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 SA 200 Series

SM Questions
Q1. ABC & Associates, Chartered Accountants has a policy to accept the clients wherein the risk evaluation is
conducted with respect to the Company and the promoter. XYZ Limited approached ABC & Associates. Promoter
of XYZ Limited is a close associate and family friend of Mr. A, Managing Partner of ABC & Associates. XYZ Limited
is in news in the previous year for certain inquiries from the regulatory authorities in relation to certain matters.
The existing auditor of XYZ Limited has resigned and has created a casual vacancy. XYZ Limited is ready to offer
25% more than the existing fees and has approached ABC & Associates for appointment as Auditor. Mr. A has
strong recommendation to the Firm to accept the audit.

What is your understanding of the functioning of the tone at the top of the Firm ABC & Associates, Chartered
Accountants.? What are the considerations one should exercise to uphold Quality of the Firm?

Solution

The given situation indicates that proposed client is a new one whose promoter is close associate and family friend
of managing partner of M/s ABC & Associates. However, previous auditor of proposed client has resigned and
company is offering hike in audit fees in comparison to audit fees paid to previous auditor. Besides, there are also
regulatory inquires against the company. In spite of all this, managing partner of firm Mr. A has recommended for
acceptance of offered audit of the company.

It reflects poorly regarding functioning at top of the firm as regards to quality control. SQC 1 requires that firm should
establish a system of quality control designed to provide it with reasonable assurance that firm and its personnel
comply with professional standards and legal and regulatory requirements. It further requires that firm’s business
strategy is subject to overriding requirement of firm to achieve quality in all engagements. However, in the given
situation, commercial considerations seem to be overriding factor.

The managing partner of firm is close associate and family friend of promoter. The matter should have been brought
to knowledge of firm in accordance with requirements of SQC 1 as it involves issue of independence of managing
partner of the firm with respect to proposed audit engagement. Further, matters of inquiries from regulators and
resignation of previous auditor raise question about integrity of the proposed client. SQC 1 further requires firm to
consider before acceptance of an engagement that client does not lack integrity. All these factors need to be taken
into consideration before accepting engagement.

Following considerations should be taken into account while upholding quality of firm: -

(i) The firm assigns its management responsibilities so that commercial considerations do not override quality
of work performed

(ii) The firm’s policies and procedures in relation to its personnel are designed to demonstrate its overriding
commitment to quality.

(iii) The firm devotes sufficient resources for development and documentation of its quality control policies and
procedures

(iv) A firm before accepting an engagement should acquire vital information about the client. Such an
information should help firm to decide about integrity of Client, promoters and key managerial personnel,

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 SA 200 Series
competence (including capabilities, time and resources) to perform engagement and compliance with ethical
requirements.

Q2. MNP & Co., a firm of auditors, is appointed by a bank to conduct stock audit of a borrower. It deputes one of its
paid Chartered accountant employees, Sudhanshu, to conduct above said stock audit. He leverages it as an
opportunity to prevail upon the client to get the accounts audited from their firm. He also assures the client of a
clean stock audit report without adverse comments as a quid pro quo. Is approach of Sudhanshu proper? How
does it reflect upon quality control system of firm?

Solution

(Introduction)

Approach of Sudhanshu is not proper. Such practices blatantly violate code of ethics and its spirit. It reflects poorly
upon quality control system of firm envisaged in SQC 1 which requires that quality control policies and procedures
should be documented and communicated to the firm’s personnel. It shows that firm’s personnel are not properly
sensitized regarding requirements of SQC 1.

Q3. CA M is introduced to a prospective client in a social function. He assures to visit office of CA M very soon in
relation to professional work. During discussions over a cup of coffee next week, it transpires that there was a
search by Enforcement Directorate in his premises about a month back resulting in recovery of huge sum of cash.
The income tax department had also searched his premises in relation to bogus capital gains on penny stocks.
Lamenting poor quality of services provided by his present auditor, he offers appointment as tax auditor of his
five family-owned firms to CA M in lieu of handsome fees. What are the factors to be evaluated by CA M if he
wants to take up the engagement?

Solution

(Introduction)

As per SQC 1, before accepting a new engagement, integrity of client should be considered including matters that
indicate involvement in money laundering or criminal activities. There has been search of ED on the said party
leading to recovery of huge amount of cash. The above coupled with actions of income tax department relating to
bogus capital gains on penny stocks indicates that client might involve in money laundering activities. Therefore,
offer should not be accepted.

Q4. GVN & Associates are auditors of a listed company involved in “fin-tech” sector. The engagement team is stuck
up with some issue pertaining to a particular Ind-AS applicable to the company. They have framed a query and
sent to ICAI for expert opinion on the matter. The issue was resolved upon receipt of expert opinion. Since expert
opinion was provided by ICAI, engagement team was of the view that appointment of engagement quality control
reviewer has lost its relevance. Do you agree?

Solution

(Introduction)

Engagement quality control review in listed entities is a mandatory requirement. Expert opinion of ICAI pertains to
issue of interpretation. The appointment of reviewer is a separate and mandatory requirement in audits of listed
companies.

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 SA 200 Series
Q5. RST & Co., a firm of Chartered accountants, are auditors of a listed company engaged in manufacturing of heavy
machinery components. The audit report for year 2021-22 also included report on matters listed in CARO,2020.
While reporting under clause vii(a) of the said order relating to regularity of undisputed statutory dues by the
company, the auditors have commented that company is “generally regular” in depositing statutory dues to
appropriate authorities. Is above reporting qualitative and in line with requirements of SA 220?

Solution

(Introduction)

Such type of reporting is not qualitative. It is not in accordance with SA 220. One of the objectives of the auditor, as
per SA 220, is to implement quality control procedures at the engagement level that provide the auditor with
reasonable assurance that the audit complies with professional standards and regulatory and legal requirements .
The reporting under CARO, 2020 is not proper. Hence, the audit does not comply with regulatory and legal
requirements.

Q6. PQR & Associates are statutory auditors of a listed company. There arose an issue during the course of audit
relating to related party transactions. The engagement partner wants to consult engagement quality control
reviewer on this matter during the course of audit process itself. Can he consult with engagement quality control
reviewer? Discuss.

Solution

(Provision)

It is necessary to maintain objectivity of reviewer. Therefore, participation in engagement or making decisions for
engagement team is to be avoided at all costs. However, engagement partner may consult engagement quality
control reviewer during the engagement so as not to compromise his objectivity and eligibility to perform the role.

Q7. Beta Private Limited has approached a firm of Chartered accountants to assist them in preparation of financial
statements and issue a compilation report in this regard. Does CA firm have responsibility in relation to quality
control for above said engagement? Discuss with reasons.

Solution

(Provision)

Such kind of services fall in category of “related services”. SQC 1 is applicable to all type of engagements including
engagement pertaining to “related services”.

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 SA 200 Series

Additional Questions
Q8. CA Ragini is offered an appointment to act as Engagement Quality Control Reviewer (EQCR) for the audit of the
financial year 2022-23 of XPM Limited, a listed company operating from a small town. She is also based in the
same town and was not engaged previously to conduct an audit of a listed entity. She accepts the appointment
to act as ECQR. She performs the review by ticking a Yes/No checklist and signing on some of the working papers
prepared by the engagement team. The audit file does not contain any material misstatement which shows that
the work of EQCR is separate from the work of the engagement team. Do you agree with the approach adopted
by EQCR? Comment. (MTP Sep’23)

Solution

As per SQC 1 engagement quality control reviewer can be a partner, other person in the firm (member of ICAI),
suitably qualified external person, or a team made up of such individuals, with sufficient and appropriate experience
and authority to objectively evaluate, before the report is issued, the significant judgments the engagement team
made and the conclusions they reached in formulating the report.

It also states that the engagement quality control reviewer for an audit of the financial statements of a listed entity
is an individual with sufficient and appropriate experience and authority to act as an audit engagement partner on
audits of financial statements of listed entities.

In addition, the work of EQCR involves objective evaluation of the significant judgments made by the engagement
team and ensuring that the conclusions reached by the team in formulating audit report are appropriate. It is
necessary for EQCR to have the requisite technical expertise and experience to enable her to perform the assigned
role of evaluating the work of engagement team so that any possible misstatement can be avoided. Without
ensuring the appropriate technical expertise and experience, the whole purpose of EQCR is defeated. Therefore, it
was not appropriate for her to accept appointment as ECQR for listed entity.

Further, SA 220 states that the engagement quality control reviewer shall document, for the audit engagement
reviewed, that the procedures required by the firm’s policies on engagement quality control review have been
performed. It also states that it shall also be documented that the reviewer is not aware of any unresolved matters
that would cause the reviewer to believe that the significant judgments the engagement team made and the
conclusions they reached were not appropriate.

In the given situation, CA Ragini is offered an appointment to act as Engagement Quality Control Reviewer (EQCR)
for the audit of the financial year 2022-23 of XPM Limited, a listed company operating from a small town. She has
accepted the appointment and performed the review by ticking a Yes / No checklist and signing on some of the
working papers prepared by the engagement team.

In the instant case, there are no working papers to show that evaluation has been done by EQCR on conclusions
reached by engagement team. Mere ticking of a Yes/No checklist and signing on some working papers of
engagement team shows that no such evaluation and review of work performed by engagement team has been
made by EQCR. Therefore, her approach was not proper in performing work of EQCR.

Q9. M/s Chandra & Co., Chartered Accountants were appointed as Statutory Auditors of Green Essence Limited for
the F.Y 2021-2022. The previous year's audit was conducted by M/s. Nath & Associates. After the audit was
completed and report submitted, it was found that closing balances of last financial year i.e., 2020-21 were
incorrectly brought forward. It was found that M/s Chandra & Co. did not apply any audit procedures to ensure

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that correct opening balances have been brought forward to the current period. Accordingly, a complaint was
filed against Chandra & Co. in relation to this matter.

You are required to inform what policies are required to be implemented by Chandra & Co. for dealing with such
complaints and allegations as required by Standard on Quality Control (SQC). (MTP Mar’22, PYP Jan’21)

Solution

In the given question, Chandra & Co. did not apply audit procedures to ensure that opening balances had been
correctly brought forward. A complaint was filed against the auditors in this context. As per Standard on Quality
Control (SQC) 1 “Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information, and
Other Assurance and Related Services Engagements”,

(i) The firm should establish policies and procedures designed to provide it with reasonable assurance that it deals
appropriately with:

(a) Complaints and allegations that the work performed by the firm fails to comply with professional standards
and regulatory and legal requirements; and

(b) Allegations of non-compliance with the firm’s system of quality control.

(ii) Complaints and allegations (which do not include those that are clearly frivolous) may originate from within or
outside the firm. They may be made by firm personnel, clients or other third parties. They may be received by
engagement team members or other firm personnel.

(iii) As part of this process, the firm establishes clearly defined channels for firm personnel to raise any concerns in
a manner that enables them to come forward without fear of reprisals.

(iv) The firm investigates such complaints and allegations in accordance with established policies and procedures.
The investigation is supervised by a partner with sufficient and appropriate experience and authority within
the firm but who is not otherwise involved in the engagement, and includes involving legal counsel as
necessary. Small firms and sole practitioners may use the services of a suitably qualified external person or
another firm to carry out the investigation. Complaints, allegations and the responses to them are documented.

(v) Where the results of the investigations indicate deficiencies in the design or operation of the firm’s quality
control policies and procedures, or non-compliance with the firm’s system of quality control by an individual
or individuals, the firm takes appropriate action.

Q10. BSS & Associates is a partnership firm of Chartered Accountants which was established five years back. The firm
was offering only advisory services at the beginning, however, after audit rotation and advent of GST, firm sees
lot of potential in these areas also and started looking for opportunities in these areas also. These services being
assurance in nature, the firm required some internal restructuring and set up some policies and procedures for
compliance year on year.

The firm started getting new clients for these new services and is now looking to 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, and when considering acceptance of a new engagement with an
existing client. Where issues have been identified, and the firm decides to accept or continue the client
relationship or a specific engagement, it has been setting up a process to document how the issues were resolved.

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 SA 200 Series
The firm is now looking to work with only select clients which are in line with the policies of the firm. The firm
understands that the extent of knowledge it will have regarding the integrity of a client will grow within the
context of an ongoing relationship with that client. With regard to the integrity of a client, you are required to
give some examples of the matters to be considered by the firm as per the requirements of SQC 1. (RTP May’19,
PYP Nov’19)

Or

MB & Associates is a partnership firm of Chartered Accountants which was established seven years back. The firm
is getting new clients and 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 and 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.

Solution

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, and when considering
acceptance of a new engagement with an existing client. Where issues have been identified, and 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:

• The identity and business reputation of the client’s principal owners, key management, related parties and those
charged with its governance.

• The nature of the client’s operations, including its business practices.

• Information concerning the attitude of the client’s principal owners, key management and those charged with its
governance towards such matters as aggressive interpretation of accounting standards and the internal control
environment.

• Whether the client is aggressively concerned with maintaining the firm’s fees as low as possible.

• Indications of an inappropriate limitation in the scope of work.

• Indications that the client might be involved in money laundering or other criminal activities.

• The reasons for the proposed appointment of the firm and 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.

Q11. HK & Co. Chartered Accountants have been auditors of SAT Ltd (a listed entity) for the last 8 financial years. CA.
H, partner of the firm, has been handling the audit assignment very well since the appointment. The audit work
of CA. H and her team is reviewed by a senior partner CA. K to assure that audit is performed in accordance with
professional standards and regulatory and legal requirements. CA. K was out of India for some personal reasons,
so this year CA. G has been asked to review the audit work. In your opinion, what areas CA. G should consider at

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 SA 200 Series
the time of review. List any four areas and also comment whether firm is complying with Standard on Quality
Control or not. (PYP Jul’21)

Solution

As per SQC 1, an engagement quality control review for audits of financial statements of listed entities includes
considering the following:

(i) The work has been performed in accordance with professional standards and regulatory and legal requirements;

(ii) Significant matters have been raised for further consideration;

(iii) Appropriate consultations have taken place and the resulting conclusions have been documented and
implemented;

(iv) There is a need to revise the nature, timing and extent of work performed;

(v) The work performed supports the conclusions reached and is appropriately documented;

(vi) The evidence obtained is sufficient and appropriate to support the report; and

(vii) The objectives of the engagement procedures have been achieved.

Q12. PQR & Associates, Chartered Accountants, is a partnership firm having 3 partners CA P, CA Q and CA R. PQR &
Associates are appointed as Statutory Auditors of ABC Limited, a listed entity for the financial year 2021-22 and
CA P is appointed as Engagement Partner for the audit of ABC Limited. Before issuing the Audit Report of ABC
Limited, CA P asked CA R to perform Engagement Quality Control Review and is of the view that his responsibility
will be reduced after review by CA R. Whether the contention of CA P is correct? What are the aspects that need
to be considered by CA R while performing Engagement Quality Control Review for audit of financial statements
of ABC Limited? (PYP May ‘22)

Solution

As per SQC 1, “Quality Control for Firms that Perform Audit and Reviews of Historical Financial Information, and
other Assurance and Related Services Engagements”, the review does not reduce the responsibilities of the
engagement partner. Hence, contention of CA. P that after engagement quality control review by CA. R, his
responsibility will be reduced, is not correct.

However, CA. R needs to consider the following aspect while performing Engagement Quality Control Review for
audit of financial statements of a listed entity ABC Ltd.:

1. The engagement team’s evaluation of the firm’s independence in relation to the specific engagement.
2. Significant risks identified during the engagement and the responses to those risks.
3. Judgments made, particularly with respect to materiality and significant risks.
4. Whether appropriate consultation has taken place on matters involving differences of opinion or other
difficult or contentious matters, and the conclusions arising from those consultations.
5. The significance and disposition of corrected and uncorrected misstatements identified during the
engagement.
6. The matters to be communicated to management and those charged with governance and, where applicable,
other parties such as regulatory bodies.

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 SA 200 Series
7. Whether working papers selected for review reflect the work performed in relation to the significant
judgments and support the conclusions reached.
8. The appropriateness of the report to be issued.
Engagement quality control reviews for engagements other than audits of financial statements of listed entities
may, depending on the circumstances, include some or all of these considerations.

Q13. AP & Associates, Chartered Accountants, are Statutory Auditors of XP Limited for the last four years. XP Limited
is engaged in the manufacture and marketing of FMCG Goods in India. During 2021-22, the Company has
diversified and commenced providing software solutions in the area of "e-commerce" in India as well as in certain
European countries. AP & Associates, while carrying out the audit for the current financial year, came to know
that the company has expanded its operations into a new segment as well as new geography. AP & Associates
does not possess necessary expertise and infrastructure to carry out the audit of this diversified business activities
and accordingly wishes to withdraw from the engagement and client relationship. Discuss the issues that need to
be addressed before deciding to withdraw. (PYP Nov 22)
Solution

Acceptance and Continuance of Client Relationships and Specific Engagements: As per SQC 1, “Quality Control for
Firms that Perform Audit and Reviews of Historical Financial Information, and other Assurance and Related Services
Engagements”, the firm should establish policies and procedures for the acceptance and continuance of client
relationships and specific engagements, designed to provide it with reasonable assurance that it will undertake or
continue relationships and engagements only where it is competent to perform the engagement and has the
capabilities, time and resources to do so.
In the given case, AP & Associates, Chartered Accountants, statutory auditors of XP Limited for the last four years,
came to know that the company has expanded its operations into a new segment as well as new geography. AP &
Associates does not possess necessary expertise for the same, therefore, AP & Associates wish to withdraw from
the engagement and client relationship. Policies and procedures on withdrawal from an engagement or from both
the engagement and the client relationship address issues that include the following:
• Discussing with the appropriate level of the client’s management and those charged with its governance
regarding the appropriate action that the firm might take based on the relevant facts and circumstances.
• If the firm determines that it is appropriate to withdraw, discussing with the appropriate level of the client’s
management and those charged with its governance withdrawal from the engagement or from both the
engagement and the client relationship, and the reasons for the withdrawal.
• Considering whether there is a professional, regulatory or legal requirement for the firm to remain in place, or
for the firm to report the withdrawal from the engagement, or from both the engagement and the client
relationship, together with the reasons for the withdrawal, to regulatory authorities.
• Documenting significant issues, consultations, conclusions and the basis for the conclusions.
AP & Associates should address the above issues before deciding to withdraw.

Q14. OP & Associates are the statutory auditors of BB Ltd. BB Ltd is a listed company and started its operations 5 years
back. The field work during the audit of the financial statements of the company for the year ended 31 March
2018 got completed on 1 May 2018. The auditor’s report was dated 12 May 2018. During the documentation
review of the engagement, it was observed that the engagement quality control review was completed on 15
May 2018. Engagement partner had completed his reviews in entirety by 10 May 2018. Please comment. (MTP
Mar 19 & Oct 18)

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Solution

Review by Engagement Partner: As per SA 220, “Quality Control for an Audit of Financial Statements”, the
engagement partner shall take responsibility for reviews being performed in accordance with the firm’s review
policies and procedures. For audits of financial statements of listed entities, the engagement partner shall:
• Determine that an engagement quality control reviewer has been appointed;
• Discuss significant matters arising during the audit engagement, including those identified during the
engagement quality control review, with the engagement quality control reviewer; and
• Not date the auditor’s report until the completion of the engagement quality control review.
SA 700, “Forming an Opinion and Reporting on Financial Statements”, requires the auditor’s report to be dated no
earlier than the date on which the auditor has obtained sufficient appropriate evidence on which to base the
auditor’s opinion on the financial statements. In cases of an audit of financial statements of listed entities where the
engagement meets the criteria for an engagement quality control review, such a review assists the auditor in
determining whether sufficient appropriate evidence has been obtained.
Conducting the engagement quality control review in a timely manner at appropriate stages during the engagement
allows significant matters to be promptly resolved to the engagement quality control reviewer’s satisfaction on or
before the date of the auditor’s report.
In the instant case, OP & Associates are the statutory auditors of a listed company BB Ltd. Which started its
operations 5 years back. The field work during the audit of the financial statements of the company for the year
ended March 31, 2018 got completed on May 1, 2018. The auditor’s report was dated May 12, 2018. During the
documentation review of the engagement, it was observed that the engagement quality control review was
completed on May 15, 2018.
Thus, in the given case, signing of auditor’s report i.e., on May 12, 2018 which is before the completion of review
engagement quality control review i.e., May 15, 2018, is not in order.

Q15. During the audit of FMP Ltd, a listed company, Engagement Partner (EP) completed his reviews and 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 and not Engagement Quality Control Reviewer. Engagement Quality
Control Reviewer objected to this and refused to sign off the documentation. Please advise as per SA 220 (MTP
Oct 19, RTP May’22 & RTP May’19)
Solution

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:
a) Obtain relevant information from the firm and, where applicable, network firms, to identify and evaluate
circumstances and relationships that create threats to independence;
b) Evaluate information on identified breaches, if any, of the firm’s independence policies and procedures to
determine whether they create a threat to independence for the audit engagement; and
c) Take appropriate action to eliminate such threats or reduce them to an acceptable level by applying 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.

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Engagement Partner shall take responsibility for reviews being performed in accordance with the firm’s review
policies and 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.

Q16. Rishi Kumar & Co. has been appointed as an auditor of PK Ltd. for the financial year 2016 -17. CA. Kumar, one of
the partners of M/s Rishi Kumar & Co., completed entire routine audit work by 29th May, 2017. Unfortunately,
on the very next morning, while roving towards office of PK Ltd. to sign final audit report, he met with a road
accident and died. CA. Rishi, another partner of M/s Rishi Kumar & Co., therefore, signed the accounts of PK Ltd.,
without reviewing the work performed by CA. Kumar. Advise, whether CA. Rishi is right in expressing an opinion
on financial statements the audit of which is performed by another auditor. (PYP April 18)
Solution

As per SA 220 “Quality Control for an Audit of Financial Statements”, an engagement partner taking over an audit
during the engagement may apply the review procedures such as the work has been performed in accordance with
professional standards and regulatory and legal requirements; significant matters have been raised for further
consideration; appropriate consultations have taken place and the resulting conclusions have been documented
and implemented; there is a need to revise the nature, timing and extent of work performed; the work performed
supports the conclusions reached and is appropriately documented; the evidence obtained is sufficient and
appropriate to support the auditor’s report; and the objectives of the engagement procedures have been achieved.

Further, one of the basic principles, which govern the auditor’s professional responsibilities and which should be
complied with wherever an audit is carried, is that when the auditor delegates work to assistants or uses work
performed by other auditor and experts, he will continue to be responsible for forming and expressing his opinion
on the financial information. However, he will be entitled to rely on work performed by others, provided he exercises
adequate skill and care and is not aware of any reason to believe that he should not have so relied. This is the
fundamental principle which is ethically required as per Code of Ethics.
However, the auditor should carefully direct, supervise and review work delegated. He should obtain reasonable
assurance that work performed by other auditors/experts and assistants is adequate for his purpose.
In the given case, all the auditing procedures before the moment of signing of final report have been performed by
CA. Kumar. However, the report could not be signed by him due to his unfortunate death. Later on, CA. Rishi signed
the report relying on the work performed by CA. Kumar.
Here, CA. Rishi is allowed to sign the audit report, though, will be responsible for expressing the opinion. He may
rely on the work performed by CA. Kumar provided he further exercises adequate skill and due care and review the
work performed by him as required in compliance with SA 220.

Q17. NEMI Limited (manufacturer of textile goods) got an order of manufacturing of PPE kits in December 2021. But
there was shortage of machinery and manpower to accomplish the ordered requirement of PPE kits. NEMI Limited
approached another manufacturing unit Rathnemi Limited for purchase of the unit. Rathnemi Limited was
interested in the sale of unit, so the deal went through, and NEMI Limited acquired ninety five percent shares of
Rathnemi Limited. The new management of Rathnemi Limited proposed and appointed Mani Associates,
Chartered Accountants, (already auditors of NEMI Limited) as new auditors of Rathnemi Limited. Mani Associates

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accepted the assignment without considering information whether the conclusions reached regarding the
acceptance and continuance of client relationships and audit engagements are appropriate. Comment with
respect to appropriate Standard on Auditing what type of information assists the engagements partner in
determining whether the conclusions reached regarding the acceptance and continuance of client relationships
and audit engagements are appropriate or not? (MTP Sep 22)
Solution

As per SA 220, “Quality Control for an Audit of Financial Statements” , SQC 1, “Quality Control for Firms that Perform
Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements”,
requires the firm to obtain information considered necessary in the circumstances before accepting an engagement
with a new client, when deciding whether to continue an existing engagement, and when considering acceptance
of a new engagement with an existing client.
Information such as the following assists the engagement partner in determining whether the conclusions reached
regarding the acceptance and continuance of client relationships and audit engagements are appropriate:
(i) The integrity of the principal owners, key management and those charged with governance of the entity.
(ii) Whether the engagement team is competent to perform the audit engagement and has the necessary
capabilities, including time and resources.
(iii) Whether the firm and the engagement team can comply with relevant ethical requirements; and
(iv) Significant matters that have arisen during the current or previous audit engagement, and their implications
for continuing the relationship.

Q18. You are an audit senior at Bohra & Company, currently engaged in the audit of Wisdom Ltd., a manufacturer of
waste paper bins. You have concerns regarding Wisdom Ltd.'s inventory valuation policy and have repeatedly
raised the issue with the audit manager. However, the audit manager, who has handled this client for several
years, does not acknowledge your objections and has refused to meet you on-site to discuss the matter.
Given the audit manager's longstanding relationship with Wisdom Ltd., the firm's partners have decided to
entrust the audit to him entirely.
Or
BNE & Co. are in midst of audit process of a listed company. During the course of audit, an issue arose relating to
revenues from contracts with customers in terms of Ind AS 115. The engagement partner took a certain stand.
However, engagement quality control reviewer recommended otherwise after review. The engagement partner
is not willing to accept recommendations of reviewer. How can the stalemate be ended?
Solution

SQC 1 "Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information and Other
Assurance and Related Services Engagements" requires a firm to establish the policies and procedures for
dealing/resolving differences of opinion within the engagement team.

An engagement partner is usually appointed to each audit engagement undertaken by the firm, to take responsibility
for the engagement on behalf of the firm. Assigning the audit to an experienced audit manager is not sufficient.
SA 220 "Quality Control for an Audit of Financial Statements" requires that the audit engagement partner takes
responsibility for settling disputes in accordance with the firm's policy in respect of resolution of differences of
opinion required by SQC 1.

In the present case, partners of the firm have decided to leave the audit in the hands of the audit manager and no
engagement partner has been assigned. The lack of an audit engagement partner also means that several of the

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requirements of SA 220, about ensuring that engagements in relation to independence and directing, supervising,
and reviewing the audit are not in place.
Further, the audit manager and senior have conflicting views about the valuation of inventory. This does not appear
to have been handled well, with the manager refusing to discuss the issue with the senior.
Conclusion: Failure to resolve the difference of opinion is a breach of the firm's policy under SQC 1. It indicates that
the firm does not have a suitable policy concerning such disputes required by SQC 1.

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SM Questions
Q1. My Décor Limited, presently engaged in manufacturing of fabrics, wants to set up a new plant for manufacturing
of special kind of fabric providing an altogether different texture and feel. This kind of fabric has become a hit
with retail customers. The company needs to set up plant for manufacturing the above kind of fabric involving
huge capital outlays to stay competitive in the market.
You are auditor of the company and find that company’s revenue has increased in financial year 2022-23 to ` 1000
crore from ` 750 crore in last year. By the time, you started the audit, there was no change in plant capacity and
information regarding need to set up new plant has become known to you during inquiry of company’s personnel.
Discuss, how you should proceed to deal with above situation, as auditor of the company, paying special attention
to risk of material misstatement due to fraudulent financial reporting?
Solution

(Introduction)
The given situation highlights need for the company to set up new plant for manufacturing of special kind of fabric
to stay competitive in the market. Setting up of such plant involves huge capital outlays which could entail financing
arrangements. Therefore, excessive pressure exists for management to be involved in fraudulent financial reporting.
In such a situation, management may be tempted to inflate its revenues to show rosy picture. It is a fraud risk factor
and needs to be evaluated by the auditor.
The revenues of company have jumped from ` 750 crore in last year to ` 1000 crore in year 2022-23 without any
change in plant capacity. The auditor may consider abovesaid fraud risk factor for assessing risk of material
misstatement due to fraud.
In case of auditor assessing risk of material misstatement due to fraudulent financial reporting, audit procedures to
address such risk like performing substantive analytical procedures relating to revenue, use of computer assisted
audit techniques to identify unusual revenue transactions and testing controls pertaining to revenue transactions
need to be performed.
Q2. CA. Ridhima, internal auditor of Track Store Limited, has pointed out following deficiencies in internal control of
the company, in her reports: -
[i] Receivables are not reconciled at stipulated intervals.
[ii] Customers are provided a credit limit based upon their track record. However, no review of customer credit
limits is undertaken at required intervals.
The statutory auditor of the company finds that no action has been taken by the company on the said deficiencies
pointed out in reports of internal auditor. What does above situation allude to statutory auditor of company?
Solution

(Introduction)
Management failing to remedy known significant deficiencies in internal control on a timely basis is a fraud risk
factor for misstatements arising from fraudulent financial reporting.
When management does not correct significant deficiencies in internal control on a timely basis, it reflects an
attitude, character or set of ethical values that allow them knowingly and intentionally to commit a dishonest act.

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Failure to rectify known control deficiencies pertaining to reconciliation of receivables and review of customer credit
limits has the potential to fraud. Lack of timely reconciliation of receivables may lead to intentional misstatements.
Further, non-reviewing customer limit may lead to grant of credit beyond creditworthiness of customers. It may
result in intentional tying up of company’s funds with risky customers due to collusion.
The above situation is a fraud risk factor for fraudulent financial reporting.
Q3. MN & Associates are the statutory auditors of ABC Ltd. for the FY 2021-22. During the course of audit, the
engagement partner, Mr. Manohar notices a misstatement resulting from a suspected fraud that brings into
question the audit team’s ability to continue performing the audit. How should the audit team deal with the
situation?
Solution

During the course of audit, the engagement partner, Mr. Manohar notices a misstatement resulting from a
suspected fraud that brings into question the audit team’s ability to continue performing the audit. In such a
situation the audit team should:
(a) Determine the professional and 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;
(b) Consider whether it is appropriate to withdraw from the engagement, where withdrawal from the engagement
is legally permitted; and
(c) If the auditor withdraws: -
(i) Discuss with the appropriate level of management and those charged with governance, the auditor’s
withdrawal from the engagement and the reasons for the withdrawal and
(ii) 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 and the reasons for the withdrawal.

Q4. You are auditor of a social media company. Of late, government has tightened noose around companies operating
in this segment by bringing in a maze of regulatory legislations to protect interests of users. How you can proceed
to verify that company is compliant with new regulatory requirements? Besides, what does above situation
underscore to you as an auditor?

Solution

(Introduction of SA 240 & SA 250)

It needs to be verified that the company has put in place systems and procedures to meet with new regulatory
requirements. The same can be verified by examining policies and procedures developed by company in this regard
like devising appropriate system of internal control, sensitizing employees regarding new rules, engaging legal
advisors etc.
Further, financial stability of the company may be threatened due to new regulatory requirements. The
management may be under pressure. It is also a fraud risk factor and may need to be evaluated by auditor.

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Additional Questions
Q5. Intelligent Ltd entered into agreement with Mr Intellectual on 15th March, 2016, whereby it agreed to pay him Rs
2 Lakhs per month as retainership fee for consultation in IT Department. However, no amount was actually paid
and Rs 24 lakhs was provided in the statement of P&L for the year ending on 31st March 2016, Management of
the company uttered that need based consultation was obtained throughout the year. However, on investigation,
no documentary or other evidences of receipt of such services was fond. As the auditor of innocent Ltd, what
would be your approach?
or
On 15th March, 2020, the directors of Phony Ltd. instructed their accountant to enter purchases amounting Rs.
1.02 crores from a company incorporated dated 11th March, 2020. However, no amount was actually paid and
Rs. 1.02 crore was provided in the books of account as purchases for the year ending on 31st March, 2020.
On inspection, no documentary or other evidence of such purchases was found. As the auditor of Phony Ltd.,
what would be your approach regarding reporting of such bogus purchases? (MTP May20)
Solution

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 recording fictitious journal entries,
particularly close to the end of an accounting period, to manipulate operating results or achieve other objectives.
In the given case, Phony Ltd. has made purchases amounting Rs. 1.02 crores, at year-end. It also debited the sum in
the books of account; however, no documentary or other evidence of such purchases was found, on investigation.
It is clear that company has passed fictitious journal entries, near year-end, to manipulate the operating results.
Accordingly, the auditor would adopt the approach which will be based on the result of misstatement on the basis
of such fictitious journal entry, i.e. 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 perfo rming
the audit, the auditor shall determine the professional and 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; or the auditor may consider for appropriateness of
withdrawal from such engagement, where withdrawal from the engagement is legally permitted.
In addition, the auditor is required to report according to section 143(12) of the Companies Act, 2013. As per section
143(12), 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, which involves or is expected to involve individually an amount of Rs. 1 crore or above is
being or has been committed in the company by its officers or employees, he shall report the matter to the Central
Government in prescribed manner.
The auditor is also required to report under clause (xi) of paragraph 3 of Companies (Auditor’s Report) Order, 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 and the amount involved is to be indicated.
Q6. 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 and 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'. (MTP Oct 18, RTP May’18)

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Solution

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 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 and evaluate the effect
that this may have on the reliability of representations (oral or written) and audit evidence in general; and 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 Rs. 1 crore or above) or Audit Committee or Board in other
cases (in case the amount of fraud involved is less than Rs. 1 crore) within such time and in such manner as may be
prescribed.
The auditor is also required to report under clause (xi) of paragraph 3 of Companies (Auditor’s Report) Order, 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 and 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 and 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; and
(iii) If the auditor withdraws:
(1) Discuss with the appropriate level of management and those charged with governance, the auditor’s
withdrawal from the engagement and the reasons for the withdrawal; and
(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 and the reasons for the withdrawal.
Q7. In the course of audit of Kushal Ltd, you suspect that the management has made misstatements in the financial
statements intentionally to deceive the users and to succumb to pressures to meet market expectations. Elucidate
how the fraudulent financial reporting may be accomplished and also discuss the techniques of committing fraud
by management overriding controls. (MTP Oct21, PYP Nov’20)

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Solution

In the given case, management of Kushal Ltd has made intentional misstatements to deceive the users in order to
meet market expectations. Auditor is suspecting such intentional behavior of the management and in such
situations, SA 240 discusses how fraudulent financial reporting may be accomplished and also discusses techniques
of committing fraud by management overriding controls.
As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements” Fraudulent
financial reporting may be accomplished by the following:
(i) Manipulation, falsification (including forgery), or alteration of accounting records or supporting documentation
from which the financial statements are prepared.
(ii) Misrepresentation in or intentional omission from, the financial statements of events, transactions or other
significant information.
(iii) Intentional misapplication of accounting principles relating to amounts, classification, manner of presentation,
or disclosure.
Fraudulent financial reporting often involves management override of controls that otherwise may appear to be
operating effectively. Fraud can be committed by management overriding controls using such techniques as:
i. Recording fictitious journal entries, particularly close to the end of an accounting period, to manipulate operating
results or achieve other objectives.
ii. Inappropriately adjusting assumptions and changing judgments used to estimate account balances.
iii. Omitting, advancing or delaying recognition in the financial statements of events and transactions that have
occurred during the reporting period.
iv. Concealing, or not disclosing, facts that could affect the amounts recorded in the financial statements.
v. Engaging in complex transactions that are structured to misrepresenting the financial position or financial
performance of the entity.
vi. Altering records and terms related to significant and unusual transactions.
Q8. M/s Prakash & Co., Chartered Accountants were appointed as statutory auditors of JIN Limited for the financial
year 2021-22. During the course of audit, one of the partners CA Prakash observed that there is misappropriation
of assets in the form of theft of entity's inventory and is perpetrated by employees in relatively small and
immaterial amounts. CA Prakash is concerned with the existence of certain circumstances for increasing the
susceptibility of assets to misappropriation. Guide CA Prakash with respect to risk factors related to
misstatements arising from misappropriation of assets with reference to relevant Standard on Auditing. (MTP
Mar ’23, PYP Dec’21)
Solution

As per SA 240, “The Auditor’s Responsibilities Relating to Fraud in an audit of Financial Statements”,
misappropriation of assets involves the theft of entity’s assets and is often perpetrated by employees in relatively
small and immaterial amounts. However, it can also involve management who are usually more able to disguise or
conceal misappropriations in ways that are difficult to detect.

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Misappropriation of assets can be accomplished in a variety of ways including stealing physical assets or intellectual
property (for example, stealing inventory for personal use or for sale, stealing scrap for resale, colluding with a
competitor by disclosing technological data in return for payment).
Risk factors that relate to misstatements arising from misappropriation of assets are also classified according to the
three conditions generally present when fraud exists: incentives/pressures, opportunities, and
attitudes/rationalization.
Incentives/Pressures
Personal financial obligations may create pressure on management or employees with access to cash or other assets
susceptible to theft to misappropriate those assets.
Adverse relationships between the entity and employees with access to cash or other assets susceptible to theft
may motivate those employees to misappropriate those assets. For example, adverse relationships may be created
by the following:
(i) Known or anticipated future employee layoffs.
(ii) Recent or anticipated changes to employee compensation or benefit plans.
(iii) Promotions, compensation, or other rewards inconsistent with expectations.
Opportunities
Certain characteristics or circumstances may increase the susceptibility of assets to misappropriation. For example,
opportunities to misappropriate assets increase when there are the following:
(i) Large amounts of cash on hand or processed.
(ii) Inventory items that are small in size, of high value, or in high demand.
(iii) Easily convertible assets, such as bearer bonds, diamonds, or computer chips.
(iv) Fixed assets which are small in size, marketable, or lacking observable identification of ownership.
Inadequate internal control over assets may increase the susceptibility of misappropriation of those assets. For
example, misappropriation of assets may occur because there is the following:
(i) Inadequate segregation of duties or independent checks.
(ii) Inadequate oversight of senior management expenditures, such as travel and other reimbursements.
(iii) Inadequate management oversight of employees responsible for assets, for example, inadequate supervision
or monitoring of remote locations.
(iv) Inadequate job applicant screening of employees with access to assets.
(v) Inadequate record keeping with respect to assets, etc.
Attitudes/Rationalizations
(i) Disregard for the need for monitoring or reducing risks related to misappropriations of assets.
(ii) Disregard for internal control over misappropriation of assets by overriding existing controls or by failing to
take appropriate remedial action on known deficiencies in internal control.
(iii) Behavior indicating displeasure or dissatisfaction with the entity or its treatment of the employee.

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(iv) Changes in behavior or lifestyle that may indicate assets have been misappropriated.
(v) Tolerance of petty theft.
Q9. M/s Innocent Limited has entered into a transaction on 25th February, 2018, near year-end, whereby it has agreed
to pay Rs. 5 lakhs per month to Mr. Yuvraj as annual retainer-ship fee for "engineering consultation". No amount
was actually paid, but Rs. 60 lakhs are provided in books of account as on March 31, 2018.
Your inquiry elicits a response that need-based consultation was obtained round the year, but there is no
documentary or other evidence of receipt of the service. As the auditor of M/s Innocent Limited, what would be
your approach? (RTP Nov 18)
Solution

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 Recording fictitious journal entries,
particularly close to the end of an accounting period, to manipulate operating results or achieve other objectives.
Keeping in view the above, it is clear that Company has passed fictitious journal entries near year end to manipulate
the operating results. Also, Auditor’s enquiry elicited a response that need-based consultation was obtained round
the year, but there is no documentary or other evidence of receipt of the service, is not acceptable.
Accordingly, the auditor would adopt the following approach-
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 and 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; and
(iii) If the auditor withdraws:
(1) Discuss with the appropriate level of management and those charged with governance, the auditor’s
withdrawal from the engagement and the reasons for the withdrawal; and
(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 and the reasons for the withdrawal.
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 Rs. 1 crore or above) or Audit Committee or Board in other
cases (in case the amount of fraud involved is less than Rs. 1 crore) within such time and 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 and the amount involved is to be indicated.

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Q10. Arihant Limited was engaged in the business of owning and managing hotels and resorts, selling tourism packages
and performing airline bookings for corporate and individuals. It appointed Upadhyay & Co. as its statutory
auditor for the financial year 2021-22. While planning the audit, the audit team decided that the risk of improper
revenue recognition from hotel business should not be treated as a fraud risk. This conclusion was based on the
assessment of earlier years, wherein no fraud was identified in revenue recorded from such business. While
testing the internal financial controls over the process of revenue recognition, it was identified that the controls
are not properly designed to mitigate the risk of fraud and risk of improper revenue recognition. As a result, the
audit team decided to perform additional substantive testing. However, the audit team still were to the
conclusion that there is no risk of fraud in revenue recognition. During the course of substantive testing, it was
identified that the management did not account for revenue received from corporate hotel bookings amounting
to ` 35 crore. These amounts were partially received in the company’s bank accounts and partially received in the
CFO’s personal account. The amounts received in the bank account of the company were disclosed as advances
received against the future bookings.
In the light of above scenario, kindly guide the statutory auditors with respect to their responsibility relating to
fraud in an audit of a financial statement. (MTP Apr’24 & RTP Nov’22)
Solution

As per SA 240, “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements” and SA 315,
“Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its
Environment”, the auditor shall identify and assess the risks of material misstatement due to fraud at the financial
statement level, and at the assertion level for classes of transactions, account balances and disclosures. When
identifying and assessing the risks of material misstatement due to fraud, the auditor shall, based on a presumption
that there are risks of fraud in revenue recognition, evaluate which types of revenue, revenue transactions or
assertions give rise to such risks.
In accordance with SA 240, “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”
and 330,” The Auditor’s Responses to Assessed Risks” the auditor shall determine overall responses to address the
assessed risks of material misstatement due to fraud at the financial statement level and assertion level.
The presumption that there are risks of fraud in revenue recognition may be rebutted. For example, the auditor may
conclude that there is no risk of material misstatement due to fraud relating to revenue recognition in the case
where there is a single type of simple revenue transaction, for example, leasehold revenue from a single unit rental
property. However, when there is a complex revenue structure or when there is lack of controls on revenue
recognition, then there is a high probability of fraud risk in revenue recognition.
Obtaining an understanding of the entity and its environment, including the entity’s internal control (referred to
hereafter as an “understanding of the entity”), is a continuous, dynamic process of gathering, updating and analyzing
information throughout the audit.
In the current scenario, the company was earning revenue from multiple streams. Also, it was identified that the
controls are not properly designed to mitigate the risk of fraud and risk of improper revenue recognition. During the
year it was identified that the management did not account for revenue from corporate hotel bookings amounting
to ` 35 crore. These amounts were partially received in the company’s bank accounts and partially received in the
CFO’s personal account. The amounts received in the bank account of the company were disclosed as advances
received against future bookings.
Therefore, the auditor while performing the risk assessment procedures should consider the complexity and nature
of the revenue for determining the fraud risks in revenue recognition. Also, there were no adequate controls

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addressing the risk of improper revenue recognition or fraud risk, the audit team rebutted the fraud risk. Moreover,
the audit team should have recognized fraud risk by identifying the deficiencies of internal control over the revenue
recognition process and should have treated the risk of improper revenue recognition as a significant risk. Also, as
per Section 143(12), the auditor is required to report all the frauds identified during the course of the audit involving
amounts above ` 1 crore within the prescribed time frame to the Central Government.
Q11. During the course of audit of PEC Limited, CA Guru has reason to believe that a fraud involving Rs.75 lakhs has
been committed in the company by its employees. Is CA Guru under statutory obligation to report the above
matter to Central government by filing prescribed form on MCA Portal? How should he proceed to report above
said matter? (MTP Oct 24)
Solution

As per section 143(12) of the Companies Act, 2013 read with Rule 13 of the Companies (Audit and Auditors) Rules,
2014, 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, which involves or is expected to involve individually an amount of Rs 1 crore or above, is being
or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central
Government within such time and in such manner as prescribed.
In the given case, CA Guru has reason to believe that a fraud involving Rs 75 lakhs has been committed in the
company by its employees. Therefore, he is under no statutory obligation to report this matter to Central
Government by filing prescribed Form (ADT-4) on MCA portal.
In case of a fraud involving lesser than the specified amount [i.e. less than Rs 1 crore], the auditor shall report the
matter to the audit committee constituted under section 177 or to the Board in other cases within such time and in
such manner as prescribed. Besides, auditor has obligation to report matters pertaining to fraud under clause (xi) of
paragraph 3 of CARO, 2020.

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SM Questions
Q1. FAS Insurance Brokers Limited is a leading online insurance intermediary. During the year, Director General of
GST Intelligence (DGGI) has issued notice to the company for allegedly creating fictitious invoices for “marketing
and sales services” amounting to ` 50 crores in favour of non-life insurance companies. The premises of company
were also searched during the year by DGGI officials. The matter was also informed to IRDAI by DGGI for violation
of norms and regulations in this regard.
Does above situation has any bearing on your responsibilities as statutory auditor of the company? Outline briefly
in context of possible non-compliance with laws by the company.
Solution

When the auditor becomes aware of the existence of or has information about investigations by government
departments and regulatory organizations, it may be an indication of non- compliance with laws and regulations.
In the instant case, notice has been served upon the company by DGGI for allegedly creating fictitious invoices in
guise of providing “marketing and sales services” for ` 50 crores. Issuing an invoice without supply of services is a
serious offence under GST laws and it could involve penalties and imprisonment. Such suspected non-compliance
may have a direct effect on financial statements.
The matter has also been informed to regulator i.e. IRDAI. Violation of IRDAI regulations may result in fines, litigation
or other consequences for the entity that may have a material effect on the financial statements.
If the auditor becomes aware of information concerning an instance of non-compliance or suspected non-
compliance with laws and regulations, the auditor shall obtain: -
(a) An understanding of the nature of the act and the circumstances in which it has occurred and
(b) Further information to evaluate the possible effect on the financial statements.
If the auditor suspects there may be non-compliance, the auditor shall discuss the matter with management and,
where appropriate, those charged with governance. If management or, as appropriate, those charged with
governance do not provide sufficient information that supports that the entity is in compliance with laws and
regulations and, in the auditor’s judgment, the effect of the suspected non-compliance may be material to the
financial statements, the auditor shall consider the need to obtain legal advice.
If sufficient information about suspected non-compliance cannot be obtained, the auditor shall evaluate the effect
of the lack of sufficient appropriate audit evidence on the auditor’s opinion.
Q2. Discuss why the potential effects of inherent limitations of an auditor’s ability to detect material misstatements
described in SA 200 are far greater in respect of non-compliance with laws and regulations?
Solution

In the context of laws and regulations, the potential effects of inherent limitations on the auditor’s ability to detect
material misstatements are greater for such reasons as the following: -

• There are many laws and regulations, relating principally to the operating aspects of an entity that typically do
not affect the financial statements and are not captured by the entity’s information systems relevant to
financial reporting.

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• Non-compliance may involve conduct designed to conceal it, such as collusion, forgery, deliberate failure to
record transactions, management override of controls or intentional misrepresentations being made to the
auditor.
• Whether an act constitute non-compliance is ultimately matter for legal determination by court of law.
Q3. CA Anand is the engagement partner for the audit assignment of NHT Ltd. engaged in manufacture of Iron and
Steel bars. The company has its plants in the state of Sikkim. While verifying the wages record of the company,
CA Anand found that maximum of the labour employed in the plants of the company was child labour. He
questioned the management of the company about the same to which the management replied that looking into
the compliance of such law is outside his scope of financial audit. Give your comments with respect to such
situation.
Solution

As per SA 250 “Considerations of Laws and Regulations in an Audit of Financial Statements”, the auditor is not
responsible for preventing non-compliance and cannot be expected to detect non-compliance with all laws and
regulations. 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. In conducting an audit of financial
statements, the auditor takes into account the applicable legal and regulatory framework.
For the compliance with provisions of those laws and regulations generally recognised to have a direct effect on the
determination of material amounts and disclosures in the financial statements, the auditor’s responsibility is to
obtain sufficient appropriate audit evidence about compliance with the provisions of those laws and regulations .
For other laws and regulations that do not have a direct effect on the determination of the amounts and disclosures
in the financial statements but compliance with which may be fundamental to the operating aspects of the business,
the auditor’s responsibility is limited to undertaking specified audit procedures to help identify non-compliance with
those laws and regulations that may have a material effect on the financial statements.
In the instant case, maximum of the labour employed in the plants of the company was child labour. When CA Anand
questioned the management of the company about the same, the management replied that looking into the
compliance of such law is outside his scope of financial audit. Such reply by the management is not acceptable as
such situation may have a material effect on the financial statements.
Therefore, CA Anand should ensure as to whether any penal provisions will be there for non- compliance of such
law and also whether the same has been duly disclosed by the company. If CA Anand concludes that such non-
compliance has a material effect on the financial statements and the same has not been adequately reflected in the
financial statements by the company, he shall express an adverse or a qualified opinion on the financial statements .

