] having jurisdiction in [name of the country/area where such regulator has jurisdiction] vide [Rule/
Directive etc. under which the disclosure is required by the Regulator].
In view of the above, M/s XYZ would have no restriction on the colours used in the website but failed to satisfy
the other two guidelines. Thus, the firm would be liable for professional misconduct since it would amount to
soliciting work by advertisement.
Q. 45: A partner of a firm of chartered accountants during a T.V. interview handed over a bio-data of his firm
to the chairperson. Such bio-data detailed the standing of the international firm with which the firm was
associated. It also detailed the achievements of the concerned partner & his recognition as an expert in the
field of taxation in the country. The chairperson read out the said bio-data during the interview. Discuss
whether this action by the Chartered Accountant would amount to misconduct or not.
Clause (6) of Part I of the First Schedule to the Chartered Accountants Act, 1949 prohibits solicitation of client
or professional work either directly or indirectly by circular, advertisement, personal communication or
interview or by any other means since it shall constitute professional misconduct. The bio-data was handed
over to the chairperson during the T.V. interview by the Chartered Accountant which included details about the
firm & the achievements of the partner as an expert in the field of taxation. The chairperson simply read out
the same in detail about association with the international firm as also the achievements of the partner & his
recognition as an expert in the field of taxation. Such an act would definitely lead to the promotion of the firms’
name & publicity thereof as well as of the partner & as such the handing over of bio-data cannot be approved.
The partner would be held guilty of professional miscount under Clause (6) of Part I of the First Schedule to the
Chartered Accountants Act, 1949.
Q. 46:
(a) An advertisement was published in a Newspaper containing the photograph of Mr. X, a member of the
institute wherein he was congratulated on the occasion of the opening ceremony of his office.
(b) Mr. X, a Chartered Accountant & the proprietor of X & Co., wrote several letters to the Assistant
Registrar of Co-operative Societies stating that though his firm was on the panel of auditors, no audit
work was allotted to the firm & further requested him to look into the matter.
(a) Publishing an Advertisement Containing Photograph: As per Clause (6) of Part I of the First Schedule to
the Chartered Accountants Act, 1949, a Chartered Accountant in practice shall be deemed to be guilty of
misconduct if he solicits clients or professional work either directly or indirectly by a circular,
advertisement, personal communication or interview or by any other means.
In the given case, Mr. X published an advertisement in a Newspaper containing his photograph on the
occasion of the opening ceremony of his office. On this context, it may be noted that the advertisement
which had been put in by the member is quite prominent. If soliciting of work is allowed, the
independence & forthrightness of a Chartered Accountant in the discharge of duties cannot be
maintained.
The above therefore amounts to soliciting professional work by advertisement directly or indirectly. Mr. X
would be therefore held guilty under Clause (6) of Part I of the First Schedule to the Chartered
Accountants Act, 1949.
(b) Soliciting Professional Work: As per Clause (6) of Part I of the First Schedule to the Chartered Accountants

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Act, 1949, a Chartered Accountant in practice shall be deemed to be guilty of misconduct if he solicits
clients or professional work either directly or indirectly by a circular, advertisement, personal
communication or interview or by any other means.
In the given case, Mr. X, a Chartered Accountant & proprietor of M/s X & Co., wrote several letters to the
Assistant Registrar of Co-operative Societies, requesting for allotment of audit work. In similar cases, it was
held that the Chartered Accountant would be guilty of professional misconduct under Clause (6) of Part I
of the First Schedule to the Chartered Accountants Act, 1949. The writing of continuous letter to ascertain
the reasons for not getting the work is quite alright but in case such either amount to request for allowing
the work then Mr. X will be liable for professional misconduct.
Consequently, Mr. X would therefore be held guilty under Clause (6) of Part I of the First Schedule to the
Chartered Accountants Act, 1949.
Q. 47: A practising Chartered Accountant uses a visiting card in which he designates himself, besides as
Chartered Accountant, Cost Accountant. Is this a misconduct?
Cost Accountant: As stated in the Illustration given in clause 7 with reference to tax consultant, this would also
constitute misconduct u/s 7 of the Act read with Clause (7) of Part I of the First Schedule to the Chartered
Accountants Act, 1949. A chartered accountant in practice cannot use any other designation than that of a
chartered accountant. Nevertheless, a member in practice may use any other letters or descriptions indicating
membership of accountancy bodies which have been approved by the Council. Thus, it is improper for a
chartered accountant to state in his documents that he is a “Cost Accountant”. However as per the Chartered
Accountants Act, 1949, the Council has resolved that the members are permitted to use letters indicating
membership of the Institute of Cost & Works Accountants but not the designation "Cost Accountant".
