Scanner CAP II Audit and Assurance

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NEPAL
COMPILATION OF
SUGGESTED ANSWER
2010-2015
AUDIT AND ASSURANCE
CAP –II
Compilation of Suggested Answers
Audit and Assurance
CAP II Examination
Table of Contents
Chapter 1: General Concept............................................................................................................... 1

Chapter 2: Planning an Audit Engagement ........................................................................................ 1
Chapter 3: Gathering Evidence during the Audit Engagement .......................................................... 1
Chapter 4: Using work of Other ......................................................................................................... 1
Chapter 5: Internal Audit and Corporate Governance ........................................................................ 1
Chapter 6: Audit Conclusion and Reporting ...................................................................................... 1
Chapter 7 Government Audit ............................................................................................................. 1
Chapter 8: Audit of Specific Organisations ........................................................................................ 1
The Institute of Chartered Accountants of Nepal

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Regulatory Compliance
Question No 1:
Give your opinions with reason on the following cases:
a) Torstar‟s Heaven is star level hotel situated at Nagarkot. During the initial discussion it is noticed that
the hotel management is aware of pilferage issues, however due attention is not paid to address the
situation. You are required to express your statement underlying the importance of internal control on
the pilferage issues and the probable consequences of it, if not addressed properly.
(June 2010)(5 Marks)
Answer
Pilfering is one of the greatest problems in any hotel and the importance of internal control cannot be
over stressed. It is the responsibility of the management to introduce controls, which will minimize
the leakage as far as possible. If the internal control in the hotel is weak, then a very serious problem
exists for the auditor. Preparing accounts at regular interval for each of the cost/ revenue centers and
investigating the deviation if any could be helpful in this regard. If necessary, scope of audit tests will
have to be increased and in the event of material margin discrepancy being unexplained, the auditor
may consider qualifying his report.
b) Care Limited purchased machinery on 1.4.2065 from a foreign country at a price of $ 200 thousands
upon terms of credit that the price should be settled within six months from the date of purchase. The
company capitalised the asset and created liability for the capital goods converting the foreign
currency liability to Nepalese Rupees at a rate of exchange prevailing as on 1.4.2065. When the
company settled the liability on 30 Poush 2065, it had to incur an additional amount of Rs. 5,00,000
due to change in foreign exchange rate on the date of settlement. It added this additional amount of
exchange variation in the capital cost of the asset and charged depreciation upon the enhanced amount
of asset value from 1 Magh 2065. Give your opinion. (June 2010)(5 Marks)
Answer
Effects of Changes in Foreign Exchange rates: According to NAS 11-Para 24, the foreign currency
transactions should be initially recognized at the exchange rate prevailing on the date of transaction.
Accordingly, the asset and liability should be accounted at exchange rate prevailing on the date of
purchase. The monetary items should be reported at the exchange rate prevailing on the close of the
accounting period. The liability for capital goods purchased is a monetary item.
If during the accounting period, if a monetary liability is settled at a rate different from the rate at
which it was initially recognized the exchange difference should be charged to P&L account in the
year of settlement.
According to NAS 11, hence, it is necessary to write off Rs, 500 thousands being exchange
differences at the date of settlement. It cannot be added to the cost of the capital. Hence, the company
is wrong in capitalizing foreign exchange differences between the amounts of initial recognition and
settlement and computing depreciation on the wrongly capitalized portion of the asset. This needs
correction by the company. Else, the auditor may qualify his report upon relevant considerations.
c) An auditor of New Nepal Ltd. audited and signed the accompanying financial statement of the
company as of July 15, 2010 (Corresponding to 31st Ashad, 2067). Date of the signature of the audit
report was August 16, 2010. (December 2010)(5 Marks)
Answer
Audit of financial statement is normally carried out for a full financial year. Financial year as per the
prevelling law is first of Shrawan to the end of Ashad month as per Nepali calendar. Date of the audit
report should be after the date of financial year end and after completation of audit functions.
However, in above mentioned case, date of financial statements is July 15,2010,which is 1 day short
of actual financial year end i.e. July 16,2010( corresponding to 32 ashad 2067).This may happen in
following situations:
i. An assurance assignment was for audit of financial statements of that date.
ii. Company ended its operation from that date.
iii. Company is merged to another company from that date.
iv. Company went in to liquidation from that date.

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v. Auditor signed wrong dated financial statement.

vi. Therefore the auditor should check out the relevant date of financial statements under audit
before signing the report.
d) Kathmandu Boarding School was established in year 2010. It recently constructed swimming pool of
2020 meter size behind its main building. Due to Vastusastra problem, the swimming pool was
reconstructed toward 5 meter west side of the building. Relocation of the pool incurred additional cost
of 20%. Suggest, how this cost be booked in account. (December 2010)(5 Marks)
Answer
According to NAS 6 Property, Plant and Equipment, the expenditure for relocation of swimming pool
should be capitalized. However, the carrying amount of those parts that are replaced should be
derecognized in accordance with the de-recognition provisions.
e) The Board of Directors meeting of M/s Dikpal Commercial Bank Limited, proposed dividend @ 50 %
for the fiscal year 2066/067. The Annual General Meeting approved the dividend @ 70% instead of
the proposed dividend by the Board of Directors. Examine the decision of the Annual General
Meeting to approve dividend in excess of the proposed dividend by the Board of Directors and
whether it is commensurate with the company Act, 2063. (June 2011)(5 Marks)
Answer
The Annual General Meeting is authorized body to approve dividend under section 77 (6) of the
Company Act, 2063. The proviso to the said section has however, restricted the Annual General
Meeting to approve the dividend in excess of the dividend proposed by the Board of Directors.
However, the dividend at lower rate can be approved. Thus, the decision of Annual General Meeting
of Ms. Shangrila Commercial Bank Ltd. to approve dividend in excess of the dividend proposed by
the Board of Directors is void and Annual General Meeting can only approve the dividend at the
lower rate or at the rate proposed by the Board of Directors.
f) The Critical Pollution Extinction Company Limited procured a pollution controlling machine for
which the government has 50% rebate in customs duty upon the precondition that the machine should
be used for at least 5 years. During the course of audit you found that the company has credited 50%
rebate provided to income for the year by disclosing the same in the Notes to Accounts in the
Financial Statement. What is your opinion as regards the accounting treatment by the company?
Answer
As mentioned in Para 8 of NAS 10 Accounting for Government Grants and Disclosure of Government
Assistance, a government grant is not recognized until there is reasonable assurance that the entity
will comply with the conditions attaching to it, and that the grant will be received. Receipt of a grant
does not of itself provide conclusive evidence that the conditions attaching to the grant have been or
will be fulfilled. Government grants shall be recognized as income over the periods necessary to
match them with the related costs which they are intended to compensate, on a systematic basis. They
shall not be credited directly to shareholders‟ interests. It is fundamental to the income approach that
government grants be recognized as income on a systematic and rational basis over the periods
necessary to match them with the related costs. Income recognition of government grants on a receipts
basis is not in accordance with the accrual accounting assumption. Government grants related to
assets, including non- monetary grants at fair value, shall be presented in the balance sheet either by
setting up the grant as deferred income or by deducting the grant in arriving at the carrying amount of
the asset. Hence the NAS has provided two acceptable alternative methods of presentation in financial
statements of grants related to assets. According to the first method, the grant amount is accounted for
as deferred income which is recognized as income on a systematic and rational basis over the useful
life of the asset. Under the other alternative method, government grant is deducted in arriving at the
carrying cost of the asset and the grant is recognized as income over the depreciable asset by way of a
reduced depreciation charge.
Hence, as mentioned here above, the treatment to credit whole of the credit rebate amount in the year
of purchase of the machine by Critical Pollution Extinction Company is not appropriate since it is

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bound by the precondition that the machine should be used for at least 5 years. The 50% rebate
received on customs duty should be credited to income for at least over a period of 5 years.
g) Grand Industries Ltd. is engaged in manufacturing and supply of gear boxes to Suzaki Vehicles Ltd.
As per terms of supply, full price of the goods are not released by Suzaki Vehicles Ltd. but 15%
thereof is retained and paid after one year, if there is satisfactory performance of the parts supplied.
Grand Industries Ltd. accounts for only 85% of the invoice value as sale at the time of supply and
balance 15% is accounted as sale in the year of receipt of payment. (December 2011)(5 Marks)
Answer
According to NAS-7 on Revenue, revenue recognition from sale of goods should be recognized when
the seller has transferred to the buyer, the property or the goods for a price or when the seller has
transferred all significant risk and rewards and the seller has no effective control over goods and no
significant uncertainty exists regarding the amount of consideration and its collectability. In the given
case the goods as well as the risk and ownership has been transferred by Grand Industries Ltd., to
Suzaki Vehicles Ltd., on the basis of invoice and delivery of material. In the instant case, therefore,
Grand Industries Ltd. should recognize sale at full 100% of the invoice value in spite of the fact that
15% payment will be released after one year. However, depending upon the past experience regarding
collectability of 15% amount, they can make a provision for the amount that is not likely to be
realized. Hence, the treatment given by the company is not correct and if they do not correct it, the
auditor should qualify his report.
h) The Company`s plant & machinery was Rs. 200 million as on 1st Shrawan 2067. It provided
depreciation at 15% per annum under WDV method. However it noticed that about Rs. 20 million
worth of imported asset, which is component of above plant & machinery acquired on 1 st Shrawan
2067, would be obsolete in 2 years. Company wants to write off this asset over 2 years. Can Company
do so? Give Comments. (December 2011)(5 Marks)
Answer
As per Nepal Accounting Standard 6 (Property, Plant and Equipment), where the addition or
extension retains a separate identity and is capable being used after the existing asset is disposed off,
depreciation should be provided independently on the basis of an estimate of its own useful life. As it
appears that imported assets of Rs. 20 million, which is component of plant and machinery, is having
independent useful life. Therefore, the company`s policy to write off over two years is correct.
i) A firm of a father and a son is receiving Rs. 2 lakhs towards job work done for XYZ Ltd. during the
year ended on 32.03.2068. 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
Nepal Accounting Standard 16 and IAS 24,“Related Party Disclosures” applies to the facts of the
case. IAS 24 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 IAS 24, 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 covered by NAS 16. The approach of the managing director is not tenable under the law and
accordingly all disclosure requirements have to be complied. Since there is related party transaction
the contention of managing Director is not correct and the auditor should advise him to make proper

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disclosure as required by NAS and if the management refuses, the auditor shall express a qualified
report.
j) Shree Ltd. has 2 divisions X and Y. The finished products of division X are transferred to division Y
where further processing is carried out before sale to customers. To achieve transparency and
accountability between the divisions, division X raises an invoice on division Y at cost plus normal
margins. At the year end the unrealized profits on inter-division stocks are eliminated. However, the
transfers are recorded at the invoice value as sales and purchases in the respective divisions for the
purpose of preparing the Profit & Loss Account. Suitable disclosures, for this are given in the „Notes
to Accounts‟. (June 2012)(5 Marks)
Answer
As per the definition of the term “Revenue” in NAS 07, revenue is the gross inflow of cash,
receivables or other consideration arising in the course of the ordinary activities of an enterprise from
the sale of goods, from the rendering of services, and from the use by others of enterprise resources
yielding interest, royalties and dividends. Revenue is measured by the charges made to customers or
clients for goods supplied and services rendered to them and by the charges and rewards arising from
the use of resources by them.
The definition clearly implies that the transfers within the enterprise cannot be considered as fulfilling
the definition of the term “revenue”. Thus, the recognition of inter-divisional transfers as sales is an
inappropriate accounting treatment and is inconsistent with NAS 07. Further, in case of inter-
divisional transfers, risks and rewards remain within the enterprise and also there is no consideration
from the point of view of the enterprise as a whole. Thus, the recognition criteria for revenue
recognition are also not fulfilled in respect of inter-divisional transfers. In the instant case, therefore,
Shree Ltd cannot recognize inter-division transfers from X to Y as sales and the same will have to be
eliminated during finalization. If management do not agree to do so, the auditor shall qualify his
report.
k) Though the audit for the year 2068/69 was completed, but not signed the financial statements of X
Limited by the board of directors. In the mean time, the board has decided to stop the operation of Z
Limited, one of the major subsidiary companies of X Limited with effect from Marg 1, 2069.
(December 2012)(5 Marks)
Answer
NAS 05 section 21 has defined the non – adjusting events after the balance sheet date, but it should be
disclosed in the balance sheet. The sections this events as follows:
If non-adjusting events after the balance sheet date are material, nondisclosure could influence the
economic decisions of users taken on the basis of the financial statements. Accordingly, an entity shall
disclose the for each material category of non-adjusting event after the balance sheet date:
i. the nature of the event; and
ii. an estimate of its financial effect, or a statement that such an estimate cannot be made.
Section 22 has defined the examples of non adjusting events after the balance sheet date are as
follows:
i. major business combination after the balance sheet date (NAS 21 Business Combinations
requires specific disclosures in such cases) or disposing of a major subsidiary;
ii. announcing a plan to discontinue an operation;
iii. major purchases of assets, classification of assets as held for sale, other disposal of assets,
or expropriation of major assets by government;
iv. the destruction of a major production plant by a fire after the balance sheet date;
v. announcing, or commencing the implementation of, a major restructuring;
vi. major ordinary share transactions and potential ordinary share transactions after the
balance sheet date (NAS 26 Earnings Per Share requires an entity to disclose a
description of such transactions, other than when such transactions involve capitalization
or bonus issues, share splits or reverse share splits all of which are required to be adjusted
under NAS 26);

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vii. abnormally large changes after the balance sheet date in asset prices or foreign exchange
rates;
viii. changes in tax rates or tax laws enacted or announced after the balance sheet date that have
a significant effect on current and deferred tax assets and liabilities (see NAS 09 Income
Taxes);
ix. entering into significant commitments or contingent liabilities, for example, by issuing
significant guarantees; and
x. commencing major litigation arising solely out of events that occurred after the balance
sheet date.
In the financial statements of X Limited, a proper disclosure is required regarding the closure of the
subsidiary company Z Limited and its effects though the financial figures will not be changed in the
balance sheet.
l) Howard Ltd., as part of overall cost cutting measure announced voluntary retirement scheme (VRS) to
its employees, to reduce the employee strength. During the year ended 32.03.2068 the company paid a
compensation of Rs.10 million to those who availed the scheme. The chief accountant has reflected
this payment as part of regular salaries and wages paid by the company. (June 2012 )(5 Marks)
Answer
NAS 1, “Presentation of Financial Statements” clearly states that when the items of income and
expenses are material, their nature and amount shall be disclosed separately. Such a disclosure shall
assist in understanding the financial performance achieved and in assessing future results. In the
instant case the payment made to the employees on account of VRS as an overall cost cutting measure
would fall under the domain of material item. Accordingly it is eligible to be shown separately in the
income statement of Howard Ltd., so that the effect of it on the operating results of the Company
during the previous year can be perceived. Therefore, clubbing of Rs. 10 million with the regular
salaries and wages of the company by the Chief Accountant is not appropriate.
m) Reena Ltd. received Rs. 50 lakhs as grant from the Nepal Government towards the part cost of a
specific machinery. The company credited the above sum of Rs. 50 lakhs as income in its profit &
loss account for the year. (June 2012 )(5 Marks)
Answer
NAS 10: Accounting for government grants recognized two methods of presentation of grants related
to specific fixed assets in financial statements as acceptable alternatives:
(i) Under first alternative, the grant is shown in the Balance Sheet as a deduction from the gross
value of a machinery. The grant is recognized in P& L A/c over the useful life of a depreciable
asset by way of a reduced depreciation charges.
(ii) (ii) Under second alternative, it can be treated as deferred income which should be recognized in
P & L A/c over useful life of asset in proportion in which depreciation on machinery will be
charged. The deferred income pending its apportionment to P & L A/c should be disclosed in
Balance Sheet with a suitable description e.g. Deferred Government Grants.
In the given case, Reena Ltd. received Rs.50 lakhs as grant towards part cost of specific machinery.
The company has credited the said sum as income in its Profit and Loss account which is incorrect as
per the above provisions.
n) Himalayan Co. Ltd. reappointed Ram and Ramita as their joint auditors in the Annual General
Meeting. The AGM authorized the Board for fill up the vacancy on their own in the event of both or
either of auditors declined to accept the assignment. The Board passed a resolution to appoint Prabhat
if any of the auditors declined to accept the assignment. Later on Ramita declined to accept the
assignment and Board of Directors appointed Prabhat in place of Ramita as per its resolution.
(June 2012 )(5 Marks)
Answer
In the present case Ramita is one of the joint auditors who was appointed in Annual General Meeting,
but declined to accept the appointment. The Board of Directors as per their resolution, appointed
Prabhat as a joint auditor in her place. In this case, the vacancy created by Ramita is neither caused by

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resignation of Ramita nor is it a casual vacancy because Ramita‟s appointment had not become
effective. Hence, appointment of Prabhat as joint auditor by the Board is not valid. Prabhat can only
be appointed as joint auditor by shareholders in the General Meeting.
o) Puran (A practicing Chartered Accountant) has been appointed as statutory auditor of ABC
Development Bank Limited for the fiscal year 2068/69. Puran has been holding certain paid up share
capital of the bank since the year 2060. Is the appointment of Puran is valid? (December 2012)(5
Marks)
Answer
Section 112 of the Companies Act, 2063 stated the disqualifications of auditor: As per Act None of
the certain 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.
Provision regarding appointing shareholder as auditor as per Companies Act stated that: persons or
the firms or companies who is 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 cannot be appointed as
auditor.
In the instance case the % of holding paid up capital is not mentioned, if the Puran himself or firm or
company he is partner or shareholder or his close relative do not hold one percent or more than one
percent of the paid up capital of ABC Development Bank Limited only than Puran is qualified to be
appointed as auditor.
p) The Balance sheet of ABC Ltd. includes inventory amounting to Rs. 3 crores out of total assets of 20
crores. The inventories were valued at cost. The market price of the inventories was Rs. 2.5 crores.
The company has disclosed this fact in the notes to accounts. (December 2012)(5 Marks)
Answer
As per Nepal Accounting Standard 4, Inventories should be measured at lower of cost or net
realizable value. In the present case the cost price of the inventories is 3 crores and net realizable
value is 2.5 crores and hence the inventories should be presented at 2.5 crores in the balance sheet.
However, the company has presented the inventories at 3 crores and disclosed in the notes to accounts
that the inventories have been presented at cost although its net realizable value is lower than the cost.
Mere disclosure of this fact in the notes however does not result into compliance with the accounting
standard. Hence as an auditor I will qualify my audit report because inventory in the present case
represents material item of the assets of the company and it has been materially misstated in the
balance sheet.
q) Sahara Garment Private Limited is one of the leading garments industries in Nepal. The company has
exported 50,000 readymade shirts to Turkey for equivalent NPR 10 millions and booked NPR 10
millions as income in their account, however, the government of Turkey for the time being has
suspended the equivalent NPR 5 millions amount to be remitted to Sahara Garment P Ltd on the
ground that the quota system as determined by the government of Turkey is below than the goods as
supplied by Sahara Garment from Nepal (December 2012)(5 marks)
Answer
NAS 07 Nepal accounting standards on revenue Para 18 has clearly defined the case of remit
suspense. As per this Para revenue is recognized only when it is probable that the economic benefits
associated with the transaction will flow to the entity. In some cases, this may not be probable until
the consideration is received or until an uncertainty is removed. For example, it may be uncertain that
a foreign governmental authority will grant permission to remit the consideration from a sale in a
foreign country. When the permission is granted, the uncertainty is removed and revenue is
recognized. However, when an uncertainty arises about collectability of an amount already included
in revenue, the uncollectable amount or the amount in respect of which recovery has ceased to be
probable is recognized as an expense, rather than as an adjustment of the amount of revenue originally
recognized.
Sahara Garment P Ltd has to adjust the balance suspended amount from the revenue which was
recognized previously. Otherwise the auditor should make qualification on the revenue
reorganization.

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r) On the basis of approval accounting policy, Bee Limited has revalued its property and charged Rs. 5
crores revaluation loss in profit and loss account in 2067/68 whereas transferred Rs. 10 crores the
revaluation gain to revaluation reserve in 2068/69. (June 2013)(5 Marks)
Answer
NAS 6 paras 39, 40 and 41 are related with the treatment of revaluation of fixed assets. As per this
para, if an asset‟s carrying amount is increased as a result of a revaluation, the increase shall be
credited directly to equity under the heading of revaluation surplus. However, it reverses a revaluation
decrease of the same asset previously recognized in profit or loss.
If an asset‟s carrying amount is decreased as a result of a revaluation, the decrease shall be recognized
in profit or loss. However, the decrease shall be debited directly to equity under heading of
revaluation surplus to the extent of any credit balance existing in the revaluation surplus in respect of
that asset.
The revaluation surplus included in equity in respect of an item of property, plant and equipment may
be transferred directly to retained earnings when the asset is derecognized. This may involve
transferring the whole of the surplus when the asset is retired or disposed of. However, some of the
surplus may be transferred as the asset is used by an entity. In such a case, the amount of the surplus
transferred would be the difference between depreciation based on the revalued carrying amount of
the asset and depreciation based on the asset‟s original cost. Transfers from revaluation surplus to
retained earnings are not made through profit or loss.
Hence in a given case, the revaluation profit of Rs 5 crores is to be credited to profit or loss account of
the year 2068/69, the amount equivalent to revaluation loss which was charged to profit or loss
account in earlier years and Rs 5 crores is to be credited to equity directly (i.e. revaluation reserve).
So, the accounting treatment on revaluation of property, plant and equipment provided by the
company for the year 2068/69 is not in accordance with the requirement of NAS.
s) G. Richak & Associates, a chartered accountant firm, was appointed as an auditor of a company on 15
Aswin 2069 for the year 2068/69 where Ram Lal, one of the partners of the audit firm, was holding
5% shares of the company since 2065. But Ram Lal sold all his shares of the company on 30 Aswin
2069. It was further noted that the audit report was signed by another partner of the firm on 15 Falgun
2069 only. (June 2013)(5 Marks)
Answer
A person or a firm in which such person has substantial shareholding 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 Ram Lal, a partner of Richak & Associates, holds 5% shares of the company, Richak &
Associates is disqualified from appointment as an auditor as on 15 Asoj 2069. But Ram Lal disposes
all his shares after appointment of his firm as an auditor and audit report is signed after his disposal of
shares. Despite this fact as per section 112(4) of the Companies Act since the appointment of auditor
is in contravention of the provisions of the Companies Act, the audit cannot be considered as valid.
t) Mr. Raj, a fellow member of the Institute of Chartered Accountants of Nepal, working as manager of
Rahul & Associates, a chartered accountant firm, signed the audit report of Om Ltd. on behalf of
Rahul & Associates. (June 2013)(5 Marks)
Answer
Signature on Audit Report: 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.