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Additional Questions
Q4. During the course of audit of CT Ltd. for the financial year 2017-18, it is noticed that Rs. 3.00 lakhs of employee
contribution and Rs. 7.50 lakhs of employer contribution towards employee state insurance contribution have
been accounted in the books of accounts in respective heads. Whereas, it was found that Rs. 5.00 lakhs only has
been deposited with ESIC department during the year ended 31st March, 2018. The Finance Manager informed
the auditor that due to financial crunch they have not deposited the amount due, but will deposit the amount
overdue along with interest as & when financial position improves. Comment as statutory auditor. (MTP Aug 18
& April 18)
Solution

As per SA 250 “Consideration of Laws and Regulations in an Audit of Financial Statement”, it is the responsibility of
management, with the oversight of those charged with governance, to ensure that the entity’s operations are
conducted in accordance with the provisions of laws and regulations, including compliance with the provisions of
laws and regulations that determine the reported amounts and disclosures in an entity’s 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. In conducting an audit of financial statements, the
auditor takes into account the applicable legal and regulatory framework. If the auditor concludes that the non-
compliance has a material effect on the financial statements, and has not been adequately reflected in the financial
statements, the auditor shall express a qualified or adverse opinion on the financial statements.
Further, the auditor is required to report under clause (vii)(a) of Para 3 of CARO, 2020 whether the company is
regular in depositing undisputed statutory dues including employees’ state insurance with the appropriate
authorities and if not, the extent of the arrears of outstanding statutory dues as at the last day of the financial year
concerned for a period of more than six months from the date they became payable, shall be indicated by the
auditor.
In the instant case, even though accrual principles have been followed, disclosure of non-payment is necessary. The
auditor should disclose the fact of non-payment of rupees 7.50 lakhs in his report.
Q5. XYZ Pvt. Ltd. has submitted the financial statements for the year ended 31-3-18 for audit. The audit assistant
observes and brings to your notice that the company's records show following dues:
Income Tax relating to A.Y. 2014-15 Rs. 125 lacs - Appeal is pending before Hon'ble ITAT since 30-9-16.
Customs duty Rs. 85 lakhs - Demand notice received on 15-9-17 but no action has been taken to pay or appeal.
Comment. As an auditor, how would you bring this fact to the members? (MTP Oct 18)

Solution

Non-Compliance of Laws and Regulations: As per SA 250 “Consideration of Laws and Regulations in an Audit of
Financial Statement”, it is the responsibility of management, with the oversight of those charged with governance,
to ensure that the entity’s operations are conducted in accordance with the provisions of laws and regulations,
including compliance with the provisions of laws and regulations that determine the reported amounts and
disclosures in an entity’s 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. In conducting an audit of financial statements,
the auditor takes into account the applicable legal and regulatory framework.

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Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements in the
financial statements may not be detected, even though the audit is properly planned and performed in accordance
with the SAs.

If the auditor concludes that the non-compliance has a material effect on the financial statements, and has not been
adequately reflected in the financial statements, the auditor shall express a qualified or adverse opinion on the
financial statements.

Further, the auditor is required to report on certain matters specified in Para 3 of CARO, 2020 under section 143 of
the Companies Act, 2013.

One of such matter is non-payment of dues to Government, on account of any dispute. As per clause (vii)(b) of Para
3 of CARO, 2020, in case dues of income tax or sales tax or service tax or duty of customs or duty of excise or value
added tax have not been deposited on account of any dispute, then the amounts involved and the forum where
dispute is pending shall be mentioned.

In the present case, there is Income Tax demand of Rs. 125 Lacs and the company has gone for an appeal, it needs
considerations as to whether the entire demand is disputed, because it is difficult to presume that the demand by
Income Tax authority is without any basis. Therefore, as per AS 29 “Provisions, Contingent Liabilities and Contingent
Assets”, partly to the extent the company considers that the demand is based on some logical basis, that amount
may be provided for and the remaining may be disclosed as the contingent liability. Further, it should be brought to
notice of the members by reporting.

Additionally, the demand notice has been received for Customs duty of Rs. 85 lakhs and is outstanding on the closure
of financial year, for which no action has been taken by the management. Therefore, it should also be brought to
notice of the members by reporting.

Q6. As an Auditor of TRP Ltd., you are suspicious that there might be non-compliance with laws and regulations to
which the Company is subject to. Indicate the possible areas or aspects where you may have to look out for
forming an opinion as to whether your suspicion has some basis to further inquire. (MTP Oct 21, PYP May ’18)

Or
You are appointed as an auditor of Moksh Ltd., a company engaged in export of agricultural equipment. During
the course of audit, your audit team informed you regarding non-deduction of TDS on huge payments made to
legal counsel of Moksh Ltd. You want to alert your team on the possibility of noncompliance with Laws and
Regulations by Moksh Ltd. Help your audit team in identifying any other indications of non-compliance with Laws
and Regulations particularly related to payments made by the company. (MTP April ’23)
Or
R & M Co. wants to be alert on the possibility of non-compliance with Laws and Regulations during the course of
audit of SRS Ltd. R & M Co. seeks your guidance for identifying the indications of noncompliance with Laws and
Regulations.
Solution

When the auditor becomes aware of the existence of, or information about, the following matters, it may be an
indication of non-compliance with laws and regulations, possible areas or aspects to look out for forming an opinion
are:

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• Investigations by regulatory organisations and 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 and 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.
• 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.
• Unauthorized transactions or improperly recorded transactions.
• Adverse media comment.
Q7. CA Abhinanadan is an auditor of KM Private Limited. During the course of audit, CA Abhinanadan becomes aware
of information concerning an instance of non- compliance or suspected non-compliance with laws and
regulations. Being a senior partner of CA. Abhinanadan, guide him regarding audit procedures to be followed
when non-compliance is identified or suspected. (RTP May 22)
Solution

As per SA 250, “Consideration of Laws and Regulations in an Audit of Financial Statements”, if the auditor becomes
aware of information concerning an instance of non-compliance or suspected non-compliance with laws and
regulations, the auditor shall obtain:
(i) An understanding of the nature of the act and the circumstances in which it has occurred; and
(ii) Further information to evaluate the possible effect on the financial statements.
If the auditor suspects there may be non-compliance, the auditor shall discuss the matter with management and,
where appropriate, those charged with governance. If management or, as appropriate, those charged with
governance do not provide sufficient information that supports that the entity is in compliance with laws and
regulations and, in the auditor’s judgment, the effect of the suspected non-compliance may be material to the
financial statements, the auditor shall consider the need to obtain legal advice.
If sufficient information about suspected non-compliance cannot be obtained, the auditor shall evaluate the effect
of the lack of sufficient appropriate audit evidence on the auditor’s opinion.
The auditor shall evaluate the implications of non-compliance in relation to other aspects of the audit, including the
auditor’s risk assessment and the reliability of written representations, and take appropriate action.
Q8. Abhinandan Limited a chemical manufacturing company, having its factory located at Nanded Village, for the year
2021-22 appointed Subahu & Co. as their statutory auditors. During the course of the audit, Subahu & Co.
identified that Abhinandan Limited received a show cause notice from National Green Tribunal based on the
investigation performed by the regional forest department for violating environmental laws. Upon gathering a
further understanding of the said matter, it was identified that Abhinandan Limited was dumping toxic solid
waste, without treating it, on the nearby grounds, and because of this, the nearby water bodies were getting
polluted. Based on the preliminary investigation performed by the regional forest department under the

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directions of the National Green Tribunal, it was identified that these practices were carried out since 2009 and a
lot of damage has been done to the environment by Abhinandan Limited. A show cause notice was already issued
to Abhinandan Limited by the National Green Tribunal for levying the penalty of an amount of ` 500 crore. The
unaudited profit for the financial year 2021 -22 of Abhinandan Limited was ` 35 crore and the unaudited turnover
was ` 100 crore. Upon inquiry it was identified that Abhinandan Limited has disclosed this matter in the financial
statements by way of footnote, the extract of which is provided below:
“The company has received a show cause notice from the National Green Tribunal for some potential violation of
environmental laws and the company’s legal department has assessed and found that the judgment would be in
favour of the company. Accordingly, no provision has been created for such notices.”
In the light of the above scenario kindly provide what should be the appropriate option for the statutory auditor
of the company to report this matter. (RTP Nov’22)
Solution

As per SA 250, “Consideration of Laws and Regulations in an Audit of Financial Statements”, the auditor is required
to obtain an understanding and need to evaluate the impact of other laws and regulations that do not have a direct
effect on the determination of the amounts and disclosures in the financial statements, but compliance with which
may be fundamental to the operating aspects of the business, to an entity’s ability to continue its business, or to
avoid material penalties (for example, compliance with the terms of an operating license, compliance with
regulatory solvency requirements, or compliance with environmental regulations); non-compliance with such laws
and regulations may therefore have a material effect on the financial statements.
The auditor shall perform the following audit procedures to help identify instances of non – compliance with other
laws and regulations that may have a material effect on the financial statements:
(a) Inquiring of management and, where appropriate, those charged with governance, as to whether the entity is
in compliance with such laws and regulations; and
(b) Inspecting correspondence, if any, with the relevant licensing or regulatory authorities. As per Section 143(3)(j)
read with Rule 11(a), the auditor is required to report whether the company has disclosed the impact, if any, of
pending litigations on its financial position in its financial statement.
As per SA 570, “Going Concern”, if the auditor concludes that management’s use of the going concern basis of
accounting is appropriate in the circumstances but a material uncertainty exists, the auditor shall determine
whether the financial statements:
(i) Adequately disclose the principal events or conditions that may cast significant doubt on the entity’s ability to
continue as a going concern and management’s plans to deal with these events or conditions; and
(ii) Disclose clearly that there is material uncertainty related to events or conditions that may cast significant doubt
on the entity’s ability to continue as a going concern and, therefore, that it may be unable to realize its assets
and discharge its liabilities in the normal course of business.
If adequate disclosure about the material uncertainty is not made in the financial statements, the auditor shall (a)
Express a qualified opinion or adverse opinion, as appropriate, in accordance with SA 705; and (b) 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 and that the financial statements do not
adequately disclose this matter.

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In the current scenario, Abhinandan Limited has received a show cause notice from the National Green Tribunal of
an amount which is more than the net profit and the turnover of the company for the year. In the event of an
unfavorable order for Abhinandan Limited, there will be an impact on Abhinandan Limited’s ability to continue as a
going concern.
As a result, appropriate disclosure should be provided by management for such events which cast significant doubt
on the entity’s ability to continue as a going concern. As no appropriate disclosure has been provided by Abhinandan
Limited for such show cause notice, Subahu & Co. should report this matter in their audit report under “Going
Concern Para” as per SA 570 and under clause (j) of Section 143(3) of the Companies Act, 2013. Also, the auditor is
required to issue an adverse opinion as per SA 705, “Modifications to the Opinion in the Independent Auditor’s
Report”.
Q9. CA Paras has been appointed as the Chief Financial Officer (CFO) of Prashanth Limited. In this role, CA Paras is
tasked with the responsibility of ensuring that the company's entity’s operations are conducted in accordance
with relevant laws and regulations. As part of his duties, CA Paras is emphasising the importance of adhering to
all applicable laws and regulations that could impact the entity's specific disclosures in its financial statements.
Additionally, he is focusing on compliance with laws and regulations that dictate the appropriate financial
reporting framework for the company. CA Paras is also highlighting the significance of avoiding any non-
compliance, as certain laws and regulations may impose penalties in the event of violations. Now CA Paras wants
to implement policies and procedures in an entity that can assist in the prevention and detection of non-
compliance with the laws and regulations. Help CA Paras by citing examples of such policies and procedures. (RTP
Nov ’23)
Or
PQ Limited, a listed entity, is in the business of manufacturing of specialty chemicals. The company has appointed
CA Jazz as CFO of the company. CA Jazz is concerned about compliance with the provisions of laws and regulations
that determine the reported amounts and disclosure in financial statements of PQ Limited. Accordingly, CA Jazz
wants to implement such policies and procedures that can assist him in the prevention and detection of non-
compliance with laws & regulation. Help CA Jazz by citing examples of such policies and procedures. (PYP Nov-20)
Solution

SA 250, “Consideration of Laws and Regulations in an Audit of Financial Statements”, states that it is the
responsibility of management, with the oversight of those charged with governance to ensure that the entity’s
operations are conducted in accordance with the provisions of laws and regulations. For this purpose, management
may apply the following procedures:

• Monitoring legal requirements and ensuring that operating procedures are designed to meet these
requirements.
• Instituting and operating appropriate systems of internal control.
• Developing, publicizing and following a code of conduct.
• Ensuring employees are properly trained and understand the code of conduct.
• Monitoring compliance with the code of conduct and acting appropriately to discipline employees who fail to
comply with it.
• Engaging legal advisors to assist in monitoring legal requirements.
• Maintaining a register of significant laws and regulations with which the entity has to comply within its
particular industry and a record of complaints.

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SM Questions
Q1. CA. Vallabh Sundar is auditor of a leading private sector bank. “IT Systems and controls” is under his consideration
to be reported as “Key audit matter” in audit report of the bank due to high level of automation and complexity
of the IT architecture and its impact on the financial reporting system.
At what time he should communicate such identified “Key audit matter”? What are relevant considerations in
this regard and their usefulness?
Solution

SA 260 requires the auditor to communicate with those charged with governance on a timely basis.
SA 701 states that the appropriate timing for communications about key audit matters will vary with the
circumstances of the engagement. However, the auditor may communicate preliminary views about key audit
matters when discussing the planned scope and timing of the audit, and may further discuss such matters when
communicating about audit findings. Doing so may help to alleviate the practical challenges of attempting to have a
robust two- way dialogue about key audit matters at the time the financial statements are being finalized for
issuance.
Communication with those charged with governance enables them to be made aware of the key audit matters that
the auditor intends to communicate in the auditor’s report, and provides them with an opportunity to obtain furt her
clarification where necessary. The auditor may consider it useful to provide those charged with governance with a
draft of the auditor’s report to facilitate this discussion.
Communication with those charged with governance recognizes their important role in overseeing the financial
reporting process, and provides the opportunity for those charged with governance to understand the basis for the
auditor’s decisions in relation to key audit matters and how these matters will be described in the auditor’s report.
It also enables those charged with governance to consider whether new or enhanced disclosures may be useful in
light of the fact that these matters will be communicated in the auditor’s report.
Q2. CA. Shelly Goel is offered appointment as auditor of RUTE Limited, a listed company. The audit committee of the
company wants her to justify independence in relation to company through proper communication. Although she
has ensured that there are no threats to her independence, she feels requirement of audit committee to be
beyond its purview. What is your opinion in this regard?
Solution

As required in SA 260, in the case of listed entities, the auditor shall communicate with those charged with
governance: -
(a) A statement that the engagement team and others in the firm as appropriate, the firm and, when applicable,
network firms have complied with relevant ethical requirements regarding independence and
(i) All relationships and other matters between the firm, network firms, and the entity that, in the auditor’s
professional judgment, may reasonably be thought to bear on independence. This shall include total
fees charged during the period covered by the financial statements for audit and non-audit services
provided by the firm and network firms to the entity and components controlled by the entity. These
fees shall be allocated to categories that are appropriate to assist those charged with governance in
assessing the effect of services on the independence of the auditor and

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(ii) The related safeguards that have been applied to eliminate identified threats to independence or
reduce them to an acceptable level.
Further, as per the Companies Act, 2013 requires audit committee to review and monitor auditor’s independence.
Therefore, audit committee requiring auditor to justify her independence is well within its purview.
Q3. UVW & Associates are the statutory auditors of Moon Ltd., a listed company, for the financial year 2022-23. CA
Udhav is the engagement partner for the audit assignment. He was of the understanding that as per the
requirement of one of the SAs he has a responsibility to communicate following matters to those charged with
governance:
(a) The auditor’s responsibilities in relation to the financial statement audit.
(b) Planned scope and timing of the audit.
(c) Auditor independence
Which of the matters is not included in the list prepared by CA Udhav. Discuss such matter in detail.
Solution

SA 260 “Communication with Those Charged with Governance” deals with auditor’s responsibility to communicate
with those charged with governance in relation to an audit of financial statements. Among various matters as
included by CA Udhav in his list, one of the matters that is not mentioned in the list is Significant findings from the
audit. With respect to such matter, the auditor shall communicate with those charged with governance: -
(a) The auditor’s views about significant qualitative aspects of the entity’s accounting practices, including accounting
policies, accounting estimates and financial statement disclosures. When applicable, the auditor shall explain to
those charged with governance why the auditor considers a significant accounting practice, that is acceptable
under the applicable financial reporting framework, not to be most appropriate to the particular circumstances
of the entity;
(b) Significant difficulties, if any, encountered during the audit;
(c) Unless all of those charged with governance are involved in managing the entity: -
(i) Significant matters arising during the audit that were discussed, or subject to correspondence, with
management;
(ii) Written representations the auditor is requesting
(d) Circumstances that affect the form and content of the auditor’s report, if any and
(e) Any other significant matters arising during the audit that, in the auditor’s professional judgment, are relevant
to the oversight of the financial reporting process.
The communication of findings from the audit may include requesting further information from those charged with
governance in order to complete the audit evidence obtained. For example, the auditor may confirm that those
charged with governance have the same understanding of the facts and circumstances relevant to specific
transactions or events.

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Additional Questions
Q4. M/s Manidhari & Associates have been appointed as an auditor of JIN Limited, a multinational company dealing
in spare parts. During the course of audit, CA Manidhari is facing many problems including the problem of not
getting the desired information from the management. Accordingly, he decided to communicate with those
charged with the governance about significant difficulties encountered during the audit. CA Manidhari seeks your
guidance on matters which can be considered as significant difficulties as per SA 260. (RTP May 22)
Solution

As per SA 260, “Communication with Those Charged with Governance”, significant difficulties encountered during
the audit may include such matters as:
(i) Significant delays by management, the unavailability of entity personnel, or an unwillingness by management to
provide information necessary for the auditor to perform the auditor’s procedures.
(ii) An unreasonably brief time within which to complete the audit.
(iii) Extensive unexpected effort required to obtain sufficient appropriate audit evidence.
(iv) The unavailability of expected information.
(v) Restrictions imposed on the auditor by management.
(vi) Management’s unwillingness to make or extend its assessment of the entity’s ability to continue as a going
concern when requested.
In some circumstances, such difficulties may constitute a scope limitation that leads to a modification of the
auditor’s opinion.as per SA 705 (Revised), Modifications to the Opinion in the Independent Auditor’s Report.
Q5. Whilst the Audit team has identified few matters, they need your advice to conclude on the same. Engagement
Partner have asked them to review the Board minutes and other secretarial/ regulatory records based on which
the following additional matters were brought to the attention of the Partner:-
(i) The long term borrowings from the parent company has no written terms and neither the interest nor the
principal has been repaid so far.
(ii) Certain computers were received from the parent company free of cost, the value of which is Rs. 0.23 lac
and no accounting or disclosure of the same has been made in the notes to accounts.
(iii) An amount of Rs. 3.25 Lakhs per month is paid to M/s. WE CARE Associates, a partnership firm, which is a
'related party' in accordance with the provisions of the Companies Act, 2013 for the marketing services
rendered by them. Based on an independent assessment, the consideration paid is higher than the arm's
length pricing by Rs. 0.25 Lakhs per month. Whilst the transaction was accounted in the financial statements
based on the amounts' paid, no separate disclosure of this related party transaction has been made in the
notes to accounts forming part of the financial statements highlighting the same as a 'related party'
transaction.
Audit Manager has reported that she had asked certain information relating to another 'related party' transaction
(amounting to approx. Rs. 47 lac) but the CFO refused to provide the same since the same is perceived to be
confidential and cannot be shared with the Auditors.
You are required to advise about items to be reported to those charged with governance, where applicable, based
on your audit findings in the given situation. (MTP Oct 20)

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Solution

SA 260 "Communication with Those charged with Governance'' deals with auditor's responsibilities to
communication with TCWG in an audit of financial statements. As per SA 550, Related Parties, communicating
significant matters arising during the audit in connection, with the entity's related parties helps the auditor to
establish a common understanding with TCWG of the nature and resolution of these matters. The auditor is also
required to ensure the compliance of Ind AS 24 / AS 18 Related Party Disclosures.
In view of above in the given scenario, the auditor is required to prepare a brief summary of following items to be
reported to those charged with governance in accordance with SA 260 Communication with Those Charged with
Governance:
(i) One of related party transaction amounting 3.25 lac per month i.e. in lieu of marketing services has been noticed
of which amount Rs 0.25 lac per month is exceeds the arm’s length price has not been disclosed highlighting the
same as related party transactions as per Ind- AS 24 / AS 18 Related Party Disclosures.
(ii) Refusal by CFO of the company to provide the details of related party transaction amounting to rupees 47 lac
on the ground that same is perceived to be confidential and cannot be shared with auditors, is not in order, as
denying for the related part details of Rs. 47 lac is imposing limitation of scope of auditor in view of SA 705.
(iii) Receipt of free of cost Computers and long-term borrowing (on no agreed terms and repayment of interest and
principal) from the Parent Company need separate disclosure in financial statements as per Ind AS 24 / AS 18
Related Party Disclosures.
Further, in case of all the above cases, the auditor would also need to assess his reporting requirements under the
clauses (xiii) of Paragraph 3 of CARO 2020 with respect to related party transactions that whether all transactions
with the related parties are in compliance with sections 177 and 188 of Companies Act, 2013 where applicable and
the details have been disclosed in the Financial Statements etc., as required by the applicable Accounting Standards.

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Additional Questions
Q1. During the course of his audit, the auditor noticed material weaknesses in the internal control system and 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. (MTP May’ 20
& Oct 18, RTP May 20 & Nov 18)
Solution

As per SA 265, “Communicating Deficiencies in Internal Control to Those who Charged with Governance and
Management”, auditor shall include in the written communication of significant deficiencies in internal control -
a) A description of the deficiencies and an explanation of their potential effects; and
b) Sufficient information to enable those charged with governance and management to understand the context of
the communication.
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 following:
(i) The letter lists down the area of weaknesses in the system and offers suggestions for improvement.
(ii) It should clearly indicate that it discusses only weaknesses which have come to the attention of the auditor as
a result of his audit and that his examination has not been designed to determine the adequacy of internal
control for management.
(iii) This letter serves as a valuable reference document for management for the purpose of revising the system
and insisting on its strict implementation.
(iv) 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.
Q2. During the course of the audit of Tirthankara Limited, CA. Shreyansh Manager in the audit team identified that
there is significant risk in lease transactions due to complex cross-border sale and lease back arrangements. This
significant risk or risk of material misstatement was not identified in management's risk assessment process.
Upon various inquiries with Management regarding their risk assessment process, it was identified and concluded
by the audit team that the management's risk assessment process is not effective to identify all the significant
risks. CA. Shreyansh decided that this in combination with other potential deficiencies in internal control
constitutes significant deficiencies in internal control and hence, is required to be communicated to those charged
with governance. However, the engagement partner had a different view regarding the audit of Tirthankara
Limited. According to him, the only matter that is identified and poses significant deficiencies due to their
magnitude is only required to be communicated. Matters of potential misstatements that are not actual
misstatements cannot be termed as significant deficiencies. You are required to guide CA. Shreyansh with respect
to examples of matters that the auditor may consider in determining whether a deficiency or combination of
deficiencies in internal control constitutes a significant deficiency. (MTP 4 Marks Oct ‘22)
Solution

As per SA 265, “Communicating Deficiencies in Internal Control to Those Charged with Governance and
Management”, significant deficiency in internal control is defined as a deficiency or combination of deficiencies in

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internal control that, in the auditor’s professional judgment, is of sufficient importance to merit the attention of
those charged with governance. Also, the significance of a deficiency or a combination of deficiencies in internal
control depends not only on whether a misstatement has actually occurred but also on the likelihood that a
misstatement could occur and the potential magnitude of the misstatement. Significant deficiencies may therefore
exist even though the auditor has not identified misstatements during the audit. Examples of matters that the
auditor may consider in determining whether a deficiency or combination of deficiencies in internal control
constitutes a significant deficiency include:

• The likelihood of the deficiencies leading to material misstatements in the financial statements in the future.
• The susceptibility to loss or fraud of the related asset or liability.
• The subjectivity and complexity of determining estimated amounts, such as fair value accounting estimates.
• The financial statement amounts exposed to the deficiencies.
• The volume of activity that has occurred or could occur in the account balance or class of transactions exposed
to the deficiency or deficiencies.
Q3. Auditors are required to obtain an understanding of internal control relevant to the audit when identifying and
assessing its effectiveness and risk of material misstatement. During the audit of Acharya Ltd., you observed that
significant deficiency exists in the internal control system, and you want to ascertain the same. Elucidate the
various indicators of significant deficiencies which will help you in assessing the efficiency of internal control
system of the organization. (RTP May ’23, PYP Jan’21)
Solution

In the given case of Acharya Ltd, Auditors, while conducting audit has come across significant deficiency existing in
the internal control system and also auditors wanted to ascertain that deficiency.
As per SA 265, “Communicating Deficiencies in Internal Control to Those Charged with Governance and
Management “, Indicators of significant deficiencies in internal control include, for example:
(i) Evidence of ineffective aspects of the control environment, such as:
(a) Indications that significant transactions in which management is financially interested are not being
appropriately scrutinised by those charged with governance.
(b) Identification of management fraud, whether or not material, that was not prevented by the entity’s internal
control.
(c) Management’s failure to implement appropriate remedial action on significant deficiencies previously
communicated.
(ii) Absence of a risk assessment process within the entity where such a process would ordinarily be expected to
have been established.
(iii) Evidence of an ineffective entity risk assessment process, such as management’s failure to identify a risk of
material misstatement that the auditor would expect the entity’s risk assessment process to have identified.
(iv) Evidence of an ineffective response to identified significant risks (e.g., absence of controls over such a risk).
(v) Misstatements detected by the auditor’s procedures that were not prevented, or detected and corrected, by the
entity’s internal control.
(vi) Disclosure of a material misstatement due to error or fraud as prior period items in the current year’s Statement
of Profit and Loss.
(vii) Evidence of management’s inability to oversee the preparation of the financial statements.

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SM Questions
Q1. Four audit firms viz. GPR & Co., MKS & Co., CY & Associates and DES & Associates have been appointed for
conducting statutory audit of KNB Bank, a public sector bank in accordance with regulatory guidelines. The
professional work was divided by audit firms on the basis of zones of bank. However, work relating to “IT Systems
and controls” was not allocated by them due to its very nature.
While planning for the above common work area, it was decided to test IT general controls, application controls
and IT dependent manual controls. Planned key audit procedures relating to this common area also included
testing design and operating effectiveness of controls over “computer operations including back-up, batch-
processing and data center security”.
The actual audit procedures pertaining to “testing controls over batch processing” were performed by team of
DES & Associates. In case work in relation to above audit procedures is not performed professionally by DES &
Associates, discuss where responsibility for such lapses would lie in line with SA 299?
Solution

(Introduction)
In respect of common areas, the joint auditors are only responsible for appropriateness of nature, timing and extent
of planned audit procedures agreed among them. The responsibility of individual execution lies with concerned joint
auditor.
In the instant case, audit procedures relating to testing design and operating effectiveness of controls over computer
operations including back-up, batch-processing and data center security have been planned jointly as it is a common
area.
However, audit procedures relating to testing controls over batch processing were actually performed by team of
DES & Associates although these were planned jointly. In case of any lapses in performing such procedures, DES &
Associates would be responsible.
Q2. A, B and C are joint auditors of a company. B is of the opinion that there are material misstatements in financial
statements of a company which, if accounted for, would turn profit reflected in financial statements for ` 25 crore
to a loss of ` 5 crore. He, therefore, wants an adverse opinion to be expressed in audit report. However , A and B
do not concur with his views and are inclined to accept management’s version. Is B required to go by majority
opinion of 2-1?
Solution

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 and shall express
opinion formed by the said joint auditor in separate audit report in case of disagreement. Therefore, B is not required
to go by majority opinion of 2-1.
In such circumstances, the audit report issued by the joint auditors shall make a reference to the separate audit
report issued by the other joint auditor. 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 SA
706.

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Q3. Magnet Interiors Ltd. is a listed company engaged in the manufacture of office furniture. The company has its
activities divided into four geographic regions. The company has appointed two joint auditors, namely, AB & Co.
and CD & Co. to conduct the joint audit of the financial statements of the company for the year ending 31.03.2023.
The engagement partners from both the firms, CA Amar and CA Chetanya along with their audit teams had a
meeting to discuss the areas of the work to be divided and their respective responsibilities. Explain the
responsibilities of the joint auditors with respect to such joint audit.
Solution

As per SA 299 “Joint Audit of Financial Statements”, in respect of audit work divided among the joint auditors, each
joint auditor shall be responsible only for the work allocated to such joint auditor including proper execution of the
audit procedures. In cases where specific divisions, zones or units are allocated to different joint auditors, it is the
separate and specific responsibility of each joint auditor to obtain information and explanations from the
management in respect of such divisions/zones/units and to evaluate the information and explanations so obtained
by said joint auditor. The joint auditors shall have proper coordination and rationality wherever required.
All the joint auditors shall be jointly and severally responsible for: -

• The audit work which is not divided among the joint auditors and is carried out by all joint auditors
• Decisions taken by all the joint auditors under audit planning in respect of common audit areas concerning
the nature, timing and extent of the audit procedures to be performed by each of the joint auditors.
• Matters which are brought to the notice of the joint auditors by any one of them and on which there is an
agreement among the joint auditors
• Examining that the financial statements of the entity comply with the requirements of the relevant statutes
• Presentation and disclosure of the financial statements as required by the applicable financial reporting
framework
• Ensuring that the audit report complies with the requirements of the relevant statutes, the applicable
Standards on Auditing and the other relevant pronouncements issued by ICAI.
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 and 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.
It shall be the responsibility of each joint auditor to determine the nature, timing and extent of audit procedures to
be applied in relation to the areas of work allocated to said joint auditor. It is the individual responsibility of each
joint auditor to study and evaluate the prevailing system of internal control and assessment of risk relating to the
areas of work allocated to said joint auditor.
As regards decisions taken by all the joint auditors under audit planning in respect of common audit areas concerning
the nature, timing and extent of the audit procedures to be performed by each of the joint auditors, all the joint
auditors are responsible only in respect of the appropriateness of the decisions concerning the nature, timing and
extent of the audit procedures agreed upon among them, proper execution of these audit procedures is the
individual responsibility of the joint auditor concerned.

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Additional Questions
Q4. NMN & Co LLP and ABC & Associates LLP are the joint statutory auditors of BHS Ltd. BHS Ltd. is a listed company
and has been in existence for the last 50 years. Since beginning this company was audited by MQS & Associates
but due to audit rotation, the company had to bring in new auditors.
Considering the size of the company, two auditors were appointed as joint auditors. Since the company is new to
these auditors and the concept of joint auditors to whom audit work has been divided, management had a
discussion and understood that each joint auditor is responsible only for the work allocated to him, whether or
not he has prepared a separate report on the work performed by him. Advise. (MTP April 19)
Solution

SA 299 “Joint Audit of Financial Statements” deals with the professional responsibilities which the auditors
undertake in accepting appointments as joint auditors. 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 and shall express 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 SA 706, “Emphasis of Matter
Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report”.
Each joint auditor is entitled to assume that:

• The other joint auditors have carried out their part of the audit work and the work has actually been performed
in accordance with the Standards on Auditing issued by the Institute of Chartered Accountants of India. It is
not necessary for a joint auditor to review the work performed by other joint auditors or perform any tests in
order to ascertain whether the work has actually been performed in such a manner.
• The other joint auditors have brought to said joint auditor’s notice any departure from applicable financial
reporting framework or significant observations that are relevant to their responsibilities noticed in the course
of the audit.
Where financial statements of a division/branch are audited by one of the joint auditors, the other joint auditors
are entitled to proceed on the basis that such financial statements comply with all the legal and regulatory
requirements and present a true and fair view of the state of affairs and of the results of operations of the
division/branch concerned.
Before finalizing their audit report, the joint auditors shall discuss and communicate with each other their respective
conclusions that would form the content of the audit report.
Q5. Dice Ltd. appointed two CA firms MN & Associates and PQ & Co. as joint auditors for conducting audit for the year
ended 31stMarch, 2019. In the course of audit, it has been observed that there is a major under statement in the
value of inventory. The inventory valuation work was looked after by MN & Associates but there was no
documentation for the division of the work between the joint auditors.
Comment on the above situation with regard to responsibilities among joint auditors. (PYP May 2019)

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Solution

As per SA299, “Joint Audit of Financial Statements”, where joint auditors are appointed, they should, by mutual
discussion, divide the audit work among themselves. The division of the work would usually be in terms of audit
identifiable units or specified area. In some cases, due to the nature of the business entity under audit, such a
division of the work may not be possible. In such situations, the division of the work may be with reference to items
of assets or liabilities or income or expenditure or with reference to period of time. The division of the work among
joint auditors as well as the areas of work to be covered by all of them should be adequately documented and
preferably communicated to the entity.
In respect of the audit work divided among the joint auditors, each joint auditor is responsible only for the work
allocated to him, whether or not he has prepared a separate audit of the work performed by him. On the other
hand, all the joint auditors are jointly and severally responsible–
(i) The audit work which is not divided among the joint auditors and is carried out by all joint auditors;
(ii) Decisions taken by all the joint auditors under audit planning phase concerning the nature, timing and extent
of the audit procedure to be performed by each of the auditor;
(iii) Matters which are bought to the notice of the joint auditors by anyone of the mandon which there is an
agreement among the joint auditors;
(iv) Examining that the financial statements of the entity comply with the requirements of the relevant statute;
(v) Presentation and disclosure of financial statements as required by the applicable financial reporting frame
work;
(vi) Ensuring that the audit report complies with the requirements of the relevant statutes, the applicable
Standards on Auditing and the other relevant pronouncements issued by ICAI;
The joint auditors shall also discuss and document the nature, timing, and the extent of the audit procedures for
common and specific allotted areas of audit to be performed by each of the joint auditors and the same shall be
communicated to those charged with governance. After identification and allocation of work among the joint
auditors, the work allocation document shall be signed by all the joint auditors and the same shall be communicated
to those charged with governance of the entity.
Hence, in respect of audit work divided among the joint auditors, each joint auditor shall be responsible only for the
work allocated to such joint auditor including proper execution of the audit procedures.
In the instant case. Dice Ltd. appointed two CA Firms MN & Associates and PQ & Co. as joint auditor for conducting
audit. As observed during the course of audit that there is a major under statement in the value of inventory and
the inventory valuation work was looked after by MN & Associates.
In view of SA 299, MN & Associate will be held responsible for the same as inventory valuation work was looked
after by MN & Associates only. Further, there is violation of SA299 as the division of work has not been documented.
Q6. Excellent Bank Ltd. is a Public Limited Company. The said Bank has various branches all over India. The Bank
appoints 3 Joint Auditors for the financial year ending on 31/03/2024. All the 3 Joint Auditors divide the work
with mutual consent. Verification of Consolidation, however, remained undivided. All branches and zones were
divided amongst the 3 Joint Auditors. During the audit of zones, CA Z, one of the joint auditors, expressed a
concern about internal control in one of the large corporate branches situated in his zone. The irregularity was
not reported in the final accounts as the other 2 Joint Auditors were not in favor of reporting, and the decision of

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not reporting the same was taken on the basis of majority. Subsequently, fraud has been detected in the said
branch which was audited by CA Z.
The Bank seeks your advice about the responsibility of the 3 Joint Auditors in the above situation. (PYP Nov 19)
Solution

SA 299 "Joint Audit of Financial Statements" lays down the principles for the effective conduct of joint audit to
achieve the overall objectives of the auditor as laid down in SA 200. As per SA 299, where joint auditors are
appointed, they should, by mutual discussion, divide the work among themselves.
Accordingly, in respect of audit work divided among the joint auditors, each joint auditor shall be responsible only
for the work allocated to such joint auditor, including the proper execution of the audit procedures. On the other
hand, all the joint auditors shall be jointly and severally responsible for:
(a) The audit work which is not divided among the joint auditors and is carried out by all joint auditors;
(b) Matters which are brought to the notice of the joint auditors by any one of them and on which there is an
agreement among the joint auditors.
In the present case, all the 3 Joint Auditors divide the work with mutual consent, except for the verification of
consolidation, which remained undivided. Hence, in accordance with SA 299, all the joint auditors are responsible
for the same.
Reporting Responsibilities in Case of Differences of Opinion:

• Joint auditors are required to issue a common audit report.

• However, in case of any disagreement among joint auditors 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 and shall express the opinion formed by the said joint auditor in a separate
audit report in case of disagreement.
• In case of separate reports, 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). Such reference shall be made under the heading
"Other Matter Paragraph" as per SA 706.
In the present case, CA Z, one of the joint auditors, expressed a concern about internal control in one of the large
corporate branches situated in his zone. The irregularity was not reported in the final accounts as the other 2 Joint
Auditors were not in favor of reporting, and the decision of not reporting the same was taken on the basis of
majority. Subsequently, fraud has been detected in the said branch which was audited by CA Z.
Conclusion: Mr. Z was required to issue a separate report. He was not bound by the views of other joint auditors.
Mr. Z will be held responsible for non-reporting of the matter.

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Questions (Consider Risk Assessment Chapter Questions Also)

Q1. In the course of audit of Z Ltd, its auditor wants to rely on audit evidence obtained in previous audit in respect of
effectiveness of internal controls instead of retesting the same during the current audit. As an auditor discuss the
factors that may warrant a re-test of controls. (MTP Oct 19, RTP May 22 & Nov 18)

Solution

As per SA 330 on “The Auditor’s Responses to Assessed Risks,” changes may affect the relevance of the audit
evidence obtained in previous audits such that there may no longer be a basis for continued reliance.

The auditor’s decision on whether to rely on audit evidence obtained in previous audits for control is a matter of
professional judgment. In addition, the length of time between retesting such controls is also a matter of
professional judgment.

Factors that may warrant a re-test of controls are:

(i) A deficient control environment.
(ii) Deficient monitoring of controls.
(iii) A significant manual element to the relevant controls.
(iv) Personnel changes that significantly affect the application of the control.
(v) Changing circumstances that indicate the need for changes in the control.
(vi) Deficient general IT controls.

Q2. While conducting a statutory audit of “Hope Solutions Limited”, CA Y has assessed the risk of material
misstatement to be low at the financial statement level and at the assertion level due to a stable, established and
relatively less risky business and extremely satisfactory internal controls operating in the company. However,
despite the low assessed risk of material misstatement, he chooses to send external confirmation requests to
third parties for confirmation of certain material contracts entered into with them by the company. By doing so,
he intends to obtain evidence regarding certain assertions contained in the financial statements of the company.
Do you think his approach is in accordance with SA? Justify your answer with reasons. (MTP Oct ‘23)

Solution

SA 330 states that irrespective of the assessed risk of material misstatement, the auditor shall design and perform
substantive procedures for each material class of transactions, account balance, and disclosure. In the given
situation, the auditor has assessed the risk of material misstatement to be low. However, despite such assessment,
substantive procedures have to be performed.

SA 330 further states that the auditor shall consider whether external confirmation procedures are to be performed
as substantive audit procedures. External confirmation procedures frequently are relevant when addressing
assertions associated with account balances and their elements but need not be restricted to these items. For
example, the auditor may request external confirmation of the terms of agreements, contracts, or transactions
between an entity and other parties.

Despite the low assessed risk of material misstatement, substantive procedures have to be performed due to the
following reasons:

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(i) The auditor’s assessment of risk is judgmental and so may not identify all risks of material misstatement, and
(ii) There are inherent limitations to internal control, including management override.

It is also in accordance with the spirit of professional skepticism. Therefore, as discussed above, the approach of CA
Y is in accordance with Standards on Auditing.

Q3. While commencing the statutory audit of Alex Co. Ltd., what would you consider as an auditor to assess risk of
material misstatement and responses to such risks? (RTP May 18)

Solution

Considerations of Auditor for Assessing the Risk of Material Misstatement:

As per SA 315 “Identifying and Assessing the Risk of Material Misstatement through Understanding the Entity and
its Environment,” the auditor shall identify and assess the risks of material misstatement at the financial statement
level and the assertion level for classes of transactions, account balances, and disclosures to provide a basis for
designing and performing further audit procedures. For this purpose, the auditor shall:

(i) Identify risks throughout the process of obtaining an understanding of the entity and its environment, including
relevant controls that relate to the risks, and by considering the classes of transactions, account balances, and
disclosures in the financial statements;
(ii) Assess the identified risks, and evaluate whether they relate more pervasively to the financial statements as a
whole and potentially affect many assertions;
(iii) Relate the identified risks to what can go wrong at the assertion level, taking account of relevant controls that
the auditor intends to test; and
(iv) Consider the likelihood of misstatement, including the possibility of multiple misstatements, and whether the
potential misstatement is of a magnitude that could result in a material misstatement.

Auditor’s Responses to the Assessed Risk of Material Misstatement:

According to SA 330 “The Auditor’s Responses to Assessed Risks,” the auditor shall design and implement overall
responses to address the assessed risks of material misstatement. In designing the audit procedures to be
performed, the auditor shall:

Consider the reasons for the assessment given to the risk of material misstatement at the assertion level for each
class of transactions, account balance, and disclosure, including:

(1) The likelihood of material misstatement due to the particular characteristics of the relevant class of transactions,
account balance, or disclosure; and
(2) Whether the risk assessment takes into account the relevant controls, thereby requiring the auditor to obtain
audit evidence to determine whether the controls are operating effectively.

Obtain more persuasive audit evidence the higher the auditor’s assessment of risk.

Q5. While formulating the audit plan and responding to the risks of material misstatement identified and assessed in
related party transaction and relationships, Ms. K the engagement manager of the audit team of ABC Limited,
decided to rely upon the internal controls placed for identification and disclosure of related party relationships
and transactions in accordance with the applicable financial reporting framework.
You are requested to guide Ms. K regarding the necessity to test the controls to obtain sufficient and appropriate
audit evidence. Also guide, whether Ms. K can use the audit evidence obtained, regarding operative effectiveness

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of control on identification and disclosure of related party relationships and transactions, in the interim period.
(RTP Nov ’21)

Solution

As per SA 550, “Related Parties,” according to the paragraph on “Responses to the risks of material misstatement
associated with related party relationships and transactions,” the auditor should design and perform further audit
procedures to obtain sufficient appropriate audit evidence about the assessed risks of material misstatement
associated with related party relationships and transactions.

Further, as per SA 330, “The Auditor’s Responses to Assessed Risks,” the auditor shall design and perform tests of
controls to obtain sufficient appropriate audit evidence as to the operating effectiveness of relevant controls when:

(a) The auditor’s assessment of risks of material misstatement at the assertion level includes an expectation that
the controls are operating effectively (i.e., the auditor intends to rely on the operating effectiveness of controls
in determining the nature, timing, and extent of substantive procedures); or
(b) Substantive procedures alone cannot provide sufficient appropriate audit evidence at the assertion level.

In designing and performing tests of controls, the auditor shall obtain more persuasive audit evidence the greater
the reliance the auditor places on the effectiveness of a control. Moreover, the auditor shall test controls for the
particular time, or throughout the period, for which the auditor intends to rely on those controls, subject to when
the auditor obtains audit evidence about the operating effectiveness of controls during an interim period, and the
timing of tests of controls over significant risks, in order to provide an appropriate basis for the auditor’s intended
reliance.

When the auditor obtains audit evidence about the operating effectiveness of controls during an interim period, the
auditor shall:

(a) Obtain audit evidence about significant changes to those controls subsequent to the interim period; and
(b) Determine the additional audit evidence to be obtained for the remaining period.

In the current case, Ms. K shall design and perform tests of controls to obtain sufficient appropriate audit evidence
as to the operating effectiveness of relevant controls as she intends to rely on the operating effectiveness of controls
in determining the nature, timing, and extent of substantive procedures.

Further, she is also required to obtain the audit evidence about significant changes to those controls subsequent to
the interim period along with the additional audit evidence to be obtained for the remaining period in accordance
with the requirements of Standards on Auditing as discussed above.

Q6. The identified risks are assessed by Auditor as to its significance on account of its likely impact, by way of material
misstatement appearing in financial statements or by affecting internal control system. What may be the points
of indication that may direct the Auditor to judge that the risks identified may be significant? (PYP Nov ’18, PYP
Jan’21)

Solution

Points of Indication that may direct the Auditor to Judge that the Risks Identified may be Significant:
As per SA 315 “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and
Its Environment,” as part of the risk assessment, the auditor shall determine whether any of the risks identified are,

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in the auditor’s judgment, a significant risk. In exercising this judgment, the auditor shall exclude the effects of
identified controls related to the risk.

In exercising judgment as to which risks are significant risks, the auditor shall consider at least the following:
(i) Whether the risk is a risk of fraud;
(ii) Whether the risk is related to recent significant economic, accounting, or other developments like changes in the
regulatory environment, etc., and therefore requires specific attention;
(iii) The complexity of transactions;
(iv) Whether the risk involves significant transactions with related parties;
(v) The degree of subjectivity in the measurement of financial information related to the risk, especially those
measurements involving a wide range of measurement uncertainty; and
(vi) Whether the risk involves significant transactions that are outside the normal course of business for the entity,
or that otherwise appear to be unusual.

When the auditor has determined that a significant risk exists, the auditor shall obtain an understanding of the
entity’s controls, including control.

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SM Questions
Q1. CA B was appointed as the auditor of ABC Limited for the financial year 2023-24. During the course of planning
for the audit, CA B intends to apply the concept of materiality for the financial statements as a whole. Please
guide him with respect to the factors that may affect the identification of an appropriate benchmark for this
purpose.
What benchmark should be adopted by CA B, if ABC Limited is engaged in:
(i) The manufacture and sale of air conditioners and is having regular profits.
(ii) The construction of large infrastructure projects and incurred losses in the previous two financial years due to
the pandemic.

Solution

Use of Benchmarks in Determining Materiality for the Financial Statements as a Whole:

As per SA 320, determining materiality involves the exercise of professional judgment. A percentage is often applied
to a chosen benchmark as a starting point in determining materiality for the financial statements as a whole. Factors
that may affect the identification of an appropriate benchmark include the following:

• The elements of the financial statements (for example, assets, liabilities, equity, revenue, expenses);
• Whether there are items on which the attention of the users of the particular entity’s financial statements tends
to be focused (for example, for the purpose of evaluating financial performance, users may tend to focus on
profit, revenue, or net assets);
• The nature of the entity, where the entity is at in its life cycle, and the industry and economic environment in
which the entity operates;
• The entity’s ownership structure and the way it is financed (for example, if an entity is financed solely by debt
rather than equity, users may put more emphasis on assets and claims on them than on the entity’s earnings);
and
• The relative volatility of the benchmark.

Determining a percentage to be applied to a chosen benchmark involves the exercise of professional judgment.
There is a relationship between the percentage and the chosen benchmark, such that a percentage applied to profit
before tax from continuing operations will normally be higher than a percentage applied to total revenue.

In case ABC Limited is engaged in the manufacture and sale of air conditioners and is having regular profits: CA B,
the auditor, may consider profit before tax/earnings.

In case ABC Limited is engaged in the construction of large infrastructure projects and incurred losses in the previous
two financial years due to the pandemic:CA B, the auditor, may consider revenue or gross profit as a benchmark.

Alternatively, CA B, the auditor, may consider the criteria relevant for the audit of entities undertaking public utility
programs/projects, where total cost or net cost (expenses less revenues or expenditure less receipts) may be
appropriate benchmarks for that particular program/project activity. Where an entity has custody of the assets,
assets may be an appropriate benchmark.

Q2. While assessing the impact of uncorrected misstatements in the audit of MINI Builders Private Limited, Mr. Gautam
encountered a significant issue related to the calculation of materiality on revenue. The initial materiality

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calculation was based on estimated figures provided by the management. Management, to estimate full-year
revenue, extrapolated the sales for 11 months to arrive at a figure for 12 months.

However, given the nature of MINI Builders as a company in the construction sector, where monthly sales exhibit
substantial variations, a unique challenge emerged. The actual sales for the last month deviated significantly from
the estimated sales due to an unexpected slowdown in project completions. As a result, the last month's actual
sales represented only 30% of the estimated sales.

Now, Mr. Gautam is confronted with a dilemma regarding the appropriate approach to evaluate uncorrected
misstatements using the previously calculated materiality. Kindly guide Mr. Gautam in the light of relevant
Standards on Auditing.

Solution

As per SA 450, “Evaluation of Misstatements Identified during the Audit,” the auditor is required to reassess
materiality, in accordance with SA 320, “Materiality in Planning and Performing an Audit,” before evaluating the
impact of uncorrected misstatements. This reassessment is crucial to confirm the ongoing appropriateness of
materiality in light of the entity's actual financial results.

The determination of materiality under SA 320 often relies on estimates of the entity's financial results, given that
the actual results may not be known during the early stages of the audit. Therefore, before the auditor proceeds to
assess the effect of uncorrected misstatements, it becomes necessary to adjust the materiality calculated under SA
320 based on the now available actual financial results.

SA 320 outlines that, as the audit progresses, materiality may be revised for the financial statements as a whole or
for specific classes of transactions, account balances, or disclosures. This revision is prompted by the auditor's
awareness of information that would have led to a different initial determination. Typically, significant revisions
occur before the evaluation of uncorrected misstatements. However, if the reassessment of materiality under SA
320 results in a lower amount, the auditor must reconsider performance materiality and the appropriateness of the
audit procedures' nature, timing, and extent. This is crucial for obtaining sufficient and appropriate audit evidence
on which to base the audit opinion.

In the present case involving MINI Builders Private Limited, it has been identified that the materiality calculated at
the beginning of the audit for revenue was based on estimates provided by the management. The management
extrapolated sales for the full year using the actual amount of 11 months, but since the company experiences
significant monthly variations in sales, the actual sales for the last month were only 30% of the estimated figure.
This discrepancy arose due to an unexpected slowdown in project completion.

In this audit scenario, Mr. Gautam, the auditor, must review and reassess the materiality initially determined under
SA 320 to ensure its continued validity in light of the actual financial results. If the re-assessed materiality is lower
than the previously calculated amount, Mr. Gautam must reconsider performance materiality and the
appropriateness of the nature, timing, and extent of further audit procedures.

This meticulous approach is essential to gather sufficient and appropriate audit evidence, enabling Mr. Gautam to
form an independent and objective opinion on the financial statements of MINI Builders Private Limited.