Q. 48: Mr. Nigal, a Chartered Accountant in practice, delivered a speech in the national conference organized
by the Ministry of Textiles. While delivering the speech, he told to the audience that he is a management
expert & his firm provides services of taxation & audit at reasonable rates. He also requested the audience to
approach his firm of chartered accountants for these services & at the request of audience he also
distributed his business cards & telephone number of his firm to those in the audience. Comment.
Using Designation Other Than a CA & Providing Details of Services Offered: Clause (6) of Part I of the First
Schedule to the Chartered Accountants Act, 1949 states that a Chartered Accountant in practice shall be
deemed to be guilty of misconduct if he solicits clients or professional work either directly or indirectly by a
circular, advertisement, personal communication or interview or by any other means. Such a restraint has been
put so that the members maintain their independence of judgment & may be able to command respect from
their prospective clients.
Section 7 of the Chartered Accountants Act, 1949 read with Clause (7) of Part I of the First Schedule to the said
Act prohibits advertising of professional attainments or services of a member. It also restrains a member from
using any designation or expression other than that of a chartered accountant in documents through which the
professional attainments of the member would come to the notice of the public. Under the clause, use of any
designation or expression other than chartered accountant for a chartered accountant in practice, on
professional documents, visiting cards, etc. amounts to a misconduct unless it be a degree of a university or a
title indicating membership of any other professional body recognised by the Central Government or the
Council.
Member may appear on television & films & agree to broadcast in the Radio or give lectures at forums & may
give their names & describe themselves as Chartered Accountants. Special qualifications or specialized
knowledge directly relevant to the subject matter of the programme may also be given but no reference should
be made, in the case of practicing member to the name & address or services of his firm. What he may say or
write must not be promotional of his or his firm but must be an objective professional view of the topic under
consideration.
Thus, it is improper to use designation "Management Expert" since neither it is a degree of a University
established by law in India or recognised by the Central Government nor it is a recognised professional
membership by the Central Government or the Council. Therefore, he is deemed to be guilty of professional
misconduct under both Clause (6) & Clause (7) as he has used the designation “Management Expert” in his

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speech & also he has made reference to the services provided by his firm of Chartered Accountants at
reasonable rates. Distribution of cards to audience is also a misconduct in terms of Clause (6).
Q. 49: Mr. A is a practicing Chartered Accountant working as proprietor of M/s A & Co. He went abroad for 3
months. He delegated the authority to Mr. Y a Chartered Accountant his employee for taking care of routine
matters of his office. During his absence Mr. Y has conducted the under mentioned jobs in the name of M/s A
& Co.
(i) He issued the audit queries to client which were raised during the course of audit.
(ii) He issued production certificate to a client under the GST Act.
(iii) He attended the Income Tax proceedings for a client as authorized representative before Income Tax
Authorities.
Please comment on eligibility of Mr. Y for conducting such jobs in name of M/s A & Co. & liability of Mr. A
under the Chartered Accountants Act, 1949.
Delegation of Authority to the Employee: As per Clause (12) of Part I of the First Schedule of the Chartered
Accountants Act, 1949, a Chartered Accountant in practice is deemed to be guilty of professional misconduct “if
he allows a person not being a member of the Institute in practice or a member not being his partner to sign on
his behalf or on behalf of his firm, any balance sheet, profit & loss account, report or financial statements”.
In this case CA A proprietor of M/s A & Co., went to abroad & delegated the authority to another Chartered
Accountant Mr. Y, his employee, for taking care of routine matters of his office who is not a partner but a
member of the Institute of Chartered Accountants
The Council has clarified that the power to sign routine documents on which a professional opinion or
authentication is not required to be expressed may be delegated & such delegation will not attract provisions
of this clause like issue of audit queries during the course of audit, asking for information or issue of
questionnaire, attending to routing matters in tax practice, subject to provisions of Section 288 of Income Tax
Act etc.
(i) In the given case, Mr. Y, a chartered accountant being employee of M/s A & Co. has issued audit queries
which were raised during the course of audit. Here Y is right in issuing the query, since the same falls
under routine work which can be delegated by the auditor. Therefore, there is no misconduct in this case
as per Clause (12) of Part I of First schedule to the Act.
(ii) Further, issuance of production certificate to a client under GST Act by Mr. Y being an employee of M/s A
& Co. (an audit firm), is not a routine work & it is outside his authorities. Thus, CA A is guilty of
professional misconduct under Clause (12) of Part I of First Schedule of the Chartered Accountants Act,
1949.
