CAP III Paper 3: Advanced Auditing

Chapter 1 Auditing

Question No 1

An Auditor is required to consider materiality and its relationship with audit risk while
conducting an audit. Describe the matters, which you will consider in this regard.
(6 Marks June 2004)
Answer

Answer should base on NSA 320. The answer should specifically deal following points in brief:

a) Define materiality.

b) Consideration at planning level:

Establishing an acceptable materiality level.

Misstatements of relatively small amounts, which, cumulatively, can affect financial
statements materially.
Materiality should be considered at both the overall financial statement level and in
relation to individual account balances, clauses of transaction and disclosures.
Nature, timing and extent of audit procedures should be determined on evaluation of the
effect of misstatements.

c) Relationship between materiality and audit risk:

As the time of evaluation of audit evidence.

Effects of misstatements.

Question No. 2
Write shorts notes on following: (6 Marks June 2004)

a. Using other experts by professional accountants.

Note should deal with conditions which require use of other experts‘ qualification and skill and
competence of expert., auditor's liability in such cases, reference in audit report. Consider the
provisions of NSA 620.

b. Inherent risk.

Refer to NSA 240 which describes inherent limitations of auditor. There are many circumstances
which involve unavoidable rule even if audit is planned and executed properly.

Inherent risk is the susceptibility of an account balance or clause of transaction to misstatement that
could be material, individually or when aggregated with misstatements in other balances or clauses,
assuming that there were no related internal controls. It is a function of the entity's business and its
environment and the nature of the account balance or clause of transactions. For example, such as a
complex accounting estimate, or that involve highly desirable and movable assets, such as

© The Institute of Chartered Accountants of Nepal 1

 jewelers, or that are particularly susceptible to changes in consumer demand or technology that
could affect their value, will involve more inherent risk than other accounts.

Although inherent risk cannot be controlled by auditor, the auditor should assess them and design
substantive procedures to produce an acceptable level of detection risk.

c. Using the work of an expert. (4 Marks December 2004)

Answer
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.
The auditors education and experience enable the auditor to be knowledgeable about the business
matters in general, but the auditor is not expected to have the expertise of a person trained for or
qualified to engage in the practice of another profession or occupation, such as advocate or
engineer.
An expert may be engaged by the entity, engaged by the auditor, employed by the entity, or
employed by the auditor.

Question No. 3
As an auditor state your views on the following situations: (4 Marks June 2004)

The auditor find that the company has made certain secured loans and advances to a sister
concern at a rate of interest of 5% per annum, from out of the funds raised through a public issue
of 14% non-convertible debentures.

The auditor should enquiry whether the rate of interest and other terms of the loan ae prejudicial to the
interest of the company prima facie it seems so. If, based on the available evidence (including the
explanations of the management in the matter), the auditor is of the opinion that the terms of the loan
are prejudicial to the interest of the company, he should report this matter. When management refused
to adjust, auditor suitably modify his opinion as per NSA 705.

Question No. 4
During the course of audit, you encounter following situations: (4 Marks each June
2004)

a. On your request to produce minutes of board meetings, finance director represents that there is
no need to waste time to look at the whole minutes of the year. Instead you may ask for the copy
of the minutes deemed necessary to verify.

Since Finance Director has made only suggestion in view of saving time of auditor it should not
be considered as limitation of scope. The auditor should explain following points to convince him
for production of minute book for verification as auditor is required to obtain sufficient
appropriate audit evidence as per NSA 500.

a. Minute book is not checked just to corroborate transactions recorded in books of accounts. If
advice of finance director is followed, it will only help to corroborate with financial
transactions.

b. Verification of minute book is necessary to check whether the decisions of the BoD are
reflected in financial statements.
 c. Verification of minute book may provide information on contingent liabilities not disclosed
by the management.

b. You receive a letter from the Managing Director of the company under audit, asking you to give
a copy of your entire file containing working papers and the audit program. He argues that
since these papers contains information concerning his company, he has a right to ask for the
documents. Moreover, the audit program will help the company in coordinating its own related
activities and thus result in a more effective audit next year.

NSA 230 requires the auditor to maintain appropriate documentation for future reference.
Documents prepared, acquired or brought into being by the professional accountant solely for his
own purpose as principal belongs to him. Thus, documents prepared by the professional
accountant are regarded as exclusive property of him. So, the auditor should refuse to give the
entire file to the Managing Director of the company.

Question No. 5
How do you express your view as an auditor in the following cases?
(5 Marks each December 2004)
a. M/S XYZ & Co. Chartered Accountants and was working as an auditor of CD Ltd. for four
years. During these four years period, the firm was doing such audit with a detail audit
planning and programming and Mr. Y was the partner in charge during the period. Whereas
for carrying out the audit of Financial Year X0X5, Mr. X was assigned as a partner in charge
to carry out the audit. In this year, Mr. X did not prepare the audit plan and programme and
followed up the previous year's audit planning and programming.
b. Mr. BRK was appointed as an audit assistant of the Auditor General (AG) of Nepal to carry out
the audit of Nepal Telkom Ltd., an HMG owned undertaking, for the Financial Year 20X4.
Further, AG ordered him to follow the directives to the auditors of the Public Sector
Enterprises, but it was not mentioned in the letter of appointment to follow the Nepalese
Standards on Auditing. Consequently, Mr. BRK did not follow the Standards on Auditing and
again did not issue the audit engagement letter for the acknowledgment of the management.
Again, he argued that he was not appointed by the Shareholders of Telkom Ltd., but was an
assistant of the Auditor General, so he need not issue an audit engagement letter while
carrying out the audit of Telkom Ltd.
c. During the finance year 200X the statutory auditor observed the following information while
auditing the financial statements of an ABC Co. Ltd.:
Share Capital (Issued, Subscribed, Called and Paid up) Rs. 5 Million
Reserve and Surplus (including undistributed profit) Rs. 10 Million
Term Loan and Current Liabilities Rs. 20 Million
Fixed Assets at Book value Rs. 10 Million
Current Assets Rs. 10 Million
Profit and Loss Account (Loss) (Rs. 15 Million)
d. Mrs. Z a leading practicing Chartered Accountant was appointed as an auditor of N. Ltd. for
the year ending 20X0. She has compiled and signed the balance sheet of the company for
submission to A bank to get an overdraft loan. The company again asked her to compile
and sign another balance sheet on the same date, inflating the value of assets by 10%
for submission to B bank to get a term loan. Both the balance sheets were not in conformity
with the books of accounts of the company corresponding to the respective date.
Answers:
a. Answer:
NSA 300 states that audit planning is necessary to conduct an effective audit in an efficient and
timely manner. It should be noted that the audit plans should be based on knowledge of client's
business.
As per NSA 300, The auditor shall establish an overall audit strategy that sets the scope, timing
and direction of the audit, and that guides the development of the audit plan.
In establishing the overall audit strategy, the auditor shall:
a. Identify the characteristics of the engagement that define its scope;
b. Ascertain the reporting objectives of the engagement to plan the timing of the audit and the
nature of the communications required;
c. Consider the factors that, in the auditor‘s professional judgment, are significant in directing
the engagement team‘s efforts;
d. Consider the results of preliminary engagement activities and, where applicable, whether
knowledge gained on other engagements performed by the engagement partner for the entity
is relevant; and
e. Ascertain the nature, timing and extent of resources necessary to perform the engagement.

Planning is a continuous process and changes in conditions of unexpected results of audit

procedures may cause revisions of the overall plan as well as the detailed audit programme.

b. Answer:
Term of Engagement is required to reduce expectation gap as it defines the roles and
responsibilities of the auditor and management. Terms of Engagement are required to establish the
pre-conditions for audit. Irrespective of whether an audit is being conducted in the private or
public sector, the basic principles of audits remain the same.
What may differ for audits carried out in the public sector is the audit objective and scope. These
factors are often attributable to differences in the audit mandate and legal requirements or the
form of reporting. The mandates and requirements may also affect, for example, the extent of the
auditors' discretion in establishing materiality, in reporting fraud and error, and in the form of the
audit report. Differences in audit approach and style may also exist.
However, these differences would not constitute a difference in the basic principles and essential
procedures in auditing. In this case, though he is an assistant of the Auditor General of Nepal, he
needs to follow the Standards on auditing in additions to the directives to the auditors.

c. Answer:
Here, Calculate the Net worth of the company, Net worth is ≤ 0.
Comment: In this case, the auditor observes that an adequate disclosure is made in the financial
statements and the auditor need not express and qualify his opinion as all above information are
drawn up from the financial statements. However, he should, in his report, add a paragraph that
highlights the going concern problem by drawing attention to the note in the financial statement
that discloses:

i. adequately, describe the principal conditions that raise substantial doubt about the entity's
ability to continue in operation for the foreseeable future. (NSA 570)

ii. state that there is significant uncertainty that the entity will be able to continue as a going
concern and, therefore, may be unable to realize its assets and discharge its liabilities in the
normal course of business. (NSA 570)
 d. Answer:
While the auditor is responsible for forming and expressing an opinion on the financial
statements, the responsibility for preparing and presenting the financial statements is that of the
management of the entity. The audit of the financial statements does not relieve management of its
responsibility.

Again, the auditor should comply with ethical principles governing professional responsibilities:

Integrity, Objectivity and independence: the auditor should be straight forward, honest and sincere
in rendering professional services. The auditor must be fair and should not allow prejudice, bias or
influence of others to override his or her objectivity. The auditor should maintain an impartial
attitude, and both be and appear to be free of any interest which might be regarded., Whatever its
actual effect, as being incompatible with integrity, objectivity and independence. The auditor
should be independent in fact and appearance.

It is; therefore, she should not depart from her professional integrity and in these situations her
services are deemed to be professionally misconduct.

Question No. 6
The statutory auditor is not required to evaluate the professional competence or independence of the
branch auditor, except in situations, which create doubt about the professional competence or
independence of the auditor. Briefly explain.
(6 Marks December 2004)

Answer:
Where the statutory auditor's report is other than unqualified, the principal auditor should also
document how he has dealt with the qualifications or adverse remarks contained in the branch auditor's
report in framing his own report. There should be sufficient liaison between the principal auditor and
the branch auditor. For this purpose, the principal auditor may find it necessary to issue a written
communication to the branch auditor. The branch auditor, knowing the context, in which his work is to
be used by the principal auditor, should cooperate with his and assist him actively, for example, y
bringing to the principal auditor's immediate attention any significant findings requiring to be dealt
with the relevant statutory requirements. The principal Auditor would not be responsible in respect of
the work entrusted to the branch auditors, except in circumstances, which should have roused his
suspicion about the reliability of the work performed by the branch auditors. When the principal auditor
has to base his opinion on the financial statements 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 statements of the entity by indicating the extent to which the financial statements of branches
audited by the other auditors have been included in the financial statements of the entity.

Question No. 7
Give your opinion as an auditor in the following cases with specific reference to criteria on which
your opinion is based.
Mr. RR Pradhan, a Chartered Accountant is attending to the tax matters of Apex Hotel Ltd. for the
fiscal year 2060/61. For this purpose, he has to attend to the company from 9 a.m. to 1 p.m. on all
working days and sometimes he also has to present before tax officer in the Inland Revenue Office at
Babar Mahal. He is paid Rs. 30,000/- per month for the same.
Apex Hotel Ltd. intends to appoint Mr. RR Pradhan as its statutory auditor at the annual general
meeting. Advice Mr. RR Pradhan giving reasons whether he can accept the appointment as per the
companies‟ act 2063 (5 Marks June 2005)
Answer:
An employee or worker of the company cannot be appointed as auditor of the company by virtue of
provision of Sec 112 of the Companies Act, 2063.
In the given case, it is not clear whether Mr. RR Pradhan is an employee of the company on part time
basis or is a consultant on retainer basis for tax matters. An auditor may render services to the company
in matters relating to taxation, finance, management consultancy or other related area as along as his
contract is ―for service‖ and not ―of service‖.
With regard to charging professional fee on monthly fees by the statutory auditor for the other services
on retainership basis, there is no specific prohibition in the Nepal Chartered Accountant Acts, 1997 and
the Regulations. Further, another fact, which has to be borne in mind that Mr. RR Pradhan, is attending
the company from 9 a.m. to 1 p.m. on all working days. It should be seen that he is not bound by the
office timings but is attending to tax matters regularly within the office hours according to his own
convenience. Therefore, having regard to the exact nature of Mr. RR Pradhan‘s existing relationship as
may be seen from the terms of appointment with Apex Ltd, he can be appointed as the auditor.

Question No. 8
Mr. ABC, a practicing Chartered Accountant audited the financial statements of M/s AP Finance
Company Ltd. for the F/Y 2060/61 and issued audit report on Aswin 28, 2061. The audited financial
statements made a provision of proposed cash dividend of 20%. Mr. XYZ, managing director of that
company then submitted the audited financial statements to Nepal Rastra Bank along with long form
audit report for getting permission to hold Annual General Meeting of that company for that year on
Kartik 25, 2061. The director of Nepal Rastra Bank after reviewing Financial Statements of that
company found that interest income booked for the period of 3 months ended on Ashad end 2061
which was not actually received on that date has also not in fact received till the NRB review date.
Therefore, the directors from NRB issue a direction to make a provision for interest suspense that
have not been actually received borrowers till the date of NRB review. As a result of which NRB
issued a direction to allow distributing cash dividend of 10% only instead of 20%. After receiving
such direction form NRB, Managing Director requested Mr. ABC to alter the audited Balance Sheet
as per the NRB direction. Give your view on above.
(5 Marks June 2005)
Answer
The auditor should review the compliance of directives issued by the regulatory authority. In the above
case, it appears that Mr. ABC, a practicing-chartered accountant, auditor of M/s AP Finance Company
Ltd. has reviewed the compliance of NRB directives till the signing date. Therefore, the interest
suspense account as directed by NRB on the basis of subsequent non-recovery of interest income from
borrower would not attract auditor responsible for the year. However, the adjustment of proposed
dividend as per the NRB direction after adjustment of interest suspense account can be done in the
following year (i.e. 2061/62) only instead of adjusting the same in the audited financial statements of
F/Y 2061/62.

Question No. 9
Give your opinion as an auditor in the following cases with specific reference to criteria on which
your opinion is based. (4 Marks each June 2005)
a. Mr. Lok Raj Pandey, CEO of M/s PK Co. Ltd. requested you to provide suggestion on the
utilization of revaluation reserve for issue of bonus share.
Answer
The revaluation reserve arises only out of book adjustments, i.e. excess of the revalued amount over
the net book value of fixed assets. The revaluation reserve represents expert‘s opinion of value and
does not represent realized gain.
 Share capital represents the amount of money or money‘s worth received from the owners and
capitalization of earned profits or other gains out of arm‘s length transactions. The main principle is
that only such profits, which are earned whether in revenue account or capital account, can be
capitalized.
Therefore, bonus share cannot be issued out of capitalization of revaluation reserve. The auditor
should qualify his report in the event of utilization of such reserve for issue of bonus shares.

b. Mr. A. Shrestha, a practicing Chartered Accountant, received a major professional assignment. In

order to complete such assignment within the deadline, he needed additional five computers. Due
to his financial crises, he could not afford to buy such computers and decided to borrow funds
from a firm where one of his article clerks and his father were interested. Is Mr. Shrestha
committed misconduct under the Institute of Chartered Accountants of Nepal, Regulation 2061?
Answer
In the given case, Mr. Shrestha had taken a loan to buy five computers from a firm where an articled
clerk and his father were interested. Regulation 39 of the Institute of Chartered Accountants of Nepal
Regulations, 2061 states, …
No financial benefit allowed: The principle shall not take benefit of any kind of fee, donation, charge,
loan, security or any other kind of financial advantage or facility from an articled trainee.
Mr. Shrestha will be held guilty of professional misconduct if it can be proved that the engagement of
article clerk is dependent upon this fact. As it appears from the facts of the case, the articled clerk has
already been engaged and serving his article ship and thus, normally, Mr. Shrestha will not be held
guilty of professional misconduct.

c. Mr. Ram Singh Bania, a Chartered Accountant in practice had confirmed in the application
made by his articled clerk Mr. Raja Ram Rauniyar to the Council for permission to study that
the normal working hours of his office were 10 am. to 5 p.m. and the hours during which Mr.
Raja Ram Rauniyar was required to attend college classes in the morning session which started
from 6.30 a.m. to 9.30 a.m. On inquiry form Principal of college, it was revealed that Mr. Raja
Ram Rauniyar used to attend classes from 10 a.m. to 1.30 p.m. Mr. Ram Singh Bania, pleaded
ignorance about his articled clerk, Mr. Raja Ram Rauniyar, attending the college classes
during office hours. Will Mr. Ram Singh Bania be held guilty of professional misconduct?

Answer:
A member shall hold guilty of professional misconduct if he contravenes any provision of the Nepal
Chartered Accountants Act or the Regulations made thereunder.
As per ICAN Regulations, 2061, Rule 35 states that the working hour of an articled trainee in articled
training service shall be of 40 hours a week within 9 a.m. to 5 p.m.
The Chartered Accountant as per Regulation is also expected to impart proper practical training. In
this given case, Mr. Raja Ram Rauniyar would not have been attending a firm on regular basis and the
explanation of Mr. Ram Singh Baniya, cannot be accepted particularly in view of the fact that Mr.
Ram Singh Baniya did not obtain certificate from the principal to confirm the timings. Under the
circumstances Mr. Ram Singh Baniya is guilty of professional misconduct in regard to the discharge
of his professional duties.

Question No. 10
While conducting the audit of the financial statements, you come across the certain matters of
Governance Interest. Explain what matters you think need to be considered for communication. Is it
necessary to design audit performance in such a manner as would enable identification of all matters
that may be relevant to those charged with governance? Explain in the light of NSA 260.
(8 Marks June 2005)
Answer:
The auditor should consider audit matters of governance interest that arise from the audit of the
financial statements and communicate them with those charged with governance. Ordinarily such
matters include:
The general approach and overall scope of the audit, including any expected limitations
thereon, or any additional requirements;
The selection of, or changes in, significant accounting policies and practices that have, or
could have, a material effect on the entity‘s financial statements;
The potential effect on the financial statements of any significant risks and exposures, such
as pending litigation. That are required to be disclosed in the financial statements;
Audit adjustments, whether or not recorded by the entity that have, or could have, a
significant effect on the entity‘s financial statements;
Material uncertainties related to events and conditions that may cast significant doubt on the
entity‘s ability to continue as a going concern.
Disagreements with management about matters that, individually or in aggregate, could be
significant to the entity‘s financial statements or the auditor‘s report. These communications
include consideration of whether the matter has, or has not, been resolved and the
significance of the matter,
Expected modifications to the auditor‘s report;
Other matters warranting attention by those charged with governance, such as material
weaknesses in internal control, questions regarding management integrity, and fraud
involving management;
Any other matters agreed upon in the terms of the audit engagement.

As part of the auditor‘s communications those charged with governance are informed that;
The auditor‘s communications of matters include only those audit matters of governance
interest that have come to the attention of the auditor as a result of the performance of the
audit;
An audit of financial statements is not designed to identify all matters that may be relevant
to those charged with governance. Accordingly, the audit does not ordinarily identify all
such matters

Question No. 11
What are audit sampling and other selective testing factors that you employ in an audit of an
entity registered under Companies Act 2063? (8 Marks December 2005)

Answer:
NSA 530 Audit Sampling deals with the auditor‘s use of statistical and non-statistical sampling when
designing and selecting the audit sample, performing tests of controls and tests of details, and
evaluating the results from the sample.
As per the said NSA, when designing audit procedures, the auditor should determine appropriate means
for selecting items for testing so as to gather audit evidence to meet the objectives of audit tests.
In accordance with NSA 500 ―Audit Evidence‖, audit evidence is obtained from an appropriate mix of
tests of control and substantive procedures. The type of tests to be performed is important to an
understanding of the application of audit procedures in gathering audit evidence.

i. Tests of Control
―Risk Assessments‖ and ―Internal Control‖ tests are performed if the auditor plans to assess control
risk less than high for a particular assertion.
 Based on the auditor‘s understanding of the accounting and internal control systems, the auditor
identifies the characteristics or attributes that indicate performance of a control, as well as possible
deviation conditions, which indicate departures from adequate performance. The presence or absence
of attributes can then be tested by the auditor.
Audit sampling for tests of control is generally appropriate when application of the control leaves
evidence of performance (for example, initials of the credit manager on a sales invoice indicting credit
approval, or evidence of authorization of data input to a microcomputer-based data processing
system).

ii. Substantive Procedures

Substantive Procedures are concerned with amounts and are two types: analytical procedures and tests
of details of transactions and balances. The purpose of substantive procedures is to obtain audit
evidence to detect material misstatements in the financial statements.
In obtaining evidence, the auditor should use professional judgement to assess audit risk and design
audit procedures to ensure this risk is reduced to an acceptably low level.
Audit risk is the risk that the auditor gives an appropriate audit opinion when the financial statements
are materially misstated. Audit risk consists of inherent risk – the susceptibility of an account balance
to material misstatement, assuming there are no related internal controls; control risk – the risk that a
material misstatement will not be prevented or detected and corrected on a timely basis by the
accounting and internal control systems; and detection risk – the risk that the material misstatements
will not be detected by the auditor‘s substantive procedures. These three components of audit risk are
considered during the planning process in the design of audit procedures in order to reduce audit risk
to an acceptably low level.
Sampling risk and non-sampling risk can affect the components of audit risk. For example, when
performing tests of control, the auditor may find no errors in a sample and conclude that control risk
is low, when the rate of error in the population is, in fact, unacceptably high (sampling risk). Or there
may be errors in the sample, which the auditor fails to recognize (non-sampling risk). With respect to
substantive procedures, the auditor may use a variety of methods to reduce detection risk to an
acceptable level. Depending on their nature, these methods will be subject to sampling and/ or non-
sampling risk. For example, the auditor may choose an inappropriate analytical procedure (non-
sampling risk_ or may find only minor misstatements in a test of details when, in fact, the population
misstatement is greater than the tolerable amount (sampling risk). For both tests of control and
substantive tests, sampling risk can be reduced by increasing sample size, while non-sampling risk
can be reduced by proper engagement planning, supervision and review.
Procedures for obtaining audit evidence include inspect, observation, inquiry and confirmation,
computation and analytical procedures. The choice of appropriate procedures is a matter of
professional judgement in the circumstances. Application of these procedures will often involve the
selection of items for testing form a population.
When designing audit procedures, the auditor should determine appropriate means of selecting items
for testing. The means available to the auditor are either selecting all items (100% examination) or
selecting specific items or audit sampling.
The decision as to which approach to use will depend on the circumstances, and the application of any
one or combination of the above means may be appropriate in particular circumstances. While the
decision as to which means, or combination of means, toe use is made on the basis of audit risk and
audit efficiency, the auditor needs to be satisfied that methods used are effective in providing
sufficient appropriate audit evidence to meet the objectives of the test.
The auditor should perform audit procedures appropriate to the particular test objective on each item
selected.
The auditor should consider the sample results, the nature and cause of any errors identified, and their
possible effect on the particular test objective and on other areas of the audit.
 For substantive procedures, the auditor should project monetary errors found in the sample to the
population and should consider the effect of the projected error on the particular test objective and on
other areas of the audit.
The auditor should evaluate the sample results to determine whether the preliminary assessment of the
relevant characteristics of the population is confirmed or needs to be revised.
If the evaluation of sample results indicates that the preliminary assessment of the relevant
characteristic of the population needs to be revised, the auditor may:
a) Request management to investigate identified errors and the potential for further errors, and to
make any necessary adjustments‘ and/ or
b) Modify planned audit procedures. For example, in the case of a test of control, the auditor might
extend the sample size, test an alternative control or modify related substantive procedures;
and/or
c) Consider the effect on the audit report.

Question No. 12
The company demanded to hand over the external confirmations of debtors and creditors
directly circularized by you during the course of an audit of the company.
(3 Marks December 2005)
Answer:
As per NSA 230: Audit Documentation: the auditor should adopt appropriate procedures for
maintaining the confidentiality and safe custody of the working papers and for retaining them for a
period sufficient to meet the needs of the practice and in accordance with legal and professional
requirements of record retention.
Working papers are the property of the auditor. Although portions of or extracts from the working
papers may be made available to the client at the discretion of the auditor, they are not a substitute for
the client‘s accounting records.
The confirmations letters obtained by the auditor form audit documentation and are the property of the
auditor as per NSA 230. Thus, the auditor may wish to provide a copy of the same to the company.
However, the company cannot demand and force the auditor to provide the conformation certificates
received by the auditor.

Question No. 13
What are the responsibilities of an auditor with respect to fraud and error in a financial statement
being audited? (5 Marks December 2005)

Answer:
Responsibilities of an auditor with respect to fraud and error in a financial statement
As per NSA 240: The Auditor‘s Responsibilities Relating to Fraud in an Audit of Financial Statements,
when planning and performing audit procedures and evaluating and reporting the results thereof, the
auditor should consider the risk of material misstatements in the financial statements resulting from
fraud or error.
Although the primary responsibility for the prevention and detection of fraud and error rests with both
those charged with the governance and the management of an entity, there are certain responsibilities on
the part of auditors.
As described in NSA 200, ―Overall Objectives of the Independent Auditor and the Conduct of Audit In
Accordance with NSAs ", the objective of an audit of financial statements is to enable the auditor to
express an opinion whether the financial statements are prepared, in all material respects, in accordance
with an identified financial reporting framework or relevant practices. An audit conducted in
accordance with NSAs or relevant practices is designed to provide reasonable assurance that the
financial statements taken as a whole are free form material misstatement, whether cause by fraud or
error. The fact that an audit is carried out may act as a deterrent, but the auditor is not and cannot be
held responsible for the prevention of fraud and error.
An auditor cannot obtain absolute assurance that material misstatements in the financial statements will
be detected. Owing to the inherent limitations of an audit, there is an unavoidable risk that some
material misstatements of the financial statements will not be detected, even though the audit is
properly planned and performed in accordance with NSAs. An audit does not guarantee all material
misstatements will be detected because of such factors as the use of judgement, the use of testing, the
inherent limitations of internal control and the fact that much of the evidence available to the auditor is
persuasive rather than conclusive in nature. For these reasons, the auditor is able to obtain only
reasonable assurance that material misstatements in the financial statements will be detected.
Whether the auditor has performed an audit in accordance with NSAs is determined by the adequacy of
the audit procedures performed in the circumstances and the suitability of the auditor‘s report based on
the result of these procedures.
In planning the audit, the auditor should discuss with other members of the audit team the susceptibility
of the entity to material misstatements in the financial statements resulting from fraud or error.
When planning the audit, the auditor should make inquires of management:
a) To obtain an understanding of:
i. Management‘s assessment of the risk that the financial statements may be materially
misstated as a result of fraud; and
ii. The accounting and internal control systems management has put in place to address such
risk;
b) To obtain knowledge of management‘s understanding regarding the accounting and internal
control systems in place to prevent and detect error;
c) To determine whether management is aware of any known fraud that has affected the entity or
suspected fraud that the entity is investigating; and
d) To determine whether management has discovered any material errors

The auditor may have an opportunity to seek the views of those charges with governance during, for
example, a meeting with those charged with governance to discuss the general approach and overall
scope of the audit. This discussion may also provide those charged with governance with the
opportunity to bring matters of concern to the auditor‘s attention.
Since the responsibilities of those charged with governance and management may vary by entity to
entity it is important that the auditor understand the nature of these responsibilities within an entity to
ensure that the inquires and communications described above are directed to the appropriate
individuals.
When assessing inherent risk and control risk, the auditor should consider how the financial statements
might be materially misstated as a result of fraud or error. In considering the risk of material
misstatement resulting from fraud, the auditor should consider whether fraud risk factors are present
that indicate the possibility of either fraudulent financial reporting or misappropriation of assets.
In making assessment of inherent risk and control risk affecting the nature, timing and extent of the
audit procedures, the auditor considers how the financial statements might be materially misstated as a
result of fraud or error.
Based on the auditor‘s assessment of inherent and control risks (including the results of any test of
controls), the auditor should design substantive procedures to reduce to an acceptably low level the risk
that misstatements resulting from fraud and error that are material to the financial statements taken as a
whole will not be detected. In designing the substantive procedures, the auditor should address the fraud
risk factors that the auditor has identified as being present.
When the auditor encounters circumstances that may indicate that there is a material misstatement in the
financial statements resulting from fraud or error, the auditor should perform procedures to determine
whether the financial statements are materially misstated. When the auditor identifies a misstatement,
the auditor should consider whether such a misstatement may be indicative of fraud and if there is such
an indication, the auditor should consider the implications of the misstatement in relation to other
aspects of the audit, particularly the reliability of management representations.
When the auditor confirms that, or is unable to conclude whether, the financial statements are materially
misstated as a result of fraud or error, the auditor should consider the implications for the audit.
The audit should document fraud risk factors identified as being present during the auditor‘s assessment
process and document the auditor‘s response to any such factors. If during the performance of the audit,
fraud risk factors are identified that cause the auditor to believe that additional audit procedures are
necessary, the auditor should document the presence of such risk factors and the auditor‘s response to
them.
The auditor should obtain written representations from management that:
a) It acknowledges its responsibility for the implementation and operations of accounting and
internal control systems that are designed to prevent and detect fraud and error;
b) It believes the effects of those uncorrected financial statement misstatements aggregated by the
auditor during the audit are immaterial, both individually and in the aggregate, to the financial
statements taken as a whole. A summary of such items should be included in or attached to the
written representation.
c) It has disclosed to the auditor all significant facts relating to any frauds or suspected frauds
known to management that may have affected the entity; and
d) It has disclosed to the auditor the results of its assessment of the risk that the financial
statements may be materially misstated as a result of fraud.