Q3. Deepti & Co., Chartered Accountants, during the audit of Magma Ltd. found that certain machinery had been
imported for the production of a new product. Although the auditors have applied the concept of materiality to

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the financial statements as a whole, they now want to re-evaluate the materiality concept for the said transaction
involving foreign exchange. Give your views in this regard?

Solution

As per SA 320, “Materiality in Planning and Performing an Audit,” when establishing the overall audit strategy, the
auditor shall determine materiality for the financial statements as a whole. 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
balances, or disclosures.

The auditor shall revise materiality for the financial statements as a whole (and, if applicable, the materiality level
or levels for particular classes of transactions, account balances, or disclosures) 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, he shall determine whether it is
necessary to revise performance materiality and whether the nature, timing, and extent of the further audit
procedures remain appropriate.

In the given case, Deepti & Co., as an auditor, has applied the concept of materiality for the financial statements as
a whole. However, they want to re-evaluate the materiality concept based on additional information regarding the
import of machinery for the production of a new product, which draws attention to a particular aspect of the
company’s business.

Thus, Deepti & Co. can re-evaluate the materiality concepts after considering the necessity of such revision.

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SM Questions
Q1. MNO Ltd. gets its accounting data processed by a service organisation. CA Riya is the statutory auditor of MNO
Ltd. CA Riya wants to obtain an understanding as to how MNO Ltd. is using the services of the service organisation.
What all understanding should she obtain?

Solution

When obtaining an understanding of MNO Ltd. (user entity) in accordance with SA 315, CA Riya shall obtain an
understanding of how MNO Ltd. uses the services of a service organisation in its operations, including:

(a) The nature of the services provided by the service organisation and their significance to the user entity, including
their effect on the user entity’s internal control. Information on the nature of services provided by a service
organisation may be available from sources such as user manuals, contracts between the user entity and service
organisation, and reports by service auditors
(b) The nature and materiality of the transactions processed or the accounts or financial reporting processes affected
by the service organisation. In certain situations, the transactions processed and the accounts affected by the
service organisation may not appear to be material to the user entity’s financial statements, but the nature of
the transactions may still be significant, requiring the user auditor to obtain an understanding of those controls.
(c) The degree of interaction between the activities of the service organisation and those of the user entity. This
refers to the extent to which a user entity is able to and elects to implement effective controls over the
processing performed by the service organisation. For example, a high degree of interaction exists when the
user entity authorises transactions and the service organisation processes and accounts for those transactions.
(d) The nature of the relationship between the user entity and the service organisation, including the relevant
contractual terms for the activities undertaken by the service organisation.

Q2. During the audit of Indo limited, CA Harish observed that processing of accounting data was given to a third party
on account of certain considerations like cost reduction, own computer working to full capacity. Indo Limited used
a service organisation to record transactions and process related data. What factors should CA Harish consider
regarding the nature and extent of activities undertaken by service organisation so as to determine whether those
activities are relevant to the audit and, if so, to assess their effect on audit risk. Discuss with reference to the
relevant Standards on Auditing.
OR

MIO Ltd. is a mobile phone operating company. Barring the marketing function, it had outsourced the entire
operations like maintenance of mobile infrastructure, customer billing, payroll, accounting functions, etc. Assist
the auditor of MIO Ltd. as to how he can obtain an understanding of how MIO Ltd. uses the services of the
outsourced agency in its operations. (MTP Oct 19 & Oct 18, RTP Nov 18)

Solution

As per SA 402, “Audit Considerations relating to an Entity using a Service Organization”, when obtaining an
understanding of the user entity in accordance with SA 315, “Identifying and Assessing the Risks of Material
Misstatement Through Understanding the Entity and its Environment”, the user auditor shall obtain an
understanding of how a user entity uses the services of a service organisation in the user entity’s operations,
including:

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(i) The nature of the services provided by the service organisation and the significance of those services to the user
entity, including the effect thereof on the user entity’s internal control;
(ii) The nature and materiality of the transactions processed or the accounts or financial reporting processes affected
by the service organisation;
(iii) The degree of interaction between the activities of the service organisation and those of the user entity; and
(iv) The nature of the relationship between the user entity and the service organisation, including the relevant
contractual terms for the activities undertaken by the service organisation.

Based on the above, while conducting the audit, CA Harish will assess the effect on the audit risk and take necessary
steps.

Q3. Happy Hospital is a very renowned hospital for Orthopedic Surgeries in Mumbai having sophisticated
infrastructure. Happy Hospital has started using a novice system which includes complete record of Indoor Patient
i.e. their diagnosis, their treatment, their medications, their billings, and receipts thereon which is developed and
managed by CT Contractors. CA Z is a statutory auditor of Happy Hospital. CA Z came to know about this system
while auditing. CA Z is concerned whether the controls at CT Contractors Associates are operating effectively or
not. For this purpose, CA Z demanded from CT Contractors, an assurance report from a practicing chartered
accountant about their opinion on the description of CT Contractor's system, and the effectiveness of the control.
Which type of report should be obtained by CA Z in terms of relevant Standard on Auditing? What aspects are to
be considered by CA Z in using such assurance report as audit evidence that controls at CT Contractors are
operating effectively?

Solution

In the given scenario, CA Z, as the statutory auditor of Happy Hospital, is concerned about the effectiveness of
controls at the service organization, specifically the system managed by CT Contractors. To address this concern, CT
Contractors should provide a Type 2 assurance report from a practicing chartered accountant as per SA 402, “Audit
Considerations Relating to an Entity Using a Service Organisation”.
This report will offer an opinion on the description of the system in use at Happy Hospital, as well as evaluate the
effectiveness of the controls implemented by CT Contractors.

Using a Type 2 Report as Audit Evidence That Controls at the Service Organisation Are Operating Effectively: If the
user auditor plans to use a Type 2 report as audit evidence that controls at the service organisation are operating
effectively, the user auditor shall determine whether the service auditor’s report provides sufficient appropriate
audit evidence about the effectiveness of the controls to support the user auditor’s risk assessment by:

(a) Evaluating whether the description, design, and operating effectiveness of controls at the service organisation is
at a date or for a period that is appropriate for the user auditor’s purposes;
(b) Determining whether complementary user entity controls identified by the service organisation are relevant to
the user entity and, if so, obtaining an understanding of whether the user entity has designed and implemented
such controls and, if so, testing their operating effectiveness;
(c) Evaluating the adequacy of the time period covered by the tests of controls and the time elapsed since the
performance of the tests of controls; and
(d) Evaluating whether the tests of controls performed by the service auditor and the results thereof, as described
in the service auditor’s report, are relevant to the assertions in the user entity’s financial statements and provide
sufficient appropriate audit evidence to support the user auditor’s risk assessment.

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Q4. FAB Limited is availing the services of Atiya Private Limited for its payroll operations. Payroll cost accounts for
63% of total cost for FAB Limited. Atiya Limited has provided the type 2 report as specified under SA 402 for its
description, design, and operating effectiveness of control. Atiya Private Limited has also outsourced a material
part of payroll operation M/s RST & Associates in such a way that M/s RST & Associates is sub-service organization
to FAB Limited. The Type 2 report which was provided by Atiya Private Limited was based on carve-out method
as specified under SA 402. CA Akram while reviewing the unmodified audit report drafted by his assistant found
that, a reference has been made to the work done by the service auditor. CA Akram hence asked his assistant to
remove such reference and modify report accordingly. Comment whether CA Akram is correct in removing the
reference of the work done by service auditor?

Solution

As per SA 402, “Audit Considerations Relating to an Entity Using a Service Organisation”, the user auditor shall
modify the opinion in the user auditor’s report in accordance with SA 705, “Modifications to the Opinion in the
Independent Auditor’s Report”, if the user auditor is unable to obtain sufficient appropriate audit evidence regarding
the services provided by the service organisation relevant to the audit of the user entity’s financial statements.

The user auditor shall not refer to the work of a service auditor in the user auditor’s report containing an unmodified
opinion, unless required by law or regulation to do so. If such reference is required by law or regulation, the user
auditor’s report shall indicate that the reference does not diminish the user auditor’s responsibility for the audit
opinion.
Thus, in view of the above, the contention of CA Akram in removing the reference to the work done by the service
auditor is in order, as in the case of an unmodified audit report, the user auditor cannot refer to the work done by
the service auditor.

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Additional Questions
Q1. Discuss the impact of uncorrected misstatements identified during the audit and the auditor's response to the
same.
Or

The auditor of XY & Co. Ltd. has intimated the management that certain misstatements identified during the
course of audit need to be corrected. As an auditor, discuss the impact of such misstatements in case the
management does not carry out the said corrections.

Solution

In accordance with SA 450 "Evaluation of Misstatements Identified During the Audit," the auditor shall determine
whether uncorrected misstatements are material, individually or in aggregate. In making this determination, the
auditor shall consider:
(i) The size and nature of the misstatements, both in relation to particular classes of transactions, account balances
or disclosures and the financial statements as a whole, and the particular circumstances of their occurrence; and
(ii) The effect of uncorrected misstatements related to prior periods on the relevant classes of transactions, account
balances or disclosures, and the financial statements as a whole.

The auditor shall communicate with those charged with governance regarding uncorrected misstatements and the
effect that they, individually or in aggregate, may have on the opinion in the auditor's report, unless prohibited by
law or regulation.

The auditor's communication shall identify material uncorrected misstatements individually. The auditor shall
request that uncorrected misstatements be corrected.

Prior to evaluating the effect of uncorrected misstatements, the auditor shall reassess materiality determined in
accordance with SA 320, to confirm whether it remains appropriate in the context of the entity's actual financial
results.

As per management, if the effect of such uncorrected misstatement is immaterial, then the auditor shall request for
a written representation from management and, where appropriate, those charged with governance that whether
they believe the effects of uncorrected misstatements are immaterial, individually and in aggregate, to the financial
statements as a whole. A summary of such items shall be included in or attached to the written representation.

If the management refuses to adjust the financial information and the results of extended audit procedures do not
enable the auditor to conclude that the aggregate of uncorrected misstatements is not material, the auditor should
report accordingly.

Refer SA 320 also with SA 450

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SM & Additional Questions

Q1. The auditor of BBNS Ltd. accepted the gratuity liability valuation based on the certificate issued by a qualified
actuary. However, the auditor noticed that the retirement age adopted is 65 years as against the existing
retirement age of 60 years. The company is considering a proposal to increase the retirement age to 65 years.
Comment.

Solution

Evaluating the Work of Management’s Expert: As per SA 500 “Audit Evidence”, when information to be used as audit
evidence has been prepared using the work of a management’s expert, the auditor shall, to the extent necessary,
having regard to the significance of that expert’s work for the auditor’s purposes,

(a) Evaluate the competence, capabilities and objectivity of that expert;

(b) Obtain an understanding of the work of that expert; and
(c) Evaluate the appropriateness of that expert’s work as audit evidence for the relevant assertion.

The auditor may obtain information regarding the competence, capabilities and objectivity of a management’s
expert from a variety of sources, such as personal experience with previous work of that expert; discussions with
that expert; discussions with others who are familiar with that expert’s work; knowledge of that expert’s
qualifications; published papers or books written by that expert.

Aspects of the management’s expert’s field relevant to the auditor’s understanding may include what assumptions
and methods are used by the management’s expert, and whether they are generally accepted within that expert’s
field and appropriate for financial reporting purposes.

The auditor may also consider the following while evaluating the appropriateness of the management’s expert’s
work as audit evidence for the relevant assertion:

(i) The relevance and reasonableness of that expert’s findings or conclusions, their consistency with other audit
evidence, and whether they have been appropriately reflected in the financial statements.

(ii) If that expert’s work involves use of significant assumptions and methods, the relevance and reasonableness
of those assumptions and methods; and

(iii) If that expert’s work involves significant use of source data, the relevance, completeness, and accuracy of that
source data.

In the instant case, BBNS Ltd. accepted the gratuity liability valuation based on the certificate issued by an expert
i.e., a qualified actuary who is management’s expert. Here the basis for computation and valuation is taken as age
65 years by the actuary, which is not correct as company is considering proposal to increase the retirement age from
existing age to 65 years.

Therefore, assumptions and methods used by the management’s expert are not appropriate for financial reporting
purposes. Hence, the auditor may qualify the report accordingly.

Q2. Mr. Atharv, while conducting the audit of Black Mountain Mining Ltd., which is involved in phosphate mining,
decided to engage an auditor’s expert to assess environmental liabilities and site clean-up costs. Black Mountain

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Mining Ltd. re-appointed Mr. Aman as an independent expert for this task. For the past five years, the
management has consistently re-appointed Mr. Aman. He calculated the environmental liabilities for both
completed mining sites and sites scheduled for closure in the near future, including provisions for clean-up costs.
Management accepted his assessment.

Mr. Atharv, after performing the inquiries with management, was of the opinion that the objectivity of the
independent expert cannot be questioned just because he was appointed by management as their expert. Hence,
there is no need to raise a question on the objectivity of Mr. Aman or on his work performed for the company.
However, the audit partner was of the opinion that the audit team needs to evaluate the objectivity of an expert
engaged by the entity, irrespective of the fact that he was appointed as an independent expert.

Guide the audit partner and Mr. Atharv with respect to requirements pertaining to evaluating the objectivity of
the management expert.

Solution

As per SA 500 “Audit Evidence”, when information to be used as audit evidence has been prepared using the work
of a management’s expert, the auditor shall, to the extent necessary, have regard to the significance of that expert’s
work for the auditor’s purposes evaluate the competence, capabilities and objectivity of that expert.

A broad range of circumstances may threaten objectivity, for example, self-interest threats, advocacy threats,
familiarity threats, self-review threats and intimidation threats. Safeguards may reduce such threats and may be
created either by external structures (for example, the management’s expert’s profession, legislation or regulation),
or by the management’s expert’s work environment (for example, quality control policies and procedures). Although
safeguards cannot eliminate all threats to a management expert’s objectivity, threats such as intimidation threats
may be of less significance to an expert engaged by the entity than to an expert employed by the entity, and the
effectiveness of safeguards such as quality control policies and procedures may be greater. Because the threat to
objectivity created by being an employee of the entity will always be present, an expert employed by the entity
cannot ordinarily be regarded as being more likely to be objective than other employees of the entity.

When evaluating the objectivity of an expert engaged by the entity, it may be relevant to discuss with management
and that expert any interests and relationships that may create threats to the expert’s objectivity and any applicable
safeguards, including any professional requirements that apply to the expert; and to evaluate whether the
safeguards are adequate. Interests and relationships creating threats may include:

• Financial interests.
• Business and personal relationships.
• Provision of other services.

In the current case, Black Mountain Mining Ltd. re-appointed Mr. Aman for this engagement as an independent
expert. The audit team was of the view that the objectivity of the independent expert cannot be questioned just
because he was appointed by management as their expert. However, the audit partner had a contrary view.

Hence, the audit team should evaluate the objectivity of an expert engaged by the entity as the threat to objectivity,
created by being an employee of the entity, will always be present. An expert appointed by the entity cannot
ordinarily be regarded as being more likely to be objective than other employees of the entity. As a result, audit
partner Atharva is correct in his view.

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Q3. During the course of the audit of TK Home Private Limited, a recognized export house engaged in manufacturing
of T-shirts under the brand name of "TK", CA Tripti is verifying the export revenues of the company for the year
2023-24. She has verified transactions entered in the "Export Sales" account maintained in accounting software
from relevant export invoices. The export sales are being made on payment of IGST, for which a refund is
automatically credited in the account of the company after the goods are shipped.
On enquiring from internal audit staff regarding the recognition of export revenues, she is told that export sales
are recognized for the year on the basis of "Bills of Lading". However, she is not convinced with such a response
and feels that the same does not appear to be proper.
She finds that three export invoices bearing dates in the month of March 2024, having a value of ₹75 lacs, have
not been recognized in export revenue on the ground that bills of lading for these invoices were issued in the
month of April 2024.
Discuss from what sources she can obtain reliable audit evidence in this regard. How can she challenge
management's assertion regarding the completeness of export revenues for the year 2023-24?
Solution
In the given case, audit evidences can be obtained by going through GST returns filed on the GST portal and
correlating the same with e-way bills. Audit evidences can be obtained as to how the company has reflected its
export sales in GST returns and whether export sales pertaining to three invoices having a value of ₹75.00 lacs are
reflected in such returns.
Further, e-way bills generated on the portal would provide evidence that goods have moved out of the company's
premises. The export revenue should have been booked at the time the goods moved out of the company's
premises. The company is claiming an IGST refund. The refund is linked to the monthly sales return. This aspect can
also be verified.
"Bill of Lading" is only a document issued by the carrier to the shipper of goods that goods have been taken on
board. She should challenge and counter management's assertion on the above grounds and point out violations of
relevant accounting standards and principles. In this way, she can obtain reliable audit evidence.
Highlighting such digital and other evidence, she can challenge management's assertion regarding the completeness
of export revenues and point out that export revenues are understated.

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SM Questions
Q1. CA Prabhjot has planned to observe the physical count of inventories at the plant of a company located in the
remote area in the state of Uttarakhand, as part of a statutory audit exercise, few days before completion of the
financial year 2023-24. He already informed his intention to management that he is planning to visit the plant site
on 29th March 2024. He plans to inspect inventories, observe the counting process and perform test counts
among other matters.
The management has made all the necessary arrangements to facilitate the above exercise. However, an agitation
in Himalayan hills started on 28th March 2024 for the announcement of a strict law regarding the conversion of
agricultural land for commercial use. Many civil society groups are participating in the agitation. NH-7 leading to
the plant site is blocked by protestors. The plant is not accessible through any other mode. The blockade is lifted
one month after the state government announced the formation of a committee to look into protestors’
demands.
Does the above case highlight a situation of “impracticability of attendance” at inventory counting in terms of
requirements of SA 501?
How should the auditor proceed in the above situation?
Solution
Provision
The given situation does not highlight the impracticability of attendance at inventory counting. It only shows that
the auditor is unable to attend physical inventory counting due to unforeseen circumstances arising out of agitation
by protestors. It has led to the inaccessibility of the plant site for a month. The blockade is lifted after a month.
SA 501 states that if the auditor is unable to attend physical inventory counting due to unforeseen circumstances,
the auditor shall make or observe some physical counts on an alternative date and perform audit procedures on
intervening transactions.
Conclusion: Auditor should attend to the physical inventory count after the blockade is lifted and perform audit
procedures on intervening transactions.
Q2. On reviewing legal expenses account of Zed Ltd., CA. Sunitha, auditor of company, finds that legal fees amounting
to Rs 10 lac was paid to B. George, a reputed lawyer, during the year 2023-24. On inquiry with management
regarding the purpose of such expenditure, evasive reply was received from management stating that a lot of
work is performed by the said lawyer on behalf of the company. However, no specific details were provided.
She finds it proper to correspond directly with the lawyer. She obtains the address and mail id of the lawyer from
his professional services bill. She shoots off an inquiry letter asking for the nature and status of litigation claims
against the company on her letterhead.
Is her approach proper? Irrespective of the merits of the approach followed by her, what is she trying to achieve
by corresponding with the lawyer of the company?
Solution
Introduction

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SA 501 states that when audit procedures performed indicate that material litigation or claims may exist, the auditor
shall seek direct communication with the entity’s external legal counsel. The auditor shall do so through a letter of
inquiry prepared by management and sent by the auditor, requesting the entity’s external legal counsel to
communicate directly with the auditor.
Therefore, her approach in communicating with an external lawyer is not correct. She needs to make management
aware of her intention to communicate directly with the lawyer. The letter of inquiry has to be prepared by
management and sent by her.
Her purpose in corresponding with the lawyer of the company is to identify litigation and claims involving the entity
which may give rise to a risk of material misstatement. It is due to the reason that litigation and claims involving the
entity may have a material effect on the financial statements and thus may be required to be disclosed or accounted
for in the financial statements.
Q3. During the audit of TS Ltd., CA Tanmaya finds that substantial inventories of the company consisting of mast
lighting poles remain with “Super Industries” for certain finishing works. While planning audit procedures, he had
planned about seeking confirmation from “Super Industries” regarding existence and condition of such mast
lighting poles belonging to TS Ltd. lying with them as on 31st March, 2024.
However, the premises of “Super Industries” were raided by DGGI officials (Director General of GST Intelligence)
in connection with the busting of a fake billing scam. The proprietor of the firm was arrested in November 2023
and came out on bail in the month of March 2024. The details of the proprietor and his firm were flashed
prominently in local newspapers of the city where company is located. CA. Tanmaya also belongs to the same
place. Discuss how he should proceed in the above matter as auditor of TS Ltd.
Solution
SA 501 states that when inventory under the custody and control of a third party is material to the financial
statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of
that inventory by performing one or both of the following:
(a) Request confirmation from third party as to the quantities and condition of inventory held on behalf of the entity.
(b) Perform inspection or other audit procedures appropriate in the circumstances.
It further states that where information is obtained that raises doubt about the integrity and objectivity of the third
party, the auditor may consider it appropriate to perform other audit procedures instead of, or in addition to,
confirmation with the third party.
Examples of other audit procedures include:
• Attending, or arranging for another auditor to attend, the third party’s physical counting of inventory, if
practicable.
• Obtaining another auditor’s report, or a service auditor’s report, on the adequacy of the third party’s internal
control for ensuring that inventory is properly counted and adequately safeguarded.
• Inspecting documentation regarding inventory held by third parties
In the given case, the integrity of the third party appears to be doubtful in view of DGGI raids and his possible
involvement in a fake billing scam. He has already been behind bars.
Keeping in view the above, besides obtaining confirmation from such party, he may attend a third party’s physical
counting or ask some other auditor to attend physical counting as on reporting date, depending upon practical

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considerations. He can also inspect the record of goods sent and received back from such party by tracing it to
challans, e-ways bills etc. and correlate the above information.
Q4. Coccyx Ltd. supplies navy uniforms across the country. The company has 3 warehouses at different locations
throughout the India and 5 warehouses at borders. The major stocks are generally supplied from the borders.
Coccyx Ltd. appointed M/s OPAQE & Co. to conduct its audit for the financial year 2023-24. Mr. P, partner of M/s
OPAQE & Co., attended all the physical inventory counting conducted throughout the India but could not attend
the same at borders due to some unavoidable reason.
You are required to advise M/s OPAQE & Co.,
(I) How sufficient appropriate audit evidence regarding the existence and condition of inventory may be
obtained?
(II) How is an auditor supposed to deal when attendance at physical inventory counting is impracticable?
Solution
(I) Special Consideration with Regard to Inventory: As per SA 501 “Audit Evidence- Specific Considerations for
Selected Items”, when inventory is material to the financial statements, the auditor shall obtain sufficient
appropriate audit evidence regarding the existence and condition of inventory by:
(1) Attendance at physical inventory counting, unless impracticable, to:
(i) Evaluate management’s instructions and procedures for recording and controlling the results of the
entity’s physical inventory counting;
(ii) Observe the performance of management’s count procedures;
(iii) Inspect the inventory; and
(iv) Perform test counts; and
(2) Performing audit procedures over the entity’s final inventory records to determine whether they accurately
reflect actual inventory count results.
(II) Attendance at Physical Inventory Counting Not Practicable: In some cases, attendance at physical inventory
counting may be impracticable. This may be due to factors such as the nature and location of the inventory, for
example, where inventory is held in a location that may pose threats to the safety of the auditor. The matter of
general inconvenience to the auditor, however, is not sufficient to support a decision by the auditor that attendance
is impracticable. Further, as explained in SA 200 “Overall Objectives of the Independent Auditor and the Conduct of
an Audit in Accordance with Standards on Auditing”, the matter of difficulty, time, or cost involved is not in itself a
valid basis for the auditor to omit an audit procedure for which there is no alternative or to be satisfied with audit
evidence that is less than persuasive.
Further, where attendance is impracticable, alternative audit procedures, for example, inspection of documentation
of the subsequent sale of specific inventory items acquired or purchased prior to the physical inventory counting,
may provide sufficient appropriate audit evidence about the existence and condition of inventory.
In some cases, though, it may not be possible to obtain sufficient appropriate audit evidence regarding the existence
and condition of inventory by performing alternative audit procedures. In such cases, SA 705 on Modifications to
the Opinion in the Independent Auditor’s Report, requires the auditor to modify the opinion in the auditor’s report
as a result of the scope limitation.

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Q5. GHK Associates, Chartered Accountants, conducting the audit of PBS Ltd., a listed company for the year ended 31-
03-2024 is concerned with the presentation and disclosure of segment information included in Company's Annual
Report. GHK Associates want to ensure that methods adopted by management for determining segment
information have resulted in disclosure in accordance with the applicable financial reporting framework. Guide
GHK Associates with 'Examples of Matters' that may be relevant when obtaining an understanding of the methods
used by the management with reference to the relevant Standards on Auditing.
Solution
The auditors, GHK Associates wanted to ensure and obtain sufficient appropriate audit evidence regarding the
presentation and disclosure of segment information in accordance with the applicable financial reporting framework
by obtaining an understanding of the methods used by management in determining segment information. SA 501
guides in this regard. As per SA 501- “Audit Evidence—Specific Considerations for Selected Items”, example of
matters that may be relevant when obtaining an understanding of the methods used by management in determining
segment information and whether such methods are likely to result in disclosure in accordance with the applicable
financial reporting framework include:
(i) Sales, transfers and charges between segments, and elimination of inter -segment amounts.
(ii) Comparisons with budgets and other expected results, for example, operating profits as a percentage of sales.
(iii) The allocation of assets and costs among segments.
(iv) Consistency with prior periods, and the adequacy of the disclosures with respect to inconsistencies

Q6. While conducting the statutory audit of Tasty Foods Limited, CA. Careful has planned attendance at physical
inventory count of the company from 29th March to 31st March 2024. The company is engaged in the business of
extracting rice from paddy grains and caters to domestic as well as international market particularly in Gulf region.
It has its plant spread in an area of about 20 acres located in National Capital Region (NCR). Paddies contained in
jute bags of nearly standard sizes is purchased from dealers/agents. It is stored in heaps on pallets (kind of
wooden structures) in an open area covered by protective sheets and in steel silos (silos are huge steel containers
with measuring strain gauges) in company’s premises.
The company mainly produces three rice brands viz. “Raja” and “Shehzada” (both for the domestic market) and
“Badshah” (for the international market). The process of obtaining rice from paddy consists of various steps like
cleaning of paddy, removing outer husk layer from paddy grains to obtain brown rice, whitening, polishing,
grading and sorting, packaging which is accomplished by means of various types of machineries installed in plant.
The company’s management has prepared a set of instructions and procedures to be followed for recording and
controlling results of company’s physical inventory counting which are listed as under: -

• The physical inventory count process is to be supervised by a responsible officer of company responsible for
storage functions.
• There should be no disturbance to the routine process of receiving goods and despatch during the counting
time period.
• Counting process is to be undertaken by constituting different teams of 3 members each for
counting/verifying raw material, work in progress and finished goods.
• Paddy in steel silos is to be estimated using their capacity.
• Quantity of work in progress is to be estimated considering plant capacity as whole.
• The responsible officer should ensure that stocks have been counted/verified in all areas.

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Before proceeding to attend physical inventory count process of company, evaluate management’s instructions
and procedures sent to CA Careful as stated above. You may suggest modification, addition or removal of such
instructions to ensure effective count process.
Solution
The set of instructions and procedures given in the case scenario are incomplete and not properly followed, which
are discussed as under:

• The physical inventory count process should be supervised by a responsible officer of the company, preferably
from finance department. The supervision of the count process should not be done by person responsible for
storage function. However, storage in-charge of each area should be present during inventory count process
for co-ordination and facilitation.
• During inventory count process, inward and outward movement of goods should not be allowed as allowing
such movement may distort the results or make it difficult to arrive at proper results.
• The instruction relating to the constitution of teams for counting process does not specify that counting shall
be undertaken by members drawn from departments not connected with storage function. For example,
these members may be from the finance department. Further, within each team, duties should be fixed
separately for counting and recording on serially numbered count sheets. It is nowhere stated that once
counting in an area is complete, certain distinctive marks or tags are required to be put.
• Count sheets should contain description of products in accordance with inventory records of company.
• The management’s instructions are silent about how team members would proceed with their work. Team
members should be provided with lay out plans for different sections/ storage areas so that all areas are
covered.
• The management’s instructions are silent on how paddy lying in open is to be counted and verified. Paddy in
jute bags lying in open in heaps should be verified by counting number of bags in one heap. As each bag is of
nearly standard size, the quantity of paddy can be determined by counting number of bags in a heap and
correlating it with the weight of standard bag.
• Paddy in steel silos should be determined using measuring strain gauges on silos. Determining quantity in silos
based on silo capacity may lead to wrong results as paddy may have been used from such silos.
• Quantities of work in progress should be estimated at each stage of production and not for the plant as a
whole. Estimating WIP inventories for plant as a whole would give inaccurate picture of work in progress
inventories.
• Finished goods inventories need to be counted category wise. Rice bags should be verified by checking the
name of brand.
• There is no instruction regarding damaged or obsolete stock items particularly in the case of finished goods
i.e. rice. Damaged/obsolete inventories should be counted and shifted to a separate area for assessment of
their condition and to prevent mix-up with other standard inventories.
• Count sheets need to be signed by each team member.
The responsible officer should ensure that stocks have been counted/verified in all areas and distinctive marks are
put to confirm completion of counting.

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Additional Questions
Q7. The Engagement Partner of the audit team of High Inventory Limited assessed that the inventory is material with
respect to the audit of the financial statement for the current period. Upon inquiring with the management, the
Engagement Partner identified that the management will be performing an annual physical inventory count at all
the warehouses where the entity stores and maintains its inventory. Moreover, management confirmed in its
written representation that they will be performing a 100% physical count of inventory for the current period.
As a result, the Engagement Partner decided not to perform any physical count of inventory as it will be a
duplication of the work. Moreover, he decided that the written representation from management stating “the
inventory exists and is in appropriate physical condition” will be sufficient and appropriate with respect to audit
evidence to conclude that the inventory balance in the financial statement is free from any material
misstatement.
In the light of SA 501, evaluate whether the decision taken by the Engagement Partner is appropriate or not. (MTP
Oct ‘22)
Solution
As per SA 501, “Audit Evidence - Specific Considerations for Selected Items,” when inventory is material to the
financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and
condition of inventory by:
(i) Attendance at physical inventory counting, unless impracticable, to:

• Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s
physical inventory counting.
• Observe the performance of management’s count procedures.
• Inspect the inventory; and
• Perform test counts; and
(ii) Performing audit procedures over the entity’s final inventory records to determine whether they accurately
reflect actual inventory count results.
Attendance at physical inventory counting involves:
1. Inspecting the inventory to ascertain its existence and evaluate its condition and perform test counts.
2. Observing compliance with management’s instructions and the performance of procedures for recording and
controlling the results of the physical inventory count; and
3. Obtaining audit evidence as to the reliability of management’s count procedures.
Hence, in the given case, the approach of the Engagement Partner is not appropriate, as when inventory is material
to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence
and condition of inventory. This should be done by performing various audit procedures, which also include
attending the physical count, observing the count, inspecting the inventory, and reperforming physical counts.
Q8. RIM Private Ltd is engaged in the business of manufacturing water bottles and is experiencing a 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 and property, plant, and 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 the annual physical verification.

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Under the above circumstances, how would you ensure that the physical verification conducted by the
management was in order? (RTP May’20)
Solution
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 provides additional guidance to that contained in SA 500, “Audit Evidence,” with respect to certain
specific financial statement amounts and other disclosures.
If the auditor is unable to be present at the physical inventory count on the planned date due to unforeseen
circumstances, the auditor should take or observe some physical counts on an alternative date and, where
necessary, perform alternative audit procedures to assess whether the changes in inventory between the date of
the physical count and the period-end date are correctly recorded. The auditor would also verify the procedure
adopted and the treatment given for discrepancies noticed during the physical count.
The auditor would also ensure that appropriate cut-off procedures were followed by the management. He should
obtain management’s written representation on:
(a) The completeness of information provided regarding the inventory, and
(b) Assurance with regard to adherence to laid-down procedures for the physical inventory count.
By following the above procedure, it will be ensured that the physical verification conducted by the management
was in order.
Q9. Moon Ltd. is a dealer in electronic appliances. The company has a centralized warehouse at the outskirts of
Mumbai. The auditors of the company, M/s J K Associates, normally attend the physical verification of stocks
carried out by the management at the end of the financial year. However, on account of certain disturbances in
the region, the physical inventory counting could not be carried out at the year-end. The stock-taking is decided
to be done by management at some other date subsequently, after a month.
In the light of the above facts:
Enumerate the audit procedures to be considered by M/s J K Associates if physical inventory counting is
conducted at a date other than the date of the financial statements, with reference to the relevant Standard on
Auditing. (PYP Nov-20)
Solution
As per SA 501, “Audit Evidence – Specific Considerations for Selected Items,” when inventory is material to the
financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and
condition of inventory.
For practical reasons, the physical inventory counting may be conducted at a date, or dates, other than the date of
the financial statements. This may be done irrespective of whether management determines inventory quantities
by an annual physical inventory counting or maintains a perpetual inventory system. In either case, the effectiveness
of the design, implementation, and maintenance of controls over changes in inventory determines whether the
conduct of physical inventory counting at a date, or dates, other than the date of the financial statements is
appropriate for audit purposes.
If physical inventory counting is conducted at a date other than the date of the financial statements, the auditor, J
K Associates, shall perform the following procedures:

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(A) Attendance at physical inventory counting, unless impracticable, to:
(i) Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s
physical inventory counting;
(ii) Observe the performance of management’s count procedures;
(iii) Inspect the inventory; and
(iv) Perform test counts; and
(B) Performing audit procedures over the entity’s final inventory records to determine whether they accurately
reflect actual inventory count results.

➤ In addition to the above, the auditor shall also perform audit procedures to obtain audit evidence about whether
changes in inventory between the count date and the date of the financial statements are properly recorded.

➤ Relevant matters for consideration when designing audit procedures to obtain audit evidence about whether
changes in inventory amounts between the count date, or dates, and the final inventory records are properly
recorded include:

• Whether the perpetual inventory records are properly adjusted.

• Reliability of the entity’s perpetual inventory records.
• Reasons for significant differences between the information obtained during the physical count and the
perpetual inventory records.

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SM Questions
Q1. As auditor of Groom Limited, you have sent positive confirmation requests to 30 creditors of the company in
March 2024. All the creditors in the informal sector are small concerns. You selected to send positive confirmation
requests to all the above parties at their business addresses stated on respective bills after discussing the matter
with the CFO of the company. The CFO is cooperative and does not raise any hassles in the matter.
Responses to confirmation requests are received within a week’s time. Your article assistant informs you that out
of 30 creditors, GST registrations of 25 creditors have been cancelled during financial year 2023-24 itself by
collating information from GST portal. He further informs you that there are no fresh registrations pertaining to
PANs of these parties.
How would you proceed to deal with the situation as an auditor of the company?
Solution
SA 505 states that if the auditor determines that a response to a confirmation request is not reliable, the auditor
shall evaluate the implications on the assessment of the relevant risks of material misstatement, including the risk
of fraud, and on the related nature, timing, and extent of other audit procedures.
In the instant case, GST registrations of 25 concerns have been cancelled in the year 2023-24. This indicates that
businesses at those addresses were closed. Further, there are no fresh registrations pertaining to the PANs of these
parties. However, the auditor sent external confirmation requests in March 2024, which were duly responded to.
This raises questions about the reliability of the responses received.
SA 500 indicates that even when audit evidence is obtained from sources external to the entity, circumstances may
exist that affect its reliability. All responses carry some risk of interception, alteration, or fraud. Such risk exists
regardless of whether a response is obtained in paper form, electronically, or through another medium.
Factors that may indicate doubts about the reliability of a response include:
• The response was received by the auditor indirectly or
• The response appeared not to come from the originally intended confirming party.
Keeping in view the circumstances described in the case situation, there is a risk that the response has not come
from the originally intended confirming party.
Unreliable responses may indicate a fraud risk factor that requires evaluation.
Q2. During the audit of Star Ltd., a company engaged in the production of paper, the auditor obtained certain
confirmations for 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 a number of small balances except
for one old outstanding balance of ₹20 lakhs, for which no confirmation was received.
Comment with respect to Standards on Auditing relating to the confirmation process and how to address the non-
receipt of confirmation.
Solution
As per SA 505, “External Confirmations”, 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.

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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, and less likely to respond otherwise.
In the instant case, while performing an audit of Star Limited, the auditor sent the negative confirmation requesting
the trade payables having outstanding balances in the balance sheet. One of the old outstanding of ` 20 lakh 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, and other records, such as goods received notes. Further, non-response for negative confirmation request
does not mean that there is some misstatement as a 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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Additional Questions
Q3. Mr. Rishabh, in the course of audit of PQ Limited, wants to perform external confirmation procedures to obtain
audit evidence. Guide Mr. Rishabh, listing out the factors that may assist him in determining whether external
confirmation procedures are to be performed as substantive audit procedures. (PYP Dec’21 & MTP Sep ‘23)
Solution
Factors that may assist Mr. Rishabh, the auditor, in determining whether external confirmation procedures are to
be performed as substantive audit procedures include:
(i) The confirming party’s knowledge of the subject matter – responses may be more reliable if provided by a person
at the confirming party who has the requisite knowledge about the information being confirmed.
(ii) The ability or willingness of the intended confirming party to respond – for example, the confirming party:

• May not accept responsibility for responding to a confirmation request;

• May consider responding too costly or time-consuming;
• May have concerns about the potential legal liability resulting from responding;
• May account for transactions in different currencies; or
• May operate in an environment where responding to confirmation requests is not a significant aspect of
day-to-day operations.
In such situations, confirming parties may not respond, may respond in a casual manner, or may attempt to
restrict the reliance placed on the response.
(iii) The objectivity of the intended confirming party – if the confirming party is a related party of the entity,
responses to confirmation requests may be less reliable.
Q4. Your firm has been appointed as the statutory auditors of AGM Private Limited for the financial year 2018-19.
During the verification of the company’s trade receivables as of 31st March 2019, the accountant of AGM Ltd.
requests you not to send balance confirmations to a specific group of trade receivables, citing that the balances
are under dispute and the matter is pending in Court. As a Statutory Auditor, how would you address this
situation? (RTP May’20)
Or
Never permit Limited refuses to allow you to get direct confirmation of the outstanding balances of trade
receivables. You want to ensure on grounds of materiality that at least outstanding above a threshold limit needs
to be confirmed and reconciliation is to be carried out before finalizing the audit. If the Company does not relent,
how will you respond? (PYP May 18)
Solution
SA 505, “External Confirmations,” sets out standards for an auditor’s use of external confirmations as a means of
obtaining audit evidence. If management refuses to permit the auditor to send a confirmation request, the auditor
shall:
(i) Inquire about management’s reasons for the refusal and seek audit evidence to assess their validity and
reasonableness.
(ii) Evaluate the impact of management’s refusal on the assessment of relevant risks of material misstatement,
including fraud risk, and determine the necessary nature, timing, and extent of other audit procedures.

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(iii) Perform alternative audit procedures to obtain relevant and reliable audit evidence.
If the auditor determines that management’s refusal is unreasonable or is unable to obtain sufficient and
appropriate audit evidence through alternative procedures, the auditor must communicate the matter to TCWG and
assess its implications for the audit and the auditor’s opinion in accordance with SA705 “Modifications to the
Opinion in the Independent Auditor’s Report”.
A refusal by management to allow the auditor to send a confirmation request is a limitation on the audit evidence
the auditor may wish to obtain. The auditor is therefore required to inquire as to the reasons for the limitation. A
common reason advanced is the existence of a legal dispute or ongoing negotiation with the intended confirming
party, the resolution of which may be affected by an untimely confirmation request. The auditor is required to seek
audit evidence as to the validity and reasonableness of the reason because of the risk that management may be
attempting to deny the auditor access to audit evidence that may reveal fraud or error.
Q5. During the audit of the financial statements of Looks Limited for the year ended March 31, 2024, CA Suyash, the
statutory auditor, requested external confirmation for certain trade receivables and trade payables as part of
audit procedures in accordance with SA 505:
(i) CA Suyash sent a confirmation request to a debtor for a balance of ₹15,50,000, which was outstanding for
more than six months, insisting that the debtor respond directly to the auditor, confirming whether they
agree or disagree with the balance stated.
(ii) He also sent a confirmation request to a creditor with an outstanding balance of ₹13,25,000, requesting a
response only if there was a disagreement with the stated amount.
CA Suyash received responses from the aforementioned debtor and creditor as follows:
(i) The debtor confirmed that, as per their records, they owed ₹14,90,000 to Looks Limited instead of
₹15,50,000 as per the company's books.
(ii) The creditor did not respond to the confirmation request.
Identify and explain the type of confirmation request sent by the auditor to the debtor and creditor. Also, discuss
the course of action the auditor should take for the discrepancy in the confirmation received from the debtor and
the non-receipt of confirmation from the creditor. (RTP May’25)
Solution
Positive confirmation request: A request that the confirming party respond directly to the auditor, indicating
whether the confirming party agrees or disagrees with the information in the request or providing the requested
information.
Exception – A response that indicates a difference between the information requested to be confirmed, or
contained in the entity’s records, and the information provided by the confirming party. The exception needs to be
assessed for the entire population after analyzing the reason for the difference.
In the given situation, the auditor has sent the positive confirmation request for the amount of ₹15,50,000 to a
debtor, which was outstanding for more than six months. However, due to a difference between the information
requested to be confirmed, or contained in the entity’s records (i.e., ₹15,50,000), and the information provided by
the confirming party (i.e., ₹14,90,000), this forms a situation of exception confirmation.
The auditor’s evaluation, when taken into account with other audit procedures the auditor may have performed,
may assist in concluding whether sufficient appropriate audit evidence has been obtained or whether performing

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further audit procedures is necessary, as required by SA 330 in case a response indicates an exception. The company
should be asked to investigate and reconcile the discrepancy indicated by the confirming party.
Negative confirmation request – A request that the confirming party respond directly to the auditor only if the
confirming party disagrees.
In the given case, the auditor has sent the negative confirmation request for ₹13,25,000 to a creditor. The non-
response by the creditor implies that the creditor agrees with the amount. Thus, the auditor is not required to take
any action in this case.

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SM & Additional Questions

Q1. CA M. Hussain is appointed as auditor of a firm for the year 2023-24 on 31st July, 2023. The accounts of the firm
were unaudited in the year 2022-23. The firm had material inventories reflected in its financial statements even
as on close of 31st March, 2023.
He is performing audit procedures, including attending physical inventory count as on 31st March 2024. However,
there is a lingering doubt in his mind regarding opening inventories reflected in financial statements.

Does there exist any responsibility on his part in such a situation?

Solution
SA 510 states that in conducting an initial audit engagement, one of the objectives of the auditor with respect to
opening balances is to obtain sufficient appropriate audit evidence about whether opening balances contain
misstatements that materially affect the current period’s financial statements. The auditor has to evaluate whether
audit procedures performed in the current period provide evidence relevant to the opening balances or specific
audit procedures are required to be performed to obtain evidence regarding the opening balances.
In the case of inventories, however, the current period’s audit procedures on the closing inventory balance provide
little audit evidence regarding inventory on hand at the beginning of the period. Therefore, additional audit
procedures may be necessary, and one or more of the following may provide sufficient appropriate audit evidence:

• Observing a current physical inventory count and reconciling it to the opening inventory quantities.
• Performing audit procedures on the valuation of the opening inventory items.
• Performing audit procedures on gross profit and cut-off.
Q2. In an initial audit engagement, the auditor will have to satisfy about the sufficiency and appropriateness of
‘Opening Balances' to ensure that they are free from misstatements, which may materially affect the current
financial statements. Lay down the audit procedure, you will follow in cases
(i) when the financial statements are audited for the preceding period by another auditor; and
(ii) when financial statements are audited for the first time.
If, after performing the procedure, as an auditor you are not satisfied about the correctness of 'Opening Balances',
what approach you will adopt in drafting your audit report? (MTP Oct ’19 & April 18, RTP May’21)
Solution
(i) Financial Statements Audited by another Auditor – Audit Procedure: If the prior period’s financial statements
were audited by a predecessor auditor, the auditor may be able to obtain sufficient appropriate audit evidence
regarding the opening balances by perusing the copies of the audited financial statements including the other
relevant documents relating to the prior period financial statements such as supporting schedules to the audited
financial statements. Ordinarily, the current auditor can place reliance on the closing balances contained in the
financial statements for the preceding period, except when during the performance of audit procedures for the
current period the possibility of misstatements in opening balances is indicated.
(ii) Audit of Financial Statements for the First Time – Audit Procedure: When the audit of financial statements is
being conducted for the first time, the auditor has to perform auditing procedures to obtain sufficient appropriate
audit evidence. Since opening balances represent effect of transaction and events of the preceding period and
accounting policies applied in the preceding period, the auditor need to obtain evidence having regard to nature of

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opening balances, materiality of the opening balances and accounting policies. Since it will not be possible for
auditor to perform certain procedures, e.g., observing physical verification of inventories, etc. the auditor may
obtain confirmation, etc. and perform suitable procedures in respect of fixed assets, investments, etc.
The auditor can also obtain management representation with regards to the opening balances.
(II) Drafting Audit Report: If 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. Further, If
the auditor concludes that the opening balances contain a misstatement that materially affects the current period’s
financial statements, and 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.
Q3. You have been appointed as the auditor of Good Health Ltd. for 2017-18 which was audited by CA Trustworthy in
2016-17. As the Auditor of the company state the steps you would take to ensure that the Closing Balances of
2016-17 have been brought to account in 2017-18 as Opening Balances and the Opening Balances do not contain
misstatements. (MTP Aug 18)
Solution
As per SA 510 “Initial Audit Engagements—Opening Balances”, in conducting an initial audit engagement, the
objective of the auditor with respect to opening balances is to obtain sufficient appropriate audit evidence about
whether:
(i) Opening balances contain misstatements that materially affect the current period’s financial statements; and
(ii) Appropriate accounting policies reflected in the opening balances have been consistently applied in the current
period’s financial statements, or changes thereto are properly accounted for and adequately presented and
disclosed in accordance with the applicable financial reporting framework.
Being a new assignment, audit evidence regarding opening balances can be obtained by perusing the copies of the
audited financial statements.
For current assets and liabilities, some audit evidence can ordinarily be obtained as part of audit procedures during
the current period. For example, the collection/payment of opening balances of receivables and payables will
provide audit evidence as to their existence, rights and obligations, completeness, and valuation at the beginning of
the period.
In respect of other assets and liabilities such as fixed assets, investments, and long-term debt, the auditor will
examine the records relating to opening balances. The auditor may also be able to get confirmation from third
parties (e.g., balances of long-term loans obtained from banks).
Q4. CA. Mack, a recently qualified practicing Chartered Accountant, received his first audit assignment for Captura (P)
Ltd. for the financial year 2017-18. He obtained all the relevant and appropriate audit evidence for the items
related to the Statement of Profit and Loss. However, while auditing the Balance Sheet items, CA. Mack did not
obtain appropriate audit evidence, such as confirmations, for the outstanding Accounts Receivable amounting to
Rs. 145 lakhs, which remained unchanged from the previous year. He relied on the management's affirmation
that there were no receipts or further credits during the year. Consequently, CA. Mack excluded the audit of
accounts receivable from the audit programme, assuming that it pertained to the preceding year, which had
already been audited by the predecessor auditor. Comment. (MTP 5 Marks, Oct 18 & May 20)
Solution

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As per SA 510 “Initial Audit Engagements – Opening Balances”, while conducting an initial audit engagement, the
objective of the auditor with respect to opening balances is to obtain sufficient appropriate audit evidence about
whether-
(i) Opening balances contain misstatements that materially affect the current period’s financial statements; and
(ii) Appropriate accounting policies reflected in the opening balances have been consistently applied in the
current period’s financial statements, or changes thereto are properly accounted for and adequately
presented and disclosed in accordance with the applicable financial reporting framework.
When the financial statements for the preceding period were audited by another auditor, the current auditor may
be able to obtain sufficient appropriate audit evidence regarding opening balances by perusing the copies of the
audited financial statements.
Ordinarily, the current auditor can place reliance on the closing balances contained in the financial statements for
the preceding period, except when during the performance of audit procedures for the current period the possibility
of misstatements in opening balances is indicated.
For current assets and liabilities, some audit evidence about opening balances may be obtained as part of the current
period’s audit procedures, say, the collection of opening accounts receivable during the current period will provide
some audit evidence of their existence, rights and obligations, completeness and valuation at the beginning of the
period.
Q5. Mr. X has been appointed as an auditor of M/s ABC Ltd., Mr. X wants to be satisfied about the sufficiency and
appropriateness of 'Opening Balances' to ensure that they are free from misstatements. Lay down the audit
procedure, Mr. X should follow, in the initial audit engagement of M/s ABC Ltd. Also suggest the approach to be
followed regarding mention in the audit report if Mr. X is not satisfied about the correctness of 'Opening
Balances'? (PYP Nov ‘19)
Solution
As per SA 510, 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 and Loss;
(ii) Determining whether the opening balances reflect the application of appropriate accounting policies; and
(iii) Performing one or more of the following:
(1) Where the prior year financial statements were audited, perusing the copies of the audited financial
statements including the other relevant documents relating to the prior period financial statements;
(2) Evaluating whether audit procedures performed in the current period provide evidence relevant to the
opening balances; or
(iv) Performing specific audit procedures to obtain evidence regarding the opening balances.
If 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. Further, If the auditor concludes that the
opening balances contain a misstatement that materially affects the current period’s financial statements, and the

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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.