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u) A company wants to adjust the bank balance on the balance sheet date by reversing the entry for a
cheque issued in the normal course of business and cancelled after the year end but before the
finalization of accounts. The cheque was returned on the ground that the signature differs.
Answer
According to the NAS-05 “Events After the Balance Sheet Date”, assets and liabilities should be
adjusted for significant events occurring after the balance sheet date that provide additional
evidence to assess estimation of amounts relating to conditions existing at the balance sheet date.
Since the phenomenon of difference in signature existed on the balance sheet due (though known
afterwards); the reversal of the entry can be made as on the balance sheet date if the amount is
material.
v) M/s Merita Impex is engaged in the business of manufacturing and trading of musical instruments. A
sum of Rs. 5 lakhs, received from an insurance company as an insurance claim for loss of goods in
transit costing Rs. 4 lakhs, is credited to the purchase account. (December 2013)(5 marks)
Answer
All items of income and expense which are recognised in a period should be included in the
determination of net profit or loss for the period. The claim for loss of goods in transit is arising out of
ordinary activities of the impex as a part of its normal course of business. However, the cost of goods
lost in transit is only Rs.4,00,000 while the insurance money received is Rs.5,00,000. Purchases
Account need not be credited since it would distort the purchases done during the year and as also the
gross profit. Therefore, entire amount of 5 lakhs needs to be taken to profit and loss account under an
appropriate head. This is an income arising from an ordinary activity of the enterprise but having
regard to amount involved and exceptional nature, a separate disclosure be made in the profit and loss
account. Such disclosure would enable the users to understand the performance of an enterprise for
the period.
As per NAS 18 Revenue is the gross inflow of economic benefits during the period arising in the
course of the ordinary activities of an entity when those inflows result in increases in equity, other
than increases relating to contributions from equity participants. In a given case it has been shown
after deducting in the purchase which is not as per this standard and it should be disclosed in gross as
per this NAS.
w) Alpha Limited purchased a high value plant from Beta Limited in exchange of 10,000 units of its
finished products. The plant was in use in Beta Limited for last 3 years and expert expects that its
useful life could be further 17 years (i.e. 20 years in total). Alpha limited sells its finished products in
the market at Rs 1,000 per unit whereas there is no specific market for the used plant but the expert
valuation of the used plant indicates the value of the plant as Rs. 1.2 crores. Hence, Alpha Limited has
recorded the cost price of the plant at Rs. 1.2 crores. (December 2013)(5 marks)
Answer
The fair value of the asset given up by Alpha Limited is Rs 10,000,000 (i.e. 10,000 units * Rs 1,000).
As per NAS 6 on property plant and equipment, if an entity is able to determine reliably the fair value
of either the asset received or the asset given up, then the fair value of the asset given up is used to
measure the cost of the asset received unless the fair value of the asset received is more clearly
evident. In the present case, the fair value of the used plan is not clearly evident because there is no
specific market for the used plant.
Hence the plant should be recorded at the fair value of finished stock of Alpha Limited given up to
purchase the used plant; i.e. Rs 1 crore. So, the accounting treatment on measurement of cost of used
plant purchased from Beta Limited by Alpha Limited is not in accordance with the requirement of
NAS.

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x) Normal waste of material in production process is 2 % of input. 10,000 kg. of input was made in
process with resultant wastage of 500 kg. Cost per kg of input is Rs. 100. The entire quantity of waste
is in stock at the year end. As an auditor how do you ensure the proper valuation of inventory?
(December 2013)(5 marks)
Answer
As per Para 16 of NAS-2, abnormal amounts of waste materials, labour or other production costs,
storage costs, unless those costs are necessary in the productin process before a further production
stage; administrative overheads that do not contribute to bringing inventories to their present location
and condition; and selling costs are excluded from cost of inventories and such costs are recognized as
expenses in the period in which they are incurred.
In this case, normal waste is 200 kg and abnormal waste is 300 kg. The cost of 200 kg will be
included in determining the cost of inventories (Finished Products) at the year end. The cost of
abnormal waste amounting to Rs. 30,000 (300 kg *Rs. 100) will be charged in the profit and loss
statement.
y) Z Ltd. paid Rs. 100,000 income tax for disposal of capital assets during fiscal year 2069/070 and
showed as deduction from cash flow from operating activities. Is this treatment in compliance with
NAS 03? Suggest correct treatment in cash flow statement. (December 2013)(5 marks)
Answer
As per Para 33 of NAS-3, cash flows arising from taxes on income shall be separately disclosed and
shall be classified as cash flows from operating activities unless they can be specifically identified
with financing and investing activities.
Further Para 34 added that taxes paid are usually classified as cash flows from operating activities.
However, when it is practicable to identify the tax cash flow with an individual transaction that gives
rise to cash flows that are classified as investing or financing activities, the tax cash flow is classified
as an investing or financing activity as appropriate.
In view of the above provision in NAS -03, the treatment for income tax (capital gain tax) on disposal
of capital asset is not in compliance with NAS 03, accordingly it should be shown under cash flow
from investing activities.
z) An audit firm was requested to perform the audit of a trading company for the year 2068/69 where all
records relating to sales transactions were seized by Inland Revenue Department for investigation.
The company requested the auditor to accept the appointment saying that audit report with
qualification on sales is acceptable. (December 2013)(5 marks)
Answer
In a given case the client is imposing the scope of audit. As per NSA 01, the term scope of an audit
refers to the audit procedures deemed necessary in the circumstances to achieve the objective of the
audit. The procedures required to conduct an audit in accordance with NSA should be determined by
the auditor having regard to the requirements of NSA, relevant professional bodies, legislation,
regulations and, where appropriate, the terms of the audit engagement and reporting requirements.
An audit in accordance with NSA is designed to provide reasonable assurance that the financial
statements taken as a whole are free from material misstatement. Reasonable assurance is a concept
relating to the accumulation of the audit evidence necessary for the auditor to conclude that there are
no material misstatements in the financial statements taken as a whole. Reasonable assurance relates
to the whole audit process. 12. However, there are inherent limitations in an audit that affect the
auditor's ability to detect material misstatements. These limitations result from factors such as:
a) The use of testing
b) The inherent limitations of any accounting and internal control system (e.g. the possibility of
collusion)
c) The fact that most audit evidence is persuasive rather than conclusive
Also the work undertaken by the auditor to form an opinion is permeated by judgment, in particular
regarding the gathering of audit evidence, e.g. in deciding the nature, timing and extent of audit
procedures; and the drawing of conclusion based on audit evidence gathered, e.g. assessing the
reasonableness of the estimates made by management in preparing the financial statements.

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Other limitations may affect the persuasiveness of evidence available to draw conclusions on
particular financial statement assertions (e.g. transactions between related parties). In these cases
certain NSA(s) identify specified procedures which will, because of the nature of the particular
assertions provide sufficient appropriate audit evidence in the absence of unusual circumstances
which increase the risk of material misstatement beyond that which would ordinarily be expected; or
any indication that a material misstatement has occurred.
In the given situation the client is imposing a limitation on the scope of audit. Since all the records
relating to sales are not available for audit, the auditor is not in the position to perform alternate audit
procedures for audit of sales. Further, sales is the most important item of profit or loss account (being
a trading company) and hence without auditing sales an opinion on profit or loss account cannot be
provided. That is the auditor has no option but to provide disclaimer of opinion. Since this situation is
known to auditor before acceptance of engagement, it is advisable not to accept such limited scope
engagement unless required by statute.
aa) Satya Limited is company listed in Recognized Stock Exchange of Nepal. During normal course of
operation, a fire broke out on 15th Ashoj, 2070, in which material worth 50 lakhs which was lying in
stock since 1st Ashadh, 2070 was totally destroyed. The financial statements of the company have not
been adopted till the date of fire. The management of the company argues that since the loss occurred
in the year, 2070-71, no provision for the loss needs to be made in the financial statements for 2069-
70. State whether argument of management is in accordance with applicable provision.
Answer
Event occurring after the balance sheet date: This case requires attention to NSA 560 “Subsequent
Events” and NAS 5 “Events After Balance Sheet Date”. As per NAS 5 “Events After Balance Sheet
Date”, adjustments to assets and liabilities are required for events occurring after the balance sheet
date that provide additional information materially affecting the determination of the amounts relating
to conditions existing at the balance sheet date or that indicate that the fundamental accounting
assumption of going concern (i.e., the continuance of existence or substratum of the enterprise) is not
appropriate. NAS – 5 also requires disclosure of the non-adjusting event, in the report of the
approving authority.
Further, as per NSA 560 “Subsequent Events”, the auditor should assure that all events occurring
subsequent to the date of the financial statements and for which the applicable financial reporting
framework requires adjustment or disclosure have been adjusted or disclosed. The event took place
after the close of the accounting year and does not relate to conditions existing at the balance sheet
date. Thus, it will have no effect on items appearing at the balance sheet date because as per NAS – 5
“Contingencies and Events Occurring after Balance Sheet Date” have to be adjusted that provide
evidence of conditions existing as at the balance sheet date. However, the auditor has to ensure that
this loss will not materially affect the substratum of the enterprises as per its size, nature and
complexity of operations.
Thus, subject to satisfaction in respect of non-violation of going concern concept, the company has
correctly accounted by not providing provision. However, the auditor is required to ensure the proper
disclosure of abovementioned event.
bb) Dhaulagiri Ltd. is an associate of Sagarmatha Ltd. How do you ensure whether Sagarmatha Ltd. has
significance influence in Dhaulagiri Ltd. or otherwise? (June 2014)(5 Marks)
Answer
As per Para 7 of NAS 25 , investment in associates ; if an investor holds, directly or indirectly (e.g.
through subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the
investor has significant influence, unless it can be clearly demonstrated that this is not the case.
Conversely, if the investor holds, directly or indirectly (e.g. through subsidiaries), less than 20 per
cent of the voting power of the investee, it is presumed that the investor does not have significant
influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by
another investor does not necessarily preclude an investor from having significant influence.
Further Para 8 of NAS 25 stated that the existence of significant influence by an investor is usually
evidenced in one or more of the following ways: (a) representation on the board of directors or

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equivalent governing body of the investee;(b) participation in policy-making processes, including

participation in decisions about dividends or other distributions; (c) material transactions between the
investor and the investee; (d) interchange of managerial personnel; or (e) provision of essential
technical information.
Accordingly in the light of aforesaid provision of NAS 25, for ensuring whether Sagarmatha Ltd. have
significance influence over Dhaulagiri Ltd ; first of all i have to ensure percentage of voting power of
Sagarmatha Ltd. in Dhaulagiri Ltd. or evidencing factor as mentioned in above Para , existence of
any one evidence is deemed to have significant influence.
cc) Ramu & Co. had conducted the audit of XYZ Limited for the financial years 2067/68, 2068/69 and
2069/70. CA. Raman Saha, partner of Ramu & Co, left the firm on 1 Baishakh 2069. CA. Raman
Saha has been appointed as the auditor of XYZ limited for the year 2070/71.
Answer
As per section 111(3) of the Companies Act, no auditor or his/her partner or ex-partner or employee
or ex-employee shall be appointed as auditor for more than three consecutive terms to perform the
audit of a public company. Provided, however, that this restriction shall not apply to any partner who
ended partnership or any employee who left the service of such auditor three years before.
dd) In the present case, Ramu & Co has been auditor of XYZ Ltd for three consecutive years till 2069/70.
Since Raman Saha is the ex-partner of Ramu & Co and 3 years has not elapsed from the date of
ending his partnership with Ramu & Co (as date of separation being 1 Baisakh 2069), his appointment
as auditor of the company for the year 2070/71 cannot be considered as lawful.
Smart Pvt. Limited sold a Television worth of Rs. 500,000 (exclusive of all taxes) on 32 Ashadh 2071
which includes Rs. 100,000 for servicing fees of the Television for 5 years from the date of sales. The
servicing fee is estimated equal amount for each guaranteed service years. Smart Pvt. Limited booked
entire Rs. 500,000 as revenue for financial year 2070/71. (December 2014)(5 Marks)
Answer
As per NAS 7 "Revenue" when the selling price of a product includes an identifiable amount for
subsequent servicing (for example, after sales support and product enhancement on the sale of
software), that amount is deferred and recognized as revenue over the period during which the service
is performed. The amount deferred is that which will cover the expected costs of the services under
the agreement, together with a reasonable profit on those services. Accordingly in the light of
aforesaid provision of NAS 7; the accounting treatment made by Smart Pvt. Limited is not correct.
Smart should book Rs. 400,000 as revenue for FY 2070/71 and Rs. 100,000 should be deferred. For
each coming year Rs. 20,000 should be recognized as revenue to match its services cost.
ee) A company purchased a plant for Rs. 20 crores on 1 Shrawan 2070. The company has the policy to
charge depreciation at the rate of 10% on such plants on straight line basis. Due to long dispute
between the management and the labour of the company, the factory was closed from Kartik 1, 2070
to Chaitra end 2070. Management has charged depreciation of Rs. 1 crore on the said plant to the
income statement for the year because the newly purchased plant was not used for 6 months in the
year. (December 2014)(5 Marks)
Answer
Depreciation of an asset begins when it is available for use, i.e. when it is in the location and condition
necessary for it to be capable of operating in the manner intended by management. Depreciation of an
asset ceases at the earlier of the date that the asset is classified as held for sale (or included in a
disposal group that is classified as held for sale) in accordance with NAS 06 and the date that the asset
is derecognized. Therefore, depreciation does not cease when the asset becomes idle or is retired from
active use unless the asset is fully depreciated. So, in the given case, depreciation expenses to be
charged to the income statement for the year 2070/71 should be Rs 2 crores (i.e. for full year) instead
of Rs 1 crore.
ff) XYZ is a manufacturing company. There was huge fire in the factory of XYZ on 1 Ashoj 2071 and

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fixed assets of written down value Rs. 10 crores was lost out of total fixed assets of Rs. 20 crores of
the company. The financial statements of the company for the year 2070/71 was approved by the
Board on 30 Ashoj 2071 in which fixed assets have been presented at WDV of Rs. 20 crores despite
the severe loss due to fire and the information about the loss due to fire is properly explained in the
Notes to the financial statements. (December 2014)(5 Marks)
Answer
As per NAS-05, Event After the Balance Sheet Date, events after the reporting period are those
events, favorable and unfavorable, that occur between the end of the reporting period and the date
when the financial statements are authorized for issue. Two types of events can be identified:
i. those that provide evidence of conditions that existed at the end of the reporting period
(adjusting events after the reporting period); and
ii. those that are indicative of conditions that arose after the reporting period (non-adjusting
events after the reporting period)
So, the event in the given case (fire after reporting period) is a non-adjusting event. An entity shall not
adjust the amounts recognized in its financial statements to reflect non-adjusting events after the
reporting period.
If events after the balance sheet date impacts going concern status of the entity, the entity is required
to prepare its financial statement on break-up value basis. This does not seem to be the case here.
If non-adjusting events after the reporting period are material, non-disclosure could influence the
economic decisions that users make on the basis of the financial statements. Accordingly, an entity
shall disclose the following for each material category of non-adjusting event after the reporting
period:
i. the nature of the event; and
ii. an estimate of its financial effect, or a statement that such an estimate cannot be made.
So, presenting fixed assets at Rs 20 crores in the balance sheet with appropriate disclosure in the
Notes to Accounts seems to be appropriate.
gg) ABC Hydropower Pvt. Ltd. has purchased equipment worth of Rs. 4 million which is kept stand by
for urgent usage on need basis for repairing the heavy equipment as and when default is reported in
functioning of heavy equipment. The accountant has treated it as recurring inventory item and charged
to profit and loss account at the end of each financial year based on consumption pattern calculated on
reasonable basis. Is the accounting treatment made by accountant is correct? Comment.
Answer
As per NAS 6- Property, Plant and Equipment, spare parts and servicing equipment are usually
carried as inventory and recognized in profit or loss as consumed. However, major spare parts and
stand-by equipment qualify as property, plant and equipment when an entity expects to use them
during more than one period. Similarly, if the spare parts and servicing equipment can be used only in
connection with an item of property, plant and equipment, they are accounted for as property, plant
and equipment.
In view of the above provision made in NAS 6, the equipment purchased by ABC Hydropower Pvt.
Ltd. should be treated as property, plant and equipment. Though it is servicing equipment used on
repairing heavy equipment; it has to be kept stand-by and can be used only in connection with heavy
equipment and usable for more than one accounting period, it should be treated as property, plant and
equipment instead of treating it as inventory.
hh) Lalu and Associates has been appointed as auditor for the year 2070/71 of ABC Bank Limited, a
commercial bank in the general meeting dated 25 Paush 2070 for remuneration of Rs. 500,000. In the
course of the audit, the auditor finds that the audit fee is too low and negotiates with the management
for increase of the fees to the tune of Rs. 700,000. The board approves the increased fee.
Answer
As per section 67 of Bank and Financial Institutions Act, 2063, the remuneration of the auditor shall
be as prescribed by the general meeting if he or she has been appointed by the general meeting and by

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the board if he or she has been appointed by the board. In the given case Lalu and Associates has been
appointed by the general meeting of ABC Bank Limited and hence his remuneration shall be as
prescribed by general meeting. So, the revision in the audit fees by the board in this case is not valid.
ii) The following information pertains to the trading stock of a company:

Product Historical cost (Rs.) Net Realizable value
(Rs.)
Clour Tvs 200,000 270,000
Black & White TVs 115,000 150,000
Ordinary Bikes 200,000 185,000
Sport bikes 110,000 115,000
Computers 80,000 100,000
Total 705,000 820,000
The company has a policy to value stock at lower of cost or net realizable value and accordingly
trading stock has been valued at Rs. 705,000 in the balance sheet of the company.
( July 2015) (5 Marks)
Answer
Inventories are usually written down to net realizable value (NRV) item by item. In the given case,
cost of all the items on total basis is lower than their NRV. However, if we compare NRV with cost
product-wise, we can note that NRV of ordinary bikes (i.e. Rs 185,000) is lower than its cost (i.e. Rs.
200,000).
The following comparative table may be useful for valuation of inventories
Product Historical cost Rs Net Realizable Presentable

value (Rs.) value (Rs.)
ClourTvs 200,000 270,000 200,000
Black & White TVs 115,000 150,000 115,000
Ordinary Bikes 200,000 185,000 185,000
Sport bikes 110,000 115,000 110,000
Computers 80,000 100,000 80,000
Total 705,000 820,000 690,000
So, inventory should be presented at Rs. 690,000 in the balance sheet rather than at Rs. 705,000.
jj) A company purchased machinery on 1st Asoj 2071 for Rs. 10 crores on credit for 6 months. The seller
normally does not sell such machineries on credit and cash price of the machinery is Rs 9.5 crores.
The buying company recognizes machinery at Rs. 10 crores in the books on 1 st Asoj and the liability
is fully paid on Falgun Masant. ( July 2015) (5 Marks)
Answer
As per NAS 6, the cost of an item of property, plant and equipment is the cash price equivalent at the
recognition date. If payment is deferred beyond normal credit terms, the difference between the cash
price equivalent and the total payment is recognized as interest over the period of credit unless such
interest is capitalized in accordance with NAS 8.
So, in the given case, the machinery should be recognized at Rs. 9.5 crores in the books and 0.5
crores should be recognized as interest over the 6 months period (Asoj-Falgun)
kk) Total trade receivable of a company is Rs. 20 crores. It includes receivables from Maheswary Limited
amounting to Rs 2 Crores. Maheswary Limited was declared bankrupt on 15th Asoj 2071; i.e. after the
reporting period of Ashad end 2071 and before the date when financial statements were authorized for

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issue; i.e. Asoj Masant 2071. The company management claims that the carrying amount of trade
receivable does not need to be adjusted because the information about bankruptcy was known after
the reporting period. ( July 2015) (5 Marks)
Answer
Events after the reporting period are those events, favorable and unfavorable, that occur between the
end of the reporting period and the date when the financial statements are authorized for issue.
Two types of events can be identified:
i. those that provide evidence of conditions that existed at the end of the reporting period
(adjusting events after the reporting period); and
ii. those that are indicative of conditions that arose after the reporting period (non-adjusting events
after the reporting period)
So, the event in the given case (knowing information about bankruptcy of the debtor after balance
sheet date) seems to be an adjusting event because the debtor was bankrupt on the balance sheet date
which was declared by the court later on. Hence the carrying amount of the trade receivable should
be presented at Rs. 18 crores instead of Rs. 20 crores in the balance sheet.
ll) Financial Statements for the year 2069/70 was issued in Paush 2070. While preparing the financial
statements of 2070/71, it was known that the financial statements of 2069/70 included error. The
auditor advises the management to correct and revise the financial statements of 2069/70 and circulate
the revised financial statements with all the authorities where original financial statements were
submitted. ( July 2015) (5 Marks)
Answer
As per NAS 8, prior period errors are corrected in the comparative information presented in the
financial statements. Unless it is impracticable, an entity shall correct material prior period errors
retrospectively in the first set of financial statements authorized for issue after their discovery by: (a)
restating the comparative amounts for the prior period(s) presented in which the error occurred; or (b)
if the error occurred before the earliest prior period presented, restating the opening balances of assets,
liabilities and equity for the earliest prior period presented.
So, in the given case, the error in the financial statements of 2069/70 can be rectified in the
comparative information of the financial statements of 2070/71. The financial statements of 2069/70
which was already issued need not be revised.
mm) A company has 10 vehicles with carrying amount of 5 crores. The company has purchased a
new machinery worth Rs 8 croreby exchanging with its 10 used vehicles and making further payment
of Rs 2 crores in cash. The company management derecognizes vehicles from its financial statements
and recognizes machinery at Rs 7 crores (5 crores plus 2 crores).
Answer
The company has acquired new machinery by exchanging with used vehicles and making further
payment of Rs 2 croresin cash. As per NAS 16, the assets acquired in such case shall be recognized at
the fair which is Rs 8 crore in this case. So, Machinery should be recognized at Rs 8 crores. Since 2
Crores has been paid in cash, disposal of vehicle should be recognized at Rs 6 crore thereby resulting
into gain of Rs 1 crore on disposal of vehicle because the carrying amount of vehicle in the books of
the company is Rs 5 crore. Hence the treatment of recognizing new machinery at Rs 7 crore and not
recognizing gain of Rs 1 croreon disposal of vehicle by the management does not seem to be
appropriate in accordance with NAS 16.
nn) A company‟s financial year ends on 31 March 2015 for group accounting purpose. Due to devastating
earthquake in the month of April 2015, the company‟s factory building with carrying amount of Rs 5
crores was totally destroyed. The board of director authorized the financial statements for issue on
30June 2015. The financial statements include the destroyed building at Rs 5 crore although the Notes
to account makes appropriate disclosure about the earthquake and the destruction of the factory
building. (December 2015)(5 Marks)