When the auditor identifies a misstatement resulting from fraud, or a suspected fraud, or error, the
auditor should consider the auditor‘s responsibility to communicate that information to management,
those charged with governance and, in some circumstances, to regulatory and enforcement authorities.
If the auditor has identified a material misstatement resulting from error, the auditor should
communicate the misstatement to the appropriate level of management on a timely basis and consider
the need to report it to those charge with governance.
The auditor should inform those charged with governance of those uncorrected misstatements
aggregated by the auditor during the audit that were determined by management to be immaterial, both
individually and in the aggregate, to the financial statements taken as a whole.
If the auditor has:
a) Identified a fraud, whether or not it results in a material misstatement in the financial statements;
or
b) Obtained evidence that indicates that fraud may exist (even if the potential effect on the financial
statements would not be material).

The auditor should communicate these matters to the appropriate level of management on a timely basis
and consider the need to report such matters to those charged with governance.

The auditor should also communicate to management any material weaknesses in internal control
related to the prevention or detection of fraud and error, which have come to the auditor‘s attention as a
result of the performance of the audit. The auditor should also be satisfied that those charged with
governance have been informed of any material weaknesses in internal control related to the prevention
and detection of fraud that either have been brought to the auditor‘s attention by management or have
been identified by the auditor during the audit.

Question No. 14
Your audit client has prepared its fixed asset and depreciation schedule in full compliance with the
provisions of Income Tax Act 2058 for the purpose of statutory accounts also citing that it eases
preparation of financial statements. As a statutory auditor, how would you react to this practice of
your good client? (8 Marks December 2005)

Answer:
Fixed Assets and depreciation
The students are required to mention the provisions related to depreciation as mention in NAS and
Income Tax Act 2058 at first and how the depreciation is computed under these separate standards.

As can be seen from above, there are difference treatment between NAS and IT Act with respect to:
Classification and grouping of assets,
Determination of cost of an asset for depreciation purpose, and
Recognition of repair & maintenance cost and resulting gain or loss on disposal of asset.
Thus, the auditor should qualify his report accordingly of statutory purpose.

Question No. 15
How does knowledge of business help in planning and performing an audit? Base your answer on
NSA 315: Identifying and Assessing the Risk of Material Misstatement through Understanding the
Entity and Its Environment. (6 Marks June 2006)

Answer:
As per NSA 315, The auditor shall obtain an understanding of the following:
a) Relevant industry, regulatory, and other external factors including the applicable financial
reporting framework.
b) The nature of the entity, including:
i. its operations;
ii. its ownership and governance structures;
iii. the types of investments that the entity is making and plans to make,
including investments in special purpose entities; and
iv. the way that the entity is structured and how it is financed,
to enable the auditor to understand the classes of transactions, account balances, and disclosures to be
expected in the financial statements.

c) The entity‘s selection and application of accounting policies, including the reasons for
changes thereto. The auditor shall evaluate whether the entity ‘s accounting policies are
appropriate for its business and consistent with the applicable financial reporting framework
and accounting policies used in the relevant industry.
d) The entity‘s objectives and strategies, and those related business risks that may result in risks
of material misstatement.
e) The measurement and review of the entity‘s financial performance.

Following matters may be considered in a specific engagement by the auditor.

i. General Economic Factors,

ii. The Industry-Important Conditions Affecting the Client's Business
iii. The Entity's Management and ownership,
iv. The Entity's Operating Management,
v. The entity' internal controls and their operating effectiveness
Such knowledge is used by the auditor in assessing inherent and control risks and in determining the
nature, timing and extent of audit procedures.
 Knowledge of the business is a frame of reference within which the auditor exercises professional
judgement. Understanding the business and using this information appropriately assists the auditor
in:

Assessing risks and identifying problems,

Planning and performing the audit effectively and efficiently,
Evaluating audit evidence, and
Providing better service to the client.

The auditor makes judgments about many matters throughout the course of the audit where
knowledge of the business is important.

The auditor should ensure that assistants assigned to an audit engagement obtain sufficient
knowledge of the business to enable them to carry out the audit work delegated to them. The auditor
would also ensure they understand the need to be alert for additional information and the need to
share that information with the auditor and other assistants.

To make effective use of knowledge about the business, the auditor should consider how it affects
the financial statements taken as a whole and whether the assertions in the financial statements are
consistent with the auditor's knowledge of the business.

Question No. 16
What are the provisions with regard to disqualification of an auditor as per Companies Act 2063?
(5 Marks June 2006)
Answer:

Disqualifications of auditor: (1) None of the following persons or the firms or companies in which
such persons are partners shall be qualified for appointment as auditor and shall, despite appointment as
auditor, continue to hold office:
a. A director, advisor appointed with entitlement to regular remuneration or cash benefit, a person or
employee or worker involved in the management of the company or a partner of any of them or and
employee of any of such partners or a close relative of a director or partner, out of them, or and
employee of such relative;
b. A debtor who has borrowed moneys from the company in any manner, or a person who has failed
to pay any dues payable to the company within the time limit and is in such arrears or close relative
of such person;
c. A person who has been sentenced to punishment for an offense pertaining to audit and a period of
five years has not elapsed thereafter;
d. A person who has been declared insolvent;
e. A substantial shareholder of the company or a shareholder holding one percent or more of the
paid-up capital of the company or his close relative;
f. A person who has been sentenced to punishment for an offense of corruption, fraud or a criminal
offense involving moral turpitude and a period of five years has not elapsed thereafter;
g. A person referred to in Sub-section (3) of Section 111;
h. In the case of a public company , any person who works, whether full time or part time , for any
governmental body or anybody owned fully or partly by the Government of Nepal or any other
company or a partner of such person or a person who is working as an employee of such partner or a
 person who is authorized to sign any documents or reports to be prepared by the management of the
company;
i. A company or corporate body with limited liability;
j. A person having interest in any transaction with the company or his/her close relative or a director,
officer or substantial shareholder of another company having any interest in any transaction with the
company

Question No. 17
While asking for certain evidences, Finance Manager of your clients informs you that he will include
the matter in the management representation. Will you accept management representation as
evidence? (5 Marks June 2006)

Answer:
Auditors should not place reliance on representations where more reliable evidence would be expected.
The absence of corroboratory evidence would, in itself, be suspicious and should lead to further audit
enquiry. Moreover, written representations do not necessarily constitute sufficient evidence. The auditor
must consider at available evidence and its reliability in forming an opinion. Therefore, auditor should
not depend upon management representations only wherever other evidences may be collected. As per
NSA 580, written representations cannot be considered as sufficient appropriate audit evidence. Audit
evidence will still be collected, and the representation will support that evidence. Any contradiction
between sources of evidence should always be investigated. Therefore, Finance Managers view should
not be accepted.

Question No. 18
On re-computation of payment to a contractor you find that the contractor was paid less than
amount derived as per agreed terms. The accountant represents that the contractor has received the
amount and has not made further claim. Therefore, auditors are not concerned anymore.
(5 Marks June 2006)
Answer:
This suspected fraud is perpetrated by company and not by employees against company. The auditor's
duty of confidentiality to the company prevents them from communicating to the contractor. However,
the company has a liability under the terms of the contract, which must be provided for until
extinguished by the statute of limitations or other limitation on the rights of creditors to claim for
amount underpaid.

The auditor should seek legal advice about possibility of further claims from the contractor. Further
possibility of defrauding the contractor for pecuniary advantage may also be explored from the point of
prevailing laws. If it is a case of defrauding the contractor auditors should mention in the report about
the same.

In case short payment is not intentional, auditor should assess the materiality and should modify the
report accordingly. Further auditor should reassess inherent risk involved in the audit at the entity level.
This may lead to increased level of substantive procedures.

Question No. 19
Give your opinion as an auditor in the following cases with specific reference to criteria on which
your opinion is based.
Mr. Bhishma is appointed auditor of Test Ltd., at a total remuneration of Rs. 1,00,000/- which is
classified as under:

(i) For C Unit of the Compan Rs. 45,000/-

(ii) For D Unit of the Company Rs. 60,000/-
(iii) For Central Office Rs. 25,000/-

According to the terms of appointment, Mr. Bhisma can collect his fees on progressive basis, on
completion of audit of unit (i) and/ or unit (ii).
Mr. Bhisma completed the audit of unit (ii) and recovered Rs. 60,000 on account of the audit fees
though the entire audit is not completed.
Whether Mr. Bhisma is indebted to the company and therefore disqualified?
(5 Marks June 2006)

Answer hint:

In this case, an auditor cannot be said to be indebted to the company at any stage if he recovers his fees
on a progressive basis as and when a part of the work is done without waiting for the completion of the
whole job provided such fees is recovered in accordance with the terms of his engagement with the
client. In this light, Mr. B cannot be considered to be indebted to the company and is qualified to act as a
statutory auditor.

Question No. 20
a) Explain "Reporting Consideration" while using the work of another auditor.
(4 Marks December 2006)
Answer
When the principal auditor concludes that the work of the other auditor cannot be used and the principal
auditor has not been able to perform sufficient additional procedures regarding the financial information
of the component audited by the other auditor, the principal auditor should express a qualified opinion
or disclaimer of opinion because there is a limitation in the scope of the audit.

If the other auditor issues, or intends to issue, modified auditor's report, the principal auditor would
consider whether the subject of the modification is of such a nature and significance, in relation to the
financial statements of the entity on which the principal auditor is reporting that a modification of the
principal auditor's report is required.

b) Write a short note on Management Representation Letter (4 Marks December 2006)

Answer
Management representation letter is issued by the management before signing of the auditor's report to
place on record as well as to confirm various significant representations of the management made in the
accounting statements. These letters are obtained by the auditors as a matter of audit procedure and they
act as a reminder to the management of their responsibilities. The letter in no way relieves the auditors
from carrying out their responsibilities. According to NSA 11 on Management Representations, the
main contents of such representation are as follows:
i. A statement that there have been no irregularities involving management or employees who have a
significant role in the accounting and internal control systems or that could have a material effect
on the financial statements.
 ii. A statement that all books of account and supporting documentation and all minutes of meetings
of shareholders and the board of directors have been made available to the auditors.

iii. A statement that financial statements are free of materials misstatements including omissions.

iv. A statement that the company has complied with all aspects of contractual agreements and with
requirements of regulatory authorities that could have a material effect on the financial statements
in the event of noncompliance.

v. A statement that the company has satisfactory title to all assets and there are no liens or
encumbrances on the company's assets except for those disclosed in the notes to the financial
statements.

vi. A statement that all liabilities, both actual and contingent, have been recorded or disclosed, as
appropriate and all guarantees given to third parties have been disclosed in notes to the financial
statements.

It is however to be noted that the auditor has to exercise his own judgment as to the extent up to
which he can rely upon such letter of representation.

Question No. 21
a) What are the statements of facts that an auditor has to report u/s 115 of the Companies Act,
2063? (5 Marks December 2006)

b) What are the auditor's functions and duties under Company Ordinance, 2062?
(4 Marks December 2006)

c) What are the provisions for removal of Member's name from the Member's register under
Chartered Accountants' Regulations, 2060? (4 Marks December 2006)

Answer
a) Section 115 of the Companies Act, 2063, deals with contents of the audit report in which the
auditor is required to report on the following statements of fact:

Whether such information and explanations have been made available as were required for the
completion of audit;
Whether the books of account as required by this Act have been properly maintained by the
company in a manner to reflect the real affairs of its business;
Whether the balance sheet, profit and loss account and cash flow statements received have
been prepared in compliance with the accounting standards prescribed under the prevailing
law and whether such statements are in agreement with the books of account maintained by
the company;
Whether, in the opinion of the auditor based on the explanations and information made
available in the course of auditing, the present balance sheet properly reflects the financial
situation of the company, and the profit and loss account and cash flow statement for the year
ended on the same date properly reflect the profit and loss, cash flow of the company,
respectively;
Whether the board of directors or any representative or any employee has acted contrary to
law or misappropriated any property of the company or caused any loss or damage to the
company or not;
 whether any accounting fraud has been committed in the company
Suggestion, if any.

(b) The functions and duties of auditor under Companies Act, 2063 are as follows:

(1) The auditor shall, addressing the shareholders or the appointing authority, submit to the
company his/her report, certifying the balance sheet, profit and loss account and cash flow
statement based on the books of account, records and accounts audited by him/her.
(2) The audit report shall be prepared in accordance with the prevailing law or in consonance
with the audit standards prescribed by the competent body; and such report shall state the
matters to be set out under this Act, as per necessity.
(3) The Auditors Report shall report on the following:
Whether such information and explanations have been made available as were required
for the completion of audit;
Whether the books of account as required by this Act have been properly maintained by
the company in a manner to reflect the real affairs of its business;
Whether the balance sheet, profit and loss account and cash flow statements received
have been prepared in compliance with the accounting standards prescribed under the
prevailing law and whether such statements are in agreement with the books of account
maintained by the company;
Whether, in the opinion of the auditor based on the explanations and information made
available in the course of auditing, the present balance sheet properly reflects the
financial situation of the company, and the profit and loss account and cash flow
statement for the year ended on the same date properly reflect the profit and loss, cash
flow of the company, respectively;
Whether the board of directors or any representative or any employee has acted contrary
to law or misappropriated any property of the company or caused any loss or damage to
the company or not;
whether any accounting fraud has been committed in the company
Suggestion, if any.

In the preparation of the financial statements, management has a responsibility to assess the
entity's ability to continue as a going concern even if the financial reporting framework does not
include an explicit responsibility to do so.

(c) Under Chartered Accountants Regulations 2060, The Council of the Institute of Chartered
Accountants of Nepal can remove members name from the Member's register in following
cases:

i. If the Council of Institute of Chartered Accountants of Nepal decides to cancel

membership of a member charged for a guilty considering the extent of guilty in
recommendation of Disciplinary Committee.

ii. If the member is found disqualified under Section 18 of the Chartered Accountants' Act
2053.

a. If the member does not meet the qualifications as required under Section 16 (2) & (3)
of the Nepal Chartered Accountants Act 2053.
 b. If the member has not completed 21 years of age.

c. If the member is declared insolvent.

iii. If the Council of The Institute of Chartered Accountants of Nepal decides to cancel
membership of a member after finding out the following:

a. If the member is punished on charge of criminal offence involving moral turpitude.

b. If the membership fees are not paid to the Institute.

c.If the member does not abide to the professional code of conduct prescribed under the
Chartered Accountants' Act, 2053.

d.If the member suffers from mental disorder.

e.If the member dies.

iv. If the Council of Institute of Chartered Accountants of Nepal becomes aware of the
recording of membership of a member due to mistake or error and founds it to be so
after investigation.

Question No. 22 (5 Marks each June 2007)

a) M/s ABC & Co., a Chartered Accountants firm was appointed as auditor of the
Sagarmatha Ltd by the annual general meeting held on Marg 20, 2062 for the audit of
fiscal year 2062/63. The auditor submitted management letter to the Board of Directors
on Kartik 5, 2063 before the submission of audit report that contains certain serious
issues relating to the accounting and management of the company. The meeting of the
Board of Directors held on Kartik 9, 2063 decided to request the auditor to remove those
issues from the management letter. The auditor did not remove the issues from the
management letter and submitted the final management report on Kartik 22, 2063
without considering the request of the Board. The meeting of the Board held on Kartik
25, 2063 decided to remove the auditor and issued letter to the auditor accordingly. Do
you think the Board can remove the auditor?

b) The BCD Company Ltd. having paid up capital of Rs. 25 million has retained earning of
Rs. 2 million as per financial statement of the financial year 2062/63 certified by the
auditor. The company prepared the interim financial statements as of Paush 30, 2063
and the profit and loss account ended on that date shows net profit of Rs. 1.5 million.
The board of directors of the company decided to distribute interim dividend of 10
percent. Do you think the decision of the board of directors is appropriate as per
prevailing law?

c) Why should the auditor assess the professional competence and objectivity of an expert
while using the work of an expert?
Answer

a) According to the provisions of Companies Act 2063, the auditor cannot be removed before
submission of audit report of the financial year for which he has been appointed and he
holds office until the next Annual General Meeting. Such provision in the Act guarantees
independence of the auditor.

The appointed auditor can be removed only when the auditor breaches the code of conducts
of auditors or acts against the interest of the auditee or commits any act contrary to the
prevailing law, through the same process whereby he was appointed as auditor, by giving
prior information to the Institute of Chartered Accountants of Nepal and obtaining approval
of the regulatory authority of the company concerned if any or of the Company Registrar's
Office in the absence of such regulatory authority. However, the auditor should be provided
with a reasonable opportunity to defend himself while removing an auditor.

As the above situation does not exist in the given case, the auditor appointed by the annual
general meeting cannot be removed by the Board under the Companies Act 2063.

b) According to the provisions of Companies Act 2063, the Board can distribute interim
dividend out of the profits for the previous financial year provided that the articles of
association contain a provision of the distribution of interim dividend and the annual
financial statement of the financial year, out of the profits of which year interim dividend is
to be distributed, has already been certified by the auditor and approved by the board of
directors. Provided that before distribution of interim dividend depreciation for the year and
any unabsorbed losses should be fully provided in the financial statements.

The profit of the previous year in the given case is only Rs. 2 million that is less than 10
percent of the paid-up capital of the company and the profit of the current year cannot be
used for distribution of the interim dividend. Therefore, the decision of the board of
directors is not appropriate and legal as per the provisions of the Companies Act.

c) According to Nepal Standards on Auditing -620, Using the work of an expert, the auditor
has to gather sufficient audit evidence to draw the conclusions for the expression of an
audit opinion on the financial statements. As the auditor does not have expertise of other
profession except accounting and auditing, the auditor should use the work performed by
an expert to obtain sufficient appropriate audit evidence related to technical work to assure
himself that such work is adequate for the purposes of the audit and for the following
reasons:
(i) the materiality of the financial statement item being considered;
(ii) the risk of misstatement based on the nature and complexity of the matter being
considered; and
(iii) the quantity and quality of other audit evidence available.

The professional competence and the objectivity of the expert have to be assessed as they
will affect the quality of the audit evidence being collected and ultimately the audit
opinion. The professional competence of the expert depends on (a) professional
certification or licensing by, or membership in, an appropriate professional body; and (b)
experience and reputation in the field in which the auditor is seeking audit evidence.
 Similarly, an expert‘s objectivity may be impaired when the expert is employed by the
entity or related in some other manner to the entity, for example, by being financially
dependent upon or having an investment in the entity.

Question No. 23 (5 Marks each June 2007)

a) The XYZ Company Ltd. having paid up capital of Rs. 100 million has accumulated loss
of Rs. 5 million up to financial year 2061/62 as per audited financial statement. The
company earned net profit of Rs. 8 million after tax in the financial year 2062/63. The
board of directors of the company proposed 5 percent dividend out of net profit of the
financial year 2062/63. Can annual general meeting of the company approve the
percentage of the proposed dividend?

b) The BCD & Co. an auditor of the DEF Company Ltd. appointed its employee, Mr. X as
an expert to assess condition and remaining life of the equipment of the company for
accounting depreciation as per Nepal Accounting Standard 16, Property, Plant and
Equipment and Depreciation. Has the BCD & Co. violated the code of ethics of the
Institute of Chartered Accountants of Nepal by appointing its own employee as an
expert?

c) What are the various procedures you would follow as an auditor in a compilation
engagement and under what circumstances you will withdraw from the engagement?

d) Disqualification of Auditors as per Company Act, 2063 (4 Marks December 2007)

Answer

a) The company has to deduct the pre-operation expenses, the depreciation to be accounted in
accordance with the accounting standards promulgated by the competent authority under
the prevailing law, any amount required to be paid or set aside out of the profits under the
prevailing law or the total amount of accumulated loss before payment or distribution of
dividend from the net profit of any fiscal year. Similarly, if the company is required to
create any reserve or fund under the prevailing law, dividend cannot be distributed without
setting aside the amount for such reserve or fund.

Accordingly, the retained profit after adjusting accumulated loss of Rs. 5 million of the
previous year from the net profit of Rs.8 million of the fiscal year 2062/063 is Rs. 3 million
only which is less than the 5 percent of the paid-up capital of the company. The Company
Act has strictly prohibited the distribution of dividend from the net profit of the current
year without setting off the accumulated loss of the previous year. Hence, the annual
general meeting cannot approve the percentage of the proposed dividend rather it can
approve the percentage of dividend sufficient to pay from the net profit after deducting the
earlier year accumulated loss.

b) According to Nepal Standards on Auditing-620, Using the Work of an Expert, an expert

means a person or firm possessing special skill, knowledge and experience in a particular
field other than accounting and auditing. An expert may be engaged by the entity or auditor
or employed by the entity or the auditor. When the auditor uses the work of an expert
employed by the auditor, that work is used in the employee‘s capacity as an expert rather
 than as an assistant on the audit. However, in such circumstances the auditor will need to
apply relevant procedures to the employee‘s work and findings.

Further Code of Ethics of Institute of Chartered Accountants of Nepal (ICAN), specifies

that the Professional Accountant should be independent of a client and all its parents,
subsidiaries and affiliates and should not assume the role of employee or of management
conducting the operations of an enterprise. The appointment of an expert employed by the
auditor for the purpose of using the work of an expert is not prohibited by the Code of
Ethics. Therefore, the BCD & Co. and auditor have not violated the code of ethics of the
ICAN.

c) According to NSRS 4410 "Compilation Engagements" a practitioner should obtain a

general knowledge of the business and operations of the entity. Also, he should be familiar
with the accounting principles and practices of the industry in which the entity operates and
with the form and content of the financial information that is appropriate in the
circumstances to compile the financial statements.

The practitioner shall compile the financial information using the records, documents,
explanations and other information, including significant judgments, provided by
management.
The practitioner shall discuss with management, or those charged with governance as
appropriate, those significant judgments, for which the practitioner has provided assistance
in the course of compiling the financial information.

Prior to completion of the compilation engagement, the practitioner shall read the compiled
financial information in light of the practitioner‘s understanding of the entity‘s business
and operations, and of the applicable financial reporting framework

If, in the course of the compilation engagement, the practitioner becomes aware that the
records, documents, explanations or other information, including significant judgments,
provided by management for the compilation engagement are incomplete, inaccurate or
otherwise unsatisfactory, the practitioner shall bring that to the attention of management
and request the additional or corrected information.

If the practitioner becomes aware during the course of the engagement that:
a. The compiled financial information does not adequately refer to or describe the
applicable financial reporting framework;
b. Amendments to the compiled financial information are required for the financial
information not to be materially misstated; or
c. The compiled financial information is otherwise misleading,
the practitioner shall propose the appropriate amendments to management and If
management declines or does not permit the practitioner to make the proposed amendments
to the compiled financial information, the practitioner shall withdraw from the engagement
and inform management and those charged with governance of the reasons for
withdrawing.

d) As per Section 112 (1) of the Company Act 2063, none of the following persons or the
firms or companies in which such persons are partners shall be qualified for appointment as
auditors and shall, despite appointment as auditor, continue to hold office:
 i. A director, advisor appointed with entitlement to regular remuneration or cash benefit, a
person or employee or worker involved in the management of the company or a partner
of any of them or an employee of any of such partners or a close relative of a director or
partner, out of them, or an employee of such relative;

ii. A debtor who has borrowed moneys from the company in any manner, or a person who
has failed to pay any dues payable to the company within the time limit and is in such
arrears or a close relative of such person;

iii. A person who has been sentenced to punishment for an offense pertaining to audit and a
period of five years has not elapsed thereafter;

iv. A person who has been declared insolvent;

v. A substantial shareholder of the company or a shareholder holding one percent or more

of the paid-up capital of the company or his close relative;

vi. A person who has been sentenced to punishment for an offense of corruption, fraud or a
criminal offense involving moral turpitude and a period of five years has not elapsed
thereafter;

vii. A person referred to in sub-section (3) of Section 111;

viii. In the case of a public company, any person who works, whether full time or part time,
for any governmental body or anybody owned fully or partly by the Government of
Nepal or any other company or a partner of such person or a person who is working as
an employee of such partner or a person who is authorized to sign any documents or
reports to be prepared by the management of the company;

ix. A company or corporate body with limited liability;

x. A person having interest in any transaction with the company or his close relative or a
director, officer or substantial shareholder of another company having any interest in any
transaction with the company.

Question No. 24

a) The auditor is required to take into account the aggregate of all uncorrected
misstatements including those involving estimates in his assessment of materiality in
audit. Discuss. (6 Marks June 2007)

b) M/s ITG Ltd. manufactures "X" machinery used in M/s ABC Ltd. M/s ITG Ltd. quotes
in various tenders issued by M/s ABC Ltd. As per terms of contract, full price of "X"
machinery is not released by M/s ABC Ltd., but 10% thereof is retained and paid after
one year if there is satisfactory performance of the "X" machinery supplied. The
company accounts for only 90% of the invoice value as sales income and the balance
amount in the year of receipt to the extent of actual receipt only. Give your view as the
auditor of the company. (4 Marks June 2007)
Answer
a) Nepal Standard on Auditing–450 on "Evaluation of Misstatement Identified During the
Year" requires the auditor to determine whether the uncorrected misstatements are material
individually or in aggregate.
In making this determination, the auditor shall consider:
a. 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
b. 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 aggregate of uncorrected misstatements comprises.

i. Specific misstatements identified by the auditor including the net effect of uncorrected
misstatements identified during the audit of previous periods; and
ii. The auditor's best estimate of other misstatements which cannot be specially identified,
that is, projected errors. The analytical procedures employed by the auditor may give
him some indication about the existence of misstatements which can be further
substantiated by him through estimates process.

If the aggregate of the uncorrected mis-statements that the auditor has identified
approaches the materiality level, or if auditor determines that the aggregate of uncorrected
mis-statements causes the financial information to be materially mis-stated, he should
consider requesting the management to adjust the financial information or extending his
audit procedures. In any event, the management may want to adjust the financial
information for known misstatements. The adjustment of financial information may
involve, for example, application of appropriate disclosure of inadequately disclosed
matters. If the management refuses to adjust the financial information and the results of
extended audit procedures do not enable the auditor to include that the aggregate of
uncorrected misstatements is not material, the auditor should express a qualified or adverse
opinion, as appropriate.

b) Nepal Accounting Standard – 18 'Revenue' states that revenue from sale of goods should be
recognized when all the following conditions have been satisfied:
i. the enterprise has transferred to the buyer the significant risks and rewards of ownership
of the goods;
ii. the enterprise retains neither continuing managerial involvement to the degree usually
associated with ownership nor effective control over the goods sold;
iii. the amount of revenue can be measured reliably;
iv. it is probable that the economic benefits associated with the transaction will flow to the
enterprise; and
v. the costs incurred or to be incurred in respect of the transaction can be measured reliably.

In the case of ITG Ltd., the goods, as well as the risks and rewards of ownership have been
transferred to ABC Ltd. The invoice raised by ITG Ltd. is for the full price, but 10% less is
received as the same is kept as "Retention Money". In this case, therefore, revenue has to
be recognized at the full invoice price, i.e. 100% has to be accounted as Sales Income.
Depending on the past experience of recovering the balance 10% from ABC Ltd., ITG Ltd.
 can, however, make a provision for sales income which is not likely to be realized. In the
absence of the above, the auditor will have to qualify his report.

Question No. 25
Distinguish between:
a) Corresponding figures and Comparative figures (5 Marks June 2007)
b) Positive confirmation and Negative confirmation (5 Marks June 2007)

Answer
a) Corresponding figures and Comparative figures

Under Corresponding figures amounts and other disclosures for the preceding period are
included as part of the current period financial statements and are intended to be read in
relation to the amounts and other disclosures relating to the current. These corresponding
figures are not presented as complete financial statements capable of standing alone but are
an integral part of the current period financial statements intended to be read in conjunction
with the amounts and other disclosures relating to the current period. The level of detail
presented in the corresponding amounts and disclosures is dictated primarily by its
relevance to the current period figures.

Under the comparative financial statements, the comparative financial statements for the
prior period(s) are considered separate financial statements and the amounts and other
disclosures for the preceding period are included for comparison with the financial
statements of the current period, but do not form part of the current period financial
statements. Accordingly, the level of information included in those comparative financial
statements (including all statement amounts, disclosures, footnotes and other explanatory
statements to the extent that they continue to be of significance) approximates that of the
financial statements of the current period.

Positive confirmation and Negative confirmation

A positive external confirmation request asks the respondent to reply to the auditor in all
cases either by indicating the respondent‘s agreement with the given information or by
asking the respondent to fill in information asked for. A response to a positive confirmation
request ordinarily provides reliable audit evidence but there is a risk of replying the
confirmation request without verifying the correctness of the information asked for by the
respondent. The auditor may not be able to detect occurrence of such situation. The auditor
may reduce this risk by using positive confirmation requests without stating the amount or
other information on the confirmation request and asking the respondent to fill in the
amount or furnish other information asked for. However, the use of this type of ―blank‖
confirmation request may result in lower response rates due to requirement of additional
effort of the respondents.

A negative external confirmation request asks the respondent to reply only in the event of
disagreement with the information provided in the request. There will not be explicit
evidence of receipt of confirmation request by the third parties and verification of
information provided in the request if response has not been received to a negative
confirmation request. Therefore, the use of negative confirmation requests ordinarily
provides less reliable evidence than the use of positive confirmation requests, and the
 auditor has to consider performing other substantive procedures to supplement the use of
negative confirmations.

Question No. 26
Comment and give your opinion on the following issues with specific reference to criteria on
which your opinion is based: (5 Marks each June 2007)
a) A commercial bank did not make any provision for proposed dividend of 10 percent in
the financial statement of the fiscal year 2062/63. Nepal Rastra Bank approved the
financial statements for publication without knowing the intention of the bank of
declaring dividend. One of the published agenda of the annual general meeting of the
bank is approval of proposed dividend of 5 percent.
b) The Audit Committee of PST Ltd. recommended the names of possible auditor to be
appointed as auditor of the company at the remuneration of Rs. 125,000 for the financial
year 2063/64. The annual general meeting held on Kartik 7, 2063 failed to appoint the
auditor due to time constraint and delegated power to the Board to appoint the auditor
from the list of the auditors at the remuneration under the terms of condition
recommended by the Audit Committee. The Board meeting held on Kartik 30, 2063
appointed M/s. XP & Co., a Chartered Accountants firm as auditor. Do you think the
appointment is valid and if not why?