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Additional Questions
Q1. In audit of DEF Limited, the Auditor had made use of certain analytical procedures with regard to certain key data
in the Statement of Profit and Loss. The results obtained showed inconsistencies with other relevant information.
State the course of action that the Auditor should take to ensure that the risk of material misstatement would be
contained to a low level fixed as per materiality level. (PYP Nov’18)

Solution

As per SA 520, “Analytical Procedures,” if analytical procedures performed in accordance with this SA identify
fluctuations or relationships that are inconsistent with other relevant information or that differ from expected
values by a significant amount, the auditor shall investigate such differences by:

(i) Inquiring of management and obtaining appropriate audit evidence relevant to management’s responses; and

(ii) Performing other audit procedures as necessary in the circumstances.

Audit evidence relevant to management’s responses may be obtained by evaluating those responses taking into
account the auditor’s understanding of the entity and its environment, and with other audit evidence obtained
during the course of the audit.

The need to perform other audit procedures may arise when, for example, management is unable to provide an
explanation, or the explanation, together with the audit evidence obtained relevant to management’s response, is
not considered adequate.

Q2. You have been appointed as an auditor of M/s Excellent Hotels Ltd. As a senior partner, you want to use analytical
procedures in respect of room rentals as well as payroll expenses. Discuss. (PYP May 19)
Solution
SA 520 "Analytical Procedures" deals with the auditor's use of analytical procedures as substantive procedures and
as procedures near the end of the audit that assist the auditor when forming an overall conclusion on the financial
statements.
Accordingly, in some cases, a predictive model may be effective as an analytical procedure.

• In case of Payroll cost - Where an entity has a known number of employees at fixed rates of pay throughout the
period, it may be possible for the auditor to use this data to estimate the total payroll costs for the period with
a high degree of accuracy, thereby providing audit evidence for a significant item in the financial statements
and reducing the need to perform tests of details on the payroll.
• In case of Room Rental Income of Hotel, different types of analytical procedures provide different levels of
assurance. Analytical procedures involving the prediction of total rental income in case of a hotel taking the
room tariff rates, the number of rooms, and vacancy rates into consideration, can provide persuasive evidence
and may eliminate the need for further verification by means of tests of details, provided the elements are
appropriately verified.

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SM Questions
Q1. CA Ritesh has drawn some samples during the audit of a manufacturing company for testing controls as well as
for tests of details. On the basis of the samples selected, he reaches an erroneous conclusion that access controls
on applications are less effective.
Further, on the basis of samples selected, he concludes erroneously that work-in-progress inventories amounting
to Rs. 5 crore in financial statements are materially misstated.

Outlining the above risk involved, discuss how it is going to affect his audit of the company.

Solution
The described risk is sampling risk. It is a risk that the auditor’s conclusion based on a sample may be different from
the conclusion if the entire population were subjected to the same audit procedure.
In the given case, the auditor has arrived at erroneous conclusions on the basis of the samples selected. In the case
of a test of controls, he has concluded that access controls are less effective than they actually are. In the case of a
test of details, he has concluded erroneously that a material misstatement exists when in fact, it does not. This type
of erroneous conclusion affects audit efficiency as it would usually lead to additional work to establish that initial
conclusions were incorrect.
Q2. Chintamani Ltd appoints Chintan & Mani as statutory auditors for the financial year 2023-24. Chintan & Mani
seem to have different opinions on the Audit approach to be adopted for audit of Chintamani Ltd. Mani is of the
opinion that 100% checking is not required and they can rely on Audit Sampling techniques in order to provide
them a reasonable basis on which they can draw conclusions about the entire population.
Chintan is concerned that whether the use of audit sampling has provided a reasonable basis for conclusions
about the population that has been tested.
You are required to guide Chintan about his role if audit sampling has not provided a reasonable basis for
conclusions about the population that has been tested in accordance with SA 530
Solution
As per SA 530, “Audit Sampling”, the auditor shall evaluate:
(a) The results of the sample; and
(b) Whether the use of audit sampling has provided a reasonable basis for conclusions about the population that
has been tested.
If the auditor concludes that audit sampling has not provided a reasonable basis for conclusions about the
population that has been tested, the auditor may:
(I) Request management to investigate misstatements that have been identified and the potential for further
misstatements and to make any necessary adjustments; or
(II) Tailor the nature, timing and extent of those further audit procedures to best achieve the required assurance.
For example, in the case of tests of controls, the auditor might extend the sample size, test an alternative
control or modify related substantive procedures.

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Additional Questions
Q3. While conducting audit of PC Ltd., CA. T decided to use sampling technique to test the trade receivables at the
planning stage. He directed his team members to divide the whole population of trade receivables balances to be
tested in a few separate groups called 'strata'. He directed to treat each stratum as if it was a separate population
and divided the trade receivables balances of PC Ltd. for the Financial Year 2022-23 into groups on the basis of
personal judgment as follows:

SI. No. Particulars

1 (a) Balances in excess of Rs 50,00,000;
2 (b) Balances in the range of 40,00,001 to 50,00,000;
3 (c) Balances in the range of 30,00,001 to 40,00,000;
4 (d) Balances in the range of 20,00,001 to 30,00,000;
5 (e) Balances in the range of 10,00,001 to 20,00,000;
6 (f) Balances Rs 10,00,000 and below
From the above-mentioned groups, CA. T directed to pick up different percentage of items for examination from
each of the groups. One of the team members, Mr. Neel, wants to use some other technique of sampling for the
above purpose as the concept of stratification is not clear to him.
You are required to explain the concept of stratification and its uses to Mr. Neel. (PYP May ‘23)
Solution
Stratification is the process of dividing a population into sub-populations, each of which is a group of sampling units
which have similar characteristics (often monetary value).
Uses of Stratification:

• Audit efficiency may be improved if the auditor stratifies a population by dividing it into discrete sub-
populations which have an identifying characteristic. The objective of stratification is to reduce the variability
of items within each stratum and therefore allow sample size to be reduced without increasing sampling risk.
• When performing tests of details, the population is often stratified by monetary value. This allows greater audit
effort to be directed to the larger value items, as these items may contain the greatest potential misstatement
in terms of overstatement. Similarly, a population may be stratified according to a particular characteristic that
indicates a higher risk of misstatement, for example, when testing the allowance for doubtful accounts in the
valuation of accounts receivable, balances may be stratified by age.
• The results of audit procedures applied to a sample of items within a stratum can only be projected to the
items that make up that stratum. To draw a conclusion on the entire population, the auditor will need to
consider the risk of material misstatement in relation to whatever other strata make up the entire population.
For example, 20% of the items in a population may make up 90% of the value of an account balance. The
auditor may decide to examine a sample of these items. The auditor evaluates the results of this sample and
reaches a conclusion on the 90% of value separately from the remaining 10% (on which a further sample or
other means of gathering audit evidence will be used, or which may be considered immaterial).
• If a class of transactions or account balance has been divided into strata, the misstatement is projected for
each stratum separately. Projected misstatements for each stratum are then combined when considering the
possible effect of misstatements on the total class of transactions or account balance.

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SM & Additional Questions

Q1. A private company 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 and 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. (MTP Nov 21, MTP Mar’19 & Mar’21, PYP May ’23, RTP May’19,
RTP May’23, New SM)

Solution

As per SA 540, “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and 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 and extent of
the auditor’s review takes account of the nature of the accounting estimates, and whether the information obtained
from the review would be relevant to identifying and 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 and 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.
• 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 and in determining the nature, timing and 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.

Q2. The statutory auditor of O Ltd requested the management to provide a written representation regarding the
obsolescence of inventory and warranty obligations recognized by the company in its financial statements.
However, the management refused to provide the representation, stating that during the audit, all necessary
procedures had already been performed by the auditor, and after obtaining sufficient appropriate audit evidence,
the auditor had issued a clean report. Please comment. (MTP Mar 19)

Solution

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As per SA 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures,
the auditor is required to obtain written representations from management and, where appropriate, from those
charged with governance regarding their belief that significant assumptions used in making accounting estimates
are reasonable.

Depending on the nature, materiality, and extent of estimation uncertainty, written representations regarding
accounting estimates recognized or disclosed in the financial statements may include:

• Confirmation of the appropriateness of measurement processes, including related assumptions and models
used in determining accounting estimates, in line with the applicable financial reporting framework, along
with consistency in their application.
• Assurance that assumptions appropriately reflect management’s intent and ability to carry out specific
courses of action, where relevant to accounting estimates and disclosures.
• Confirmation that disclosures related to accounting estimates are complete and appropriate under the
applicable financial reporting framework.
• Assertion that no subsequent event necessitates adjustments to the accounting estimates and disclosures
included in the financial statements.
• For accounting estimates that are not recognized or disclosed in the financial statements, written
representations may also include:

a) Justification for management’s basis in determining that recognition or disclosure criteria under the
applicable financial reporting framework have not been met.
b) Justification for management’s decision to override the presumption related to fair value measurement
under the entity’s applicable financial reporting framework, where estimates are not measured or
disclosed at fair value.

Therefore, management's contention that written representation is unnecessary because the auditor has already
performed all required procedures and issued a clean report is incorrect. Management is obligated to provide
written representations to the auditor.

Furthermore, as per SA 580, Written Representations, if management refuses to provide the requested written
representations, the auditor must:
(a) Discuss the matter with management.
(b) Re-evaluate management’s integrity and assess how this may affect the reliability of both written and oral
representations, as well as the overall audit evidence.
(c) Take appropriate action, including assessing the potential impact on the auditor’s opinion in accordance with SA
705.

Q3. CA Harry is appointed as a Statutory Auditor of Delist Limited for the financial year 2021-22. M/s Delist Limited is
a listed entity at the National Stock Exchange, and the financial statements are to be drawn up in compliance with
Ind AS. M/s Delist Limited made certain fair value accounting estimates on complex financial instruments that are
not traded in an active and open market. CA Harry is concerned with the identification and assessment of the
risks of material misstatement for accounting estimates. Guide him with regard to the estimation-making process
adopted by management with reference to the relevant Standard on Auditing. (PYP May ‘22)

Solution

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As per SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures”,
CA Harry shall obtain an understanding of the following in order to provide a basis for the identification and
assessment of the risks of material misstatements for accounting estimates:

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, and if so, why.
(6) Whether and, if so, how the management has assessed the effect of estimation uncertainty.

Q4. M/s ABC Limited is engaged in the business of construction of infrastructure and housing projects. While
preparing the financial statements for the year ended 31.03.2023, management has made various accounting
estimates and confirmed to the auditor that all necessary accounting estimates have been recognized, measured,
and disclosed in the financial statements in accordance with the applicable financial reporting framework. The
auditor, during the course of the audit, observed some changed circumstances giving rise to the need for an
accounting estimate. Inquiries of the same were sought from the management. Can you list down some
circumstances, the change of which will result in inquiries from the management? (PYP May ‘23)

Solution

As per SA 540, “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures”,
inquiries of management about changes in circumstances may include, for example, inquiries about whether:

• The entity has engaged in new types of transactions that may give rise to accounting estimates.
• Terms of transactions that gave rise to accounting estimates have changed.
• Accounting policies relating to accounting estimates have changed, as a result of changes to the
requirements of the applicable financial reporting framework or otherwise.
• Regulatory or other changes outside the control of management have occurred that may require
management to revise, or make new, accounting estimates.
• New conditions or events have occurred that may give rise to the need for new or revised accounting
estimates.

During the audit, the auditor may identify transactions, events, and conditions that give rise to the need for
accounting estimates that management failed to identify. SA 315 deals with circumstances where the auditor
identifies risks of material misstatement that management failed to identify, including determining whether there
is a significant deficiency in internal control with regard to the entity’s risk assessment processes.

Q5. 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? (MTP Apr’21,
MTP Mar’18)

Solution

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As per SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures”,
the auditor shall obtain an understanding of the following in order to provide a basis for the identification and
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, and conditions that may give rise to the need for
accounting estimates to be recognized 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, and if so, why.
(6) Whether and, if so, how the management has assessed the effect of estimation uncertainty.

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SM & Additional Questions

Q1. “Living Well Private Limited” is engaged in the manufacturing and export of floor coverings. Such products are
labour-intensive and do not require much capital investment in machinery. The company has no plans to diversify
in other product lines. Its directors are also holding significant interest in another company “My Living Private
Limited” engaged in manufacturing of blankets using capital intensive machinery.

During the audit of “My Living Private Limited”, it was noticed that the company has sold machinery of ` 1 crore
to “Living Well Private Limited” during the year. The transaction has been done at normal market rates applicable
to such used machinery.
How do you view the above transaction as auditor of “My Living Private Limited”?

Solution

In respect of significantly related party transactions outside the normal course of business of an entity, it is the
responsibility of the auditor, in accordance with SA 550, to evaluate the business rationale or lack thereof of
transactions that may have been entered to indulge in fraudulent financial reporting or conceal misappropriation of
assets.

The auditor has to seek to understand the business rationale of such a transaction from a related party’s perspective.
It would help him understand the economic reality of such a transaction and why it was carried out.

In the given situation, there is no primary rationale for such a transaction. Living Well Private Limited does not
manufacture blankets, and the purchase of part of old machinery pertaining to blanket manufacturing has no
rationale for it primarily. A business rationale from the related party’s perspective that appears inconsistent with
the nature of its business may represent a fraud risk factor.

Q2. A firm of a father and a son is receiving Rs. 2 lakhs towards job work done for XYZ Ltd. during the year ended on
31.03.16. The total job work charges paid by XYZ Ltd. during the year are over Rs. 50 lakhs. The father is Managing
Director of XYZ Ltd. having substantial holding. The Managing Director told the auditor that since he is not
involved in the activities of the firm and since the amount paid to it is insignificant; there is no need to disclose
the transaction. He further contended that such a payment made in the last year was not disclosed. Advise
whether Managing Director is right in his approach. (MTP Aug ‘18)

Solution

As per definition given in the AS 18 “Related Party Disclosures”, parties are considered to be related if at any time
during the reporting period one party has the ability to control the other party or exercise significant influence over
the other party in making financial and/or operating decisions. Related party transaction means a transfer of
resources or obligations between related parties, regardless of whether or not a price is charged.

In the instant case, the managing director of XYZ Ltd. is a partner in the firm with his son which has been paid Rs. 2
lakhs as job work charges. The managing director is having a substantial holding in XYZ Ltd. The case is squarely
covered by AS 18. According to AS-18, in the case of related party transactions, the reporting enterprise should
disclose the following:

(i) the name of the transacting related party;

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(ii) a description of the relationship between the parties;
(iii) a description of the nature of transactions;
(iv) volume of the transactions either as an amount or as an appropriate proportion;
(v) any other elements of the related party transactions necessary for an understanding of the financial statements;
(vi) the amounts or appropriate proportions of outstanding items pertaining to related parties at the balance sheet
date and provisions for doubtful debts due from such parties at that date; and
(vii) amounts written off or written back in the period in respect of debts due from or to related parties.

Further, SA 550 on “Related Parties”, also prescribes the auditor’s responsibilities and audit procedures regarding
related party transactions.

The approach of the managing director is not tenable under the law and accordingly, all disclosure requirements
have to be complied with in accordance with the AS 18. Auditor should insist to make proper disclosure as per the
AS and if management refuses, the auditor shall have to modify his report. Also, it has to be seen whether section
184 of the Companies Act, 2013 regarding disclosure of interest by director has been complied with. If it is not
complied with, the auditor needs to modify the report.

Q3. You are the Auditor of Power Supply Corporation Limited, a Government Company for the year ended on 31st
March 2018. The turnover of the Company for the period was Rs. 12,000 crores from sale of power.

During your audit, you found that the Company had procured Spares for Transmitters for Rs. 850 crores from
abroad through a Corporation by name Procurement and Supply India Limited, which is also owned and controlled
by Government of India. The Financial Statements of the Power Supply Corporation Limited, prepared in
compliance with Ind AS for the year ended on 31/03/2018 did not contain any additional disclosure regarding the
procurement of spares as referred to above.
To your query as to whether any disclosure regarding Related Party Transaction would be required, the
Management of the Corporation replied that no such disclosure would be necessary for transactions between
State Controlled Enterprises.

Analyze this issue in finalizing the Audit Report. (PYP Nov’18)

Solution

As per Ind AS 24, “Related Party Disclosures”, a reporting entity is exempt from the disclosure requirements in
relation to related party transactions and outstanding balances, including commitments, with

(i) a government that has control or joint control of, or significant influence over, the reporting entity; and
(ii) another entity that is a related party because the same government has control or joint control of, or
significant influence over, both the reporting entity and the other entity.

If a reporting entity applies the above exemption, it shall disclose the following about the transactions and related
outstanding balances referred to:

(1) The name of the government and the nature of its relationship with the reporting entity (i.e. control, joint
control or significant influence);

(2) The following information in sufficient detail to enable users of the entity’s financial statements to understand
the effect of related party transactions on its financial statements:

(i) The nature and amount of each individually significant transaction; and

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(ii) For other transactions that are collectively, but not individually, significant, a qualitative or quantitative
indication of their extent.

Further, as per SA 550 Related Parties, in forming an opinion on the financial statements in accordance with SA 700,
the auditor shall evaluate whether the identified related party relationships and transactions have been
appropriately accounted for and disclosed in accordance with the applicable financial reporting framework.

In the instant case, Power Supply Corporation Limited, a Government Company, has procured spares for
transmitters for ₹850 crore from abroad through a corporation namely Procurement and Supply India Limited, which
is also owned and controlled by Government of India. Even after applying the exemption of Ind AS 24, Power Supply
Corporation Limited has to disclose the matters specified above (i.e. name of Government, nature of its relationship
with the reporting entity, the nature and amount of transaction, etc.)

Contention of Management of Corporation regarding no requirement of disclosure for transactions between State
Controlled Enterprises is not tenable.

Q4. Mr. X, while conducting audit of PQR Ltd, comes across certain transactions which according to him are significant
transactions with related parties and identified to be outside the entity's normal course of business. Guide Mr. X
with examples of such transactions and to understand the nature of significant transactions outside the entity's
normal course of business. (PYP NOV-20)

Solution

In the given case of PQR Ltd, Mr. X, while conducting audit, has come across certain significant related party
transactions which are identified to be outside the entity’s normal course of business. Mr. X wants guidance through
examples of such significant transactions which are given in SA 550.

As per SA 550 “Related Parties”, examples of transactions outside the entity’s normal course of business may
include:

• Complex equity transactions, such as corporate restructurings or acquisitions.

• Transactions with offshore entities in jurisdictions with weak corporate laws.
• The leasing of premises or the rendering of management services by the entity to another party if no
consideration is exchanged.
• Sales transactions with unusually large discounts or returns.
• Transactions with circular arrangements, for example, sales with a commitment to repurchase.
• Transactions under contracts whose terms are changed before expiry.

Q5. JKL Limited is engaged in the business of Construction and real estate having various projects across states. M/s
YT & Co, Chartered Accountants have been appointed as Statutory Auditors. Audit Team from M/s YT & Co for
audit of JKL Limited comprises of CA Z-Engagement Partner, CA Q, a paid assistant and 3 Articled Assistants.
During preliminary verification, CA Z observed that huge amount of sub-contract payments were made to M/s JB
Associates, a partnership firm in which Director of JKL Limited is a managing partner. The engagement team
discussed that SA 315 and SA 240 shall include specific consideration of the susceptibility of the financial
statements to material misstatement due to fraud or error that could result from the JKL Limited's related party
relationships and transaction.

Highlight the matters that are to be addressed in the discussion by CA Z with engagement team members with
reference to the relevant Standard on Auditing. (PYP May ‘22)

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Solution

As per SA 550 “Related Parties”, the engagement team discussion that SA 315 and SA 240 require shall include
specific consideration of the susceptibility of the financial statements to material misstatement due to fraud or error
that could result from the entity’s related party relationships and transactions.

Accordingly, matters that are to be addressed in the discussion by CA Z among the engagement team include:

• The nature and extent of the entity’s relationships and transactions with related parties.
• An emphasis on the importance of maintaining professional skepticism throughout the audit regarding the
potential for material misstatement associated with related party relationships and transactions.
• The circumstances or conditions of the entity that may indicate the existence of related party relationships or
transactions that management has not identified or disclosed to the auditor.
• The records or documents that may indicate the existence of related party relationships or transactions that
management has not identified or disclosed to the auditor.
• The importance that management and those charged with governance attach to the identification, appropriate
accounting for, and disclosure of related party relationships and transactions and the related risk of
management override of relevant controls.
• In addition, the discussion in the context of fraud may include specific consideration of how related parties may
be involved in fraud. For example:
(a) how special-purpose entities controlled by management might be used to facilitate earnings
management.
(b) how transactions between the entity and a known business partner of a key member of management
could be arranged to facilitate misappropriation of the entity’s assets.

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SM Questions
Q1. “Move Fast Limited” is engaged in the manufacturing of shoes and slippers located in Bahadurgarh in Haryana.
Due to unprecedented rains in the area in the month of September 2023, many areas of the town got inundated
due to the choking of sewer systems. As a result of the above, the company’s premises located in town were also
affected, resulting in damage of stocks.
The company has lodged a claim with the insurance company for Rs 1 crore, and the same is shown as a claim
receivable as of 31st March 2024, as the claim was not settled at year end.

The insurance surveyor appointed in the case submitted a report to the insurance company recommending a
claim of Rs. 45 lacs in the month of April 2024. The company has also given its consent for the same, and the
settled amount of Rs. 45 lacs was transferred to the bank account of the company on 15th May 2024.

You have just finished performing substantive procedures of the company by the end of May 2024. Is there any
responsibility cast upon you as auditor of the company in the above situation?

Solution

The given situation provides evidence of conditions that existed at the date of financial statements. Initially, the
company had lodged claim of `1 crore and the same is reflected as claim receivable in financial statements as on
31st March, 2024.

However, subsequent events occurring have provided evidence that claim was settled for Rs. 45 lacs only. Such a
settled amount has already been accepted by the company by providing its consent. Therefore, such events have
provided fresh information about items included in financial statements.

Further, the performance of substantive procedures has been finished implying that the audit report is not yet
issued.
Therefore, financial statements as on 31st March, 2024 should be adjusted to reflect fresh information emanating
from described events and management should be asked to take appropriate action in this regard so that adjustment
pertaining to above is properly reflected in financial statements in accordance with applicable financial reporting
framework.

Q2. CA Anuj is the auditor of a listed company, and he is in the midst of conducting an audit of the said company for
the financial year ending 31st March 2024. At a meeting of the Board of Directors held on 17th April 2024, a
dividend of Rs. 1 crore is proposed to equity shareholders @ Rs. 10/- per share, and such a proposal has a good
chance of being approved in the AGM of the company to be held after few months.

His audit procedures are near completion. He is contemplating finalizing the audit report by 31st July 2024. Is
there any responsibility thrust upon him as an auditor of the company?

Solution

In the given situation, dividend has been proposed by Board of Directors on 17th April, 2024. It is an example of
conditions that arose after the reporting period. No liability exists for the company on the reporting date because
there is no obligation to pay at the reporting date in accordance with Ind AS 1.

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Therefore, the above situation does not require recognition of the above proposed dividend in financial statements.
It is an example of events which do not require adjustments. However, it should be disclosed in financial statements
in notes to accounts. Therefore, it should be ensured that it is disclosed in notes to accounts in financial statements.
He should verify in accordance with SA 560 that it is disclosed in notes to accounts.

Q3. Ramadhan & Co. are the auditors of XYZ Company Ltd. for the year ended on 31/03/2024. The Audit Report for
that year was signed by Ramadhan & Co. on 04/05/2024. The Annual General Meeting was decided to be held
during the month of August 2024. On 06/05/2024, the Company had received a communication from the Central
Government that an amount of ₹5800 crore kept pending on account of incentives pertaining to Financial Year
2023-24 had been approved and the amount would be paid to the Company before the end of May 2024.
To a query to the Chief Financial Officer of the Company by the Board, it was informed that this amount had not
been recognised in the Audited Financial Statements in view of the same not being released before the close of
the Financial Year and due to uncertainty of receipt.
Now, having received the amount, the Board of Directors wished to include this amount in the Financial
Statements of the Company for the Financial Year ended on 31/03/2024. On 08/05/2024, the Board amended the
accounts, approved the same and requested the Auditor to consider this event and issue a fresh audit report on
the Financial Statements for the year ended on 31/03/2024.

Analyse the issues involved and give your views as to whether or not the Auditors could accede to the request of
the Board of Directors.

Solution

Facts Which Become Known to the Auditor After the Date of the Auditor’s Report but Before the Date the Financial
Statements are Issued: As per SA 560, “Subsequent Events”, the auditor has no obligation to perform any audit
procedures regarding the financial statements after the date of the auditor’s report. However, when, after the date
of the auditor’s report but before the date the financial statements are issued, a fact becomes known to the auditor
that, had it been known to the auditor at the date of the auditor’s report, may have caused the auditor to amend
the auditor’s report, the auditor shall

(i) Discuss the matter with management and, where appropriate, those charged with governance.
(ii) Determine whether the financial statements need amendment and, if so,
(iii) Inquire how management intends to address the matter in the financial statements.

If management amends the financial statements, the auditor shall carry out the audit procedures necessary in the
circumstances on the amendment. Further, the auditor shall extend the audit procedures and provide a new
auditor’s report on the amended financial statements. However, the new auditor’s report shall not be dated earlier
than the date of approval of the amended financial statements.

In the instant case, XYZ Company Ltd. received an amount of ` 5800 crore on account of incentives pertaining to the
year 2023-24 in the month of May 2024 i.e. after finalisation of financial statements and signing of audit report. The
Board of Directors of XYZ Ltd. amended the accounts, approved the same and requested Ramadhan & Co. (auditor)
to consider this event and issue a fresh audit report on the financial statements for the year ended on 31-03-2024.

After applying the conditions given in SA 560, Ramadhan & Co. can issue new audit report subject to date of audit
report which should not be earlier than the date of approval of the amended financial statements.

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Q4. CA Shobit is conducting an audit of XYZ Ltd. for the year 2023-24. The company is engaged in the export of
handicraft items in Europe. The audit is nearing completion in the month of July 2024. However, it becomes
known to CA Shobit that one of overseas buyers has made a legal claim against the company on 1st June 2024 for
injury caused to a customer of one European buyer due to sub-standard dyes used in rugs of one lot of order
shipped in August 2023. The management of the company has decided to agree to an out-of-court settlement of
₹4 crore to protect its reputation. The financial statements of the company are silent on this issue.
Discuss, how, CA Shobit should proceed to deal with the above issue.

Solution

In the given case, the auditor has come to know the legal claim against the company before the issuance of the audit
report. It has also come to his knowledge that the management of the company has agreed to an out of court
settlement of ₹ 4 crore.
This is an example of a subsequent event between the date of the financial statements and the date of the auditor’s
report. It provides evidence of conditions that existed at the date of the financial statements and requires
adjustment in financial statements.

Further as per SA 560, “Subsequent Events”, the auditor shall request management and, where appropriate, those
charged with governance, to provide a written representation in accordance with SA 580, “Written Representations”
that all the events occurring subsequent to the date of the financial statements and for which the applicable financial
reporting framework requires adjustment or disclosure have been adjusted or disclosed.

CA Shobit should ensure that appropriate adjustments and disclosures are made by the management. In the absence
of the same, he should consider the impact of the said event and report accordingly.

Q5. The audit report of Rare (P) Ltd for F.Y. 2023-24 was issued by SRM & Co. on 23rd July 2024. However, a case was
filed against Rare (P) Ltd on 9th August 2024, with the Civil Court, with respect to an incident caused in its factory
on 24th January 2024, the future outcome of which may result in paying a heavy penalty by Rare (P) Ltd, which
was informed to Mr. Rishabh Pandey, the partner of SRM & Co.

Mr. Rishabh discussed the said matter with the management, and it was determined to amend the financial
statements for F.Y. 2023-24. Further, Mr. Rishabh inquired how the management intended to address the said
matter in the financial statements, to which he was told that the said matter was going to be disclosed as a
“Contingent Liability for a Court case” in the footnote in the balance sheet with no additional disclosures.

The management told Mr. Rishabh that such disclosure was enough as he would be further going to provide a
description of the said court case and its outcome in the ‘EOM’ paragraph in his amended audit report.

In the context of the aforesaid case scenario, please answer the following questions: -

(i) Whether Mr. Rishabh on behalf of SRM & Co. has properly adhered to his responsibilities in accordance with
SA 560, on becoming aware of the court case filed against Rare (P) Ltd?
(ii) Whether the contention of the management of Rare (P) Ltd is valid with respect to the disclosure of the court
case in the financial statements?

Solution

(i) As per SA 560, ‘Subsequent Events’, the auditor has no obligation to perform any audit procedures regarding the
financial statements after the date of the auditor’s report. However, when, after the date of the auditor’s report

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but before the date the financial statements are issued, a fact becomes known to the auditor that, had it been
known to the auditor at the date of the auditor’s report, may have caused the auditor to amend the auditor’s
report, the auditor shall:

(1) Discuss the matter with management and, where appropriate, those charge
(2) Determine whether the financial statements need amendment and, if so,
(3) Inquire how management intends to address the matter in the financial statements.

In the given case, on becoming aware of the court case filed against Rare (P) Ltd., Mr. Rishabh discussed the said
matter with the management, and was determined to amend the financial statements. Also, he inquired how the
management intended to address the said matter in the financial statements.
Thus, it can be said that Mr. Rishabh has properly adhered to his responsibilities in accordance with SA 560, o n
becoming aware of the court case filed against Rare (P) Ltd.

(ii) As per SA 706, ‘Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s
Report’, an Emphasis of Matter paragraph is not a substitute for:

(a) A modified opinion in accordance with SA 705 (Revised) when required by the circumstances of a specific
audit engagement;
(b) Disclosures in the financial statements that the applicable financial reporting framework requires
management to make, or that are otherwise necessary to achieve fair presentation; or
(c) Reporting in accordance with SA 570 (Revised) when a material uncertainty exists relating to events or
conditions that may cast significant doubt on an entity’s ability to continue as a going concern.

In the given case, the management of Rare (P) Ltd. has presumed that as the auditor was going to provide a
description of the said court case and its outcome in the ‘Emphasis of Matter’ paragraph in his amended audit
report, there was no further need for it to provide additional disclosures about the court case in the financial
statements.

The said contention of management of Rare (P) Ltd. is not valid as ‘Emphasis of Matter’ paragraph cannot be
used as a substitute for disclosures required to be made in the financial statements as per the applicable financial
reporting framework or that is otherwise necessary to achieve fair presentation, which is the responsibility of the
management.

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Additional Questions
Q6. A Co. Ltd. has not included in the Balance Sheet as on 31-03-2017 a sum of ` 1.50 crores being amount in the
arrears of salaries and wages payable to the staff for the last 2 years as a result of successful negotiations which
were going on during the last 18 months and concluded on 30-04-2017. The auditor wants to sign the said Balance
Sheet and give the audit report on 31-05-2017. The auditor came to know the result of the negotiations on 15-05-
2017. Advise. (MTP March 18)

Solution

Subsequent Events: This case requires attention to SA 560 “Subsequent Events”, AS 4 “Contingencies and Events
occurring after the Balance Sheet Date” and AS 29 "Provisions, Contingent Liabilities and Contingent Assets".

As per AS 4 “Contingencies and Events occurring after the Balance Sheet Date”, adjustments to assets and liabilities
are required for events occurring after the balance sheet date that provide additional information materially
affecting the determination of the amounts relating to conditions existing at the balance sheet date. Similarly, as
per AS 29 "Provisions, Contingent Liabilities and Contingent Assets", 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 they will occur.

In the instant case, the amount of ₹1.50 crores is a material amount and it is the result of an event, which has
occurred after the Balance Sheet date. The facts have become known to the auditor before the date of issue of the
Audit Report and Financial Statements.

The auditor has to perform the procedure to obtain sufficient, appropriate evidence covering the period from the
date of the financial statements i.e. 31-03-2017 to the date of the Auditor’s Report i.e. 31-05-2017. It will be
observed that as a result of long pending negotiations, a sum of ₹1.50 crores representing arrears of salaries of the
year 2015-16 and 2016-17 has not been included in the financial statements. It is quite clear that the obligation
requires provision for outstanding expenses as per AS 4 and AS 29.

As per SA 560 “Subsequent Events”, the auditor should assure that all events occurring subsequent to the date of
the financial statements and for which the applicable financial reporting framework requires adjustment or
disclosure have been adjusted or disclosed.

So, the auditor should request the management to adjust the sum of ₹1.50 crores by making provision for expenses.
If the management does not accept the request, the auditor should qualify the audit report.

Q7. M/s Krishna Associates, Chartered Accountants, while conducting the audit of Love Kush Ltd want to conduct an
inquiry of management and those charged with governance as to whether any subsequent events have occurred
which might affect the financial statements. Guide M/s Krishna Associates with the matters where specific
inquiries may be conducted to evaluate subsequent events. (MTP April 22)

Solution

As per SA 560, “Subsequent Events”, in inquiring of management and, where appropriate, those charged with
governance, as to whether any subsequent events have occurred that might affect the financial statements, the
auditor may inquire as to the current status of items that were accounted for on the basis of preliminary or
inconclusive data and may make specific inquiries about the following matters:

(i) Whether new commitments, borrowings or guarantees have been entered into.

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(ii) Whether sales or acquisitions of assets have occurred or are planned.
(iii) Whether there have been increases in capital or issuance of debt instruments, such as the issue of new shares
or debentures, or an agreement to merge or liquidate has been made or is planned.
(iv) Whether any assets have been appropriated by government or destroyed, for example, by fire or flood.
(v) Whether there have been any developments regarding contingencies.
(vi) Whether any unusual accounting adjustments have been made or are contemplated.
(vii) Whether any events have occurred or are likely to occur that will bring into question the appropriateness of
accounting policies used in the financial statements, as would be the case, for example, if such events call
into question the validity of the going concern assumption.
(viii) Whether any events have occurred that are relevant to the measurement of estimates or provisions made
in the financial statements.
(ix) Whether any events have occurred that are relevant to the recoverability of assets.

Q8. You are the auditor of PQR Ltd. which is in the business of supplying food products to various airline companies
operating aircrafts in domestic circle only. As per terms of agreement with airlines, the company needs to stock
various non-perishable food items for coming one month (average holding of inventory to the tune of INR 75
Crores). Also the payment terms have been settled and the company receives payment in 45 days after the supply
of goods. Everything was going-on well till the end of March 2020 when pandemic Covid hit the world and
everything came to a stand still. Aviation sector was hit hard and there were no flights from April 2020 onwards.
Consequently, the business of PQR Ltd. also got severely affected and the scheduled supplies of goods to airlines
also were not made. Also, the liquidity position of airline companies got hit and the scheduled payments were
also not received on due dates.
As the auditor of PQR Ltd. what audit procedures would you perform to ensure that all subsequent events are
considered, so that financial statements for the year ended 31.03.2020 represent true & fair view? (PYP Nov-20)

Solution

As per SA 560 “Subsequent Events”, the auditor shall perform audit procedures designed to obtain sufficient
appropriate audit evidence that all events occurring between the date of the financial statements and the date of
the auditor’s report that require adjustment of, or disclosure in, the financial statements have been identified. The
auditor is not, however, expected to perform additional audit procedures on matters to which previously applied
audit procedures have provided satisfactory conclusions.

➢ The auditor shall perform the procedures required in the above paragraph so that they cover the period from the
date of the financial statements to the date of the auditor’s report, or as near as practicable thereto.

Being the auditor of PQR Ltd, to ensure that all subsequent events are considered so that financial statements for
the year ending 31.03.2020 represent a true and fair view, the auditor shall take into account the auditor’s risk
assessment in determining the nature and extent of such audit procedures, which shall include the following:

(a) Obtaining an understanding of any procedures management has established to ensure that subsequent events
are identified.
(b) Inquiring of management and, where appropriate, those charged with governance as to whether any
subsequent events have occurred which might affect the financial statements.
(c) Reading minutes, if any, of the meetings of the entity’s owners, management, and those charged with
governance that have been held after the date of the financial statements and inquiring about matters discussed
at any such meetings for which minutes are not yet available.

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(d) Reading the entity’s latest subsequent interim financial statements, if any.

➢ When, as a result of the procedures performed as required above, the auditor identifies events that require
adjustment of, or disclosure in, the financial statements, the auditor shall determine whether each such event is
appropriately reflected in those financial statements.

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SM Questions
Q1. CA Somya is auditor of a company engaged in rearing of poultry birds and obtaining eggs therefrom. The company
has performed very well since its incorporation in 2013. Its sales had also grown and the company had expanded
its market from the native northern state of promoters to far-flung areas in eastern parts of country.

However, since last two years, company’s fortunes have nosedived. First, due to the effects of the pandemic and
then due to recurrent outbreaks of bird flu thrice in a span of two years. The company’s sales have dipped from
around ` 50 crores to `10 crores. Further, a major part of its livestock was also wiped off during bird flu. She is not
optimistic about the going concern assumption followed by management.

The management now wants to start with new batches of birds. The earlier working capital facilities of the
company granted by bank have also been restructured to support the business. She was informed that the
repayments of restructured working capital term loans are to begin from ensuing year. No fresh credit facilities
have been granted by the bank. The company also plans longer credits from animal feed suppliers.

The company plans to take additional measures to prevent the safety of live stocks, including aggressive
vaccination, preventive health check-ups, and more frequent visits of veterinary staff. The villagers in surrounding
areas have accused the company of spreading air pollution.

The management has prepared a cash flow forecast for her examination. Discuss approach to be adopted by her
in examining the “going concern” assumption keeping in view above with specific reference to cash flow forecast.

Solution

In accordance with SA 570, "Going Concern", if events or conditions have been identified that may cast significant
doubt on the entity’s ability to continue as a going concern, the auditor shall obtain sufficient appropriate audit
evidence to determine whether or not 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 by performing additional audit procedures,
including consideration of mitigating factors.

Where the entity has prepared a cash flow forecast, and analysis of the forecast is a significant factor in considering
the future outcome of events or conditions in the evaluation of management’s plans for future actions, it includes:

(i) Evaluating the reliability of the underlying data generated to prepare the forecast and
(ii) Determining whether there is adequate support for the assumptions underlying the forecast.

In the above situation, a cash flow forecast has been prepared by management. Therefore, she should carefully
evaluate assumptions underlying the forecast and also the reliability of data to prepare the forecast. For example:

• She should verify the assumption regarding a fresh batch of livestock. The bankers have not provided fresh credit
facilities. How funds from the same would be arranged? The reasonability of the assumption in the cash flow
forecast needs to be looked into.

• She needs to check loan sanction letters/agreement to verify when repayments are beginning to see their
accuracy in cash flow forecasts.

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• The company plans to avail longer credits from animal feed suppliers. In the downturn situation of the company,
how would suppliers extend longer credits? This is going to have an effect on the cash flow forecast.

• Whether the company has accounted for increased expenditure on preventive health check-ups, vaccination,
and more frequent visits of veterinary staff in the cash flow forecast.

• Since villagers have accused the company of spreading air pollution, how does the company plan to deal with
the same? Whether any proposed expenditure in this regard is accounted for in the cash flow statement. She
may also consider other implications of this issue and possible effects on cash flows.

Q2. CA Sooraj finds that key financial ratios of a company, like current ratio, debt-service coverage ratio, inventory
turnover ratio, and trade receivables turnover ratio, are in red and have deteriorated considerably as compared
to last year. The company is also not able to pay to its creditors on time. The company is requesting time and
again to its bankers to grant additional credit facilities , but bankers are not listening.

There have been significant losses to the company due to the lack of response of the company’s products in the
market. As a result of it, many products are sold at below cost price. There have been situations where the
company is not able to pay the salaries of staff on time.
All these negative findings have led him to conclude that the use of going concern as the basis of accounting is
not appropriate. He brings this matter to the knowledge of CFO of the company. What is reporting duty cast upon
him in such a scenario?

The CFO informs him that the management, in turn, is ready to include in the disclosures the inappropriateness
of its use of going concern assumption of accounting.
How should it impact the auditor’s opinion in case management itself discloses the inappropriateness of its use
of going concern assumption of accounting now?

Solution

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 financial statements is inappropriate,
the auditor shall express adverse opinion.

The requirement for an auditor to express an adverse opinion applies regardless of whether or not the financial
statements include disclosure of the inappropriateness of management’s use of the going concern basis of
accounting.

Therefore, even if management discloses that its use of going concern assumption of accounting is inappropriate, it
would have no impact on auditor’s opinion. He would need to express adverse opinion.

Q3. M/s Airlift Ltd., carrying on the business of passenger transportation by air, is running into continuous financial
losses as well as reduction in sales due to stiff competition and frequent break down of its own aircrafts. The
Financial Statements for the Year ended on 31/03/2024 are to be now finalized. The Management is quite
uncertain as to its ability to continue in near future and has informed the Auditors that having seized of this
matter, it had constituted a committee to study this aspect and to give suggestions for recovery, if any, from this
bad situation. Till the study is completed, according to the Management, the issue involves uncertainty as to its
ability to continue its business and it informs the Auditor that the fact of uncertainty clamping on the "Going
Concern" would suitably be disclosed in notes to accounts. State the reporting requirement if any, in the
Independent Auditor's Report in respect of this matter.

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Solution

As per SA 570 “Going Concern”, if the auditor concludes that management’s use of the going concern basis of
accounting is appropriate in the circumstances but a material uncertainty exists, the auditor shall determine
whether the financial statements:

(i) Adequately disclose the principal events or conditions that may cast significant doubt on the entity’s ability to
continue as a going concern and management’s plans to deal with these events or conditions; and
(ii) 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 and, therefore, that it may be unable to realize its
assets and discharge its liabilities in the normal course of business.

If adequate disclosure about the material uncertainty is made in the financial statements, the auditor shall express
an unmodified opinion and the auditor’s report shall include a separate section under the heading “Material
Uncertainty Related to Going Concern” to:

(i) Draw attention to the note in the financial statements that discloses the matters set out above; and
(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 and that the auditor’s opinion is not modified in respect
of the matter.

In the instant case, M/s Aircraft Ltd. is running into continuous financial losses as well as a reduction in sales due to
stiff competition and frequent breakdown of its own aircrafts, and management of Aircraft Ltd. is uncertain as to its
ability to continue in the near future. Therefore, a committee has been constituted to study this aspect, and till the
time the study is completed, management has accordingly decided to suitably disclose this aspect in notes to
accounts.

Therefore, the auditor should disclose the material uncertainty and express an unmodified opinion, and in his audit
report shall include a separate section under the heading “Material Uncertainty Related to Going Concern” to draw
attention to the note in the financial statements that discloses the matters set out above and 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 and that the auditor’s opinion is not modified in respect of the matter.

Q4. Mudit & Associates is appointed as Statutory Auditors of GRF Private Limited for the financial year 2023-24. The
company is into the business of Health Club, Fitness Centre and gym costumes. CA M is the Engagement Partner
for the audit assignment. CA M observed the following points while auditing:

(i) Customer's base is reducing continuously due to tough competition and discount war existing in the
market.
(ii) Payments of creditors are delayed and made with overdue interest.
(iii) Company has not been able to pay the salaries of staff and trainers on time.
(iv) Key financial ratios of the company, like current ratio, debt-service coverage ratio, are in the red and have
deteriorated considerably as compared to last year.
(v) The company has requested its bankers to provide it with additional working capital credit facilities of `
1.5 Crores, but bankers are not considering the company's proposal favorably.

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What audit procedures should be followed by CA M considering the above circumstances as per SA 570 - "Going
Concern"? How auditor should deal if the use of going concern basis of accounting is appropriate, but a material
uncertainty exists, and adequate disclosure of material uncertainty is made in the financial statements?

Solution

As per SA 570, “Going Concern”, if events or conditions have been identified that may cast significant doubt on the
entity’s ability to continue as a going concern, the auditor shall obtain sufficient appropriate audit evidence to
determine whether or not 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 through performing additional audit procedures,
including consideration of mitigating factors. These procedures shall include:

(a) Where management has not yet performed an assessment of the entity’s ability to continue as a going concern,
requesting management to make its assessment.
(b) Evaluating management’s plans for future actions in relation to its going concern assessment, whether the
outcome of these plans is likely to improve the situation and whether management’s plans are feasible in the
circumstances.
(c) Where the entity has prepared a cash flow forecast, and analysis of the forecast is a significant factor in
considering the future outcome of events or conditions in the evaluation of management’s plans for future
actions:

(i) Evaluating the reliability of the underlying data generated to prepare the forecast; and
(ii) Determining whether there is adequate support for the assumptions underlying the forecast.

(d) Considering whether any additional facts or information have become available since the date on which
management made its assessment.

(e) Requesting written representations from management and, where appropriate, those charged with
governance, regarding their plans for future actions and the feasibility of these plans.

In the given case, CA M has observed such points that may cast significant doubt on the entity’s ability to continue
as a going concern. Therefore, CA M should follow audit procedures such as:

• Review of management’s assessment of the company's ability to continue as a going concern.

• Examine and challenge the reasonableness of the company's cash flow forecasts and key assumptions.
• Review events after the reporting period that might affect the going concern assumption, such as further
financial deterioration or inability to secure financing.
• Analysis of the company's key financial ratios and compliance with loan agreements to assess liquidity and
solvency.
• Review of the company’s challenges and efforts to secure additional financing and the reasons for the bank's
reluctance to provide further credit.
• Assess the impact of declining customer base, delayed payments, and other operational challenges on the
company’s ability to continue as a going concern.

Further, as per SA 570 if adequate disclosure about the material uncertainty is made in the financial statements, the
auditor shall express an unmodified opinion and the auditor’s report shall include a separate section under the
heading “Material Uncertainty Related to Going Concern” to:

(a) Draw attention to the note in the financial statements that discloses the matters set out in paragraph 19; and

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(b) 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 and that the auditor’s opinion is not modified in respect
of the matter.

Q5. 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 and Odisha. During the FY 2023-24, 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 2023 and as such entire power
generation process of Sun Moon Ltd, came to a halt in that month. As a result of such ban, and the resultant
stoppage of the production process, many key managerial personnel of the company left the company. There
were delays in the payment of wages and salaries and 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?

Solution

SA 570 - “Going Concern” deals with the auditor’s responsibilities in the audit of financial statements relating to
going concern and the implications for the auditor’s report.
The auditor’s responsibilities are to obtain sufficient appropriate audit evidence regarding, and conclude on, the
appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial
statements, and 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); and
(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 and that the
financial statements do not adequately disclose this matter.

In the present case, 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 and 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:

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(1). Express an adverse opinion in accordance with SA 705 (Revised) and
(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 concern and
that the financial statements do not adequately disclose this matter.

The auditor is also required to report as per clause (xix) of CARO 2020 that on the basis of the financial ratios, ageing
and expected dates of realisation of financial assets and payment of financial liabilities, other information
accompanying the financial statements, the auditor’s knowledge of the Board of Directors and management plans,
whether the auditor is of the opinion that no material uncertainty exists as on the date of the audit report that
company is capable of meeting its liabilities existing at the date of balance sheet as and when they fall due within a
period of one year from the balance sheet date.

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Additional Questions
Q6. Rathi Limited had definite plan of its business being closed within a short period from the close of the accounting
year ended on 31st March, 2018. The Financial Statements for the year ended 31/03/2018 had been prepared on
the same basis as it had been in earlier periods with an additional note that the business of the Company shall
cease in near future and the assets shall be disposed off in accordance with a plan of disposal as decided by the
Management. The Statutory Auditors of the Company indicated this aspect in Key Audit Matters only by a
reference as to a possible cessation of business and making of adjustments, if any, thereto to be made at the time
of cessation only. Comment on reporting by the Statutory Auditor as above. (MTP Mar 19 & May 20, PYP May 18)

Solution

As per SA 570 “Going Concern”, management intentions to liquidate the entity or to cease operations is one of the
events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern.

As per SA 570, if events or conditions have been identified that may cast significant doubt on the entity’s ability to
continue as a going concern but, based on the audit evidence obtained, the auditor concludes that no material
uncertainty exists, the auditor shall evaluate whether, in view of the requirements of the applicable financial
reporting framework, the financial statements provide adequate disclosures about these events or conditions.

Even when no material uncertainty exists, it requires the auditor to evaluate whether, in view of the requirements
of the applicable financial reporting framework, the financial statements provide adequate disclosure about events
or conditions that may cast significant doubt on the entity’s ability to continue as a going concern.

Further, as per SA 701 “Communicating Key Audit Matters in the Independent Auditor’s Report,” when matters
relating to going concern may be determined to be key audit matters, it explains that a material uncertainty related
to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern is, by its
nature, a key audit matter. SA 701 also emphasizes the auditor’s responsibility to communicate key audit matters in
the auditor’s report.

As per the facts given in the case, the intention of Mishti Limited had a definite plan of its business being closed
down within a short period from 31st March 2018. However, financial statements for the year ended 31.03.2018
had been prepared on the same basis as in earlier periods with an additional note.

Thus, management intentions to liquidate the entity or to cease operations is one of the events or conditions that
may cast significant doubt on the entity’s ability to continue as a going concern, making it a key audit matter.
Therefore, the auditor is required to communicate the Key Audit Matters in accordance with SA 570 in the above-
stated manner. A simple reference to a possible cessation of business and making of adjustments, if any, at the time
of cessation only by the auditor in his report is not sufficient.

Q7. AQP Limited is one of the prominent players in the chemicals industry. The company is a public company
domiciled in India and listed on BSE and NSE. The Company was facing extreme liquidity constraints and there
were multiple indicators that casted doubt over the company’s ability to continue as a going concern. The
Company was led into insolvency proceedings by consortium of banks led by PNB and the NCLT ordered the
commencement of corporate insolvency process against the Company on 31 August 2017. The company invited
prospective lenders, investors and others to submit their resolution plans to the Resolution Professional (RP)
latest by 1 January 2018. The RP reviewed the resolution plans and ensured conformity with Insolvency and
Bankruptcy Code 2016. The compliant plans were presented to Committee on Creditors (CoC) on 2 February 2018

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and the resolution plan submitted by PQR Ltd. was evaluated as highest evaluated Compliant Resolution Plan.
CoC of AQP Ltd approved the Resolution Plan submitted by PQR Ltd. on 2 March 2018. The approval of NCLT was
finally obtained on 4 May 2018. PQR Ltd submitted detailed plans and commitments as part of the resolution plan
including clearance of all outstanding debts which were leading to negative cash flows.