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Answer
Earthquake occurred in the month of April 2015 which is after the end of the accounting year (31
March 2015) and before the date when the financial statements are authorized for issue (30 June
2015). Hence it is an event after reporting period. Since this event does not provide further evidence
of the condition existed at the end of reporting period (31 March 2015) and it indicates the condition
that arose after the reporting period, it is a non-adjusting event. So, the carrying value of the destroyed
factory building need not be adjusted in the financial statements and appropriate disclosure in the
Notes to account seems to be in line with NAS 10.
oo) PQR limited has computed the cost of the inventory using last in fast out (LIFO) method and the
value comes to Rs 2 crores (if the cost of the inventory is computed as per first in first out formula, its
cost will be Rs 2.5 crores). Net realizable Value of the stock is Rs 2.25 crores. Since the policy of the
company is to present inventory at lower of cost or NRV, the company has presented inventory in the
financial statement at Rs 2 crores, being the lowest. (December 2015)(5 Marks)
Answer
As per NAS 2, cost of inventories should be assigned as per first in first out or weighted average
formula. Determining the cost as per last in first out is not allowed. So, despite the fact the cost of
inventories of PQR will be more if FIFO is used than if LIFO is used, the cost should be determined
as per FIFO. Hence the cost of inventory shall be taken as 2.5 crore in the given case instead of 2
crore as per LIFO. Since NRV of the inventory is 2.25 crores, lower than the cost, inventory shall be
presented at Rs 2.25 crores in the financial statements.
pp) A company purchased a plant at the cost of Rs 10 crores on 1 Srawan 2066 and the company is
charging depreciation on straight line basis over 10 years useful life assuming there will be no scrap.
In the year 2071/72 the company decides to charge depreciation as per written down value method @
10%. The company management considers this as the change in accounting estimate and accordingly
considers the effect due to the change prospectively; i.e. depreciation charged in the year 2071/72 is
Rs 50 lakh and no adjustment in retained earnings and carrying amount of machinery.
Answer
As per NAS 8,
Accounting policies are the specific principles, bases, conventions, rules and practices applied by an
entity in preparing and presenting financial statements. A change in accounting estimate is an
adjustment of the carrying amount of an asset or a liability, or the amount of the periodic consumption
of an asset, that results from the assessment of the present status of, and expected future benefits and
obligations associated with, assets and liabilities. Examples of estimate provided in the standard
includes the useful lives of, or expected pattern of consumption of future economic benefits embodied
in depreciable assets.
Straight line method or written down value method of depreciation reflects the estimate of useful life
and expected pattern of consumption of future economic benefits from depreciable assets. Hence
change of depreciation method from straight line to WDV is the change in accounting estimate and
not the change in accounting policy. So, the effect of the change considered by the management in the
preparation of the financial statements seems to be appropriate.
qq) Organo Pvt. Ltd., manufacturing noodles, has valued at the year end its closing stock of packed
finished goods for which firm sales contracts have been received, at realizable value inclusive of
profit and cash incentive. As at the year end, the ownership of the goods has not been transferred to
the buyers. (December 2015)(5 Marks)
Answer
Valuation of Inventories: NAS 2 requires that inventories should be valued as lower of cost and Net
realizable value(NRV). A departure from the general principle can be made if the NAS is not
applicable or having regard to the nature of industry. NAS 2 also states that (a) work in progress
arising under construction contracts, including directly related service contracts (b) work in progress

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arising in the ordinary course of business of service providers;(c) shares, debentures and other
financial instruments held as stock-in-trade; and (d) producers‟ inventories of livestock, agricultural
and forest products are measured as NRV based on established practices. In the given case the sale is
assumed under a forward contract but the goods are not of a nature covered by the above exceptions
taking into account the facts the closing stock of finished goods should have been valued at cost, as it
is lower than the realizable value (as it includes profit). Further, sale cash incentives should not be
included for valuation purposes.
The policy adopted by the Organo Pvt. Ltd. for valuing its closing stock of inventory of finished
goods on selling price plus sale incentives is not correct. The statutory auditor should give a qualified
report.
Question No 2
Auditing and Assurance

Give your opinion with reason in following cases
a) Shareholder of ABC Ltd. appointed Goddar & Co. as statutory auditor for last financial year. During
the audit, auditor found that previous auditor had issued qualified audit report in respect of assets
which was overstated by Rs.15 Million and a director‟s capital account was credited by that amount.
After series of discussion, current auditor reached in to conclusion that he was appointed for the
current financial year and he is not responsible for the misstatement in previous year which is already
reported by previous auditor. (December 2010)(5 Marks)
Answer
As per NSA 510 Initial Engagements- Opening Balances, for initial audit engagements, the auditor
should obtain sufficient appropriate audit evidence that (a)the opening balance do not contain
misstatements that materially affect the current period‟s financial statements; (b) the prior period‟s
closing balances have been correctly brought forward to the current period or, when appropriate, have
been restated. If the effect of the misstatement is not properly accounted for and adequately disclosed,
the auditor should express a qualified opinion or an adverse opinion, as appropriate. Since the
misstatement is carried forward during the current year, it has affected current year position as well
and accordingly the, auditor‟s contention is not valid. Goddar &Co. should qualify his report
quantifying the misstatements unless management is ready to correct the statements.
b) Paudel Provident Fund (PPF) is a approved retirement fund, which manages retirement benefits of
employees of group of companies relating to "Poudel Group". PPF has entered into an agreement with
a commercial bank for maintenance and operation of the retirements accounts relating to its
beneficiaries. Under the agreement, PPF is required to open a deposit account in the bank and
maintain the entire fund only with the bank. During the audit of PPF, auditor finds that bank has
credited its account with excess interest by 4,32,000. All the interest income in the account is
distributed on pro-rata basis to the individual employees through accounts maintained in the bank
itself. (June 2011)(5 Marks)
Answer
As per NSA 200 "Objective and General Principles Governing an Audit of Financial Statements", 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.
Once the financial statements are misstated, auditor is required to report on the matter by quantifying
its impact on the financial statements. Therefore, auditor should look in to the matter by verifying the
fact about how PPF has treated the excess credit by the bank in its account. Even if bank cannot
recover from PPF's employee, and the PPF has not given any effect to this item in its account, auditor
should ask management to disclose the fact in notes to the account of financial statements and of
require, should modify the audit report accordingly.
c) Audit of the Sagarmatha Byapar Co. Pvt. Ltd. is in final stage and the audit report is being drafted.
Management of the company, including Chief Executive Officer, is of the view that auditors are

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primarily responsible for preparation and fair presentation of financial statements. Management of the
company is of the view that they are free to prepare accounts in their own way and it is the duty of the
auditor to satisfy about financial statements to government and other regulatory agencies.
Answer
Paragraph 15 of Nepal Standard on Auditing (NSA 200) mentions that 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. Management rather than the auditor is
responsible for the preparation and fair presentation of financial statements. This responsibility
includes designing, implementing and maintaining internal control relevant to the preparation and fair
presentation of financial statements that are free from material misstatements, whether due to fraud or
error, selecting and applying appropriate accounting policies, and making accounting estimates that
are reasonable in the circumstances. Thus, the contention of the management is not correct.
d) Surya, a Chartered Accountant was engaged by Terai Company Pvt. Ltd. for auditing their accounts.
He sent his letter of engagement to the Board of Directors, which was accepted by the company. In
the course of audit of the company, the auditor was unable to obtain appropriate sufficient audit
evidence regarding inventories. The client requested for a change in the terms of engagement.
Answer
Nepal Standard on Auditing (NSA-210) stated about the “Terms of Audit Engagements”. Auditor
should consider following matters:
i. An auditor who is required to change the engagement which requires lower level of assurance
before the completion of engagement should consider the appropriateness of doing so.
ii. But when the terms of engagement are changed, both the auditor and the client should agree on
the new terms.
iii. However, the auditor should not agree to a change in terms where there is no reasonable
justification for doing so.
In the instant case, the auditor was unable to obtain sufficient evidence regarding inventories. The
client requested him for a change in the terms of the agreement to avoid qualified/adverse opinion.
Hence there is no reasonable justification for change in the terms of engagement.
Thus the auditor should not agree for change in the terms of engagement letter.
e) New auditor of XYZ Limited signed the financial statements for the year 2068/69 without considering
the previous year auditor's report and financial figures. (December 2012)(5 Marks)
Answer
NSA 24 Para 9 has defined the treatment of the previous figures and auditors' report. As per the Para
9, the auditor should obtain sufficient appropriate audit evidence that the corresponding figures meet
the requirement of the relevant financial reporting framework. The extent of audit procedures
performed on the corresponding figures is significantly less than for the audit of the current period
figures and is ordinarily limited to ensuring that the corresponding figures have been correctly
reported and are appropriately classified. This involves the auditor assessing whether:
i. accounting policies used for the corresponding figures are consistent with those of the
current period or whether appropriate adjustments and/or disclosures have been made; and
ii. corresponding figures agree with the amounts and other disclosures presented in the prior
period or whether appropriate adjustments and/or disclosures have been made.
In Para 10 when the financial statements of the prior period have been audited by another auditor, the
incoming auditor assesses whether the corresponding figures meet the conditions specified in
paragraph 9 above and also follows the guidance in NSA 21, “Initial Engagements-Opening
Balances.”
In Para 11 when the financial statements of the prior period were not audited, the incoming auditor
nonetheless assesses whether the corresponding figures meet the conditions specified in paragraph 9
above and also follows the guidance in NSA 21.

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In Para 12 if the auditor becomes aware of a possible material misstatement in the corresponding
figures when performing the current period audit, the auditor performs such additional procedures as
are appropriate in the circumstances.
When the comparatives are presented as corresponding figures, the auditor should issue an auditor‟s
report in which the comparatives are not specifically identified because the audit opinion is on the
current period financial statements as a whole, including the corresponding figures.
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 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.
f) During the course of audit of a limited company, the auditor detected that the managing director had
committed a fraud involving a loss to the company. And the managing director has also fully
compensated the loss as committed by him to the company immediately after the detection of fraud.
Answer
The detection of a fraud committed by the Managing Director involving a loss to the company is a
serious matter irrespective of the fact that the Managing Director has fully compensated the company
before the end of the fiscal year. In this context, NSA-240 on “the Auditor responsibility to consider
fraud and error in an audit of financial statements” enumerates responsibilities of the auditor in case
fraud and error to exist while conducting the audit. It requires, first of all that auditor should consider
the implications of the circumstances on the true and fair view which the financial statements ought to
convey and secondly, where the significant fraud has occurred, that auditor should consider the
necessary for a disclosure of fraud in the financial statements and if adequate disclosure is not made,
the necessity for a suitable disclosure in his report.
NSA 240 further defined the duties of the auditor to 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 in such case.
When the auditor has obtained evidence that fraud exists or may exist, it is important that the matter
be brought to the attention of an appropriate level of management. This is so even if the matter might
be considered inconsequential (for example, a minor defalcation by an employee at a low level in the
entity‟s organization). The determination of which level of management is the appropriate one is also
affected in these circumstances by the likelihood of collusion or the involvement of a member of
management. If the auditor has determined that the misstatement is, or may be, the result of fraud, and
either has determined that the effect could be material to the financial statements or has been unable to
evaluate whether the effect is material, the auditor: (a) discusses the matter and the approach to further
investigation with an appropriate level of management that is at least one level above those involved,
and with management at the highest level; and (b) if appropriate, suggests that management consult
with legal counsel.
g) The chief executive officer of a client company has returned your draft representation letter stating
that the directors fail to see why such a letter is necessary and declaiming to issue the letter.
Answer
NSA 580 has defined the management representations while conducting the audit. 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. Matters which might be included in a letter from management
or in a confirmatory letter to management are contained in the example of a management

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representation letter in the Appendix to this NSA. 8. Written representations requested from
management may be limited to matters that are considered either individually or collectively material
to the financial statements. Regarding certain items it may be necessary to inform management of the
auditor‟s understanding of materiality.
If management refuses to provide a representation that the auditor considers necessary, this constitutes
a scope limitation and the auditor should express a qualified opinion or a disclaimer of opinion. In
such circumstances, the auditor would evaluate any reliance placed on other representations made by
management during the course of the audit and consider if the other implications of the refusal may
have any additional effect on the auditor‟s report.
h) The auditor of G-Mall had completed the audit of the financial statements for the year 2069/70. The
date of the audit report was 8 Kartik 2070 whereas financial statements were approved by the
management of the company on 10 Kartik 2070. (December 2013)(5 marks)
Answer
NSA 8 Para 25 has defined the date of report. As per this para the auditor should date the report as of
the completion date of the audit. This informs the reader that the auditor has considered the effect on
the financial statements and on the report of events and transactions of which the auditor became
aware and that occurred up to that date. Since the auditor's responsibility is to report on the financial
statements as prepared and presented by management, the auditor should not date the report earlier
than the date on which the financial statements are signed or approved by management.
The auditor should date the report on the financial statements no earlier than the date on which the
auditor has obtained sufficient appropriate audit evidence on which to base the opinion on the
financial statements. Sufficient appropriate audit evidence should include evidence that the entity‟s
complete set of financial statements has been prepared and that those with the recognized authority
have asserted that they have taken responsibility for them. Since the management has approved the
complete set of the financial statements on 10 Kartick 2070, it cannot be considered that the
management has taken the responsibility of the financial statements before 10 Kartick 2070. So, the
auditor should not have dated his report before 10 kartick 2070.
i) Auditor of Makalu Ltd. is of the opinion that “Nepal Standards of Auditing” are meant only for
references and it is not mandatory to adhere such Standards. (June 2014)(5 Marks)
Answer
Contention of the auditor is totally wrong and is against the fundamental assumptions and guidelines
governing Nepal Standards on Auditing.
NSA 200 "Objectives and General Principles Governing an Audit of Financial Statements" stated that
the auditor should conduct an audit in accordance with the Nepal Standards on Auditing. These
contain basic principles and essential procedures together with related guidance in the form of
explanatory and other material.
As per ICAN, while discharging their attest function, it will be the duty of the members of the
Institute to ensure that the NSAs are followed. The NSAs will apply whenever an independent
financial audit is carried out to express an opinion thereon.
The member of the Institute must follow the NSAs. The auditors must draw attention to the material
departures from NSAs in their audit report along with the reasons for such departure. Auditors in
their report has to mention that audit was conducted in accordance with “Nepal Standards on
Auditing” in Nepalese context.
Hence the auditor is duty bound to follow the NSAs.
j) The financial statement of Sagarmatha Ltd. for the fiscal year 2070/71 has been approved by its Board
of Directors on 1 Kartik 2071; auditor has issued his audit report on 25 Aswin 2071.
Answer
Per NSA 700 , the auditor should date the report as of the completion date of the audit. This informs
the reader that the auditor has considered the effect on the financial statements and on the reports of

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events and transactions of which the auditor become aware and that occurred up to that date. Since the
auditor`s responsibility is to report on the financial statements as prepared and presented by
management, the auditor should not date the report earlier than the date on which the financial
statements are signed or approved by Board of Directors.
k) The management of Sathi Limited suggested for quick completion of the statutory audit that it would
give its representation about the receivables in terms of their recoverability. The management also
acknowledged to the auditors that the management would give their representation after scrutinizing
all accounts diligently and they own responsibility for any errors in these respects. They wanted
auditors to complete the audit checking all other important areas except receivables. The auditor
certified the account clearly indicating in his report the fact of reliance he placed on representation of
the management. (December 2015)(5 Marks)
Answer
The management of Sathi Limited wants the auditor to carry out audit on all areas, except on area of
receivables. There cannot be any restriction on scope of audit in case of statutory audit.
The management representation, according to NSA 580, cannot substitute other audit evidence that
the auditor could reasonably expect to be available to the auditor.
The audit evidence for checking receivables – say, invoices, debt acknowledgement documents,
receipts, statement of accounts, confirmations etc., are available evidences which auditor is duty
bound to verify.
Just because management had owned responsibility for the correctness of its evaluation of
receivables, the auditor cannot shirk his responsibility. This is negligence on his part if he relies on the
management representation without assessing the corroborative available evidences.
Question No 3
Ethics and code of conduct
Give the answer with reason in the following cases
a. M/s Joshi & Joshi is a practicing Chartered Accountants firm. One of the senior partners of the firm is
also associated with import/export trade and he is the sole proprietor of that business. Mr. Joshi has
also taken huge amount of loan from various banks and he is found visiting more to government
offices than in his own firm or to his clients. Comment on given case with reference to „Code of
Ethics‟. (June 2010)(5 Marks)
Answer
A professional accountant in public practice should not concurrently engage in any business,
occupation or activity which impairs or might impair integrity, objectivity or independence, or the
good reputation of the profession and therefore would be incompatible with the rendering of
professional services. The simultaneous engagement in other business, occupation or activity
unrelated to professional services, which have the effect of not allowing the professional accountant in
public practice properly to conduct a professional practice in accordance with the fundamental ethical
principles of the accountancy profession should be regarded as inconsistent with the practice of public
accountancy.
b. Mr. Yadav, a Chartered Accountant in practice enters into an agreement with Mr. Puspa Adhikari, an
individual who has passed one group of CA final 2 years back. The agreement provides that Mr.
Puspa Adhikari shall work in all professional assignments of Mr. Yadav and shall receive 15 percent
of fee received from such assignments as remuneration. Explain whether the agreement is in order as
per Code of Ethics or any other relevant reference? If remuneration is based on cash flow, does it
violate the provisions of the Code of Ethics? (June 2011)(5 Marks)
Answer.
As per section 34(3) of Nepal Chartered Accountants Act, 1997, one shall not share the auditing fees
or remuneration or distribute as profit with any person other than a member of the institute and shall
not pay any commission, brokerage, etc. out of the professional fees earned to any person or member.
In the above case also, Mr. Yadav a Chartered Accountant in practice enter into agreement to share
auditing fees. Accordingly, Mr. Yadav would be held guilty of professional misconduct since he
agreed to share the fees to his employee.

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Even if remuneration were based on cash flow, it would tantamount to be based on fees received on
cash and accordingly Mr. Yadav would be held guilty of professional misconduct.
c. Mr. Saroj Khandelwal, a professional accountant and member of ICAN performs his auditing services
in a country other than Nepal also. He published his advertisement in one of the country other than
Nepal explaining about his competency and skill to perform auditing, management and consultancy
services at very reasonable fee. He argued that it was permitted by the local ethical requirement of that
country. How would you analyze this issue if you were a member of disciplinary committee of ICAN
and the issue had been lodged before the committee? (December 2011)(5 Marks)
Answer
The issue mentioned in the question above should be analyzed as per section 6 of the Code of Ethics
issued by the ICAN to its members which states that a professional accountant qualifying in Nepal
may reside in another country or may be temporarily visiting that country to perform professional
services. In all circumstances, the professional accountant should carry out professional services in
accordance with the relevant technical standards and ethical requirements. When a professional
accountant performs services in a country other than Nepal and differences on specific matters exist
between ethical requirements of the two countries the following provisions should be applied:
i. When the ethical requirements of the country in which the services are being performed are less
strict than the ICAN Code of Ethics, then the ICAN Code of Ethics should be applied.
ii. When the ethical requirements of the country in which services are being performed are stricter
than the ICAN Code of Ethics, then the ethical requirements in the country where services are
being performed should be applied.
iii. When the ethical requirements of Nepal are mandatory for services performed outside that
country and are stricter than set out in (i) and (ii) above, then the ethical requirements of Nepal
should be applied.
Hence, in the given context, Mr Saroj Khandelwal will be held liable for disciplinary action under the
Codes of Ethics of ICAN.
d. Mr. Shushil Maharjan, a Chartered Accountant published a book and gave his personal details as the
author. These details also mentioned his professional experience and his present association as partner
with M/s Daniel Brisk, a Swedish firm of Chartered Accountant Firm. What will be your opinion in
this respect? (December 2011)(5 Marks)
Answer
The supplementary Directive to code of ethics issued by the Institute of Chartered Accountants of
Nepal on “Publicity and Advertisement” prescribes the provisions for publishing book or article. It
allows the members to state their name, professional qualification and the name of their firms but
restricts the members from disclosing the services provided by them. In the given case, Mr. Shushil
Maharjan. a chartered accountant, published the book and mentioned his professional experience and
his association as a partner with M/s Daniel Brisk, a Swedish firm of chartered accountants. Mr.
Shushil Maharjan being a chartered accountant in practice has committed the professional misconduct
by mentioning that at present he is a partner in M/s Daniel Brisk, a Swedish firm of chartered
accountants.
e. Mr. Shanti Das a Chartered Accountant audited a religious institution established for purely
promoting social values without charging any audit fee. Give your comment.
Answer

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The Code of Ethics issued by the Institute of Chartered Accountants of Nepal on “Soliciting Business,
Accepting New Engagement, Fees and Commission” prescribes the provisions for providing service
free of cost. Subject to non compromise in the quality of professional services being offered, it allows
the members to provide services without charging any fee to the welfare or spiritual institutions
established with an objective of providing social services. Further, the council of The Institute of
Chartered Accountants of Nepal has waved (vide decision dated 2067/6/17) requirement of minimum
fee for the religious organizations which have annual transactions of less than 2 lacs.
Accordingly in the given case, if the transactions of the institution does not exceed 2 lacs, it will not
be termed as guilty of professional misconduct as the service was provided to a religious institution
established for purely promoting social values. However, if the transactions of the institution exceeds
2 lacs, the auditor shall be guilty of violating code of conduct.
f. During the audit period, the liaison officer deputed by the client Lumbini Insurance Company
constantly asks you to participate in lunch arranged outside office premises. He has also informed you
that there is a program of welcome and farewell dinner too. Liaison officer has also informed you that
you need not worry about time schedule, as there would be someone available among client's staff to
bailout if needed. Daily newspapers and magazines are made available in plenty in the audit room.
Other staff of the client are also having regular visit in the working area. (December 2011)(5 Marks)
Answer
Section 260 of Code of Ethics for the members of the Institute of Chartered Accountants of Nepal -
2060 prescribed the ICAN states about the gift and hospitality to the auditors by the client.
The existence and significance of any threat will depend on the nature, value, and intent of the offer.
Where gifts or hospitality are offered that a reasonable and informed third party, weighing all the
specific facts and circumstances, would consider trivial and inconsequential, a professional accountant
in public practice may conclude that the offer is made in the normal course of business without the
specific intent to influence decision making or to obtain information. In such cases, the professional
accountant in public practice may generally conclude that any threat to compliance with the
fundamental principles is at an acceptable level.
The objectives of the accountancy profession are to work to the highest standards of professionalism,
to attain the highest levels of performance and generally to meet the public interest requirement set
out above. These objectives require four basic needs to be met. They are credibility, professionalism,
quality of services and confidence. An auditor is expected to maintain the highest degree of integrity,
professionalism and independence. He represents the trust and faith of the whole professional body.
There could be various obstacle and impediments while conducting his professional duty. However,
he should remain intact and vigilant towards achieving his professional goal.
Provision of lunch is governed by conditions laid in engagement letter and appointment letter. If the
contract states provision of lunch, it should not be construed as accepting any undue advantage
whether arranged inside or outside. However, attendance in farewell party is not concerned with the
auditor. Thus, the auditor needs to avoid such attendance. Receiving Newspapers as courtesy from the
client and the regular visits by the staff of the client in the working place is not the problem but it
must be seen that there would be no compromise in the professional ethics and standards.
g. A firm or a member of the audit team accepts gifts or hospitality of which the value is not trivial and
inconsequential. (Give your answer on the basis of the Provision of IFAC Code of Ethics adopted by
ICAN.) (June 2012) ( 5 Marks)
Answer
There will be self-interest and familiarity threat to compliance with the fundamental principles which
the auditors are required to comply. The threat would be so significant that no safeguards could