Answer

a) As per NAS 10, If an entity declares dividends to holders of equity instruments after the
balance sheet date, the entity shall not recognize those dividends as a liability at the balance
sheet date.
If dividends are declared (i.e. the dividends are appropriately authorized and no longer at
the discretion of the entity) after the balance sheet date but before the financial statements
are authorized for issue, the dividends are not recognized as a liability at the balance sheet
date because they do not meet the criteria of a present obligation. Such dividends are
disclosed in the notes in accordance with NAS 01 Presentation of Financial Statements.

Similarly, as per Bank and Financial Institution Act 2063, the bank can declare or distribute
dividend to its shareholders only after recovering all its preliminary expenses, setting off
accumulated loss up to previous year, maintaining adequate provision for capital fund, loan
losses and statutory reserve fund, and obtaining prior approval of the Nepal Rastra Bank.

In the given case, the commercial bank has not mentioned in the notes of the financial
statements as required by the Nepal Accounting Standards which is to be followed by the
commercial bank as per prevailing Act. Due to non-disclosure in the notes to the financial
statements, the Nepal Rastra Bank was not aware of the declaration of the dividend. The
prior approval of the Nepal Rastra Bank as required by the Act has also not been obtained.
Therefore, the agenda put for approval of declaration of the dividend is null and void and
annual general meeting cannot approve the agenda of dividend.

b) According to the provisions of Companies Act 2063, every company has to appoint the
auditor to have its accounts audited. The annual general meeting on recommendation of the
Audit Committee in the case of public company has the authority to appoint an auditor of
the company from amongst the auditors holding certificate of practice under the prevailing
law and the name of the auditor appointed should be forwarded to the Company Registrar's
 office within fifteen days from the date of such appointment. The Act does not have any
provision of delegating power to anyone for appointment of auditor. The annual general
meeting of the public company has authority to appoint auditor at the remuneration under
the terms and conditions as recommended by the Audit Committee.
Where the annual general meeting fails to appoint an auditor for any reason or where the
annual general meeting itself cannot be held or where the auditor appointed pursuant to the
Companies Act ceases to continue his office for any reason, the Company Registrar's office
may at the request of the Board of Directors of the company appoint another auditor. In this
situation, the Board of the company can request the Company Registrar's office for the
appointment of the auditor, but the office has sole authority to appoint any auditor holding
certificate of practice at remuneration under terms and conditions decided by the office.
The Companies Act does not have provision of delegating power of the appointment of the
auditor and no one else has authority to select the auditor for appointment except the annual
general meeting and Company Registrar's Office in case of failure to appoint the auditor by
the Annual General Meeting (AGM) , the appointment of the auditor by the Board of
Directors under the delegation of authority by AGM is not valid. The Company Registrar's
office can only appoint anyone as the auditor on request of the Board of the company.

Question No. 27
M/s Raghu Manufacturing Company Ltd. has invested in the shares and debenture and other
scripts of various companies listed in Nepal Stock Exchange Ltd. During the course of audit of
the FY 2063/64, in spite of repeated reminders and follow up made by its external auditor,
company officials did not provide the details of investments in shares and various securities held
by the company at the Balance Sheet date. As a result, the external auditor came to conclusion
that he/she should issue his/her final audit report as follows;

“Subject to the verification of the value of investments held in shares and debentures and other
scripts of various companies listed in Nepal Stock Exchange Ltd., the balance sheet reflects a
true and fair view.”
Do you think the audit report to be issued by the auditor is appropriate in view of the
Company
Act, 2063? Give your view. (5 Marks December 2007)

Answer
Failure to Obtain Information and Explanation:
The external auditor is required to express his opinion on the truth and fairness of the financial
statement audited by him only after examining the authenticity with reference to the information
and explanations given to him as required by Section 115 of Company Act 2063. He must
determine the extent of information which should be obtained by him before expressing an opinion
on the financial statement submitted for audit. The auditor should not express an opinion before
obtaining the required data and information.
In the given case, since the external auditor did not see the existence and also valuation of the
investments held by the company, the auditor, should not report as mentioned in the question. In
this case, the external auditor has not been able to obtain information and might not be able to
satisfy himself by adopting other audit procedure and accordingly may have to appropriately
modify the report.
The auditor may state that because of these circumstances, he has been unable to form an opinion.
But, reporting by the auditor that,‖ subject to verification of the existence and value of the
investments held in shares and debenture and other scripts in the various companies listed in the
Nepal Stock Exchange Ltd., the Balance Sheet shows a true and fair view‖, the auditor is not
providing information but only means to information. By reporting in the above manner auditor is
not conveying any information rather the auditor is arousing the suspicion of users of financial
statements. In case the auditor has not been able to obtain relevant information or explanations as
required by the provisions of the Company Act, 2063, he may have to qualify his opinion on the
truth and fairness of the information or explanations or express his inability to give an opinion in
the matter. In view of above, the auditor‘s report which he is going to issue, as stated above in the
question, is not appropriate in as per the provisions of the Company Act, 2063. Besides as per the
requirements of NSA 705, while qualifying the report the auditor has to quantify the effect of the
matter reported.

Question 28
a) Explain the composition of the Audit Committee as per the Company Act 2063. How an
audit committee can contribute to the enterprise for maintaining good corporate
governance? (5 Marks June 2008)
b) Explain the provision relating to Registration of Accounting Professional Firm under
the Nepal Chartered Accountants Act, 2053 (with amendment). (5 Marks June 2008)
Answer
a) Section 164 of Company Act 2063 provides for composition of the Audit Committee. As
per the said section, any company having paid up capital of Rs. 3 crores or more or an
undertaking of government (fully or partly owned) shall have an audit committee
comprising of at-least 3 members headed by a non-executive director. Any close relative of
the chief executive shall not be the member of the committee. One member of the
committee shall be professionally qualified in accounting or any person having bachelor's
degree in accounts, finance, management or economics and relevant experience in accounts
of finance.

Section 165 provides for the authority, duties and responsibilities of the audit committee
and most of their duties are directed towards good governance. As per the act, board shall
act upon the recommendation of the committee and if anything cannot be implemented, it
shall be mentioned in the annual reports with reasons.

Since the audit committee comprised of non-executive director, independent and

professional persons and had power to recommend for effective and efficient use of
resources to the Board, it helps in maintaining good governance of the company.

b) Section 28a of Nepal Chartered Accountants Act 2053, regarding Registration of Auditing
Firms requires that: (1) Members, holding Certificate of Practice and willing to carry on
audit business under the name of an accounting firm, shall apply to the Institute, in a
prescribed format, for registration of such firm.
(2) The other procedures relating to the registration of accounting firms shall be as
prescribed.
(3) The Council, after completion of the procedures mentioned in subsection (2), shall issue
Certificate of Firm Registration in a prescribed format.

Accordingly, Rule 57 of Nepal Chartered Accountants Rules, 2061, Registration of

Accounting Firm has prescribed following procedures for registration of firm:
(i) Member desiring to practice accountancy profession shall have to register his/her sole
proprietorship firm or firm in partnership with one or more partners of his/her own
class with the Institute.
 (ii) To register a firm of sole proprietorship or in partnership according to sub rule (i) an
application shall be made in the prescribed format in Schedule-32 with applicable fees
fixed by the council and a copy of the deed of partnership between /among partners
shall be attached.

(iii) The partnership deed according to sub–rule (ii) among other things must contain the
following subjects:
(a) The number of shares of each partner,
(b) The process of admission and retirement of a partner,
(c) Conditions of dissolution of partnership
(d) Conditions about continuity/discontinuity of the name after the dissolution of
partnership.
(e) Distribution of business, assets and liabilities after the dissolution of partnership.
(f) Liability of a partner who gives up partnership

Question No. 29
Briefly describe the auditor‟s responsibility regarding subsequent events.
(5 Marks June 2008)
Answer
When the auditor draws up his audit plan, checking of subsequent events is an important audit
procedure irrespective to the level of test checks employed for checking of the transactions during
the year. In fact, more detailed check is normally required for subsequent events to confirm certain
assertions contained in the financial statements, e.g. the payment made by debtors after the close of
accounting period would confirm that outstanding debtors on the date of the balance sheet date
have been realized. NSA 560 on Subsequent Events establishes standards on the auditor‘s
responsibility regarding the subsequent events. NSA 560 states that the term subsequent events
refer to significant events occurring between the balance sheet date and the date of the auditor‘s
report.
NAS 10 on Events After the Reporting Date deals with all those significant events both favorable
and unfavorable events that occurred between the balance sheet date and the date on which the
financial statements are approved by the board of directors in case of a company and by the
corresponding approving authority in case of any other entity. As per NAS 10 events can be
identified as adjustable events which provide further evidence of conditions that existed at balance
sheet date and non-adjusting events are those which are indicative of conditions that arose
subsequent to the balance sheet date. NAS 560 lays down that the auditor should consider the
effect of subsequent events on the financial statement and on the auditor‘s report. When the time
between the close of the year end and the adoption of accounts is about to take place, examination
of subsequent events gains more importance.

The auditor should perform procedures designed to obtain sufficient appropriate audit evidence
that all events up to the date of the auditor‘s report that may require adjustment of, or disclosure in,
the financial statements have been identified. These procedures are in addition to routine
procedures which may be applied to specific transactions occurring after period end to obtain audit
evidence as to account balances as at period end, for example, the testing of inventory cutoff and
payments to creditors. The auditor is not, however, expected to conduct a continuing review of all
matters to which previously applied procedures have provided satisfactory conclusions.
The procedures to identify events that may require adjustment of, or disclosure in, the financial
statements would be performed as near as practicable to the date of the auditor‘s report and
ordinarily include the following:

reviewing procedures management has established to ensure that subsequent events are identified,

reading minutes of the meetings of shareholders, the board of directors and audit and executive
committees held after period end and inquiring about matters discussed at meetings for which
minutes are not yet available,

reading the entity‘s latest available interim financial statements and, as considered necessary
and appropriate, budgets, cash flow forecasts and other related management reports,

inquiring, or extending previous oral or written inquiries, of the entity‘s lawyers concerning
litigation and claims and

inquiring of management as to whether any subsequent events have occurred which might
affect the financial statements. Examples of inquiries of management on specific matters are:

the current status of items that were accounted for on the basis of preliminary or
inconclusive data,
whether new commitments, borrowings or guarantees have been entered into,
whether sales of assets have occurred or are planned,
whether the issue of new shares or debentures or an agreement to merge or liquidate has
been made or is planned,
whether any assets have been appropriated by government or destroyed, for example, by
fire or flood, or earthquake, or made unproductive without complete destruction,
whether there have been any developments regarding risk areas and contingencies,
whether any unusual accounting adjustments have been made or are contemplated, and
whether any events have occurred or are likely to occur which 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.

When the auditor becomes aware of events which materially affect the financial statements, the
auditor should consider whether such events are properly accounted for in the financial statements.
When the management does not account for such events that the auditor believes should be
accounted for, the auditor should express qualified option or an adverse opinion as appropriate.

Question No. 30
Explain what is meant by “representation by management” and indicate to what extent an
auditor can place reliance on such representation. (8 Marks December 2008)
Answer
The management is responsible for appropriate preparation and presentation of the financial
information. Thus, it is quite natural that during the course of audit, management would be
required to make several representations on various matters relating to financial statements. These
representations may be made by the management either orally or in writing to the auditor. For
example, the auditor may ask the management to confirm about the existence of contingent
liability and disclosure thereof, etc. In other words, the representation by the management
constitutes the acknowledgement by the management about its responsibility for the preparation
and approval of the financial information. A written representation may either take the form of a
letter from the management or letter by the auditor outlining auditors understanding and
confirmation of the same.

Extent of reliance: NSA 580 ―Written representations‖ Written representations are necessary
information that the auditor requires in connection with the audit of the entity‘s financial
statements. Accordingly, similar to responses to inquiries, written representations are audit
evidence

However, it must be noted that representation by the management cannot be the substitute for other
audit evidence that the auditor could reasonably expected to be available. For example, a
representation by the management as to existence, quantity and cost of inventory is not substitute
for adopting the audit procedure regarding verification and valuation of inventories. If a
representation by management is contradicted by other evidence, the auditor should examine the
circumstances and, when necessary, reconsider the reliability of other representations made by the
management as well.

Question No. 31
Give your opinion as an auditor in the following case with specific reference to criteria on
which your opinion is based. (5 Marks December 2008)

You are manager in-charge on the audit of the financial statements of New Nepal Limited, a
large manufacturing company, which has appointed your firm as auditors for the first time.
During the course of finalization of audit, you had various meetings with the senior
management of the Company. The management of the company is really proud of their systems,
business ethics and transparency in the financial reporting systems. Nevertheless, during
discussion you came across a situation whereby the management has refused the request of
signing the general representation letter. The chief executive and chief financial officer of the
company are of the view that all their procedures and financial reporting systems are
transparent and you are given full liberty to check and verify any information and there is no
bar on providing you any information that you may require for the purpose of your audit.
Accordingly, they feel that through a representation letter, you wish to transfer your
responsibility to them. Therefore, they are not willing to sign any sort of representations by
whatever name called.
Answer
As per NSA 580: Written Representations, the auditor should obtain appropriate representations
from management. The auditor should obtain written representations from management on matters
material to the financial statements when other sufficient appropriate audit evidence cannot
reasonably be expected to exist.

During the course of an audit, management makes many representations to the auditor, either
unsolicited or in response to specific inquiries. A written statement by management provided to
the auditor to confirm certain matters or to support other audit evidence. Written representations in
this context do not include financial statements, the assertions therein, or supporting books and
records. Further, representation by management can neither substitute for other audit evidence that
the auditor could reasonably expect to be available nor it transfer auditor's liability to the
management.
If management does not provide one or more of the requested written representations, the auditor
shall:
a. Discuss the matter with management;
b. Reevaluate 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
c. Take appropriate actions, including determining the possible effect on the opinion in the
auditor‘s report in accordance with NSA 705 (Revised).

Thus, the auditor shall make it clear to the management that obtaining of representations helps
them to establish their responsibilities to fair presentation of financial statements, confirmations of
representations made to them and it constitute an audit evidence to base their audit opinion. It will
not in any way transfer the responsibility of auditors to the management but refusal of the same
may lead to qualification of auditor's report as scope limitation.

Question No. 32
Express your views in the following case (5 Marks each June 2009)

a. An auditor of ABC Ltd. was not able to get the confirmation about the existence and value of
certain machineries. However, the management gave him a certificate to prove the existence
and value of the machinery as appearing in the books of account. The auditor accepted the
same without any further procedure and signed the audit report. Is he right in his approach?

Answer
The physical verification of fixed assets is the primary responsibility of the management. The
auditor, however, is required to examine the verification programme adopted by the
management. He must satisfy himself about the existence, ownership and valuation of fixed
assets. In the case of ABC Ltd., the auditor has not been able to verify the existence and value
of some machinery despite the verification procedure followed in routine audit. He accepted
the certificate given to him by the management without making any further enquiry.

As per NSA 580 Written Representations, when representation relate to matters which are
material to the financial information, then the auditor should seek corroborative audit evidence
for other sources inside or outside the entity. He should evaluate whether such representations
are reasonable and consistent with other evidences and should consider whether individuals
making such representations can be expected to be well informed on the matter.
―Representation by Management" cannot be a substitute for other audit evidence that the
auditor could reasonably expect to be available. If the auditor is unable to obtain sufficient
appropriate audit evidence that he believes would be available regarding a matter, which has or
may have a material effect on the financial information, this will constitute a limitation on the
scope of his examination even if he has obtained a representation from management on the
matter. Therefore, the approach adopted by the auditor is not right.

b. A firm of a father and a son is receiving Rs. 2 lakhs towards job work done for XYZ Ltd.
th
during the year ended on 15 July 2007. The total job work charges paid by XYZ Ltd. during
the year are over Rs. 50 lakhs. The father is a 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. Is Managing Director right in his approach?
 Answer
NAS 24 and NSA 550, ―Related Party‖ applies to the facts of the case. NSA 550
requires
disclosure of party relationship and transactions between a reporting enterprise and its related
parties. The 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 decisions. As per the explanation given in NAS 28, significant influence is
said to exist in case the investing party has 20% or more voting power in the enterprise. 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 the firm. The case is squarely covered by the standard. The approach of the
managing director is not tenable under the law and accordingly all disclosure requirements
have to be complied. Accordingly, the approach followed by the Managing Director is not
right. Under the circumstances, the auditor shall have to modify his report.

Question No. 33
You are appointed as a statutory auditor of M/s Unreliable Company Limited for the FY
2064/65. When you come across the cases where it is not possible to continue performing the
audit and not able to complete the audit engagement as a result of a misstatement resulting
from fraud or suspected fraud. What would be your course of action as an auditor of that
company?
(5 Marks June 2009)

Answer
As per para 38 of NSA 240, 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:
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 is
possible under applicable law or regulation; 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.

Because of the variety of the circumstances that may arise, it is not possible to describe definitely
when withdrawal from an engagement is appropriate. Factors that affect the auditor‘s conclusion
include the implications of the involvement of a member of management or of those charged with
governance (which may affect the reliability of management representations) and the effects on the
auditor of continuing association with the entity.

The auditor has professional and legal responsibilities in such circumstances and these
responsibilities may vary by entity. For example, the auditor may be entitled to, or required to,
make a statement or report to the person or persons who made the audit appointment or, in some
cases, to regulatory authorities. Given the exceptional nature of the circumstances and need to
advice when deciding whether to withdraw from an engagement and in determining an appropriate
course of action.
Question No. 34
Answer the following:
Auditor's responsibilities regarding comparatives (5 Marks June 2009)

Answer
NSA 710, ―Comparative Information Corresponding Figures and Comparative Financial
Information‖, establishes standards on the auditor‘s responsibilities regarding comparatives.
The
auditor responsibilities laid down are as under:
i. The auditor shall determine whether the financial statements include the comparative
information required by the applicable financial reporting framework and whether such
information is appropriately classified

ii. If 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 modification
is unresolved, the auditor shall modify the auditor‘s opinion on the current period‘s financial
statements.

iii.If the auditor obtains audit evidence that a material misstatement exists in the prior period
financial statements on which an unmodified opinion has been previously issued, and the
corresponding figures have not been properly restated or appropriate disclosures have not been
made, the auditor shall express a qualified opinion or an adverse opinion in the auditor‘s report
on the current period financial statements, modified with respect to the corresponding figures
included therein

iv. If the financial statements of the prior period were audited by a predecessor auditor and the
auditor is not prohibited by law or regulation from referring to the predecessor auditor‘s report
on the corresponding figures and decides to do so, the auditor shall state in an Other Matter
paragraph in the auditor‘s report:
a. That the financial statements of the prior period were audited by the predecessor
auditor;
b. The type of opinion expressed by the predecessor auditor and, if the opinion was
modified, the reasons therefore; and
c. The date of that report.

Question No. 35
Describe Auditor‟s responsibility regarding subsequent events. (5 Marks December 2009)

Answer
The auditor should consider the effect of subsequent events on the financial statements and on the
auditor‘s report. Both favorable and unfavorable event can occur after the balance sheet date
materially affecting the financial statement.

The auditor should obtain sufficient appropriate evidence that all events occurring after balance
sheet date have been identified, adjusted/disclosed where required in the financial statements by
employing the following procedures:

Review of management procedures to identify subsequent events

Reading of minutes of meeting of board of directors, shareholders etc.
Reading the latest available interim financial information, budgets, forecasts etc.
 Inquiring the lawyers of the entity as to the litigation and claims
Inquiring management as to any subsequent events after the balance sheet date affecting the
financial statements

In case of subsequent events materially affecting the financial statements, the auditor should
consider whether such events have been properly accounted for in the financial statements. Where
the management has not accounted for such events, the auditor should qualify the report.

When after the date of the auditor‘s report but before the financial statements are issued, the
auditor becomes aware of a fact which may materially affect the financial statement and the
auditor should consider whether the financial statements need amendment, should discuss the
matter with management and should take the appropriate actions.

When after the financial statements have been issued, the auditor becomes aware of a fact which
existed at the date of the auditor‘s report and which if known at that date may have caused the
auditor to modify the auditor‘s report, the auditor should consider whether the financial statements
need revision, should discuss with management and should take action accordingly

Question No. 36
Describe the contents of a standard Management Letter issued to the management
containing the findings observed during the course of the audit and recommendations to
overcome it? Give examples for each component. (5
Marks December 2009) Answer
A standard management letter contains the following components:
Condition – it shows what is the issue? For example- fixed assets register not
maintained.
Criteria – it describes the criteria that what should be there? For example-As stipulated
in the financial policy the logistic department should maintain a comprehensive fixed
asset register.
Impact – it describes the results/ impact due to the condition. For example-in the
absence of the fixed assets register the existence of the assets could not be ensured.
Cause – why does it happen? It includes the reason for the condition. For example- the
management is unaware of the provision.
Recommendation – the Auditors‘ recommendation address to the issue. For example – the
management should maintain a comprehensive fixed asset register as described in the
financial policies.
Management comments – the management response to the auditors‘ recommendation.
For example – the management will initiate action to maintain a comprehensive fixed
asset register.
Auditors‟ subsequent comments – if the management response contradicts the issue
but the evidence supports the findings then the auditor can put subsequent comments and
stand by with the observation. However, this is unlikely.

Question No. 37
Express your opinion as an auditor on the following cases with specific reference to the criteria
on which your opinion is based: (5 Marks each June 2010)
a) The accountant of Kathmandu Ltd. has requested you, not to send balance confirmations to
a particular group of debtors since the said balances are under dispute and the matter is
pending in the court.
b) While the refrigeration units were undergoing modernization, ABC & Co. outsourced all its
cold storage requirements to Dinesh & Co. Warehousing Services. At 31 March 2009 it was
not possible to physically inspect ABC‟s inventory held by Dinesh & Co. due to health and
safety requirements preventing unauthorized access to cold storage areas. ABC‟s
management has provided written representation that inventory held at 31 March 2009 was
Rs. 10.1 million (2008 – Rs. 6.7 million). This amount has been agreed to a costing of
Dinesh & Co.‟s monthly return of quantities held at 31 March 2009.
c) In the course of audit of Hytide Company Limited, you come across a case where one of
your audit assistants had been paid Rs. 50,000/- by the company in the previous year for
providing some sales related information of Medico Company Limited. Medico Company
Limited is also your audit client and both Companies are manufacturer of medicines. Give
your opinion in this regard with reference to the Nepal Standards on Auditing.

a) Answer
NSA 505, ―External Confirmations‖, establishes standards on the debtor‘s use of external
confirmation as a means of obtaining audit evidence. It requires that the auditor should employ
external confirmation procedures in consultation with the management. The auditor may come
across certain situations in which the management may request him not to seek external
confirmation from certain parties because of dispute with the debtors, etc. The management, for
example, might make such a request on the grounds that due to a dispute with the particular debtor,
the request for confirmation might aggravate the sensitive negotiations between the entity and the
debtor. In such cases, when an auditor agrees to management‘s request not to seek external
confirmation regarding a particular debtor, the auditor should consider validity of grounds for such
a request and assess management‘s integrity and obtain evidence to support the same. The auditor
should also ask the management to submit its request in a written form, dealing therein the reasons
for such a request. If the auditor agrees to management‘s request not to seek external confirmation
regarding a particular matter, the auditor should document the reasons for acceding to the
management‘s request and should apply alternative procedures to obtain sufficient appropriate
evidence regarding that matter. While considering the validity of request, in case the auditor
reaches at a conclusion that the same was not valid, he may appropriately modify the report.

b) Answer
Inability to inspect inventory may amount to a limitation in scope if the auditor cannot obtain
sufficient audit evidence regarding quantity and its condition. This would result in an ‗except for‘
opinion. Although Dinesh & Co.‘s monthly return provides third party documentary evidence
concerning the quantity of inventory it does not provide sufficient evidence with regard to its
valuation. Inventory will need to be written down if, for example, it was contaminated by the
leakage (before being moved to Dinesh & Co.‘s cold storage) or defrosted during transfer. ABC‘s
written representation does not provide sufficient evidence regarding the valuation of inventory as
presumably ABC‘s management did not have access to physically inspect it either. If this is the
case this may call into question the value of any other representations made by management. In
addition to this, a copy of the health and safety regulation preventing the auditor from gaining
access to Dinesh & Co.‘s cold storage to inspect ABC‘s inventory should be taken and physical
inspection should be made for the inventory in ABC‘s refrigeration units after the balance sheet
date to confirm its condition.

c) Answer
As per NSA 200 para 17, confidentiality is one of the basic principles governing an audit. The
auditor should comply with ethical principles governing professional responsibilities. In this
context, the auditor should respect the confidentiality of information which comes to the
knowledge of the auditor during the course of performing professional services. That information
should not be used or disclosed or shared with others without proper and specific authority or
unless there is a legal or professional right or duty to disclose.
In the given case the information relating to the sales of Medico Company Limited was provided
to Hytide Company Limited which is in the same line of manufacture of medicine. This act is
against the basic ethical principles governing professional responsibilities of an auditor. Thus,
action should be initiated against the audit assistant. The auditor should also make appropriate
mechanism for checking these types of unethical activities of the audit staff so as to ensure
confidentiality of information obtained during the course of audit.

Question No. 38
Explain the general principals of an audit of financial statements. (8 Marks June 2010)
Answers:
a) The audit of financial statements is of paramount significance. The auditor‘s opinion enhances
the credibility of the financial statements since the auditor expresses an opinion whether the
financial statements are prepared, in all material respects in accordance with an identified
financial reporting framework. Hence, the auditors should conduct their audits based upon
general principles of an audit. They are governed by certain general principles of an audit as
prescribed in Nepal Standards on Auditing, NSA 200 - Objectives and General Principles
Governing Audit of Financial Statements. The auditor should comply with ethical principles
governing professional responsibilities. They are explained here under:

i. Integrity,
The auditor should be honest, sincere and straight forward in providing his professional services

ii. Objectivity
He must be fair and should not be prejudicial, biased or influenced by others to override
objectivity. He should be impartial and independent in fact and appearance.

iii. Professional competence and due care.

The auditor should possess continued professional knowledge and skill at a level required
to ensure that he can deliver competent professional services to the client. He should
perform his audit with due care and competence.

iv. Confidentiality
The auditor should perform his duty with confidentiality of information acquired during
the course of his professional services and should not use or disclose any such information
without proper approval or unless he is legally or professionally bound to disclose.

v. Professional behavior
The auditor should perform his duty keeping in mind the good reputation of the profession
and should not involve in any activity that would discredit the profession.

Question No. 39
Comment and give your views as auditor with reasons in the light of Nepal Accounting
Standards and Nepal Standards on Auditing on each of the following case:
(5 Marks each June 2010)
a) The auditor came to know that there was a noncompliance having material effect on
the financial statements of the Bank. The auditor issued an unqualified report as the
Board of Directors of the Bank was of the view that the regulation was for the
 Commercial Bank and the Bank had been upgraded as a Commercial Bank from the
Development Bank two months ago.
b) At planning stage of the audit of a new client, you, as an audit manager had a meeting
with the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) of the
company. Various matters such as company‟s performance, profitability, turnover of
staff, import of plant and machinery during the year, inventory turnover, collection from
debtors, payment to creditors, investment in marketable securities, etc. were discussed.
As a result of the discussion you were able to assess that a significant portion of
the
company‟s business is conducted with parties which are closely linked with the company.
c) Mr. TN Sharma a chartered accountant in practice purchased goods worth Rs. 60,000
from M/s Giant Traders Ltd. a trading company on credit. The company has the policy of
selling goods on credit. Mr. Sharma had outstanding dues of Rs. 30,000 on 16.07.2008.
He was appointed as auditor of M/s Giant Traders Ltd. for the F.Y. 2008-09. Without
knowing about his appointment as the auditor, the finance department of the company
issued reminder letter to Mr. Sharma for the payment of due amount. Mr. Sharma
verbally replied that his due can be deducted from his fees.
Answers:
a) NSA-250 on "Consideration of laws and regulations in an audit of financial statements"
states that if the auditor concludes that the non-compliance has a material effect on the
financial statements, and has not been properly reflected in the financial statements, the
auditor should express a qualified or an adverse opinion depending on the effect of
materiality. The management's contention that the regulation would not be applicable for
the bank since it had been upgraded as a commercial bank two months ago is totally wrong
as the status of the financial statements at the end of the year represents for the complete
fiscal year. The auditor has not complied with the provisions of NSA-250.

b) As per NSA 550: Related Parties, the auditor should perform audit procedures designed to
obtain sufficient appropriate audit evidence regarding the identification and disclosure by
management of related parties and the effect of related party transactions that are material
to the financial statements.

As per NSA 550, The objectives of the auditor are to obtain an understanding of related
party relationships and transactions sufficient to be able to recognize fraud risk factors, if
any, arising from related party relationships and transactions that are relevant to the
identification and assessment of the risks of material misstatement due to fraud; and to
conclude, based on the audit evidence obtained, whether the financial statements, are
presented in fair and transparent manner.