Please suggest how would you deal with this situation as the auditors of AQP Ltd. (MTP Mar 19 & RTP Nov’19)

Solution

As per SA 570 Going Concern, if events or conditions have been identified that may cast significant doubt on the
entity’s ability to continue as a going concern, the auditor shall obtain sufficient appropriate audit evidence to
determine whether or not 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 (hereinafter referred to as “material uncertainty”)
through performing additional audit procedures, including consideration of mitigating factors. These procedures
shall include:
a) Where management has not yet performed an assessment of the entity’s ability to continue as a going concern,
requesting management to make its assessment.
b) Evaluating management’s plans for future actions in relation to its going concern assessment, whether the
outcome of these plans is likely to improve the situation and whether management’s plans are feasible in the
circumstances.
c) Where the entity has prepared a cash flow forecast, and analysis of the forecast is a significant factor in
considering the future outcome of events or conditions in the:
i. Evaluating the reliability of the underlying data generated to prepare the forecast; and
ii. Determining whether there is adequate support for the assumptions underlying the forecast.
d) Considering whether any additional facts or information have become available since the date on which
management made its assessment.
e) Requesting written representations from management and, where appropriate, those charged with governance,
regarding their plans for future actions and the feasibility of these plans.
The auditor shall evaluate whether sufficient appropriate audit evidence has been obtained regarding, and shall
conclude on, the appropriateness of management’s use of the going concern basis of accounting in the preparation
of the financial statements.
If events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as a
going concern but, based on the audit evidence obtained, the auditor concludes that no material uncertainty exists,
the auditor shall evaluate whether, in view of the requirements of the applicable financial reporting framework, the
financial statements provide adequate disclosures about these events or conditions.
In the instant case, the approval of the resolution plan is a significant mitigating factor to counter the going concern
issues of AQP Ltd. PQR Ltd has submitted a detailed plan and commitments that have been given as part of the
resolution plan, which includes clearance of all outstanding debts that were leading to negative cash flows.
Therefore, it can be said that the events and conditions are mitigated effectively, and there is no material uncertainty
in relation to the ability of the company to continue as a going concern.
Q8. OM Ltd. is a company engaged in the business of manufacture of spare parts. Shanti & Associates are the statutory
auditors of the company for the FY 2020-21. During the course of audit, CA Shanti noticed that the company had
a major customer, namely, Korean Mart from South Korea. Owing to an outbreak of war and subsequent

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destruction leading to government ban on import and export in South Korea, the demand from Korean Mart for
the products of OM Ltd. ended for an unforeseeable time period. When discussed with the management, CA
Shanti was told that the company is in the process of identifying new customers for their products. CA Shanti
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 OM
Ltd. for the FY 2020-21. How should CA Shanti deal with this matter in the auditor’s report for the FY 2020-21 in
accordance with relevant Standard on Auditing? (MTP Nov 21 & April ‘23)
Solution
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, OM 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 and government ban on import and export in South Korea.
Further, the company has not yet identified new customers and is in the process of doing the same. As such, the
identification of new customer is a material uncertainty that casts a significant doubt on the company’s ability to
continue as a going concern.
However, this matter is duly disclosed by the management of OM 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 Shanti should:
(1) Express an unmodified opinion and
(2) Include in his audit report, a separate section under the heading “Material Uncertainty Related to Going
Concern” to:
(i) Draw attention to the note in the financial statements that discloses the matters and
(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 and that the auditor’s opinion is not modified
in respect of the matter.
(iii) Thus, CA Shanti should deal with this matter in his auditor’s report in the above-mentioned manner.
Q9. CA.K is appointed statutory auditor of SEEK INDIA LTD under Companies Act, 2013 for the first time. The company
is preparing its accounts keeping in view applicable requirements of Division II of Schedule III of Companies Act,
2013. On scrutiny of financial statements of company put up for audit, it was noticed that notes to accounts show
ageing of trade payables as per amended requirements of Schedule III of the Companies Act, 2013. The ageing
schedule forming part of notes is as under: -
Outstanding for following periods from due date of payment (` In crore)
Particulars Less than 1 1-2 years 2-3 years More than 3 Total
year years
MSME NIL NIL NIL NIL NIL
Others 2 4 3 1 10
Disputed NIL NIL NIL NIL NIL
dues-MSME
Disputed NIL NIL NIL NIL NIL
dues-others

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Besides above, current ratio, debt-equity ratio, trade payables turnover ratio, and net profit ratio disclosed in
notes to accounts have slipped drastically as compared to last year and from standard norms. Most of the key
financial ratios are in red. There is no other relevant information concerning above in notes to accounts.
Further, on reviewing the bank statement of the cash credit limit (against hypothecation of paid stocks), it was
noticed that there is no debit transaction in the month of March 2022. On inquiry, he came to know that a stock
audit of the company was conducted in the month of January 2022, and stock auditors have commented vide
their report dated 25.2.2022 that the company had negative drawing power due to high creditors. Accordingly,
the bankers have refused further debits in the cash credit account from the start of March 2022. There is no
information in this respect in financial statements and notes to accounts.
Discuss how CA K should deal with the above for reporting in his audit report under the Companies Act, 2013.
(MTP Oct ‘22)
Solution
In the given situation, it is clear from the ageing schedule that company is not able to pay its creditors on time.
Outstanding to creditors for a period of 1 year or more account for 80% of total dues to the creditors of the company
from due date of payment. Most of key financial ratios are adverse.
Further, bankers have refused further debits in cash credit account due to negative drawing power from March
2022. Cash credit loans are repayable on demand. There is no other information or disclosure available how the
company plans to run its business without bank finance.
All the above factors are indicators that a material uncertainty exists that may cast a significant doubt on the
company’s ability to continue as a going concern. There is no express disclosure of this fact in financial statements.
Therefore, it is a situation where material uncertainty exists which has cast a significant doubt on company’s ability
to continue as going concern in accordance with SA 570, “Going Concern”.
Keeping in view above the fact that although a material uncertainty exists casting a significant doubt on the ability
of company to continue as going concern, adequate disclosure of material uncertainty is not made in financial
statements, CA K shall give qualified or adverse opinion in accordance with SA-705, “Modifications to the Opinion
in the Independent Auditor’s Report”.
Q10. MZE Limited is engaged in the manufacturing and export of ready-made garments. The company has lost overseas
buyers to Asian competitors with lower raw materials and labour costs. As a result, MZE Limited has lost out on
a significant chunk of export orders, and the trend has become more pronounced in the year 2022-23. Further,
the US economic recession caused delays in the company's overseas payments, leading to the company being
unable to keep its loan repayment commitments with bankers. Further, the company has not been able to pay its
creditors on time. Even statutory dues payable by the company are either not paid or being paid after a gap of 5
-6 months, leading to extra costs. Due to declining revenue, the company cannot cover its fixed costs and has
begun laying off employees.
Considering all these circumstances, CA P doubts the company's ability to continue as a going concern while
conducting the statutory audit for the year 2022 -23. He is studying management’s assessment of the company’s
ability to continue as a going concern by studying projected profitability statements for the next two years
containing turnover, expenses and profits estimates.
Comment on the above situation with specific reference to audit procedures being performed by CA P in context
of relevant Standards on Auditing. (MTP Oct ‘23)
Solution

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The indicated events or conditions in MZE Limited may cast significant doubt on the ability of the company to
continue as a going concern. SA 570 requires that if events or conditions have been identified that may cast
significant doubt on the entity’s ability to continue as a going concern, the auditor shall obtain sufficient appropriate
audit evidence to determine whether or not 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 through performing additional audit
procedures, including consideration of mitigating factors.
In the given situation, the auditor is studying management’s assessment of the company’s ability to continue as a
going concern, including its future plan of action containing projected profitability statements for the next two years
containing estimates of turnover, expenses, and profits. However, as required in SA 570, the auditor’s procedures
should focus on cash flow forecasts and not on future profit projections. It is quite possible that a company may
continue to carry on as a going concern so long as it can meet its liabilities. Therefore, analyzing the projected
profitability statements alone is insufficient to support the conclusion on the going concern assumption followed by
the company.
Therefore, the auditor should require management to prepare a cash flow forecast in the given circumstances. The
auditor should then analyze the cash flow forecast in the evaluation of management’s future plan of action. It
includes:
(i) Evaluating the reliability of the underlying data generated to prepare the forecast, and
(ii) Determining whether there is adequate support for the assumptions underlying the forecast.
Further, some major overseas payments of the company are stuck up. It is quite possible that the timing of cash
inflows on account of these payments may affect the situation. The auditor would have to evaluate the reliability of
data for preparation for such a forecast and its underlying assumptions. He should perform procedures to obtain
evidence regarding assumptions and timing of cash inflows and outflows like any restructuring undertaken by
bankers providing relief to the company, future sales and consequent cash realization in downturn conditions,
willingness of creditors to provide credit in such a situation, and incurring of expenditures to keep the company
afloat. All these assumptions underlying such cash flow forecasts need to be challenged and examined.
Q11. Joy Ltd. is an entertainment company which runs a circus and travels around the country to entertain the masses.
The circus began losing its popularity over the past few years and attendance has reportedly dropped by as much
as 75% in the current financial year. Animal rights activists continuously targeted the circus for its use of animal
creatures like elephants in the show. The CEO noted that the audience seemed to be abandoning the circus due
to their expanding entertainment options. The high cost of moving the show from city to city eventually made
the business model untenable. As a result, many key managerial personnel of the company left the company,
there were delays in the payment of wages and salaries, and the bank from whom the company had taken funds
also decided not to extend further finance or to fund further working capital requirements of the company.
When discussed with the management, the statutory auditor understood that the company had no action plan to
mitigate such circumstances (Use of going concern assumption is inappropriate). Further, all such circumstances
were not reflected in the financial statements of Joy Ltd. What course of action should the statutory auditor of
the company take in the auditor's report in such a situation? (PYP May ‘23)
Solution
SA 570, “Going Concern,” deals with the auditor’s responsibilities in the audit of financial statements relating to
going concern and the implications for the auditor’s report.
The auditor’s responsibilities are to obtain sufficient appropriate audit evidence regarding, and conclude on, the
appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial

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statements, and 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 the 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
express a qualified opinion or adverse opinion, as appropriate, in accordance with SA 705 (Revised); and 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 and that the financial statements do not
adequately disclose this matter.
In the present case, the following circumstances indicate the inability of Joy Ltd. to continue as a going concern:

• Losing popularity over the past few years.

• Animal rights activists continuously targeting the circus.
• Audience abandoning the circus due to their expanding entertainment options.
• High cost of moving the show from city to city, making the business model untenable.
• Key managerial personnel leaving the company.
• Banks deciding not to extend further finance and not to fund the working capital requirements of the
company.
• Non-availability of a 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 Joy Ltd. should:
• Express an adverse opinion in accordance with SA 705 (Revised), and
• In the Basis of Adverse 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
concern and that the financial statements do not adequately disclose this matter.
The auditor is also required to report as per clause (xix) of CARO 2020 that, on the basis of the financial ratios, ageing
and expected dates of realization of financial assets and payment of financial liabilities, other information
accompanying the financial statements, and the auditor’s knowledge of the Board of Directors and management
plans, whether the auditor is of the opinion that no material uncertainty exists as on the date of the audit report
that the company is capable of meeting its liabilities existing at the date of the balance sheet as and when they fall
due within a period of one year from the balance sheet date.

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SM Questions
Q1. PRSH & Co is the statutory auditor of Make My Journey Ltd. The company is in the business of tours and travels.
The annual turnover of the company is Rs. 2000 crores and profits are Rs. 190 crores. During the planning meeting
of the management and the auditors, it was discussed that the management needs to provide written
representation letter to the auditors for the preparation of the financial statements and for the completeness of
the information provided to the auditor. At the time of closure of the audit, there has been some confusion about
the requirements of the written representation letter. Management argued that representation need not be
written, it can also be verbal which has been provided to the audit team during the course of their audit. Auditors
have completed their documentation and hence in a way, representation based on verbal discussions with the
auditors has also got documented. Auditors explained that this is mandatory to obtain written representation in
accordance with the requirements of SA 580. However, still some confusion remains regarding the date and
period covered by the written representation. You are required to advise about the date of, and period covered
by written representation in view of SA 580.
Solution
As per SA 580, “Written Representations”, as written representations are necessary audit evidence, the auditor’s
opinion cannot be expressed, and the auditor’s report cannot be dated, before the date of the written
representations. Furthermore, because the auditor is concerned with events occurring up to the date of the
auditor’s report that may require adjustment to or disclosure in the financial statements, the written
representations are dated as near as practicable to, but not after, the date of the auditor’s report on the financial
statements.
In some circumstances it may be appropriate for the auditor to obtain a written representation about a specific
assertion in the financial statements during the course of the audit. Where this is the case, it may be necessary to
request an updated written representation.
The written representations are for all periods referred to in the auditor’s report because management needs to
reaffirm that the written representations it previously made with respect to the prior periods remain appropriate.
The auditor and management may agree to a form of written representation that updates written representations
relating to the prior periods by addressing whether there are any changes to such written representations and, if
so, what they are.
Situations may arise where current management were not present during all periods referred to in the auditor’s
report. Such persons may assert that they are not in a position to provide some or all of the written representations
because they were not in place during the period. This fact, however, does not diminish such persons’
responsibilities for the financial statements as a whole. Accordingly, the requirement for the auditor to request from
them written representations that cover the whole of the relevant period(s) still applies.
Q2. CA N is carrying out an audit of restated financial statements of BQR Limited for past 3 financial years i.e. 2023-
24, 2022-23 and 2021-22 for onward submission to SEBI pursuant to their upcoming IPO (Initial Public Offer). CA
N is planning to issue an Audit Report on 5th August, 2024 covering these restated financial statements. Before
issuing the audit report, CA N requested Management Representation Letter from the management of the
Company for this assignment. The Management of the Company provided Management Representation Letter
dated 1st April, 2024 covering the period of financial year 2023-24 only as they were not in position to provide
for the financial year 2022-23 and 2021-22 because they were not in place during that period.

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How would CA N deal with the above situation as per relevant Standard on Auditing?
Solution
In the given situation, CA N is carrying out an audit of restated financial statements of BQR Limited for past 3 financial
years i.e., 2023-24, 2022-23 and 2021-22 so he requested Management Representation Letter from the
management of the Company for this assignment before issuance of the report. The management of the Company
provided the Management Representation Letter only for the financial year 2023 -24 as they were not in place
during that period.
As per SA 580, “Written Representations”, as written representations are necessary audit evidence, the auditor’s
opinion cannot be expressed, and the auditor’s report cannot be dated before the date of the written
representations.
As per SA 560, “Subsequent Events”, the auditor is concerned with events occurring up to the date of the auditor’s
report that may require adjustment to or disclosure in the financial statements, the written representations are
dated as near as practicable to, but not after, the date of the auditor’s report on the financial statements.
In some circumstances it may be appropriate for the auditor to obtain a written representation about a specific
assertion in the financial statements during the course of the audit. Where this is the case, it may be necessary to
request an updated written representation.
The written representations are for all periods referred to in the auditor’s report because management needs to
reaffirm that the written representations it previously made with respect to the prior periods remain appropriate.
The auditor and management may agree to a form of written representation that updates written representations
relating to the prior periods by addressing whether there are any changes to such written representations and, if
so, what they are.
Situations may arise where current management were not present during all periods referred to in the auditor’s
report. Such persons may assert that they are not in a position to provide some or all the written representations
because they were not in place during the period. This fact, however, does not diminish such persons’
responsibilities for the financial statements as a whole.
Accordingly, the requirement for the auditor to request from them written representations that cover the whole of
the relevant period(s) still applies. Therefore, as per the above requirement of SA 580 CA N should take written
representation letter from management of BQR Limited for the financial year 2022-23 and 2021-22 also.
In case the management of BQR Limited does not provide written representation as requested, the auditor shall
discuss with the management, re-evaluate the integrity of management, and take appropriate actions including the
impact on the audit report as per SA 705

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Additional Question
Q3. Mokshda & Co is the statutory auditor of Get My Trip Ltd. The company is in the business of tours and travels.
Annual turnover of the company is INR 2765 crore and profits are INR 285 crore. During the planning meeting of
the management and the auditors, it was discussed that the management needs to provide a written
representation letter to the auditors for the preparation of the financial statements and for the completeness of
the information provided to the auditor. At the time of closure of the audit, there has been some confusion about
the requirements of the written representation letter. Management argued that representation need not be
written, it can also be verbal which has been provided to the audit team during the course of their audit. Auditors
have completed their documentation and hence in a way, representation based on verbal discussions with the
auditors has also got documented. Auditors explained that this is mandatory to obtain written representation in
accordance with the requirements of SA 580. However, still, some confusion remains regarding the date and
period covered by the written representation. You are required to advise about the date of and period covered
by written representation in view of SA 580. (MTP March 21, RTP May’19)
Solution
As per SA 580, “Written Representations,” as written representations are necessary audit evidence, the auditor’s
opinion cannot be expressed, and the auditor’s report cannot be dated, before the date of the written
representations. Furthermore, because the auditor is concerned with events occurring up to the date of the
auditor’s report that may require adjustment to or disclosure in the financial statements, the written
representations are dated as near as practicable to, but not after, the date of the auditor’s report on the financial
statements. In some circumstances, it may be appropriate for the auditor to obtain a written representation about
a specific assertion in the financial statements during the course of the audit. Where this is the case, it may be
necessary to request an updated written representation.
The written representations are for all periods referred to in the auditor’s report because management needs to
reaffirm that the written representations it previously made with respect to the prior periods remain appropriate.
The auditor and management may agree to a form of written representation that updates written representations
relating to the prior periods by addressing whether there are any changes to such written representations and, if
so, what they are.
Situations may arise where current management were not present during all periods referred to in the auditor’s
report. Such persons may assert that they are not in a position to provide some or all of the written representations
because they were not in place during the period. This fact, however, does not diminish such persons’
responsibilities for the financial statements as a whole.
Accordingly, the requirement for the auditor to request from them written representations that cover the whole of
the relevant period(s) still applies.
Q4. Udit & Co. is the statutory auditor of Fun Journey Ltd., a company engaged in the tours and travel business. The
company has an annual turnover of 1,200 crores and profits of 150 crores. While planning, the auditors discussed
the requirement for a written representation letter from management for confirming that:
(i) The auditor is provided with all relevant information & access as agreed in the terms of audit engagement; and
(ii) All transactions have been recorded and are reflected in the financial statements.
As the audit was near to completion, the auditor disagreed with the management on one of the matters including
the need for a written representation, contending that verbal confirmations given during the audit should be
sufficient. Thus, a separate written representation is not required. Udit & Co., however, explained that under SA

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580, obtaining a formal written statement from management is mandatory. Fun Journey Ltd. refuses to provide
a written representation letter, despite the auditor’s several requests.
(a) Whether the contention of the auditor for seeking a written representation letter is justified?
(b) What should be the form of such written representation?
(c) How should the auditor proceed if management refuses to provide the written representation? (MTP May’25)
Solution
(a) As per SA 580, “Written Representations,” the auditor shall request management to provide a written
representation that it has fulfilled its responsibility for the preparation of the financial statements in accordance
with the applicable financial reporting framework, including where relevant their fair presentation, as set out in
the terms of the audit engagement.
Further, the auditor shall request management to provide a written representation that:
(i) It has provided the auditor with all relevant information and access as agreed in the terms of the audit
engagement.
(ii) All transactions have been recorded and are reflected in the financial statements.
In the given case, Fun Journey Ltd. refuses to provide a written representation letter, despite the auditor’s
several requests. Thus, in view of the above, the contention of the auditor is correct.
(b) The written representations as per SA 580 shall be in the form of a representation letter addressed to the auditor.
If law or regulation requires management to make written public statements about its responsibilities, and the
auditor determines that such statements provide some or all of the representations required, the relevant
matters covered by such statements need not be included in the representation letter.
(c) As per SA 580, if management does not provide one or more of the requested written representations, the
auditor shall:
(i) Discuss the matter with management;
(ii) Re-evaluate the integrity of management and evaluate the effect that this may have on the reliability of
representations (oral or written) and audit evidence in general; and
(iii) Take appropriate actions, including determining the possible effect on the opinion in the auditor’s report
in accordance with SA 705 (Revised).
Furthermore, the auditor shall disclaim an opinion on the financial statements in accordance with SA 705
(Revised) if the auditor concludes that there is sufficient doubt about the integrity of management such that the
written representations required are not reliable or if management does not provide the written representations
required.
Thus, refusal to provide a written representation could impact the auditor’s ability to obtain sufficient
appropriate audit evidence, potentially leading to a modified audit report.

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SM & Additional Questions

Q1. CA Sourabh, an engagement partner, is conducting statutory audit of BBI Bank for SBT & Associates. The bank has
1034 branches spread all over the country which are audited by branch auditors. In respect of one large branch
audited by a branch auditor, there were errors in NPA classification of many advances which were not pointed
out by branch auditor in his report through memorandum of changes and NIL memorandum of changes was
reported electronically. During overall review of financial statements of bank by statutory auditor, the above said
errors did not come into light. The statutory auditor had also called soft copies of internal inspection report and
concurrent audit reports of above branch as part of overall review procedures. However, these reports did not
point towards any irregularities in such accounts. Would the statutory auditor of bank be liable for above lapses?
What precautions have to be taken by him while expressing opinion considering possibilities of such situations?

Solution

SA 600 states that the principal auditor would not be responsible in respect of the work entrusted to the other
auditors, except in circumstances which should have aroused his suspicion about the reliability of the work
performed by the other auditors. When the principal auditor has to base his opinion on the financial information of
the entity as a whole, relying upon the statements and reports of the other auditors, his report should state clearly
the division of responsibility for the financial information of the entity by indicating the extent to which the financial
information of components audited by the other auditors have been included in the financial information of the
entity, e.g., the number of divisions/branches/subsidiaries or other components audited by other auditors.

In the given situation, nothing has come to light of the statutory auditor which would arouse his suspicion about the
reliability of work performed by the branch auditor. Therefore, he would not be responsible for work performed by
the branch auditor. Further, it should be clearly stated in the report that 1034 branches of the bank have been
audited by branch auditors.

Q2. Seeta Ltd is the Subsidiary Company of Geeta Ltd. Ram & Associates has been appointed as auditor of Geeta Ltd.
for the financial year 2019-20 and Hanuman & Associates has been appointed as auditor of Seeta Ltd. for the year
2019-20. Explain the role of Ram & Associates and Hanuman & Associates as auditors of the parent company and
subsidiary company respectively. (MTP March ’23, MTP Oct 20)

Solution

Role of Auditor in case of Parent Company and Subsidiary Company: As per SA 600 “Using the Work of Another
Auditor”, there should be sufficient liaison between the principal auditor (hereinafter referred as auditor of Parent
Company) and the other auditor (hereinafter referred as auditor of Subsidiary Company).

Role of Principal Auditor (Ram & Associates - Auditor of Parent Company):

(i) It is necessary to issue written communication(s) as a principal auditor to the other auditor.
(ii) The principal auditor should advise the other auditor of any matters that come to his attention that he thinks
may have an important bearing on the other auditor’s work.
(iii) When considered necessary by him, the principal auditor may require the other auditor to answer a detailed
questionnaire regarding matters on which the principal auditor requires information for discharging his duties.

Role of Other Auditor (Hanuman & Associates - Auditor of Subsidiary Company):

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(i) The other auditor, knowing the context in which his work is to be used by the principal auditor, should co-ordinate
with the principal auditor. For example, by bringing to the principal auditor’s immediate attention to any
significant findings requiring to be dealt with at entity level, adhering to the time-table for audit of the
component, etc.
(ii) He should ensure compliance with the relevant statutory requirements.
(iii) The other auditor should respond to the questionnaire sent by Principal Auditor on a timely basis.

Q3. PQ Limited, a listed entity, headquartered in Mumbai and is having 15 branches all over India. The Company is in
the business of buying paddy grown by farmers directly and processing to produce final products for selling in
domestic as well as international markets. PQ Limited appointed four firms of Chartered Accountants for audit of
its head office and branches. Your firm is one of those firms. It was agreed that your firm will act as Principal
auditor. 'What factors will be considered by you while accepting the position of Principal auditor? (PYP July 21)

Solution

Factors to be considered while accepting the position of Principal Auditor -

SA 600 – Using the Work of Another Auditor: While accepting the position of Principal Auditor, the auditor should
consider whether the auditor's own participation is sufficient to be able to act as the principal auditor.

For this purpose, the auditor would consider:

(a) the materiality of the portion of the financial information which the principal auditor audits;
(b) the principal auditor's degree of knowledge regarding the business of the components;
(c) the risk of material misstatements in the financial information of the components audited by other auditor; and
(d) the performance of additional procedures as set out in this SA regarding the components audited by other
auditor resulting in the principal auditor having significant participation in such audit.

Q4. CA H was appointed as a Statutory Auditor of MNL Limited, a listed company, which has three subsidiaries namely
M Ltd., N Ltd., L Ltd. and also 15 branches across India. Auditors are duly appointed for the subsidiaries and
branches as well. With regard to the determination of materiality during the audit of consolidated financial
statements, what should be the considerations of CA H?

How he should deal in his report if there are observations (for instance modification and/or emphasis of matter
in accordance with SA 705/706) made by component auditors? (PYP May ‘22)

Solution

CA. H should consider the requirement of SA 600, “Using the Work of Another Auditor”, if he decides to use the
work of another auditor in relation to the audit of consolidated financial statements and he should comply with the
requirements of SA 600.
In carrying out the audit of the standalone financial statements, the computation of materiality for the purpose of
issuing an opinion on the standalone financial statements of each component would be done component-wise on a
standalone basis.

However, with regard to determination of materiality during the audit of consolidated financial statements (CFS),
the auditor should consider the following:
(i) The auditor is required to compute the materiality for the group as a whole. This materiality should be used to
assess the appropriateness of the consolidation adjustments (i.e. permanent consolidation adjustments and
current period consolidation adjustments) that are made by the management in the preparation of CFS.

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(ii) The parent auditor can also use the materiality computed on the group level to determine whether the
component's financial statements are material to the group to determine whether they should scope in
additional components, and consider using the work of other auditors as applicable.

(iii) The principal auditor also computes materiality for each component and communicates to the component
auditor, if he believes is required for true and fair view on CFS.

However, while considering the observations (for instance modification and/or emphasis of matter in accordance
with SA 705/706) of the component auditor in his report on the standalone financial statements, the principles of
SA 600 needs to be considered i.e. the parent auditor should comply with the requirements of SA 600, “Using the
Work of Another Auditor”.

Q5. B is the Principal Auditor of ABC Co. Ltd., with 8 branches audited by 8 Branch Auditors. B wanted to ensure that
the works of Branch Auditors were adequate for the purpose of his audit. Hence he insisted on Branch Auditors
to get familiar with a check list he prepared for branches and, besides, required them to share the working papers
compiled by them for his review and return. Is Principal Auditor within his right in asking for such sharing of
working papers? (PYP May ’18)

Solution

Using the Work of Another Auditor: When the accounts of the branch are audited by a person other than the
company’s auditor, there is a need for a clear understanding of the role of such auditor and the company’s auditor
in relation to the audit of the accounts of the branch and the audit of the company as a whole; also, there is great
necessity for a proper rapport between these two auditors for the purpose of an effective audit. In recognition of
these needs, the Council of the Institute of Chartered Accountants of India has dealt with these issues in SA 600,
“Using the Work of Another Auditor”.

It makes clear that in certain situations, the statute governing the entity may confer a right on the principal auditor
to visit a component and examine the books of account and other records of the said component, if he thinks it
necessary to do so. Where another auditor has been appointed for the component, the principal auditor would
normally be entitled to rely upon the work of such auditor unless there are special circumstances to make it essential
for him to visit the component and/or to examine the books of account and other records of the said component.

Further, it requires that the principal auditor should perform procedures to obtain sufficient appropriate audit
evidence, that the work of the other auditor is adequate for the principal auditor's purposes, in the context of the
specific assignment. When using the work of another auditor, the principal auditor should ordinarily perform the
following procedures:

• Advise the other auditor of the use that is to be made of the other auditor's work and report and make sufficient
arrangements for coordination of their efforts at the planning stage of the audit. The principal auditor would
inform the other auditor of matters such as areas requiring special consideration, procedures for the
identification of inter-component transactions that may require disclosure, and the timetable for completion
of the audit.
• Advise the other auditor of the significant accounting, auditing, and reporting requirements and obtain
representation as to compliance with them.

The principal auditor might discuss with the other auditor the audit procedures applied or review a written summary
of the other auditor’s procedures and findings, which may be in the form of a completed questionnaire or checklist.

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The principal auditor may also wish to visit the other auditor. The nature, timing, and extent of procedures will
depend on the circumstances of the engagement and the principal auditor's knowledge of the professional
competence of the other auditor.

This knowledge may have been enhanced from the review of the previous audit work of the other auditor. Further,
SA 230 issued by ICAI on Audit Documentation, and “Standard on Quality Control (SQC) 1, “Quality Control for Firms
that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services
Engagements”, issued by the Institute, provides that, unless otherwise specified by law or regulation, audit
documentation is the property of the auditor. He may at his discretion, make portions of, or extracts from, audit
documentation available to clients, provided such disclosure does not undermine the validity of the work performed,
or, in the case of assurance engagements, the independence of the auditor or of his personnel.

In the light of the aforesaid, the principal auditor was not within his right for asking for such sharing of working
papers. It depends upon the discretion of the auditor.

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SM & Additional Questions

Q1. CA Keshavraj is conducting statutory audit of a listed company “Live with Nature Limited”. The company is engaged
in producing environment-friendly niche products for new-born babies. There is also a well-functioning internal
audit department in the company. On perusal of internal audit reports, he finds that not only verification of
inventories was attended by internal auditor at regular intervals during the year, workings were also made in
respect of inventory valuation as at year end. He has also attended inventory count at end of financial year and
no prima facie adverse inferences were drawn by him. However, ongoing through inventory reports, he gathers
that inventories are being held for considerably long period before being sold. The internal audit reports have not
taken this aspect into consideration. Should he choose to rely upon inventory valuation work performed by
internal auditor?

Solution

For a particular account balance, class of transaction, or disclosure, the higher the assessed risk of material
misstatement at the assertion level, the greater the judgment required in planning and performing audit procedures
and evaluating the results. In such cases, the external auditor must perform more procedures directly and rely less
on the internal audit function to obtain sufficient appropriate audit evidence. Furthermore, as outlined in SA 200, a
higher assessed risk of material misstatement necessitates more persuasive audit evidence, requiring the external
auditor to perform a greater portion of the work directly.

In this scenario, inventories are held for a significantly long period before being sold. Since the company deals in
niche products for newborn babies, there is a risk of inventory obsolescence due to changing customer preferences.
This presents a significant risk of material misstatement, demanding greater judgment from the statutory auditor in
planning and performing audit procedures.

Under such circumstances, the statutory auditor must carry out procedures directly, such as comparing the net
realizable value of products with costs to verify the completeness of provisions and recomputing provisions for
obsolete stock.

Therefore, in this situation, the statutory auditor should perform procedures directly in accordance with SA 610.

Q2. OPQ Ltd is in the software consultancy business. The company had large balance of accounts receivables in the
past years which have been assessed as area of high risk. For the year ended 31 March 2019, in respect of the
valuation of accounts receivable, the statutory auditor was assigned with the checking of accuracy of the aging of
the accounts receivables and provision based on ageing, to the internal auditor providing direct assistance to him.
Comment. (MTP Oct 19 & April 19, RTP May’19)

Solution

As per SA 610 Using the Work of Internal Auditor, the external auditor (Statutory Auditor) shall not use internal
auditors to provide direct assistance to perform procedures that:

a). Involve making significant judgments in the audit;

b). Relate to higher assessed risks of material misstatement where the judgment required in performing the relevant
audit procedures or evaluating the audit evidence gathered is more than limited;

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c). Relate to work with which the internal auditors have been involved and which has already been, or will be,
reported to management or those charged with governance by the internal audit function; or
d). Relate to decisions the external auditor makes in accordance with this SA regarding the internal audit function
and the use of its work or direct assistance.

In the given case where the valuation of accounts receivable is assessed as an area of higher risk, the statutory
auditor could assign the checking of the accuracy of the aging to an internal auditor providing direct assistance.
However, because the evaluation of the adequacy of the provision based on the aging would involve more than
limited judgment, it would not be appropriate to assign that latter procedure to an internal auditor providing direct
assistance.

Q3. ABC Ltd. is engaged in the business of trading and manufacturing of readymade garments. The company has large
balances of accounts receivables as on March 31, 2022, which has been assessed as the area of high risk in the
audit planning stage. For the year ended March 31, 2022, in respect of the valuation of accounts receivables, the
Statutory Auditor has assigned the checking of the accuracy of the ageing of the accounts receivables and
provision made towards doubtful receivables to the internal auditor.

Please advise the statutory auditor on the areas in which direct assistance from the internal auditor cannot be
taken. Also, comment in this scenario on whether the statutory auditor can take the internal auditor's assistance.
(PYP Nov 22)

Solution

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:
(i) Involve making significant judgments in the audit;
(ii) Relate to higher assessed risks of material misstatement where the judgment required in performing the relevant
audit procedures or evaluating the audit evidence gathered is more than limited;
(iii) Relate to work with which the internal auditors have been involved and which has already been, or will be,
reported to management or those charged with governance by the internal audit function; or
(iv) Relate to decisions the external auditor makes in accordance with this SA regarding the internal audit function
and the use of its work or direct assistance.

Therefore, the amount of judgment involved, and the risk of material misstatement are also relevant in determining
the work that may be assigned to internal auditors providing direct assistance.

In the given situation of ABC Ltd., in circumstances where the valuation of accounts receivable is assessed as an area
of higher risk, the external auditor could assign the checking of the accuracy of the aging to an internal auditor
providing direct assistance.

However, because the evaluation of the adequacy of the provision based on the aging would involve more than
limited judgment, it would not be appropriate to assign that latter procedure to an internal auditor providing direct
assistance.

Q4. 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 and handed over the report of such
verification to CA. Kishor, the statutory auditor of the Company, for his view and reporting. Can CA. Kishor rely
on such report? (MTP Oct 18)

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Solution

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 and relevant policies and procedures
support the objectivity of the internal auditors;
(b) The level of competence of the internal audit function; and
(c) Whether the internal audit function applies a systematic and 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 and relevant policies and 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 and disciplined approach, including quality control.

In the instant case, CA. Kishor should ascertain the internal auditor’s scope of verification, area of coverage, and
method of verification. He should review the report on physical verification, taking into consideration these factors.
If possible, he should also test-check a few items and observe the procedures performed by the internal auditors.

If the statutory auditor is satisfied with 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 an opinion
on the financial statements remains with the statutory auditor.

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SM Questions
Q1. While doing audit, Ram, the Auditor requires reports from experts for the purpose of Audit evidence. What types
of reports/opinions he can obtain and to what extent he can rely upon the same?

Solution

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, and statements of an expert.

While doing the audit, Ram, the auditor, can obtain the following types of reports, opinions, or statements of an
expert for the purpose of audit evidence:

(i) The valuation of complex financial instruments, land and buildings, plant and machinery, jewelry, works of art,
antiques, intangible assets, assets acquired and liabilities assumed in business combinations, and 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 and gas reserves.
(iv) The valuation of environmental liabilities and site clean-up costs.
(v) The interpretation of contracts, laws, and regulations.
(vi) 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 and reasonableness of that expert’s findings or conclusions and their consistency with
other audit evidence; if that expert’s work involves the use of significant assumptions and methods, the relevance
and reasonableness of those assumptions and methods in the circumstances; and if that expert’s work involves the
use of source data that is significant to his work, the relevance, completeness, and accuracy of that source data.

If the auditor determines that the work of the auditor’s expert is not adequate for the auditor’s purposes, he shall
agree with that expert on the nature and extent of further work to be performed by that expert or perform further
audit procedures appropriate to the circumstances.

Q2. KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y and Mr. Z as joint auditors to conduct audit for
the financial year 2023-24. For the valuation of gratuity scheme of the company, Mr. X, Mr. Y and 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 report shall be considered in audit report
due to majority of votes. Now, Mr. Z is in a dilemma. Explain the responsibility of auditors, in case, report made
by Mr. Y’s actuary, later, was found faulty.

Solution

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, and that
responsibility is not reduced by the auditor’s use of the work of an auditor’s expert.

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The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes, including the
relevance and reasonableness of that expert’s findings or conclusions and their consistency with other audit
evidence as per SA 500. Further, in view of SA 620, if the expert’s work involves the use of significant assumptions
and methods, then the relevance and reasonableness of those assumptions and methods must be ensured by the
auditor, and if the expert’s work involves the use of source data that is significant to that expert’s work, the
relevance, completeness, and accuracy of that source data in the circumstances must be verified by the auditor.

In the instant case, Mr. X, Mr. Y, and Mr. Z, jointly appointed as auditors of KRP Ltd., referred their own known
actuaries for the valuation of the 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 a situation, it was the duty of Mr. X, Mr. Y, and Mr. Z, before using the gratuity valuation report of the
actuary, to ensure the relevance and reasonableness of assumptions and methods used. They were also required to
examine the relevance, completeness, and accuracy of source data used for such a report before expressing their
opinion.

Mr. X and Mr. Y will be held responsible for gross negligence and for using such a faulty report without examining
the adequacy of the expert actuary’s work, whereas Mr. Z will not be held liable for the same due to the separate
opinion expressed by him.

Q3. 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. The auditor and 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.

Solution

As per SA 620, Using the Work of an Auditor’s Expert, the nature, scope, and objectives of the auditor’s expert’s
work may vary considerably with the circumstances, as may the respective roles and responsibilities of the auditor
and the auditor’s expert, and the nature, timing, and extent of communication between the auditor and the
auditor’s expert. It is therefore required that these matters are agreed upon between the auditor and the auditor’s
expert.

In certain situations, the need for a detailed agreement in writing is required, such as:

• 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 and its significance in the context of the audit.

In the given case, considering the complexity involved in the valuation and volume of derivatives, and also due to
the fact that the auditor and auditor’s expert were new to each other, the auditor should have signed a formal
agreement/engagement letter with the auditor’s expert in respect of the work assigned to him.

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Additional Questions
Q4. Mr. Shreyansh, while performing the audit of Red Rock & Silver Sand Limited, which was involved in phosphorus
mining, decided to appoint an auditor’s expert for the valuation of environmental liabilities and site clean-up
costs. Red Rock & Silver Sand Limited re-appointed Mr. Sheetal as an independent expert for this engagement.
For the last five years, management has been reappointing Mr. Sheetal.

Mr. Sheetal calculated the environmental liabilities pertaining to completed mining sites and the sites which will
be discarded in the near future and a provision for clean-up costs. This provision was accepted by management.
Mr. Shreyansh, after performing the inquiries with management, was of the opinion that the objectivity of the
independent expert cannot be questioned just because he was appointed by management as their expert. Hence,
there is no need to raise a question on the objectivity of Mr. Sheetal or on his work performed for the company.
However, the audit partner was of the opinion that the audit team needs to evaluate the objectivity of an expert
engaged by the entity, irrespective of the fact that he was appointed as an independent expert.

Kindly guide the audit partner and Mr. Shreyansh with respect to requirements pertaining to evaluating the
objectivity of the management expert. (RTP Nov ’23)

Solution

As per SA 500 “Audit Evidence”, when information to be used as audit evidence has been prepared using the work
of a management’s expert, the auditor shall, to the extent necessary, have regard to the significance of that expert’s
work for the auditor’s purposes and evaluate the competence, capabilities, and objectivity of that expert.

A broad range of circumstances may threaten objectivity, for example, self-interest threats, advocacy threats,
familiarity threats, self-review threats, and intimidation threats. Safeguards may reduce such threats and may be
created either by external structures (for example, the management’s expert’s profession, legislation, or regulation)
or by the management’s expert’s work environment (for example, quality control policies and procedures).

Although safeguards cannot eliminate all threats to a management expert’s objectivity, threats such as intimidation
threats may be of less significance to an expert engaged by the entity than to an expert employed by the entity, and
the effectiveness of safeguards such as quality control policies and procedures may be greater. Because the threat
to objectivity created by being an employee of the entity will always be present, an expert employed by the entity
cannot ordinarily be regarded as being more likely to be objective than other employees of the entity.

When evaluating the objectivity of an expert engaged by the entity, it may be relevant to discuss with management
and that expert any interests and relationships that may create threats to the expert’s objectivity.

Objectivity and any applicable safeguards, including any professional requirements that apply to the expert, should
be evaluated to determine whether the safeguards are adequate. Interests and relationships creating threats may
include:

• Financial interests.
• Business and personal relationships.
• Provision of other services.

In the current case, Red Rock & Silver Sand Limited re-appointed Mr. Sheetal for this engagement as an independent
expert. The audit team was of the view that the objectivity of the independent expert cannot be questioned just
because he was appointed by management as their expert. However, the audit partner had a contrary view.

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Hence, the audit team should evaluate the objectivity of an expert engaged by the entity, as the threat to objectivity
created by being an employee of the entity will always be present. An expert appointed by the entity cannot
ordinarily be regarded as being more likely to be objective than other employees of the entity. As a result, the audit
partner is correct in his view.

Q5. HAM Ltd. is engaged in the business of manufacturing of medicines. The manufacturing process requires raw
materials such as hydrochloric acid, caustic soda and other chemicals for the manufacturing of various drugs. The
Company has maintained large stock of raw materials of all types of chemicals being used. The nature of raw
material is such that its physical verification requires the involvement of an expert. Management hired their
expert for the stock taking and auditors also involved their expert for the same purpose.

The auditor observed that the work of the auditor's expert was not adequate for the auditor's purposes and he
could not resolve the matter through additional audit procedures which included further work performed by both
the auditor's expert and the auditor.

Based on above, the auditor knows that it would be right to express a modified opinion in the auditor's report
because he has not obtained sufficient appropriate audit evidence. But he was reluctant in doing so and issued a
clean audit report and included the name of the expert in his report to reduce his responsibility for the audit
opinion expressed.
Comment with respect to relevant Standard of Auditing relating to the action of the auditor of issuing clean audit
report. (PYP May ’23, MTP April 19)

Solution

As per SA 620, “Using the work of an Auditor’s Expert”, if the auditor concludes that the work of the auditor’s expert
is not adequate for the auditor’s purposes and the auditor cannot resolve the matter through the additional audit
procedures, which may involve further work being performed by both the expert and the auditor, or include
employing or engaging another expert, it may be necessary to express a modified opinion in the auditor’s report in
accordance with SA 705 because the auditor has not obtained sufficient appropriate audit evidence.

In addition, the auditor shall not refer to the work of an auditor’s expert in an auditor’s report containing an
unmodified opinion unless required by law or regulation to do so. If such reference is required by law or regulation,
the auditor shall indicate in the auditor’s report that the reference does not reduce the auditor’s responsibility for
the audit opinion.

If the auditor makes reference to the work of an auditor’s expert in the auditor’s report because such reference is
relevant to an understanding of a modification to the auditor’s opinion, the auditor shall indicate in the auditor’s
report that such reference does not reduce the auditor’s responsibility for that opinion. In such circumstances, the
auditor may need the permission of the auditor’s expert before making such a reference.

In the given case, the auditor cannot reduce his responsibility by referring the name of auditor’s expert and thereby
issuing a clean report. The auditor should have issued a modified report and could have given reference to the work
of an auditor’s expert in that report if such reference was relevant to understanding of a modification to the auditor’s
opinion but even in that case the auditor should have indicated in his report that such reference of an auditor’s
expert does not reduce his responsibility for that opinion.

Q6. CA Dabu has been appointed as an auditor of M/s MAP Technocraft Ltd. to conduct statutory audit. While
conducting audit, he came across some difficulties which the management could not explain to him properly and,

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therefore, he decided to take services of Mr. Jay, an engineering consultant. Mr. Jay performed his work and
submitted details to CA Dabu. State the specific procedure which CA Dabu should follow to evaluate the adequacy
of work performed by Mr. Jay. (PYP May ‘19)

Solution

Evaluating the Adequacy of the Auditor’s Expert’s Work: As per SA 620 on “Using the Work of an Auditor’s Expert,”
specific procedures to evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes may include:

(i) Inquiries of the auditor’s expert.

(ii) Reviewing the auditor’s expert’s working papers and reports.
(iii) Corroborative procedures, such as:
• Observing the auditor’s expert’s work;
• Examining published data, such as statistical reports from reputable, authoritative sources;
• Confirming relevant matters with third parties;
• Performing detailed analytical procedures; and
• Re-performing calculations.
(iv) Discussion with another expert with relevant expertise when, for example, the findings or conclusions of the
auditor’s expert are not consistent with other audit evidence.
(v) Discussing the auditor’s expert’s report with management.

Therefore, as per SA 620 on “Using 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:

(i) The relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other audit
evidence;
(ii) If that expert’s work involves use of significant assumptions and methods, the relevance and reasonableness of
those assumptions and methods in the circumstances; and
(iii) If that expert’s work involves the use of source data that is significant to that expert’s work, the relevance,
completeness, and accuracy of that source data.
If the auditor determines that the work of the auditor’s expert is not adequate for the auditor’s purposes, the auditor
shall:

(i) Agree with that expert on the nature and extent of further work to be performed by that expert; or
(ii) Perform further audit procedures appropriate to the circumstances.

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SM & Additional Questions

Q1. CA Sameer is the statutory auditor of Tram Fram Ltd. for the FY 2023-24. 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 2023-24. Explain how CA
Sameer will deal with the above situation in his auditor’s report (draft the relevant portion of the auditor’s
report).

Solution

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, 2024. 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.

Q2. The auditors of a listed company have affirmed in their audit report communication of significant audit findings
including significant deficiencies in internal control of the company identified to those charged with governance.
Where are such matters included in the audit report of a listed company?
Also dwell upon the importance of such communication.

Solution

Such matters are in nature of auditor’s responsibilities and are stated in “The Auditor’s Responsibilities for the Audit
of the Financial Statements” section of the auditor’s report in accordance with SA 700. Communication of significant
audit findings and deficiencies identified in internal control to those charged with governance is one of important
responsibilities of auditor.
Such communication assists those charged with governance in fulfilling their responsibility to oversee the financial
reporting process and in fulfilling their oversight responsibilities.

Q3. CA S has been appointed as Statutory Auditor of SRT Ltd. for the financial year 2022-2023. The Company while
preparing financial statements for the year under audit prepared one additional profit and loss account that
disclosed specific items of expenditure and included the same as an appendix to the financial statements. CA. S
has not been able to understand this as the additional profit and loss account is not covered under the applicable
financial reporting framework. Guide him as to how he should deal with this issue while reporting on the financial
statements of SRT Ltd. (MTP Sep ’23, RTP May ’23)

Solution

If supplementary information that is not required by the applicable financial reporting framework is presented with
the audited financial statements, the auditor shall evaluate whether, in the auditor’s professional judgment,
supplementary information is nevertheless an integral part of the financial statements due to its nature or how it is

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presented. When it is an integral part of the financial statements, the supplementary information shall be covered
by the auditor’s opinion.

If supplementary information that is not required by the applicable financial reporting framework is not considered
an integral part of the audited financial statements, the auditor shall evaluate whether such supplementary
information is presented in a way that sufficiently and clearly differentiates it from the audited financial statements.
If this is not the case, then the auditor shall ask management to change how the unaudited supplementary
information is presented.

If management refuses to do so, the auditor shall identify the unaudited supplementary information and e xplain in
the auditor’s report that such supplementary information has not been audited.

When an additional profit and loss account that discloses specific items of expenditure is disclosed as a separate
schedule, included as an appendix to the financial statements, the auditor may consider this to be supplementary
information that can be clearly differentiated from the financial statements. Thus, an additional profit and loss
account is not considered an integral part of the audited financial statements, and the auditor shall evaluate that
supplementary information is presented in a way that sufficiently and clearly differentiates it from the audited
financial statements.

Q4. KPI Ltd. is a company on which International Standards on Auditing are applicable along with Standard on Auditing
issued by the ICAI. The company appointed new auditors for the audit of the financial statements year ended 31
March 2019 after doing all appointment formalities. Therefore, the auditor’s report referred the International
Standard on Auditing in addition to the Standard on Auditing issued by the ICAI.
As an expert, you are required to advise the auditor regarding auditor’s report for audits conducted in accordance
with both the Standards. (RTP Nov 19)

Solution

Auditor’s Report for Audits Conducted in Accordance with Both Standards on Auditing Issued by ICAI and
International Standards on Auditing or Auditing Standards of Any Other Jurisdiction:

As per SA 700, “Forming an Opinion and Reporting on Financial Statements,” 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:

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; and

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.

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However, reference to “law or regulation” in the above paragraph shall be read as a 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 and 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.

Q5. XYZ Limited, involved in the hospitality business, appointed Charan & Karan Associates as their statutory auditor
for FY 2022-23. Management of XYZ Limited, while drawing up the financial statement for the said period, decided
to add the following statement after the Statement of Cash Flow as supplementary information to be presented
with financial statements. No specific mentions or labels were added to this statement to present that this is
supplementary information.