(iii) In this instance, Mr. Y, CA employee of the audit firm M/s A & Co. has attended the Income tax
proceedings for a client as authorized representative before Income Tax Authorities. Since the council
has allowed the delegation of such work, the chartered accountant employee can attend to routine
matter in tax practice as decided by the council, subject to provisions of Section 288 of the Income Tax
Act. Therefore, there is no misconduct in this case as per Clause (12) of Part I of First schedule to the Act.
Q. 50: XYZ Co. Ltd. has applied to a bank for loan facilities. The bank on studying the financial statements of
the company notices that you are the auditor & requests you to call at the bank for a discussion. In the
course of discussions, the bank asks for your opinion regarding the company & also asks for detailed
information regarding a few items in the financial statements. The information is available in your working
paper file. What should be your response & why?
As per Clause (1) of Part I of the Second Schedule of the Chartered Accountants Act, 1949, a Chartered
Accountant in practice is deemed to be guilty of professional misconduct if he discloses information acquired in
the course of his professional engagement to any person other than his client, without the consent of the client
or otherwise than as required by law for the time being in force. SA 200 on " Overall Objectives of the
Independent Auditor & the Conduct of an Audit in Accordance with Standards on Auditing" also reiterates that,
"the auditor should respect the confidentiality of information acquired in the course of his work & should not
disclose any such information to a third party without specific authority or unless there is a legal or professional

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duty to disclose".
In the instant case, the bank has asked the auditor for detailed information regarding few items in the financial
statements available in his working papers. Having regard to the position stated earlier, the auditor cannot
disclose the information in his possession without specific permission of the client. As far as working papers are
concerned, working papers are the property of the auditor. The auditor may at his discretion, make portions of
or extracts from his working papers available to his client".
Thus, there is no requirement compelling the auditor to divulge information obtained in the course of audit &
included in the working papers to any outside agency except as & when required by any law.
Q. 51: Mr. A, a newly qualified Chartered Accountant, started his practice & sought clients through telephone
calls from his family & friends, almost all of them employed in one or the other retail trade business. One of
his friends Mr. X gave him an idea to start online services & give stock certifications to traders with Cash
Credit Limits in Banks. Mr. A started a website with colorful catchy designs & shared the website address on
his all social media posts & stories & tagged 30 traders of his local community with the caption “Easy Online
Stock Certification Services”. Besides, Mr. A entered in an agreement with a Digital Marketer to give him 5%
commission on each service procured through him. Discuss if the actions of Mr. A are valid in the light of the
Professional Ethics & various pronouncements & guidelines issued by ICAI.
As per Clause (6) of Part I of the First Schedule of the Chartered Accountants Act, 1949, a Chartered Accountant
in practice is deemed to be guilty of professional misconduct if he solicits clients or professional work either
directly or indirectly by circular, advertisement, personal communication or interview or by any other means.
Mr. A is wrong in seeking clients through family & friends. Creating a website is not a non-compliance provided
it is in line with the guidelines issued by the Institute in this regard. One of the guidelines is that the website
should not be in push mode. Further, mentioning of clients’ names is also prohibited as per the guidelines.
In the given situation, Mr. A shared the website address on his all social media posts & stories & tagged 30
traders of his local community with the caption “Easy Online Stock Certification Services” mentioning his
current clients as well. This is in complete contravention of the guidelines on website issued by the ICAI.
Thus, CA, A would be held guilty of professional misconduct under clause 6 of Part 1 of First Schedule of the
Chartered Accountants Act, 1949.
Q. 52: Mr. D, a practicing CA, is appointed as a Director Simplicitor in XYZ Pvt. Ltd. After one year of
appointment, Mr. D resigned as the Director & accepted the Statutory Auditor position of the company. Is
Mr. D right in accepting the auditor position?
As per Clause (4) of Part I of the Second Schedule of the Chartered Accountants Act, 1949, a Chartered
Accountant in practice is deemed to be guilty of professional misconduct if he expresses his opinion on financial
statements of any business or enterprise in which he, his firm, or a partner in his firm has a substantial interest.
Section 141 of the Companies Act, 2013 specifically prohibits a member from auditing the accounts of a
company in which he is an officer or employee. Although the provisions of the aforesaid section are not
specifically applicable in the context of audits performed under other statutes, e.g. tax audit, yet the underlying
principle of independence of mind is equally applicable in those situations also. Therefore, the Council’s views
are clarified in the following situations.
As per the clarifications issued by the Council, a member shall not accept the assignment of audit of a Company
for a period of two years from the date of completion of his tenure as Director, or resignation as Director of the
said Company.
In the instant case, Mr. D, a practicing CA, is appointed as a Director Simplicitor in XYZ Pvt. Ltd. After one year
of appointment, Mr. D resigned as the Director & accepted the Statutory Auditor position of the company. In
view of above provisions Mr. D cannot accept the Directorship of the company until the completion of two
years after his resignation.