The auditor needs to have a level of knowledge of the entity‘s business and industry that
will enable identification of the events, transactions and practices that may have a material
effect on the financial statements. While the existence of related parties and transactions
between such parties are considered ordinary features of business, the auditor needs to be
aware of them because:

(a) the financial reporting framework may require disclosure in the financial statements of
certain related party relationships and transactions;
(b) the existence of related parties or related party transactions may affect the financial
statements. For example, the entity‘s tax liability and expense may be affected by the
tax laws in various jurisdictions which require special consideration when related
parties exist;
 (c) the source of audit evidence affects the auditor‘s assessment of its reliability. A greater
degree of reliance may be placed on audit evidence that is obtained from or created by
unrelated third parties; and
(d) a related party transaction may be motivated by other than ordinary business
considerations, for example, profit sharing or even fraud.

Thus, the auditor shall pay special attention at the planning stage as well employ additional
audit procedures and consider the adequacy of control procedures over the authorization
and recording of related party transactions and its adequate and proper disclosures in the
financial statements.

c) Integrity, objectivity and independence are the foremost ethical principle of an audit. The
auditor must be fair and should not allow prejudice, bias or influence of others to override
his/her objectivity. The auditor should maintain an impartial attitude, and both be and
appear to be free of any interest which might be regarded, whatever its actual effect, as
being incompatible with integrity, objectivity and independence. The auditor should be
independent in fact and appearance.

In the given case two questions arises immediately i.e. whether under the circumstances
that Mr. Sharma can maintain his integrity and independence as he has not paid his due
within the credit period of the company and asking for setting off his due against fee. This
is the question of ethics. Second question arises about the legality of his appointment as per
prevailing act (Company Act 2006). In both instances answer is negative. Mr. Sharma is
not eligible for appointment as the auditor of the company on ethical ground as well as on
the ground of legal provision of section 112 of Company Act 2006.

Question No. 40
Mr. Ram Prasad, statutory auditor of XYZ Bank Ltd. while performing audit of the Bank relied
on Internal Audit Report comments and did not go through separate examination of those loan
records which has already been examined. The Internal Audit Report had no serious
observations on those loans. Subsequently, it was found that internal auditor Mr. Raju had not
taken adequate measures to establish the exact situation of various loan accounts and hence the
deficiencies in loan status were not properly reported. Please answer with reasons whether Mr.
Ram Prasad or Mr. Raju will be held liable? (4 Marks June 2010)
Answer
According to Nepal Standard on Auditing 610 on "Using the Work of an Internal Auditors", the
external auditor should perform an assessment of the internal audit function when internal audit
function when internal auditing is relevant to the external auditor's risk assessment and when
external auditors intends to use specific work of internal auditing, the external auditor should
evaluate and perform audit procedures on that work to confirm its adequacy for the external
auditor's purposes.

The external auditor shall determine whether the work of the internal audit function can be used
for purposes of the audit by evaluating the following:
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.
Since, in the given case, Mr. Ram Prasad had not gone through evaluation of audit procedures
performed by Mr. Raju, Internal Auditor, he had not complied with the NSA-610 and hence liable
for his incomplete work. In addition to this, Mr. Raju will also be held liable as he has also not
performed his duty properly and adequately with reasonable prudence.

Question No. 41
What are the documents and accounting disclosures requirement of a subsidiary company in the
annual accounts of holding company as per Company Act, 2006 (5 Marks June 2010)?
Answer
As per section 143 of the Company Act 2006, the following documents and accounting
disclosures of a subsidiary company are required to be included in the annual accounts of the
holding company:
Annual Audited Accounts along with the report from the board of directors and Auditors
Report (Annual Report).
The details of investment by the holding as at the end of reporting year.
Any change of holding or rights of the holding company in the period not covered by the
annual accounts if the financial year of the holding company and that of subsidiary
company is different.
Net accumulated profit or loss of the subsidiary company at the end of reporting year.
Any profit or losses or contingent liabilities not reflected in the accounts of the
subsidiary company concerning the shareholders of the holding company.
The disclosure/note, in case the Audited Balance Sheet and the profit and loss situation
of the subsidiary could not be obtained by the board of directors.
Any loans availed by the holding company by mortgaging the fixed assets of the
subsidiary company.

Question No. 42
Express your opinion as an auditor on the following cases: (5 Marks each June 2010)
a) The annual general meeting of Curex Company Limited on Poush 25, 2066 failed to appoint
the auditor for the financial year 2066/67 due to time constraint and delegated the power to
appoint the auditor to the Board under the terms recommended by the Audit Committee. The
Board meeting held on Poush 29, 2065 appointed M/S Tibrewala & Co, a Chartered
Accountants firm as auditor remaining within the terms and conditions recommended by the
Audit Committee. Do you think the appointment of M/S Tibrewala & Co is valid?
b) At planning stage of the audit of a new client, you, as an audit manager had a meeting with
the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) of the company. The
various matters such as company‟s performance, profitability, turnover of staff, import of
plant and machinery during the year, inventory turnover, collection from debtors, payment
to creditors, investment in marketable securities, etc. were discussed.
As a result of the discussion you were able to assess that a significant portion of
the
company‟s business is conducted with parties which are closely linked with the company.

Answer
a. According to Section 110 the Companies Act, 2063 every Company shall appoint an auditor
under the Act to have its accounts audited. As per Section 111 of the same Act, the general
meeting shall appoint the auditor of a company from amongst the auditors licensed to carry
out audit under the prevailing law subject to Chapter 18 of the Act, in the case of a public
limited Company. The Act also provides that the board of directors may appoint the auditor
prior to the holding of the first annual general meeting. Nowhere in the Act, there is any
 provision of delegation of authority to anyone for appointment of an auditor. In the case of a
public limited company, the annual general meeting has authority to appoint auditor amongst
the proposed auditors under the terms and conditions as recommended by the Audit
Committee as per Section 165 of the same Act.
As per Section 113 of the Act, in case of failure to appoint an auditor in the annual general
meeting of the company for any reason or where the annual general meeting itself cannot be
held, the auditor is appointed by the company Registrar‘s office at the request of the Board of
directors of the Company.

Hence, the Companies Act does not have any provision of delegating power of the
appointment of the auditor and no one can appoint auditor except the annual general meeting
and Company Registrar‘s Office in case of failure to appoint the auditor by the AGM.

In the above context, the appointment of M/S Tibrewala & Co, a chartered accountant‘s firm
by the Board of Curex Company Limited at the recommendation of the Audit Committee as
per the authority delegated by the annual general meeting held on Poush 25, 2066 is not valid.
The Company Registrar‘s Office can only appoint auditor in such case at the request of the
Board of the Company.

b. As per NSA 550: Related Parties, the auditor should perform audit procedures designed to
obtain sufficient appropriate audit evidence regarding the identification and disclosure by
management of related parties and the effect of related party transactions that are material to
the financial statements.

As per NSA 550, The objectives of the auditor are to obtain an understanding of related party
relationships and transactions sufficient to be able to recognize fraud risk factors, if any,
arising from related party relationships and transactions that are relevant to the identification
and assessment of the risks of material misstatement due to fraud; and to conclude, based on
the audit evidence obtained, whether the financial statements, are presented in fair and
transparent manner.

The auditor needs to have a level of knowledge of the entity‘s business and industry that
will enable identification of the events, transactions and practices that may have a material
effect on the financial statements. While the existence of related parties and transactions
between such parties are considered ordinary features of business, the auditor needs to be
aware of them because:

(a) the financial reporting framework may require disclosure in the financial statements of
certain related party relationships and transactions;
(b) the existence of related parties or related party transactions may affect the financial
statements. For example, the entity‘s tax liability and expense may be affected by the tax
laws in various jurisdictions which require special consideration when related parties exist;
(c) the source of audit evidence affects the auditor‘s assessment of its reliability. A greater
degree of reliance may be placed on audit evidence that is obtained from or created by
unrelated third parties; and
(d) a related party transaction may be motivated by other than ordinary business
considerations, for example, profit sharing or even fraud.
 Thus, the auditor shall pay special attention at the planning stage as well employ additional
audit procedures and consider the adequacy of control procedures over the authorization and
recording of related party transactions and its adequate and proper disclosures in the financial
statements.

Question No. 43
The financial statements of Modern Equipment (Pvt.) Limited reveal that the company has paid
a donation of Rs.15 million to a political party during an election where one of the directors of
the company is a central executive committee member. The company has earned a gross profit
of Rs. 40 million. The selling and administration expenses including the donation amount to
Rs.
60 million and as a result the company has incurred a net loss of Rs. 20
million.
You are required to discuss the significance of the above donation to the auditor and design
appropriate audit procedures to address the issue. (7 Marks December 2010)

Answer
This is a case of related party transactions and of public interest although the company is a
private
limited company. The amount of donation has been very significant and has contributed to loss
during the year. This is a material item and needs proper and adequate attention for its verification
and association with the business relation.

Thus, the auditor shall carry out following audit procedures as outlined in NSA550:
a) Authorization of payment of such a huge amount
b) Whether the issue related to related party known before the payment is made
c) Whether proper receipt of the amount has been obtained
d) Whether the same can be considered as reasonable business expenses
e) Whether the amount has been separately disclosed and a note to this effect has been
given in the financial statements

Question No. 44
Obtaining the proof of evidence is one of the principle procedures of audit. Discuss.
(5 Marks December 2010)
Answer
As per NSA 500 on Audit Evidence, the objective of the auditor is to design and perform
audit
procedures in such a way as to enable the auditor to obtain sufficient appropriate audit evidence
to
be able to draw reasonable conclusions on which to base the auditor‘s
opinion.
The auditor shall design and perform audit procedures that are appropriate in the circumstances for
the purpose of obtaining sufficient appropriate audit evidence.

The auditor should obtain sufficient and appropriate audit evidence through the performance of
compliance and substantive audit procedure so that he in a position to draw reasonable conclusion
there from on which he could base his opinion on the cost and financial information or statements.
He begins his compliance procedures or test to obtain reasonable assurance that the internal control
devised in the client‘s organization on which audit reliance is placed are in effect. His application
of substantive audit procedures or test also seeks to obtain evidence as to the completeness,
accuracy and validity of the financial data produced by client‘s accounting system.

Auditing is an attest function. In his report, the auditor has to give his expressed opinion on the
truthfulness and fairness of the financial statements. Before submission of his report, he must
have
to establish a basis for his judgment for which he has to look for evidences which will definitely
indicate the fair presentation of the client‘s financial records and accounts. Thus, he depends on
those evidences which will provide him reliability, relevancy and authenticity. For this purpose,
the auditor has to examine the books of accounts of the client with documentary evidence. He
vouches the documentary evidences by reference to their existence, legitimacy, completeness and
accuracy as essential procedure of audit.

Question No. 45
a) Roles of Audit Committee (4 Marks June 2010)
Answer
The role of audit committee is primarily of an advisory character. Its role includes co-ordination of
all audit functions and review of the feedback provided by various auditors already engaged
leading to a general review of the internal control mechanism for rectification/improvement of
management efficiency/functions. The committee is not expected to interfere in day-to-day affairs
of the company and make any decisions of its own in any areas of management functions. It
would, however, be its duty to make available its review report periodically to the Board to enable
the latter to make decisions on matters brought to it. In other words, it acts as an analyser and
purveyor of information/data not capable of being obtained from reports presented and reviewed in
an appropriate manner at a full-fledged board meeting. The functions which may be performed by
the audit committee could be broadly classified as under:
(i) To review weaknesses in internal controls, if any, reported by internal and statutory auditors
and report to the Board the recommendations relating thereto.
(ii) To review reports of Internal Audit Department and recommend to the Board to decide about
the scope of its work including examination of major items of expenditure.
(iii) To review the audit reports on financial statements and to seek clarification thereon, if
required, from the auditors.
(iv) to act as a link between statutory and internal auditors and the Board of directors.
(v) To recommend a change in the auditors if in the opinion of the Committee the auditors have
not discharged their duties properly and adequately.

b) Explain the Auditor‟s responsibilities regarding comparatives. (5 Marks June 2011)

Answer
NSA 710, ―Comparative Information, Corresponding Figures and Comparative Financial
Statements‖ establishes standards on the auditor‘s responsibilities regarding comparatives.
The auditor should evaluate whether:

a. The comparative information agrees with the amounts and other disclosures presented in the
prior period or, when appropriate, have been restated
b. The accounting policies reflected in the comparative information are consistent with those
applied in the current period or, if there have been changes in accounting policies, whether
those changes 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 NSA 560. If the prior period financial statements are
amended, the auditor shall determine that the comparative information agrees with the
amended financial statements.
 e. As required by NSA 580, 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 restatement made to correct a material misstatement in prior
period financial statements that affect the comparative information.

Question No. 46
Answer the following questions:
a. Mr. Ram Prasad, a chartered accountant in practice, has been appointed as an auditor of
M/S Big Ltd. for the first time. What are the major additional audit evidences that he may
have to be considered in opening balances?
Answer
Mr. Ram Prasad should follow Nepal Accounting Standard on Auditing 510 before initial audit
engagement.

As per NSA 510 " Initial Audit Engagements- Opening Balances" The auditor shall obtain
sufficient appropriate audit evidence about whether the opening balances contain misstatements
that materially affect the current period‘s financial statements by:
a) Determining whether the prior period‘s closing balances have been correctly brought
forward to the current period or, when appropriate, have been restated;
b) Determining whether the opening balances reflect the application of appropriate accounting
policies; and
c) Performing one or more of the following:
Where the prior year financial statements were audited, reviewing the predecessor
auditor‘s working papers to obtain evidence regarding the opening balances;
Evaluating whether audit procedures performed in the current period provide evidence
relevant to the opening balances; or
Performing specific audit procedures to obtain evidence regarding the opening
balances.
If the auditor obtains audit evidence that the opening balances contain misstatements that could
materially affect the current period‘s financial statements, the auditor shall perform such additional
audit procedures as are appropriate in the circumstances to determine the effect on the current
period‘s financial statements. If the auditor concludes that such misstatements exist in the current
period‘s financial statements, the auditor shall communicate the misstatements with the
appropriate level of management and those charged with governance in accordance with NSA 450.

b. What is joint audit? Describe how the work is performed by the joint auditors.
(6 Marks June 2011)
Answer
The term joint audit is quite widespread in big companies and corporations. It is a practice of
appointing more than one auditor as joint auditors. Where joint auditors are appointed, they should,
by mutual discussion, divide the audit work among themselves. The division of work would
usually be in terms of identifiable units or specific areas. In some cases, due to the nature of the
business of the entity under audit, such a division of work may not be possible. In such situations,
the division of work may be with reference to items of assets and liabilities or income or
expenditure or with reference to periods of time.

In respect of audit work divided among the joint auditors, each joint auditor is responsible for the
work allocated to him, whether or not he has prepared as separate report on the work performed by
him.
On the other hand, all the joint auditors are jointly and severally responsible:
in respect of the audit work which is not divided among the joint auditors and is carried
out by all of them;
in respect of decisions taken by all the joint auditors concerning the nature, timing or
extend of audit procedures to be performed by any of the joint auditors;
in respect of matters which are brought to the notice of the joint auditors by any one of
them and on which there is agreement among the joint auditors;
for examining that the financial statements of the entity comply with the disclosure
requirements of the relevant statute; and
for ensuring that the audit report complies with the requirements of the relevant statute.

Normally joint auditors have to arrive at an agreed report and issue a joint audit opinion on the
financial statement.

c. Communication of audit matters those charged with governance.

(5 Marks December 2011)
Answer
Communication of audit matters those charged with governance.
The auditor should communicate audit matters of governance interest arising from the audit of
financial statements with those charged with governance of an entity. As mentioned in the NSA
260 on Communication of audit matters with those charged with governance, ―governance‖ is the
term used to describe the role of persons entrusted with the supervision, control and direction of
an entity and ―audit matters of governance interest‖ are those that arise from the audit of financial
statements and, in the opinion of the auditor, are both important and relevant to those charged
with governance in overseeing the financial reporting and disclosure process. Those charged with
governance ordinarily are accountable for ensuring that the entity achieves its objectives, financial
reporting, and reporting to interested parties. The auditor should determine the relevant persons
who are charged with governance and with whom audit matters of governance interest are
communicated.
The auditor should consider audit matters of governance interest that arise from the audit of the
financial statements and communicate them with those charged with governance. The
effectiveness of communications is enhanced by developing a constructive working relationship
between the auditor and those charged with governance. This relationship is developed while
maintaining an attitude of professional independence and objectivity. The auditor should
communicate audit matters of governance interest on a timely basis. This enables those charged
with governance to take appropriate action.
The audit matters of governance interest that are required to be communicated include matters
like the general approach and overall scope of the audit, including any expected limitations
thereon, or any additional requirements; the selection of, or changes in, significant accounting
policies and practices that have, or could have, a material effect on the entity‘s financial
statements; the potential effect on the financial statements of any significant risks and exposures,
such as pending litigation, that are required to be disclosed in the financial statements; audit
adjustments, whether or not recorded by the entity that have, or could have, a significant effect on
the entity‘s financial statements; material uncertainties related to events and conditions that may
cast significant doubt on the entity‘s ability to continue as a going concern; disagreements with
management about matters that, individually or in aggregate, could be significant to the entity‘s
financial statements or the auditor‘s report and other matters warranting attention by those
charged with governance, such as material weaknesses in internal control, questions regarding
management integrity, and fraud involving management.
Question No. 47
You are meeting with executives of Lily Cosmetics Company to arrange your firm‟s engagement
nd
to audit the company‟s financial statement for the year ended 32 Ashadh 2067. One executive
suggested that the work should be divided among three audit staff members so one person would
examine asset accounts, a second would examine liability accounts, and the third would
examine income and expenses accounts to minimize audit time, avoid duplication of staff effort
and curtail interference with company operations.

Advertising expense being the company‟s expense, and the advertising manager suggested that
a staff member of your firm whose uncle owns the advertising agency which handles the
company‟s advertising should be assigned to examine the advertising expense account. The staff
member has a thorough rather complex contract between Lily Cosmetic Company and the
advertising agency on which Lily‟s advertising are based.
To what extent should a Chartered Accountant follow his client‟s suggestions for conducting an
audit? (4 Marks June 2011)

Answer
According to NSA 200, "Overall Objectives of the Independent Auditor and the Conduct of Audit
In Accordance with NSAs" explains the scope, authority and structure of the NSAs, and includes
requirements establishing the general responsibilities of the independent auditor applicable in all
audits, including the obligation to comply with the NSAs.

NSAs are written in the context of an audit of financial statements by an auditor. They are to be
adapted as necessary in the circumstances when applied to audits of other historical financial
information.
An audit conducted in accordance with NSAs and relevant ethical requirements enables the auditor
to form the opinion.

The NSAs require that the auditor exercise professional judgment and maintain professional
skepticism throughout the planning and performance of the audit and, among other things:
Identify and assess risks of material misstatement, whether due to fraud or error, based on an
understanding of the entity and its environment, including the entity‘s internal control.
Obtain sufficient appropriate audit evidence about whether material misstatements exist,
through designing and implementing appropriate responses to the assessed risks.
Form an opinion on the financial statements based on conclusions drawn from the audit
evidence obtained.

The auditor shall comply with relevant ethical requirements, including those pertaining to
independence, relating to financial statement audit engagements.
The auditor shall comply with all NSAs relevant to the audit. The NSA is relevant to the audit
when the NSA is in effect and the circumstances addressed by the NSA exist.

The objective of an audit of financial statements is to enable the auditor to express an opinion
whether the financial statements are prepared, in all material respects, in accordance with an
identified financial reporting framework. An auditor should maintain the Objectivity of his work.
A professional accountant should not allow prejudice or bias, conflict of interest or undue
influence of others to override professional or business judgments.
Also, an auditor should perform his audit with Professional Competence and Due Care. A
professional accountant has a continuing duty to maintain professional knowledge and skill at the
level required to ensure that a client or employer receives the advantage of competent professional
service based on current developments in practice, legislation and techniques.
Based on the above explanations it can be concluded that the auditors are not supposed to take
orders or advice from the client on what to do and how to do. Auditors may take client advice,
suggestion only on non- judgmental matters, on mechanical type of matters, such as where the
information available, how to get the information etc.

Question No. 48
An auditor of Babar Mahal Ltd. was not able to get the confirmation about the existence and
value of certain machineries. However, the management gave a certificate to prove the existence
and value of the machinery as appearing in the books of account. The auditor accepted the same
without any further procedure and signed the audit report. Is the auditor's approach, right?
(5 Marks December 2011)
Answer
The physical verification of fixed assets is the primary responsibility of the management. The
auditor, however, is required to examine the verification programme adopted by the management.
The auditor must satisfy themselves about the existence, ownership and valuation of fixed assets.
In the case of Babar Mahal Ltd., the auditor has not been able to verify the existence and value of
some machinery despite the verification procedure followed during routine audit. The auditor
accepted the certificate given by the management without making any further enquiry. As per NSA
580, when representation relate to matters which are material to the financial information, then the
auditor should seek corroborative audit evidence for other sources inside or outside the entity. The
auditor should also evaluate whether such representations are reasonable and consistent with other
evidences and should consider whether individuals making such representations can be expected to
be well informed on the matter. ―Written Representations‖ cannot be a substitute for other audit
evidence that the auditor could reasonably expect to be available. If the auditor is unable to obtain
sufficient appropriate audit evidence that he/she believes would be available regarding a matter,
which has or may have a material effect on the financial information, this will constitute a
limitation on the scope of his examination even if he/she has obtained a representation from
management on the matter. Therefore, the approach adopted by the auditor is not correct.

Question No. 49
Mr. Rohan Sharma is a sales executive of M/s Duo Electric Company. He is involved in sales,
collection of payments and stock supervision. Managing Director of the company found that Rs.
2 lakhs were embezzled by the sales executive by overstating the receivables. How would you
deal with the situation as a statutory auditor? (5 Marks December 2011)
Answer:
The overstating of receivable by Mr. Rohan Sharma needs close examination of transaction with
the debtors. Taking confirmation from debtors is the key tool to verify the embezzlement. Once the
confirmation is received, the actual receivable can be confirmed and deviation if any, with the
books of account will lead the embezzlement by the concerned staff. As per Nepal Standard on
Auditing (NSA) 240, ―The Auditor‘s Responsibilities Relating to Fraud in an Audit of Financial
Statements,‖ the auditor should consider the risks of material misstatements in the financial
statements due to fraud while planning and performing the audit to reduce audit risk to an
acceptably low level.
Question No. 50
As an auditor, express your comments/views on the following situations:
(5 Marks each December 2011)
a) During the course of statutory audit of M/s Grow More Investment Company dealing in
shares and securities, in spite of repeated reminders by the statutory auditor, the company
officials did not provide the investments held by the company at the Balance Sheet date for
verification and also did not provide the details for valuation of unlisted shares as on the
Balance Sheet date. The statutory auditor, in his final audit report to the shareholders,
reported as follows: “Subject to the verification of the existence and value of the
investments, the Balance Sheet shows a true and fair view”.

b) One of the employees of M/s Star Company Ltd. had embezzled a handsome amount of
revenue during the financial year 2062-063 to 2067-068 by submitting fraud bank voucher
and fraud bank reconciliation statement to the management. The embezzlement was traced
out only after the financial statements have been issued for the year 2067-068. What
would be the auditor's responsibility regarding such embezzlement? Justify your answer in
accordance with Nepal Standard on Auditing.

c) Arun Vegetable Ghee Company Limited has a policy of writing back unclaimed balances
(creditors/sundry payables etc.) as income if it remained for more than 3 years. During the
year 2067-68, it has written back Rs. 1,24,550 out of Rs. 2,55,000 balance in dividend
payable as the Rs. 1,24,550 was more than 5 years old.

d) In the course of audit of Sunrise Company Limited, you came across a difference of huge
amount between the control accounts and subsidiary records. The Finance Director
informed that this has happened due to huge volume of business done by the company
during the year and this has been very common. Now as an auditor of Sunrise Company
Limited what will be your opinion in such circumstance?

Answer
a) The statutory auditor is required to express his opinion on the truth and fairness of financial
statement audited by him only after examining the authenticity with reference to the
information and explanations given to him. He must determine the extent of information
which should be obtained by him before he expresses his opinion on the financial statement
submitted to him for report. He should not express an opinion before obtaining the required
data and information.

In the given case, the auditor was not provided the details of the investment held by Grow
More Investment Company and the valuation of unlisted shares. Owing to that there was a
situation that the statutory auditor could not confirm the existence and also valuation of the
investments held by the company. Since the said evidences extremely material; the non-
availability of which would highly misstate the financial position/ statement of the
company, the auditor should not state ―Subject to the verification of the existence and
value of the investments, the balance sheet shows a true and fair view.‖

In fact, as per facts given in the question, the auditor should state that because of these
circumstances, he has been unable to form an opinion. By reporting, ―subject to verification
of the existence and value of the investments, the balance sheet shows a true and fair
view‖, the auditor is not providing information but only means to information. The
situation in this case is analogous to London and General Bank‘s case. By reporting in the
 above manner auditor is not conveying any information. Rather, the auditor is arousing the
suspicion of users of financial statements.

Section 115(1) of the Company Act 2063 requires the auditor to specifically, state whether
or not he has obtained all such information and explanation. If the auditor has not been able
to obtain relevant information or explanations, he may have to qualify his opinion on the
truth and fairness of the financial statements or express his inability to give an opinion in
the matter. Thus, the auditor has failed to perform his responsibilities.

b) With reference to the Nepal Standard on Auditing – 560, "Subsequent Events", the auditor
has no obligation to make any inquiry regarding such financial statements after the
financial statements have been issued. When, after the financial statements have been
issued, the auditor becomes aware of a fact which existed at the date of the auditor‘s report
and which, if known at that date, may have caused the auditor to modify the auditor‘s
report, the auditor should consider whether the financial statements need revision, should
discuss the matter with management, and should take the action appropriate in the
circumstances. When management revises the financial statements, the auditor would carry
out the audit procedures necessary in the circumstances, would review the steps taken by
management to ensure that anyone in receipt of the previously issued financial statements
together with the auditor‘s report thereon is informed of the situation, and would issue a
new report on the revised financial statements. The new auditor‘s report would be dated not
earlier than the date the revised financial statements are approved.
When management does not take the necessary steps to ensure that anyone in receipt of the
previously issued financial statements together with the auditor‘s report thereon is informed
of the situation and does not revise the financial statements in circumstances where the
auditor believes they need to be revised, the auditor would notify those persons ultimately
responsible for the overall direction of the entity that action will be taken by the auditor to
prevent future reliance on the auditor‘s report.

c) Write back of unclaimed balances unilaterally without consent of the party involved is not
in line with Nepal Accounting Standards. Therefore, the policy adopted by Arun Vegetable
Ghee Company Limited is not consistent with Accounting Standards. In case of Dividends,
Section 182 of company Act 2063 requires that the amount of dividend not
claimed/received by any Shareholder even after the expiry of a period of five years after the
date of resolution adopted by the company in its general meeting to distribute dividend
shall be credited to the investors protection fund to be established under Section 183 of the
same Act. Before crediting the amount to the fund, it shall publish a notice in a national
daily newspaper inviting the concerned to receive the dividend, within the time limit of at
least one month.

Therefore, the writing back of dividend of Rs. 124,550.00 by the company is violation of
provisions of Company Act and shall be liable.

d) The occurrence of difference of huge amount between Control accounts and subsidiary
records in the books of Sunrise Company Limited indicates that there may be chance of
material misstatements requiring detailed examination by the auditor so as to ascertain the
basic reason of difference. The view of the finance director that this has happened due to
huge volume of business done by the company during the year and this has been very
common cannot be accepted. Such a situation indicates that the accounting system of the
company has been faulty because it has failed to capture all transactions in time. It also
 indicates that recording of transaction is not being done properly. There may also be
possibilities that it is a recurring phenomenon. Such a situation indicates that there may be
possibility of some material misstatements. In case the auditor encounters circumstances
that there is possibility of material misstatements, the auditor should as per NSA -240 ―The
Auditor‘s Responsibilities Relating to Fraud and Error in an audit of financial Statement‖
perform procedures to determine whether the financial statements are materially misstated.
The auditor should report appropriately in case if he comes across any material information
involving fraud or gross irregularities

Question No. 51
Mr. Parashar Koirala, a Chartered Accountant in practice is a general shareholder holding less
than one percent of the paid-up capital of Birgunj Sugar Factory Ltd. He was appointed as an
auditor for FY 2067/68. Mr. Koirala formally accepted the appointment as an auditor of the
company. Give your opinion in this respect. (4 Marks December 2011)

Answer
Section 112 of the Company Act 2063 disqualifies the person holding one percent or more of the
paid-up capital of the company from being appointed as an auditor of the company. In the given
case since Mr. Parashar Koirala holds less than one percent of the paid-up share capital of the
company, he is eligible for being appointed as an auditor of that company. Section 34 of the ICAN
Act prescribes that the members while certifying financial statements or making report thereon of
any corporate body in which he or his partner has interest, clearly mention the extent of his or his
partner's interest therein. However, being merely a shareholder in a company shall not be deemed
to have interest therein. Hence in any case the appointment of Mr. Koirala is valid.

Question No. 52
What are the fundamental principles that a professional accountant has to observe in order to
achieve the objectives of the accountancy profession? (8 Marks December 2011)

Answer
The fundamental principles that a professional accountant has to observe are:
 Integrity
A professional accountant should be straightforward and honest in performing professional
services.
 Objectivity
A professional accountant should be fair and should not allow prejudice or bias, conflict of
interest or influence of others to override objectivity.
 Professional Competence and Due Care
A professional accountant should perform professional services with due care, competence
and diligence and has a continuing duty to maintain professional knowledge and skill at a
level required to ensure that a client or employer receives the advantage of competent
professional service based on up to-date developments in practice, legislation and
techniques.
 Confidentiality
A professional accountant should respect the confidentiality of information acquired during
the course of performing professional services and should not use or disclose any such
information without proper and specific authority or unless there is a legal or professional
right or duty to disclose.
  Professional Behavior
A professional accountant should act in a manner consistent with the good reputation of the
profession and refrain from any conduct which might bring discredit to the profession.
 Technical Standards
A professional accountant should carry out professional services in accordance with the
relevant technical and professional standards. Professional accountants have a duty to carry
out with care and skill, the instructions of the client or employer insofar as they are
compatible with the requirements of integrity, objectivity and, in the case of professional
accountants in public practice, independence.