Statement of Average Revenue Per Booking (ARPB) and Comparative

(in ` or otherwise stated)

Total Bookings during FY

- FY 2021-22 36500
- FY 2022-23 39000
Average Revenue per Booking
- FY 2021-22 (Refer Note 28 Revenue from Operations) 3500
- FY 2022-23 (Refer Note 28 Revenue from Operations) 4200
Bookings Ratio (Organic source by Inorganic source)
- FY 2021-22 1:2
- FY 2022-23 1:1.65
Kindly guide the audit team regarding the requirement of SA 700 with respect to the Supplementary Information
Presented with the Financial Statements. (RTP Nov ’23)

Solution

As per SA 700, “Forming an Opinion and Reporting on Financial Statements,” if supplementary information that is
not required by the applicable financial reporting framework is presented with the audited financial statements, the
auditor shall evaluate whether, in the auditor’s professional judgment, supplementary information is nevertheless
an integral part of the financial statements due to its nature or how it is presented. When it is an integral part of the
financial statements, the supplementary information shall be covered by the auditor’s opinion.

If supplementary information that is not required by the applicable financial reporting framework is not considered
an integral part of the audited financial statements, the auditor shall evaluate whether such supplementary
information is presented in a way that sufficiently and clearly differentiates it from the audited financial statements.
If this is not the case, then the auditor shall ask management to change how the unaudited supplementary
information is presented. If management refuses to do so, the auditor shall identify the unaudited supplementary
information and explain in the auditor’s report that such supplementary information has not been audited.

The auditor’s evaluation of whether unaudited supplementary information is presented in a manner that could be
construed as being covered by the auditor’s opinion includes, for example, where that information is presented in

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relation to the financial statements and any audited supplementary information and whether it is clearly labeled as
“unaudited.”

In the current case, the Statement of Average Revenue Per Booking (ARPB) and Comparative is unaudited
supplementary information that could be construed as being covered by the auditor’s opinion. Hence, the audit
team should evaluate whether such supplementary information is presented in a way that sufficiently and clearly
differentiates it from the audited financial statements.

If not, then the audit team can suggest management to change the presentation of unaudited supplementary
information by:

• Removing any cross-references from the financial statements to unaudited supplementary schedules or
unaudited notes so that the demarcation between the audited and unaudited information is sufficiently clear.
• Placing the unaudited supplementary information outside of the financial statements or, if that is not possible
in the circumstances, at a minimum placing the unaudited notes together at the end of the required notes to
the financial statements and clearly labeling them as unaudited. Unaudited notes that are intermingled with
audited notes can be misinterpreted as being audited.

If the management of XYZ Limited refuses to do so, the auditor shall identify the unaudited supplementary
information, i.e., Statement of ARPB and Comparative, and explain in the auditor’s report that such supplementary
information has not been audited.

Q6. The auditor’s inability to obtain sufficient appropriate audit evidence (also referred to as a limitation on the scope
of the audit) may arise from:

(i) Circumstances beyond the control of the entity;

(ii) Circumstances relating to the nature or timing of the auditor’s work; or
(iii) Limitations imposed by management.

Explain with the help of examples (RTP May 20)

Solution

The auditor’s inability to obtain sufficient appropriate audit evidence (also referred to as a limitation on the scope
of the audit) may arise from:

(i) Circumstances beyond the control of the entity;

(ii) Circumstances relating to the nature or timing of the auditor’s work; or
(iii) Limitations imposed by management.

An inability to perform a specific procedure does not constitute a limitation on the scope of the audit if the auditor
is able to obtain sufficient appropriate audit evidence by performing alternative procedures.

Limitations imposed by management may have other implications for the audit, such as for the auditor’s assessment
of fraud risks and consideration of engagement continuance.

Examples of circumstances beyond the control of the entity include when:

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• The entity’s accounting records have been destroyed.

• The accounting records of a significant component have been seized indefinitely by governmental authorities.

Examples of circumstances relating to the nature or timing of the auditor’s work include when:

• The entity is required to use the equity method of accounting for an associated entity, and the auditor is unable
to obtain sufficient appropriate audit evidence about the latter’s financial information to evaluate whether the
equity method has been appropriately applied.
• The timing of the auditor’s appointment is such that the auditor is unable to observe the counting of the
physical inventories.
• The auditor determines that performing substantive procedures alone is not sufficient, but the entity’s controls
are not effective.

Examples of an inability to obtain sufficient appropriate audit evidence arising from a limitation on the scope of the
audit imposed by management include when:

• Management prevents the auditor from observing the counting of the physical inventory.
• Management prevents the auditor from requesting external confirmation of specific account balances.

Q7. MN & Associates, Chartered Accountants, have been appointed as statutory auditors of Cotton Ltd. for the F.Y.
2020-2021. The company is into the business of yarn manufacturing. For this purpose, cotton ginning is also done
within the factory premises. Raw cotton is purchased from the local market and processed in-house.

The company received a notice from the State Government to deposit a market development fee for the last five
years to the tune of ₹10.00 crores. The company and all other organizations in the same business have not
deposited the market development fee, taking shelter under an old circular issued by the government. The trade
association met with the government officials to resolve the matter and agreed to deposit the same prospectively.
However, the matter relating to payment of the development fee for the last five years is pending before the
government as at the end of the financial year.

The company, however, disclosed the same in the notes to accounts as a contingent liability, without quantifying
the effect and proper explanation. If the liability is provided in the books of accounts, the entire reserves will be
wiped off. The auditor seeks your guidance as to how this disclosure affects them while forming an opinion on
the financial statements. (PYP July 21)

Solution

Forming an opinion and reporting on financial statements –

As per Ind AS 37, “Provisions, Contingent Liabilities and Contingent Assets”, an entity should disclose for each class
of contingent liability at the end of the reporting period a brief description of the nature of the contingent liability
and, where practicable:
(a) an estimate of its financial effect, measured in the standard;
(b) an indication of the uncertainties relating to the amount or timing of any outflow; and
(c) the possibility of any reimbursement.

SA 700 - Forming an opinion and reporting on financial statements:

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The auditor shall evaluate whether, in view of the requirements of the applicable financial reporting framework –

(i) The financial statements adequately disclose the significant accounting policies selected and applied;
(ii) The accounting policies selected and applied are consistent with the applicable financial reporting framework
and are appropriate;
(iii) The accounting estimates made by the management are reasonable;
(iv) The information presented in the financial statements is relevant, reliable, comparable, and understandable;
(v) The financial statements provide adequate disclosures to enable the intended users to understand the effect
of material transactions and events on the information conveyed in the financial statements.

If financial statements prepared in accordance with the requirements of a fair presentation framework do not
achieve fair presentation, the auditor shall discuss the matter with management and, depending on the
requirements of the applicable financial reporting framework and how the matter is resolved, shall determine
whether it is necessary to modify the opinion in the auditor’s report in accordance with SA 705. In the present case,
the auditor may consider modifying his opinion considering the financial effect of liability not disclosed pro perly.

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SM & Additional Questions

Q1. AKY Ltd. is a listed company engaged in the business of software and is one of the largest companies operating in
this sector in India. The company’s annual turnover is Rs. 40,000 crores with profits of Rs. 5,000 crores. Due to the
nature of the business and the size of the company, the operations of the company are spread out in India as well
as outside India. The company’s contracts with its various customers are quite complicated and different. During
the course of the audit, the audit team spends significant time on the audit of revenue – be it planning, execution,
or conclusion. This matter was also discussed with management at various stages of the audit. The efforts towards
the audit of revenue also involve significant involvement of senior members of the audit team, including the audit
partner. After the completion of the audit for the year ended 31 March 2019, the audit partner was discussing
significant matters with the management wherein they also communicated to the management that he plans to
include revenue recognition as a key audit matter in his audit report. The management did not agree with revenue
recognition to be shown as a key audit matter in the audit report. Comment (MTP Oct 19)

Solution

Determining Key Audit Matters: SA 701, “Communicating Key Audit Matters in the Independent Auditor’s Report”,
deals with the auditor’s responsibility to communicate key audit matters in the auditor’s report. It is intended to
address both the auditor’s judgment as to what to communicate in the auditor’s report and the form and content
of such communication.

The auditor shall determine, from the matters communicated with those charged with governance, those matters
that required significant auditor attention in performing the audit. In making this determination, the auditor shall
take into account the following:

a) Areas of higher assessed risk of material misstatement, or significant risks identified in accordance with SA 315
Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its
Environment.
b) Significant auditor judgments relating to areas in the financial statements that involved significant management
judgment, including accounting estimates that have been identified as having high estimation uncertainty.
c) The effect on the audit of significant events or transactions that occurred during the period.

The auditor shall determine which of the matters determined in accordance with the above were of most
significance in the audit of the financial statements of the current period and therefore are the key audit matters.
In the instant case, AKY Ltd., a listed company engaged in the business of software, has contracts with its various
customers that are quite complicated and different. Further, the audit team spends significant time on the audit of
revenue, and efforts towards the audit of revenue also involve significant involvement of senior members of the
audit team, including the audit partner during the audit. This matter was also discussed with management at various
stages. After the completion of the audit, the audit partner communicated with the management regarding the
inclusion of a paragraph on revenue recognition as a key audit matter in his audit report.

In view of SA 701, the assessment of the auditor is valid as the above matter qualifies to be a key audit matter in the
opinion of the auditor. Hence, it should be reported accordingly by the auditor in his audit report.

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Q2. “The auditor shall determine, from the matters communicated with those charged with governance, those matters
that required significant auditor attention in performing the audit. In making this determination, the auditor shall
take into account the key factors”. You are required to define key audit matters and briefly discuss the factors
determining the key audit matters. (MTP April’18)

Solution

Definition of Key Audit Matters: SA 701 “Communicating Key Audit Matters in the Independent Auditor’s Report”
defines Key Audit Matters as matters that, in the auditor’s professional judgment, were of most significance in the
audit of the financial statements of the current period. Key audit matters are selected from matters communicated
with those charged with governance.

Factors determining Key Audit Matters: As per SA 701, the auditor shall determine, from the matters communicated
with those charged with governance, those matters that required significant auditor attention in performing the
audit. In making this determination, the auditor shall take into account the following:

(i) Areas of higher assessed risk of material misstatement, or significant risks identified in accordance with SA 315
Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its
Environment.
(ii) Significant auditor judgments relating to areas in the financial statements that involved significant management
judgment, including accounting estimates that have been identified as having high estimation uncertainty.
(iii) The effect on the audit of significant events or transactions that occurred during the period.

Q3. While auditing the complete set of consolidated financial statements of Moksh Ltd., a listed company, using a fair
presentation framework, XYZ & Co., a Chartered Accountant firm, discovered that the consolidated financial
statements are materially misstated due to the non-consolidation of one of the subsidiary. The material
misstatement is deemed to be pervasive to the consolidated financial statements. The effects of the misstatement
on the consolidated financial statements could not be determined because it was not practicable to do so. Thus,
XYZ & Co. decided to provide an adverse opinion for the same and further determined that, there are no key audit
matters other than the matter to be described in the Basis for Adverse Opinion section. Comment whether XYZ
& Co. needs to report under SA 701 ‘Communicating Key Audit Matters in the Independent Auditor’s Report’?
(MTP Sep 22)

Solution

SA 700 establishes requirements and provides guidance on forming an opinion on the financial statements.
Communicating key audit matters is not a substitute for disclosures in the financial statements that the applicable
financial reporting framework requires management to make, or that are otherwise necessary to achieve fair
presentation. SA 705, “Modifications to the Opinion in the Independent Auditor’s Report,” addresses circumstances
in which the auditor concludes that there is a material misstatement relating to the appropriateness or adequacy of
disclosures in the financial statements.

When the auditor expresses a qualified or adverse opinion in accordance with SA 705, presenting the description of
a matter giving rise to a modified opinion in the Basis for Qualified (Adverse) Opinion section helps to promote
intended users’ understanding and to identify such circumstances when they occur. Separating the communication

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of this matter from other key audit matters described in the Key Audit Matters section, therefore, gives it the
appropriate prominence in the auditor’s report.

Further, when the auditor expresses a qualified or adverse opinion, communicating other key audit matters would
still be relevant to enhancing intended users’ understanding of the audit, and therefore the requirements to
determine key audit matters apply. However, as an adverse opinion is expressed in circumstances when the auditor
has concluded that misstatements, individually or in the aggregate, are both material and pervasive to the financial
statements depending on the significance of the matter(s) giving rise to an adverse opinion, the auditor may
determine that no other matters are key audit matters.

In the given situation, Moksh Ltd., a listed company, has not consolidated one of its subsidiaries. Further, the
Consolidated Financial Statements of Moksh Ltd. are materially misstated due to such non-consolidation. The
material misstatement is also deemed to be material and pervasive, and the effect of the failure to consolidate has
not been determined. In the given situation, it is appropriate to give an Adverse Opinion by XYZ & Co., a Chartered
Accountant Firm.

Since, in the given case, an Adverse Opinion is being expressed, XYZ & Co. can communicate the Key Audit Matter
in the following manner:
Key Audit Matters: Except for the matter described in the Basis for Adverse Opinion section, we have determined
that there are no other key audit matters to communicate in our report.

Q4. Mr. Hemant Ramsey was appointed as the engagement partner for conducting the audit of Kshetra Lap Ltd. for
F.Y. 2020-21, on behalf of Ramsey & Associates. Mr. Vishay Tyagi was appointed as the engagement quality
control reviewer by the firm for the said audit.
During F.Y. 2020-21, there was an implementation of an ERP system in a phased manner in Kshetra Lap Ltd., due
to which some of its business processes got automated. As a result of the implementation of such a system, there
was a significant effect on the auditor’s overall audit strategy. Mr. Hemant discussed the implementation of such
a system with Mr. Vishay and also told him that such a matter may be a key audit matter to be reported in the
audit report.
Mr. Vishay considered the significance of such a matter but, however, he was of the opinion that such a matter
did not appear to link with the matters disclosed in the financial statements and so there was no need to disclose
such a matter as a key audit matter.

Whether the contention of Mr. Vishay is proper with respect to the matters to be communicated as a key audit
matter? (RTP Nov ’21)

Solution

As per SA 701, ‘Communicating Key Audit Matters in the Independent Auditor’s Report,’ the auditor shall determine,
from the matters communicated with those charged with governance, those matters that required significant
auditor attention in performing the audit. In making this determination, the auditor shall take into account the
following:

(i) Areas of higher assessed risk of material misstatement, or significant risks identified in accordance with SA 315.

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(ii) Significant auditor judgments relating to areas in the financial statements that involved significant
management judgment, including accounting estimates that have been identified as having high estimation
uncertainty.
(iii) The effect on the audit of significant events or transactions that occurred during the period.

The auditor shall determine which of the aforesaid matters considered were of most significance in the audit of the
financial statements of the current period and therefore are the key audit matters.

These aforesaid considerations focus on the nature of matters communicated with those charged with governance.
Such matters are often linked to matters disclosed in the financial statements and are intended to reflect areas of
the audit of the financial statements that may be of particular interest to intended users.

The fact that these considerations are required is not intended to imply that matters related to them are always key
audit matters; rather, matters related to such specific considerations are key audit matters only if they are
determined to be of most significance in the audit.

In addition to matters that relate to the specific required considerations, there may be other matters communicated
with those charged with governance that required significant auditor attention and that therefore may be
determined to be key audit matters. Such matters may include, for example, matters relevant to the audit that was
performed that may not be required to be disclosed in the financial statements. For example, the implementation
of a new IT system (or significant changes to an existing IT system) during the period may be an area of significant
auditor attention, in particular if such a change had a significant effect on the auditor’s overall audit strategy or
related to a significant risk (e.g., changes to a system affecting revenue recognition).

In the given case, there was implementation of an ERP system in the company due to which some of its business
processes got automated and which had a significant effect on the auditor’s overall audit strategy during the period.

Accordingly, such a matter can be considered as a key audit matter if according to Mr. Hemant, such a matter
required significant attention that had affected his overall audit strategy.

Thus, the contention of Mr. Vishay is not proper as matters that do not link with the matters disclosed in the financial
statements can also be considered as a key audit matter if it required significant attention of the auditor which had
an impact on its audit.

Q5. What is the auditor’s responsibility to report a key audit matter for which there are no relevant disclosures in the
financial statements? (RTP May 22)

Solution

When communicating key audit matters, the fact that there are no disclosures in the financial statements related to
a matter determined to be a key audit matter does not relieve the auditor from the requirement to communicate
it. An auditor may determine a key audit matter related to the audit for which relevant disclosure requirements do
not exist in the applicable financial reporting framework.

For example, the implementation of a new IT system (or significant changes to an existing IT system) during the
period may be an area of significant auditor attention, in particular, if such a change had a significant effect on the
auditor’s overall audit strategy or related to significant risk (e.g., changes to a system affecting revenue recognition).

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Also, if an auditor determines that it is necessary to include information about the entity in order to effectively
describe a key audit matter that has not been disclosed by management and management does not agree to disclose
that information, the auditor should reconsider the adequacy of the disclosures in accordance with the applicable
financial reporting framework.

The auditor should communicate the matter as a key audit matter unless law or regulation precludes public
disclosure about the matter or in extremely rare circumstances, the auditor determines that the matter should not
be communicated in the auditor’s report because the adverse consequences of doing so would reasonably be
expected to outweigh the public interest benefits of such communication.

Q6. How does the inclusion of Emphasis of Matter (EOM) paragraphs in the Auditor's Report differ from the disclosure
of Key Audit Matters (KAM)? (RTP Nov ’23)

Solution

Relationship between Emphasis of Matter Paragraphs and Key Audit Matters in the Auditor’s Report

Key audit matters Emphasis of Matter paragraph

Those matters that, in the auditor’s professional A paragraph included in the auditor’s report that refers
judgment, were of most significance in the audit of the to a matter appropriately presented or disclosed in the
financial statements of the current period. Key audit financial statements that, in the auditor’s judgment,
matters are selected from matters communicated with is of such importance that it is fundamental to users’
those charged with governance. understanding of the financial statements. [SA 706]
Matters that are determined to be key audit matters in A widespread use of Emphasis of Matter paragraphs
accordance with SA 701 may also be, in the auditor’s may diminish the effectiveness of the auditor’s
judgment, fundamental to users’ understanding of the communication about such matters. Use of Emphasis
financial statements. In such cases, in communicating of Matter paragraphs is not a substitute for a
the matter as a key audit matter in accordance with SA description of individual key audit matters where SA
701, the auditor may wish to highlight or draw further 701 is applicable.
attention to its relative importance. There may be a matter that is not determined to be a
Communicating key audit matters provides additional key audit matter in accordance with SA 701 (i.e.,
information to intended users of the financial because it did not require significant auditor
statements to assist them in understanding those attention), but which, in the auditor’s judgment, is
matters that, in the auditor’s professional judgment, fundamental to users’ understanding of the financial
were of most significance in the audit and may also statements (e.g., a subsequent event). If the auditor
assist them in understanding the entity and areas of considers it necessary to draw users’ attention to such
significant management judgment in the audited a matter, the matter is included in an Emphasis of
financial statements. Matter paragraph in the auditor’s report in accordance
with this SA.
The communication of key audit matters in the The auditor may do so by presenting the matter more
auditor’s report may also provide intended users a prominently than other matters in the Key Audit
basis to further engage with management and those Matters section (e.g., as the first matter) or by
charged with governance about certain matters including additional information in the description of
the key audit matter to indicate the importance of the

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relating to the entity, the audited financial statements, matter to users’ understanding of the financial
or the audit that was performed. statements.

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SM Questions
Q1. XYZ Ltd. is a company engaged in the manufacture of cranes. CA Sudhir is the statutory auditor of the company
for the FY 2023-24. The company has taken long-term funding for fixed capital requirements and 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, and the company is unable to re- negotiate or obtain the replacement
financing. As such the company may be unable to realize its assets and 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 and the total financing arrangements; however, the financial statements do not
include discussion on the impact or the availability of refinancing. Thus, the financial statements (and notes
thereto) do not fully disclose this fact. What kind of opinion should CA Sudhir issue in case of XYZ Ltd.?

Solution

In the present case, XYZ Ltd. is unable to re- negotiate or obtain the replacement financing for its long term and
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 and therefore, XYZ Ltd. may be unable to
realize its assets and discharge its li abilities 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 and Basis for Qualified Opinion paragraph is as under:

Qualified Opinion
In our opinion and to the best of our information and 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 and
give a true and fair view in conformity with the accounting principles generally accepted in India, of the state of
affairs of XYZ Ltd. as at March 31, 202 4, and 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, and 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.

Q2. ABC Ltd. is a company engaged in the manufacture of iron and steel bars. PP & Associates are the statutory
auditors of ABC Ltd. for FY 2023-24. During the course of audit, CA Prakash, the engagement partner, found that
the Company’s financing arrangements have expired, and the amount outstanding was payable on March 31,
2024. The Company has been unable to re-negotiate or obtain replacement financing and is considering filing for
bankruptcy. These events indicate a material uncertainty that may cast significant doubt on the Company’s ability

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to continue as a going concern and therefore it may be unable to realize its assets and discharge its liabilities in
the normal course of business. The financial statements (and notes thereto) do not disclose this fact. What
opinion should CA Prakash express in the case of ABC Ltd.?

Solution

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, and 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 and pervasive.

The relevant extract of the Adverse Opinion Paragraph and 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 e ntity as at
March 31, 2024, and of its financial performance and its cash flows for the year then ended in accordance with the
Accounting Standards issued by the Institute of Chartered Accountants of India.

Basis for Adverse Opinion

The financing arrangements of ABC Ltd. have expired, and the amount outstanding was payable on March 31, 2024.
The entity has been unable to conclude re-negotiations or obtain replacement financing and 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.

Q3. MNO Ltd. is a power generating company having its plants in the northeastern states of the country. For the FY
2023-24, M/s PRT & Associates are the statutory auditors of the company. During the 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 auditor’s issue in such case?

Solution

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 and 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 and Basis for Disclaimer of Opinion paragraph is as
under:

Disclaimer of Opinion

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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 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, 2024. We were not allowed
access to the management and 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 and expenses for the
year, (and the elements making up the consolidated statement of changes in equity) and the consolidated cash flow
statement.

Q4. CA Yash is the statutory auditor of Laksmi Vardhan Limited for the FY 2023-24. In respect of loans and advances
of ` 55,00,000/- given to Sarvagya Private Limited, the Company has not furnished any agreement to CA Yash and
in absence of the same, he is unable to verify the terms of repayment, chargeability of interest and other terms.
What kind of opinion should CA Yash give in such situation?

Solution

In the present case, with respect to loans and 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 and other terms. For an auditor, while verifying any loans and
advances, one of the most important audit evidences is the loan agreement. Therefore, the absence of such a
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 and Basis for Qualified Opinion paragraph is as under:

Qualified Opinion
In our opinion and to the best of our information and according to the explanations given to us, except for the
possible 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 and fair view in conformity with the accounting principles
generally accepted in India, of the state of affairs of th Company as on 31.03.2024 and 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 and advances of Rs. 55,00,000/- given
to Sarvagya Private Limited. Consequently, in the absence of such an agreement, we are unable to verify the terms
of repayment, chargeability of interest and other terms.

Q5. In the financial year 2023-24, MSD Ltd. faced an extraordinary event (earthquake), which destroyed a lot of
business activity of the company. These circumstances indicate material uncertainty about the company’s ability

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to continue as going concern. Due to such an 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 and 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?

Solution

In the present case, there exists a material uncertainty that casts a significant doubt on the company’s ability to
continue as going concern and the same is not disclosed in the financial statements of MSD Ltd.
As such, the financial statements of MSD Ltd. for the FY 2023-24 are materially misstated, and the effect of the
misstatement is so material and pervasive on the financial statements that giving only a qualified opinion will be
insufficient and therefore the statutory auditor of MSD Ltd. should issue an adverse opinion.

The relevant extract of the Adverse Opinion Paragraph and 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 on
March 31, 2024, and of its financial performance and its cash flows for the year then ended in accordance with the
Accounting Standards issued by the Institute of Chartered Accountants of India.

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 an 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 and notes to the financial
statements of the company do not disclose this fact.

Q6. CA Abhimanyu is the statutory auditor of PQR Ltd. for the FY 2023-24. 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 crores. 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 and 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?

Solution

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In the present case, CA Abhimanyu is unable to obtain sufficient and appropriate audit evidence with respect to the
following:

1. The balance confirmation with respect to debtors amounting to Rs. 150 crores is not available. Further there has
been default in payment by the debtors and 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, and the possible effects on the financial statements of undetected misstatements, if any, could be
both material and pervasive.
Thus, CA Abhimanyu should give a Disclaimer of Opinion.

The relevant extract of the Disclaimer of Opinion Paragraph and 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 crores during the year under audit which is
inadequate in the circumstances of the company. The carrying value of trade receivables could not be ascertained.

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 and as such the value of inventory could not be verified.

Q7. ABC Ltd. is a construction company engaged in infrastructure projects across various locations. For the FY 2023-
24, M/s XYZ & Co. are the statutory auditors of the company.

Relevant Notes given by the management in the financial statements of ABC Limited:
(a) During the year, the management circulated request for confirmation to key vendors of maintenance expenses
and has written-back the liabilities recorded in earlier years of ₹2 crores that have not been claimed by these
vendors and have also not been responded to management’s request for confirmation. The management is
confident that the balances are no longer payable and that no further adjustments are required to the financial
statements in this regard.

(b) During the year, the management has undertaken detailed assessment regarding advances of ₹ 2.5 Crore paid
to certain project managers including ₹1 Crore paid during earlier years. The Company has incurred expenses on

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account of travel expense at various sites in cash and has closing balance of ₹1.75 crores against which
management has obtained confirmation from respective project managers for balances aggregating ₹0.65 crores
and has provided balance amount of ₹1.1 crores as provision for doubtful advances. The management is confident
that the expenditure incurred is towards business operations of the Company and that no further adjustments
are required to the financial statements in this regard.

What kind of opinion should the statutory auditor’s issue in such case?

Solution

Report on the Audit of the Standalone Financial Statements

Qualified Opinion
We have audited the standalone financial statements of ABC Limited (“the Company”), which comprise the balance
sheet as on March 31, 20X1, and the statement of Profit & Loss, (statement of changes in equity) and the statement
of cash flows for the year then ended, and notes to the financial statements, including a summary of significant
accounting policies and other explanato ry information.

In our opinion, and to the best of our information and according to the explanations given to us the aforesaid
financial statements, subject to the matters discussed in Basis for Qualified Opinion paragraph below, the
consequential impact, if any, whereof is not quantifiable, give a true and fair view, in conformity with the accounting
principles generally accepted in India, of the state of affairs of the Company as on March 31st, 2XXX and profit/loss,
(changes in equity) and its cash flows for the year ended on that date.

Basis for Qualified Opinion

(a) As stated in Note XX of the financial statements, the management has during the year circulated request for
confirmation to key vendors of maintenance expenses and written-back the liabilities recorded in earlier years of `
2 crores considering that these balances have not been claimed by these vendors and they have also not responded
to management request for confirmation. In the absence of balance confirmation of these vendors, we are unable
to comment upon such write back of `2 crores and any further adjustments that may be required to the financial
statement in this regard.

(b) Attention is invited to Note which explains management assessment regarding advances of Rs. 2.5 crore paid
to certain project managers including Rs. 1 crore paid during earlier years. The Company has incurred expenses on
account of travel at various sites in cash and has closing balance of ` 1,75 crores against which management has
obtained confirmation from respective project managers for balances aggregating ` 0.65 crores and has provided
balance amount of ` 1.1 crores as provision for doubtful advances. Further, for such transactions, the Company has
not complied with provision for deduction of taxes at source.

Q8. CA Omkar is the statutory auditor of Sabhyata Ltd. for the FY 2023-24. The company is engaged in the business of
manufacture of floor tiles. During the 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.

Solution

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SA 705 (Revised) deals with the auditor’s responsibility to issue an appropriate report in circumstances when, in
forming an opinion in accordance with SA 700, 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; and
(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 and pervasive to the
financial statements.

Thus, since CA Omkar has obtained audit evidence which is inconsistent with the affirmations made in the financial
statement, CA Omkar should modify his opinion as per the circumstances of the case.

Q9. Fancy Limited is a foreign company providing software support services having its Branch Office at Delhi. During
the year 2023-24, Fancy Limited incorporated a subsidiary Nancy Private Limited in Gurgaon. For furtherance of
objectives, Fancy Limited entered into a Business Transfer Agreement dated 5th October 2023 with Nancy Private
Limited for transfer of all assets and liabilities along with the business of Delhi Branch to Nancy Private Limited
on a going concern basis effective from 01st April, 2023. Further necessary approval from regulatory authorities
is also received on 20th December, 2023 for such transfer. Fancy Limited promised that it shall provide continuing
financial and operational support to Delhi Branch and further confirmed that any losses incurred post the date of
transfer shall be borne by Fancy Limited.

During the year 2023-24, Delhi Branch of Fancy Limited have prepared its financial statements on the basis that
the Branch Office does not continue to be a going concern and all its assets are carried in the books of accounts
at the values likely to be recovered at the time of closure of operations, to the extent ascertainable at the time
of preparation of the financial statements. Delhi Branch has incorporated above matter in detailed form in Note
XX to the financial statements.

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You are the statutory auditor of Delhi Branch of Fancy Limited for the financial year 2023-24. According to you,
Delhi Branch has correctly disclosed about the matter in Note XX to the Financial Statements regarding
management's intention to close the operations of the branch office. Further you have obtained sufficient
appropriate audit evidence concerning audit and on the verge of finalization of audit report.

Draft a suitable opinion paragraph and basis thereof in the given case along with disclosure of Note XX with
suitable place in audit report in terms of relevant auditing standard.

Solution

Drafting of Opinion Paragraph and basis thereof along with disclosure of Note XX:
INDEPENDENT AUDITOR’S REPORT
To the Members of Delhi Branch Office of Fancy Limited Report on the Audit of the Standalone Financial
Statements Opinion
We have audited the standalone financial statements of Delhi Branch Office of Fancy Limited (“the Company ”),
which comprise the balance sheet as at March 31, 2024, and the statement of Profit & Loss, (statement of changes
in equity) and the statement of cash flows for the year then ended, and notes to the financial statements, including
a summary of significant accounting policies and other explanatory information.
In our opinion, and to the best of our information and according to the explanations given to us the aforesaid
financial statements, give a true and fair view, in conformity with the accounting principles generally accepted in
India, of the state of affai rs of the Delhi Branch Office of the Company as at March 31, 2024 and profit/loss, (changes
in equity) and its cash flows for the year ended on that date.
Basis for Opinion
We conducted our audit in accordance with Standards on Auditing (SAs). Our responsibilities under those standards
are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report.
We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of
the financial statements as per the ICAI’s Code of Ethics and the provisions of the Companies Act, 2013, and we have
fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence
we have obtained is sufficient and appropriate to provide a basis for our opinion.
Emphasis of Matter
We draw attention to Note XX regarding Delhi Branch Office management’s intention to close the operations of the
Branch Office subject to regulatory approvals. Accordingly, the financial statements have been prepared on the basis
that the Delhi Branch Office does not continue to be a going concern and provisions have been made in the books
of account for the losses arising or likely to arise on account of closure of operations including the losses on the
realizability of current assets.
Our opinion is not modified in respect of this matter.
Q10. While conducting audit of CGX Limited, a listed company, for year 2023-24, CA Srishti notices that company has
extinguished following material liabilities unilaterally without entering into settlement with creditors and
reported these amounts as gains under “Other income”. The details in this respect are as under: -

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S. No. Particulars Amount involved

(i) Liabilities for purchases of raw material were written back on account of ` 3.50 crores
poor quality of raw material and difference in rates
(ii) Liabilities for capital goods were written back on account of defects in ` 2.00 crores
machinery supplied by creditors
The management is of the opinion that these dues are no longer payable. Therefore, retaining these liabilities on
financial statements would lead to overstatement of liabilities. Extinguishment of liabilities was made by
company in accordance with normal trade practices and outstandings were written back after stopping dealing
with such creditors. She wanted to send external confirmation requests to such creditors. However, management
informed her that sending such requests may be used by creditors as proof of existence of liability.
She is contemplating inclusion of above matters under “Key audit matters" in audit report. Analyse the situation
threadbare.
Solution
A liability is a present obligation of the entity to transfer an economic resource as a result of past events. Instead of
fulfilling an obligation to transfer an economic resource to the party that has a right to receive that resource, entities
sometimes decide to, for example: -
(a) settle the obligation by negotiating a release from the obligation;
(b) transfer the obligation to a third party; or
(c) replace that obligation to transfer an economic resource with another obligation by entering into a new
transaction.
In the above situations, an entity has the obligation to transfer an economic resource until it has settled, transferred
or replaced that obligation.
In the given situation, company has written back liabilities due to creditors unilaterally. The company has not settled
the obligation by negotiating a release from the obligation from respective creditors. Such an accounting treatment
by management is questionable and against the conceptual framework for financial reporting under Ind AS.
CA Srishti wanted to send external confirmations in accordance with SA 505, “External Confirmations” but
management informed her that sending such requests may be used by creditors as proof of existence of liability. In
fact, she should display professional skepticism and be alert to the possibility of misstatements in financial
statements, if restrained by management from obtaining external confirmations. The reasons advanced by
management do not appear to be valid and reasonable. In accordance with SA 505, she should reassess risks and
perform alternative audit procedures to mitigate such risks. Besides, she should consider implications of same for
her audit opinion.
Further, SA 705, “Modifications to the Opinion in the Independent Auditor’s Report” requires that the auditor shall
modify the opinion in the auditor’s report when: -
(a) The auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are not
free from material misstatement; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements
as a whole are free from material misstatement.

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SA 705 also states that misstatements in financial statements arise when selected accounting policies are not in
accordance with an applicable financial reporting framework. It also states that examples of an inability t o obtain
sufficient appropriate audit evidence arise from a limitation on the scope of audit imposed by management when
management prevents the auditor from requesting external confirmation of specific account balances. Therefore,
she needs to issue a modified opinion.
Keeping in view above, her contemplation of including above matters under “Key audit matters” is not proper and
is not in accordance with SA 701,” Communicating Key Audit Matters in the Independent Auditor’s Report”. It states
that the auditor shall not communicate a matter in the Key Audit Matters section of the auditor’s report when the
auditor would be required to modify the opinion in accordance with SA 705 as a result of the matter. Communicating
key audit matters in the auditor’s report is not a substitute for the auditor expressing a modified opinion when
required by the circumstances of a specific audit engagement in accordance with SA 705.
Q11. BPMR and Associates, a renowned audit firm in the field of CA practice for the past three decades, was appointed
to conduct the statutory audit of Rexlon Ltd., an unlisted company engaged in the business of paper
manufacturing. The firm decided to commence the audit for the recently concluded financial year. After making
significant progress in the audit, the auditors made the following observations:
Observation 1: The management had disclosed in the financials that, during the year, one of the warehouses of
the Company was affected due to a major flood. As a result of the same, the Company had incurred some losses.
But the management was of the view that it was not material.
Observation 2: Due to the flood, few records maintained by the Company with respect to a particular transaction
was completely destroyed and there was no duplicate record maintained by the Company. However, those details
were not pervasive, but material.
You are required to advise whether BPMR and Associates should report Observation 1 and 2 in its audit report?
If so, under which heading should it be reported?
Solution
Observation 1 - The management had disclosed in the financials that, during the year, one of the warehouses of the
Company was affected due to a major flood. As a result of the same, the Company had incurred some losses. But
the management was of the view that it was not material. As per SA 706, “Emphasis of Matter Paragraph & Other
Matter Paragraph in the Independent Auditor’s Report”, an Emphasis of Matter Paragraph refers to matter
appropriately disclosed in the financials, that in the auditor’s judgement is of such importance that it is fundamental
to users’ understanding of the financials. Hence, in this case, the auditor shall report about the consequences of the
flood which affected the company’s warehouse under Emphasis of Matter Paragraph.
Observation 2 - Due to flood, few records maintained by the Company with respect to a particular transaction were
destroyed and no duplicate records were maintained by the Company. However, those details were not pervasive,
but material. As per SA 705, “Modifications to the Opinion in the Independent Auditor’s Report”, where the auditor
is unable to obtain sufficient and appropriate audit evidence and where such matter is material but not pervasive,
the auditor shall issue a Qualified opinion.
Thus, in the given situation, on account of flood few records pertaining to particular transactions were completely
destroyed and in the absence of duplicate records, the auditor was unable to obtain sufficient and appropriate audit
evidence and those details were material but not pervasive. Therefore, in accordance with SA 705, the auditor is
required to issue Qualified opinion.

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Q12. Compare and explain the following: Audit Qualification vs. Emphasis of Matter
Solution

Audit Qualification Emphasis of Matter

Standard on Auditing 705 “Modifications to the Standard on Auditing 706 “Emphasis of Matter
Opinion in the Independent Auditor’s Report”, deals Paragraphs and Other Matter Paragraphs in the
with the provisions relating to Audit Qualification. Independent Auditor’s Report” deals with the
provisions relating to Emphasis of Matter.
Audit Qualifications are also known as “subject to Emphasis of Matter is a paragraph which is included
report” or “except that report”. in auditor’s report to draw users’ attention to
important matter(s) which are already disclosed in
Financial Statements and are fundamental to users’
for understanding of Financial Statements.
Audit Qualifications are given when auditor is having Emphasis of Matter is a paragraph which is issued
reservations on some of the items out of the financial when there is a uncertainty relating to future
statements as a whole i.e. Auditor’s Judgment about outcome of exceptional litigation, regulatory action,
the Pervasiveness of the Effects or Possible Effects on etc.; or there is early application (where permitted) of
the Financial Statements relating to if the impact of a new accounting standard that has a pervasive effect
material misstatements is not pervasive on the on the financial statements in advance of its effective
financial statements but is present at some levels of date.
the financial statements, qualified report is issued.

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Additional Questions
Q13. BREW Ltd., FMCG Company having its tea gardens in northeastern states of the country is exclusively dealing in
blending, processing, packing and selling of various brands of Tea. During the year under audit, the company
entered into joint venture for purchasing Tea Gardens in Sri Lanka and Kenya. M/s PM & Associates are the
statutory auditors of the company for the financial year 2021-22. During the course of audit, the audit team was
unable to obtain sufficient appropriate evidence about a single element of the consolidated financial statement
being Joint venture investment in Dharma Ltd. representing over 91% of the group’s net assets having both
material and pervasive possible effect to the consolidated financial statements. The group’s investment in
Dharma Ltd. is carried at ` 115 crore in the group’s consolidated balance sheet.
Draft the opinion paragraph and basis of opinion paragraph to be included in the Independent Auditor’s report.
(MTP Oct ‘22)
Solution
M/s PM & Associates are unable to obtain sufficient appropriate audit evidence about the financial information of
a joint venture investment that represents over 91% of the group’s net assets. The possible effects of this inability
to obtain sufficient appropriate audit evidence are both material and 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 and Basis for Disclaimer of Opinion paragraph is as
under:
Disclaimer of Opinion
We were engaged to audit the accompanying consolidated financial statements of BREW Ltd., (hereinafter referred
to as the “Holding Company”) and its subsidiaries (the Holding Company and its subsidiaries together referred to as
“the Group), which comprise the consolidated balance sheet as at March 31, 2022, the consolidated statement of
Profit and Loss, (consolidated statement of changes in equity) and consolidated statement of cash flows for the year
then ended, and notes to the consolidated financial statements, including a summary of significant accounting
policies (hereinafter referred to as the “Consolidated Financial Statements”).
We do not express an opinion on the accompanying consolidated financial statements of the Group. Because of the
significance of the matter 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 consolidated
financial statements.
Basis for Disclaimer of Opinion
The Group’s investment in its joint venture Dharma Ltd. Company is carried at ` 115 crore on the Group’s
consolidated balance sheet, which represents over 91% of the Group’s net assets as at March 31, 2022. We were
not allowed access to the management and the auditors of Dharma Ltd. Company, including Dharma Ltd.’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 Dharma Ltd.’s assets that it controls jointly, its proportional share of Dharma
Ltd.’s liabilities for which it is jointly responsible, its proportional share of Dharma Ltd.’s income and expenses for
the year, (and the elements making up the consolidated statement of changes in equity) and the consolidated cash
flow statement.

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Q14. CA Subhadra is the statutory auditor of SATI Ltd. for the financial year 2021-22. In respect of loans and advances
of ₹ 95 lakh given to Shripal Pvt. Ltd., the Company has not furnished any agreement to CA Subhadra and in
absence of the same, he is unable to verify the terms of repayment, chargeability of interest and other terms.
Justify the type of opinion which CA Subhadra should give in such situation. Also, Draft an appropriate Opinion
paragraph and Basis of Opinion paragraph. (MTP March ’23 & April ’23, PYP Dec ‘21)
Solution
In the present case, with respect to loans and advances of ₹ 95 Lacs given to Shripal Pvt. Limited, the Company has
not furnished any agreement to CA Subhadra. In the absence of such an agreement, CA Subhadra is unable to verify
the terms of repayment, chargeability of interest and other terms. For an auditor, while verifying any loans and
advances, one of the most important audit evidence 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 Subhadra 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 Subhadra should give a qualified opinion.
The relevant extract of the Qualified Opinion Paragraph and Basis for Qualified Opinion paragraph is as under:
Qualified Opinion
In our opinion and to the best of our information and 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 SATI
Limited give a true and fair view in conformity with the accounting principles generally accepted in India, of the state
of affairs of the Company as on 31.03.2022 and 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 and advances of ₹ 95 Lacs given to
Shripal Pvt. Limited. Consequently, in the absence of such an agreement, we are unable to verify the terms of
repayment, chargeability of interest and other terms.
Q15. While conducting audit of RAC Limited, CA R has discovered a misstatement in the financial statements of a
company due to non-write off of a huge trade receivable with an outstanding amount of 2 crores. The party in
question has fled from India and is now absconding. After reviewing the audit evidence, it was concluded by the
auditor that there is no possibility of recovering the outstanding debt. Despite the matter being brought to the
attention of the management, they have refused to correct the misstatement. As a result, the financial statements
of the company show a profit before tax of 1 crore, which is incorrect due to management's refusal to correct the
aforementioned misstatement. Materiality has been determined for financial statements @ 5% of profit before
tax.
Comment as regards to type of opinion to be given by CA R in above situation on the basis of provided information.
(MTP Oct ‘23)
Solution
SA 705 states that the auditor shall modify the opinion in the auditor’s report when:
(a) The auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are not
free from material misstatement or

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(b) The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements
as a whole are free from material misstatement.
In the given situation, auditor has obtained evidence in relation to non-recoverability of outstanding trade
receivable.
SA 705 further states that 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 and
pervasive to the financial statements.
In this scenario, the uncorrected misstatement stands at 200% of the profit before tax, while the materiality has
been determined at 5% of the profit before tax. Hence, this misstatement should be considered as material.
Additionally, if such a substantial amount is written off, it would significantly impact the financial position of the
company. As a result, losses would have to be reported instead of profits. Taking the above factors into
consideration, this misstatement should be classified as both material and pervasive.
Therefore, adverse opinion needs to be expressed in accordance with the requirements of SA 705.
Q16. You have been appointed as an auditor of Dharmnath & Sons for FY 2020-21, as an entity other than a company
incorporated under the Companies Act, 2013, using a fair presentation framework. Appointment had been made
in the month of April 2021. The financial statements have been prepared by the management in accordance with
the Accounting Standards. The management had introduced the new computerized accounts receivable system
from November 2020 and is still in the implementation phase, and thus management is in the process of rectifying
system deficiencies and correcting the errors. At the time of implementation of a new system, the earlier system
of accounting of receivables had been discarded. The auditor was unable to obtain sufficient appropriate audit
evidence about the entity’s accounts receivable and inventories. The possible effects of the inability to obtain
sufficient appropriate audit evidence are deemed to be both material and pervasive to the financial statements.
Write the opinion paragraph and basis of opinion paragraph to be included in the Independent Auditor’s Report.
(RTP May 22)
Solution
Opinion Paragraph
Disclaimer of Opinion
We were engaged to audit the financial statements of Dharmnath & Sons (“the entity”), which comprise the balance
sheet as at March 31, 2021, the statement of Profit and Loss, (the statement of changes in equity) and the statement
of cash flows for the year then ended, and notes to the financial statements, including a summary of significant
accounting policies.
We do not express an opinion on the accompanying financial statements of the entity. 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 were not appointed as auditors of the Company until after March 31, 2021, and thus did not observe the
counting of physical inventories at the beginning and end of the year. We were unable to satisfy ourselves by
alternative means concerning the inventory quantities held at March 31, 2020, and 2021, which are stated in the
Balance Sheets at xxx and xxx, respectively.

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In addition, the introduction of a new computerized accounts receivable system in November 2020 resulted in
numerous errors in accounts receivable. As of the date of our report, management was still in the process of
rectifying the system deficiencies and correcting the errors. We were unable to confirm or verify by alternative
means accounts receivable included in the Balance Sheet at a total amount of ` xxx as at March 31, 2021.
As a result of these matters, we were unable to determine whether any adjustments might have been found
necessary in respect of recorded or unrecorded inventories and accounts receivable, and the elements making up
the statement of Profit and Loss (and statement of cash flows).
Q17. CA. Uma is the Statutory Auditor of RJ Ltd. for the financial year 2021-22. The company is engaged in the
production of electronic products. During the course of audit, CA. Uma obtained certain audit evidence of
incorrect disclosure of related party transactions and structured finance deals which was not considered with the
affirmation leading to misstatement in the financial statements.
Discuss how CA Uma should deal with the situation in the auditor's report and the different options which can be
considered? (PYP Nov 22)
Solution
SA 705 “Modifications to the Opinion in the Independent Auditor’s Report”, deals with 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; and
(b) The auditor’s judgement 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, that the financial statements as a whole are not free from material misstatement:
In the present case, during the course of the audit, CA Uma obtained certain audit evidence which was not consistent
with the affirmation made in financial statements. Therefore, CA Uma should modify his report in accordance with
SA 705.
Conclusion:
Since CA Uma has obtained audit evidence which is inconsistent with the affirmations made in the financial
statements, CA Uma should modify his opinion as per the circumstances of the case.

• CA Uma 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.
• CA Uma shall express an Adverse opinion where the auditor, having obtained sufficient appropriate evidence,
concludes that misstatements, individually, or in the aggregate, are both material and pervasive to the financial
statements.

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Q18. ALM Associates has been appointed as auditor of M/s Hary Ltd. which acquired 55% shares-in M/s Sam Ltd. on
15th October, 2018. During audit of Harry Ltd., the auditors found that the company has not prepared
consolidated financial statements because on the date of acquisition the fair value of certain assets & liabilities
has not been ascertained which is significant and are accounted for on estimated basis only. Help ALM Associates
in framing opinion paragraph of audit report. (PYP May ‘19)
Solution
Opinion Paragraph of Audit Report:
In the instant case, M/s Hary Ltd. acquired 55% shares in M/s Sam Ltd. and the company did not prepare the
consolidated financial statements because on the date of acquisition the fair value of certain assets and liabilities
has not been ascertained. Therefore, accounting is done on an estimate basis only, which is not correct as the
financial statements are materially misstated due to non-consolidation of the subsidiary. The material
misstatement is deemed to be pervasive to the consolidated financial statements. Thus, 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 and pervasive to the financial statements.
Adverse Opinion
In our opinion and to the best of our information and according to the explanations given to us, because of the
significance of the matter discussed in the Basis for Adverse Opinion section of our report, the accompanying
consolidated financial statements do not give a true and fair view in conformity with the accounting principles
generally accepted in India, of their consolidated state of affairs of the Group, its associates, and jointly controlled
entities, as at March 31, 2019, of its consolidated profit/loss, (consolidated position of changes in equity) and the
consolidated cash flows for the year then ended.
Basis for Adverse Opinion
As explained in Note X, M/s Hary Ltd. has not consolidated subsidiary M/s Sam Ltd. that M/s Hary Ltd. acquired
during 2018 because it has not yet been able to determine the fair values of certain of the subsidiary’s material
assets and liabilities at the acquisition date. This investment is therefore accounted for on an estimate basis. Under
the accounting principles generally accepted in India, the Group should have consolidated this subsidiary and
accounted for the acquisition based on provisional amounts. Had M/s Sam Ltd. been consolidated, many elements
in the accompanying consolidated financial statements would have been materially affected. The effects on the
consolidated financial statements of the failure to consolidate have not been determined.
Q19. ABC Ltd. has been dealing in tyres since 1995. The Company envisaged to expand its business and wanted to
manufacture tyres besides trading. Accordingly, machinery was imported, installed, & manufacturing operations
commenced. The Government also gave certain incentives like power subsidy, land acquisition subsidy, etc.
After 2 years of operations, the Company received a notice from the Income Tax authorities to pay tax on the
incentive received in the form of power subsidy. The demand notice was served for ₹150.00 Lakhs.
The Company, however, filed an appeal with higher tax authorities against the demand, and the matter is
undecided as on 31.03.2021. The legal team of the Company anticipated that the tax liability might mature. The
Company has not made a provision for the anticipated tax liability.
Considering the provisions of the Companies Act, 2013, how an auditor of ABC Ltd. should see this matter and
report in the audit report, if required? (PYP July 21)
Solution

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Audit report - Legal team anticipated tax liability but the company did not make any provision for that:
The Council of the Institute of Chartered Accountants of India has taken note of the fact that there is a practice
prevalent whereby companies do not make provision for tax even when such a liability is anticipated. It has
expressed the view that on an overall consideration of the relevant provisions of law, non-provision for tax (where
a liability is anticipated) would amount to contravention of the provisions of Sections 128 and 129 of the Companies
Act, 2013.
Accordingly, it is necessary for the auditor to qualify his report, and such qualification should bring out the manner
in which the accounts do not disclose a “true and fair” view of the state of affairs of the company and the profit or
loss of the company.
Applying the above to the facts given in the question, auditor should qualify his report.
An example of the manner in which the report on the balance sheet and the Statement of Profit and Loss may be
qualified in this respect is given below: “The company has not provided for taxation in respect of its profits and the
estimated aggregate amount of taxation not so provided for is `............including.............for the Year ended on
..............To the extent of such non-provision for the year, the profits of the Company for the financial year under
report have been overstated and to the extent of such aggregate non-provision, the reserves of the company
appearing in the said balance sheet have been over-stated and the current liabilities and provisions appearing in
the said balance sheet have been understated”.