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reduce it to an acceptable level. The firm or the member of the audit team shall not accept such gifts
or hospitality.
h. ABC Commercial Bank provided loan to an audit team member under terms and conditions other than
normal. (Give your answer on the basis of the Provision of IFAC Code of Ethics adopted by ICAN.)
(June 2012) ( 5 Marks)
Answer
There will be self-interest threat and the significance of the threat would be so significant that no
safeguard could reduce it to an acceptable level. So such loan shall not be accepted.
i. A proprietary audit firm of Chartered Accountant has accepted the engagement to audit the accounts
of a private school with annual turnover of Rs 10 lakhs at the audit fee of Rs 8,500. The firm
anticipates that the audit will consume estimated time of 2 man days of the Chartered Accountant.
Answer
As per directive issued by the council, a CA member holding COP shall charge the audit fee to his
audit client and the fee shall not be less than Rs 10,000. If the audit client is a financial institution
regulated by Nepal Rastra Bank or insurance company regulated by the Insurance Board, the audit fee
shall not be less than Rs 40,000. However, above minimum fee does not apply where the audit client
is a Government Primary School/Community School with annual turnover of less than Rs 5 lakhs and
where the audit client is an organization with annual turnover of less than Rs 2 lakhs. In the present
case the CA member has charged the audit fee of Rs 8,500 to a private school with annual turnover of
Rs 10 lakhs which is not covered by the exception for charging lower fee and hence the auditor should
have charged at least Rs 10,000 as audit fee. Hence the member seems to have not followed the
directive of the council and accordingly may be subject to disciplinary action.
j. What is the responsibility of the professional accountant " When he knows a material error or
omission in a tax return of a prior year (with which the professional accountant may or may not have
been associated), or of the failure to file a required tax return? (December 2012)(5 Marks)
Answer
As per Section 5.8 of the Code of Ethics of the institute of the chartered accountants of Nepal in such
case professional accountant is responsible for:
i. Promptly advise the client or employer of the error or omission and recommend that disclosure be
made to the revenue authorities. The professional accountant is not obligated to inform
the revenue authorities.
ii. If the client or the employer does not correct the error the professional accountant:
a. should inform the client or the employer that it is not possible to act for them in connection
with the return or other related information submitted to the authorities; and
b. should consider whether continued association with the client or employer in any capacity is
consistent with professional responsibilities.
iii. If the professional accountant concludes that a professional relationship with the client or
employer can be continued, all reasonable steps should be taken to ensure that the error is not
repeated in subsequent tax returns.
k. Ramesh Sharma was Chief Finance Officer of A Ltd for the period 1 Srawan 2064 to 15 Ashad, 2069.
He joined XYZ Chartered Accountant firm from 1 Srawan 2069 as Senior Audit Manager. A Ltd. has
approached the firm on 15 Shrawan 2069 for the audit of accounts for the year 2068/69 with Ramesh
Sharma as Engagement Manager of the audit team. Please provide your opinion on what the audit
firm should do? (December 2012)(5 Marks)
Answer
Ramesh Sharma was the Chief Finance Officer of A Ltd. for almost entire year 2068/69. He has left A
Ltd just a month before the audit firm was approached by A Ltd for audit of 2068/69 and proposes his
name to be engaged as engagement manager in the audit team. This situation may result into self-
interest, self review and familiarity threat to the firm. Hence the firm should request A Ltd. that the

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firm cannot assign Ramesh as an audit team member. If A Ltd does not accept the audit team without
Ramesh as senior member in the audit team from the firm, the audit firm should not accept this
engagement.
l) Siddhi & Co., a chartered accountant firm is appointed a fund manager of an INGO situated in Nepal.
The INGO has then transferred money in the current account of Siddhi & Co. for the operation of
project activities. Opine on the act of Siddhi & Co. for:
i. transferring certain money to saving bank account and
ii. charging/ drawing fee due from the client. (June 2013)(5 Marks)
Answer
Section 12 of the Code of Ethics of the Institute of the Chartered Accountants of Nepal permits
keeping client‟s money for using on legal activities on behalf of client and which is also permitted by
the ToR and the agreement with the client.
i) The act of transferring client‟s money in saving bank account for reasonable time is valid only
when it seems likely that the client‟s monies remain on current account for a significant period of
time and Siddhi & Co. have taken prior concurrence of the client.
ii) Siddhi & Co., can charge/draw fees due from a client‟s monies provided that client, after being
notified of the amount of such fees, has agreed to such withdrawal.
m. RB Associates, a firm of chartered accountants has two partners, R and B. The firm is already holding
audit of 130 companies including audit of 90 NGOs. The firm is offered the audit of Labour Welfare
Association. (June 2013)(5 Marks)
Answer
As per the notification issued by the ICAN :
i. In case of partnership firms of auditor, the ceiling on audit is hundred entities per partner of the
firm.
ii. The maximum number of audits of the public company registered under Company Act is 15 and
number of audits of other entities is 85 per partner.
iii. The firm can taken maximum of two hundred audits (100 × 2), but the number of Audits of NGOs
should not exceed 90. There are two partners – R and B.
iv. The firm is holding 90 audits of NGOs at present.
v. The firm can, therefore, accept audit of Labour Welfare Association assuming that Labour
Welfare Association is registered under the Association Registration Act, 2034.
n. Ram, a Chartered Accountant prepared a project report for one of his clients to obtain bank finance
(long-term) of Rs. 50 lakhs from a commercial bank. Consequent to the sanction of the loan by the
bank, Ram charged 2% fee on the figures of loan sanctioned. (December 2013)(5 marks)
Answer
Section 10 of Code of Conduct has defined the way how the practicing professional accountants
charge fee on their works.
10.2 Professional fees should be a fair reflection of the value of the professional services
performed for the client, taking into account:
(a) The skill and knowledge required for the type of professional services involved.
(b) The level of training and experience of the persons necessarily engaged in performing the
professional services.
(c) The time necessarily occupied by each person engaged in performing the professional
services.
(d) The degree of responsibility that performing those services entails.
10.3 Professional fees should normally be computed on the basis of appropriate rates per hour or
per day for the time of each person engaged in performing professional services. These rates should
be based on the fundamental premise that the organization and conduct of the professional accountant

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in public practice and the services provided to clients are well planned, controlled and managed. They
should take into account the factors set out in paragraph 10.2 and are influenced by the legal, social
and economic conditions of each country. It is for each professional accountant in public practice to
determine the appropriate rates.
10.4 A professional accountant in public practice should not make a representation that specific
professional services in current or future periods will be performed for either a stated fee, estimated
fee, or fee range if it is likely at the time of the representation that such fees will be substantially
increased and the prospective client is not advised of that likelihood.
10.5 When performing professional services for a client it may be necessary or expedient to charge
a pre-arranged fee, in which event the professional accountant in public practice should estimate a fee
taking into account the matters referred to in paragraphs 10.2 through 10.4.
Section 34(10) of Nepal Chartered Accountants Act, 1997 states that “Members holding Certificate of
Practice shall not base their remuneration as a percentage on the profit or on any other uncertain
results”.
Entering into a contingent fee arrangement relating to an assurance engagement is an example of self
interest threat. In the present case, audit fee is contingent upon the profit after tax of the client. So, this
is the situation of self interest threat to the auditor and hence it is advisable for the auditor not to
accept the engagement under such fee arrangement.
o. Goma Limited, a leading trading business in electronic goods, has appointed CA. Ranaji Ojha a
statutory auditor with Rs. 1.5 lakhs audit fees. Besides, the company has offered 5 latest model
iphones costing of Rs. 1.5 lakhs to his family members as gift. (December 2013)(5 marks)
Answer
A professional accountant should not accept any gifts or goods from the client which threat the
independence. Code of Conduct Section 8.6 and 8.9 attracts to the professional accountant to accept
the gift and goods. Section 8.6 says personal and family relationships can affect independence. There
is a particular need to ensure that an independent approach to any assignment is not endangered as a
consequence of any personal or family relationship.
It is recognized that it would be impracticable to attempt to prescribe in detail in ethical requirements
the permissible extent of a personal relationship between a professional accountant in public practice
and a client, or those occupying responsible executive positions (e.g., director, chief executive,
financial officer or another employee in a similar position) with a client.
Section 8.10 of the Code of Conduct has defined not to accept any goods and services from the client.
Acceptance of goods and services from a client may be a threat to independence. Acceptance of undue
hospitality poses a similar threat. Goods and services should not be accepted by professional
accountants in public practice, their spouses or dependent children except on business terms no more
favorable than those generally available to others. Hospitality and gifts on a scale which is not
commensurate with the normal courtesies of social life should not be accepted.
In a given case offering of 5 mobile sets of significant value to the auditor by Goma Limited seems to
have the intent of influencing the decision making of the auditor. Hence this is the situation of self
interest threat, familiarity threat and intimidation threat. In this situation the auditor should evaluate
the significance of the threats and apply safeguards to eliminate threats or reduce them to an
acceptable level. If the threat cannot be eliminated or reduced to an acceptable level, the gifts shall not
be accepted by the auditor.
p. While submitting the financial proposal on consultancy works of Emiliya Gypsum Limited, PZT
Associates, a CA. firm has calculated the cost as follows:
FCA Rs. 5,000 Per day/person

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ACA Rs. 2,500 Per day/person

RA Rs. 2,000 Per day/person
Assistants Rs. 1,000 Per day/person (December 2013)(5 marks)
Answer
Nepal Chartered Accountant Act, 2053, Nepal Chartered Accountants Rules, 2061 and the Code of
Conduct of the Institute have given authority to make certain standards on the charging of fees by its
members. Applying the power as provided in the above statutes, the Council has decided and fixed
certain fundamental principles on minimum fees, consultancy services fee and fee on certification
work. As per the clause 2 of the decision, the Council has fixed the minimum consultancy charges as
follows:
FCA member Rs. 6000/- per working days
CA member Rs. 4000/- per working days
RA member Rs. 2000/- per working days
Other/assistants Rs. 1500/- per working days
In a given case, the fee as quoted by the CA firm is not complying with the decision as made by the
Council except RA member charge which is as per the decision of the Council.
q. Commission for the Investigation of Abuse of Authority (CIAA) has asked certain information from
XYZ & Co.; Chartered Accountants relating to certain client of the audit firm for which legal
proceeding is in process with CIAA. The XYZ & Co. refused to provide such information to CIAA. Is
the action of XYZ & Co. is tenable? (June 2014)(5 Marks)
Answer
Section 4 of the Code of Ethics of the Institute of the Chartered Accountants of Nepal deals with
"Confidentiality" applicable too Professional Accountants in Public Practice. Section 4.1 stated that
Professional accountants have an obligation to respect the confidentiality of information about a
client‟s or employer‟s affairs acquired in the course of professional services. The duty of
confidentiality continues even after the end of the relationship between the professional accountant
and the client or employer. However Section 4.7 exemplified the points which should be considered in
determining whether confidential information may be disclosed: (a) When disclosure is authorized.
When authorization to disclose is given by the client or the employer the interests of all the parties
including those third parties whose interests might be affected should be considered. (b) When
disclosure is required by law. Examples of when a professional accountant is required by law to
disclose confidential information are: (i) to produce documents or to give evidence in the course of
legal proceedings; and (ii) to disclose to the appropriate public authorities infringements of the law
which come to light. (c) When there is a professional duty or right to disclose : (i) to comply with
technical standards and ethics requirements; such disclosure is not contrary to this section; (ii) to
protect the professional interests of a professional accountant in legal proceedings ; (iii) to comply
with the quality (or peer) review of ICAN ; and (iv) to respond to an inquiry or investigation by ICAN
or regulatory body.
In view of the above provision of Code of Ethics of the Institute of the Chartered Accountants of
Nepal ; XYZ & Co. has the professional liability for disclosing the client`s information to CIAA ,
since a professional accountant is required by law to disclose confidential information are to produce
documents or to give evidence in the course of legal proceedings .
Hence the action of XYZ & Co. is not tenable, though the audit firm may consult ICAN before
providing client`s information to CIAA.
r. Auditors of a commercial bank was interviewed by the inspection team of Nepal Rastra Bank and
requested the auditors to share their views on the quality of loans of the bank to assist inspection. Will
this situation affect the confidentiality clause in code of ethics? (June 2014)(5 Marks)
Answer
The principle of confidentiality imposes an obligation on all professional accountants to maintain
confidentiality of information acquired as a result of professional or business relationship unless there

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is legal or professional right or duty to disclose. However there are certain circumstances when
confidential information can be disclosed.
As per 4.7 of the Code of Ethics of ICAN provides the circumstances where confidential information
can be disclosed as below
a. When disclosure is authorized.
b. When disclosure is required by law.
c. When there is a professional duty or right to disclose.
i) To comply with technical standards and ethics requirements
ii) To protect the professional interests of a professional accountant in legal proceedings;
iii) To comply with the quality (or peer) review of ACAN, and
iv) To respond to an inquiry or investigation by ICAN or regulatory body;
In view of the above requirement of 4.7 (c) (iv) auditor can assist the regulator for inspection.
r. Mr. A, a practicing Chartered Accountant has been found guilty in respect of Professional
Misconduct. So, Mr. A, a Chartered Accountant in practice has been suspended from practice for a
period of 4 months. During the said period, though he did not undertake the audit assignment since he
had surrendered certificate of practice, he had appeared before Income Tax authorities in his capacity
as a Chartered Accountant. (June 2014)(5 Marks)
Answer
A chartered accountant not holding certificate of practice cannot take up any other work because it
would amount to violation of the relevant provisions of the Chartered Accountants Act, 2053. In case
a member is suspended and is not holding Certificate of Practice, he cannot in any other capacity take
up any practice separable from his capacity to practices as a member of the Institute. This is because
once a member becomes a member of the Institute; he is bound by the provisions of the Chartered
Accountants Act, 2053 and its Regulations. If he appears before the income tax authorities, he is only
doing so in his capacity as a chartered accountant and a member of the Institute. Having bound
himself by the said Act and its Regulations made there under, he cannot then set the Regulations at
naught by contending that even though he continues to be a member and has been punished by
suspension, he would be entitled to practice in some other capacity. Thus, in the instant case, a
chartered accountant would not be allowed to represent before the income tax authorities for the
period he remains suspended. Accordingly, in the present case he is guilty of professional misconduct.
However, if the Chartered Accountant is summoned by Income Tax Authorities for any work
conducted by the person before suspension of COP by ICAN, the Chartered Accountant will be
answerable to the authorities.
s. Aashriya & Associates has two Partners holding Certificate of practice. It has 14 Public company
clients and other small clients. The firm is in dilemma as to accept the forthcoming audit request of
two Public companies. (December 2014)(5 Marks)
Answer
The Directive issued by ICAN on Ceiling over the number of audit requires that a member holding
COP can audit the books of accounts of a maximum 100 clients only, in a financial year. Out of these
100 clients, number of Public Companies shall not exceed 15. The above limit is applicable for each
member of a partnership firm. Provided, organizations whose annual turnover is less than NRs. 2
lakhs, such as small Cooperatives, Religious organizations, Social Organizations, Consumer Group,
Different Committees, Trade Unions, Professional Associations and other entities of similar nature are
not included while calculating the above limit. Thus, in view of above requirement, new audit can be
accommodated subject to total limit for two partners.

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t. PQR Company conducts its business through 3 offices situated in Kathmandu, Pokhara and
Nepalgunj. 50% of the business volumes are conducted through the offices outside Kathmandu valley.
All the vouchers and records of Pokharaand Nepalgunj offices are maintained at Pokhara and
Nepalgunj Offices respectively. The management of PQR has approached the auditor for audit with
the request that the offices outside Kathmandu valley are not to be visited by the auditor to save the
audit costs. Whether the auditor should accept the appointment. ( July 2015) (5 Marks)
Answer
If management or those charged with governance impose a limitation on the scope of the auditor‟s
work in the terms of a proposed audit engagement such that the auditor believes the limitation will
result in the auditor disclaiming an opinion on the financial statements, the auditor shall not accept
such a limited engagement as an audit engagement, unless required by law or regulation to do so.
In the given case if the auditor accepts the appointment he has to provide his opinion without
verifying the records which constitutes around 50% of business volume of the company. So, it is
better not accept such appointment because it is known in advance that the limitation put by the
management on auditor‟s work. However, if he accepts the audit, he should consider disclaiming
opinion based on possible effects of the opinion.
u. An INGO invites bid from interested CA firms for audit service for the calendar year 2014. Upon
request by Lakhe & Co, Chartered Accountants, the INGO does not provide information about the
audit fees for the year 2013. Please advise whether Lakhe & Co should submit his bid for the audit or
not. ( July 2015) (5 Marks)
Answer
As per council decision/code of ethics in relation to minimum audit fee, an audit firm shall take into
account the audit fees of the previous year while quoting audit fees such that the current year‟s fee
should not be less than the previous year. If information about the previous year‟s fee cannot be
obtained, the auditor shall specify in his proposal that his fee shall be higher of the proposed audit fee
and previous year‟s audit fee.
So, in the given case, Lakhe & Co can submit his proposal by clearly mentioning that the audit fee
shall be the higher of the proposed audit fee or previous year‟s audit fee.
v. Elephant Bank Ltd. is the "A" Class Commercial Bank. As per audited financial statement of FY
2071/72 , its gross loan is Rs. 50,000 million and its gross deposit is Rs. 63,000 million. The Annual
General Meeting of the bank for FY 2071/72 was conducted on 12 Aswin 2072. The auditor for FY
2072/73 has been appointed by the bank with audit fees (other than other audit related expenses) of
Rs. 1,100,000. Comment. (December 2015)(5 Marks)
Answer
The decision of 194th Meeting of the Council of the Institute of the Chartered Accountants of Nepal
(ICAN), the minimum fees for listed public financial institutions has been prescribed which is
applicable for appointments made from 1 Shrawan 2072. The fees should be determined based on
Gross Loan or Deposit whichever is higher of immediately preceding year as follows:
Loan or Deposit Amount (Rs.) Minimum Audit Fees (Rs.)
Exceeding 100,000 Million 25 Lakh
Minimum 01 Lakh
Further it has been mentioned that audit fee of the "A" Class Commercial Bank should not be less
than Rs. 10 Lakh.

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In view of the aforesaid council decision, the minimum audit fee (other than other audit related
expenses) of the Elephant Bank Ltd. should be Rs. 20 Lakh since its gross deposit is exceeding Rs.
50,000 million as of 31 Asadh 2072.
Accordingly decision made by AGM of Elephant Bank Ltd. for audit fees for FY 2072/73 is not
consistent with decision of 194th Meeting of the Council of the Institute of the Chartered Accountants
of Nepal (ICAN).
w. Raman & Associates is the audit firm of registered auditor (B Class). He has carried out the audit of
Prabhu Ltd. for FY 2071/72. The Total Assets or Liabilities of Prabhu Ltd. for FY 2071/72 as per
Financial Statement is Rs. 650 million. Comment. (December 2015)(5 Marks)
Answer
As per the Rule 53 of the Nepal Chartered Accountants Regulations 2061 (as amended) ; the limit
(threshold) for audit of entities based on volume of total assets or total liabilities has been prescribed
unlimited amount for CA member and upto Rs. 600 million , Rs.150 million and Rs. 20 million for B,
C & D class members respectively.
In view of the above amended rule of the ICAN Regulation 2061, Raman & Associates, being B class
audit firm is not eligible for carrying out the audit of Prabhu Ltd. for FY 2071/72 , since total assets or
total liabilities of the company exceeds the prescribed limit of Rs. 600 million.
Question No 4:
Write short notes on the following
a) Change in Accounting Policies (June 2010)(5 Marks)
Answer
The consistency is also an accounting assumption. Therefore the accounting policies should
consistently be applied and followed from years to years.
Change in accounting policy is permitted only if such change is to bring accounts in line with
accounting standards, provisions of law or for better presentation of financial statements.
When change in accounting policies or method is effected, the fact of such change and its impact on
accounts must be disclosed.
If change is made in the accounting policies which has no material effect on the financial statements
for the current period but which is reasonably expected to have a material effect in later periods, the
fact of such change should be appropriately disclosed in the period in which the change is adopted.
b) Impairment of assets. (December 2010)(5 Marks)

Answer
An asset is impaired when the carrying amount of the asset exceeds its recoverable amount. The
difference between the carrying amount of an asset and recoverable amount is termed as impairment
loss. Besides charging annual depreciation on assets by the reason of normal wear and tear, afflux ion
of time and obsolescence to reinstate the correct value of the assets considering the future cash flows
that the asset can generate, impairment loss needs to be provided. Some indications that an asset
might have been impaired are mentioned as follows:
i. Significant changes with an adverse effect on the entity have taken place during the period, or will
take place in the near future, in the technological, market, economic or legal environment in
which the entity operates or in the market to which an asset is dedicated.
ii. The carrying amount of the net assets of the entity is more than its market capitalization.
iii. Evidence is available of obsolescence or physical damage of an asset.
iv. Evidence is available from internal reporting that indicates that the economic performance of an
asset is, or will be, worse than expected.
If any of the above indications is present, an entity is required to make a formal estimate of
recoverable amount and impairment loss need to be provided.
c) Familiarity threat (June 2012) ( 5 Marks)

Answer

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The circumstances in which professional accountants operate may create specific threats to
compliance with the fundamental principles which the auditors are required to comply. Threats may
be created by a broad range of relationship and circumstances. One of such threat may be Familiarity
threat. It is a threat that due to a long or close relationship with a client or employer, a professional
accountant will be too sympathetic to their interests or too accepting of their work. Some of the
circumstances that create familiarity threat include:
 A member of the audit team having a close or immediate family member who is a director or
officer of the client,
 Senior personal having a long association with the audit client etc.
d) Legal liabilities of auditor (December 2012)(2.5 Marks)

Answer
Auditors must always perform their work complying the basic principles of audit, which are, integrity,
objectivity, independence, confidentiality, professional competency, due care and technical standards.
If the same is not complied with, then they can be held liable on account of:
i) Non compliance with Nepal Standards on Auditing; and
ii) Failure to protect the interest of stakeholders relying upon the audited financial statements;
Accordingly, the auditors‟ liability falls under three categories:
i) To their clients (company itself);
ii) To third parties in case of negligence; and
iii) Civil and criminal liabilities.
e) A qualifying insurance policy (December 2013)(5 marks)

Answer
A qualifying insurance policy is an insurance policy issued by an insurer that is not a related party (as
defined in NAS 16 Related Party Disclosures) of the reporting entity, if the proceeds of the policy:
a. can be used only to pay or fund employee benefits under a defined benefit plan; and
b. are not available to the reporting entity‟s own creditors (even in bankruptcy) and cannot be paid to
the reporting entity, unless either:
i. the proceeds represent surplus assets that are not needed for the policy to meet all the related
employee benefit obligations; or
ii. the proceeds are returned to the reporting entity to reimburse it for employee benefits already
paid.
f) Professional skepticism (June 2014)(2.5 Marks)