In addition, they should conform with the technical and professional standards promulgated
by:
Nepal Accounting Standards Board
Nepal Standards on Auditing Board
ICAN or other regulatory body; and
relevant legislation

Question No. 53
Write Short Notes on the following
a. Date of approval of the financial statements as per NSA 560 "Subsequent Events"
(5 Marks June 2011)
"Date of approval of the financial statements‖ is the date on which those with the recognized
authority assert that they have prepared the entity‘s complete set of financial statements,
including the related notes, and that they have taken responsibility for them. In some
jurisdictions, the law or regulation identifies the individuals or bodies (for example, the
directors) that are responsible for concluding that a complete set of financial statements has
been prepared and specifies the necessary approval process. In other jurisdictions, the approval
process is not prescribed in law or regulation and the entity follows its own procedures in
preparing and finalizing its financial statements in view of its management and governance
structures. In some jurisdictions, final approval of the financial statements by shareholders is
required before the financial statements are issued publicly. In these jurisdictions, final
approval by shareholders is not necessary for the auditor to conclude that sufficient appropriate
audit evidence has been obtained. The date of approval of the financial statements for purposes
of the NSAs is the earlier date on which those with the recognized authority determine that a
complete set of financial statements has been prepared.

b. Functions and duties of auditor as per Section 115 of Companies Act, 2063 (5 Marks June
2011)
(1) The auditor shall, addressing the shareholders or the appointing authority, submit to the
company his/her report, certifying the balance sheet, profit and loss account and cash flow
statement based on the books of account, records and accounts audited by him/her.
(2) The audit report shall be prepared in accordance with the prevailing law or in consonance
with the audit standards prescribed by the competent body; and such report shall state the
matters to be set out under this Act, as per necessity.
(3) The audit report as referred to in Sub-section (2) shall also indicate the following matters,
inter alia:
a) Whether such information and explanations have been made available as were required
for the completion of audit;
 b) Whether the books of account as required by this Act have been properly maintained by
the company in a manner to reflect the real affairs of its business;
c) Whether the balance sheet, profit and loss account and cash flow statements received
have been prepared in compliance with the accounting standards prescribed under the
prevailing law and whether such statements are in agreement with the books of account
maintained by the company;
d) Whether, in the opinion of the auditor based on the explanations and information made
available in the course of auditing, the present balance sheet properly reflects the
financial situation of the company, and the profit and loss account and cash flow
statement for the year ended on the same date properly reflect the profit and loss, cash
flow of the company, respectively;
e) Whether the board of directors or any representative or any employee has acted
contrary to law or misappropriated any property of the company or caused any loss or
damage to the company or not;
f) Whether any accounting fraud has been committed in the company
g) Suggestion, if any.

c. Subsequent events (5 Marks June 2012)

Subsequent events are events occurring between the date of the financial statements and the
date of the auditor's report and facts discovered after the auditor's report. An auditor should
consider the effect of subsequent events on the financial statements and the auditor's report.
An auditor should:
Obtain from management the latest interim financial statements and compare them with the
financial statements being reviewed or with those for comparable periods from the preceding
year.
Inquire about events after the balance sheet date that would have a material effect on the
financial statements under review and, in particular, inquire whether:
(a) Any substantial commitments or uncertainties have arisen subsequent to the balance sheet date:
(b) Any significant changes in the share capital, long term debt or working capital have occurred
up to the date of inquiry.
(c) Any unusual adjustments have been made during the period between the balance sheet date and
the date of inquiry.
Obtain and read the minutes of meetings of shareholders, directors and appropriate committees
subsequent to the balance sheet date.
Consider the need for adjustments or disclosure in the financial statements.

d. Management Representation (3 Marks June 2012)

It is a representation made by management to the auditor during the course of an audit, either
unsolicited or in response to specific enquiries. It acknowledges its responsibility for the
implementation and operation of accounting and internal control system that are designed to
prevent and detect fraud and error. Nepal Standard on Auditing –580, Written Representations
states that the auditor should obtain appropriate representation from management evidencing
that the management acknowledges its responsibility for the fair presentation of the financial
statements in accordance with the relevant financial reporting framework. The auditor can
obtain evidence of management‘s acknowledgment of such responsibility and approval from
relevant minutes of meetings of the board of directors or similar body or by obtaining a written
representation from management or a signed copy of the financial statements. The auditor
should obtain written representations from management on matters material to the financial
statements when other sufficient appropriate audit evidence cannot reasonably be expected to
exist. The possibility of misunderstandings between the auditor and management is reduced
 when oral representations are confirmed by management in writing. If a representation by
management is contradicted by other audit evidence, the auditor should investigate the
circumstances and, when necessary, reconsider the reliability of other representations made by
management.

e. Nepal Standard on Quality Control (NSQC) (3 Marks June 2012)

NSQC refers to Nepal Standard on Quality Control and applies to all firms. The firm‘s system
of quality control should include policies and procedures addressing each of the following
elements:
i) Leadership responsibilities for quality within the firm.
ii) Ethical requirements.
iii) Acceptance and continuance of client relationships and specific engagements.
iv) Human resources.
v) Engagement performance.
vi) Monitoring.

The quality control policies and procedures should be documented and communicated to the
firm‘s personnel.

f. Disqualifications of Auditors as per Companies Act, 2063 (5 Marks December 2012)

As per Section 112(1) of the Companies Act, 2063, None of the following persons or the firms or
companies in which such persons are partners shall be qualified for appointment as auditor and
shall, despite appointment as auditor, continue to hold office:
1) A director, advisor appointed with entitlement to regular remuneration or cash benefit, a
person or employee or worker involved in the management of the company or a partner of
any of them or an employee of any of such partners or a close relative of a director or partner,
out of them, or an employee of such relative;
2) A debtor who has borrowed moneys from the company in any manner, or a person who has
failed to pay any dues payable to the company within the time limit and is in such arrears or
close relative of such person;
3) A person who has been sentenced to punishment for an offense pertaining to audit and a
period of five years has not elapsed thereafter;
4) A person who has been declared insolvent;
5) A substantial shareholder of the company or a shareholder holding one percent or more of the
paid-up capital of the company or his close relative;
6) A person who has been sentenced to punishment for an offense of corruption, fraud or a
criminal offense involving moral turpitude and a period of five years has not elapsed
thereafter;
7) A person referred to in Sub-section (3) of Section 111 which mentions that no auditor or his
partner or ex-partner or employee or ex-employee can be re-employed for more than 3 times
consecutively.
8) In the case of a public company, any person who works, whether full time or part time , for
any governmental body or anybody owned fully or partly by the Government of Nepal or any
other company or a partner of such person or a person who is working as an employee of
such partner or a person who is authorized to sign any documents or reports to be prepared
by the management of the company;
9) A company or corporate body with limited liability;
A person having interest in any transaction with the company or his/her close relative or a
director, officer or substantial shareholder of another company having any interest in any
transaction with the company.
g. Corresponding figures. (4 Marks June 2015)
As per NSA 710 "Comparative", "corresponding figures" is comparative information where
amounts and other disclosures for the preceding periods are included as part of the current
period financial statements and are intended to be read in relation to the amounts and other
disclosures relating to the current period. These corresponding figures are not presented as
complete financial statements capable of standing alone but are an integral part of the current
period financial statements intended to be read only in relationship to the current period
figures.

Question No. 54
Comment on the following cases: (5 Marks each June 2012)
a) M/S XYZ & Associates, Chartered Accountants, were appointed as the statutory
auditor by the annual general meeting of LMN Company Ltd. for the financial year 2067/068.
This was their first appointment as an auditor of this company. During the course of the audit,
the auditor was unable to obtain sufficient appropriate audit evidence concerning opening
balances.
b) M/S MNY & Associates, Chartered Accountants, were the auditor of ABC Ltd. for
the financial year 2067/068. Engineering Consultants (P) Ltd. was appointed as an expert to
help them in certain technical matters. During the finalization of the audit, the audit team
decided that Engineering Consultants (P) Ltd. is the team of specialist so there is no need to
review their work.

Answer
a) As stated in NSA 510 "Initial Audit Engagements-Opening Balances", for initial audit
engagements, the auditor should obtain sufficient appropriate audit evidence that:
i. The opening balances do not contain misstatements that materially affect the current
period‘s financial statements;
ii. The prior period‘s closing balances have been correctly brought forward to the
current period or, when appropriate, have been restated; and
iii. Appropriate accounting policies are consistently applied or changes in accounting
policies have been properly accounted for and adequately presented and disclosed.

If, after performing audit procedures including those set out in Nepal Standards on
Auditing, the auditor is unable to obtain sufficient appropriate audit evidence concerning
opening balances, the auditor‘s report should include:
a. A qualified opinion,
b. A disclaimer of opinion; or
c. In those jurisdictions where it is permitted, an opinion which is qualified or
disclaimed regarding the results of operations and unqualified regarding financial
position
If the effect of the misstatement is not properly accounted for and adequately presented and
disclosed, the auditor should express a qualified opinion or an adverse opinion, as
appropriate.

b) Evaluating the Work of the Expert

As per the requirement of clause 12 of NSA 620 "Using the work of an expert", the auditor
should evaluate the appropriateness of the expert‘s work as audit evidence regarding the
assertion being considered. This will involve evaluation of whether the substance of the
expert‘s findings is properly reflected in the financial statements or supports the assertions, and
consideration of:
 Source data used;
Assumptions and methods used and their consistency with prior periods; and
Results of the expert‘s work in the light of the auditor‘s overall knowledge of the
business and of the results of other audit procedures.
When considering whether the expert has used source data which is appropriate in the
circumstances, the auditor would consider the following procedures:

Inquiries of the auditor‘s expert.

Reviewing the auditor‘s expert‘s working papers and reports.
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
Reperforming calculations.
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.
Discussing the auditor‘s expert‘s report with management.

The appropriateness and reasonableness of assumptions and methods used, and their
application are the responsibility of the expert. The auditor does not have the same expertise
and, therefore, cannot always challenge the expert‘s assumptions and methods. However, the
auditor will need to obtain an understanding of the assumptions and methods used and to
consider whether they are appropriate and reasonable, based on the auditor‘s knowledge of the
business and the results of other audit procedures.
If the results of the expert‘s work do not provide sufficient appropriate audit evidence or if the
results are not consistent with other audit evidence, the auditor should resolve the matter. This
may involve discussions with the entity and the expert, applying additional audit procedures,
including possibly engaging another expert, or modifying the auditor‘s report.

Question No. 55
While compiling the financial statements of a company, you observed that the information
supplied by the company is incomplete, incorrect and some of the Accounting Standards
have not been complied with. Describe, in brief, the procedure you will follow in this case.
(5 Marks June 2012)
Answer
Compilation of Financial Information:
As per para 32 of NSRS 4410 ―Compilation Engagements‖,
If, in the course of the compilation engagement, the practitioner becomes aware that the records,
documents, explanations or other information, including significant judgments, provided by
management for the compilation engagement are incomplete, inaccurate or otherwise
unsatisfactory, the practitioner shall bring that to the attention of management and request the
additional or corrected information.

Again as per para 33, If the practitioner is unable to complete the engagement because
management has failed to provide records, documents, explanations or other information,
including significant judgments, as requested, the practitioner shall withdraw from the engagement
and inform management and those charged with governance of the reasons for withdrawal.
Question No. 56
Answer the followings (5 Marks June 2012)

a) Mr. Rahul, partner of M/s SG & Associates, a Chartered Accountant firm, was appointed as
an auditor of Bindas Commercial Bank Ltd. One of the shareholders of the bank lodged a
complaint against the auditor for not assuming the responsibilities to comply with directives
of Nepal Rastra Bank with regards to lending to a business house. You are asked to identify
the auditors' responsibilities to consider laws and regulations in an audit of financial
statements of bank with regards to complaint lodged against the auditor.
b) Wax & Co.‟s financial statements for the year ended 31 July 2010 include the following
balances

Profit before tax Rs. 50,000

Inventory Rs. 25,000
Total assets Rs. 350,000
The inventory comprised stocks of books, diaries, calendars and greetings cards.
Explain (In relation to opening balances) the audit procedures required by NSA 510 Initial
Audit Engagements – Opening Balances and recommend the specific audit procedures to be
applied to Wax & Co.‟s opening balance of inventory.

Answer
a) In accordance with NSA 200: ―Overall Objective of the Independent Auditor and the
Conduct of an Audit in Accordance with NSAs" requires the auditor to maintain
professional skepticism. The auditor shall plan and perform an audit with professional
skepticism recognizing that circumstances may exist that cause the financial statements to
be materially misstated.

In accordance with specific statutory requirements, the auditor may be specifically required
to report as part of the audit of the financial statements whether the entity complies with
certain provisions of laws or regulations. In these circumstances, the auditor would plan to
test for compliance with these provisions of the laws and regulations.
Further, the auditor should obtain sufficient appropriate audit evidence about compliance
with those laws and regulations generally recognized by the auditor to have an effect on the
determination of material amounts and disclosures in financial statements. The auditor
should have a sufficient understanding of these laws and regulations in order to consider
them when auditing the assertions related to the determination of the amounts to be
recorded and the disclosures to be made.
As per NSA 250 'Consideration of Laws and Regulation in an audit of Financial
Statements', the auditor is not, and cannot be held responsible for preventing
noncompliance. However, when designing and performing audit procedures and in
evaluating and reporting the results thereof, the auditor should recognize that
noncompliance by the entity with laws and regulations may materially affect the financial
statements.
Here, in given situation, it is the responsibility of the management to comply with the
directives of NRB and the responsibility of Mr. Rahul ,the auditor, is to plan and perform
the audit with an attitude of professional skepticism recognizing that the audit may reveal
conditions or events that would lead to questioning whether an entity is complying with
laws and regulations He should have sufficient knowledge of statutory provisions of
lending and its reporting in prescribed format.
 b) ISA 510 Initial Audit Engagements – Opening Balances requires certain audit procedures
to be carried out in an initial engagement where the prior year financial statements were not
audited or were audited by a predecessor auditor.
Firstly, it is required that the auditor shall read the most recent financial statements for
information relevant to opening balances, including disclosures.
Then the auditor shall obtain sufficient appropriate evidence about whether the opening
balances contain misstatements that materially affect the current year‘s financial
statements. This evidence is obtained by firstly determining whether the prior period‘s
closing balances have been correctly brought forward.
The auditor shall also determine whether the opening balances reflect the application of
appropriate accounting policies.
Depending on the nature of the opening balances, specific audit procedures are performed
to gain specific evidence on those opening balances. Additional procedures would be
required if it appears that the opening balances contain misstatements that could materially
affect the current period‘s financial statements.
Finally, the auditor shall obtain sufficient appropriate evidence about whether the
accounting policies reflected in the opening balances have been consistently applied in the
current period‘s financial statements, and that any changes in accounting policies have been
accounted for and disclosed in accordance with IFRS 8 Accounting Policies, Changes in
Accounting Estimates and Errors.
In relation to the opening balance of inventory, the following procedures are recommended:
Inspection of records of any inventory counts held at the prior period year end, 31
July 2010, to confirm the quantity of items held in inventory agrees to accounting
records.
Observation of an inventory count at the current period year end, 31 July 2011, and
reconciliation of closing inventory quantities back to opening inventory quantities.
Analytical procedures on gross profit margins, comparing the opening and closing
gross profit margins year on year for the various types of items held in inventory.
Verifying the sales value in the current financial year of items held in inventory at
31 July 2010 and comparing the sales value with cost. This should provide evidence
that inventory is correctly valued at the lower of cost and net realizable value.
Inspection of management accounts for evidence of any inventory items written off
in the current financial period – this is important for inventory of calendars and
diaries which are likely to be obsolete.
Discussion with management regarding any slow-moving items of inventory which
were included in opening inventory.
Analytical procedures such as inventory turnover calculations to highlight slow
moving inventory from the opening balance.

Question No. 57
Explain the following: (5 Marks each June 2012)
i) Assertions about account balances at the period end as per NSA 500 "Audit Evidence".
ii) The Auditor‟s responsibilities regarding comparatives.
Answer
i) Assertions about account balances at the period end:
a. Existence—assets, liabilities, and equity interests exist.
b. Rights and obligations—the entity holds or controls the rights to assets, and liabilities
are the obligations of the entity.
c. Completeness—all assets, liabilities and equity interests that should have been recorded
have been recorded.
 d. Valuation and allocation—assets, liabilities, and equity interests are included in the
financial statements at appropriate amounts and any resulting valuation or allocation
adjustments are appropriately recorded

ii) NSA 710, ―Comparatives‖ establishes standards on the auditor‘s responsibilities regarding
comparatives.
The auditor responsibilities laid down are as under:

i. The auditor should determine whether the comparatives comply, in all material respects
with the financial reporting framework relevant to the financial statements being
audited. Further, the auditor should obtain sufficient appropriate audit evidence that the
corresponding figures meet the requirements of the financial reporting framework.
ii. When the comparatives are presented as corresponding figures, the auditor‘s report
should not specifically identify comparatives because the auditor's opinion is on the
current period financial statements as a whole, including the corresponding figures.
iii. When the auditor‘s report on the prior period, as previously issued, included a qualified
opinion, disclaimer of opinion, or adverse opinion and the matter which gave rise to the
modification in the audit report is:

(a) unresolved and results in a modification of the auditor‘s report regarding the current
period figures, the auditor‘s report should also be modified regarding the corresponding
figures; or
(b) unresolved but does not result in a modification of the auditor‘s report regarding the
current period figures, the auditor‘s report should be modified regarding the
corresponding figures.
In such circumstances, the auditor should examine that appropriate disclosures have been
made or if appropriate disclosures have not been made, the auditor should issue a
modification report on the current period financial modified with respect to the
corresponding figures included therein.

Question No. 58
Comment and give your views as auditor with reasons in the light of Nepal Accounting
Standards, Nepal Standards on Auditing and Code of Ethics on each of the following case:
(5 Marks each June 2012)
a) Raghabdhoj & Co. and Sansar Bhakta & Co. are the joint auditors of Winchester Bank
Limited. The bank had been able to cleverly conceal certain transactions that could not be
detected by both the auditors, in these circumstances, what would be their professional
responsibilities?

b) The annual general meeting of Sundarijal Company Limited on Poush 11, 2068 failed to
appoint the auditor for the financial year 2068/69 due to time constraint and delegated the
power to appoint the auditor to the Board under the terms recommended by the Audit
Committee. The Board meeting held on Poush 25, 2068 appointed M/s Bhandary & Co., a
Chartered Accountants firm as auditor remaining within the terms and conditions
recommended by the Audit Committee. Do you think the appointment of M/s Bhandary &
Co. is valid?
c) Mr. Relax was appointed as the auditor of M/s XYZ Co. Ltd. However during the course of
the audit, Mr. Q, his senior audit manager led the audit team and supervised all the audit
 works of the Co. Mr. Relax was out of town at time of signing the report, and Mr. Q is Mr.
Relax‟s most reliable staff and assisting him for so many years in this profession. Hence,
Mr. Relax is of the opinion that Mr. Q should sign the audit report on behalf of him. Is Mr.
Relax correct in his decision?
d) Mr. Jamun is a chartered accountant who has been recently retired from ABC National
Bank Limited after serving for 25 years as chief finance officer of the Bank. Of late, he has
taken the certificate of practice and owns his own audit firm since his retirement (i.e. from
last 2 year 5 months). He now approached the senior management of the bank for the
statutory audit of the bank and they are agreed to appoint him the next statutory auditor of
the bank. Advise Mr. Jamun and the senior management of the Bank about his validity
as the statutory auditor.

Answer
a) The joint auditors should by mutual discussion, divide the audit work among themselves. The
division of work among them as well as areas of work to be covered by all of them should be
adequately documented and preferably communicated to the client. While dividing their work,
it has to be taken care of that they have not left any area unattended and exercised reasonable
care and skill while performing their audit. Each of the joint auditors should communicate
with each other about any matter which is relevant to the areas of responsibility of other joint
auditors and which deserve their attention. The communication should be in writing by the
submission of a report or note prior to the finalization of the audit. In the case of joint audit,
each joint auditor is responsible only for the work allocated to him, whether or not he has
prepared separate report on the work performed by him. Each joint auditor is entitled to
assume that the other joint auditor has carried out their part of the audit work in accordance
with the generally accepted audit practice.
In the given case also, if it can be ensured that the joint auditors, Raghab Dhoj & co. and
Sansar Bhakta & co. have exercised reasonable care and skill in auditing the books of
accounts of Winchester Bank Limited, and still the bank has been able to conceal certain
transactions, both the auditors cannot be held responsible for professional negligence.
However, the auditors would be responsible for professional negligence if such concealment
could have been traced out by the exercise of reasonable care and skill.

b) According to Section 110 the Companies Act, 2063 every company shall appoint an auditor
under the Act to have its accounts audited. As per Section 111 of the same Act, the general
meeting shall appoint the auditor of a company from amongst the auditors licensed to carry
out audit under the prevailing law subject to Chapter 18 of the Act, in the case of a public
limited Company. The Act also provides that the board of directors may appoint the auditor
prior to the holding of the first annual general meeting. Nowhere in the Act, there is any
provision of delegation of authority to anyone for appointment of an auditor. In the case of a
public limited company, the annual general meeting has authority to appoint auditor under the
terms and conditions as recommended by the Audit Committee as per Section 165 of the same
Act.

As per Section 113 of the Act, in case of failure to appoint an auditor in the annual general
meeting of the company for any reason or where the annual general meeting itself cannot be
held, the auditor is appointed by the company Registrar‘s office at the request of the board of
directors of the Company.
 Hence, the Companies Act does not have any provision of delegating power of the
appointment of the auditor and no one can appoint auditor except the annual general meeting
and Company Registrar‘s Office in case of failure to appoint the auditor by the AGM.

In the above context, the appointment of M/S Bhandary & Co, a chartered accountant‘s firm
by the Board of Sundarijal Company Limited at the recommendation of the Audit Committee
as per the authority delegated by the annual general meeting held on Poush 11, 2068 is not
valid. The Company Registrar‘s Office can only appoint auditor in such case at the request of
the Board of the Company.

c) As per Section 116 of the Companies Act 2063, an audit report prepared by the auditor
appointed by any company under this Act shall be signed and dated by the auditor himself.
Also, it provides that where any company has appointed any accounting institution licensed
under the prevailing law to carry out audit, the member who has been authorized by a decision
of the partners of such institution shall sign and date the audit report. Also, NSA 700 requires
that the auditor‘s signature either in the name of the audit firm, the personal name of the
auditor or both.

In the given case of M/S XYZ Co. Ltd. where Mr. Relax is the auditor and Mr. Q is only his
audit manager and not his partner of his firm, only Mr. A is authorized to sign the audit report
and not his manager by virtue of the above provisions. However, he can use Mr. Q for
conducting the audit work of M/S XYZ Co., Mr. Relax by signing the report himself takes the
responsibility of the report and ensures that he has through convince on the report issued by
him.

d) As per Section 34(12) of the Chartered Accountants Act, 1997, one shall not perform audit of
accounts of any organization where he has served until the elapse of at least three years of his
leaving the service.
Here in the case of Mr. Jamun, who has served ABC National Bank Limited for twenty-five
years as Chief Finance Officer and has retired from the service. Now, by virtue of the above
clause of the Act, he is restricted from taking up the statutory auditor‘s assignment for at least
three years after his retirement. He has just completed two years and five months and hence he
should not take up the assignment or the management of the bank should not appoint him as
statutory auditor of the bank.

Question No. 59
You are auditor of Elina Garments Limited which exports Readymade garments to M/s.
Warnoff Inc., of USA for the financial Year 2067-68. The Company‟s around 75% sale
constitutes export to Warnoff Inc. and there is outstanding balance of Rs. 17 Crore in Sundry
Debtors which covers around 85% of the total debtors as at 32 Ashad, 2068. Due to global
recession, the Warnoff Inc. has filed bankruptcy in USA on 15 Ashwin, 2068 which came to
your notice during the audit. Give your opinion as an auditor.
(5 Marks June 2012)
Answer
The filing of bankruptcy of the company during the course of audit but after the balance sheet date
is subsequent event or events occurring after balance sheet date. It is seen that the debtor covers
the major portion of debtors, the debtors shown in the balance sheet may no longer be appropriate
and hence adequate provision should be made. Since, the party is major customer and covers major
portion of the debtor, the going concern assumption of the company may no longer be appropriate
if receivable amount from Warnoff Inc. is more than total amount of equity of the company.
As per NSA 570 on Going Concern, 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. These responsibilities exist even if the financial
reporting framework used in the preparation of the financial statements does not include an explicit
requirement for management to make a specific assessment of the entity‘s ability to continue as a
going concern.

In such circumstances, the auditor should ask the management for necessary
adjustment/provisioning in the financial statement regarding the debtor balances and necessary
disclosure thereof.
Further, the auditor should also:
a) Review management's plans for future actions based on its going concern assessment;
b) Gather sufficient appropriate audit evidence to confirm or dispel whether or not a
material uncertainty exists through carrying out procedures considered necessary,
including considering the effect of any plans of management and other mitigating
factors; and
c) Seek written representations from management regarding its plans for future action.

Based upon further assessment and actions of management, the auditor shall issue his opinion.

Question No. 60
“The reliability of audit evidence is influenced by its source and by its nature and is dependent
on the individual circumstances under which it is obtained”. Explain.
(5 Marks June 2012)
Answer
Explanatory Paragraph A31, of Nepal Standard on Auditing 500 ―Audit Evidence‖ deals with
the above statement. The following generalization about the reliability of audit evidence may
be useful:
i) Audit evidence is more reliable when it is obtained from independent sources outside
the entity.
ii) Audit evidence obtained directly by the auditor is more reliable that audit evidence
obtained indirectly or by inference.
iii) Audit evidence is more reliable when it exists in documentary form.
iv) Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles.

Accordingly, audit evidence in the form of original written responses to confirmation requests
received directly by the auditor from the third parties who are not related to the entity being
audited, when considered individually or cumulatively with audit evidence from other audit
procedures, may assist in reducing the risk of material misstatement for the related assertions to an
acceptably low level.
Question No. 61
Express your opinion as an auditor on the following case:
(5 Marks each December 2012)
a) The accountant of C Ltd. has requested you, not to send balance confirmations to a
particular group of debtors since the said balances are under dispute and the matter is pending
in the Court.
b) The existing auditors re-appointed at the AGM of the Company, refused to accept the
appointment. Is the Board of Directors entitled to fill up the vacancy? Comment.

a) Answer
NSA 505 on ―External Confirmations‖, establishes standards on the auditor‘s use of external
confirmation as a means of obtaining audit evidence. It requires that the auditor should employ
external confirmation procedures in consultation with the management.
As Per Para 8 Of NSA 505, If management refuses to allow the auditor to send a confirmation
request, the auditor shall:
a. Inquire as to management‘s reasons for the refusal, and seek audit evidence as to their
validity and reasonableness;
b. Evaluate the implications of management‘s refusal on the auditor‘s assessment of the
relevant risks of material misstatement, including the risk of fraud, and on the nature, timing
and extent of other audit procedures; and
c. Perform alternative audit procedures designed to obtain relevant and reliable audit
evidence.

If the auditor concludes that management‘s refusal to allow the auditor to send a confirmation
request is unreasonable, or the auditor is unable to obtain relevant and reliable audit evidence from
alternative audit procedures, the auditor shall communicate with those charged with governance in
accordance with NSA 260 The auditor also shall determine the implications for the audit and the
auditor‘s opinion in accordance with NSA 705 (Revised).

Therefore, it can be understood that the auditor may come across certain situations in which the
management may request him not to seek external confirmation from certain parties because of
dispute with the debtors, etc. The management, for example, might make such a request on the
grounds that due to a dispute with the particular debtor, the request for confirmation might
aggravate the sensitive negotiations between the entity and the debtor. In such cases, when an
auditor agrees to management‘s request not to seek external confirmation regarding a particular
debtor, the auditor should consider validity of grounds for such a request and assess management‘s
integrity and obtain evidence to support the same. The auditor should also ask the management to
submit its request in a written form, detailing therein the reasons for such a request. The auditor
agrees to management‘s request not to seek external confirmation regarding a particular matter, the
auditor should document the reasons for acceding to the management‘s request and should apply
alternative procedures to obtain sufficient appropriate evidence regarding that matter. While
considering the validity of request, in case the auditor reaches at a conclusion that the same was
not valid, he may appropriately modify the report.

b) Answer
Appointment not effective: when the existing auditors who have been re-appointed at the AGM
refuse to accept the appointment, it does not create a casual vacancy or vacancy by resignation.
The auditor‘s appointment has not become effective due to the refusal.
 Board not empowered: since the auditors are appointed in the AGM, the subsequent refusal
of appointment does not empower the Board of Directors to appoint Auditors in the place of
those refusing to accept.
Conclusion: in the instant case, the Auditors appointment has not become effective. Hence
the appointment should be made properly by the Shareholders at a properly convened
AGM/EGM. It cannot be made by the Directors, since there is no question of casual vacancy.
Also, company Act provides that where at AGM, no auditors are appointed or re-appointed,
the Company Registrar Office on the request of the Board of Directors may appoint a person
to fill the vacancy.

Question No. 62
Comment on the following case: (5 Marks December 2012)
In the course of the statutory audit of Z Ltd., its statutory auditors, having determined that the
work of internal auditor is likely to be adequate for the purpose of statutory audit, wanted to use
the work of internal auditor in respect of physical verification of fixed assets. How an evaluation
of this specific work done by the internal auditor can be done?