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SM Questions
Q1. 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 2021-22. The thermal power project comprises of
the plant and equipment amounting to Rs. 5.95 crore and capital work in progress of Rs. 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 31.03.2024 and 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.
Solution
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, 2024 comprise of plant and equipment of `
5.95 crore and capital work in progress of ` 147.50 crore.
Our opinion is not modified in respect of this matter.
Other Matter
We did not audited 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 31.03.2024 and 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, and 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.
Q2. Below is draft extract of audit report of a listed company. Para (A) below reflects certain matters stated in audit
report communicated with CFO of company and Para (B) is in nature of auditor’s response to said matter.
(A) The Company recognizes revenues when the control of goods is transferred to the customer at the net
consideration which the Company expects to receive for those goods from customers in accordance with
contracts terms and conditions.
The terms of sales arrangements based on the terms and conditions of relevant contracts and nature of
discount and rebates create complexities that require judgment in determining revenues.
(B) We read the Company’s revenue recognition policy and assessed its compliance in terms of Ind AS 115
“Revenue from contracts with customers”.
We assessed design and tested the operating effectiveness of internal controls related to sales and
rebates/discounts.

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We tested on a sample basis that revenue has been recognized in the proper period with reference to the
supporting documents including confirmations from customers.
From the description given above, identify what auditors are trying to report and under what heading such matter
should be reflected in audit report of the company?
Solution
The above matter is in nature of Key audit matter and should be stated under heading “Key audit matters” in audit
report. Key audit matters are those matters that, in the auditor’s professional judgment, were of most significance
in the audit of the financial statements of the current period. Key audit matters are selected from matters
communicated with those charged with governance.
SA 701 states that the auditor shall determine, from the matters communicated with those charged with
governance, those matters that required significant auditor attention in performing the audit. In making this
determination, significant auditor judgments relating to areas in the financial statements that involved significant
management judgment including accounting estimates that have been identified as having high estimation
uncertainty be taken into account.
The above described matter relates to revenue recognition and creation of complexities requiring judgment in
revenues. Further, the description also describes how the matter was addressed by auditors by performing various
audit procedures in accordance with SA 701.
Q3. PTD Limited is engaged in the business of executing construction contracts for its clients. There are non-current
receivables outstanding in the financial statements of the company as on 31st March, 2024 for ` 500 crore. Such
amounts represent caused by claims raised by the company on its clients relating to cost overruns necessitated
due to delays clients, change in work specifications and related matters. Bes des negotiations, the company has
also gone for arbitration in some of the said cases. The management of the company has considered the above
amounts to be fully recoverable as stated in notes to accounts.
CA Piyush, auditor of the company, has relied only upon management representation in this regard. Besides, he
has decided to include the said matter in “Emphasis of Matter” Paragraph in audit report.
How do you view decision to include above matter in “Emphasis of Matter” Paragraph by auditor of the company?
Solution
In accordance with SA 706, Emphasis of Matter Paragraph is a paragraph included in the auditor’s report that refers
to a matter appropriately presented or disclosed in the financial statements that, in the auditor’s judgment, is of
such importance that it is fundamental to users’ understanding of the financial statements.
As per SA 706, the objective of the auditor, having formed an opinion on the financial statements, is to draw users’
attention, when in the auditor’s judgment it is necessary to do so, by way of clear additional communication in the
auditor’s report, to: -
(a) A matter, although appropriately presented or disclosed in the financial statements, that is of such importance
that it is fundamental to users’ understanding of the financial statements or
(b) As appropriate, any other matter that is relevant to users’ understanding of the audit, the auditor’s
responsibilities or the auditor’s report.
Further, the auditor shall include an Emphasis of Matter paragraph in the auditor’s report provided the auditor
would not be required to modify the opinion in accordance with SA 705 as a result of the matter.

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In the given situation, auditor has relied upon management representation letter only. He has not performed any
other audit procedures like verifying contracts with customers, status of arbitration proceedings etc. Since
management representations by themselves do not constitute sufficient appropriate evidence, performing
necessary audit procedures may lead auditor to conclude that modification in opinion is necessary. In such
circumstances, matter cannot be included in Emphasis of matter Paragraph.
Therefore, auditor should form his opinion by performing necessary audit procedures and obtaining sufficient
appropriate evidence. It is only when he concludes that modification of opinion is not required as a result of said
matter in terms of SA 705, the said matter may be included in Emphasis of Matter paragraph.
Q4. ABC Limited, a foreign company with operations in India, decided to transfer the business of one of its Indian
branch offices to its newly incorporated Indian subsidiary, XYZ Private Limited, through a slump sale. Below are
the disclosures given by management in Financial Statement:
"During the year, ABC Limited (‘the Company’) has incorporated a private limited company ('XYZ Private Limited')
in India for the purpose of furtherance of the Company’s objectives and has entered into a Business Transfer
Agreement dated October 5, 2024 with XYZ Private Limited for transfer of all assets and liabilities alongwith the
business of India Branch Office to XYZ Private Limited on going concern basis effective April 01, 2024. Further, the
Reserve Bank of India (RBI) vide letter No.…dated December 22, 2024 has also granted approval for transfer of
assets and liabilities and business of India Branch Office to XYZ Private Limited.
ABC Limited has confirmed that it shall provide continuing financial and operational support to its Branch Office
in India for its operations during the transitional period and loss incurred post the date of transfer of business to
XYZ Private Limited, if any, shall be borne by ABC Limited
The current year financial statements of India Branch Office have been prepared on the basis that the Branch
Office does not continue to be a going concern, and all its assets are carried in the books of accounts at the values
likely to be recovered at the time of closure of operations, to the extent ascertainable at the time of preparation
of these financial statements".
Draft a suitable opinion paragraph and basis thereof in the given case along with disclosure of Note XX with
suitable place in audit report in terms of relevant auditing standard.
Solution
INDEPENDENT AUDITOR’S REPORT
To the Members of India Branch Office of ABC Limited Report on the Audit of the Standalone Financial Statements
Opinion
We have audited the standalone financial statements of India Branch Office of ABC Limited (“the Company”), which
comprise the balance sheet as at March 31, 20X1, and the statement of Profit & Loss, (statement of changes in
equity) and the statement of cash flows for the year then ended, and notes to the financial statements, including a
summary of significant accounting policies and other explanatory information.
In our opinion, and to the best of our information and according to the explanations given to us the aforesaid
financial statements, give a true and fair view, in conformity with the accounting principles generally accepted in
India, of the state of affairs of the India Branch Office of the Company as at March 31st, 2XXX and profit/loss,
(changes in equity) and its cash flows for the year ended on that date.

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Basis for Opinion

We conducted our audit in accordance with Standards on Auditing (SAs). Our responsibilities under those standards
are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report.
We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of
the financial statements as per the ICAI’s Code of Ethics and the provisions of the Companies Act, 2013, and we have
fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence
we have obtained is sufficient and appropriate to provide a basis for our opinion.
Emphasis of Matter
We draw attention to Note XX regarding India Branch Office management’s intention to close the operations of the
Branch Office subject to regulatory approvals. Accordingly, the financial statements have been prepared on the basis
that the India Branch Office does not continue to be a going concern, and provisions have been made in the books
of account for the losses arising or likely to arise on account of closure of operations including the losses on the
realizability of current assets.
Our opinion is not modified in respect of this matter.

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Additional Questions
Q5. Difficult Books Limited is engaged in manufacturing of active pharmaceutical ingredients. Due to change in laws
and regulations, every company engaged in manufacturing in active pharmaceutical ingredients would now
require production capacity license which will restrict the production of companies. Management of the company
assessed the impact of the change in law over the financial position of company and appropriately disclosed the
same in the financial statement.
Audit Team of the company evaluated management's disclosure and found it appropriate and sufficient.
However, considering the said matter as most important and fundamental to users understanding regarding
financial statement the audit team decided to disclose the same in Other Matter Paragraph.
You as an Engagement Partner are required to guide the Audit Team with respect to reporting of the said matter
in Audit Report. (MTP Oct ‘22)
Solution
As per SA 706, “Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report,”
if the auditor considers it necessary to draw users’ attention to a matter presented or disclosed in the financial
statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of
the financial statements, the auditor shall include an Emphasis of Matter paragraph in the auditor’s report provided:
i) The auditor would not be required to modify the opinion in accordance with SA 705 as a result of the matter; and
ii) When SA 701 applies, the matter has not been determined to be a key audit matter to be communicated in the
auditor’s report.
In the instant case, since Difficult Books Limited is engaged in the manufacturing of active pharmaceutical
ingredients, it would now require a production capacity license, which will restrict the production of companies due
to changes in laws and regulations. The management of Difficult Books Limited assessed the impact of the change
in law over the financial position of the company and appropriately disclosed the same in the financial statements.
The audit team of Difficult Books Limited evaluated management's disclosure and found it appropriate and
sufficient. However, considering the said matter as most important and fundamental to users’ understanding
regarding financial statements, the audit team decided to disclose the same.
The said matter is already disclosed and presented appropriately in the financial statement and is of such importance
that it is fundamental to the users’ understanding of the financial statement and hence, it is required to be disclosed
under the Emphasis of Matter paragraph. Therefore, the decision of the audit team to disclose the same in the Other
Matter Paragraph is not in order; it should be disclosed in the Emphasis of Matter Paragraph.
Q6. The audit report of Kolsi (P) Ltd. for F.Y. 2020-21 was issued by Bishnoi & Co. on 25th July, 2021. However, a case
was filed against Kolsi (P) Ltd. on 4th August, 2021, with the Civil Court, with respect to an incident caused in its
factory on 17th January, 2021, the outcome of which may result in paying a heavy penalty by Kolsi (P) Ltd.
Mr. Raj Bishnoi, the partner of Bishnoi & Co., discussed the said matter with the management, and it was
determined to amend the financial statements for F.Y. 2020-21. Further, Mr. Raj inquired how the management
intended to address the said matter in the financial statements, to which he was told that the said matter was
going to be disclosed as a “Contingent Liability for a Court case” in the footnote of the balance sheet with no
additional disclosures.

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The management told Mr. Raj that such disclosure was enough as he would further provide a description of the
said court case and its outcome in the ‘Emphasis of Matter’ paragraph in his amended audit report.
In the context of the aforesaid case scenario, please answer the following questions:
Whether the contention of the management of Kolsi (P) Ltd. is valid with respect to the disclosure of the court
case in the financial statements? (RTP Nov ’21)
Solution
As per SA 706, ‘Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report’,
an Emphasis of Matter paragraph is not a substitute for:
(a) A modified opinion in accordance with SA 705 (Revised) when required by the circumstances of a specific audit
engagement;
(b) Disclosures in the financial statements that the applicable financial reporting framework requires management
to make, or that are otherwise necessary to achieve fair presentation; or
(c) Reporting in accordance with SA 570 (Revised) when a material uncertainty exists relating to events or
conditions that may cast significant doubt on an entity’s ability to continue as a going concern.
In the given case, the management of Kolsi (P) Ltd. has presumed that as the auditor was going to provide a
description of the said court case and its outcome in the ‘Emphasis of Matter’ paragraph in his amended audit report,
there was no further need for it to provide additional disclosures about the court case in the financial statements.
The said contention of management of Kolsi (P) Ltd. is not valid as ‘Emphasis of Matter’ paragraph cannot be used
as a substitute for disclosures required to be made in the financial statements as per the applicable financial
reporting framework or that is otherwise necessary to achieve fair presentation, which is the responsibility of the
management.

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SM & Additional Questions

Q1. Neptune Ltd. is a company that holds significant investments in a portfolio of equity securities. Due to a decline
in market value, the company's investments have suffered a notable diminution in value. For the financial year
ended 31st March 2023, the audit report of Neptune Ltd. included a qualification regarding the non-provision of
₹ 70 lakh for the diminution in the value of these investments. As the auditor for the financial year 2023-24, how
would you report in the following situations:
(i) If the company does not make a provision for diminution in the value of investments in the year 2023-24?
(ii) If the company makes an adequate provision for the diminution in the year 2023 - 24?
Solution
As per SA 710, “Comparative Information – Corresponding Figures and Comparative Financial Statements”, when
the auditor’s report on the prior period, as previously issued, included a qualified opinion, a disclaimer of opinion,
or an adverse opinion and the matter which gave rise to the modified opinion is resolved and properly accounted
for or disclosed in the financial statements in accordance with the applicable financial reporting framework, the
auditor’s opinion on the current period need not refer to the previous modification.
SA 710 further states that if the auditor’s report on the prior period, as previously issued, included a qualified opinion
and the matter which gave rise to the modification is unresolved, the auditor shall modify the auditor’s opinion on
the current period’s financial statements. In the Basis for Modification paragraph in the auditor’s report, the auditor
shall either:
(i) Refer to both the current period’s figures and the corresponding figures in the description of the matter giving
rise to the modification when the effects or possible effects of the matter on the current period’s figures are
material; or
(ii) In other cases, explain that the audit opinion has been modified because of the effects or possible effects of
the unresolved matter on the comparability of the current period’s figures and the corresponding figures.
In the instant case, if Neptune Ltd. does not make a provision for a diminution in the value of investment to the
extent of ` 70 lakh, the auditor will have to modify his report for both the current and previous year’s figures as
mentioned above. If, however, the provision is made, the auditor need not refer to the earlier year’s modification.
Q2. It was observed from the modified audit report of the financial statements of Shravasti Ltd. for the year ended
31st March, 2021 that depreciation of ₹ 3.95 crore for the year 2020-2021 had been charged off to the Statement
of Profit and Loss instead of including it in "carrying value of asset under construction". State in relation to the
audit for the year ended 31st March 2022, whether such modification in the previous year's audit report would
have any audit implication for the current year i.e. FY 2021-22 and if yes, how the auditor is required to deal with
the same in his audit report for the current year? (MTP March ’23, MTP Oct’20)
Solution
Auditor’s responsibility in cases where the audit report for an earlier year is qualified is given in SA 710, Comparative
Information – Corresponding Figures and Comparative Financial Statements.
As per SA 710, when the auditor’s report on the prior period, as previously issued, included a qualified opinion, a
disclaimer of opinion, or an adverse opinion, and the matter which gave rise to the modified opinion is resolved and

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properly accounted for or disclosed in the financial statements in accordance with the applicable financial reporting
framework, the auditor’s opinion on the current period need not refer to the previous modification.
SA 710 further states that if the auditor’s report on the prior period, as previously issued, included a qualified opinion
and the matter which gave rise to the modification is unresolved, the auditor shall modify the auditor’s opinion on
the current period’s financial statements. In the Basis for Modification paragraph in the auditor’s report, the auditor
shall either:

• Refer to both the current period’s figures and the corresponding figures in the description of the matter giving
rise to the modification when the effects or possible effects of the matter on the current period’s figures are
material; or
• In other cases, explain that the audit opinion has been modified because of the effects or possible effects of
the unresolved matter on the comparability of the current period’s figures and the corresponding figures.
In the instant case, if Shravasti Ltd. does not correct the treatment of depreciation to the extent of ₹3.95 crore for
the previous year, the auditor will have to modify his report for both current and previous years’ figures as
mentioned above. If, however, the figures and provisions are corrected, the auditor need not consider the earlier
year’s modification.
Q3. Mr. A, a practicing Chartered Accountant, audited the financial statements of C Ltd. for the previous year 2022-
23 and expressed an unmodified opinion. C Ltd. was of the view that Mr. A is not conducting the audit properly,
and therefore, for the current year 2023-24, it appointed Ms. B, a leading practicing Chartered Accountant, to
conduct the audit and present Comparative Financial Statements.
Ms. B, while performing the auditing procedures, found that C Ltd. has undercharged the wages of ₹10 lakhs
during the previous year, resulting in an overstatement of profits. What are the further procedures Ms. B is
required to pursue?
Solution
Auditor's Procedures in Respect of Examination of Comparative Financial Statements:
SA 710 "Comparative Information – Corresponding Figures & Comparative Financial Information" deals with the
auditor's responsibilities regarding comparative information in an audit of financial statements.
To examine comparative information, the auditor is required to perform the following procedures:

• Determine whether the financial statements include comparative information required by the financial
reporting framework and whether such information is classified appropriately.
• Evaluate whether the comparative information agrees with the amounts and other disclosures presented in
the prior period.
In the given case, the auditor identified a material misstatement for the previous year, the financial statements of
which were audited by Mr. A. Ms. B, the current auditor, is required to discuss the matter with the management
and issue a suitable report based on the action taken by the management in this regard.
Conclusion: Ms. B is required to communicate the matter to the management and request them to inform the same
to Mr. A. After revision or non-revision of the prior period's financial statements, Ms. B may report accordingly.
Q4. You as a statutory auditor had audited the financial statements of A Ltd., a listed company, for F.Y. 2022-23. The
company has included the comparative financial information in the financial statements prepared for the current

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F.Y. 2023-24. You as an auditor want to obtain sufficient appropriate audit evidence that comparative financial
information has been presented, in all material aspects, in accordance with the requirements in the applicable
financial reporting framework. List out audit procedures, as specified in relevant SA, which you are required to
follow for the purpose.
Solution
Auditor's Procedures in respect of examination of corresponding figures:
SA 710 "Comparative Information - Corresponding Figure and Comparative Financial Information" deals with the
auditor's responsibilities regarding comparative information in an audit of financial statements.
To examine the comparative information, the auditor is required to perform the following procedures:
(a) Determine whether F.S. include Comparative Information required by applicable FRF, & whether such
information is classified appropriately.
(b) Evaluate the following:

• Whether the comparative information agrees with the amounts and other disclosures presented in the prior
period; and
• Whether the accounting policies reflected in the comparative information are consistent with those applied
in the current period.
• Whether changes in accounting policies, if any, have been properly accounted for and adequately presented
and disclosed.
(c) If the auditor becomes aware of a possible material misstatement in the comparative information while
performing the current period audit, the auditor shall perform such additional audit procedures as are necessary
in the circumstances to obtain sufficient appropriate audit evidence to determine whether a material
misstatement exists.
(d) If the auditor had audited the prior period's financial statements, the auditor shall also follow the relevant
requirements of SA 560, "Subsequent Events".
(e) As required by SA 580, "Written Representations," the auditor shall request written representations for all
periods referred to in the auditor's opinion. The auditor shall also obtain a specific written representation
regarding any prior period item that is separately disclosed in the current year's statement of profit and loss.

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SM & Additional Questions

Q1. Naresh & Co., Chartered Accountants, have been appointed Statutory Auditors of Suchi Ltd. for the F.Y. 2023-24.
The audit team has completed the audit and is in the process of preparing audit report. The management of the
company has also prepared draft annual report.
The audit in-charge was going through the draft annual report and observed that the company has included an
item in its Annual Report indicating a downward trend in market prices of key commodities/raw material as
compared to previous year. However, the actual profit margin of the company as reported in financial statements
has gone in the reverse direction. The Audit Manager discussed this issue with a partner of the firm who in reply
said that auditors are not covered with such disclosures made by the management in its annual report, it being
the responsibility of the management.
Do you think that the partner is correct in his approach on this issue?
Discuss the Auditor's duties with regard to reporting with reference to the relevant Standards on Auditing.
Solution
Responding When the Auditor Concludes That a Material Misstatement of the Other Information Exists:
As per SA 720, “The Auditor’s Responsibility in Relation to Other Information”, descriptions of trends in market
prices of key commodities or raw materials is an example of amounts or other Items that may be included in the
other information.
The auditor’s discussion with management about a material inconsistency (or other information that appears to be
materially misstated) may include requesting management to provide support for the basis of management’s
statements in the other information. Based on management’s further information or explanations, the auditor may
be satisfied that the other information is not materially misstated. For example, management explanations may
indicate reasonable and sufficient grounds for valid differences of judgment.
Auditor’s duties with regard to reporting in the given case are given hereunder:
As per SA 720, “The Auditor’s Responsibility in Relation to Other Information”, if the auditor concludes that a
material misstatement of the other information exists, the auditor shall request management to correct the other
information. If management:
(i) Agrees to make the correction, the auditor shall determine that the correction has been made; or
(ii) Refuses to make the correction, the auditor shall communicate the matter with those charged with governance
and request that the correction be made.
Contention of the partner of the firm that auditors are not concerned with such disclosures made by the
management in its annual report, is incorrect.
Q2. ING Associates, Chartered Accountants, conducting the audit of XYZ Ltd., a listed Company for the year ended
31st March 2020, is concerned with the auditor's responsibilities relating to misstatements in other information,
both financial and non-financial, included in the Company’s annual report. While reading other information, ING
Associates considers whether there is any material misstatement of the other information in the Company.
After performing their procedures, the auditor concludes that a material misstatement of the other information
exists. ING Associates discussed with the Management about the other information that appeared to be

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materially misstated to the auditor and also requested management to provide evidence for the basis of
management’s statements in the other information along with supporting documents.
Guide ING Associates as to how to respond to that material misstatement of other information obtained prior to
the date of the auditor’s report. Will your answer be different in case ING Associates conclude the same after the
date of the auditor’s report? (MTP Oct 20)
Solution
Responding When the Auditor Concludes That a Material Misstatement of the Other Information Exists:
As per SA 720, “The Auditor’s Responsibility in Relation to Other Information,” if the auditor concludes that a
material misstatement of the other information exists, the auditor shall request management to correct the other
information. If management:
(i) Agrees to make the correction, the auditor shall determine that the correction has been made; or
(ii) Refuses to make the correction, the auditor shall communicate the matter with those charged with governance
and request that the correction be made.
If the auditor concludes that a material misstatement exists in other information obtained prior to the date of
the auditor’s report, and the other information is not corrected after communicating with those charged with
governance, the auditor shall take appropriate action, including:
(i) Considering the implications for the auditor’s report and communicating with those charged with governance
about how the auditor plans to address the material misstatement in the auditor’s report;
(ii) Withdrawing from the engagement, where withdrawal is possible under applicable law or regulation.
If the auditor concludes that a material misstatement exists in other information obtained after the date of the
auditor’s report, the auditor shall:
(i) If the other information is corrected, perform the procedures necessary in the circumstances; or
(ii) If the other information is not corrected after communicating with those charged with governance, take
appropriate action considering the auditor’s legal rights and obligations, to seek to have the uncorrected
material misstatement appropriately brought to the attention of users for whom the auditor’s report is
prepared.
Q3. Sujit & Co., Chartered Accountants, have been appointed as Statutory Auditors of Anand Mills Ltd. for FY 2022-
23. The audit team has completed the audit and is in the process of preparing the audit report. The Management
of the company has also prepared a draft annual report. While reviewing the company's draft annual report, the
auditor observed a section that stated a decline in market prices for essential products compared to the previous
year. Surprisingly, the financial statements indicated that the company's profit margin had actually increased.
The audit Manager discussed this issue with the firm's partner, who replied that the auditors are not responsible
for disclosures made by management in the annual report.
Do you think that the partner is correct in his approach to this issue? Discuss with reference to the relevant
Standards on Auditing the Auditor's duties with regard to reporting.
Solution
Auditor’s responsibilities as to Other Information included in Annual Report:

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SA 720, "The Auditor's Responsibilities Relating to Other Information," delineates the responsibilities of auditors in
regard to other information, which can pertain to financial or non-financial matters and is encompassed within an
organization’s annual report. This encompasses documentation of market trends pertaining to significant products
and quantities or other items that may be included in the other information.
The auditor’s discussion with management about a material inconsistency (or other information that appears to be
materially misstated) may include requesting management to provide support for the basis of management’s
statements in the other information. Based on management’s further information or explanations, the auditor may
be satisfied that the other information is not materially misstated. For example, management explanations may
indicate reasonable and sufficient grounds for valid differences of judgment.
Auditor’s duties with regard to reporting: If the auditor concludes that a material misstatement of the other
information exists, the auditor shall request management to correct the other information. If management:
(i) Agrees to make the correction, the auditor shall determine that the correction has been made; or
(ii) Refuses to make the correction, the auditor shall communicate the matter with those charged with governance
and request that the correction be made.
In the given situation, Sujit & Co., Chartered Accountants, have been appointed as Statutory Auditors of Anand Mills
Ltd. The auditor, while reviewing the company’s draft annual report, has observed a section mentioning a decline in
market prices for essential products compared to the previous year, while the financial statements indicate that the
company’s profit margin has increased. Considering the requirements of SA 720 as stated above, it can be concluded
that the contention of the firm’s partner, that auditors are not responsible for disclosures made by management, is
not correct. Accordingly, the partner is not correct in his approach to this issue.

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SM & Additional Questions

Q1. During the course of audit of PEC Limited, CA Guru has reason to believe that a fraud involving ₹ 75 lakhs has
been committed in the company by its employees. Is CA Guru under statutory obligation to report the above
matter to Central government by filing prescribed form on MCA Portal? How should he proceed to report above
said matter?
Solution
As per section 143(12) of the Companies Act, 2013 read with Rule 13 of the Companies (Audit and Auditors) Rules,
2014, 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, which involves or is expected to involve individually an amount of Rs. 1 crore or above, is being
or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central
Government within such time and in such manner as prescribed.
In the given case, CA Guru has reason to believe that a fraud involving Rs. 75 lakhs has been committed in the
company by its employees. Therefore, he is under no statutory obligation to report this matter to Central
Government by filing prescribed Form (ADT- 4) on MCA portal.
In case of a fraud involving lesser than the specified amount [i.e. less than Rs. 1 crore], the auditor shall report the
matter to the audit committee constituted under section 177 or to the Board in other cases within such time and in
such manner as prescribed. Besides, auditor has obligation to report matters pertaining to fraud under clause (xi) of
paragraph 3 of CARO, 2020.
Q2. Mr. Raj, the engagement partner of R.O.K. & Co., in connection with the statutory audit of Waria Ltd., had
assigned the responsibility of enquiring into propriety matters of the Company as required by section 143(1) of
the Companies Act, 2013, to Mr. Samay, an engagement team member. Mr. Samay, while making such enquiries,
was having the following queries, as tabulated below, which he ought to get resolved from Mr. Raj, as follows: -

Sr. No. Query of Mr. Samay

1 What documents to be seen in case of loan given by the company in lieu of hypothecation of goods
from lender as a security for the purpose of reporting as per clause (a) of section 143(1) of the
Companies Act, 2013?
2 What shall be the cost of Debentures and Bonus Shares sold by the company for which the cost is
not ascertainable for the purpose of reporting as per clause (c) of section 143(1) of the Companies
Act, 2013?
3 Whether the shares allotted by Waria Ltd. against a loan taken by it from a NBFC can be considered
to be allotted for cash for the purpose of reporting as per clause (f) of section 143(1) of the
Companies Act, 2013?
Assuming that you are Mr. Raj, the engagement partner, please provide answers to the queries of Mr. Samay?
(MTP March 21)
Solution

Sr No. Query of Mr. Samay Response to Query

1 What documents to be seen in case of loan given Mr. Samay should see deed of Hypothecation or
by the company in lieu of hypothecation of goods other document creating the charge, together

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from lender as a security for the purpose of with a statement of stocks held at the balance
reporting as per clause (a) of section 143(1) of sheet date in order.
the Companies Act, 2013?
2 What shall be the cost of Debentures and Bonus For Debentures sold: Where the cost of
Shares sold by the company for which the cost is debentures sold is not ascertainable, the book
not ascertainable for the purpose of reporting as value thereof at the date of sale may be treated
per clause (c) of section 143(1) of the Companies as the cost for the purposes of this clause.
Act, 2013? For Bonus Shares sold: When bonus shares are
received, the number of shares in the portfolio
would be increased by the bonus shares while
the cost of the total portfolio would remain the
same as before. The result would be that the
average cost per unit of the total holding would
come down proportionately. The usual
accounting practice for apportioning the cost of
a part of the total holding on the sale thereof is
to take it at its average cost.
3 Whether the shares allotted by Waria Ltd. The law on the subject has hitherto been that,
against a loan taken by it from a NBFC can be where the consideration for the issue of shares is
considered to be allotted for cash for the an adjustment against a bona fide debt payable
purpose of reporting as per clause (f) of section in money on demand by the company, the shares
143(1) of the Companies Act, 2013? are deemed to have been subscribed in cash.
According to the legal opinion obtained by the
ICAI, the expression “shares allotted for cash”
may also include shares allotted against a debt.
Therefore, in cases which are covered by the
decision in Spargo’s case, no comment is
required by the auditor, even though the
company may have in the Return of Allotment
under Section 75, shown such shares as allotted
against adjustment of a debt. Thus, the shares
allotted by Waria Ltd. against a loan taken by it
from a NBFC can be considered to be allotted for
cash.

Q3. CA. G, was appointed by DP Ltd., as Statutory Auditor. While doing the audit of DP Ltd., CA. G observed that
certain loans and advances were made without proper securities; certain trade receivables and trade payables
were adjusted inter se; and personal expenses were charged to revenue. As a company auditor comment on the,
reporting responsibilities of CA. G (PYP Nov‘19)
Solution
Duty of Auditor to Inquire on Certain Matters: Section 143(1) of the Companies Act, 2013 requires the auditor to
make an enquiry in respect of specified matters during the course of his audit. Since the law requires the auditor to
make an enquiry, the Institute opinion that the auditor is not required to report on the matters specified in sub-
section (1) unless he has any special comments to make on any of the items referred to therein. If the auditor is

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satisfied as a result of the enquiries, he has no further duty to report that he is so satisfied. It is to be noted that the
auditor is required to make only enquiries and not investigate into the matters referred to therein.
The opinion of the Research Committee of the Institute of Chartered Accountants of India on section 143(1) of the
Companies Act, 2013 is worth considering and reproduced below:
“The auditor is not required to report on the matters specified in sub-section (1) unless he has any special comments
to make on any of the items referred to therein. If he is satisfied as a result of the inquiries, he has no further duty
to report that he is so satisfied. In such a case, the content of the Auditor’s Report will remain exactly the same as
the auditor has to inquire and apply his mind to the information elicited by the enquiry, in deciding whether or not
any reference needs to be made in his report. In our opinion, it is in this light that the auditor has to consider his
duties under section 143(1).”
Clause (a) of Section 143(1) requires the auditor to inquire: “Whether loans and advances made by the company on
the basis of security have been properly secured and whether the terms on which they have been made are
prejudicial to the interests of the company or its members.”
If the auditor finds that the loans and advances have not been properly secured, he may enter an adverse comment
in the report but cannot probably doubt the true view of the accounts by reference to this fact so long as the loans
and advances are properly described and presented in terms of Part I of Schedule III to the Companies Act. Further,
the auditor has to inquire whether or not the terms on which the loans or advances have been made are prejudicial
to the interests of the company or its members. If it is, he should qualify his report.
If trade receivables and trade payables are adjusted inter se, this amounts to merely book entries. The auditor, as
per clause (b) of section 143(1), should inquire “whether transactions of the company which are represented merely
by book entries are prejudicial to the interests of the company.” This proposition has got to be inquired into by
reference to the effects of the book entries, unsupported by transactions, on the legitimate interests of the
company. The auditor has to exercise his judgment based on certain objective standards.
Regarding Personal Expenses, Clause (e) of section 143(1) requires the auditor to inquire: “Whether personal
expenses have been charged to revenue account.” The charging to revenue of such personal expenses, either on
the basis of the company’s contractual obligations or in accordance with accepted business practice, is perfectly
normal and legitimate or does not call for any special comment by the auditor. Where, however, personal expenses
not covered by contractual obligations or by accepted business practice are incurred by the company and charged
to the revenue account, it would be the duty of the auditor to report thereon. It suffices to say that if the auditor
finds that personal expenses have been charged to revenue and if the amounts are material, he should qualify his
report also.

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SM Questions
Q1. Discuss the reporting responsibilities of statutory auditor in the following situations for year 2023-24 under CARO,
2020:
(i) In the financial year 2023-2024, Candy Ltd. decided to upgrade its registered office, located at a prime spot in
Bangalore. As a part of this upgrade, the company sought to acquire an adjacent plot of land owned by Mr.
Sidhant, who is also a director of Candy Ltd. Initially hesitant to sell, Mr. Sidhant was persuaded to transfer his
property to the company in exchange for a larger plot owned by Candy Ltd. This plot, located on a nearby
street, is double the size of Mr. Sidhant’s land.
Satisfied with the exchange, Mr. Sidhant agreed to transfer the property, and the exchange was formalised in
a deed executed by the company's authorised representatives and Mr. Sidhant. The registration of the
properties was completed by December 31, 2023.
(ii) On 15th May, 2023, a TDS survey was carried out in premises of SSO Industries Limited in accordance with the
provisions of the Income Tax Act, 1961.The survey team pointed out certain lapses regarding non-deduction
of tax at source and subsequently Deputy Commissioner of Income Tax (TDS) raised a demand of ₹ 25 lacs on
the company treating it as “assessee in default”. The company has not deposited demand raised and filed
appeal against impugned order on 01st March, 2024 under e-appeals scheme with JCIT (Appeals).
Solution
(i) The auditor is required to report the transaction as per Clause (xv) of Paragraph 3 of the CARO, 2020 which states
that whether the company has entered into any non-cash transactions with directors or persons connected with
him and if so, whether the provisions of section 192 of the Companies Act have been complied with.
Further, as per Clause (xiii) of Paragraph 3 of the CARO, 2020, auditor should report whether all transactions with
the related parties are in compliance with sections 177 and 188 of Companies Act where applicable and the
details have been disclosed in the financial statements, etc., as required by the applicable accounting standards.
In the given situation, Candy Ltd. has entered into non-cash transactions with one of the directors, Mr. Sidhant
during the year, by transferring the property (by Mr. Sidhant) in favour of the Company in a deed of exchange of
a site owned by the company.
Thus, the auditor is required to report the same as per Clause (xv) and Clause (xiii) of Paragraph 3 of the CARO,
2020.
(ii) As per clause (vii) (b) of Paragraph 3 of CARO,2020, the auditor is required to report where statutory dues have
not been deposited on account of any dispute, then the amounts involved and the forum where dispute is
pending shall be mentioned.
In the given situation, the survey team pointed out certain lapses regarding non- deduction of TDS and demand
raised by DCIT(TDS). TDS dues are in the nature of statutory dues and the company has filed appeal against order
of DCIT (TDS) raising a demand of ₹ 25 lacs with JCIT (Appeals). Therefore, these are in the nature of disputed
statutory dues. Thus, it should be reported in accordance with Clause (vii) (b) of Paragraph 3 of CARO, 2020.
Q2. You are appointed as a Statutory Auditor of SDA Limited for the year 2023 -24 in the place of CA T. During the
audit you found an order dated 01.05.2023 under section 148 of the Income-tax Act, 1961 wherein tax of ₹ 50
lakhs were demanded owing to undisclosed cash sales of ₹ 150 lakhs for the financial year 2020-21 which was

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accepted by the company and the applicable tax was paid by the Company during the year 2023-24. The company
has not recorded such undisclosed income in their books of account during the year 2023-24. On further inquiring
the matter with CA T, you came to know that CA T resigned due to non-recording of such transaction by the
company. Is there any reporting responsibility cast on you regarding the above matters under CARO, 2020 for the
year 2023-24?
Solution
Reporting under Paragraph 3 of CARO, 2020: Clause (viii) of Paragraph 3 of CARO, 2020 requires the auditor to report
whether any transactions not recorded in the books of account have been surrendered or disclosed as income during
the year in the tax assessments under the Income-tax Act, 1961 (43 of 1961), if so, whether the previously
unrecorded income has been properly recorded in the books of account during the year.
In addition, Clause (xviii) of Paragraph 3 of CARO, 2020 requires the auditor to report whether there has been any
resignation of the statutory auditors during the year, if so, whether the auditor has taken into consideration the
issues, objections or concerns raised by the outgoing auditors.
In the given situation, during audit an order dated 01.05.2023 under section 148 of the Income-tax Act, 1961 was
noticed wherein tax of ` 50 lakh were demanded owing to undisclosed cash sales of 150 lakh for the financial year
2020 -21 which was accepted by the company and the applicable tax was paid by the company during the year 2023-
24. The company has not recorded such undisclosed income in their books of account during the year 2023-24. The
auditor would be required to report as per Clause (viii) of Paragraph 3 of CARO, 2020.
Further CA T, the auditor of SDA Limited resigned due to non-recording of such undisclosed income in their books
of account. The auditor would be required to report the same in CARO, 2020 as per Clause (xviii) of Paragraph 3 of
CARO, 2020.
Hence, the auditor would be required to report as per Clause (viii) and Clause (xviii) of Paragraph 3 of CARO 2020
for the year 2023-24.

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Additional Questions
Q3. Whilst the Audit team has identified various matters, they need your advice to include the same in your audit
report in view of CARO 2020:-
Physical verification of only 40% of items of inventory has been conducted bythe company. The balance 60% will
be conducted in next year due to lack of time and resources. (MTP Oct’19)
Solution
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 and whether, in
the opinion of the auditor, the coverage and the procedure of such verification by the management is appropriate,
whether any discrepancies of 10% or more in the aggregate for each class of inventory were noticed and if so,
whether it has been properly dealt with in books of accounts.
Physical verification of inventory is the responsibility of the management, which should normally verify all material
items at least once in a year and more often in appropriate cases. The auditor, in order to satisfy himself about
verification at reasonable intervals, should examine the adequacy of evidence and records of verification.
In the given case, the above requirement of CARO, 2020 has not been fulfilled as such, and the auditor should point
out the specific areas where he believes the procedure of inventory verification is not reasonable. He may consider
the impact on the financial statements and report accordingly.
Q4. Rishabh Finance Ltd. is a Non-Banking Finance Company and was in the business of accepting public deposits and
giving loans since 2015. The company was having net owned funds of ₹ 1,50,00,000/- (one crore fifty lakh) and
was not having registration certificate from RBI and applied for it on 30 th March 2020. The company appointed
Mr. Gautam as its statutory auditors for the year 2019-20.
Advise the auditor with reference to auditor procedures to be taken and reporting requirements on the same in
view of CARO 2020? (MTP Oct 21, Mar’19)
Solution
As per Clause (xvi) of Paragraph 3 of CARO 2020, the auditor is required to report on the following:
(a) Whether the company is required to be registered under section 45-IA of the Reserve Bank of India Act, 1934,
and if so, whether the registration has been obtained.
(b) Whether the company has conducted any non-banking financial or housing finance activities without a valid
certificate of registration from the RBI.
(c) Whether the company is a Core Investment Company (CIC) and, if yes, whether it fulfills the criteria of a CIC.
(d) Whether the group has more than one CIC as part of the group and, if so, the number of CICs in the group.
Audit Procedures and Reporting:
The auditor is required to examine whether the company is engaged in activities that necessitate registration as an
NBFC. Registration is required if financing activities constitute the principal business of the company. The RBI
restricts companies from carrying on the business of a non-banking financial institution without obtaining the
certificate of registration.
(i) The auditor should examine the company’s transactions in relation to activities covered under the RBI Act and
directions applicable to Non-Banking Financial Companies (NBFCs).

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(ii) The financial statements should be reviewed to determine whether the company’s financial assets constitute
more than 50% of the total assets and whether income from financial assets constitutes more than 50% of the
gross income.
(iii) Whether the company has the required net owned funds for NBFC registration.
(iv) Whether the company has obtained NBFC registration. If not, the reasons should be sought from management
and documented.
(v) The auditor should report incorporating the following:
• Whether registration is required under section 45-IA of the RBI Act, 1934.
• If so, whether the company has obtained the registration.
• If registration has not been obtained, the reasons for non-compliance.
Rishabh Finance Ltd., a Non-Banking Financial Company (NBFC), has been engaged in accepting public deposits and
providing loans since 2015. The company had net owned funds of ₹1.5 crore, which is below the prescribed limit of
₹2 crore. Additionally, it did not possess an RBI registration certificate, although it applied for one on 30th March
2020. The auditor is required to report on these matters as per Clause (xvi) of Paragraph 3 of CARO 2020.
Q5. Whilst the audit team has identified various matters, they need your advice on including the same in the audit
report in view of CARO 2020:
(i) The long-term borrowings from the parent company have no agreed terms, and neither the interest nor the
principal has been repaid so far. (MTP Nov’21, Mar’19, RTP May’19
(ii) An amount of ₹2.35 lakh per month is paid to M/s. RARE Associates, a partnership firm, which is a 'related
party' as per the provisions of the Companies Act, 2013, for marketing services rendered by them. Based on
an independent assessment, the consideration paid is higher than the arm's length price by ₹0.35 lakh per
month. While the transaction was accounted for in the financial statements based on the amounts paid, no
separate disclosure has been made in the notes forming part of the accounts highlighting the same as a 'related
party' transaction. (MTP Nov’21, MTP Oct’19, RTP May’19)
Solution
As per clause (xiii) of paragraph 3 of CARO 2020, the auditor is required to report, “whether all transactions with the
related parties are in compliance with sections 177 and 188 of the Companies Act, 2013 where applicable and
whether the details have been disclosed in the Financial Statements, as required by the applicable accounting
standards.”
In the present case, the auditor is required to report as per clause (xiii) of paragraph 3 of CARO 2016 (CARO 2020)
regarding the receipt of long-term borrowing from the Parent Company, which qualifies as a transaction with a
related party.
(ii) As per clause (xiii) of paragraph 3 of CARO 2020, the auditor is required to report “whether all transactions with
the related parties are in compliance with sections 177 and 188 of the Companies Act, 2013 where applicable and
whether the details have been disclosed in the Financial Statements, as required by the applicable accounting
standards.”
Therefore, the duty of the auditor under this clause is to report:
(i) Whether all transactions with related parties are in compliance with sections 177 and 188 of the Companies Act,
2013 (“Act”);

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(ii) Whether related party disclosures as required by relevant Accounting Standards (AS 18, as applicable) are
included in the financial statements.
In the present case, the auditor is required to report as per clause (xiii) of paragraph 3 of CARO 2020, as a related
party transaction amounting to ₹2.35 lakh per month for marketing services has been identified, wherein ₹0.35 lakh
per month exceeds the arm’s length price and has not been disclosed as a related party transaction as per AS 18.
Thus, the auditor is required to report accordingly.
Q6. Whilst the Audit team has identified various matters, they need your advice to include the same in your audit
report in view of CARO 2020: -
(i) The Company is in the process of selling its office along with the freehold land available at Pune and is actively
on the lookout for potential buyers. Whilst the same was purchased at ₹ 20 Lakh in 2006, the current market
value is ₹ 200 Lakh. This property is pending to be registered in the name of the Company due to certain
procedural issues associated with the registration, though the Company is having valid possession and has paid
its purchase cost in full. The Company has disclosed this amount under Fixed Assets, though no disclosure of
non-registration is made in the notes forming part of the accounts. (MTP Oct’21, RTP May’19)
(ii) The Internal Auditor of the Company has identified a fraud in the recruitment of employees by the HR
department wherein certain sums were alleged to have been taken as kickbacks from the employees for taking
them on board with the Company. After due investigation, the concerned HR Manager was sacked. The
amount of such kickbacks is expected to be in the range of ₹13.50 Lakh. (MTP Oct’21, MTP Mar’19, RTP May’19)
Solution
(i) As per Clause (i)(c) of Para 3 of CARO 2020, the auditor is required to report:
"whether the title deeds of all immovable properties (other than properties where the company is the lessee and
lease agreements are duly executed in favor of the lessee) disclosed in the financial statements are held in the
name of the company. If not, provide details thereof in the prescribed format."
In the present case, the Company has an office along with freehold land in Pune. Although the Company has paid
the purchase cost in full, the title deed has not been registered in its name since 2006. Hence, the auditor must
report this under Clause (i)(c) of Para 3 of CARO 2020, including details such as:
• Description of Property
• Gross Carrying Value
• Held in the name of
• Whether Promoter, Director, or their relative or employee
• Period held – indicate range, where appropriate
• Reason for not being held in the name of the Company
(ii) As per Clause (xi) of Para 3 of CARO 2020, the auditor is required to report:
(a) “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 and the amount involved is to be indicated.”
(b) Whether any report under Section 143(12) of the Companies Act has been filed by the Auditors in Form ADT-
4 as prescribed under Rule 13 of the Companies (Audit & Auditor) Rules, 2014 with the Central Government.
(c) Whether the auditor has considered whistleblower complaints, if any, received during the year.

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In the instant case, a fraud has been identified in the recruitment of employees by the HR Department, wherein
certain sums were alleged to have been taken as kickbacks from the Company, amounting to approximately ₹13.50
lakh. The auditor is required to report on the same in accordance with Clause (xi) of Para 3 of CARO 2020.
Q7. Stone Private Limited was engaged in the business of manufacturing Cycles. CA. Chandra was appointed as the
Statutory Auditor of the Company for the financial year 2021-22. During the year under audit, Stone Private
Limited obtained working capital facilities from Royal Bank Limited for ₹10 crore, hypothecating the stock of
goods as primary security.
On inquiry, CA. Chandra was informed by management that stock statements are furnished periodically to Royal
Bank Limited, and the details of submission of the quarterly stock statement are as follows:

Period of Stock Value as per Books of Stock Value as per Quarterly Statement
Stock Account (₹ in crore) submitted to Royal Bank Limited (₹ in crore)
Q1-2021-22 21.50 24.00
Q2-2021-22 24.75 27.00
Q3-2021-22 21.50 24.00
Q4-2021-22 25.25 25.25
The management of Stone Private Limited did not disclose the above variations in the Notes to Accounts forming
part of the Financial Statements of the Company for the year 2021-22. The management replied that there are no
variations as on the Balance Sheet date and further stated that they are of the view that the stock statement
furnished to the bank is only a formality and computed arbitrarily only for the purpose of securing higher drawing
power, and hence, statutory auditors need not be bothered.
Is the contention of the management valid?
As a Statutory Auditor, how CA. Chandra should deal with the same and discuss the disclosure/reporting
requirements if any, as per CARO, 2020. (MTP March ’23, PYP May ’22)
Solution
As per Para 3(ii)(b) of CARO 2020, the auditor is required to report whether during any point of time of the year, the
company has been sanctioned working capital limits in excess of five crore rupees, in aggregate, from banks or
financial institutions on the basis of security of current assets; and whether the quarterly returns or statements filed
by the company with such banks or financial institutions are in agreement with the books of account of the company.
If not, give details.
The above clause requires CA Chandra to comment on:
• Whether during any point of time of the year, the company has been sanctioned working capital limits in excess
of ₹5 crores in aggregate.
Stone Private Limited has been sanctioned working capital facilities/limit of ₹10 crores, which is apparently in
excess of ₹5 crores.

• Whether the quarterly returns filed by Stone Private Limited with Royal Bank Limited are in agreement with
the books of accounts of the company.
According to the data given in the instant situation, it is clear that there are variations in Quarter 1, Quarter 2 &
Quarter 3, requiring reporting under this clause because of differences in stock value as per Book of Accounts &
Stock Value as per Quarterly Returns submitted to Royal Bank Limited.
Therefore, the contention of the management is not valid.

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Quarter Stock Value as per Book Stock Value as per Quarterly Statement Variation
of Accounts (₹ Crore) Submitted to Royal Bank Ltd. (₹ in Crore)
Q1 21.50 24.00 Excess reporting of stock
to Bank by ₹2.50 crore
Q2 24.75 27.00 Excess reporting of stock
to Bank by ₹2.25 crore
Q3 21.50 24.00 Excess reporting of stock
to Bank by ₹2.50 crore
CA Chandra should report these discrepancies as per CARO 2020 and the Companies Act, 2013.
Q8. Mr. Arjun was appointed as the engagement partner on behalf of Bhism & Co., a Chartered Accountant Firm, for
conducting the statutory audit assignment of Sinwar Ltd., an unlisted public company. Mr. Brijesh, one of the
senior engagement team members, was given the responsibility to audit the matters as per the requirements of
CARO 2020, and in that connection, he made the following observations that may be relevant for reporting as per
the said Order:

Sr. No. Observations

(a) One of the Plant and Equipment taken on a lease (‘right of use’ asset) by Sinwar Ltd. was revalued
based on the valuation by a registered valuer, and the net carrying value of Plant and Equipment
in aggregate was changed from ₹ 4 crore to ₹ 4.45 crore.
(b) During the year under consideration, a cash credit limit of ₹ 5.5 crore was sanctioned to Sinwar
Ltd. by DMC Bank based on the security of current assets, which was reduced to ₹ 4.5 crore after
6 months. In this connection, quarterly returns have been filed by the company with DMC Bank,
which are in agreement with the Books of Accounts.
You are required to examine the contention of Mr. Brijesh regarding the reporting of the above observations in
accordance with CARO 2020.
Solution
Matters to be reported by Mr. Brijesh as per CARO 2020 are as follows:
(a) According to Clause (i)(d) of Para 3 of CARO 2020, the auditor is required to report whether the company has
revalued its Property, Plant and Equipment (including Right of Use assets) or intangible assets or both during the
year and, if so, whether the revaluation is based on the valuation by a Registered Valuer; specify the amount of
change if the change is 10% or more in the aggregate of the net carrying value of each class of Property, Plant
and Equipment or intangible assets.
In the given situation, Sinwar Ltd. has revalued one of the Plant and Equipment taken on a lease (‘Right of Use’
asset) based on the valuation by a registered valuer. The amount of change in the value of such Plant and
Equipment is ₹ 45 lakh. As the net carrying value of Plant and Equipment in aggregate changed from ₹ 4 crore to
₹ 4.45 crore, i.e., the change was 10% or more, the auditor is required to report the amount of change of ₹ 45
lakh in accordance with Clause (i)(d) of Para 3 of CARO 2020.
(b) As per Clause (ii)(b) of Para 3 of CARO 2020, the auditor is required to report whether during any point of time
of the year, the company has been sanctioned working capital limits in excess of ₹ 5 crore, in aggregate, from
banks or financial institutions on the basis of security of current assets; whether the quarterly returns or
statements filed by the company with such banks or financial institutions are in agreement with the books of
account of the Company; if not, give details.