Answer
It is a requirement of NSA 200 that, when planning and performing an audit, the auditor should adopt
an attitude of professional skepticism. Professional skepticism is defined by NSA 200 as an attitude
that includes a questioning mind, being alert to conditions which may indicate possible misstatement
due to error or fraud, and a critical assessment of audit evidence.
This does not mean that the auditors should disbelieve everything they are told, but they should view
what they are told with a skeptical attitude, and consider whether it appears reasonable and whether it
conflicts with any other evidence. In other words, they must not simply believe everything
management tells them.
g) Revaluation of Fixed Assets (December 2014)(5 Marks)

Answer
Revaluation of fixed assets is the process of increasing or decreasing their carrying value in case of
major changes in fair market value of the fixed asset. NAS-06, Property, Plant and Equipment
requires fixed assets to be initially recorded at cost but they allow two models for subsequent
accounting for fixed assets, namely the cost model and the revaluation model. Under the Revaluation
model, the asset is carried at a revalued amount, being its fair value at the date of revaluation less

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subsequent depreciation and impairment, provided that fair value can be measured reliably.
Revaluations should be carried out regularly, so that the carrying amount of an asset does not differ
materially from its fair value at the balance sheet date. If an item is revalued, the entire class of assets
to which that asset belongs should be revalued. Revalued assets are depreciated in the same way as
under the cost model. If a revaluation results in an increase in value, it should be credited to other
comprehensive income and accumulated in equity under the heading "revaluation surplus" unless it
represents the reversal of a revaluation decrease of the same asset previously recognised as an
expense, in which case it should be recognised in profit or loss. A decrease arising as a result of a
revaluation should be recognised as an expense to the extent that it exceeds any amount previously
credited to the revaluation surplus relating to the same asset. When a revalued asset is disposed of,
any revaluation surplus may be transferred directly to retained earnings, or it may be left in equity
under the heading revaluation surplus. The transfer to retained earnings should not be made through
profit or loss.
h) Qualities of an Auditor (December 2014)(5 Marks)

Answer
An auditor should adhere to the fundamental principles applicable for the auditor. The fundamental
principles are integrity, objectivity, professional competence and due care, confidentiality and
professional behavior. The qualities required in and auditor are tact, caution, firmness, good temper,
integrity, discretion, industry judgment, patience, clear headedness and reliability. In addition, he
must have the shine of culture for attaining a great height. He must have the highest degree of
integrity backed by adequate independence. He must have a thorough knowledge of general principles
of law which govern matters with which he is likely to be intimate contact. He must pursue an
intensive program of theoretical education in subjects like financial and management accounting,
general management, business and corporate laws, computer and information systems, taxation,
economics etc. An auditor must be honest; i.e; he must not certify what he does not believe to be true
and must take reasonable care and skill before he believes that what he certifies is true.
i) Consultation in quality audit (July 2015) (2.5 Marks)

Answer
NSQC 1 and NSA 220 provides that the engagement partner should:
i. Be responsible for the engagement team undertaking appropriate consultation on difficult or
contentious/controversial matters;
ii. Be satisfied that members of the engagement team have undertaken appropriate consultation
during the course of the engagement
iii. Be satisfied that the nature and scope of, and conclusions resulting from, such consultations are
documented and agreed with the party consulted; and
iv. Determine that conclusions resulting from consultations have been implemented
j) Self-review threat ( July 2015) (2.5 Marks)

Answer
It is the threat that a professional accountant will not appropriately evaluate the results of a previous
judgment made or service performed by the professional accountant, or by another individual within
the professional accountant‟s firm or employing organization, on which the accountant will rely when
forming a judgment as part of providing a current service.
Question No 5
Distinguish between the following
a. Management Audit and Operational Audit. (December 2011)(5 Marks)
Answer
Management audit is an audit of the management. The management audit is, therefore, concerned
itself with the whole field of activities of the concern, from top to bottom starting from the top,
because we are primarily concerned with whether the general management is functioning smoothly

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and satisfactorily. Management audit is concerned with appraising management‟s accomplishment of

organizational objectives, the management functions of planning, organizing, directing and
controlling, and the adequacy of management‟s decisions and actions in moving towards its stated
objectives.
Management audit is a complex task closely linked with the process of management. It usually
involves the following steps:
i. Identification of the objectives of the organization.
ii. The overall objectives are to be split down into detailed targets and plans for various segments.
iii. The organizational structure is to be reviewed to assess whether or not it can effectively achieve
the overall objectives and detailed targets.
iv. The performance of each functional area or responsibility center is to be examined and compared
with the targets and objectives.
v. On the basis of above examination, a realistic course of action may be recommended.
On the other hand, operational audit is an audit for the management. It is undertaken at the instance
of the management for providing it with information and appraisal of operations and activities.
Operational auditing is essentially a review and appraisal of operations of an organization carried on
by a competent independent person. Hence, operational audit refers to a systematic independent
appraisal activity within an organization for a review of the entire departmental operations as a service
to management. Operations audit is a technique for regularly and systematically, appraising unit or
function effectiveness against corporate and industry standards by utilizing personnel who are not
specialists in the area of study with the objective of assuring a given management that its aims are
being carried out in identifying conditions capable of being improved.
Management audit deals with various aspects of the management process whereas operational audit is
confined to various activities and operations in the functional areas. Management audit attempts to
evaluate the performance of various management process and functions.
b. Statutory & System Audit (December 2012)(5 Marks)

Answer
The major differences between statutory and system auditing can be described as follows:
(i) Purpose: The statutory auditing is basically concerned with the opinion that whether the
historical information recorded is correct or not, whereas the system auditing emphasizes on
effectiveness and efficiency of operations for future performance.
(ii) Area: Statutory audits are restricted to the matters directly affecting the appropriateness of the
presented financial statements whereas the system audit covers all the activities that are related
to efficiency and effectiveness of operations directed towards accomplishment of objectives of
organization.
(iii) Reporting: The statutory audit report is sent to all stock holders, bankers and other persons
having interest in the organization. However, the system audit report is primarily for the
management.
(iv) End task: The statutory audit has reporting the findings to the persons getting the repost as its
end objectives, however, the system audit is not limited to the reporting only, but includes
suggestions for improvements also.
(v) Auditor: In Statutory Audit generally opinion on the financial statement has to be expressed by
COP holder of ICAN, though system audit could be done in-house or by outsourcing where it is
not necessary for carrying out by COP holder.
c. Auditing and Investigation (December 2014)(5 Marks)

Answer
Objects: The object of auditing is to find out whether Financial Statements give a true and fair view of
business. Investigation is undertaken to know the essential facts about a matter under inquiry. It is
done with some special purpose of view.
Period: Auditing usually covers one accounting year . Investigation may cover more than one
accounting year.

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Legally Binding : Auditing is conducted for proprietors or is normally legally binding. Investigation is
carried out on behalf of any party interested in the matter.
Scope : Auditing is legally compulsory for companies & restricted to the financial statement.
Investigation is voluntary and carried out on certain circumstances & may be carried out beyond the
financial statement.
Time : Auditing may be conducted at the year end. Investigation may be conducted at any time in case
of suspicion about any transaction.
Report : In auditing form of report is prescribed. In investigation it is not prescribed.
Appointment : In auditing appointment is made by shareholders in AGM. In investigation
appointment can be done by other delegated authorities.
Qualification : Auditors qualification is prescribed by Laws. Investigators qualification has not
prescribed by Laws.
Re-work : Re-audit is not generally carried out . Re-investigation may be carried out.
Perception : Audit is not carried out with doubtful mind . Investigation may be carried out with
doubtful mind.
d. Reserves and provisions (December 2015)(5 Marks)

Answer
1. Reserve is an appropriation of profit whereas provision is a charge against Profit.
2. Reserves are not intended to meet any liability, contingency or diminution in the value of
assets. Provisions are made to provide for depreciation, renewal or a known liability or a
disputed claim.
3. Reserves cannot be created unless there is a profit except revaluation reserve and capital subsidy.
Provisions must be created whether or not there is profit.
4. Reserves are generally optional except in certain situations – Capital Redemption reserve,
Debenture Redemption Reserve, Declaration of dividend higher than 10% etc. Provisions are not
optional and have to be made as per generally accepted accounting principles.
5. Reserves are shown on the liability side. Provisions for depreciation and provision for
doubtful debts are shown as deduction from respective assets. Provision for liability is shown on
the liability side
Question No 6:
What are the basic elements of an assurance engagement? (December 2010)(7 Marks)
Answer
a) Three party relationship: Assurance engagements involve three separate parties: a practitioner, a
responsible party and intended users.
b) An appropriate subject matter: Subject matter information may be the reorganization,
measurement, presentation and disclosers represented in financial statements, key indicators,
special documents, assertion about effectiveness or statement of compliance depending on the
nature of assurance engagements.
c) Suitable criteria: Criteria can be formal or informal depending up on the nature of assurance
engagement. It may be Nepal Standards on Auditing or an established internal control framework
or individual control objectives specifically designed for the engagement or applicable law,
regulation or contract.
d) Sufficient appropriate evidence: The practitioner plans and performs an assurance engagement
with an attitude of professional skepticism to obtain sufficient appropriate evidence about whether
the subject matter information is free of material misstatement. The practitioner considers
materiality, assurance engagement risk, and the quantity and quality of available evidence when
planning and performing the engagement.
e) Assurance report: The practitioner provides a written report containing a conclusion that conveys
the assurance obtained about the subject matter information.
Question No 7

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Ramila & Associates is a proprietorship firm of chartered accountant. Ramila, the proprietor of the
firm, was the board member of Lalima Bank Ltd till 32 Asadh, 2067. During the AGM of Bank for
the financial year 2066/67, she has been appointed as statutory auditor for the financial year 2067/68.
Should she accept the said appointment? (December 2010)((5 Marks)
Answer
As per section 8.4 of Code of Ethics issued by ICAN, “when professional accountants in public
practice are or were, within the period under current review or immediately preceding an assignment:
i. a member of the board, an officer or employee of a company; or
ii. a partner of or in the employment of, a member of the board or an officer or employee of a
company. They would be regarded as having an interest which could detract from
independence when reporting on that company”.
Accordingly as per above Para, CA Ramila was board member of the bank immediately preceding an
assignment and the period is not less two years, hence she should not accept this assignment as
statutory auditor for the financial year 2067/68.
Question No 8
Answer the following:
You are appointed as manager of quality control section in one of the leading audit firm of Nepal, the
senior partner of the firm instructs you to draft objectives statement for quality control policies &
procedures. (December 2011)(8 Marks)
Answer
As per Nepal Standards on Quality Control(NSQC) 1, it is necessary for quality control for firm`s that
perform audits and review of historical financial information and other, accordingly, the relevance of
quality control The relevance of quality control issue in auditing services is equal importance like in
other services. If quality control could not be done in auditing work, quality services could not be
provided to client which may result negative consequences both for auditor and client including in
overall economy. Hence, every auditor should carry out the audit work based on formal quality
control policy & procedures. The objective statement of quality control policies & procedures would
be:
i. Professional Requirements:
Personnel in the firm should adhere to the principles of independence, integrity, objectivity,
confidentiality and professional behavioral number of procedures may be framed to achieve this
objective .for example, a firm may require all its personnel to make a written statement every year as
to whether they hold any shares or any other interest in the enterprises being audited by the firm.
ii. Skills and Competence
the audit skills firm should be staffed by personnel who have attained and maintain the technical
standards and professional required to enable them to fulfill their responsibilities with due care .for
example, a firm can achieve this objective through proper recruitment procedures, periodic staff and a
system whereby latest information relating to current development in professional standards, law, etc
is regularly communicated to audit staff.
iii. Assignment
Audit work should be assigned to such personnel as have the degree of technical training and
proficiency required in the circumstances.
iv. Delegation
There should be sufficient direction, supervision and review of work at all levels to provide
reasonable assurance that the work performed meets appropriate quality standards. For example, a
firm may establish guidelines relating to the form and content of working papers; use of standardized
forms, etc .similarly, the audit plans may identify the staffing requirements and timing of various
phases of audit to facilitate delegation of audit now.
v. Consultation
Where ever necessary, persons having appropriate expertise, within or outside the firm, should be
consulted.
vi. Acceptance and Retention of Clients

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Before accepting an audit, the firm should evaluate its independence and ability to serve the
prospective client properly. A similar review should be made, on-going basis, of association with the
existing clients.
vii. Monitoring
The continued adequacy and operational effectiveness of the quality control policies and procedures
should be maintained.
Question No 9:
Describe the policies to be considered by an auditor regarding quality control as prescribed in quality
control standard. (June 2012)(7 Marks)
Answer
The policies to be considered by an auditor regarding quality control as prescribed in quality control
standard (NSQC) are given below:
- Professional requirements as mentioned in Code of Ethics,
Personnel in the firm are to adhere to the principles of independence, integrity, objectivity,
confidentiality and personal behaviours.
- Skills and competence,
Staffing should be arranged to maintain the technical and professional competence required to enable
them to fulfil their responsibilities with due care.
- Assignment,
Audit work to be assigned to personnel who have the degree of technical training and proficiency
required in the circumstances.
- Delegation,
There is to sufficient direction, supervision and review of work at all levels to provide reasonable
assurance that the work performed meets appropriate standards of quality.
- Consultation,
Whenever necessary, consultation within or outside the firm is to occur with those who have
appropriate expertise.
- Acceptance and Retention of Clients,
An evaluation of prospective clients and review, on an ongoing basis, of existing clients is to be
conducted. In making a decision to accept or retain a client, the firm's independence and ability to
serve the client properly are to be considered.
- Monitoring,
The continued adequacy and operational effectiveness of quality control policies and procedures is to
be monitored.
Question No 10:
"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. (June 2012)(5 Marks)
Answer
NSA 260 deals with communications of audit matters with those charged with governance.
The following are the audit matters of governance interest which are to be communicated.
(i) The general approach and overall scope of audit including expected limitations.
(ii) The selection of or change in significant accounting policies and practices that have a material
effect on the entity‟s financial statements.
(iii) The potential effect on the financial statements of any significant risks and exposures.

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(iv) Adjustment to financial statements arising out of audit which have a significant effecton the
financial statement.
(v) Material uncertainties that may cast significant doubt on the entity‟s ability to continue as a
going concern.
(vi) Disagreement with management on matters which could have significant impact to the financial
statements and to audit report.
(vii) Expected modifications to the audit report.
(viii) Others matters like material weakness in internal control measures, questions on management
integrity and fraud involving management.
(ix) Other matters agreed in terms of audit engagement.
Question No 11
As a quality control manager of the audit engagement team of D Limited, how can you ensure that
your team has performed the audit works as per the standard maintained by your audit firm along with
the other mandatory compliance of various national and international standards in auditing and
accounting? Points out the review procedures to ensure the quality of the audit work?
Answer
The quality control manager inform the responsibilities of the engagement team and also give some of
the things to be ensured before starting the works as follows;
 understanding the nature of the entity's business
 Possible risk related issues
 Problems that may arise; and
 The detailed approach to the performance of the engagement.
The engagement team's responsibilities includes maintaining an objective state of mind and an
appropriate level of professional skepticism, and performing the work delegated to them in
accordance with the ethical principle of due care.
The quality control manager before review the files, will supervise the engagement team and do the
following works:
 Tracking the progress of the audit engagement;
 Considering the capabilities and competence of individual members of the engagement team,
whether they have sufficient time to carry out their work, whether they understand their
instructions, and whether the work is being carried out in accordance with the planned approach
to the audit engagement.
 Addressing significant issues arising during the audit engagement, considering their significance
and modifying the planned approach appropriately.
 Identifying matters for consultation or consideration by more experienced engagement team
member during the audit engagement.
The quality control manager will review the work performed by their team members and consider the
following while reviewing the works and working papers:
 The work has been performed in accordance with professional standards and regulatory and legal
requirements;
 Significant matters have been raised for further consideration;
 Appropriate consultations have taken place and the resulting conclusions have been documented
and implemented.
 There is a need to revise the nature, timing and extent of work performed;
 The work performed supports the conclusions reached and is appropriately documents;
 The evidence obtained is sufficient and appropriate to support the auditor's report;
 The objectives of the engagement procedures have been achieved.
The engagement partner conducts timely reviews at appropriate stages during the engagement. This
allows significant matters to be resolved on a timely basis to the engagement partner‟s satisfaction

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before the auditor‟s report is issued. The reviews cover critical areas of judgment, especially those
relating to difficult or contentious matters identified during the course of the engagement, significant
risks, and other areas the engagement partner considers important. The engagement partner need not
review all audit documentation. However, the partner documents the extent and timing of the reviews.
Issues arising from the reviews are resolved to the satisfaction of the engagement partner.
Question No 12
Write down ten areas where different accounting policies are applied on accounting the financial
transactions based on the nature of entities. (June 2013)(5 Marks)
Answer
Various Nepal Accounting Standards (NAS) are issued by the Accounting Standard Board of Nepal
which are mandatory in nature and few are recommendatory as well. For prudent accounting
practices; application of NAS should be made on accounting of financial transactions. Some areas
where accounting policies suggested by NAS are:
i) Method of depreciation, depletion and amortization-Straight Line Method, Written Down
Value method.
ii) Accounting Concept: Historical cost convention is to be defined.
iii) Fluctuation of foreign currency and its treatment should be defined.
iv) Valuation of inventories – FIFO, LIFO, weighted average etc.
v) Treatment of goodwill – write off, retain.
vi) Valuation of investment –at cost, market or net realizable value etc.
vii) Treatment of retirement benefits-Actuarial, funded through trust, insurance policy etc.
viii) Recognition of Revenue either on mercantile or accrual basis is defined.
ix) Revaluation of fixed assets and writeoff of fixed assets having certain value say Rs. 1,000 or less.
x) Treatment of contingent liabilities.
Question No 13
State the reporting responsibilities of an auditor in the context of non-compliance of laws and
regulations in an audit of financial statements. (December 2013)(5 marks)
Answer
NSA 15 Para 14 has defined the reporting responsibilities of an auditor in the context of non-
compliance of laws and regulations in an audit of financial statements.
The auditor should as soon as practicable, either communicate with the audit committee, the Board of
Directors and senior management or obtain evidence that they are appropriately informed regarding
non-compliance that comes to the auditors attention.
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.
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.
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.
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.
If the auditor is unable to determine whether non compliance has occurred because of limitations
imposed by the circumstances rather then by the entity, the auditor should consider the effect on the
auditor‟s report.
The auditor‟s duty of confidentiality would ordinarily preclude reporting non compliance to a third
party. However, in certain circumstances, that duty of confidentiality is overridden by statement, law
or by courts of laws.

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Question No 14
Explain Principal Auditor in line with NSA 600. What are the factors to be considered by auditor to
act as Principal Auditor? (June 2014)(5 Marks)
Answer
As per NSA 600 Principal auditor means the auditor with responsibility for reporting on the financial
statements of an entity when those financial statements include financial information of one or more
components audited by another auditor.
The auditor should consider whether the auditor‟s own participation is sufficient to be able to act as
the principal auditor. For this purpose the principal auditor would consider:
(i) the materiality of the portion of the financial statements which the principal auditor
audits;
(ii) the principal auditor‟s degree of knowledge regarding the business of the components;
(iii) the risk of material misstatements in the financial statements of thecomponents audited by
the other auditor; and
(iv) the performance of additional procedures as set out in this NSA regarding the components
audited by the other auditor resulting in the principal auditor having significant
participation in such audit.
Question No 15
Explain „An appropriate subject matter‟ as an element of assurance. (December 2014)(5 Marks)
Answer
Assurance engagement is an engagement in which a practitioner expresses a conclusion designed to
enhance the degree of confidence of the intended users other than the responsible party about the
outcome of the evaluation or measurement of a subject matter against criteria.
The subject matter, and subject matter information, of an assurance engagement can take many forms,
such as:
 Financial performance or conditions (for example, historical or prospective financial position,
financial performance and cash flows) for which the subject matter information may be the
recognition, measurement, presentation and disclosure represented in financial statements.
 Non-financial performance or conditions (for example, performance of an entity) for which the
subject matter information may be key indicators of efficiency and effectiveness.
 Physical characteristics (for example, capacity of a facility) for which the subject matter
information may be a specifications document.
 Systems and processes (for example, an entity‟s internal control or IT system) for which the
subject matter information may be an assertion about effectiveness.
 Behavior (for example, corporate governance, compliance with regulation, human resource
practices) for which the subject matter information may be a statement of compliance or a
statement of effectiveness.
Subject matters have different characteristics, including the degree to which information about them is
qualitative versus quantitative, subjective versus objective, historical versus prospective, and relates to
a point in time or covers a period. Such characteristics affect the:
(i) Precision with which the subject matter can be evaluated or measured against criteria; and
(ii) The persuasiveness of available evidence.
The assurance report notes characteristics of particular relevance to the intended users.
An appropriate subject matter is:
(i) Identifiable, and capable of consistent evaluation or measurement against the identified
criteria; and
(ii) Such that the information about it can be subjected to procedures for gathering sufficient
appropriate evidence to support a reasonable assurance or limited assurance conclusion, as
appropriate.

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Question No 16
Explain the types of threat as explained in ICAN Code of ethics. (December 2014)(5 Marks)
Answer
The various types of threats explained in ICAN code of ethics are as follows:
 Self-interest threat – the threat that a financial or other interest will inappropriately influence the
professional accountant‟s judgment or behavior; For e.g. lowballing, hospitality or other benefits,
contingent fees, loans to clients etc.
 Self-review threat – the threat that a professional accountant will not appropriately evaluate the
results of a previous judgment made or service performed by the professional accountant, or by
another individual within the professional accountant‟s firm or employing organization, on which
the accountant will rely when forming a judgment as part of providing a current service; For e.g.
valuation services along with audit service, accounting services.
 Advocacy threat – the threat that a professional accountant will promote a client‟s or employer‟s
position to the point that the professional accountant‟s objectivity is compromised; For e.g. the
auditor Should not offer legal services to a client and defend them in dispute or litigation which is
material to the financial statement
 Familiarity threat - the threat that due to a long or close relationship with a client or employer, a
professional accountant will be too sympathetic to their interests or too accepting of their work.
For e.g. participation in client affairs, family and personal relationship, audit partners leaving to
join clients etc.
 Intimidation threat – the threat that a professional accountant will be deterred from acting
objectively because of actual or perceived pressures, including attempts to exercise undue
influence over the professional accountant. For e.g. if there is actual or threatened litigation
between client and assurance firm, the firm should not continue to act
Question No 17
"The rendering of two or more types of professional services concurrently does not by itself impair
integrity, objectivity or independence". Comment. (December 2014)(5 Marks)
Answer
Section 11 of Code of Ethics of the Institute of the Chartered Accountants of Nepal deals with
"Activities Incompatible with the Practice of Public Accountancy".
Section 11 (2) stated that "the rendering of two or more types of professional services concurrently
does not by itself impair integrity, objectivity or independence".
As per Section 11 (1) a professional accountant in public practice should not concurrently engage in
any business, occupation or activity which impairs or might impair integrity, objectivity or
independence, or the good reputation of the profession and therefore would be incompatible with the
rendering of professional services.
Further as per Section 11 (3) the simultaneous engagement in another business, occupation or activity
unrelated to professional services which have the effect of not allowing the professional accountant in
public practice properly to conduct a professional practice in accordance with the fundamental ethical
principles of the accountancy profession should be regarded as inconsistent with the practice of public
accountancy.
Question No 18
Explain propriety audit in the context of Audit Act, 2048. ( July 2015) (5 Marks)
Answer
As per section 5 of) the Audit Act, 2048 requires that the Auditor General shall audit following
matters considering the propriety thereof-
I) On the propriety of any expenditure and its authorization, if in the opinion of the Auditor
General such expenditure is a reckless one or is an abuse of national property, whether
movable or immovable, despite that the expenditure confirms to the authorization, and
ii) On the propriety of all authorizations issued in respect of any grant of national property
whether movable or immovable, fixed or current, or underwriting of any revenue, or any
contract, license or permits relating to mining, forest, water resources, etc. and any other act
of abandoning movable or immovable, assets of the nation.