Answer
The statutory auditor should as a part of his audit, carryout general evaluation of the internal audit
function to determine the extent to which he can place reliance upon the work of the internal
auditor.
As per NSA 610 "Using the work of Internal Auditors",

The external auditor shall determine whether the work of the internal audit function can be used
for purposes of the audit by evaluating the following:

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.

The external auditor shall perform sufficient audit procedures on the body of work of the internal
audit function as a whole that the external auditor plans to use to determine its adequacy for
purposes of the audit, including evaluating whether:
a) The work of the function had been properly planned, performed, supervised, reviewed and
documented;
b) Sufficient appropriate evidence had been obtained to enable the function to draw reasonable
conclusions; and
c) Conclusions reached are appropriate in the circumstances and the reports prepared by the
function are consistent with the results of the work performed.

Question No. 63
Answer the following questions (5 Marks each December 2012)
a. Briefly describe the auditor's responsibility regarding subsequent events.
b. What is external confirmation? Give few examples of situations where external
confirmation may be used.
Answer:
a) NSA 560 on "Subsequent Events" establishes standards on the auditor's responsibility
regarding subsequent events. NSA 560 on "Subsequent Events" states that the term "subsequent
events" refers to significant events occurring between the balance sheet date and the date of the
auditor's report. NAS 10 on " Events after the Reporting Date " deals with all those significant
events, both favorable and unfavorable, that occur between the balance sheet date and the date on
which the financial statements are approved by the Board of Directors in the case of a company
and by the corresponding approving authority in the case of any other entity. As per NAS 10,
events can be identified as adjustable events which provide further evidence of conditions that
existed at the balance sheet date; and, non-adjusting events are those which are indicative of
conditions that arose subsequent to the balance sheet date. NSA 560 lays down that the "auditor
should consider the effect of subsequent events on the financial statements and on the auditor's
report". When the time between the close of the year-end and the adoption of accounts is about to
take place, examination of subsequent events gains more importance.
NSA 560 further requires that the auditor should perform procedures designed to obtain sufficient
appropriate audit evidence that all events up to the date of auditor's report that may require
adjustment of, or disclosure in, the financial statements have been identified. The procedures to
identify events that may require adjustment of, or disclosure in, the financial statements would be
performed as near as practicable to the date of the auditor's report and ordinarily include the
following:

i. Reviewing procedures that the management has established to ensure that subsequent events
are identified.
ii. Reading minutes of the meetings of shareholders, the board of directors and audit and
executive committees held after the balance sheet date and inquiring about matters discussed
at meetings for which minutes are not yet recorded.
iii. Reading the entity's latest available interim financial statements and, as considered
iv. Necessary and appropriate, budgets, cash flow forecasts and other related management
reports.
v. Inquiring, or extending previous oral or written inquiries, of the entity's lawyers concerning
litigation and claims.
vi. Inquiring of management as to whether any subsequent events have occurred after the balance
sheet date which might affect the financial statements.

When the auditor becomes aware of events which materially affect the financial statements, the
auditor should consider whether such events are properly accounted for in the financial
statements. When the management does not account for such events that the auditor believes
should be accounted for, the auditor should express a qualified opinion or an adverse opinion as
appropriate.

b) As per Nepal Standard on Auditing 505, External confirmation is the process of obtaining
and evaluating audit evidence through a representation of information or an existing condition
directly from a third party in response to a request for information about a particular item
affecting assertions in the financial statements or related disclosures. In deciding to what extent to
use external confirmations the auditor considers the characteristics of the environment in which
the entity being audited operated and the practice of potential respondents in dealing with requests
for direct confirmation.
Few examples of situations where external confirmations may be used are:
Bank balances and other information from bankers;
Account receivable balances;
 Stock held by third parties at bonded warehouses or on consignment;
Property title deeds held by lawyers or financiers for safe custody or as security;
Investments purchased from stockholders but not delivered at the balance sheet date;
Loan from lenders;
Account payable balances

Question No. 64
CA. Mr. A is the auditor of M/S PQR Ltd. During the course of audit, Mr. An encounter few
instances of the risks of material misstatement due to fraud and the results of audit tests
indicate a significant risk of material and pervasive fraud. Hence, Mr. A reach to the
conclusion that he shall not continue the engagement. Suggest the procedure to be followed by
him to discontinue the engagement.
(5 Marks each December 2012)
Answer
Nepal Standard on Auditing 240 “ The Auditor‟s Responsibility Relating to Fraud in an
Audit of Financial Statement” provides that 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 should consider 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, and he should consider the possibility of withdrawing from the
engagement; and if he withdraws, he should 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.

As per para 38 of NSA 240, 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:
(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 is
possible under applicable law or regulation; and
c) If the auditor withdraws:
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
(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.

In the given case, Mr. A is the auditor who considers the risks of material misstatement and his
audit tests also indicates a significant risk of material and pervasive fraud. Due to these reasons,
he reached to the conclusion that he shall not continue the engagement. So, the auditor should
discontinue the engagement as provided in the above paragraph of NSA 240. He should consider
whether there is a professional or legal requirement to report to the person or persons who made
the audit appointment or, to the regulatory authorities about his withdrawal from the engagement
and the reasons for the withdrawal. The auditor may consider seeking legal advice when deciding
whether to withdraw from an engagement and in determining an appropriate course of action,
including the possibilities of reporting to shareholders, regulators or others.
Question No. 65
Describe in brief “Benefits of Audit Planning” and “Materiality” (8 Marks June 2013)
Answer
Benefits of Audit Planning (reference to NSA 300)
Main benefits from planning audit are it helps the auditor obtain sufficient appropriate
evidence for the circumstances, helps keep audit costs at a reasonable level, and helps avoid
misunderstandings with the client.
An audit plan helps to obtain information on audit risk and inherent risk as these risks
influence how the audit is carried out and the costs involved. The audit plan establishes an
overall strategy for the audit, develops an audit plan, reduces audit risk to an acceptably low
level and helps to execute the audit work in an effective manner.
The audit plan should allow flexibility to revise overall audit plan (and thereby the planned
nature, extent and timing of further audit procedures) when unexpected events, changed
conditions or the audit evidence achieved from audit procedures lead to information that is
significantly different from information available to the auditor when he first planned his
audit. This will save time, cost and allows develop an effective response to the risk of
material misstatement.
Audit plan helps to assign appropriate staff, knowledgeable about the client‘s business to the
engagement.
Experience gained from previous year‘s engagements and other assignments is properly
utilized that helps to identify potential problems are resolved on a timely basis
Confirmation that all stages of an audit are completed with important areas of the audit
received the appropriate attention
Audit file documentation is reviewed on a timely basis
Ensure review of work performed by engagement members by review manager or partner.

Materiality (reference to NSA 320)

Materiality is defined in the Nepal Accounting Standard Board‘s ―Framework for the
preparation and presentation of Financial Statements‖ in the following terms:
Information is material if its omission or misstatement could influence the economic decisions
of users taken on the basis of the financial statements. Materiality depends on the size of the
item or error judged in the particular circumstances of its omission or misstatement. This
materiality provides a threshold or cut off point rather than being a primary qualitative
characteristic which information must have if it is to be useful.
The assessment of what is material is a matter of professional judgment. Judgments about
materiality are made in the light of surrounding circumstances and are affected by the auditor‘s
perception of financial information needs of users. Materiality should be considered by the
auditor when determining the nature, timing and extent of audit procedures and evaluating the
effect of misstatements.
The auditor‘s assessment of materiality, related to classes of transactions, account balances and
disclosures helps the auditor decide whether to use sampling and substantive analytical
procedures. This enables auditor to select audit procedures to reduce the audit risk to an
acceptably low level. There is an inverse relationship between materiality and the level of risk
i.e. the higher the materiality level, the lower the audit risk and vice versa.

Question No. 66
As per Section 78 of the Company Act, 2063, what is the responsibility of the statutory auditor
of a public limited company? (4 Marks June 2013)
CAP III Paper 3: Advanced Auditing

Answer:
As per Section 78 of the Companies Act, every public limited company shall prepare a report
indicating the following matters and submit the same to the Office of the Company Registrar in
advance of at least twenty-one days before the holding of the annual meeting. Such report has to
be approved by the board of directors and certified by the statutory auditor of the company:
i) The total number of the shares allotted,
ii) Number of fully paid up and unpaid shares out of the allotted shares,
iii) Particulars of director, managing director, auditor, executive chief and manager of
the company, and the amount of remuneration, allowance and facilities paid to them,
iv) The names of individuals or corporate bodies subscribing five percent or more of the
paid-up capital of the company, and details of shares or debentures held in their
names.
v) The total proceeds of the sale of shares, and particulars of the new shares and
debentures issued and raised by the company in the financial year concerned,
vi) The amount due and payable by the director or substantial shareholder or his close
relative to the company,
vii) The details of payment made or to be made against the sale of shares or for any other
matters,
viii) The amount of loans borrowed from banks and financial institutions and of principal
and interest due and payable,
ix) The amount claimed to be receivable by the company or payable by the company to
any other person or details of lawsuits, if any, ongoing in this respect,
x) The number of employees or workers engaged in the management of the company
and at other levels,
xi) The number of expatriate employees engaged in the management of the company
and at other levels, and remuneration, allowances and facilities paid to them,
xii) Where any agreement has been entered into between the company and any foreign
body or person on investment, management or technical service or other matter for a
period of more than one year, particulars thereof and the particulars of the dividend,
commission, fee, charge and royalty as well paid under such agreement in the
financial year concerned,
xiii) A statement of the management expenditures of the company in a financial year,
xiv) The amount of dividends yet to be claimed by the shareholders,
xv) A declaration that the company has fully observed this Act and the prevailing law,
xvi) Other necessary matters.
The responsibility of auditor is to verify the above information and certify. The auditor
should ensure that the information is consistent with those of audited one.

Question No. 67

Answer the following

a) Based upon the legal opinion of a leading advocate, Kathmandu Limited made a provision
of Rs. 50 million towards income tax liability. The assessing authority has worked out the
liability at Rs. 60 million. You as the statutory auditor of Kathmandu Limited observed that
the opinion of the advocate was inconsistent with legal position with regards to certain
revenue items. Indicate the precise nature of auditor‟s liability in such situation and
support your view with authority, if any.
b) Briefly explain the Auditor‟s responsibilities regarding comparatives.
(5 Marks each June 2013)
a) NSA 620 ―Using the work of an Expert‖ provides guidance on using the work of an expert
as audit evidence. NAS-620 states that during the audit, the auditor may need to obtain, in
conjunction with the client or independently, audit evidence in the form of reports, opinions,
valuations and statement of an expert, e.g. legal opinions concerning interpretations of
agreements, statutes and regulations.

Before relying on advocate opinion:

a) The relevance and reasonableness of that expert‘s findings or conclusions, and their
consistency with other audit evidence;
b) 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
c) 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 results of the expert‘s work do not provide sufficient appropriate audit evidence or if
the results are not consistent with other audit evidence, the auditor should resolve the matter.
This may involve discussion with the entity and the expert, applying additional audit
procedures, including possibly engaging another expert, or modifying the auditor‘s report.
The question states very clearly that the opinion of the advocate was inconsistent with legal
position with regards to certain revenue items. And, as an auditor, after applying due audit
procedures on the work of an expert, I decided to suggest Kathmandu Limited for making
additional provision for income tax and issuance of unmodified audit report.

b) NSA 710, ―Comparatives‖ establishes standards on the auditor‘s responsibilities regarding

comparatives.
The auditor responsibilities laid down are as under:
i) The auditor should determine whether the comparatives comply, in all material
respects with the financial reporting framework relevant to the financial statements
being audited. The extent of audit procedures performed on the corresponding figures
is significantly less than for the audit of the current period but ensure that the figures
have been correctly reported and appropriately classified. And see that:
Accounting policies used for corresponding figures are consistent with those of
current period or whether appropriate adjustments and/or disclosure were made
Corresponding figures agree with the amounts and other disclosure presented in
the prior period or whether appropriate adjustment and/or disclosure were made
ii) When the financial statement of the prior period have been audited another auditor or
not audited, the income auditor assesses whether the corresponding figures meet the
condition specified in above para (i) and guidance in NSA 510.
iii) During the course of audit of current period, the auditor becomes aware of a possible
material misstatement in the corresponding figures, the audit should perform
appropriate additional audit procedures.
iv) When the auditor‘s report on the prior period, as previously issued, included a
qualified opinion, disclaimer of opinion, or adverse opinion and the matter which gave
rise to the modification in the audit report is:
CAP III Paper 3: Advanced Auditing

unresolved and results in a modification of the auditor‘s report regarding the

current period figures, the auditor‘s report should also be modified regarding the
corresponding figures; or
unresolved, but does not result in a modification of the auditor‘s report regarding
the current period figures, the auditor‘s report should be modified regarding the
corresponding figures.
v) When the prior period financial statements are not audited, the incoming auditor
should state in the auditor‘s report that the corresponding figures are unaudited.

Question No. 68
Briefly explain with example, four types of audit evidence that the auditor can obtain.
(5 Marks June 2013)
Answer
Four types of audit evidence:
a. Physical examination
Inspection or count by the auditor of a tangible assets. Most often associated with cash or
inventory, but it is also applicable for verification of securities and tangible fixed assets
b. Confirmation
The receipt of a written or oral response from an independent third party verifying the
accuracy of information. Auditor has client request that the third party respond directly to
the auditor.
Positive confirmation: Ask for response even if balance is correct.
Negative confirmation: Ask for response only if balance is negative.
c. Documentation
Audit documentation is the principal record of auditing procedures applied, evidence
obtained, and conclusion reached by auditor.
Internal document: Prepared and used within client company and does not go outside
client.
External document: Document has been in the hands of outside party to transaction.
d. Observation:
Use of senses to assess client‘s activities. Auditor witnesses the physical activities of the
client. Differs from physical examination because physical examination counts assets,
while observation focuses on client activities.
The following are the methods to obtain audit evidence
i) Inspection – examination of records or documents in whatever form. Example:
manual, computerized, internal, external.
ii) Observation- looking at the process or procedures being carried out by others;
Example – attending the physical stock take at the year end
iii) Inquiry- seeking information from knowledgeable persons, both financial and non-
financial, within or outside the entity being audited. Example – discussion with
management /accountants.
iv) Confirmation- the process of obtaining a representation of an existing condition
from a third party. Example- bank confirmation, receivable letter
v) Recalculation – checking the mathematical accuracy of documents and records.
Example- checking calculation of staff leave liabilities
vi) Re-performance- Re-performance is the auditor‘s independent execution of
procedures or controls that were originally performed as part of the entity‘s
internal control, either manually or through the use of CAATs, for example, re
performing the aging of accounts receivable.
 vii) Analytical Procedures- Evaluation of financial information made by a study of
plausible relationships among both financial and non-financial data, Example;
Ratio, trend.

Question No. 69
Comment and give your views with reasons on each of the following cases, giving consideration
to Nepal Accounting Standards, Nepal Standards on Auditing and Code of Ethics.

a) You are the auditor of XYZ Ltd, a contractor, for the year end 31 Ashadh 2070. XYZ
Ltd carried out a major construction work for ABC Pvt. Ltd. and billed work in progress
of Rs. 1 million (total accounts receivable balance at the yearend is Rs. 1.5 million)
which is yet to be paid. ABC Pvt. Ltd. has suspended the payment of contract on the
ground that work carried out is not as per contract signed and appropriate rectifications
have to be done. XYZ Ltd. has accepted the deficiencies and rectified the work in Kartik,
2070. While finalizing the audit report in Mangsir 2070, you came to know that ABC
Pvt. Ltd is not satisfied with the level of rectifications and has terminated the contract.
Assume there are no concerns other than those described above, and that going concern
is not an issue. In relation to the subsequent event issue:
i) Identify the impact (if any) on the financial report for the year ended 31 Ashadh
2070.
ii) Justify your decision in (i) above.
iii) Determine the type of audit opinion that would be issued, assuming that XYZ
management has no intention to addressing the issue in the financial report.
(5 Marks December 2013)

b) PSS & Co, Chartered Accountants, were appointed as the auditor by the annual general
meeting of Chicken Products Ltd. for the financial year 2069/70. This was their first
appointment as an auditor of this company. During the course of the audit, after
performing all required audit procedures, the auditor was unable to obtain sufficient
appropriate audit evidence concerning opening balances. Briefly outline your role as an
auditor.
(5 Marks December 2013)
Answer hint:
a)
i)
a) Subsequent event: Termination of major contract
b) Adjusting event: Revenue and receivable need to be adjusted based on subsequent
event.
ii) Account receivable and revenue no longer exist as contract has been terminated.
iii) Type of qualification: Qualified

b)
As stated in NSA 510 "Initial Engagements-Opening Balances", for initial audit engagements,
the auditor should obtain sufficient appropriate audit evidence that:
i) The opening balances do not contain misstatements that materially affect the current
period‘s financial statements;
ii) The prior period‘s closing balances have been correctly brought forward to the current
period or, when appropriate, have been restated; and
 iii) Appropriate accounting policies are consistently applied or changes in accounting policies
have been properly accounted for and adequately presented and disclosed.
If, after performing audit procedures including those set out in Nepal Standards on Auditing,
the auditor is unable to obtain sufficient appropriate audit evidence concerning opening
balances, the auditor‘s report should include:

a) A qualified opinion,
b) A disclaimer of opinion; or
c) In those jurisdictions where it is permitted, an opinion which is qualified or
disclaimed regarding the results of operations and unqualified regarding
financial position.
If the effect of the misstatement is not properly accounted for and adequately presented and
disclosed, the auditor should express a qualified opinion or an adverse opinion, as appropriate.

Question No. 70
Describe few instances in which the auditor may seek to use the work of an expert during the
course of his audit. (6 Marks December 2013)
Answer:
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 as per NSA 620. Few instances are:
i) Valuations of certain types of assets, for example, land and buildings, plant and
machinery, works of arts, and precious stones.
ii) Determination of quantities or physical condition of assets, for example, mineral stored in
stockpiles, mineral and petroleum reserves and remaining useful life of plant and
machinery.
iii) Determination of amounts using specialized techniques or methods for example, an
actuarial valuation.
iv) The measurement of work completed and to be completed on contracts in progress for the
purpose of revenue recognition.
v) Legal opinion concerning interpretations of agreements, statutes regulations, notifications,
circulars etc.

Question No. 71
As an auditor of M/S XYZ Finance Company Ltd., you came across a payment of Rs. 20
million for investment in share of ABC Hydro Company Ltd. The share investment script was
not provided to you for verification. In response to the positive external confirmation from ABC
Hydro Company Ltd., you received a phone call confirming the investment of the said amount
and specifying the reason for delay in delivering the investment script on the ground that the
same is in the process of printing. However, upon your personal request, you received a written
confirmation from ABC Hydro Company Ltd. of the receipt of the said amount but with the
restrictive language „Information is furnished as a matter of courtesy without a duty to do
so and without responsibility, liability, or warranty, expressed or implied‟. Give your
opinion whether the oral confirmation and the written confirmation obtained amounts to
sufficient appropriate audit evidence.
(5 Marks June 2014)
Answer:
An oral response to a confirmation request does not meet the definition of an external
confirmation because it is not a direct written response to the auditor. Provided that the auditor
has not concluded that a direct written response to a positive confirmation is necessary to obtain
sufficient appropriate audit evidence, the auditor may take the receipt of an oral response to a
confirmation request into consideration when determining the nature and extent of alternative
audit procedures required to be performed for non-responses. The auditor may perform additional
procedures to address the reliability of the evidence provided by the oral response, such as
initiating a call to the respondent using a telephone number that the auditor has independently
verified as being associated with the entity. For example, the auditor might call the main
telephone number obtained from a reliable source and ask to be directed to the named respondent
instead of calling a direct extension provided by the client or included in the statement or other
correspondence received by the entity. The auditor may determine that the additional evidence
provided by contacting the respondent directly, together with the evidence upon which the
original confirmation request is based (for example, a statement or other correspondence received
by the entity), is sufficient appropriate audit evidence. For appropriately documenting the oral
response, the auditor may include specific details, such as the identity of the person from whom
the response was received, his or her position, and the date and time of the conversation.
However, in certain circumstances the auditor may identify an assessed risk of material
misstatement at the assertion level for which a response to a positive confirmation request is
necessary to obtain sufficient appropriate audit evidence. Such instances include the information
available to corroborate management‘s assertion is only available outside the entity or specific
fraud risk factors, such as the risk of management override of controls or the risk of collusion,
which can involve employee(s) or management, or both, prevent the auditor from relying on
evidence from the entity.
A response to a confirmation request may contain restrictive language regarding its use. Such
restrictions do not necessarily invalidate the reliability of the response as audit evidence. Whether
the auditor may rely on the information confirmed and the degree of such reliance will depend on
the nature and substance of the restrictive language. Restrictions that appear to be disclaimers of
liability may not affect the reliability of the information being confirmed.
In the case of XYZ Finance Company Ltd. as the client could not produce investment script for
physical verification, obtaining of mere oral response does not tantamount to sufficient
appropriate audit evidence. However, with regards to the written confirmation received with
restrictive language, incorporation of restrictive language on the confirmation letter does not
invalidate the reliability of the confirmation received. The substance of the confirmation letter lies
with the assertion of the confirmation of the investment in clear language with amount. Hence, if
the main content of the confirmation letter clearly substantiates the investment amount, the same
becomes sufficient appropriate audit evidence. Otherwise, other audit procedures should be
initiated.

Question No. 72
How should the auditor deal with a fraud detected during the audit? Outline the
auditor‟s
specific responses in relation to the fraudulent reporting in revenue
recognition.
(8 Marks June 2014)
Answer
The relevant auditing standard is NSA 240-The Auditor‘s Responsibilities relating to Fraud in an
Audit of the Financial Statement. This standard makes it clear in that the responsibility for the
detection of fraud is that of management and the directors who need to establish and maintain
internal controls suitable to safeguard the assets and activities of the business.

Where fraud is detected, standard requires the auditor to communicate, in a timely manner, the
findings that suggest the possibility of fraud. These should be communicated to the appropriate
level of management, or in the case where management is believed to be involved in the fraud, to
the appropriate higher level of governance. The auditor should consider matter of confidentiality,
whether the communication should be orally or in writing and the possible necessity of obtaining
legal advice or communicating with a regulator. NSA 260- Communications with Those Charged
with Governance also provides additional guidance to assist an auditor whether a matter should be
reported orally or in writing.

The exact nature of action and reporting will depend on the facts and circumstance of the
particular case. Common elements to report could include the tests the auditor carried out, their
findings, the reasons fraud is suspected, what further investigatory procedures, if any, have been
undertaken, and possible recommendations for action.

Specific responses – misstatement due to fraudulent reporting – revenue recognition:

Performing substantive analytical procedures relating to revenue using disaggregated data, for
example, comparing revenue reported by month and by product line or business segment
during the current reporting period with comparable prior periods.
Confirming with customers certain relevant contract terms and the absence of side agreements.
Enquiring of the entity‘s sales and marketing personnel or in-house legal counsel regarding
sales or shipments near the end of the period and their knowledge of any unusual terms or
conditions associated with these transactions.
Being physically present at one or more locations at period end to observe goods being shipped
or being readied for shipment (or returns awaiting processing) and performing other
appropriate sales and inventory cut-off procedures.
For those situations for which revenue transactions are electronically initiated, processed, and
recorded, testing controls to determine whether they provide assurance that recorded revenue
transactions occurred and are properly recorded.

Question No. 73
In the course of audit of ABC Ltd., its management refuses to provide written representations.
As an auditor, what is your duty? (4 Marks June 2014)
Answer:
As per NSA -580 ―Written Representations‖ if the management does not provide one or more of
the requested representations the auditor shall.
(i) Discuss the matters with management.
(ii) Re-evaluate the integrity of the 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.

The auditor should disclaim an opinion on the financial statements if management does
not provide written representations.
Question No. 74
Answer the following
a) What do you mean by Working Papers? How important is working papers for an auditor to
perform an audit? (8 Marks December 2014)

b) “The risk of not detecting a material misstatement resulting from fraud is higher than the
risk of not detecting a material misstatement resulting from error and the risk of the
auditor not detecting a material misstatement resulting from management fraud is greater
than that of the employee fraud”. Explain. (4 Marks December
2014)

c) As a Statutory Auditor, how would you deal with the following?

The accountant of C Ltd. has requested you not to send balance confirmation letters to a
particular group of debtors since the said balances are under dispute and the matter is
pending in the court. (4Marks December 2014)

Answer:
a) Answer
As per the definition given in Nepal Standard on Auditing 230, ―Audit Documentation‖ means
the record of audit procedures performed, relevant audit evidence obtained, and conclusions
the auditor reached. The terms working papers or work papers are also sometimes used for
audit documentation.

Thus, working papers mean the material prepared by and for, or obtained and retained by the
auditor in connection with the performance of the audit. Working papers may be in the form
of data stored on paper, film, electronic media or other media. They assist in the planning and
performance of the audit, assist in the supervision and review of the audit work and provide
evidence of the audit work performed to support the auditor's opinion. Therefore, working
papers are very important document to the auditor while performing an audit.

Working papers are designed and organized to meet the circumstances and the auditor's needs
for each individual audit. The use of standardized working papers (for example, checklists,
specimen letters, organization of working papers) may improve the efficiency with which
such working papers are prepared and reviewed. They facilitate the delegation of work while
providing a means to control its quality.

Working papers should be sufficiently complete and detailed for an auditor to obtain an
overall understanding of the audit. The extent of documentation is a matter of professional
judgement since it is neither necessary nor practical to document every observation,
consideration or conclusion by the auditor in his working papers.
Working papers normally include:
information concerning the legal and organizational structure of the client,
extracts or copies of important legal documents, agreements and minutes,
information concerning the industry, economic environment and legislative
environment within which the client operates,
evidence of the planning process including audit programs and any changes thereto,
evidence of the auditor's understanding of the accounting and internal control systems,
evidence of inherent and control risk assessments and any revisions thereof,
evidence of the auditor's consideration of the work of internal auditor and conclusions
reached,
analyses of transactions and balances,
 analyses of significant ratios and trends,
a record of the nature, timing and extent of audit procedures performed and the results
of such procedures.

Working paper files may be classified as permanent working paper file and current working
paper file. The basic information about the organization that normally do not change from
year to year are filed in the permanent working paper file whereas information pertaining to
the audit of particular year is filed in the current working paper file.

b) Answer
It is obvious that the risk of not detecting a material misstatement resulting from fraud is
higher than the risk of not detecting a material misstatement resulting from error because
fraud may involve sophisticated and carefully organized schemes designed to conceal it, such
as forgery, deliberate failure to record transactions, or intentional misrepresentations being
made to the auditor. Such attempts at concealment may be even more difficult to detect when
accompanied by collusion. Collusion may cause the auditor to believe that evidence is
persuasive when it is, in fact, false. The auditor‘s ability to detect a fraud depends on factors
such as the skillfulness of the perpetrator, the frequency and extent of manipulation, the
degree of collusion involved, the relative size of individual amounts manipulated, and the
seniority of those involved. Audit procedures that are effective for detecting an error may be
ineffective for detecting fraud. Furthermore, the risk of the auditor not detecting a material
misstatement resulting from management fraud is greater than for employee fraud, because
those charged with governance and management are often in a position that assumes their
integrity and enables them to override the formally established control procedures. Certain
levels of management may be in a position to override control procedures designed to prevent
similar frauds by other employees, for example, by directing subordinates to record
transactions incorrectly or to conceal them. Given its position of authority within an entity,
management has the ability to either direct employees to do something or solicit their help to
assist management in carrying out a fraud, with or without the employees‘ knowledge.
Nepal Standard on Auditing 240 describes about the auditor‘s responsibility to consider fraud
in an audit of financial statements.

c) Answer
External confirmation Requests: NSA 505, ―External Confirmations‖, establishes standards
on the use of external confirmation as a means of obtaining audit evidence. It requires that the
auditor should employ external confirmation procedures in consultation with the management.
The auditor may come across certain situations in which the management may request him not
to seek external confirmation from certain parties because of dispute with the debtors, etc. The
management, for example, might make such a request on the grounds that due to a dispute
with the particular debtor, the request for confirmation might aggravate the sensitive
negotiations between the entity and the debtor. In such cases, when an auditor agrees to
management‘s request not to seek external confirmation regarding a particular debtor, the
auditor should consider validity of grounds for such a request and assess management‘s
integrity and obtain evidence to support the same. The auditor should also ask the
management to submit its request in a written form, dealing therein the reasons for such a
request. If the auditor agrees to management‘s request not to seek external confirmation
regarding a particular matter, the auditor should document the reasons for consideration to the
management‘s request and should apply alternative procedures to obtain sufficient appropriate
evidence regarding that matter. While considering the validity of request, in case the auditor
reaches at a conclusion that the same was not valid, he may appropriately modify the report.
Question No. 75
Answer the following (6 Marks each December 2014)
a) What procedures should be followed for the audit of transactions with related parties as per
the requirement of Nepal Standards on Auditing?

b) What are the procedures for obtaining Audit Evidence?

Answer:
a) As required by NAS 24 and other provision of acts/rules like Companies Act, Nepal Rastra
Bank Directives and Insurance Board Directives, the transactions with related parties are to
be identified and disclosed in the financial statements. There are certain restrictions on
transactions with related parties as per the provision of such acts and rules/directives.

As per NSA 550, the auditor should perform audit procedures designed to obtain sufficient
appropriate audit evidence regarding the identification and disclosure by management of
related parties and the effect of related party transactions that are material to the financial
statements. However, an audit cannot be expected to detect all related party transactions.