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In the instant case, Sinwar Ltd. has been sanctioned a cash credit limit of ₹ 5.5 crore by DMC Bank during the
year under consideration, which exceeds the prescribed limit of ₹ 5 crore based on the security of current assets.
Further, quarterly returns have also been filed by the company with DMC Bank, which are in agreement with
the Books of Accounts.
In view of the above, the auditor is required to report the same in accordance with Clause (ii)(b) of Para 3 of
CARO 2020.
Q9. Gautam Limited had borrowed ₹ 1000 crore from XYZ Bank, with the principal repayable after 5 years and interest
payable at the end of each year. For the first 4 years, Gautam Limited paid the interest on time. However, the
company defaulted on the 5th installment of interest payment and principal, which was due on June 30, 2021.
On March 31, 2021, Gautam Limited approached XYZ Bank and MNO Bank to restructure the existing liability. As
a result, the existing principal and outstanding overdue interest were restructured into a new loan amounting to
₹ 1,100 crore. The management did not provide any disclosure for the default on the loan, believing that the old
loan ceased to exist and the new loan had a maturity of another 5 years.
During the statutory audit for the financial year 2021-22, KP & Co. identified this transaction and obtained the
relevant documents and understanding. Based on the underlying documents, it was identified that the
restructuring agreement was approved and signed on April 8, 2022, by both banks. As a result, on March 31, 2022,
the restructuring was still not approved.
In light of the above scenario, the statutory auditors should report this transaction appropriately in accordance
with the relevant accounting and auditing standards.
Solution
As per Clause 3(ix) of CARO 2020, the auditor is required 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 period and the amount
of default are to be reported as per the format below:

Nature of Borrowing Name of Amount Not Paid on Whether Principal No. of Days Remarks, if any
(including Debt Lender Due Date (₹ in Crore) or Interest Delay or Unpaid
Securities)
In the given case, Gautam Limited defaulted in payment of the principal loan amount of ₹ 1000 crore due on 30 June
2021 and the interest installment of ₹ 100 crore. The default continued till the end of the year, and on 8 April 2022,
a restructuring agreement was signed by the banks and the company for restructuring the outstanding loan.
Moreover, no disclosure was provided by the company with respect to the said matter.
Hence, the auditor is required to report the same matter under Clause (ix) of Para 3 of CARO 2020, i.e., 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 details of the period and the amount of default must be provided.
Additionally, the auditor needs to consider the impact of such non-disclosure and non-compliance with the financial
reporting framework. Accordingly, the auditor should either issue a qualified opinion or an adverse opinion as per
SA 705, "Modifications to the Opinion in the Independent Auditor’s Report."
Q10. LIU Private Limited is a company based out of Mumbai. The company had an authorised capital of ₹ 200 lakh and
paid-up capital plus reserves of ₹ 95 lakh as of 31st March. During the audit for the year ended 31st March 202X,
the auditor M/s Y&S Associates noted the following points:

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(i) On 15th December, the company had total bank borrowings of ₹ 75 lakh. On the said date, the company
received a new loan of ₹ 30 lakh for a new project that was to be developed. However, the project was
shelved on 17th December due to technical reasons, and the whole loan was paid on the same date.
(ii) During the financial year, a new proceeding was initiated against the company for holding a benami property
worth ₹ 2.5 crore. However, the company's legal team had advised that the case would not withstand the
law and would be dismissed during the hearing in April of the next financial year.
(iii) The company had incurred a cash loss of ₹ 39 lakh during the financial year compared to a cash profit of ₹ 15
lakh in the previous financial year. The total turnover of the company for the financial year was ₹ 45 Crore.
During the year, the Y&S Associates had offered to resign from acting as the company's auditors. However, they
later decided to postpone their resignation to the following year. At the conclusion of the audit, there was a
difference of opinion between two articled assistants (Jack & Jill), who were assigned to the engagement,
concerning disclosing the points mentioned above in the Companies (Auditor's Report) Order 2020.
Jack was of the opinion that the proceeding initiated under Benami Property Act need not be disclosed since the
expert legal team had informed them that the case would not withstand the law. However, he insisted that the
cash loss shall be disclosed along with the amount.
Jill was of the opinion that CARO is not at all applicable to the company, hence nothing needs to be reported.
They both approached the firm's partners (Mr. Y & Mr. S) to resolve their argument.
Mr. Y supported Jack's viewpoint & Mr. S supported Jill's viewpoint. Now, both partners approached their Senior
Partner to get clarification on the same. As a Senior Partner, kindly clarify the correct disclosure requirement.
(RTP May ’23)
Solution
As per para 1 of Companies (Auditor's Report) Order 2020, CARO 2020 is applicable to every company, including a
foreign company, as defined in clause (42) of section 2 of the Companies Act 2013, except:
(i) a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949);
(ii) an insurance company as defined under the Insurance Act, 1938 (4 of 1938);
(iii) a company licensed to operate under section 8 of the Companies Act;
(iv) a One Person Company as defined under clause (62) of section 2 of the Companies Act and a small company as
defined under clause (85) of section 2 of the Companies Act; and
(v) a private limited company, not being a subsidiary or holding company of a public company, having a paid-up
capital and reserves and surplus not more than rupees one crore as on the balance sheet date and 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 and which does not have a total revenue as disclosed in Schedule 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, though LIU is a private company, and its paid-up capital is less than ₹ 1 crore as on the balance
sheet date, it is to be noted that for the period 15th December to 17th December, the total borrowings of the
company had exceeded ₹ 1 crore (₹ 75 lakh + ₹ 30 lakh). The borrowings are less than ₹ 1 crore as of the balance
sheet date, and the authorized capital is ₹ 200 lakh, are irrelevant to the current scenario. Also, the turnover of the
company was greater than ₹ 40 crore. Hence, CARO 2020 is applicable to LIU Private Limited.
(i) As per clause (i)(e) of para 3 of CARO 2020, the auditor shall include a statement on whether any proceedings
have been initiated or pending against the company for holding any benami property under the Benami

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Transactions (Prohibition) Act, 1988 (45 of 1988) and rules made thereunder, if so, whether the company has
appropriately disclosed the details in its financial statements.
In the given situation, a new proceeding was initiated against the company for holding a benami property worth
₹ 2.5 crore during the financial year. However, the company's legal team had advised that the case would not
withstand the law and would be dismissed during the hearing, which would be held in April of the next financial
year.
Therefore, the above observation of a new proceeding initiated against the company for holding a benami
property worth ₹ 2.5 crore needs to be disclosed as per clause (i)(e) of para 3 of CARO 2020.
(ii) As per clause (xvii) of para 3 of CARO 2020, the auditor shall include a statement on whether the company has
incurred cash losses in the financial year and in the immediately preceding financial year, if so, state the amount
of cash losses.
In the given situation, the company incurred a cash loss of ₹ 39 lakh during the financial year. Hence, a cash loss
of ₹ 39 lakh during the financial year needs to be reported as per clause (xvii) of para 3 of CARO 2020.
(iii) As per clause (xviii) of para 3 of CARO 2020, the auditor shall include a statement on whether there has been
any resignation of the statutory auditors during the year, if so, whether the auditor has taken into consideration
the issues, objections, or concerns raised by the outgoing auditors.
In the instant case, there has been no resignation made by the statutory auditors during the financial year. The
mere fact that Y&S Associates were thinking of resigning does not matter in the current scenario, and hence this
clause shall not be applicable in the given situation.
Q11. CA. F has been appointed as the Statutory Auditor of XYZ Limited for the financial year 2022-23. XYZ Limited has
one subsidiary, namely AT Private Limited, whose statutory auditor is CA. B for same financial year i.e., 2022-23.
CA. B issued a qualification in CARO 2020 for AT Private Limited, stating that short-term funds raised were utilised
for long-term purposes. When consolidating the financial statements, CA. F decided to include the
aforementioned qualification in the audit report of the Consolidated Financial Statements for the financial year
2022-23. The management of XYZ Limited argued that CA. F is not obligated to take into account and report the
qualification given by CA. B in the audit report of the subsidiary company in the consolidated financial statements
for the financial year 2022-23.
Discuss the reporting requirement as per CARO, 2020. (RTP Nov ’23)
Solution
XYZ Limited is the parent company, and it has a subsidiary named AT Private Limited. CA F is the appointed statutory
auditor for XYZ Limited for the financial year 2022-23. Another auditor, CA B, has conducted the statutory audit for
AT Private Limited and issued a CARO 2020 report, which includes a qualification regarding the short-term funds
raised and utilised for long-term purposes.
Provision of Paragraph 2 of CARO 2020: Paragraph 2 of CARO 2020 specifies that the CARO provisions do not apply
to the auditor's report on consolidated financial statements except for clause (xxi) of Paragraph 3.
Clause (xxi) of Paragraph 3 of CARO 2020: Clause (xxi) of Paragraph 3 of CARO 2020 mandates the auditor to
comment on whether there are any qualifications or adverse remarks in the CARO reports of companies included in
the consolidated financial statements. If such qualifications or adverse remarks exist, the auditor is required to
provide details of the companies and the paragraph numbers of the CARO report containing those qualifications or
adverse remarks.

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CA F's Responsibility: Considering the provisions stated above, CA F, as the auditor of XYZ Limited's consolidated
financial statements, is required to follow these steps:
a). Report under Clause (xxi) of Paragraph 3 of CARO 2020: CA F must include a comment in the consolidated financial
statement's audit report regarding whether there are any qualifications or adverse remarks in the CARO reports
of the companies included in the consolidated financial statements.
b). Incorporate Qualification by CA B: CA F should incorporate the qualification made by CA B (regarding short-term
funds raised and utilized for long-term purposes in AT Private Limited) into the auditor's report for XYZ Limited's
consolidated financial statements.
c). Mention Paragraph Number: CA F must also provide the paragraph number of CA B's CARO report where the
qualification is stated.
Management's Contention: The management of XYZ Limited's contention that CA F is not required to consider and
report CA B's qualification in the subsidiary's CARO report for the consolidated financial statements is not valid. As
per the provisions, CA F is indeed required to report such qualifications as specified in Clause (xxi) of Paragraph 3 of
CARO 2020.
In conclusion, based on the information provided and the provisions of CARO 2020, CA F is obligated to incorporate
the qualification from CA B's CARO report for AT Private Limited into the auditor's report for XYZ Limited's
consolidated financial statements for the financial year 2022-23, as well as provide the necessary details as per the
requirements of Clause (xxi) of Paragraph 3 of CARO 2020.
Q12. C Limited has defaulted in repayment of dues to a financial institution during the financial year 2016- 17 and the
same remained outstanding as at March 31, 2017. However, the Company settled the total outstanding dues
including interest in April, 2017 subsequent to the year end and before completion of the audit. Discuss how you
would deal with this matter and draft a suitable Auditor's Report. (RTP May 18)
Solution
Reporting for Default in Repayment of Dues (As per CARO 2020):
As per Clause (ix) of Paragraph 3 of the Companies (Auditor’s Report) Order, 2020, the auditor is required to report
on the following matters related to default in repayment of dues:
(a) Whether the company has defaulted in repayment of loans or other borrowings to a financial institution, bank,
government, or debenture holders. If yes, the auditor must report the amount and period of default.
(b) Whether the company is declared a willful defaulter by any bank or financial institution or other lender.
(c) Whether term loans were utilized for the purpose for which they were obtained.
(d) Whether funds raised for short-term purposes have been utilized for long-term purposes. If yes, the amount and
nature of the same must be reported.
(e) Whether the company has taken any funds from any entity or person on account of or to meet the obligations
of its subsidiaries, joint ventures, or associates. If yes, the amount and nature of such transactions must be
reported.
(f) Whether the company has raised loans on the pledge of securities held in its subsidiaries, joint ventures, and
associates. If yes, details must be provided, along with any default in repayment.
In the given case, C Ltd. defaulted in repayment of dues to a financial institution during the financial year 2016-17,
which remained outstanding as of March 31, 2017. However, the company settled the total outstanding dues,

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including interest, in April 2017. Since the default existed as of March 31, 2017, it must be reported in the notes to
accounts.
The draft report for the above matter is as follows:
*"The company has taken a loan during the year from a financial institution amounting to Rs. XXXX @ X% p.a., which
is repayable by monthly installment of Rs. XXXX for XX months.
The company has defaulted in repayment of dues, including interest, to a financial institution during the financial
year 2015-16, amounting to Rs. XXXX, which remained outstanding as of March 31, 2017. The period of default is
XXX days. However, the outstanding sum was settled by the company in April 2017."*
Q13. Under CARO,2020, as a statutory auditor, how would you report?
(i) RPS Ltd. has entered into non-cash transactions with Mr. Rahul, son of director, which is an arrangement by
which the RPS Ltd. is in process to acquire assets for consideration other than cash.
(ii) NSP Limited has its factory building, appearing as fixed assets in its financial statements in the name of one of
its director who was overlooking the manufacturing activities. (RTP Nov 19)
Solution
(i) Non-cash Transactions with Relative of Director:
As per Clause (xv) of Paragraph 3 of CARO, 2020, the auditor is required to report “whether the company has
entered into any non-cash transactions with directors or persons connected with him and if so, whether the
provisions of Section 192 of the Companies Act, 2013 have been complied with.”
Section 192 of the said Act deals with restrictions on non-cash transactions involving directors or persons
connected with them. The section prohibits the company from entering into such types of arrangements unless
it is an arrangement by which the company acquires or is to acquire assets for consideration other than cash
from such director or person so connected.
In the instant case, RPS Ltd. has entered into non-cash transactions with Mr. Rahul, son of a director, which is an
arrangement by which RPS Ltd. is in the process of acquiring assets for consideration other than cash. In the
above situation, the provisions of Section 192 of the Companies Act, 2013, have been complied with.
However, the reporting requirements under this clause are given in two parts. The first part requires the auditor
to report on whether the company has entered into any non-cash transactions with the directors or any persons
connected with such directors. The second part of the clause requires the auditor to report whether the
provisions of Section 192 of the Act have been complied with.
Therefore, the second part of the clause becomes reportable only if the answer to the first part is affirmative. In
the given situation, RPS Ltd. has entered into non-cash transactions with Mr. Rahul, son of a director, which is an
affirmative answer to the first part of Clause (xv) of Paragraph 3 of CARO, 2020. Thus, reporting is required for
the same. The draft report is given below:
Draft Report:
"According to the information and explanations given to us, the Company has entered into non-cash transactions
with Mr. Rahul, son of one of the directors, during the year, for the acquisition of assets, which in our opinion is
covered under the provisions of Section 192 of the Companies Act, 2013."

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(ii) Title Deeds of Immovable Property in the Name of Director:

As per Clause (i)(c) of Paragraph 3 of CARO 2020, the auditor is required to report, “whether the title deeds of
immovable properties are held in the name of the company (other than properties where the company is the
lessee and the lease agreements are duly executed in favor of the lessee). If not, provide the details thereof in
the following format below.”
In the present case, the Company has an office along with freehold land in Pune. Though the company has paid
its purchase cost in full, this property is pending registration in the name of the company, i.e., the title deed is
not in the name of the Company since 2006. Therefore, the auditor is required to report the same in accordance
with Clause (i)(c) of Paragraph 3 of CARO 2020.
The reporting under this clause is in the form of a table:
• Description of Property
• Gross Carrying Value
• Held in Name of
• Whether Promoter, Director, Relative, or Employee
• Period Held – Indicate Range Where Appropriate
• Reason for Not Being Held in the Name of the Company (Also Indicate if in Dispute)
Q14. ABC & Associates are conducting audit of consolidated financial statements of “Crazy Paints Limited” for year
2022-23. The consolidated financial statements consist of financial statements of parent company and its five
subsidiaries (audited by component auditors). While drafting audit report in respect of consolidated financial
statements under Companies Act, 2013, how firm should proceed to deal with issue of reporting under CARO,
2020? (MTP Oct ‘23)
Solution
CARO, 2020 specifically provides that it shall not apply to the auditor’s report on consolidated financial statements
except clause (xxi) of paragraph 3. This means that the auditor will need to give a CARO report on the consolidated
financial statements with respect to clause 3(xxi) of the Order only. Thus, the auditor is not required to report on
rest of the clauses of paragraph 3.
Clause 3(xxi) of CARO 2020 requires the auditor to state whether there have been any qualifications or adverse
remarks by the respective auditors in the Companies (Auditor’s Report) Order (CARO) reports of the companies
included in the consolidated financial statements. If yes, indicate the details of the companies and the paragraph
numbers of the CARO report containing the qualifications or adverse remarks.
Therefore, it requires the auditor to provide details of the companies and the paragraph numbers of the respective
CARO report containing the qualifications or adverse remarks only. Reporting under this is only required for those
entities included in the consolidated financial statements to whom CARO 2020 is applicable.
Q15. The Property, Plant and Equipment of ABC Ltd. included ₹ 25.75 crores of earth removing machines of outdated
technology which had been retired from active use and had been kept for disposal after knock down. These assets
appeared at residual value and had been last inspected ten years back. As an Auditor, what may be your reporting
concern as regards matters specified above? (PYP May ’18, MTP May’20 & April 21)

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Solution
The auditor is required to specifically include certain matters in the audit report as per CARO 2020 under Section
143 of the Companies Act, 2013.
According to Clause (i)(a) of CARO 2020, the auditor must comment on whether the company is maintaining proper
records showing full particulars, including quantitative details and the situation of Property, Plant & Equipment
(PPE), and whether proper records are maintained for intangible assets.
Further, as per Clause (i)(b) of CARO 2020, the auditor must report whether these PPE and intangible assets have
been physically verified by the management at reasonable intervals and whether any material discrepancies were
noticed during such verification. If so, the auditor must confirm whether these discrepancies have been properly
accounted for in the books of accounts.
In the given case, ABC Ltd. intends to sell its earth-removing machines of outdated technology, which have been
retired from active use and kept for disposal after knockdown. These assets are appearing at residual value.
However, the last physical verification of such machines was conducted 10 years ago, even though their carrying
value is ₹25.75 crores, which is a material amount. This non-compliance with Clause (i)(b) of CARO 2020 requires
disclosure in the audit report.
Audit Report Disclosure:
Hence, this fact needs to be disclosed in Audit Report as per Clause (i)(a) and (i)(b) of Paragraph 3 of CARO 2020.
Q16. During the financial year ended on 31/03/2018, LM Private Limited had borrowed from a Nationalized Bank, a
term loan of ₹ 120 lakhs consisting of ₹ 100 lakhs for purchase of a machinery for the new plant and ₹ 20 lakhs
for erection expenses. As on the date of 31st March, 2018, the total of capital and free reserves of the Company
was ₹ 50 lakhs and turnover for the year 2017-18 was ₹ 750 lakhs. The Bank paid ₹ 100 lakhs to the vendor of the
Company for the supply of machinery on 31/12/2017. The machinery had reached the yard of the Company. On
28/02/2018, the Company had drawn the balance of loan viz. ₹ 20 lakhs to the credit of its current account
maintained with the Bank and utilized the full amount for renovating its administrative office building. The
machinery had been kept as capital stock under construction. Comment as to reporting issues, if any, that the
Auditor should be concerned with for the financial year ended on 31/03/2018, in this respect. (PYP Nov ‘18)
Solution
CARO 2020 specifically exempts a private limited company from its applicability if it meets all of the following
conditions:

• It is not a subsidiary or holding company of a public company.

• Its paid-up capital and reserves & surplus do not exceed ₹1 crore as of the balance sheet date.
• Its total borrowings from banks or financial institutions do not exceed ₹1 crore at any point during the financial
year.
• Its total revenue, as disclosed in Schedule III to the Companies Act, 2013, does not exceed ₹10 crore during
the financial year.
In the case of LM Pvt. Ltd., the paid-up capital is ₹50 lakh, which is below the specified limit of ₹1 crore. The turnover
is ₹7.5 crore, which is also below the specified ₹10 crore threshold. However, the total borrowing of ₹1.20 crore
exceeds the ₹1 crore limit. Hence, CARO 2020 is applicable to LM Pvt. Ltd.

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Utilization of Term Loans (As per Clause (ix) of Para 3 of CARO 2020)
According to Clause (ix) of Para 3 of CARO 2020, the auditor must report on the following aspects:
(a)The auditor must state whether term loans were applied for the purpose for which they were obtained. If not,
the details of misutilization, delays, defaults, and subsequent rectification, if any, must be reported in a
structured format as follows:

Nature of Name of Amount Not Whether No. of Days Remarks, if

Borrowings Lender Paid on Due Principal or Delay or any
(Including Debt Date Interest Unpaid
Securities)
(b) Reporting whether company has been declared a willful defaulter by bank, financial institution, or other lender.
(c) Reporting whether term loans were applied for the intended purpose.
(d) Reporting whether funds raised for short-term purposes have been utilized for long-term purposes. If yes, the
amount and nature of such diversion must be reported.
(e) Reporting whether the company has taken any funds from any entity or person to meet the obligations of its
subsidiaries, joint ventures, or associates. If yes, the amount and nature of such transactions must be disclosed.
(f) Reporting whether the company has raised loans against the pledge of securities held in subsidiaries, joint
ventures, or associates. If yes, details and any default in repayment must be reported.
Audit Procedure for Verification
The auditor must examine the terms and conditions under which the company obtained the term loan. The loan
sanction letter and related documents typically mention the end-use of the funds. The auditor should:

• Verify whether the actual utilization of funds aligns with the intended purpose.
• Obtain sufficient and appropriate audit evidence regarding how the funds were used.
• Report any misutilization if the funds were not used for the intended purpose.
• Findings in the Case of LM Pvt. Ltd.
In the present case, LM Pvt. Ltd. obtained a term loan of ₹20 lakh, which was meant for erection expenses. However,
the funds were instead used for renovating the administrative office building.
Additionally, assuming that the erection work has not been completed and the machinery has not been installed,
disclosure of the same as Capital Stock Under Construction would be required.
Audit Report Disclosure
Since the term loan was not utilized for its intended purpose, the auditor must report this fact in accordance with
Clause (ix) of Para 3 of CARO 2020. The report should clearly state that:
Pending utilization for erection expenses, the funds were temporarily used for an alternate purpose.
This misutilization must be disclosed in the audit report.
Q17. You are appointed as the Auditor of XMP Pvt. Ltd. for financial year 2021-22 after the resignation of RS & Co.
Chartered Accountants, as statutory auditor of the company. RS & Co. had certain concerns on the accounting
matters of the company, leading to change of auditors. All the compliances under Sections 139 and 140 are made
by the company with regard to resignation and appointment.

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During the course of audit, it came to your notice that a survey has been conducted on December 7, 2021 by the
Income Tax Department and department has unearthed unrecorded sales of ₹ 5 lakhs which had been made in
cash on different dates during the year 2020-21. XMP Pvt. Ltd. has purchased gold from such collections and these
transactions are not recorded. Company surrendered and disclosed these transactions before the assessing officer
and paid taxes thereon. However, company has not recorded those transactions in books of account even after
surrender before Income Tax authorities.
You want to report the above matters in CARO, but the management requested you not to report them. Comment
with respect to auditor's response to the management and his reporting requirements to the shareholders. (PYP
Nov 22)
Solution
Clause (xviii) of Paragraph 3 of CARO, 2020:
In the given situation of XMP Pvt Ltd, the auditors RS & Co. resigned due to concerns on the accounting matters of
the company. However, all the compliances regarding resignation and appointments discussed in section 139 and
140 of the Companies Act, 2013 are also being complied with. The auditor would be required to report the same in
CARO, 2020 as per Clause (xviii) of Paragraph 3 of CARO, 2020 given hereunder:
Clause (xviii) of Paragraph 3 of CARO, 2020 requires the auditor to report whether there has been any resignation
of the statutory auditors during the year, if so, whether the auditor has taken into consideration the issues,
objections or concerns raised by the outgoing auditors.
Clause (viii) of Paragraph 3 of CARO, 2020:
Further, the auditors noticed that a survey was conducted by the Income Tax Department and unrecorded sales of
Rs 5 Lakhs were unearthed which had been made in cash on different dates during the year. XMP Pvt Ltd. has also
purchased gold and the transactions remained unrecorded. Though Company surrendered and disclosed these
transactions before the Assessing Officer and paid taxes thereon. The auditor would be required to report in CARO
as per Clause (viii) of Paragraph 3 of CARO, 2020.
Clause (viii) of Paragraph 3 of CARO, 2020 requires the auditor to report - whether any transactions not recorded in
the books of account have been surrendered or disclosed as income during the year in the tax assessments under
the Income Tax Act, 1961 (43 of 1961), if so, whether the previously unrecorded income has been properly recorded
in the books of account during the year.
Since it is a statutory obligation on the part of the auditor to report in terms of CARO, 2020 as given above and
consequently management’s request to the auditor that not to report the above transactions is not tenable.
Q18. SPM Ltd., about to complete fifty years of age since its incorporation in the F.Y 2023-2024, decided during the F.Y
year 2022-23 to upgrade its registered office at an important location in Mumbai city. As part of planned package,
it decided to acquire a land very adjacent to the site of registered office, which had been owned by Mr. Parry,
who is a director of the Company. Since he was reluctant to part with the ownership, he had been persuaded to
convey the property in favour of the company in exchange of a site owned by the company located at the next
street to the street where the registered office is situated, which is 1.50 times larger in area than that of the site
owned by the director adjacent to the Registered office. Happier with what he was offered in negotiation, Mr.
Parry agreed for transferring the property in favour of the company in a deed of exchange duly executed by
authorized persons of the Board, and Mr. Parry. The registration formalities were completed by 31st December,
2022. Assuming that you are the engagement partner for the audit of the accounts of the company for the

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financial year ended on 31st March, 2023, give a list of additional audit procedures and reporting requirements,
if any, that this transaction might trigger in your audit. (PYP May ‘23)
Solution
CARO Audit Procedures and Reporting:
In the given situation, SPM Ltd has entered into non-cash transactions with one of the directors, Mr. Parry, during
the year, by transferring the property (by Mr. Parry) in favour of the Company in a deed of exchange of a site owned
by the company.
Paragraph 3 Clause (xv) of the CARO 2020 & Reporting Requirements:
The auditor is required to report the transaction as per Paragraph 3(xv) of the CARO, 2020, which states that whether
the company has entered into any non-cash transactions with directors or persons connected with him and if so,
whether the provisions of section 192 of Companies Act have been complied with.
For reporting on the first part of this clause, the starting point of the auditor’s procedures could be obtaining a
management representation as to whether the company has undertaken any non-cash transactions with the
directors or persons connected with the directors, as envisaged in section 192(1) of the Act.
The second part of this clause requires the auditor to report whether the company has complied with the provisions
of section 192 in this regard. Section 192(1) and (2) of the Act envisage the following compliances in respect of such
transactions:
(i) The company should have obtained a prior approval for such arrangement by a resolution in the general meeting.
(ii) Notice for approval of the resolution should contain details of the arrangement along with the value of assets
involved.
The auditor should check compliance with section 192(2) of the Act and verify the notice of the general meeting
that it includes particulars of the arrangement along with the value of the assets involved in such arrangements.
This transaction was duly executed by the authorised persons of the Board. The auditor has to state the fact whether
approval has been obtained in the general meeting of the company.
Related Party Transactions:
This is a transaction with a related party. The provisions of section 188 of the Companies Act, 2013, as regards
Related Party Transactions, are to be checked for compliance. Section 189 of the Companies Act, 2013, requires a
register to be maintained wherein the contract with related parties is to be entered.
The compliance with section 177 and section 188 has to be reported under Clause (xiii) of the CARO, 2020.
Documents to be verified:
A scrutiny of the following books of account, records, and documents could provide a source of such audit evidence
to the auditor as to the existence of such non-cash transactions.

• Register of Loans, Guarantee, Security and Acquisition Made by the Company, Register of Contracts with
Related Party and Contracts and Bodies etc. in which Directors are Interested.
• Movements in the Fixed Asset Register.
• Minutes book of the General Meeting and Meetings of Directors.
• Report on Annual General Meeting.
Q19. TEA Ltd., a public company, is exclusively dealing in blending, processing, packing, and selling of various brands
of Tea. During the year 2023-24, it had availed credit facilities from Kuber Bank Ltd. The bank had sanctioned a

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working capital cash credit facility on 21st April 2023, for a limit of ₹4.50 crore and a Letter of Credit facility for a
limit of ₹2.50 crores, aggregating to ₹7 crore on the basis of the hypothecation of stocks and book debts of the
company, against which utilisation of the limits by TEA Ltd. during the year in the case of cash credit facility was
₹3.90 crore and of Letter of Credit was ₹1.05 crore, aggregating to ₹4.95 crore.
During the year under review, the company had faced sluggish market conditions for its various brands of teas
due to its inability to cater to the requirements of its customers' expectations. It faced severe cash crunch and
found it difficult to manage working capital stress. In order that the bank does not reduce its drawing power of
the working capital limit, the management decided to peg up the values of the stock statements it submitted to
the bank by a hike of 15% during the quarters ended June 2023, September 2023, and December 2023.
When an engagement partner leading the audit team happened to review the stock statements submitted to the
bank, it was noticed that the stock figures declared were not in agreement with book figures and had been hiked
as above. The matter was taken up with the CFO of the company, who contended that auditors need not examine
and compare the quarterly statements with the books of accounts as the utilisation of working capital limits is
less than the specified sanctioned limit as on 31st March 2024, and hence this case is beyond the scope of
reporting under CARO, 2020.
Is the contention of the CFO correct? Analyse the issue and discuss the reporting responsibilities of the auditor.
(PYP Nov’24)
Solution
Reporting Responsibility of the Auditor as per Para 3(ii)(b) of CARO, 2020:
As per para 3(ii)(b) of CARO, 2020, the auditor is required to report whether during any point of time of the year,
the company has been sanctioned working capital limits in excess of five crore rupees, in aggregate, from banks or
financial institutions on the basis of security of current assets; whether the quarterly returns or statements filed by
the company with such banks or financial institutions are in agreement with the books of account of the company,
if not, give details.
The above clause requires the auditor to comment on whether during any point of time of the year, the company
has been sanctioned working capital limits in excess of ₹5 crores in aggregate. TEA Ltd. has been sanctioned a
working capital cash credit facility for a limit of ₹4.50 crore and a Letter of Credit facility for a limit of ₹2.50 crores,
aggregating working capital facilities/limits of ₹7 crores, which is apparently in excess of ₹5 crores, based on the
security of current assets, i.e., hypothecation of stocks and book debts of the company.
In addition, the auditor is required to ensure whether the quarterly returns filed by TEA Ltd. with Kuber Bank Ltd.
are in agreement with the books of account of the company.
In the instant situation, the management of TEA Ltd. submitted its stock statement by a hike of 15% during the
quarters ended June 2023, September 2023, and December 2023, to peg up the values of the stock due to fear of
reduction in the drawing power of the working capital limit. The auditor noticed that the stock figures declared by
TEA Ltd. were not in agreement with the book figures and had been hiked as above.
Thus, the contention of the CFO is not correct regarding the applicability of CARO, 2020, as the working capital is
more than the specified sanctioned limit as on 31st March 2024. Hence, the auditor is required to report the same
in accordance with Clause (ii)(b) of Paragraph 3 of CARO, 2020.
Q20. You are appointed as a Statutory Auditor of SDA Limited for the year 2023-24 in the place of CA T. During audit
you found an order dated 01.05.2023 under section 148 of the Income-tax Act, 1961 wherein tax of ` 50 lakhs

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were demanded owing to undisclosed cash sales of ₹ 150 lakhs for the financial year 2020-21 which was accepted
by the company and the applicable tax was paid by the Company during the year 2023-24. The company has not
recorded such undisclosed income in their books of account during the year 2023-24. On further inquiring the
matter with CA T, you came to know that CA T resigned due to non-recording of such transaction by the company.
Is there any reporting responsibility casted on you regarding the above matters under CARO, 2020 for the year
2023-24? (PYP May’24)
Solution
Reporting under Paragraph 3 of CARO, 2020:
Clause (viii) of Paragraph 3 of CARO, 2020 requires the auditor to report whether any transactions not recorded in
the books of account have been surrendered or disclosed as income during the year in the tax assessments under
the Income-tax Act, 1961 (43 of 1961), if so, whether the previously unrecorded income has been properly recorded
in the books of account during the year.
In addition, Clause (xviii) of Paragraph 3 of CARO, 2020 requires the auditor to report whether there has been any
resignation of the statutory auditors during the year, if so, whether the auditor has taken into consideration the
issues, objections, or concerns raised by the outgoing auditors.
In the given situation, during the audit, an order dated 01.05.2023 under section 148 of the Income-tax Act, 1961
was noticed wherein tax of ₹50 lakh was demanded owing to undisclosed cash sales of ₹150 lakh for the financial
year 2020-21, which was accepted by the company, and the applicable tax was paid by the company during the year
2023-24. The company has not recorded such undisclosed income in their books of account during the year 2023-
24. The auditor would be required to report as per Clause (viii) of Paragraph 3 of CARO, 2020.
Further, CA T, the auditor of SDA Limited, resigned due to the non-recording of such undisclosed income in their
books of account. The auditor would be required to report the same in CARO, 2020 as per Clause (xviii) of Paragraph
3 of CARO, 2020.
Hence, the auditor would be required to report as per Clause (viii) and Clause (xviii) of Paragraph 3 of CARO, 2020
for the year 2023-24.
Q21. Comment with reference to the provisions of CARO, 2020:
(a) Relon Limited has a turnover of ₹ 650 crores during the financial year 2023-24. It has outstanding dues towards
income tax of ₹ 15 lakhs since July 2023. When inquired by the auditor, the company's management informed
him that they have filed an objection letter for the said demand with the Income-tax Authorities; however, no
response is received from the department. Is there any reporting responsibility of auditor under CARO, 2020?
(b) During the audit, CA Kunal found that physical verification of inventories of the company has been conducted
by management at regular intervals. The following is a summary of inventory as per physical verification
conducted by management vis-à-vis its books of accounts as at the year-end:
Particulars As per physical verification (₹ in As per books of accounts (₹ in
crores) crores)
Raw material 1,160 1,180
Work-in-progress 410 430
Finished goods 2,500 2,790
Stores and spares 220 180
Total 4,290 4,580
(RTP May’25)

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Solution
(a) Reporting responsibility of the auditor under Paragraph 3 of CARO, 2020:
The auditor is required to report as per Clause (vii)(a) of Paragraph 3 of CARO, 2020 whether the company is
regular in depositing undisputed statutory dues including Goods and Services Tax, provident fund, employees'
state insurance, income tax, sales tax, service tax, duty of customs, duty of excise, value-added tax, cess, and any
other statutory dues to the appropriate authorities and if not, the extent of the arrears of outstanding statutory
dues as on the last day of the financial year concerned for a period of more than six months from the date they
became payable, shall be indicated.
Further, the auditor is also required to report as per Clause (vii)(b) of Paragraph 3 of CARO, 2020, where statutory
dues referred to in sub-clause (a) have not been deposited on account of any dispute, then the amounts involved
and the forum where the dispute is pending shall be mentioned (a mere representation to the concerned
Department shall not be treated as a dispute).
In the given case, Relon Limited has an outstanding Income-tax liability of ₹ 15 lakhs since July 2023. Although
the management has filed an objection letter, no formal dispute has been raised, and the dues remain unpaid
for more than six months. Therefore, the auditor is required to report the same under Clause (vii)(a) of Paragraph
3 of CARO, 2020.
(b) As per Clause (3)(ii)(a) of CARO, 2020, the auditor is required to report whether any discrepancies of 10% or more
in the aggregate for each class of inventory were noticed on physical verification conducted by management and
if so, whether they have been properly dealt with in the books of account.
Computation of % of discrepancies found in physical verification and Books of Accounts:

Particulars As per physical As per books of accounts % Change

verification (₹ in crores) (₹ in crores)
Raw material 1,160 1,180 1.72%
Work-in-progress 410 430 4.87%
Finished goods 2,500 2,790 11.6%
Stores and spares 220 180 18.18%
Since the discrepancies in the value of finished goods (11.6%) and stores and spares (18.18%) exceed the 10%
threshold specified under Clause (3)(ii)(a) of CARO, 2020, the auditor should report these discrepancies
accordingly.

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SM Questions
Q1. CA Lalita is auditor of a company. She is also offered professional work of audit of financial statements prepared
specifically for meeting requirements of a loan agreement for the same period. She chooses to accept work and
has made up her mind to disclose this fact in “Emphasis of Matter Paragraph” in audit report to be issued by her
for this specific engagement. Is her approach proper?

Solution
In the given situation, the approach of CA Lalita is proper. There is no bar upon accepting such an engagement even
though she is the auditor of the company. Besides, she has intended to disclose this fact in “Emphasis of Matter
Paragraph” of the audit report to be issued by her for such specific engagement.

Q2. CA Lakshmi has prepared a draft audit report for financial statements of X Ltd. prepared in accordance with
financial reporting provisions of a contract with Y Ltd. She has drafted an unmodified opinion to be given in audit
report. Besides, she has also drawn attention in draft audit report to Note “A “to the financial statements which
describes the basis of accounting (under the heading “Basis of accounting”). How she should ensure that report
would not be misused? Draft a suitable para to be included in the report for this purpose.

Solution
She may consider it appropriate to indicate that the auditor’s report is intended solely for specific users. Depending
on the law or regulation applicable, this may be achieved by restricting the distribution or use of the auditor’s report.
In these circumstances, the paragraph alerting the readers may be expanded to include these other matters and the
heading modified accordingly. The draft para should read as under: -
Basis of Accounting and Restriction on Distribution and Use
Without modifying our opinion, we draw attention to Note A to the financial statements, which describes the basis
of accounting. The financial statements are prepared to assist the company to comply with the financial reporting
provisions of the contract referred to above. As a result, the financial statements may not be suitable for another
purpose. Our report is intended solely for X Ltd. and Y Ltd. and should not be distributed to or used by parties other
than X Ltd. and Y Ltd.

Q3. SA 800 deals with special considerations applicable in respect of audit of financial statements prepared in
accordance with special purpose framework. Explain, by giving examples, the meaning of special purpose
framework.

Solution
SA 800 defines special purpose framework as a financial reporting framework designed to meet the financial
information needs of specific users. The financial reporting framework may be a fair presentation framework or a
compliance framework. The requirements of the applicable financial reporting framework determine the form and
content of the financial statements and what constitutes a complete set of financial statements.
Examples of Special purpose frameworks are:
• The cash basis of accounting and also cash flow information that an entity may be required to prepare for
creditors.
• The financial reporting provisions established by a regulator to meet the requirements of that regulator.
• The financial reporting provisions of a contract, such as a bond indenture, a loan agreement, etc.

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Additional Questions
Q4. The financial statements of AKY & Co. have been prepared by management of an entity in accordance with the
financial reporting provisions of a contract (that is, a special purpose framework) to comply with provisions of the
contract. Based on the contract, management does not have a choice of financial reporting frameworks. As an
auditor advise considerations to be taken care while planning & performing audit? (MTP Aug 18, MTP March 18).

Solution

Considerations for Planning and Performing Audit in case of Special Purpose Framework: As per SA 800 “Special
Considerations—Audits of Financial Statements Prepared in accordance with Special Purpose Frameworks,”
financial statements prepared in accordance with a special purpose framework may be the only financial statements
an entity prepares. In such circumstances, those financial statements may be used by users other than those for
whom the financial reporting framework is designed.

While planning and performing audit of such special purpose framework-based company, the auditor should
consider the below-mentioned factors:

a) To obtain an understanding of the entity’s selection and application of accounting policies. In the case of financial
statements prepared in accordance with the provisions of a contract, the auditor shall obtain an understanding
of any significant interpretations of the contract that management made in the preparation of those financial
statements.

b) Compliance of all SAs relevant to audit, the auditor may judge it necessary to depart from a relevant requirement
in an SA by performing alternative audit procedures to achieve the aim of that requirement.

c) Application of some of the requirements of the SAs in an audit of special purpose financial statements may require
special consideration by the auditor. For example, in SA 320, judgments about matters that are material to users
of the financial statements are based on a consideration of the common financial information needs of users as
a group. In the case of an audit of special purpose financial statements, however, those judgments are based on
a consideration of the financial information needs of the intended users.

d) In the case of special purpose financial statements, such as those prepared in accordance with the requirements
of a contract, management may agree with the intended users on a threshold below which misstatements
identified during the audit will not be corrected or otherwise adjusted. The existence of such a threshold does
not relieve the auditor from the requirement to determine materiality in accordance with SA 320 for purposes
of planning and performing the audit of the special purpose financial statements.

e) Communication with those charged with governance in accordance with SAs is based on the relationship between
those charged with governance and the financial statements subject to audit, in particular, whether those
charged with governance are responsible for overseeing the preparation of those financial statements. In the
case of special purpose financial statements, those charged with governance may not have such a responsibility.

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SM & Additional Questions

Q1. CA M. Surya is auditor for financial statements of an entity prepared in accordance with financial reporting
provisions of a contract. He is also offered an audit of trade receivables appearing in above financial statements.
Can he accept such an engagement? Discuss brief outline of his audit approach in such a situation.

Solution

The single financial statement or the specific element, account or item of a financial statement may be prepared in
accordance with a general or special purpose framework. If prepared in accordance with a special purpose
framework, SA 800 also applies to the audit.

In the given case, financial statements of the entity are prepared in accordance with financial reporting provisions
of a contract. It is a special purpose framework. The auditor of financial statements prepared in accordance with the
special purpose framework is also offered to audit trade receivables appearing in the above financial statements,
which relate to the audit of the elements of financial statements prepared in accordance with the special purpose
framework. Hence, his audit approach should include considering requirements of both SA 800 and SA 805.

Q2. CA G is offered appointment for audit of trade payables of financial statements of a company. However, financial
statements prepared under Companies Act, 2013 are audited by CA Jignesh. Discuss why it would be practically
difficult for CA G to perform such an audit.

Solution

Compliance with the requirements of SAs relevant to the audit of a single financial statement or of a specific element
of a financial statement may not be practicable when the auditor is not also engaged to audit the entity’s complete
set of financial statements. In such cases, the auditor often does not have the same understanding of the entity and
its environment, including its internal control, as an auditor who also audits the entity’s complete set of financial
statements. Accordingly, the auditor may need further evidence to corroborate audit evidence acquired from the
accounting records.

In the case of an audit of a specific element of a financial statement, certain SAs require audit work that may be
disproportionate to the element being audited. If the auditor concludes that an audit of a single financial statement
or of a specific element of a financial statement in accordance with SAs may not be practicable, the auditor may
discuss with management whether another type of engagement might be more practicable.

Q3. CA P is auditor of a company responsible for auditing the complete set of financial statements. He intends to
express adverse opinion on complete set of financial statements considering conclusions drawn by him during
course of audit. He is also auditing trade receivables of company for the same period in a separate engagement.
Can he express an unmodified opinion in respect of trade receivables? If so, discuss those circumstances.

Solution
If the auditor undertakes an engagement to report on a single financial statement or on a specific element of a
financial statement in conjunction with an engagement to audit the entity's complete set of financial statements,
the auditor shall express a separate opinion for each engagement.
If the auditor concludes that it is necessary to express an adverse opinion or disclaim an opinion on the entity's
complete set of financial statements as a whole, Revised SA 705 does not permit the auditor to include in the same

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auditor's report an unmodified opinion on a single financial statement that forms part of those financial statements
or on a specific element that forms part of those financial statements. This is because such an unmodified opinion
would contradict the adverse opinion or disclaimer of opinion on the entity's complete set of financial statements
as a whole.
If the auditor concludes that it is necessary to express an adverse opinion or disclaim an opinion on the entity's
complete set of financial statements as a whole but, in the context of a separate audit of a specific element that is
included in those financial statements, the auditor nevertheless considers it appropriate to express an unmodified
opinion on that element, the auditor shall only do so if:
• The auditor is not prohibited by law or regulation from doing so;
• That opinion is expressed in an auditor's report that is not published together with the auditor's report
containing the adverse opinion or disclaimer of opinion; and
• The specific element does not constitute a major portion of the entity's complete set of financial statements.

Q4. XYZ Ltd. has engaged an auditor to issue a report on its revenue statement for the year ended March 31, 2024, as
required under a contractual agreement with a key investor. The auditor has already issued a qualified opinion
on the complete set of financial statements of XYZ Ltd. due to material misstatements in inventory valuation that
did not comply with the applicable financial reporting framework. The auditor is now assessing whether and how
these matters impact the audit of the revenue statement. Comment.

Solution
SA 805 applies when an auditor conducts an audit of a single financial statement or a specific element of a financial
statement. If the auditor has already issued an audit report on the complete set of financial statements, they must
consider how matters in that report impact the separate audit opinion on the single financial statement or element.
The auditor should evaluate whether modifications, emphasis of matter (EOM) paragraphs, or other significant
issues in the full audit report affect the audit of the specific financial statement or element.

Factors that may be relevant in considering those implications include:

1. Nature of the Matter(s) Being Described in the Auditor’s Report on the Complete Set of Financial Statements &
Extent to Which It Relates to What Is Included in the Single Financial Statement or a Specific Element of a Financial
Statement.
2. Pervasiveness of the Matters.
3. Nature and Extent of Differences Between the Applicable Financial Reporting Framework
4. Extent of Difference Between Period Covered by Complete Set of Financial Statements Compared to Single
Financial Statement or Element of Financial Statement.
5. Time Elapsed Since the Date of Auditor’s Report on the Complete Set of Financial Statements.

Even when certain matters included in the auditor’s report on the complete set of financial statements do not have
implications for the audit of, or for the auditor’s report on, the single financial statement or the specific element of
a financial statement, the auditor may deem it appropriate to refer to the matter(s) in an Other Matter paragraph
in an auditor’s report on the single financial statement or on the specific element of a financial statement as per SA
706(Revised).

Conclusion: In this case, matter in the complete set of financial statements does not impact the revenue audit, the
auditor does not modify the opinion on the revenue statement. However, as per SA 706 (Revised), the auditor may
include an Other Matter (OM) paragraph to provide additional context without affecting the audit opinion.

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SM Questions
Q1. CA Madhur is auditor of a company and has issued audit report dated 15th June of a particular year. The audit
report on summary financial statements derived from such audited financial statements is dated 15th July of that
particular year. Discuss whether there exists any additional reporting responsibility for auditor in such a situation
in respect of audit report on summary financial statements.
Solution
The audit report on summary financial statements derived from audited financial statements is dated 15th July of
that particular year. However, the audit report on audited financial statements is dated 15th June of that year.
In the above situation, the auditor’s report on summary financial statements should state that the summary financial
statements and the audited financial statements do not reflect the effects of events that occurred subsequent to
the date of the auditor’s report on the audited financial statements.
Q2. When auditor’s report on the audited financial statements contains a qualified opinion, but the auditor is satisfied
that the summary financial statements are a fair summary of the audited financial statements, in accordance with
the applied criteria, which other matters shall the auditor’s report on the summary financial statements contain
in addition to elements of auditor’s report described in SA 810?
If summary financial statements are not a fair summary of the audited financial statements, in accordance with
the applied criteria, and management does not agree to make the necessary changes, what are implications for
auditor’s opinion on summary financial statements?
Solution
If the auditor is satisfied that the summary financial statements are consistent, in all material respects, with or are
a fair summary of the audited financial statements, in accordance with the applied criteria, he can issue an
unmodified opinion.
However, when auditor’s report on audited financial statements contains a qualified opinion, the auditor’s report
on the summary financial statements shall, also contain following:
(a) State that the auditor’s report on the audited financial statements contains a qualified opinion.
(b) Describe:
(i) The basis for the qualified opinion on the audited financial statements, and that qualified opinion in the
auditor’s report on the audited financial statements; and
(ii) The effect thereof on the summary financial statements, if any.
If the summary financial statements are not consistent, in all material respects, with or are not a fair summary of
the audited financial statements, in accordance with the applied criteria, and management does not agree to make
the necessary changes, the auditor shall express an adverse opinion on the summary financial statements.
Q3. CA Y is auditor of a company. He has expressed adverse opinion on audited financial statements. What additional
points he has to keep in mind while expressing opinion on summary financial statements derived from such
audited financial statements?
Solution
When the auditor's report on the audited financial statements contains an adverse opinion or a disclaimer of
opinion, the auditor's report on the summary financial statements shall, additionally:

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(a) State that the auditor's report on the audited financial statements contains an adverse opinion or disclaimer of
opinion;
(b) Describe the basis for that adverse opinion or disclaimer of opinion; and
(c) State that, as a result of the adverse opinion or disclaimer of opinion, it is inappropriate to express an opinion on
the summary financial statements.
Q4. Mr. BK has been engaged by XYZ Ltd. to report on summary financial statements derived from the financial
statements audited by him in accordance with SAs. Mr. BK wants to determine whether the applied criteria are
acceptable before accepting such assignment. Guide him the factors affecting auditor's determination of the
acceptability of applied criteria as per relevant Standard on Auditing.
Solution
In the given situation, Mr. BK has been engaged by XYZ Ltd. to report on summary financial statements derived from
the financial statements audited by him in accordance with SAs. Mr. BK wants to determine whether the applied
criteria are acceptable before accepting such assignment.
As per SA 810, “Engagements to Report on Summary Financial Statements”, before accepting an engagement to
report on summary of financial statements, the auditor shall determine whether applied criteria are acceptable.
‘Applied criteria’ refers to the criteria applied by management in the preparation of the summary financial
statements.
Factors affecting the auditor’s determination of the acceptability of the applied criteria are:
• The nature of the entity;
• The purpose of the summary financial statements;
• The information needs of the intended users of the summary financial statements; and
• Whether the applied criteria will result in summary financial statements that are not misleading in the
circumstances.

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