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The Auditor General may not include in the report minor items of discrepancy and other items
deemed as insignificant in view of their property which were observed during the audit of income and
expenditure.
Question No 19
Explain the provisions of Custody of Client Assets as given in Code of Ethics. What are the
safeguards or measures to be taken to balance this threat? ( July 2015) (5 Marks)
Answer
While taking custody of Client Assets following things needs to be evaluated:
 Keep such assets separately from personal or firm assets;
 Use such assets only for the purpose for which they are intended;
 At all times be ready to account for those assets and any income, dividends, or gains
generated, to any persons entitled to such accounting;
 Comply with all relevant laws and regulations relevant to the holding of and accounting
for such assets.
 Make appropriate inquiries about the source of such assets and consider legal and
regulatory obligations.
 Consider seeking legal advice where needed.
Question No 20
How are ISA, NSA, IAASB and IFAC connected? ( July 2015) (5 Marks)
Answer
International Standards on Auditing (ISA) are professional standards for the performance of financial
audit of financial information. These standards are issued by International Federation of Accountants
(IFAC) through the International Auditing and Assurance Standards Board (IAASB). The
International Auditing and Assurance Standards Board (IAASB) is an independent standard-setting
body that serves the public interest by setting high-quality international standards for auditing,
assurance, and other related standards, and by facilitating the convergence of international and
national auditing and assurance standards. In doing so, the IAASB enhances the quality and
consistency of practice throughout the world and strengthens public confidence in the global auditing
and assurance profession.
In 2006, the Auditing Standards Board (AuSB) adopted an official position of convergence to ISAs -
aligning its agenda with that of the IAASB and using the ISAs as a base. AuSB started redrafting
Nepal Auditing Standards in line with relevant ISAs, including the Preface and Framework. 22 out of
30 issued NSAs are already revised and are in the process of issuing for mandatory application by
members of the Institute of Chartered Accountants of Nepal.
Question No 21
Is there any conflict of interest if the engagement auditor prepares financial regulation and internal
control system of the same client ? (December 2015)(5 Marks)
Answer
It will not be treated as conflict of interest only on the ground that financial regulation and internal
control system has been prepared by the Auditor. Though auditor has to assess the effectiveness of
such imposed system during the course of audit. Accordingly the chances of excusing by the auditor
on the lapses of implementation of those system observed during auditing process could not be ruled
out which will impair the very efficiency and independence of the auditor. Hence chances of arising
the situation of conflict of interest have been existed in such circumstances

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Question No 1:
Give your comments on the following:
a. Giant Ltd. is newly established cement industry and yet to start commercial production. Various
payments, large and small, are being regularly made. You are required to prepare internal control
questionnaire regarding „procedure for authorization‟ for payments. (June 2010)(5 Marks)
Answer
The internal control questionnaire for „procedure for authorization‟ may be drawn as below:
i. Does the enterprise have a formal document showing the various authorities, which can
sanction payments along with the nature of the relevant payments and the limit on sanctioning
powers?
ii. Does the system provide for authorization for certain payments by the top management or the
governing body?
iii. Are the financial powers of various sanctioning/disbursing authorities reasonable?
iv. Have the financial powers of various authorities been intimated to various departments of the
enterprise?
v. Is there a system of post facto authorization of payments in exceptional cases where prior
sanction could not be obtained?
b. During the course of audit, M/s Guess and Guess Associates, an audit firm, has checked 20 percent of
the postings from Cashbook to General Ledger. Some serious questions could be raised about the
representative nature of the sample and about the validity of sample results. What could those serious
concerns be? (June 2010)(8 Marks)
Answer
Some of the serious concerns about the representative nature of the sample and about the validity of
sample results could be:
i. Why select, say 20 percent of the posting? Why can it not be 15 or 25 percent? Why check
only 2 months?
ii. Can we just state the percentage size of the sample without reference to the total number of
transactions? Are we taking the same amount of risk if we check 2 out of a total of 10
transactions or 200 out of 2000 transactions?
iii. How can we draw conclusions about the transactions of the whole year by merely checking
the transactions of a few specified months, especially as the level of activity may vary from
month to month?
iv. By not stating the manner in which the 20 percent of the transactions have to be selected,
would not the audit assistants consciously or unconsciously select only those transactions,
which are simpler and easier to audit?
c. Mr. Lakhan, Statutory Auditor of Radha Krishna Pvt. Ltd wants to verify cash on hand as on 31st
Asadh, 2069. The Management informs Mr. Lakhan that it is not possible to cooperate, as cashier has
been out of station. Advise Mr. Lakhan on how to deal with the situation. (December 2012)(5 marks)
Answer
The scope of audit may be limited for varied reasons,
i. the entity may impose restriction on scope of audit,
ii. the limitation may be imposed by circumstances. When the audit is carried out under and as
per statute, the auditor should not accept the assignment when his duties are curtailed by
agreement, unless required by any Law.
When audit is carried out in accordance with the entity‟s terms voluntarily, the auditor may indicate
his scope in his audit report.
Sometimes, the circumstances may impose restrictions on audit scope. For example, if the auditor is
appointed after the year end, he may not be able to participate in inventory checking. Or sometimes,
the records required may not be available so that the auditor may not be able to check details in the
manner he liked. Such limitations in scope may warrant an auditor to express disclaimer of opinion or
qualified opinion in his audit report depending upon the circumstances.

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The non co-operation of Radha Krishna Pvt. Limited will amount to limitation on scope of auditors.
Question No 2:
Write short notes on the following
a. Permanent Audit File. (December 2010)(5 Marks)
Answer
In a recurring audit, the file of working papers that are relevant to more than one audit engagement or
core documents are often kept separately in a file known as permanent audit file. Permanent audit file
is updated regularly with information of continuing importance to succeeding audit. As per NSA 230-
Audit Documentation a permanent audit file normally includes:
i. Information concerning the legal and organizational structure of the client. In the case of a
company, this includes the memorandum and articles of association. In the case of a statutory
corporation, this includes the Act and Regulations under which the corporation operates.
ii. Extracts or copies of important legal documents, agreements and minutes relevant to the audit.
iii. A record of the study and evaluation of the internal controls related to the accounting system.
iv. Copies of audited financial statements of previous years.
v. Analysis of significant ratios and trends.
vi. Copies of management letters issued by the auditor if any.
vii. Record of communication with the retiring auditor, if any before acceptance of the appointment
as a auditor and
viii. Notes regarding significant accounting policies.
b. Cut off Procedure. (December 2010)(5 Marks)

Answer
It refers to the procedure adopted by the management to ensure that transactions of one period are
separated from those at the commencement of the next accounting period. The cut off r is very
significant so as to ensure that revenue and expenditures of one year do not get recorded in the
following year since it will distort the true and fair view of the accounts. These procedures are applied
to ensure that:
i. The proper procedure has been followed for adjusting the inventory to take into account
movements to and from inventory, which have taken place between the stock taking date and
balance sheet date where stock has been taken on a date other than the balance sheet date.
ii. Goods sold have been excluded from the inventories and credit has been taken for the sales in
the case of credit sales.
iii. Goods purchased have been in the inventories and that the liabilities have been provided for in
case of credit purchase.
c. Performance Audit. (December 2010)(5 Marks)

Answer
Performance audit refers to the evaluation of the economy, efficiency and effectiveness of selected
activities of the client. In this situation, economy is concerned with minimizing the cost of resources
acquired or used, having regard to appropriate quality. Efficiency refers to the relationship between
the output of goods/ services or other results and the resources used to produce them. Here, the auditor
examines how far maximum output is attained for a given input.
Similarly, effectiveness refers to the relationship between the intended results and the actual results of
the activity. Thus, the auditor examines how successfully the outputs in the form of goods/ services or
other results achieve policy objectives, operational goals and other expected effects.
In practice, therefore, while carrying out the performance audit, the auditor looks at these different
aspects together particularly when considering the closely linked aspects of economy and efficiency.

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d. Disadvantages of the use of an audit program. (June 2011)(5 Marks)

Answer
The possible disadvantages of the use of an audit program are:
i. The work may become mechanical and particular parts of the programme may be carried out
without any understanding of the object of such parts in the whole audit scheme.
ii. The programme often tends to become rigid and inflexible following set grooves; the business
may change in its operation of conduct, but the old programme may still be carried on. Changes
in staff or internal control may render precaution necessary at points different from those
originally decided upon.
iii. Inefficient assistants may take shelter behind the programme i.e. defend deficiencies in their
work on the ground that no instruction in the matter is contained therein.
iv. A hard & fast audit program may kill the initiative of efficient and enterprising assistants.
v. Preparation of audit program without preliminary depth assessment of clients business and
without considering scope of work to be carried out by auditor will not provide objectivity of
the audit work.
e. Flow Chart (June 2011)(5 Marks)

Answer
Flow Chart is a graphical presentation of all the processes within an organization. It gives bird`s eye
view of the system and the flow of transactions that is of particular interest for the auditors. It
facilitates the auditors in accumulation of the information necessary for the proper review and
evaluation of internal controls implemented within an organization. It is considered to be the most
concise way of recording the auditor`s review of the system. It minimizes the amount of narrative
explanation and thereby achieves a consideration or presentation not possible in any other form.
f. Inherent Limitations of an Audit (December 2011)(5 Marks)

Answer
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 judgment, 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.
g. Control Risk (December 2011)(5 Marks)

Answer
Audit risk is the risk that an auditor may give an inappropriate opinion on financial information that
is materially misstated. Audit risk is composed of three components viz. inherent risk, control risk and
detection risk. Control risk is the risk that misstatement that could occur in an account balance or class
of transactions and that could be material, individually or when aggregated with misstatements in
other balances or classes, will not be prevented or detected on a timely basis by the system of internal
control. There will always be some control risk because of the intrinsic limitations of any system of
internal control.
For assessing control risk, the auditor should consider the adequacy of control design, as well as test
adherence to control procedures. In the absence of such assessment, the auditor should assume that
control risk is high. The auditor ordinarily assesses control risk at a high level for some or all
assertions where:
- The entity`s policies and procedures relating to an assertion are not effective or
- Evaluating the effectiveness of the entity`s policies and procedures would be inefficient
The auditor may make a preliminary assessment of control risk at less than a high level only when the
auditor:

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- Is able to identify policies and procedures of the accounting and internal control systems relevant to
specific assertions which are likely to prevent or detect material misstatements in the financial
statements ; and
- Plans to perform tests of control or support the assessment.
It may be noted that nature, timing and extent of substantive audit procedures to be performed would
depend upon the auditor`s assessment of the inter-relationship between inherent risk, control risk and
detection risk.
h. Analytical procedures in planning an audit (June 2012) ( 5 Marks)

Answer
In the planning stage, analytical procedures assist the auditor in understanding the client‟s business
and in identifying areas of potential risk by indicating aspects of and developments in the entity‟s
business of which he was previously unaware. This information will assist the auditor in determining
the nature, timing and extent of his other audit procedures.
Analytical procedures in planning the audit use both financial data and non-financial information,
such as number of employees, the square feet of selling space, volume of goods produced and similar
information.
i. Engagement Letter (December 2012)(2.5 Marks)

Answer
It is letter issued by the auditor to the auditee which includes written terms of engagement. This letter
basically sets out the responsibilities of the auditor and the auditee and includes other information
such as audit fee and its payment terms, out of pocket expenses etc. This letter helps to resolve the
confusion which may arise during or subsequent to audit.
j. Detection risk (June 2013)(2.5 Marks)

Answer
Detection risk: Detection risk is the risk that the auditor will not detect a misstatement that exists in an
assertion that could be material, either individually or when aggregated with other misstatements.
Detection risk is a function of the effectiveness of an audit procedure and of its application by the
auditor. Detection risk cannot be reduced to zero because the auditor usually does not examine all of a
class of transactions, account balance, or disclosure and because of other factors. Such other factors
include the possibility that an auditor might select an inappropriate audit procedure, misapply an
appropriate audit procedure, or misinterpret the audit results. These other factors ordinarily can be
addressed through adequate planning, proper assignment of personnel to the engagement team, the
application of professional skepticism, and supervision and review of the audit work performed.
k. Audit strategy (June 2013)(2.5 Marks)

Answer
Audit planning is the process of gathering information and design audit strategies. The main output of
audit planning is a tailored audit approach supported by appropriate administrative arrangements.
Audit strategy is concerned with designing optimized audit approaches that seeks to achieve the
necessary audit assurance at the lowest cost within the constraints of the information available. Audit
procedures should be relevant to the important assertions, and as cost effective as possible to perform.
Audit strategy generally involves the following steps:
i. Obtaining knowledge of clients business,
ii. Performing analytical procedures at initial stage,
iii. Evaluating inherent risks,
iv. Evaluating internal control system for strategy purpose and
v. Formulating the strategy.
The auditor should also develop the strategy by considering the results of gathering or updating
information about the client, and making preliminary judgment about materiality, inherent risk and
control effectiveness.

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The initial assessment of the quality and complexity of the client‟s system will affect the amount of
the information the auditor needs to gather. Sometimes, on a new engagement, the appropriate
strategy may be oblivious from a limited amount of investigation work.
l. Tolerable error (June 2013)(5 Marks)

Answer
Tolerable error: Tolerable error is the maximum error that that the auditor would be willing to accept
and still concludes that the result from the sample has achieved the audit objective. Tolerable error is
considered during the planning stage and for substantive procedures related to the auditor judgment
about materiality. The smaller the tolerable error, the greater the sample size will need‟s be.
In test of control, the tolerable error is the maximum rate of deviation from a prescribed control by
control procedure that at the auditor would be willing to accept, based on the preliminary assessment
of control risk. In substantive procedure, tolerable error is the maximum monetary error in an account
balance or a class of transactions that the auditor would be willing accept, so that when the result of
all audit procedure are reasonable assurance, that the financial statement are not materially mis-stated.
m. Guiding factors of materiality concept (December 2013)(5 marks)

Answer
NSA 320 “Audit Materiality”, establishes standards on the concept of materiality and the relationship
with audit risk while conducting an audit. Guiding factors for determining the materiality are:
i. Item of materiality may be determined individually or in aggregate.
ii. The materiality depends on the regulatory or legal considerations.
iii. Materiality is not often reckoned with respect to quantitative details above. It has qualitative
dimensions as well.
n. Going concern (December 2013)(5 marks)

Answer
The going concern assumption is a fundamental principle in the preparation of financial statements.
Under the going concern assumption, an entity is ordinarily viewed as continuing in business for the
foreseeable future with neither the intention nor the necessity of liquidation, ceasing trading or
seeking protection from creditors pursuant to laws or regulations. Accordingly, assets and liabilities
are recorded on the basis that the entity will be able to realise its assets and discharge its liabilities in
the normal course of business
o. Use of flow chart in evaluation of internal control (June 2014)(2.5 Marks)

Answer
Use of Flow Charts in evaluation of internal control: It is a graphic presentation of each part of the
company‟s system of internal control. A flow chart is considered to be the most concise way of
recording the auditor‟s review of the system. It minimizes the amount of narrative explanation and
thereby achieves a consideration or presentation not possible in any other form. It gives bird‟s eye
view of the system and the flow of transactions and integration and in documentation, can be easily
spotted and improvements can be suggested. It is also necessary for the auditor to study the significant
features of the business carried on by the concern; the nature of its activities and various channels of
goods and materials as well as cash, both inward and outward; and also a comprehensive study of the
entire process of manufacturing, trading and administration. This will help him to understand and
evaluate the internal controls in the correct perspective.
p. Cut off arrangements (June 2014)(2.5 Marks)

Answer
Cut-off arrangements: Accounting is a continuous process because the business never comes to halt. It
is, therefore, necessary that transactions of one period would be separated from those in the ensuing

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period so that the results of the working of each period can be correctly ascertained. The arrangement
that is made for this purpose is technically known as “cut-off arrangement”. It essentially forms part
of the internal control system of the organization. Accounts, other than sales, purchase and stock are
not usually affected by the continuity of the business and therefore, this arrangement is generally
applied only to sales, purchase and stock. The auditor satisfies by examination and test-checks that the
cut-off procedures are adequately followed and ensure that:
 Goods purchased, property in which passed on to the client, have in fact been included in the
inventories and that the liability has been provided for in case of credit purchase.
 Goods sold have been excluded from the inventories and credit has been taken for the sales. If
the value of sales is to be received, the concerned party has been debited.
 The auditor may examine a sample of documents, evidencing the movement of stock into and
out of stores, including documents pertaining to period shortly before and after the cut-off date
and check whether stocks represented by those documents were included or excluded as
appropriate during stock taking for perfect and correct presentation in the financial statements.
q. Objectives of Audit of the Financial Statement (December 2014)(5 Marks)

Answer
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 on whether the financial statements are prepared, in all material respects, in accordance
with an applicable financial reporting framework; and
 To report on the financial statements, and communicate as required by the NSAs, in accordance
with the auditor‟s findings.
Audits are not conducted with the objective of identifying fraud and errors prevalent in the company,
but the audit process normally result in identification of fraud or errors while conducting internal
control evaluation and using substantive procedures. This is because the auditing standards requires
an auditor to bear in mind the possibility of the existence of frauds or errors in the accounts under
audit since they may cause the financial position to be mis-stated. So, detection of material frauds and
errors as an incidental objective of independent financial auditing flows from the main objective of
determining whether or not the financial statements give a true and fair view.
r. Ownership and Custody of Working Papers (December 2014)(5 Marks)

Answer
NSA 230, Audit Documentation contains the set of standards that deal with working papers. The
standard provides that the auditor should prepare, on a timely basis, audit documentation that provides
a sufficient appropriate record of the basis for the auditor‟s report, and evidence that the audit was
performed in accordance with NSAs and applicable legal and regulatory requirements. Working
papers provide evidence that an effective, efficient, and economic audit has been carried out. As such,
working papers are the property of the auditor. The auditor may, at his discretion, make portions of or
extracts from his working papers available to his client. The auditor should retain the working papers
for the period specific or the period necessary to fulfill professional responsibility relating to the
assignment.
s. Teeming and lading ( July 2015) (2.5 Marks)

Answer
It is a fraud arrangement whereby amount received from a customer being misappropriated; also to
prevent its detection the money received from another customer subsequently being credited to the
account of the customer who has paid earlier. Similarly, moneys received from the customer who has
paid thereafter being credited to the account of the second customer and such a practice is continued
so that no one account is outstanding for payment for any length of time, which may lead the
management to either send out a statement of account to him or communicate with him.

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t. Detection risk (December 2015)(2.5 Marks)

Answer
Detection Risk: It is the risk that the auditor will not detect a misstatement that exists in an assertion
that could be material, either individually or when aggregated with other misstatements. Detection
risk is a function of the effectiveness of an audit procedure and of its application by the auditor.
u. Materiality (December 2015)(2.5 Marks)

Answer
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. Thus, 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. The auditor should consider materiality and its relationship with audit risk
when conducting an audit.
v. Going concern (December 2015)(2.5 Marks)

Answer
The going concern assumption is a fundamental principle in the preparation of financial statements.
Under the going concern assumption, an entity is ordinarily viewed as continuing in business for the
foreseeable future with neither the intention nor the necessity of liquidation, ceasing trading or
seeking protection from creditors pursuant to laws or regulations. Accordingly, assets and liabilities
are recorded on the basis that the entity will be able to realize its assets and discharge its liabilities in
the normal course of business.
Question No 3:
So far as the auditor is concerned, the examination and evaluation of the internal control system is an
indispensable part of the overall audit programme. What are the key areas that auditor will enable to
know after reviewing internal controls. (June 2010)(7 Marks)
Answer
The review of internal controls will enable the auditor to know:
i. Whether errors and frauds are likely to be located in the ordinary course of operations of the
business.
ii. Whether an adequate internal control system is in use and operating as planned by the
management.
iii. Whether an effective internal auditing department is operating.
iv. Whether the controls adequately safeguards the assets.
v. How far and the how adequately the management is discharging its function in so far as correct
recording of transactions is concerned.
vi. How reliable the reports, records and the certificates to the management can be.
vii. The extent and the depth of the examination that he needs to carry out in the different areas of
auditing.
viii. What would be appropriate audit technique and audit procedure in the given circumstances.
ix. What are the areas where control is weak and where it is excessive.
x. Whether some worthwhile suggestions can be given to improve the control system.
Question No 4:
The auditor may encounter circumstances that, individually or in combination, indicate the possibility
that the financial statements may contain a material misstatement resulting from fraud or error. List
down some of those (at least 8) circumstances that indicate a possible misstatement.

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Answer
Some of the circumstances that, individually or in combination, indicate the possibility that the
financial statements may contain the material misstatement:
i. Unrealistic time deadlines for audit completion imposed by management.
ii. Reluctance by management to engage in frank communication with appropriate third parties,
such as regulators or bankers.
iii. Limitation of audit scope imposed by management.
iv. Identification of important matters not previously disclosed by management.
v. Significant difficult-to-audit figures in the accounts.
vi. Aggressive application of accounting principles.
vii. Conflicting or unsatisfactory evidence provided by management or employees.
viii. Unusual documentary evidence such as handwritten alterations to documentations
ix. Information provided unwillingly or after unreasonable delay.
x. Seriously incomplete or inadequate accounting records.
Question No 5:
Mention briefly the conditions or events, which increase the risk of fraud or error leading to material
misstatement in Financial Statements. (June 2010)(5 Marks)
Answer
In planning and performing his examination, the auditor should take into consideration the risk of
material misstatements of the financial information caused by fraud or error. Weaknesses in the
design of the internal control system and non-compliance with identified control procedures
amongst other conditions or events which increase the risk of fraud or error are:
i. Weaknesses in the design of internal control system and non-compliance with the laid down
control procedures, e.g., a single person is responsible for the receipt of all dak and marking it
to the relevant sections or two persons are responsible for receipt of dak but the same is not
followed in actual practice, etc.
ii. Doubts about the integrity or competence of the management, e.g., domination by one person,
high turnover rate of employees, frequent change of legal counsels or auditors, significant and
prolonged understaffing of the accounts department, etc.
iii. (iii)Unusual pressures within the entity, for example, industry is doing well but the company
is not performing all right, heavy dependence on a single line of product, inadequate working
capital, entity needs raising share prices to support the market price in the wake of public
offer, etc.
iv. (iv)Unusual transactions such as transactions with related parties, excessive payment for
certain services to lawyers, etc.
v. (v) Problems in obtaining sufficient and appropriate audit evidence, e.g., inadequate
documentation, significant differences between the figures as per the accounting records and
confirmation received from third parties, etc.
Question no 6:
STU Bank Ltd. appointed you as due diligence auditor to find reason of loss in international Wool
Ltd. The company imports woolen threads and manufactures and exports woolen sweaters to Wall
Mart. Profit margin in such business after input vat refund is 26%. International Wool Ltd. imported
woolen raw materials of Rs. 200 million and sales was 220 million in F/Y 2009/10. Cost of raw
materials is inclusive of all material input. Opening and closing stock remained the same for the year.
How would you plan your audit work and what area would you focus? (December 2010)(5 Marks)
Answer
Based on the information furnished, audit plan of international wool Ltd. is to obtain or update the
knowledge of the business including consideration of the entity‟s organization, accounting systems,
operating charecteristics and the nature of its assets, liabilities, revenues and expenses. After initial
assessment and knowledge about the nature of business, areas for special attention can be identified.
In this case following areas need special attention:
i. Whether proper accounting policy is adopted or not.