The auditor should review information provided by the directors and management identifying
the names of all known related parties and should perform the following procedures in
respect of the completeness of this information:
review prior year working papers for names of known related parties;
review the entity‘s procedures for identification of related parties;
inquire as to the affiliation of directors and officers with other entities;
review shareholder records to determine the names of principal shareholders or, if
appropriate, obtain a listing of principal shareholders from the share register;
review minutes of the meetings of shareholders and the board of directors and other
relevant statutory records such as the register of directors ‗interests;
inquire of other auditors currently involved in the audit, or predecessor auditors, as to
their knowledge of additional related parties; and
review the entity‘s income tax returns and other information supplied to regulatory
agencies.
Reviewing accounting records for large or unusual transactions or balances, paying
particular attention to transactions recognized at or near the end of the reporting period
Performing detailed tests of transactions and balances

The auditor should obtain a written representation from management concerning:

the completeness of information provided regarding the identification of related
parties; and
the adequacy of related party disclosures in the financial statements

If the auditor is unable to obtain sufficient appropriate audit evidence concerning related
parties and transactions with such parties or concludes that their disclosure in the financial
statements is not adequate, the auditor should modify the auditor‘s report appropriately
.
b) Nepal Standard on Auditing 500 describes about the audit evidence. According to this
standard, ―Audit Evidence‖ is all the information used by the auditor in arriving at the
conclusions on which the audit opinion is based and also includes the information contained
in the accounting records underlying the financial statements and other information. The
auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable
conclusions for expressing his opinion on the financial statements. The auditor obtains audit
 evidence by one or more of the following procedures: inspection, observation, inquiry and
confirmation, computation and analytical procedures. The timing of such procedures will be
dependent, in part, upon the periods of time during which the audit evidence sought is
available.
Inspection
Inspection consists of examining records, documents, or tangible assets. Inspection of
records and documents provides audit evidence of varying degrees of reliability
depending on their nature and source and the effectiveness of internal controls over their
processing. Three major categories of documentary audit evidence, which provide
different degrees of reliability to the auditor, are:
a. documentary audit evidence created and held by third parties;
b. documentary audit evidence created by third parties and held by the entity; and
c. documentary audit evidence created and held by the entity. Inspection of tangible
assets provides reliable audit evidence with respect to their existence but not
necessarily as to their ownership or value.
Observation
Observation consists of looking at a process or procedure being performed by others, for
example, the observation by the auditor of the counting of inventories by the entity's
personnel or the performance of control procedures that leave no audit trail.
Inquiry and Confirmation
Inquiry consists of seeking information of knowledgeable persons inside or outside the
entity. Inquiries may range from formal written inquiries addressed to third parties to
informal oral inquiries addressed to persons inside the entity. Responses to inquiries may
provide the auditor with information not previously possessed or with corroborative audit
evidence. Confirmation consists of the response to an inquiry to corroborate information
contained in the accounting records. For example, the auditor ordinarily seeks direct
confirmation of receivables by communication with debtors.
Computation
Computation consists of checking the arithmetical accuracy of source documents and
accounting records or of performing independent calculations.
Analytical Procedures
Analytical procedures consist of the analysis of significant ratios and trends including the
resulting investigation of fluctuations and relationships that are inconsistent with other
relevant information or deviate from predicted amounts.

Question No. 76
Comment and give your views with reasons on each of the following cases.
(5 Marks each June 2015)
a) While auditing Galaxy Limited, Mr. GN, the statutory auditor of the company, came to
know that some of the trade payables are outstanding as it is from previous year in the
Balance sheet of the current year. Mr.GN, therefore, requested written confirmation of
balances from trade payables. In the list of confirmations request sent, one of the trade
payables, having outstanding balance of Rs 12 lakh, sent his confirmation through an
electronic mail. You are required to explain what the further procedures are required to rely
on such responses received electronically.
b) ABC ltd entered into agreement with Mr. R on 2070/03/15, whereby it agreed to pay him
Rs. 1 lakh per month as retainership fee for consultation in IT department. However, no
amount was actually paid, and 12 lakhs was provided in the statement of profit and loss for
the year ending 2070/03/31. Management of the company uttered that need-based
 consultation was obtained throughout the year. However, no documentary or other evidence
of receipt of such service was found. As the auditor of ABC ltd, what would be your
approach?
c) M/s AP & Associates, auditors of Welfare Dalit Organization, a recognized
nonprofit organization feels that the standard on auditing need not to be applied as Welfare
Dalit Organization is a non-profit making organization.
d) Mr. Raj, a fellow member of the Institute of Chartered Accountants of Nepal, working
as Manager of Ram & Associates, a Chartered Accountant firm, signed the audit report of
Om Ltd. on behalf of Ram & Associates.
a) Answer
According to NSA 505 on external confirmation, if the auditor identifies factors that give rise to
doubts about the reliability of the response to a confirmation request, the auditor shall obtain
further audit evidence to resolve those doubts. Responses received electronically, for example by
facsimile or email, involve risks as to reliability because proof of origin and authority of the
respondent may be difficult to establish, and alterations may be difficult to detect. A process used
by the auditor and the respondent that creates a secure environment for responses received
electronically may mitigate these risks. If auditor is satisfied that such a process is secure and
properly controlled, the reliability of the related responses is enhanced. An electronic
confirmation process might incorporate various techniques for validating the identity of a sender
of information in electronic form for e.g. through the use of encryption, electronic digital
signatures, and procedures to verify authenticity.

The auditor is required by NSA 500 "Audit evidence" to determine whether to modify or add
procedures to resolve doubts over the reliability of information to be used as audit evidence. The
auditor may choose to verify the source and contents of a response to a confirmation request by
contacting the confirming party. E.g. the auditor may telephone the confirming party to determine
whether the confirming party did, in fact, send the response. In the given case, Mr. GN, has
received a response, through e-mail, hence the risk as to reliability of the response exists because
proof of origin and authority of the respondent is difficult to establish. He may ask the party to
incorporate some of the techniques for validity of identity and the confirmation received, like,
digital signatures etc. he may also contact the party through telephone to check the authenticity of
the confirmation received.

b) Answer
As per NSA 240 on "The Auditor's Responsibilities Relating to fraud and error 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, ABC ltd has
entered into agreement with Mr. R at Year-end, for consultation in IT department. It also charged
yearly fee of Rs. 12 lakhs in the statement of profit and loss, however, no documentary or other
evidence of receipt of such service was found. It is clear that company has passed fictitious
journal entries, near year-end, to manipulate the operating results. Hence the auditor should 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 performing the audit 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 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 case the auditor decides to withdraw, then the
auditor should 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.
Further, the auditor is required to comply with the 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.

c) Answer
As per NSA 200 NSAs are written in the context of an audit of financial statements by an auditor.
They are to be adapted as necessary in the circumstances when applied to audits of other historical
financial information.

Provided that until any auditing standards are notified, any standard, or standards of auditing
specified by the Institute of Chartered Accountant of Nepal shall be deemed to be the auditing
standards.

Further, the preface to Standards on Auditing gives the scope of the Standards on Auditing. As
per the preface, the NSAs will apply whenever an independent audit is carried out; that is, in the
independent examination of financial statements/information of any entity; whether profit
oriented or not and irrespective of its size, or legal form (unless specified otherwise) when such
an examination is conducted with a view to expressing an opinion thereon.
Also, while discharging their attest function; it is the duty of the Chartered Accountant to ensure
that NSAs are followed in the audit of financial information covered by their audit reports.
In the given case, even though the client is a non-profit oriented entity the NSAs shall apply and
the auditor shall be guilty of professional misconduct for failing to discharge his duty in case of
noncompliance with NSAs.

d) Answer
Section 116 of the Companies Act, 2063 requires that only a person appointed as the auditor of
the company or where a firm is so appointed, the member who has been authorized by a decision
of the partners of such institution, may sign the auditor‘s report or sign or authenticate any other
document of the company required by law to be signed or authenticated by the auditor. Therefore,
Mr. Raj, a fellow member of the Institute and a manager of M/s Ram & Associates., Chartered
Accountants, cannot sign on behalf of the firm in view of the specific requirements of the
Companies Act, 2063. Further, as per Section 29 of Nepal Chartered Accountants Act 1997, to
carry out an accounting profession, Certificate of Practice (COP) is a must and the Institute of
Chartered Accountants of Nepal restricts its Chartered Accountant member in service even to
hold a COP. So, Mr. Raj cannot sign the audit report.

Question No. 77
Answer the following:
a) Briefly explain the financial statements assertions as per NSA 500. (5 Marks June 2015)
b) What are the functions, duties and powers of the audit committee? (6 Marks June 2015)

a. Answer
As per NSA 500: Audit Evidence, financial statement assertions are assertions by
management. They are:
i. Existence: An asset or a liability exists at a given date
 ii. Right and Obligations: An asset or a liability pertains to the entity at a given
date
iii. Occurrence: A transaction or event took place which pertains to the entity during
the period
iv. Completeness: There are no unrecorded or undisclosed assets,
liabilities, transactions events
v. Valuation: An asset or a liability is recorded at an appropriate carrying value
vi. Measurement: A transactions or event is recorded at the proper amount and for
proper period
vii. Presentation and disclosure: An item are disclosed, classified and described as
per requirement.
The auditor should consider the sufficiency and appropriateness of audit evidence to support
those financial statement assertions. While external confirmations may provide audit
evidence regarding these assertions, the ability of an external confirmation to provide
evidence relevant to a particular financial statement assertion varies.

b. Answer
As per section 165 of Companies Act, 2063, the functions, duties and powers of the audit
committee shall be as follows:
i. To review the accounts and financial statements of the company and ascertain the
truth of the facts mentioned in such statements;
ii. To review the internal financial control system and the risk management system of
the company;
iii. To supervise and review the internal auditing activities of the company;
iv. To recommend the names of the potential auditors for the appointment of the auditor
of the company, fix the remuneration and terms and conditions of appointment of the
auditor and present the same in the general meeting for the ratification thereof;
v. To review and supervise as to whether the auditor of the company has observed such
conduct, standards and directives determined by the competent body pursuant to
prevailing law as required to be observed in the course of doing auditing work;
vi. Based on the conduct, standard and directives determined by the competent body
pursuant to the prevailing law, to formulate the policies required to be observed by
the company in respect of the appointment and selection of the auditor.
vii. To prepare the accounts related policy of the company and enforce, or cause to be
enforced the same.
viii. Where any regulatory body has provided for the long-term audit report to be set out
in the audit report of the company, to comply with the terms required to prepare such
report;
ix. To perform such other terms as prescribed by the board of directors in respect of the
accounts, financial management and audit of the company.

Question No. 78
Comment and give your views with reasons on each of the following cases.
(4 Marks Each June 2015)
a) The books of accounts of M/s Max & co. for the accounting year 2070/71 have been
prepared estimating the useful life of a depreciable assets being 15 years. However, due
to current market scenario, it has been determined to revise the estimated useful life of
that depreciable asset to 10 years. The management of the company wants to adjust the
same through prior period adjustment. You are required to advise the management in
this regard.
b) Mr. A, a Chartered Accountant was the auditor of 'A Limited'. During the financial year
2070-71, the investment appeared in the Balance Sheet of the company of Rs.10 lakhs and
was the same amount as in the last year. Later on, it was found that the company's
investments were only Rs.25,000, but the value of investments was inflated for the purpose
of obtaining higher amount of Bank loan.
c) Mr. Shyam, a practicing Chartered Accountant, prepared a feasibility report for one of his
clients to obtain a long-term loan of Rs. 5 crores from a commercial bank and decided to
charge fees @ 5% of the loan approved. Subsequently, the bank approved the loan.
Consequent to the approval of loan by the bank, Mr. Shyam raised an invoice for his
services @ 5% of the loan approved as decided.
d) The Company auditor became aware of a matter, only after he had issued his audit
opinion. Had he become aware of the same prior to his issuing the audit report, he would
have issued a different opinion. What are his responsibilities in such a case?

a. Answer.
As per NAS 08 ―Accounting policies, changes in accounting estimates and errors‖, prior
period items are income or expenses which arise in the current period as a result of errors or
omissions in the preparation of the financial statements of one or more prior periods. The
change in estimated useful life of a depreciable asset does not constitute prior period
adjustment since it neither constitutes error nor omission but it merely involves making
estimates based on prevailing circumstances when financial statements were being prepared.
It is a mere estimate process involving judgment based on the latest information available.
An estimate may have to be revised if changes occur regarding the circumstances on which
the estimate was based, or as a result of new information, more experience or subsequent
developments. The revision of the estimate, by its nature, does not bring the adjustment
within the definitions of an extraordinary item or a prior period item.
The effect of change in an accounting estimate shall be included in the determination of net
profit or loss in:
a) the period of the change, if the change affects the period only; or
b) the period of the change and future periods if the changes affect both.

The nature and amount of a change in an accounting estimate which has a material effect in
the current period, or which is expected to have a material effect in subsequent periods, shall
be disclosed.

Further as per NSA 540 "Audit of Accounting Estimates" 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 year.

In the given case, the company has prepared its books of accounts assuming estimated useful
life of a depreciable assets being 15 years for the accounting year 2070/71. However, due to
change in current market scenario, it was determined to revise the estimated useful life of that
depreciable asset to 10 years. Revision of such an estimate does not bring the resulting
amount within the definition of a prior period item. So, the intention of the management to
adjust as prior period adjustment is not correct. It‘s only a change in accounting estimate and
shall be dealt as mentioned above

.
 b. Answer
Section 34(14) of the Nepal Chartered Accountants Act requires a member to obtain
sufficient information prior to giving any audit opinion. Similarly, Section 34(8) of the Act
requires a member to clearly indicate all the material facts or any false statements or
explanations known to him or to the best of his knowledge in order to truly present the
financial statement certified by him.
The primary duty of physical verification and valuation of investments is of the management.
However, the auditor‘s duty is also to verify the physical existence and valuation of
investments placed, at least on the last day of the accounting year. The auditor should verify
the documentary evidence for the cost/value and physical existence of the investments at the
end of the year. He should not blindly rely upon the Management‘s representation. In the
instant case, such non-verification happened for two years. It also appears that auditors failed
to confirm the value of investments from any proper source. In case auditor has simply relied
on the management‘s representation the auditor has failed to perform his duty. Accordingly,
Mr. A will be held liable for professional misconduct under the Chartered Accountants Act,
1997 in terms of Sections 34(8) and (14).

c. Answer
As per section 34 (10) of chapter VIII of Nepal Chartered Accountant Act 1997 and section
240 of Part B of code of Ethics for professional Accountant in practice, a Chartered
Accountant in practice is deemed to be guilty of professional misconduct if he charges or
offers to charge or accepts or offers to accept in respect of any professional employment fees
which are based on a percentage of profit or on any other uncertain events.
In the given case, Mr. Shyam has prepared a feasibility report for one of his clients, to obtain
a long-term loan. However, he decided to raise an invoice for his services @ 5% of the loan
to be sanctioned in the future, which is basically contingent upon the findings. Therefore, Mr.
Shyam will be held for professional misconduct under the above-mentioned clause.

d. Answer
Legal and professional perspective
(i) Right to receive notice and to attend general meeting
The auditor has a right to receive all notices of and other communications relating
to any general meeting of a company as are sent to the members of the company.
He can attend any general meeting like a member.
However, he can speak only on the matters which concern him as an auditor.
(ii) NSA 560 – As per NSA 560, the auditor before issuing the audit report should
consider subsequent events i.e. events occurring from date of balance sheet to the date
on which audit report is issued.
(iii)Events subsequent to the date of audit report– The auditor, in case he becomes aware
of a matter subsequent to his audit report and such a discovery would cause the
revision of the audit report, he may bring this to the notice of shareholders.
Present case
Based on the above perspective, the auditor may attend the general meeting and bring
to the notice of shareholders the matter concerned and should communicate to them
the change in his opinion.

Question No. 79
While verifying the employees‟ records in a company, it was found that a major portion of the
labor employed was child labor. On questioning the management, the statutory auditor was
told
that it was outside his scope of the financial audit to look into the compliance with other
laws. (5 Marks December
2015)
Answer
As per NSA 250 ―Consideration of Laws and Regulation in an Audit of financial
statements‖ requires the auditor to obtain sufficient appropriate audit evidence regarding
the compliance with the provisions of those laws and regulations generally recognized to
have a direct impact on the determination of material amounts and disclosures in the
financial statements including tax and labor law.
For the other laws, the auditor‘s responsibility is limited to undertake specified audit
procedures to help identify non-compliance with those laws and regulations that may have
a material effect on the financial statements.
Noncompliance with other laws and regulations may result in fines, litigation or other
consequences for the entity, the cost of which may need to be provided for.

In the instant case, major portion of the labor employed was child labor. Auditor should ensure
the disclosure of above fact and provision of the cost of fines, litigation or other consequences. In
case auditor concludes that non-compliance may have a material effect on financial statements,
he should modify his opinion accordingly

Question No. 80
Answer the following: (5 Marks each December 2015)
a) While commencing the statutory audit of ABC Limited, you as an auditor undertook the
risk assessment and found that the detection risk relating to certain class of transactions
cannot be reduced to acceptable level. How would you deal with the situation?
b) The management of X Ltd. has prepared summary financial statements to be provided to its
investors. Consequently, the company wants to appoint you for conducting audit of such
summary financial statements. Mention the factors you would consider before accepting
such engagement to report on summary financial statements.
c) Mr. Shyam was appointed as the auditor of Sagarmatha Trading Limited and intends
to apply the concept of materiality for the financial statements as a whole. Guide him as to
the factors that may affect the identification of an appropriate benchmark for this purpose.
d) What are the professional obligations of an auditor who has resigned from the audit before
completion of his term due to non-co-operation of the Management in completing certain
audit procedures?

a. Answer

NSA 315 ―Identifying and Assessing the risk of material misstatement through understanding the
entity and its environment‖ and NSA 330 ― The Auditor‘s Responses to Assessed Risks‖
establishes standards on the procedures to be followed to obtain an understanding of the
accounting and internal control systems and on audit risk and its components.

NSA 315 and NSA 330 require that the auditor should use professional judgment to assess risk
of material misstatement and to design audit procedures to ensure that it is reduced to an
acceptably low level.
Risk of material misstatements comprises of inherent risk and control risk. ―Detection Risk‖ is
the risk that an auditor‘s substantive procedure will not detect a misstatement that exists in an
account balance or class of transactions that could be material.

The higher the risk of material misstatement, the more audit evidence the auditor should obtain
from the performance of substantive procedure. When both inherent and control risks are
assessed as high, the auditor needs to consider whether substantive procedures can provide
sufficient appropriate evidence to reduce detection risk, therefore audit risk, to an acceptably low
level.

The auditor should use his professional judgment to assess audit risk and to design audit
procedures to ensure that it is reduced to an acceptably low level. If it cannot be reduced to an
acceptable level, the auditor should express a qualified opinion or disclaimer of opinion as may
be appropriate.

b. Answer

As per NSA 810 ―engagement to report on summary Financial statements‖, before accepting an
engagement to report on summary financial statement an auditor shall –
(i) Determine whether the applied criteria are acceptable.
(ii) Obtained the agreement of the management that it acknowledges and understand its
responsibility
a) For the preparation of summary financial statements in accordance with the applied
criteria
b) To make the audited financial statements available to the intended users of the
summary financial statements without undue difficulty
c) To include the auditor‘s report on the summary financial statements in any document
that contains the summary financial statements and that indicates that the auditor has
reported on them.
Agree with the management the form of opinion to be expressed on the summary financial
statements.

c. Answer

NSA 320 ―Audit Materiality‖ prescribes the use of benchmarks in determining materiality for the
financial statements as a whole. Accordingly 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 statement s as a whole. Factor that may affect the
identification of an appropriate benchmark include the following:
i. the elements of the financial statements (for example, assets, liabilities, equity,
revenue, expenses);
ii. 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);
iii. 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;
iv. the entity‘s ownership structure and the way it is financed (for example, if the entity is
financed solely by debt rather than equity, user may put more emphasis on assets, and
claims on them, than on the equity‘s earning); and
v. the relative volatility on the benchmark
d. Answer

NSA 705 ―Modifications to the opinion in the Independent Auditor‘s Report‖ provides the
consequence of an inability to obtain sufficient appropriate audit evidence due to a management -
imposed limitation after the auditor has accepted the engagement. The practicability of resigning
from the audit may depend upon the stage of completion of the engagement at the time that
management imposes the scope limitation.

When the auditor concludes that resignation from the audit is necessary because of a scope
limitation, there may be a professional, regulatory or legal requirement for the auditor to
communicate matters relating to the resignation from the engagement to regulators or the entity‘s
owners.

As per NSA 210 ―Terms of Audit Engagements‖, If the auditor is unable to agree to a change of
the engagement and is not permitted to continue the original engagement, the auditor should
withdraw and consider whether there is any obligation , either contractual or otherwise , to report
to board of directors or shareholders, the circumstances necessitating such withdrawal.

Question No. 81
Mention any four information which assists the auditor in accepting and continuing of
relationship with the client as per NSA 220. (4 Marks December 2015)

Answer
As per NSA 220 "Quality control for audits of historical financial information‖ the information
which assists the auditor in accepting and continuing of relationship with the client may include
the following:
The integrity of the principal owners, key management and those charged with governance
of the entity;
Competency of the engagement team to perform the audit engagement and availability of
necessary capabilities, including time and resources;
Compliance with relevant ethical requirements by firm and the engagement team; and
Significant matters that have arisen during the current or previous audit engagement, and
their implications for continuing the relationship.

Question No. 82
“The auditor should communicate audit matters of governance interest arising from the audit
of financial statements with those charged with the governance of an entity." Briefly state the
matters to be included in such Communication. (8 Marks June 2016)

Answer
The following are the audit matters of governance interest which are to be communicated as per
NSA 260:
i. The general approach and overall scope of the audit, including any expected
limitations thereon, or any additional requirements;
ii. the selection of, or changes in, significant accounting policies and practices that have,
or could have, a material effect on the entity‘s financial statements;
iii. The potential effect on the financial statements of any significant risks and exposures,
such as pending litigation, that are required to be disclosed in the financial statements;
 iv. Audit adjustments, whether or not recorded by the entity that have, or could have, a
significant effect on the entity‘s financial statements;
v. Material uncertainties related to events and conditions that may cast significant doubt
on the entity‘s ability to continue as a going concern;
vi. Disagreements with management about matters that, individually or in aggregate,
could be significant to the entity‘s financial statements or the auditor‘s report. These
communications include consideration of whether the matter has, or has not, been
resolved and the significance of the matter;
vii. Expected modifications to the auditor‘s report;
viii. Other matters warranting attention by those charged with governance, such as material
weaknesses in internal control, questions regarding management integrity, and fraud
involving management;
ix. Any other matters agreed upon in the terms of the audit engagement.

Question No. 83 (5 Marks each June 2016)

Comment and give your views with reasons on each of the following cases, giving consideration
to respective Standards, Laws and Code of Ethics:
a. The statutory auditor of the Holding Company “XYZ Ltd.” demands for the working papers
of the auditors of the subsidiary company “ABC Ltd.” How would you deal with the given
circumstances if you are the auditor of ABC Ltd.?
b. An assistant of Ram & Associates, Chartered Accountants detected an error of Rs.15 for
interest payment which occurred number of times. The General Manager (Finance) of XYZ
Bank Ltd. advised him not to request for passing adjustment entries as individually the
errors were of small amounts. The company had 19,000 deposit accounts and interest was
paid monthly.
Answer
a) As per NSA 230 "Audit Documentation", working papers are the property of the auditor.
the auditor may at his discretion, make portion of or extracts of his working papers available
to his clients.
General Principles of Code of Ethics imposes an obligation on all professional accountants to
maintain confidentiality of information acquired as a result of professional or business
relationship unless there is legal or professional right or duty to disclose.
NSA 600, ―Special Considerations – Audit of Group Financial Statements (including the work
of component auditors)" also states that an auditor should respect the confidentiality of
information acquired during the course of his audit work and should not disclose such
information unless there is legal or professional duty to disclose.

Except to the extent stated above, the auditor is not required to provide the client or other
auditors of the same enterprise or its related enterprises such as a parent or a subsidiary,
access to his audit working papers. The statutory auditor of an enterprise does not have right
of access to the audit working papers of the branch auditor. An auditor can rely on the work of
another auditor, without having any right of access to the audit working papers of other
auditor.
Hence, statutory auditor of holding company cannot have access to audit working papers of
the subsidiary company's auditor. He can, however, ask the auditors to answer certain
questions about the manner in which the audit is conducted and certain other clarifications
regarding audit process. The auditor of subsidiary shall cooperate the holding company‘s
auditor in all material aspects and may even involve him in the audit work if required.
b) As per NSA 320 ―Materiality in planning and performing an audit‖ Misstatements, including
omissions, are considered to be material if they, individually or in the aggregate, could
reasonably be expected to influence the economic decisions of users taken on the basis of the
financial statements. In conducting an audit of financial statements, the overall objectives of
the auditor are to obtain reasonable assurance about whether the financial statements as a
whole are free from material misstatement, whether due to fraud or error, thereby enabling the
auditor to express an opinion. The auditor is primarily concerned with items which either
individually or as a group are material in relation to the affairs of the enterprise. Therefore, the
auditor while carrying out his audit function needs to consider the possibility of misstatements
of relatively small amounts that cumulatively could have a material effect on the financial
statements. In the instant case, an error of Rs. 15 in the interest computation, even if small
individually, will have a material effect due to the number of transactions. Therefore, the
request made by the manager is not acceptable and adjustment entry shall be passed.
Hence, the auditor should advise XYZ Bank Ltd., to make the adjustment. If XYZ Bank Ltd.,
does not accept the advice, the auditor should qualify his report with suitable quantification of
amount involved.

Question No. 84
The auditor of Mohan Ltd. was not able to get the confirmation about the existence and value
of certain machineries. However, the management gave him a certificate to prove the existence
and value of the machinery as appearing in the books of account. The auditor accepted the
same without any further procedure and signed the audit report. Is he right in his approach?
(4 Marks June 2016)
Answer
The physical verification of fixed assets is the primary responsibility of the management. The
auditor, however, is required to examine the verification programme adopted by the management.
He must satisfy himself about the existence, ownership and valuation of fixed assets. In the case
of Mohan Ltd., the auditor has not been able to verify the existence and value of some machinery
despite the verification procedure followed in routine audit. He accepted the certificate given to
him by the management without making any further enquiry.
As per NSA 580 ―Written Representations‖ the representations received from management are
recognized as audit evidence, but they do not constitute Sufficient and appropriateness. Auditor is
required to seek corroborative audit evidence from other sources inside or outside the entity, to
evaluate whether such representations are reasonable and consistent with other evidences.
Representation received from Management cannot be a substitute for other audit evidence that the
auditor could reasonably expect to be available. If the auditor is unable to obtain sufficient
appropriate audit evidence that he believes would be available regarding a matter, which has or
may have a material effect on the financial information, this will constitute a limitation on the
scope of his examination even if he has obtained a representation from management on the matter.
Conclusion: The approach adopted by the auditor is not right.

Question No. 85
Answer the following: (4×5=20)
a) A company outsourced the activity of accounting data maintenance to the service
organization to achieve cost reduction. As an auditor of such company what are the
precautions that you would consider for conducting the audit? (5 Marks June 2016)

b) State the reporting responsibility of an auditor in the context of non-compliance of Law and
Regulation in an audit of Financial Statements. (5 Marks June 2016)
Answer:
a) Answer
A client may use a service organization such as one that executes transactions and maintains
related accountability or records transactions and processed related data. If a client uses a
service organization, certain policies, procedures and records maintained by the service
organization might be relevant to the audit of financial statement of the client. Consequently,
the auditor would consider the nature and extent of activities undertaken by service
organization so as to determine whether those activities are relevant to the audit and, if so, to
access their effect on audit risk.
While planning the audit, the auditor of the client should determine the significance of the
activities of the service organization to the client and their relevance to the audit. In doing so,
the auditor of the client would need to consider the following as appropriate; (NSA 402: Audit
Consideration Relating to an Entity using a service organization):

i. The nature of the services provided by the service organization 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 accounts or financial
reporting processes affected by the service organization
iii. The degree of interaction between the activities of the service organization and those
of the user entity.
iv. The nature of the relationship between the user entity and the service organization,
including the relevant contractual terms for the activities undertaken by the service
organization.

b) Answer
As per NSA 250, ―Consideration of Laws and Regulations in an audit of Financial
Statements‖ the reporting responsibility of the auditor shall be as given below:
i. If in the auditor‘s Judgment, the non-compliance is believed to be intentional and/ or
material, the auditor should communicate the findings without delay.
ii. If the auditor suspects that members of senior management, including members of the
Board of Directors, are involved in non-compliance, the auditor should communicate
the matter to the next higher level of authority at the entity, such as, the audit
committee or Board of Directors, to the users of the auditors‘ report or financial
statements.
iii. If the auditor concludes that the non-compliance has a material effect on the financial
statements and has not been properly reflected in the financial statements, the auditor
should express a qualified or an adverse opinion.
iv. If the auditor is precluded by the entity from obtaining sufficient and appropriate audit
evidence to evaluate whether non-compliance is, or is likely to have occurred that have
or may have material impact on the financial statements, the auditor should express a
qualified opinion or a disclaimer of opinion on the financial statements on the basis of
a limitation on the scope of the audit.
v. If the auditor is unable to determine whether noncompliance has occurred because of
limitations imposed by the circumstances rather than by the entity, the auditor should
consider the effect on the auditor‘s report.
vi. The auditor‘s duty of confidentiality would ordinarily preclude reporting
noncompliance to a third party. However, in certain circumstances, that duty of
confidentiality is overridden by statement, law or by courts of laws.
Question No. 86
What are the elements that auditor should consider while evaluating the design of the
entity‟s
control environment? (8 Marks June 2016)
Answer:
a) As per NSA 315 ―Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and its Environment‖ Para A77, the auditor should consider the
following elements while evaluating the design of the entity‘s control environment:
i. Communication and enforcement of integrity and ethical values – essential elements
which influence the effectiveness of the design, administration and monitoring of
controls.
ii. Commitment to competence – management‘s consideration of the competence levels
for particular jobs and how those levels translate into requisite skills and knowledge.
iii. Participation by those charged with governance – independence from management,
their experience and stature, the extent of their involvement and scrutiny of activities,
the information they receive, the degree to which difficult questions are raised and
pursued with management and their interaction with internal and external auditors.
iv. Management‘s philosophy and operating style – management‘s approach to taking and
managing business risks, and management‘s attitudes and actions toward financial
reporting, information processing and accounting functions and personnel.
v. Organizational structure – the framework within which an entity‘s activities for
achieving its objectives are planned, executed, controlled and reviewed.
vi. Assignment of authority and responsibility – how authority and responsibility for
operating activities are assigned and how reporting relationships and authorization
hierarchies are established.
vii. Human resource policies and practices – recruitment, orientation, training, evaluating,
counseling, promoting, compensating and remedial actions.