Thus, CA, D would be held guilty of professional misconduct under clause 4 of Part 1 of Second Schedule of the
Chartered Accountants Act, 1949.
Q. 53: Mr. F, a Chartered Accountant, gave advisory services to PQR Pvt. Ltd. Further, he gave them GST
consultancy & helped in ERP set up. Later, the company turned out to be a part of a group of companies

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involved in money laundering. Mr. F was asked to provide details of the companies. Mr. F refused on the
grounds that he gave only consultancy services to the company & wasn’t supposed to keep any information
about the company. Is Mr. F right as per the guidelines issued by the ICAI?
The financial services industry globally is required to obtain information of their clients & comply with Know
Your Client Norms (KYC norms). Keeping in mind the highest standards of Chartered Accountancy profession in
India, the Council of ICAI issued such norms to be observed by the members of the profession who are in
practice.
In the given situation, CA. F, gave GST consultancy & helped in ERP set up along with advisory services to PQR
Pvt. Ltd. Mr. F was asked to provide details of the companies as the company, turned out to be a part of a
group of companies, involved in money laundering. Contention of Mr. F that he gave only consultancy services
to the company & wasn't supposed to keep any information about the company is not valid as Mr. F should
have kept following information in compliance with KYC Norms which are mandatory in nature & shall
apply in all assignments pertaining to attestation functions.
In the given case of PQR Pvt. Ltd., a Corporate Entity, Mr. F should have kept following information:
b. General Information
▪ Name & Address of the Entity
▪ Business Description
▪ Name of the Parent Company in case of Subsidiary
▪ Copy of last Audited Financial Statement
c. Engagement Information
▪ A Type of Engagement
(C) Regulatory Information
▪ Company PAN No.
▪ Company Identification No.
▪ Directors' Names & Addresses
▪ Directors' Identification No.
Q. 54: Mr. S, the auditor of ABC Pvt. Ltd. has delegated following works to his articles & staff: i. Issue of audit
queries during the course of audit. ii. Issue of memorandum of cash verification & other physical verification.
iii. Letter forwarding draft observations/financial statements. iv. Issuing acknowledgements for records
produced. v. Signing financial statements of the company. Is this correct as per the Professional Ethics &
ICAI’s guidelines & pronouncements?
As per Clause (12) of Part I of the First Schedule of the Chartered Accountants Act, 1949, a Chartered
Accountant in practice is deemed to be guilty of professional misconduct if he allows a person not being a
member of the institute in practice or a member not being his partner to sign on his behalf or on behalf of his
firm, any balance sheet, profit & loss account, report or financial statements.
The Council has clarified that the power to sign routine documents on which a professional opinion or
authentication is not required to be expressed may be delegated in the following instances & such delegation
will not attract provisions of this clause:
(i) Issue of audit queries during the course of audit.
(ii) Asking for information or issue of questionnaire.
(iii) Letter forwarding draft observations/financial statements.
(iv) Initiating & stamping of vouchers & of schedules prepared for the purpose of audit.
(v) Acknowledging & carrying on routine correspondence with clients.
(vi) Issue of memorandum of cash verification & other physical verification or recording the results thereof in
the books of the clients.
(vii) Issuing acknowledgements for records produced. Raising of bills & issuing acknowledgements for money
receipts.

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(viii) Attending to routine matters in tax practice, subject to provisions of Section 288 of Income Tax Act.
(ix) Any other matter incidental to the office administration & routine work involved in practice of
accountancy.
In the instant case, Mr. S, the auditor of ABC Pvt. Ltd. has delegated certain task to his articles & staff such as
issue of audit queries during the course of audit, issue of memorandum of cash verification & other physical
verification, letter forwarding draft observations/financial statements, issuing acknowledgements for records
produced & signing financial statements of the company.
Therefore, Mr. S is correct in allowing first four tasks i.e. issue of audit queries during the course of audit, issue
of memorandum of cash verification & other physical verification, letter forwarding draft observations/financial
statements, issuing acknowledgements for records produced to his staff & articles.
However, if the person signing the financial statements on his behalf is not a member of the institute in
practice or a member not being his partner to sign on his behalf or on behalf of his firm, Mr. S is wrong in
delegating signing of financial statements to his staff.
Conclusion: In view of this, S would be guilty of professional misconduct for allowing the person signing the
financial statements on his behalf to his articles & staff under Clause 12 of Part 1 of First Schedule of the
Chartered Accountants Act, 1949.

ICAI STUDY MATERIAL Q & A COMPILER – BY CA AARTI N. LAHOTI