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ii. Whether VAT input/VAT refund is excluded from the cost or not
iii. Whether process loss is normal and comparable to the industry or not.
iv. Whether pilferage and theft of raw material is properly controlled or not.
v. Whether raw material cost and sales value was properly accounted or not.
vi. Whether other items of revenue or expenses pertaining to business are properly recorded in
the book of accounts or not.
Question No 7:
An statutory auditor of a commercial Bank is requested to report about frauds. The management
suspects that in two loan files there could be fraud. The auditor has already found a case of
misuse of authority relating to a loan amount of Rs. 2500000 resulting into loss to the Bank to the
extent of that amount. However, the auditor was unable to find fraud in any other loan
transactions. Suggest the auditor about his course of action. (December 2010)(8 Marks)
Answer
The primary responsibly for the prevention and detection of fraud and error rests with both those
charged with the governance and the management of an entity. The auditor should obtain evidence
that management acknowledges its responsibility for the fair presentation of the financial statements
in accordance with the relevant financial reporting framework, and has approved the financial
statements.
Objective of an audit of financial statements is to enable an auditor to express an opinion on such
financial statements and not the detection and prevention of fraud and error. Audit involves exercise
of judgement. Also, the nature of the audit evidence enables the auditor to draw only reasonable
conclusions therefrom. Because of the inherent limitation of an audit, there is an unavoidable risk that
some material misstatements may remain undiscovered. While in many situations, the discovery is not
the main objective of audit nor is the auditor‟s program of work specifically designed for such
discovery. The audit cannot, therefore be relied upon to ensure the discovery of all frauds or errors but
where the auditor has such indication, he should extend his procedures to confirm or dispel his
suspicions.
Question No 8:
PR Sharma & Co. appointed you as an assistant auditor for audit of a business organization. You were
asked to prepare internal control questionnaire for audit of payments of the organization. (December
2010)(5 Marks)
Answer
Internal control questionnaire for audit of payment is as given below:
1) Are the duties related to payment segregated and rotated periodically?
2) Are the financial powers properly laid down and reasonable?
3) Have the financial powers of various authorities been intimated to various departments?
4) Whether proper and adequate documents are maintained for each payment?
5) Is the arithmetical accuracy, price, quality, timing and other terms and conditions ( of the
contract) is ensured before approving a payment?
6) Are payments made through account payee cheques except in exceptional cases?
7) Are bills marked as „paid‟ once the payment has been made? Are there adequate controls to
ensure that payment is not made twice against the same bill?
8) Is the person/party, to whom payment is made, properly identified?
9) Is issue of cheque properly controlled? Are all cheques pre numbred? Is each cheque duly
accounted for?
10) Is there a system of sending monthly statement of accounts to suppliers and other parties?
11) Are there adequate controls for safe custody of cheque books?
Question No 9:
What is the importance of working papers to the auditor? List out the documents to be kept in
permanent audit files. (December 2010)((5 Marks)

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Answer
Working papers are the property of the auditor. In view of the importance of working papers to the
auditor, ICAN has issued NSA 230/Documentation. The importance of working papers are: i.) to
assist in the planning and performance of the audit, ii.) to assist in the supervision and review of the
audit work and iii.) to provide evidence of the audit work performed to support the auditor`s opinion.
Working paper files are generally divided in to two types as per nature of documents; namely
permanent working paper files (permanent audit files) and current working paper files (current audit
files). The contents of permanent audit files are:
i. information concerning the legal and organizational structure of the client. In the case of a
company, this includes the Memorandum and Articles of Association. In case of a statutory
corporation, this includes the Act and Regulations, under which the corporation functions,
ii. extracts or copies of important legal documents, agreements and minutes relevant to the audit,
iii. a record of the study and evaluation of the internal controls related to the accounting system.
This might be in the form of narrative descriptions, questionnaires or flow charts, or some
combination thereof,
iv. copies of audited financial statements of previous years,
v. analysis of significant ratios and trends,
vi. copies of management letters issued by the auditor, if any,
vii. record of communication with the retiring auditor, if any before acceptance of the appointment
as auditor,
viii. notes regarding significant accounting policies and
ix. significant audit observations of earlier years.
Question No 10:
Define the concept of internal control and explain its inherent limitations.
(December 2010)((5 Marks)
Answer
The concept of internal control may be defined as the plan of organization and all the methods and
procedures adopted by the management of an entity to assist in achieving management‟s objectives of
ensuring the orderly and efficient conduct of its business, including adherence to management
policies, the safeguarding of assets, prevention and detection of fraud and error, the accuracy and
completeness of the accounting records, and the timely preparation of reliable financial information.
The system of internal control extends beyond those matters which relate directly to the functions of
the accounting system and comprises control environment and control procedures. Internal control is
an essential prerequisite for efficient and effective management of any organization. It is thus, a
primary responsibility of every management to establish and maintain an adequate system of internal
control appropriate to the size and nature of the business of the entity.
An internal control system can provide only reasonable, not absolute, assurance that the
management‟s objectives in establishing the system are achieved. This is because there are some
inherent limitations of internal control. These limitations are mentioned hereunder:
(a) Controls have to be cost effective. Hence, some control mechanisms may not have been
implemented merely because they are not cost-effective.
(b) Most control tools are directed at transactions of a usual nature. Therefore, transactions of
unusual nature might have been escaped from such controls.
(c) The human error potentiality prevails everywhere, even in the control systems.
(d) Any system of control has its limitations in preventing frauds through collusion between two or
more persons.
(e) Controls may not change with the pace of changes in conditions.
(f) Management itself may manipulate transactions or accounting estimates.
(g) A member of management may himself override the control system.
Question No 11:
Briefly explain the concept of Materiality. (December 2010)(June 2011)((5 Marks)
Answer

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Materiality is an important consideration for an auditor to evaluate whether the financial statements
reflect a true and fair view or not. The auditor should consider materiality and its relationship with
audit risk when conducting an audit. The Nepal Accounting Standards Board's "Framework for the
Preparation and Presentation of Financial Statements" defines Materiality 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. Thus, 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."
In designing the audit plan, the auditor establishes an acceptable materiality level so as to detect
quantitatively material misstatements. However, both the amount (quantity) and nature (quality) of
misstatements need to be considered. Examples of qualitative misstatements would be the inadequate
or improper description of an accounting policy when it is likely that a user of the financial statements
would be misled by the description, and failure to disclose the breach of regulatory requirements
when it is likely that the consequent imposition of regulatory restrictions will significantly impair
operating capability.
The auditor should consider the possibility of misstatements of relatively small amounts that,
cumulatively, could have a material effect on the financial statements. For example, an error in a
month end procedure could be an indication of a potential material misstatement if that error is
repeated each month.
The auditor should also consider materiality at both the overall financial statement level and in
relation to individual account balances, classes of transactions and disclosures. Materiality may be
influenced by considerations such as legal and regulatory requirements and considerations relating to
individual financial statement account balances and relationships. This process may result in different
materiality levels depending on the aspect of the financial statements being considered.
While determining the nature, timing and extent of audit procedures; and evaluating the effect of
misstatements, the auditor should consider the materiality. When planning the audit, the auditor
should consider what would make the financial statements materially misstated. The auditor's
assessment of materiality, related to specific account balances and classes of transactions, helps the
auditor decide such questions as what items to examine and whether to use sampling and analytical
procedures. This enables the auditor to select audit procedures that, in combination, can be expected
to reduce audit risk to an acceptably low level. There is an inverse relationship between materiality
and the level of audit risk, that is, the higher the materiality level, the lower the audit risk and vice
versa.
The auditor in addition to exercising professional judgment should consider any legislation or
regulation which may impact that assessment while assessing materiality in the case of the public
sector. In the public sector, materiality is also based on the “context and nature” of an item and
includes, for example, sensitivity as well as value. Sensitivity covers a variety of matters such as
compliance with authorities, legislative concern or public interest.
Question No 12
Justify with reason, whether following statement is true or false.
Generally, purpose of misstatement in a financial statement of a medium sized sole proprietorship
business in Nepal is to benefit proprietor himself. (December 2010)(5 Marks)
Answer
True: Typical medium sized business in Nepal, tend to mispresents their financial statements to
benefit their proprietor by way of lowering or reducing tax liability by understanding income or over
standing the expenses. Typical medium sized business-man tends to lower payment of tax or do not
want to pay any tax. Some time such business man may mistake his financial statements to justify his
loan application to a bank and financial institutions. In other situations such financial statements may
be misstated to mislead the various stakeholders or users of such financial statements so that benefits
is derived by proprietor of such business.
Question No 13

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Audit plan is substitute for audit program. (December 2010)(5 Marks)

Answer
The statement is false: Audit plan is initial step of audit. Whereas, audit program is setting up of
procedures that are needed to implement the audit plan. Overall audit plan is for expected scope ans
conduct of audit. On the other hand audit program shows nature, time and extend of audit procedures.
In planning an audit, auditor should consider facteo such as complexity of the audit, the environment
in which the clint operates, his previous experience with the clint and knowledge of clint‟s business.
The audit program serves as a set of instructions to the assistants involved in the audit and a means to
control the proper execution of the work. Therefore, audit program supplement the audit plat for
execution and it does not stand out as substitute.
Question No 14
What are the auditor‟s responsibilities for detection of frauds and errors? (June 2010)( 10 Marks)
Answer
It has been explicitly mentioned in the NSA 240 that the primary responsibility for the prevention and
detection of fraud rests with both those charged with governance of the entity and with management.
The respective responsibilities of those charged with governance and of management may vary by
entity to entity. It is important that management, with the oversight of those charged with governance,
place a strong emphasis on fraud prevention, which may reduce opportunities for fraud to take place,
and fraud deterrence, which could persuade individuals not to commit fraud because of the likelihood
of detection and punishment. It is the responsibility of those charged with governance of the entity to
ensure, through oversight of management, that the entity establishes and maintains internal control to
provide reasonable assurance with regard to reliability of financial reporting, effectiveness and
efficiency of operations and compliance with applicable laws and regulations. This responsibility
includes establishing and maintaining controls pertaining to the entity‟s objective of preparing
financial statements that give a true and fair view (or are presented fairly in all material respects) in
accordance with the applicable financial reporting framework and managing risks that may give rise
to material misstatements in those financial statements. Such controls reduce but do not eliminate the
risks of misstatement.
An auditor conducting an audit in accordance with NSAs obtains reasonable assurance that the
financial statements taken as a whole are free from material misstatement, whether caused by fraud or
error. An auditor cannot obtain absolute assurance that material misstatements in the financial
statements will be detected because of such factors as the use of judgment, the use of testing, the
inherent limitations of internal control and the fact that much of the audit evidence available to the
auditor is persuasive rather than conclusive in nature.
The primary objective of an auditor is to express an opinion on the financial statements. However, the
auditor while conducting the audit is required to consider the risk of material misstatements in the
financial statements resulting from fraud or error. An audit conducted in accordance with the auditing
standards generally accepted in Nepal is designed to provide reasonable assurance that the financial
statements taken as a whole are free from material misstatement, whether caused 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.
The auditor's opinion on the financial statements is based on the concept of obtaining reasonable
assurance; hence, in an audit, the auditor does not guarantee that material misstatements, whether
from fraud or error, will be detected.
Question No 15
Proper audit is not possible without adequate knowledge of client‟s business. Explain it. (June
2011)(5 Marks)
Answer
Obtaining an understanding of the entity and its environment is an essential aspect of performing an
audit in accordance with Nepal Standard on Auditing . In particular, that understanding establishes a
frame of reference within which the auditor plans the audit and exercises professional judgment about
assessing risks of material misstatement of the financial statements and responding to those risks
throughout the audit, for example when:

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 Establishing materiality and evaluating whether the judgment about materiality remains
appropriate as the audit progresses;
 Considering the appropriateness of the selection and application of accounting policies, and the
adequacy of financial statement disclosures;
 Identifying areas where special audit consideration may be necessary, for example, related party
transactions, the appropriateness of management‟s use of the going concern assumption, or
considering the business purpose of transactions;
 Developing expectations for use when performing analytical procedures;
 Designing and performing further audit procedures to reduce audit risk to an acceptably low level;
and
 Evaluating the sufficiency and appropriateness of audit evidence obtained, such as the
appropriateness of assumptions and of management‟s oral and written representations.
The auditor uses professional judgment to determine the extent of the understanding required of the
entity and its environment, including its internal control. The auditor‟s primary consideration is
whether the understanding that has been obtained is sufficient to assess the risks of material
misstatement of the financial statements and to design and perform further audit procedures. The
depth of the overall understanding that is required by the auditor in performing the audit is less than
that possessed by management in managing the entity.
Question No 16
Define the concept of internal control and explain its inherent limitations. .(June 2011)(5 Marks)
Answer
The concept of internal control may be defined as the plan of organization and all the methods and
procedures adopted by the management of an entity to assist in achieving management‟s objectives of
ensuring the orderly and efficient conduct of its business, including adherence to management
completeness of the accounting records, and the timely preparation of reliable financial information.
The system of internal control extends beyond those matters which relate directly to the functions of
the accounting system and comprises control environment and control procedures. Internal control is
an essential prerequisite for efficient and effective management of any organization. It is thus, a
primary responsibility of every management to establish and maintain an adequate system of internal
control appropriate to the size and nature of the business of the entity.
An internal control system can provide only reasonable, not absolute, assurance that the
management‟s objectives in establishing the system are achieved. This is because there are some
inherent limitations of internal control. These limitations are mentioned hereunder:
1. Controls have to be cost effective. Hence, some control mechanisms may not have been
implemented merely because they are not cost-effective.
2. Most control tools are directed at transactions of a usual nature. Therefore, transactions of
unusual nature might have been escaped from such controls.
3. The human error potentiality prevails everywhere, even in the control systems.
4. Any system of control has its limitations in preventing frauds through collusion between two
or more persons.
5. Controls may not change with the pace of changes in conditions.
6. Management itself may manipulate transactions or accounting estimates.
7. A member of management may himself override the control system.
Question No 17
Briefly explain five methods of sampling. (June 2011)(5 Marks)
Answer
Methods of sampling is presented below:
i. Haphazard Sampling
Haphazard sampling is a technique adopted by the auditor where the sample does not follow a
structured technique. Haphazard sampling is not appropriate when using statistical sampling and the

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auditor should always ensure that haphazard sampling is not „doctored‟ in such a way that it
deliberately avoids sampling items which, for example, are difficult to locate. All items in the
population should stand a chance of being sampled.
ii. Stratified Sampling
This is a technique where the auditor will split items in a sample into their various strata‟s. For
example, in a payroll sample the auditor might split the sample between full-time males, full-time
females, part-time males and part-time females and work out the percentage of the strata in the
population (the population being the total amount that makes up a figure). For example if 30% of the
population are full-time males, 40% full-time females, 20% part-time males and 10% part-time
females, then the sample will consist of 30% full-time males, 40% full-time females etc.
iii. Systematic Sampling
Often referred to as „interval‟ sampling this is where the auditor will take the number of sampling
units in the population and divide this into the sample size to give a sampling interval. For example in
a sales invoice sample where the sampling interval is 20, then the auditor will determine a starting
point for sampling and sample every 20th sales invoice thereafter.
iv. Block Sampling
Block sampling is a technique where the auditor applies procedures to such items that all occur in the
same block of time or sequence. For example testing amounts received from customers in the month
of September. Alternatively, a „block‟ of remittance advices received in September would be tested in
their entirety. It is to be noted that block sampling should be used with caution because valid
references cannot be made beyond the period or block examined. Where the auditor does use block
sampling, then many blocks should be selected to help minimise sampling risk.
v. Judgement
Auditors can use their judgement in selecting items for sampling. There are three basic issues which
determine which items are selected:
 The value of items
 The relative risk (items prone to error should be given special attention)
 The representativeness (the sample should be representative of the population)
Question No 18
What are the principal contents of audit engagement letter? (June 2011)(5 Marks)
Answer
The form and content of audit engagement letters may vary for each client, but they would generally
include reference to:
 The objective of the audit of financial statements;
 Management‟s responsibility for the financial statements;
 The scope of the audit, including reference to applicable legislation, regulations, or
pronouncements of professional bodies to which the auditor adheres;
 The form of any reports or other communication of results of the engagement;
 The fact that because of the test nature and other inherent limitations of an audit,
together with the inherent limitations of internal control, there is an unavoidable risk that even
some material misstatement may remain undiscovered; and
 Unrestricted access to whatever records, documentation and other information requested in
connection with the audit.
 Management‟s responsibility for establishing and maintaining effective internal control.
Question No 19
Reducing assurance engagement risk to zero is very rare. (June 2011)(5 Marks)
Answer
The statement is true. Reducing assurance engagement risk to zero is very rare because of the
following reasons:
 The use of selective testing;
 The inherent limitations of internal control;

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 The fact that much of the evidence available to practitioner is persuasive rather than
conclusive; and
 The use of judgment in gathering and evaluating evidence and framing conclusions based on
that evidence.
Question No 20
What is the relationship between materiality and audit risk and how audit risk can be reduced to an
acceptable level? (December 2011)(5 Marks)
Answer
The auditor is concerned with expressing opinion on true and fairness of the the financial statements.
Similarly, as per NSA-240 Nepal Standards on Auditing the auditors' responsibility to consider fraud
and error in an audit of financial statements. Audit Risk is the risk that the auditor gives an
inappropriate audit opinion when the financial statements are materially misstated or the frauds and
errors are not reported. Due to nature of audit evidence and the characteristics of fraud, the auditor is
not able to obtain absolute assurance of detecting misstatements and frauds. Thus, the auditor gives
only reasonable assurance that material misstatements are detected.
The concept of materiality recognizes that some matters, either individually or in the aggregate, are
important for fair presentation of ﬁnancial statements in conformity with generally accepted
accounting principles, while other matters are not important. As per NSA-320 on Audit Materiality
the auditor should consider materiality and its relationship with audit risk when conducting an audit.
"Materiality" is defined in the Nepal Accounting Standards 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. Thus, 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."
According to NSA-320 on Audit materiality, there is an inverse relationship between materiality and
degree of audit risk. Higher the materiality level, lower the audit risk and vice-versa. The risk that a
particular account balance or class of transaction would be mis-stated by an extremely large amount
might be very low. But the risk that it could be mis-stated by an extremely small amount might be
very high. The auditor considers this inverse relationship when he determines the nature, timing and
extent of his audit procedures. If after planning for specific audit procedures, he concludes that
acceptable materiality level is lower, audit risk is increased. The auditor should try to reduce the audit
risk to an acceptable level by:-
 Reducing the assessed degree of control risk by carrying out extended or additional test of
control, or
 Reducing detection risk by modifying the nature, timing and extent of his substantive
procedures.
Question No 21
a. Audit Planning and Audit Program (December 2011)(5 Marks)
Answer
As per NSA-300 on Audit Planning, the auditor should plan the audit work so that the audit will be
performed in an effective manner. The "Audit Planning" means developing a general strategy and a
detailed approach for the expected nature, timing and extent of the audit. The auditor plans to perform
the audit in an efficient and timely manner. Audit planning is one of the basic principles of auditing.
Plan should be based on knowledge of the clients business. Audit planning is a continuous process

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throughout the audit engagement and covers developing an overall plan for the expected scope and
conduct of the audit and developing an audit program showing the nature, timing and extent of audit
procedures. Adequate planning of the audit work helps to ensure that appropriate attention is devoted
to important areas of the audit, those potential problems are identified and that the work is completed
expeditiously. Planning also assists in proper assignment of work to assistants and in coordination of
work done by other auditors and experts. The extent of planning will vary according to the size of the
entity, the complexity of the audit and the auditor's experience with the entity and knowledge of the
business. Matters to be considered by the auditor in developing the overall audit plan include
knowledge of business, understanding the accounting and internal control systems, risk and
materiality, nature, timing and extent of procedures, coordination, direction supervision and review
process etc.
The same NSA-300 mentions that the auditor should develop and document an audit program setting
out the nature, timing and extent of planned audit procedures required to implement the overall audit
plan. Hence, audit program is nothing but a list of examination and verification steps to be applied set
out in such a way that the inter-relationship of one step to another in clearly shown and designed,
keeping in view the assertions discernible in the statements of account produced for audit or on the
basis of an appraisal of the accounting records of the client. In other words, an audit program is a
detail plan of applying the audit procedures in the given circumstances with instructions for the
appropriate techniques to be adopted for accomplishing the audit objectives.
The difference between audit plan and audit program is that audit program is a part of audit plan.
While audit plans involves each step of audit from engagement to issuance of final report audit
program deals with only nature, timing and extent of audit procedures.
b. Compliance procedures and substantive procedure (December 2011)(5 Marks)

Answer
Compliance procedures are those tests designed to obtain reasonable assurance that those internal
controls on which audit reliance is to be placed are in effect. In obtaining audit evidence from
compliance procedures, the auditor is concerned with assertions that the control exists, the control is
operating effectively and the control has so operated throughout the period of intended reliance.
Whereas substantive procedures are tests designed to obtain evidences as to the completeness,
accuracy and validity of the data produced by accounting system. They are of two types: tests of
details of transactions and balances and analysis of significant ratios and trends. As mentioned in
NSA-500 Audit Evidence, when obtaining audit evidence from substantive procedures, the auditor
should consider the sufficiency and appropriateness of audit evidence from such procedures together
with any evidence from tests of control to support financial statement assertions.
c. Internal check and Internal control (June 2012) ( 5 Marks)

Answer
Internal check is a check on day-to-day transactions which operate continuously as part of the routine
system whereby the work of one person is proved independently or is complementary to the work of
another, the object being the prevention or early detection of errors or fraud. Internal check is a part of
the overall internal control system and operates as built-in device as far as the staff organization and
job allocation aspects of the control system are concerned.
The internal control is a plan of an organization and all the methods and procedures adopted by the
management of an entity to assist in achieving management's objective of ensuring, as far as
practicable, the orderly and efficient conduct of its business, including adherence to management
completeness of the accounting records and the timely preparation of reliable financial information.
d. Test checking and statistical sampling (June 2012) ( 5 Marks)

Answer
During audit, entries, involving large amounts or relating to material accounts are seen exhaustively
and they are picked up for verification at random from the remainder according to certain plan is