Question No. 87
Comment and give your views with reasons on each of the following cases, giving consideration
to respective Standards, Laws and Code of Ethics:

a) The auditor of a limited company did not verify the investment; he inserted a note in the
balance sheet – “Investment not verified”. The shareholders approved and adopted the
accounts at the annual general meeting. Subsequently, it transpired that the investments
were misappropriated, and the company suffered a loss. (6 Marks December2016)
b) The statutory auditor of the Holding Company demands for the working papers of the
auditors of the subsidiary company, of which you are the auditor. How would you deal with
the situation? (4 Marks December2016)

a. Answer:
The Company Act, 2053 has clearly mentioned the functions and duties of an auditor in section
115. This section requires an auditor to carry out audit as per prevailing laws and audit standards
and give his opinion on the financial statements.
Code of Ethics: The Principle of professional competence and Due care imposes an obligation on
all professional accountants to act diligently in accordance with applicable technical and
professional standards when providing professional services.
As per Sec. 34(6) of Nepal Chartered Accountants Act 2053, member holding COP shall not
certify any financial statement or give report of any type until they or their partner or employee
check and verify it.
Further as per Sec. 34(14) of Nepal Chartered Accountants Act 2053, one should have obtained
sufficient information prior to give audit opinion.
As per NSA 700 (Forming an opinion and Reporting on financial statements)
The objectives of auditor are:
a. To form an opinion on the financial statements based on an evaluation of the conclusions
drawn from the audit evidence obtained, and
b. To express clearly that opinion through a written report that also describes the basis for
that opinion.
In order to form that opinion, the auditor conclude as to whether he has obtained reasonable
assurance about whether the financial statements as a whole are free from material misstatement,
whether due to fraud or error.
Verification of investments is a very important function of an auditor, since, it is an important
asset shown in the balance sheet. The auditor cannot be expected to give a report on the ‗truth and
fairness‘ of the financial statements of the company without verifying its investment. If he
specifically mentions in his audit report the fact that, he did not verify the investments, he would
not be relieved from his statutory duties. Such statutory duties can never be curbed, though they
may be extended.

Thus, the auditor will be held guilty of professional misconduct.

b. Answer
Demand of working papers: As per NSA 230, ―Audit Documentation‖ working papers are the
property of the auditor. The auditor may, at his discretion, make portion of or extracts of his
working papers available to his client. • NSA 600 ―special considerations-audit of group financial
statements(including work of component Auditors)‖ also states that an auditor should respect the
confidentiality of information acquired during the course of his audit work and should not
disclose such information unless there is a legal or professional duty to disclose. Statutory auditor
of an enterprise does not have right of access to the audit working papers of the branch auditor.
An auditor can rely on the work of another auditor, without having any right of access to the audit
working papers of other auditor.
Conclusion: Statutory auditor of Holding company cannot have access to audit working papers of
the subsidiary company‘s auditor. He can, however, asks the auditor to answer certain questions
about the manner in which the audit is conducted and certain other clarifications regarding audit.

Question No. 88
Answer the following:
a) Explain what is meant by “Management Representations” and indicate to what extent an
auditor can place reliance on such representations. (8 Marks December 2016)
b) Kalu & Associates is auditor of Alpha Beta Ltd. for the financial year 2072/73. Audit team
has completed the audit procedures and the engagement manager is clear in respect of
providing clean audit report on the financial statements of the company but he is confused
about the manner in which to draw user‟s attention about a pending lawsuit against Alpha
Beta for which the company has made appropriate presentation and disclosure in Note 10
of the financial statement. Advise the manager as per relevant NSA guidance.
(7 Marks December 2016)
Answer:
a) AS per NSA 580 ―Written Representations‖ It is a written statement by management provided
to the auditor to confirm certain matters or to support other audit evidence. Management
representations in this context do not include financial statements, the assertions therein, or
 supporting books and records. The management representations shall be in the form of a
representation letter addressed to the auditor.
Management representations are necessary information that the auditor requires in connection
with the audit, hence they are recognized as audit evidence as a response to inquiries.
Although management representations provide necessary audit evidence, they do not provide
sufficient appropriate audit evidence on their own about any of the matters with which they
deal.
Extent of Reliance:
i. If the auditor has concerns about the competence, integrity, ethical values or diligence
of management, the auditor shall determine their effect on the reliability of
representations (oral or written) and audit evidence in general.
ii. In particular, if management representations are inconsistent with other audit
evidence, the auditor shall perform additional audit procedures to attempt to resolve
the matter.
iii. If the auditor concludes that the management representations are not reliable, the
auditor shall take appropriate actions, including determining the possible effect on the
opinion.
iv. If he claims that there is sufficient doubt about integrity of management, he shall
issue a disclaimer of opinion.

b) Emphasis of matter Paragraph: NSA 706: ―Emphasis of Matter Paragraph and other matter
paragraph in the independent auditor‘s report‖ provides guidance to the auditor for dealing
with additional communication in the auditor‘s report when the auditor considers it necessary
to draw users‘ attention to a matter or matters presented or disclosed in the financial
statements that are of such importance that they are fundamental to users‘ understanding of
the financial statements.

Since the engagement manager considers it necessary to draw users‘ attention to the lawsuit
presented or disclosed in Note 10 of financial statements that, the manager should include an
Emphasis of Matter paragraph in the auditor‘s report provided the audit team has obtained
sufficient appropriate audit evidence that the matter is not materially misstated in the financial
statements. Such a paragraph shall refer only to information presented or disclosed in the
financial statements. While including an Emphasis of Matter paragraph in the auditor‘s report,
the auditor shall:
i. Include it immediately after the Opinion paragraph in the auditor‘s report;
ii. Use the heading ―Emphasis of Matter,‖ or other appropriate heading;
iii. Include in the paragraph a clear reference to the matter being emphasized and to where
relevant disclosures that fully describe the matter can be found in the financial
statements; and
iv. Indicate that the auditor‘s opinion is not modified in respect of the matter emphasized.

Extract from Independent Auditor‟s Report

Opinion
In our opinion, the financial statements present fairly, in all material respects (or give a true
and fair view of) the financial position of Alpha Beta Limited as at 31 Ashad 2073 and (of) its
financial performance and its cash flows for the year then ended in accordance with Nepal
Financial Reporting Standards.
 Emphasis of Matter
We draw attention to Note 10 to the financial statements which describes the uncertainty
related to the outcome of the lawsuit filed against the company by XYZ Company. Our
opinion is not qualified in respect of this matter.

Question No. 89
Answer the following:
a) What are the factors affecting form, contents and extent of audit documentation?
(5 Marks June 2017)
b) What do you mean by “Management Representations”? Indicate to what extent an auditor
can place reliance on such representations. (5 Marks June 2017)
Answer
a) The form and content of working papers are affected by matters such as:
i. The Nature of the engagement
ii. Form of the auditor's report,
iii. Nature and complexity of the client's business,
iv. Nature and conditions of the client's records and degree of reliance on internal
control,
v. Needs in the particular circumstances for direction, supervision and review of work
performed by assistants, and
vi. Specific audit methodology and technology used in the course of the audit.
b) AS per NSA 580 ―Written Representations‖ -it is a written statement by management
provided to the auditor to confirm certain matters or to support other audit evidence.
Management representations in this context do not include financial statements, the
assertions therein, or supporting books and records. The management representations shall
be in the form of a representation letter addressed to the auditor.
Management representations are necessary information that the auditor requires in
connection with the audit, hence they are recognized as audit evidence as a response to
inquiries. Although management representations provide necessary audit evidence, they
do not provide sufficient appropriate audit evidence on their own about any of the matters
with which they deal.
Extent of Reliance:
i. If the auditor has concerns about the competence, integrity, ethical values or diligence
of management, the auditor shall determine their effect on the reliability of
representations (oral or written) and audit evidence in general.
ii. In particular, if management representations are inconsistent with other audit evidence,
the auditor shall perform additional audit procedures to attempt to resolve the matter.
iii. If the auditor concludes that the management representations are not reliable, the
auditor shall take appropriate actions, including determining the possible effect on the
opinion.
iv. If he claims that there is sufficient doubt about integrity of management, he shall issue
a disclaimer of opinion.

Question No. 90
Comment and give your views with reasons on the following cases.
You are a senior audit in-charge working for the firm Ram & Associates. You are currently
carrying out the audit of Bajra Ltd., a manufacturer of plastic bags. You are unhappy with
Bajra Ltd.‟s inventory valuation policy and have raised the issue several times with the
audit
manager. He has dealt with the client for a number of years and does not see what you are
making an objection about. He has refused to meet you on site to discuss those issues.
As the audit manager has dealt with Bajra Ltd. for so many years, the other partners have
decided to leave the audit of Bajra Ltd. in his capable hands. (7 Marks June 2017)

Answer
Quality control Issues on an engagement: Several quality control issues are raised in the scenario:
Engagement partner: 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.
The lack of an audit engagement partner also means that several of the requirements of NSA 220
on ‗Quality control for audits of financial statements, about ensuring that engagements in relation
to independence and directing, supervising and reviewing the audit not in place.
Conflicting views: In this scenario 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.
NSA 220 on ―Quality control for audits 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 difference of opinion required by NSQC 1 ―Nepal Standards on Quality
Control‖. In this case, the lack of engagement partner may have contributed to this failure to
resolve the disputes. In any event, at best, the failure to resolve the difference of opinion is a
breach of the firm‘s policy under NSQC 1. At worst, it indicates that the firm does not have a
suitable policy concerning such disputes required by NSQC 1.

Question No. 91
XYZ Ltd. has paid up capital of Rs. 20 million. 30% of the company‟s share is owned by
Government of Nepal. The directors of the company are in dilemma regarding the formation of
audit committee in its organization. Chief Executive Officer desires his son to be the member of
the committee as he is a Chartered Accountant by profession and has experience in the
accounting field. As an expert, provide your opinion to the company regarding whether audit
committee is actually required or not and also highlighting the qualification criteria to be its
member along with the functions to be performed by the committee.
(10 Marks December 2017)
Answer
Requirement of Audit Committee
Section 164 of Chapter 18 of Company Act 2063 mentions about the formation of Audit
Committee. As per the section, a listed company with paid up capital of thirty million rupees or
more or a company which is fully or partly owned by the Government of Nepal shall form an
audit committee under the Chairpersonship of a director who is not involved in the day-to –day
operations of the company and consisting of a least three members. Though Paid up capital of
XYZ company is only Rs. 20 million, its 30% of the share is owned by the Government of Nepal
which means there is partial ownership of government. So, the company is required to form an
Audit Committee as per Company Act.

Qualification criteria: Any person who is a close relative of the chief executive of a company
shall not be eligible to be a member of the audit committee. At least one member of the audit
committee shall be an experienced person having obtained professional certificate on accounting
or a person having gained experience in accounting and financial field after having obtained at
least bachelor‗s degree in accounts, commerce, management, finance or economics. The son of
the CEO cannot be appointed as member of the Audit Committee as he is a close relative of the
CEO.

Functions, duties and powers of audit committee:

The functions, duties and powers of the audit committee are as follows:
(a) To review the accounts and financial statements of the company and ascertain the truth
of the facts mentioned in such statements;
(b) To review the internal financial control system and the risk management system of the
company;
(c) To supervise and review the internal auditing activity of the company;
(d) To recommend the names of potential auditors for the appointment of the auditor of
the company, fix the remuneration and terms and conditions of appointment of the
auditor and present the same in the general meeting for the ratification thereof;
(e) To review and supervise as to whether the auditor of the company has observed such
conduct, standards and directives determined by the competent body pursuant to the
prevailing law as required to be observed in the course of doing auditing work;
(f) Based on the conduct, standard and directives determined by the competent body
pursuant to the prevailing law, to formulate the polices required to be observed by the
company in respect of the appointment and selection of the auditor;
(g) To prepare the accounts related policy of the company and enforce, or cause to be
enforced, the same;
(h) Where any regulatory body has provided for the long form audit report to be set out in
the audit report of the company, to comply with the terms required to prepare such
report;
(i) To perform such other terms as prescribed by the board of directors in respect of the
accounts, financial management and audit of the company.

Question No. 92
ABC Ltd. supplies stationery materials to Government Office across the country. The company
has 15 warehouses at different locations throughout the Nepal of which 8 warehouses at the
borders. The major stocks are generally supplied from the borders. ABC Ltd. appointed M/s
Ram & Associates to conduct its audit for the financial year 2072/73. Mr. Ram, partner of Ram
& Associates, attended all the physical inventory counting conducted throughout Nepal but
could not attend the same at borders due to some unavoidable reason.
You are required to advice M/s Ram & Associates: (10 Marks December 2017)
i) How sufficient appropriate audit evidence regarding the existence and condition of
inventory may be obtained?
ii) How an auditor is supposed to deal when attendance at physical inventory counting is
impracticable?

Answer:
i) Special consideration with regards to inventory: As per NSA 501 ―Audit Evidence
Specific consideration for selected items‖, is applicable in the case given. When
inventory is material to the financial statements, the auditor shall obtain sufficient
appropriate audit evidence regarding the existence and condition of inventory by;
a. Attendance at physical inventory counting, unless impracticable, to:
i. Evaluate management‘s instruction and procedure for recording and controlling
the results of the entity‘s physical inventory counting;
ii. Observe the performance of management‘s count procedure;
 iii. Inspect the inventory; and
iv. Perform test count;

b. 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 NSA 200 ―Overall
objectives of the independent Auditor and the conduct of an audit in accordance with
Nepal 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 procedure. In such cases, NSA 705 on ―modification 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.

Question No. 93
Comment and give your views with reasons.
A company wants to amend its accounts after the completion of the audit and adoption of the
Accounts by the Board, but before circulation to the shareholders. It requires its statutory
auditor to report on the amended accounts. State the steps the statutory auditor should adopt in
such a situation. (7 Marks December 2017)

Answer
As per NSA 560(Subsequent event): Management can revise its accounts after adoption on which
report has been issued by the Auditors, but before circulation to the shareholders. In the instant
case, the statutory auditor should ascertain whether the original audit report along with audited
accounts has been circulated to the shareholders. If not, he can issue a revised report on the
amended Financial Statement subject to following:
(i) Revised accounts must be re-approved by the Board of Directors of the company.
(ii) Ask the company to return all the original copies of the earlier audit report along with the
audited accounts.
(iii) The fact of revision of Financial Statement with reasons should be incorporated in the
Directors‘ Report. If it is neither included nor found adequately disclosed in the
Director‘s Report, auditor should include the fact with figures and reasons in his revised
audit report to the shareholders.
(iv) Mention specifically that it is a revised audit report.
Question No. 94
a) In the course of audit of Alibaba Ltd., its auditor Mr. Jacob 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.
Jacob 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. Jacob as per the relevant provisions of Nepal Standards on Auditing.
(7 Marks June 2018)
b) Amul Ltd., dealing in manufacturing and trading of milk butter, has a benchmark in its
product for so many years. DTC Ltd., a rival company to Amul Ltd., has introduced its new
product, peanut butter. Due to being health conscious, the consumers have shifted from
milk butter to peanut butter within few months. This has resulted into massive loss during
the year to Amul Ltd. due to non-selling of perishable milk products. The company has also
started having negative net worth. It's production head, finance head and marketing head
have also left the company. The company has no sound action plan to mitigate these
situations. Kindly guide the auditor of Amul Ltd., how he should deal with the situation.
(8 Marks June 2018)
Answer:
a) Auditor‘s Responsibilities Relating to Fraud: As per NSA 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 NSA
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.
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:
1. 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;
2. Consider whether it is appropriate to withdraw from the engagement, where
withdrawal from the engagement is legally permitted; and
3. If the auditor withdraws:
a. 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
b. 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.

b) Answer
i) Inability to Continue as a Going Concern:
As per NSA 570 on ―Going Concern‖, it is the responsibility of the Auditor to obtain
sufficient appropriate audit evidence about the appropriateness of management‘s use of
the going concern assumption in the preparation and presentation of the financial
statements and to conclude whether there is a material uncertainty about the entity‘s
ability to continue as a going concern.
The auditor shall evaluate management‘s assessment of the entity‘s ability to continue as
a going concern. In evaluating management‘s assessment, the auditor shall consider
whether management‘s assessment includes all relevant information of which the auditor
is aware as a result of the audit.
In the instant case, Amul Ltd. has suffered massive loss due to introduction of a
substitute of its product by its rival company, DTC Ltd., and having negative net worth
also. Besides this, its production head, finance head and marketing head have also left
the company. The company, in addition, has no action plan to mitigate these situations.
Thus, there are clear indications that there is danger to entity‘s ability to continue in
future. Considering the fact that there is no sound plan of action from the management to
mitigate these factors and to put the company back on the recovery, the going concern
assumption does not hold appropriate.

Therefore, the auditor should ask the management for its adequate disclosure in the
financial statement and include the same in his report. However, if the management fails
to make adequate disclosure, the auditor should express a qualified or adverse opinion. If
the result of the inappropriate assumption used in the preparation of financial statements
is so material and pervasive as to make the financial statements misleading, the auditor
should express an adverse opinion.

Question No. 95
Answer the following
i) Expert Limited has not included in the Balance Sheet as on 32/3/2075 a sum of Rs. 15
million being amount in the arrears of salaries and wages payable to the staff for the
last two years as a result of successful negotiations which were going on during the last
18 months and concluded on 30/4/2075. The auditor wants to sign the said Balance
Sheet and give the audit report on 31/5/2075. The auditor came to know the result of the
negotiations on 15/5/2075. Comment.
(5 Marks December 2018)
ii) ABC and Associates has a policy to retain working paper file for 4 years after signing of
report, due to shortage of space in its office, unless the group auditor or any law
requires the retention for a longer period.
(5 Marks December 2018)
i) Answer
As per NAS 10, "Events After the Reporting Period" adjustments to assets and liabilities are
required for events occurring after the Balance sheet date provide additional information
materially affecting the determination of the amounts relating to conditions existing at the
Balance Sheet date. Similarly, as per NAS 37, "Provisions, Contingent Liabilities and
Contingent Assets" future events that may affect the amount required to settle an obligation
 should be settled in the amount of a provision where there is sufficient objective evidence that
the event will occur.
In the instant case, the amount of Rs. 15 million 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 statement i.e. 31/3/2075 to the date of Auditors
Report i.e. 31/5/2075. It will be observed that as a result of long pending negotiations a sum of
Rs. 15 million representing arrears of salaries of the previous 2 financial years have not been
included in the financial statements. It is quite clear that the obligation requires provision for
outstanding expenses as per NAS 10 and NAS 37.

As per NSA 560, "Subsequent Events" the auditor should assume 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 Rs. 15 million by making
provision for expenses. If the management does not accept the request the auditor should
qualify the audit report.

ii) Answer
Retention period of working papers: NSQC 1 (or national requirements that are at least as
demanding) requires firms to establish policies and procedures for the retention of
engagement documentation. Accordingly, the firm can establish a policy of retention period
for working paper. However, NSA 230 requires that the retention period for audit
engagements ordinarily should not be shorter than five years from the date of the auditor‘s
report, or, if later, the date of the group auditor‘s report.

On the basis of above requirements of the standards it seems that the working paper retention
policy of ABC and Associates is not appropriate and hence it can be suggested that ABC and
Associates should review its policy of retention period to meet the requirement of NSA 230.

Question No. 96
Comment and give your views with reasons on the following case:
XYZ & Associates had been appointed as external auditor of ABC Ltd. During the audit, the
auditor relied upon the procedures followed by the internal audit function of the entity and
expressed unmodified opinion on the financial statements. However, later on some
misstatements in the financial statements were revealed. The auditor is seeking relief stating
that the internal audit function of the entity was liable for the negligence. Express your
opinion regarding the situation. (8 Marks December 2018)

Answer:
Reliance on internal Audit function: NSA 610, ―Using the work of internal auditors clearly
mentions that the external auditor has sole responsibility for the audit opinion expressed, and that
responsibility is not reduced by the external auditor‗s use of the work of the internal audit
function on the engagement. Although the function may perform audit procedures similar to those
performed by the external auditor, neither the internal audit function nor the internal auditors are
independent of the entity as is required of the external auditor in an audit of financial statements
in accordance with NSA 200.
While determining whether, in which areas, and to what extent the work of the Internal Audit
Function can be used, the auditor need to evaluate the internal audit function. The external auditor
exercises professional judgment in determining whether the work of the internal audit function
can be used for purposes of the audit, and the nature and extent to which the work of the internal
audit function can be used in the circumstances.

The application of a systematic and disciplined approach to planning, performing, supervising,

reviewing and documenting its activities distinguishes the activities of the internal audit function
from other monitoring control activities that may be performed within the entity. Factors that may
affect the external auditor‗s determination of whether the internal audit function applies a
systematic and disciplined approach include the following:
The existence, adequacy and use of documented internal audit procedures or guidance
covering such areas as risk assessments, work programs, documentation and reporting, the
nature and extent of which is commensurate with the size and circumstances of an entity.
Whether the internal audit function has appropriate quality control policies and
procedures, for example, such as those policies and procedures in NSQC that would be
applicable to an internal audit function (such as those relating to leadership, human
resources and engagement performance) or quality control requirements in standards set
by the relevant professional bodies for internal auditors. Such bodies may also establish
other appropriate requirements such as conducting periodic external quality assessments.

Hence, in the above case, XYZ and associates were required to evaluate the internal audit
function based on above criteria during the audit. However, with regards to the opinion expressed
the full responsibility vests upon the auditor.

Question No. 97
Answer the following (4 Marks each June 2019)
a) Mahatara and Associates, a chartered accountant firm was appointed as an auditor of a
company on Ashwin 15, 2074 for the financial year 2073/74 where Kishan Kumar, one
of the partners of the audit firm, was holding 3 percent paid up shares of the company
since 2068. But, Kishan Kumar sold all his shares of the company on Ashwin 30, 2074.
It was further noted that the audit report was signed by another partner of the firm
Falgun 15, 2074 only.
Will you answer be different in case Kishan Kumar holds 0.8 percent of shares of the
company?

b) "The auditors should communicate audit matters of governance interest arising

from the audit of financial statements with those charged with the governance of an
entity". Briefly state the five major matters to be included in such communication.

a) Answer
A person or a firm, in which such person has substantial shareholding, 5% of paid up capital
of Public Company as per section 50 of Company Act 2063, which is also called basic
shareholders of the company or a shareholder holding one percent or more of the paid up
capital of the company or his/her close relative is not qualified for appointment as an auditor
as per section 112(1) of the Companies Act. So, in the present case since Kishan Kumar, a
partner of Mahatara & Associates, holds 3 percent shares of the company, Mahatara &
Associates is disqualified from appointment as an auditor as of Ashwin 15, 2074. But Kishan
Kumar disposes all his shares after the appointment as an auditor and audit report is signed
 after disposal of the shares. Despite this fact as per section 112(4) of the Companies Act since
the appointment of audit is in contravention of the provision of the Companies Act, the audit
cannot be considered as valid.
Similarly, as per section 112 subsection 2 of Company Act 2063 (as amended), before
accepting the appointment every auditor to be appointed should declare in writing that he is
not ineligible for appointing as external auditor of the any particular company. In this case
audit firm, which is going to be appointed should have been declared his qualification before
appointment which was not happened.
In case, Kishan Kumar holds only 0.8 percent of the shares of the company, the appointment
of Mahatara & Associates will be valid as per section 112(1) of the Companies Act.

b) Answer
Communications of audit matters with those charged with governance:
As per NSA 260 ―Communication with Those Charged with Governance‖, the auditor shall
communicate with those charged with governance, the responsibilities of the auditor in
relation to the financial statement audit, including that:
1. The auditor is responsible for forming and expressing an opinion on the financial
statements that have been prepared by management with the oversight of those
charged with governance; and
2. The audit of the financial statements does not relieve management or those charged
with governance of their responsibilities.
The auditor shall communicate with those charged with governance the following:
1. 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;
2. Significant difficulties, if any, encountered during the audit;
3. Unless all of those charged with governance are involved in managing the entity:
Significant matters, if any, arising from the audit that were discussed, or subject to
correspondence with management; and
Written representations the auditor is requesting; and
4. Other matters, if any, arising from the audits that, in the auditor‘s professional
judgment, are significant to the oversight of the financial reporting process.

Question No. 98
Answer the following (7 Marks, June 2019)
Describe the main intent to introduce The Sarbanes-Oxley Act of 2002. What were the major
events contributing the adaptation of this Act in United States?

Answer
The Sarbanes-Oxley Act of 2002, also known as the "Public Company Accounting Reform and
Investor Protection Act" or "Corporate and Auditing Accountability and Responsibility Act" and
more commonly called as Sarbanes-Oxley, Sarbox or SOX, is a United States federal law that set
new or expanded requirements for all US public company boards, management and public
accounting firms. The intent of the SOX Act was to protect investors, and really all stakeholders
in a business firm, by improving the accuracy and reliability of corporate disclosures, such as
earnings reports, pursuant to securities laws and regulations.
A variety of complex factors created the conditions and culture in which a series of large
corporate frauds occurred between the years 2000 to 2002. The spectacular, highly publicized
frauds at Enron, WorldCom and Tyco exposed significant problems with conflicts of interest and
incentive compensation practices for senior management and accounting firm. It ultimately
reveals problems like inadequate oversight of accountants, lack of auditor independence, weak
corporate governance procedures, and stock analysts, conflict of interests, inadequate disclosure
provisions, and grossly inadequate funding of the Securities Exchange Commission.
Reasons for adaptation of SOX:
The following are the main reasons for the adaptation of SOX:
a. Auditor conflict of interest
b. Boardroom failures
c. Securities analysts' conflicts of interest
d. Banking practices
The SOX Act holds company CEO's and CFO's responsible for the information presented by their
company in the financial statements. It created new standards of accountability for corporations as
well as penalties of those standards of accountability are not met. SOX established new financial
reporting standards. All companies, according to SOX, must provide a year-end report about the
internal controls they have in place and the effectiveness of those internal controls.

Question No. 99
Answer the following:
State what may be the evaluative or review procedures that the statutory auditor may do before
concluding as to relevance and reasonableness of auditor's expert work for using it for his
audit purposes? (7 Marks, June 2019)
Evaluating the Adequacy of the Auditor‘s Expert‘s Work: As per NSA 620 Using the work of an
Expert, the auditor shall evaluate the adequacy of the 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, etc.
Specific procedure to evaluate the adequacy of the expert‘s work is –
Enquiries of the expert.
Reviewing the expert‘s working papers and reports
Corroborative procedure such as-
a) Observing the expert‘s work
b) Examining the published data, such as statistical reports from reputed source
c) Confirming the relevant matters with third parties
d) Performing detailed analytical procedure to see whether principles of materiality
aspects considered
e) Re performing calculations
Discussions with another expert with relevant expertise when, for example, the findings or
the conclusion of the auditor‘s expert are not consistent with other audit evidence.
Discussing the expert‘s report with the management.
Question No. 100
Write short notes on the following: (3 Marks each, June 2019)
i) Audit expectation gap
Auditing expectation gap or simply expectation gap is the term used to signify the difference in
expectations of users of financial statements and auditor‘s expectation concerning audited
financial statements. Although it's about expectations but still its scope and meanings have been
defined in number of ways. Difference in expectation can arise on the performance i.e. the level of
performance what users expect from auditor and how auditor actually performed.
Expectation gap can also be explained as the difference between the effectiveness of audit
engagement what users believe and what auditor believes. Expectation gap in related to audit can
also be explained as the difference between expectation of user and auditor himself on the
responsibilities of the auditor. It can also refer to difference in understanding regarding nature of
audit engagement i.e. what users believe audit is and what audit actually is.

ii) Tolerable misstatement and tolerable rate of deviation

Tolerable misstatement is the monetary amount set by the auditor in respect of which the auditor
seeks to obtain an appropriate level of assurance that the monetary amount set by the auditor is
not exceeded by the actual misstatement in the population.
While determining the sample, the auditor determines tolerable misstatement in order to address
the risk that the aggregate of individual material misstatements may cause the financial statements
to be materially misstated and provide the margin for possible undetected misstatements.
Tolerable rate of deviation is the rate of deviation from the prescribed internal control procedures
set by the auditor in respect of which the auditor seeks to obtain an appropriate level of assurance
that the rate of deviation set by the auditor is not exceeded by the actual rate of deviation in the
population.

iii) Reporting of review engagement

The review report should contain a clear written expression of negative assurance. The auditor
should review and assess the conclusions drawn from the evidence obtained as the basis for the
expression of negative assurance. Based on the work performed, the auditor should assess
whether any information obtained during the review indicates that the financial statements do not
give a true and fair view (or are not presented fairly, in all material respects) in accordance with
the identified financial reporting framework. The report on a review of financial statements
describes the scope of engagement to enable the reader to understand the nature of the work
performed and make it clear that an audit was not performed and, therefore, that an audit opinion
not expressed.