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known as test checking. The only quality that this technique can claim lies in its keenness to cover
larger amounts and material accounts. Even if errors, frauds etc. remain undetected in the part not
checked, they are not likely to be too big as to upset the truth and fairness of the financial statement.
On the other hand, Statistical sampling is a method of audit testing which is more scientific based
entirely on the auditors own judgment because it involves use of mathematical laws of probability in
determining the appropriate sample size in varying circumstances. Statistical sampling has reasonably
wide application where a population to be tested consists of a large number of similar items and more
in the case of transactions involving compliance testing, debtors confirmation, payroll checking,
vouching of invoices and petty cash vouchers.
e. Audit Plan and Audit Program (December 2013)(5 marks)

Answer
The Distinction between Audit Plan and Audit Program are outlined as follows:
Audit plan is the developing a general strategy and a detailed approach for the expected nature, timing
and extent of the audit. The auditor plans to perform the audit in efficient and timely manner where as
audit program is the step and guidance and works as a tool for performing/implementing audit at the
execution level. The distinctions of those two are:
i. Audit plan is prepared before preparing audit program.
ii. Audit plan is border scope than audit program.
iii. Audit plan assists acquiring knowledge of clients business and concentrating on risk areas which
will help for preparing effective audit program.
iv. Audit plan generally prepares by senior auditors and program may be prepared by juniors based
on plan and duly approved by seniors.
f. Internal Control Questionnaire and Internal Control Evaluation (June 2014)(2.5 Marks)
Answer
Internal Control Questionnaire (ICQ) and Internal Control Evaluation (ICE) : The internal control
questionnaires show the area where weakness occur or likely to occur. They do not give any idea of
the importance of those weaknesses. The Internal Control Evaluation brings to light importance of
those weakness disclosed by ICQ. Main points of distinctions are:
1. ICQ incorporates a large number of detailed questions but does not attempt to distinguish
their relation in materiality. ICE isolates the main control objectives within the area of review.
2. Weaknesses are highlighted by answer “Yes” on ICE compared with „No‟ on ICQ.
3. Answer „no‟ in ICQ indicates a weakness real or potential, but its significance is not revealed.
Whereas ICE requires audit personnel to state whether, an apparent weakness may prove to be
material in relation to the accounts as a whole.
4. The „Control Checklist‟ in ICE is more than a summary of key control factors, and is no
substitute for ICQ.
Question No 22
An audit is not a guarantee that the financial statements are free from material misstatement, because
absolute assurance is not attainable. What are the factors which hinders the auditor to provide absolute
assurance? (December 2012)(5 Marks)
Answer
Auditor provides reasonable assurance on the financial statements and is not in the position to provide
absolute assurance due to the following factors:
i. Use of testing/sampling rather than 100% checking,
ii. The inherent limitations of internal control (for example, the possibility of management override
or collusion),
iii. The fact that most audit evidence is persuasive rather than conclusive and
iv. The work undertaken by the auditor to form an audit opinion is permeated by judgment, in
particular regarding: (a) The gathering of audit evidence, for example, in deciding the nature,

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timing and extent of audit procedures; and (b) The drawing of conclusions based on the audit
evidence gathered, for example, assessing the reasonableness of the estimates made by
management in preparing the financial statements.
Question No 23
As an auditor of a small business, how can you assure the internal control system of that company?
Answer
Internal control is a set of internally generated policies and procedures adopted by the management of
an enterprise which is pre requisite for an organization‟s efficient and effective performance. It is thus
a primary responsibility of every management to create and maintained adequate system of internal
control appropriate to the size and nature of the business entity.
The system of internal control as the process designed, implemented and maintained by those charged
with governance, management and other personnel to provide reasonable assurance about the
achievement of an entity‟s objectives with regard to reliability of financial reporting, effectiveness &
efficiency of operations, safeguarding of assets and compliance with applicable laws & regulations.
The auditor needs to obtain the same degree of assurance in order to given an unqualified opinion on
the financial statements of both small & large entities. However many controls which would be
relevant to large entities are not practical in small business. For example, in a small business,
accounting procedure may be performed by a few persons.
Small business is characterized by the lower number of employees, minimum investment of capital,
small capacity of production, difficulty to segregate the owner and the management and there is less
use of technology. It means the business is producing the product (if it is a manufacturing industry)
manually using very less mechanical tools and traditional tools.
Like, another characteristic is the simplicity and local products designed to cover up the local
environment. It is highly labour intensive and less machine oriented in nature. Also the business is
dependent with the skill labour instead of installing high value of machine.
Those persons may have both operating and custodial responsibilities and segregation of function may
be missing or severely limited.
Inadequate segregation of duties, may in some cases, is offset by supervisory controls exercised by the
owner. The supervisory function by the owner becomes possible because of the fact that he has direct
personal knowledge of the business and involvement in the business transactions.
In circumstances where segregation of duties is limited and the evidence of supervisory controls is
lacking the evidence necessary to support the auditors opinion on the financial information may have
to be obtained largely through substantive procedure.
Question No 24
Give your comment
The management of Shri Ram Pvt. Ltd. argued that auditor has not carried out the work properly
citing reason that certain fraud and error were revealed after issuing audit report, whereas audit report
was silent on such fraud & error. (June 2013)(5 Marks)
Answer
Nepal Standards on Auditing (NSA) 240 on „The Auditor's Responsibility to Consider Fraud and
Error in an Audit of Financial Statements‟ deals the matter on auditor responsibility. NSA 01 has
defined the objective of an audit of financial statements and as per this standard, the auditor should
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 from material misstatement, whether caused 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 detection of fraud and error.
The management connotation on charge to auditor will be tenable only if the auditor fails to carry out
his duty under following parameters:

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i) Using professional skepticism for understanding the risk of material misstatements resulting
from the errors and frauds in financial statements.
ii) Audit preliminaries for gaining knowledge about any susceptibility of misstatements arising
from fraud; Audit planning with audit team, audit enquiry of management; discussion
with charge of corporate governance; identification of fraud risk factors etc.
iii) Audit Response when fraud risk factors are identified to be present-Considering modifying
substantive procedures to reduce detection risk.
iv) Circumstances indicative of presence of misstatement resulting from fraud, identification of
misstatement.
v) Determining the effect of misstatement in financial statements, tagging it with fraud,
documentation, communication and reporting.
vi) Awareness of auditor‟s responsibility in addition with the responsibility of that charge of
governance.
Question No 25
What is audit risk? Explain three components of audit risk and also define their relationship.
Answer
Audit Risk (AR): Audit risk is the risk that the auditor gives an inappropriate audit opinion when the
financial statements are materially misstated. In other words, it is a function of the risk of material
misstatement of the financial statements (or simply, the “risk of material misstatement”) (i.e., the risk
that the financial statements are materially misstated prior to audit) and the risk that the auditor will
not detect such misstatement (“detection risk”).
Three components of audit Risk:

i. Inherent Risk (IR): “Inherent risk” is the susceptibility of an assertion to a misstatement that could
be material, either individually or when aggregated with other misstatements, assuming that there
are no related controls.
ii. Control Risk (CR): “Control risk” is the risk that a misstatement that could occur in an assertion and
that could be material, either individually or when aggregated with other misstatements, will not be
prevented, or detected and corrected, on a timely basis by the entity‟s internal control. That risk is a
function of the effectiveness of the design and operation of internal control in achieving the entity‟s
objectives relevant to preparation of the entity‟s financial statements. Some control risk will always
exist because of the inherent limitations of internal control.
iii. Detection Risk (DR): “Detection risk” is the risk that the auditor will not detect a misstatement that
exists in an assertion that could be material, either individually or when aggregated with other
misstatements. Detection risk is a function of the effectiveness of an audit procedure and of its
application by the auditor. Detection risk cannot be reduced to zero because the auditor usually does
not examine all of a class of transactions, account balance, or disclosure and because of other
factors. Such other factors include the possibility that an auditor might select an inappropriate audit
procedure, misapply an appropriate audit procedure, or misinterpret the audit results. These other
factors ordinarily can be addressed through adequate planning, proper assignment of personnel to
the engagement team, the application of professional skepticism, and supervision and review of the
audit work performed.
Relationship of Audit Risk with its components:

The relationship is expressed by the following Equation:
AR=IR*CR*DR
From the definition of various components of audit risk stated above, it is clear that IR and CR cannot
be reduced by the auditor. In other words the auditor has control over DR only. So, to keep the audit
risk at acceptable level based on above equation, if the product of IR and CR is high, the auditor
should reduce DR.

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Question No 26
What are the elements that an auditor has to be considered while evaluating the design of the entity‟s
control environment? (December 2013)(5 marks)
Answer
As per NSA 315 Section 67 the auditor should obtain an understanding of the control environment.
The control environment includes the governance and management functions and the attitudes,
awareness, and actions of those charged with governance and management concerning the entity‟s
internal control and its importance in the entity. The control environment sets the tone of an
organization, influencing the control consciousness of its people. It is the foundation for effective
internal control, providing discipline and structure.
Section 68 has defined the primary responsibility for the prevention and detection of fraud and error
rests with both those charged with governance and the management of an entity. In evaluating the
design of the control environment and determining whether it has been implemented, the auditor
understands how management, with the oversight of those charged with governance, has created and
maintained a culture of honesty and ethical behavior, and established appropriate controls to prevent
and detect fraud and error within the entity.
In evaluating the design of the entity‟s control environment, the auditor considers the following
elements and how they have been incorporated into the entity‟s processes:
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 27
Mention briefly the conditions or events, which increase the risk of fraud or error leading to material
misstatement in financial statements. (December 2013)(5 marks)
Answer
NSA 5 has defined the risk of fraud and error in the entity. In planning and performing his
examination, the auditor should take into consideration the risk of material misstatements of the
financial information caused by fraud or error. Weaknesses in the design of the internal control
system and non-compliance with identified control procedures amongst other conditions or events
which increase the risk of fraud or errors are:
i) Weaknesses in the design of the internal control system and non-compliance with the laid
down control procedures.
ii) Doubts about the integrity or competence of the management.
iii) Unusual pressures within the entity
iv) Unusual transactions
v) Problem in obtaining sufficient and appropriate audit evidence.
Question No 28

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While conducting the audit of X-ray Limited, Mr. Pratap, the statutory auditor found that the detection
risk relating to certain transactions cannot be reduced to acceptable level. As a Statutory Auditor, how
would you deal in the given situation? (June 2014)(5 Marks)
Answer
The auditor should use professional judgment to assess audit risk and to design audit procedures to
ensure that it is reduced to an acceptably low level.
“Detection risk” is the risk that an auditor‟s substantive procedures will not detect a misstatement that
exists in an account balance or class of transactions that could be material. The higher the assessment
of inherent and control risks, the more audit evidence the auditor should obtain from the performance
of substantive procedures. When both inherent and control risks are assessed as high, the auditor
needs to consider opinion or a disclaimer of opinion as may be appropriate.
Question No 29
Answer the question
P.G. & Company is the auditors of Professional Systems Company Ltd. The Managing Director of the
Company demands copies of the working papers from the auditors. Are the auditors bound to oblige
the Managing Director? (June 2014)(5 Marks)
Answer
As per principle of Audit Documentation, the working papers are the property of the auditor, the
auditor may, at his discretion make portion of or extracts from his working papers available to the
client. In the instant case the managing director of the company has demanded copies of the working
papers from the auditor. He has no right to obtain copies of the working papers from the auditor
because they are the property of the auditor. However the auditor may at his discretion make portions
of or extracts from the working paper to the managing director of Professional Systems Company Ltd.
The auditor is not bound to oblige the managing director by supplying copies of the audit working
papers.
Question No 30
Explain briefly the technique of "Internal Control Questionnaire" to facilitate the accumulation of
information necessary for proper evaluation of internal control. (June 2014)(5 Marks)
Answer
Internal control questionnaire is a comprehensive series of questions concerning internal control. It is
the most widely used form for collecting information about the existence, operation and efficiency of
internal control in the organisation.
In the questionnaire, questions are generally so framed that a „Yes‟ answer denotes satisfactory
position and a „No‟ answer suggests weakness. Provision is made for an explanation or further details
of „No‟ answers. In respect of questions not relevant to the business, „Not Applicable‟ reply is given.
The questionnaire is usually issued to the client and the client is requested to get it filled by the
concerned executives and employees. If on a perusal of the answers, inconsistencies or apparent
incongruities are noticed, the matter is further discussed by auditor‟s staff with the client‟s employees
for a clear picture. The concerned auditor then prepares a report of deficiencies and recommendations
for improvement.
An important advantage of the questionnaire approach is that oversight or omission of significant

internal control review procedures is less likely to occur with this method. With a proper
questionnaire, all internal control evaluation can be completed at one time or in sections. The review
can more easily be made on an interim basis. The questionnaire form also provides an orderly means
of disclosing control defects. It is the general practice to review the internal control system annually
and record the review in detail.
Question No 31

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Explain the limitations of Internal Control. (June 2014)(5 Marks)

Answer
An Internal Control system can provide only reasonable assurance that the management‟s objectives
in establishing the system are achieved. That is, no internal control system can provide absolute
assurance that the control objectives are achieved. This is due to the fact that any internal control
system has certain internal limitations. The limitations may arise due to:
i) Management‟s usual requirement that the cost of an internal control does not exceed the
expected benefits to be derived.
ii) Most internal controls tend to be directed at routine transactions rather than non-routine
transactions.
iii) The potential for human error due to carelessness, distraction, mistakes of judgment and the
misunderstanding of instructions.
iv) The possibility of circumvention of internal controls through the collusion of a member of
management or an employee with parties outside or inside the entity.
v) The possibility that a person responsible for exercising an internal control could abuse that
responsibility, for example, a member of management overriding an internal control.
vi) The possibility that procedures may become inadequate due to changes in conditions, and
compliance with procedures may deteriorate. Controls has to be cost-effective.
The inherent limitation of internal control system requires the auditor to perform substantive
procedure to be able to express an opinion.
Question No 32
What are the factors that are to be considered while designing a confirmation request?
Answer
As per NSA -505 “External Confirmations”, the design of a confirmation request may directly affect
the confirmation response rate, and the reliability and the nature of the audit evidence obtained from
responses. The following factors should be considered while designing a confirmation request:-
 The assertions being addressed.
 Specific identified risks of material misstatement, including fraud risks.
 The layout and presentation of the confirmation request.
 Prior experience on the audit or similar engagements.
 Management‟s authorization to the confirming parties to respond to the auditor. Confirming
parties may only be willing to respond to a confirmation request containing management‟s
authorization.
 The ability of the confirming party to provide the requested information
Question No 33
Explain „Audit Sampling‟ and „Sampling Risk‟ in the light of NSA - 530 Audit Sampling and Other
Selective Testing Procedures. (December 2014)(5 Marks)
Answer
Audit sampling involves the application of audit procedures to less than 100% of items within an
account balance or class of transactions such that all sampling units have a chance of selection. This
will enable the auditor to obtain and evaluate audit evidence about some characteristic of the items
selected in order to form or assist in forming a conclusion concerning the population from which the
sample is drawn. Audit sampling can use either a statistical or a non-statistical approach.
Sampling risk arises from the possibility that the auditor's conclusion, based on a sample may be
different from the conclusion reached if the entire population were subjected to the same audit
procedure. There are two types of sampling risk:
i) the risk the auditor will conclude, in the case of a test of control, that control risk is lower than
it actually is, or in the case of a substantive test, that a material error does not exist when in
fact it does. This type of risk affects audit effectiveness and is more likely to lead to an
inappropriate audit opinion; and

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ii) the risk the auditor will conclude, in the case of a test of control, that control risk is higher
than it actually is, or in the case of a substantive test, that a material error exists when in fact it
does not. This type of risk affects audit efficiency as it would usually lead to additional work
to establish that initial conclusions were incorrect.
Question No 34
What are the principal contents of Terms of Audit Engagement as per NSA 210?
Answer
The form and content of audit engagement letters may vary for each client, but they would generally
include reference to:
 The objective of the audit of financial statements.
 Management's responsibility for the financial statements.
 The scope of the audit, including reference to applicable legislation, regulations or
pronouncements of the Institute of Chartered Accountants of Nepal (ICAN).
 The form of any reports or other communication of results of the engagement
 The fact that because of the test nature and other inherent limitations of an audit, together with
the inherent limitations of any accounting and internal control system, there is an unavoidable
risk that even some material misstatement may remain undiscovered.
 Unrestricted access to whatever records, documentation and other information requested in
connection with the audit.
 Management's responsibility for establishing and maintaining effective internal control.
Other matters that may be included are:

 Description of the basis for fees.
 Ownership and accessibility of the auditor‟s files to external parties.
 Interactions with specialists, internal auditors, and the predecessor auditor needed to conduct the
audit
 Restrictions to the auditor's liability.
Question No 35
Explain the control environment as a part of Internal Control System. ( July 2015) (5 Marks)
Answer
Control environment refers to overall attitude, awareness and actions of governance and management
regarding the internal control system and its importance in the entity. The control environment has an
effect on the effectiveness of the specific control procedures. A strong control environment, for
example, one with tight budgetary controls and an effective internal audit function, can significantly
complement specific control procedures. However, a strong environment does not, by itself, ensure
the effectiveness of the internal control system.
Factors reflected in the control environment include:
 The function of the board of directors and its committees.
 Management‟s philosophy and operating style.
 The entity‟s organizational structure and methods of assigning authority and responsibility.
 Management‟s control system including the internal audit function, personnel policies and
procedures and segregation of duties.
Question No 36
„Doing a statutory audit is full of risk. `Narrate the factors which cause the risk.
Answer

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An independent audit whether performed in terms of relevant statutory legislation or in terms of the
engagement, the auditor has to be reasonably satisfied as to whetherthe information contained in the
underlying accounting records and other source datais reliable for the preparation of financial
statements. Since the entire process of auditing is based on the assessment of judgements made by the
management of theentity as well as evaluation of internal controls, the audit suffers certain
inherentrisks. Factors which can such risk in conducting an audit are discussed below:
i) Exercising judgement on the part of the auditor: The auditor‟s work involvesexercise of
judgement, for example, in deciding the extent of audit procedures andin assessing the
reasonableness of the judgements and estimates made bymanagement in preparing the financial
statements.
ii) Nature of audit evidence: The auditor normally relies upon persuasive evidenc erather than
conclusive evidence. Even in circumstances where conclusive evidenceis available, the cost of
obtaining such an evidence may far exceed the benefits.
iii) Inherent limitations of internal control: Internal control can provide only reasonable, but not
absolute, assurance on account of several inherent limitations such as potential for human error,
possibility of circumstances of control through collusion, etc.
On account of above, it is quite nature that an audit suffers from control risk on account of inherent
limitations of internal control risk and detection risk on account oftest nature of audit and judgement
and estimates involved in formulating accounting policies.
Question No 47
Your CA firm has been allotted with Information Systems Audit of one of the reputed Commercial
Bank of Nepal. How would you assess the reliability of internal control system in computerized
information system? (December 2015)(5 Marks)
Answer
For evaluating the reliability of internal control system in CIS, the auditor would consider the
followings:-
 That authorised, correct and complete data is made available for processing.
 That it provides for timely detection and corrections of errors.
 That in case of interruption due to mechanical, power or processing failures,the system restarts
without distorting the completion of entries and records.
 That it ensures the accuracy and completeness of output.
 That it provides security to application softwares & data files against fraud etc.
 That it prevents unauthorised amendments to programs.

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Question No 1:
Give your comments on the following:
a) Forward Looking Co Ltd is dealing with various transactions that could be well termed as contingent
liability. As an auditor, suggest some of the procedures for verifying contingent liabilities?
Answer
The auditor may carryout the following procedures for verifying the contingent liabilities:
a) Review the minutes of the meetings of board of directors/ committees.
b) Review the relevant contracts, agreements and arrangements.
c) Review the list of pending legal cases, correspondence relating to taxes, duties etc.
d) Review the records maintained by the entity regarding contingent liabilities.
e) Make enquiries of and hold discussion with the entity‟s management.
f) Obtain representations from the management.
b) Metro Developers Pvt. Ltd is Bharatpur based Real Estate Company. It has invested heavily on the
apartments and commercial complexes on and around Narayangarh. Recently, audit of the transaction
for rental receipts was hastily completed by taking monthly average figure and multiplying it by 12.
You are required to suggest appropriate way of conducting of audit for the above said transaction of
rental receipts. (June 2010)(5 Marks)
Answer
To vouch for rental receipts, various documents need to be seen. To start with, copies of bills issued to
tenants should be test checked by reference to copies of tenancy agreements and bills of charges paid
by the landlord on behalf of the tenants e.g., house tax, water tax etc. The amounts collected from
tenants on account of rent should be checked by reference to receipts issued by them. The entries in
the Rental Register in respect of rents accrued afterwards should be verified. The register should also
be scrutinized for finding out the rent amount, which have not been recovered and are considered bad
or irrecoverable, for deciding whether these should be written off or provision against the same should
be made.
c) Association for Backward Communities (ABC) is one of the NGOs working in the Midwest part of
the country. There seems to be confusion regarding total receipt of the NGO as what could be the
probable revenue sources and how they should be vouched. The chief of the NGO is mostly on the
foreign tour and the accountant of the NGO simply says „boss knows everything and he is just clerk‟.
What documents you will insist to check to deal with the situation? (June 2010)(5 Marks)
Answer
The receipt of income of NGO may be checked on the following lines:
i) Contribution and grants for projects and programmes: Check agreements with donors and grants
letters to ensure that funds received have been accounted for. Check that all foreign contributions
receipts are deposited into bank accounts and proper disclosure is made.
ii) Receipts from fund raising programmes: Verify in detail the internal control system and ascertain
who are the persons responsible for collection of funds and mode of receipt.
iii) Interest and dividends: Check the interest and dividends received and receivable with investments
held during the year.
iv) Miscellaneous receipts: Check sale of scrap, rental receipts etc, if any.
d) During the course of audit of M/s Grow Company Limited, you, as an auditor found huge difference
between the control accounts and subsidiary records. The chief finance controller informed that this is
common due to huge volume of business conducted by the company during the year. How would you
deal in this situation? (June 2012)(5 Marks)
Answer
The finding of huge difference between the control accounts and subsidiary records of M/s Grow
Company Limited indicates that there may be material misstatements requiring detailed examination
of the books and records so as to ascertain the reason for the difference. The contention of the chief
financial controller cannot be acceptable simply because the company has conducted huge volume of

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business during the year. Such finding indicates recording of business transactions is not being done
properly or the accounting system in the company fails to capture all transactions in time. The auditor
would rather check whether it is a recurring phenomenon or not. He would also verify why such
reconciliation could not be done at a subsequent date. Considering all these facts, it may indicate the
possibility of some kind of material misstatements in the financial statements. As per NSA 240, “The
Auditor‟s Responsibility to Consider Fraud and Error in an audit of Financial Statements” the auditor
should perform procedures to determine whether the financial statements are materially misstated
when the auditor encounters the situation that there is material misstatement in the financial
statements. The auditor is required to report appropriately if he came across any material information
involving fraud or gross irregularity.
e) Cash book of an entity showed huge debit balances throughout the year. (December 2013)(5 marks)
Answer
Cash balance is maintained to meet the day to day operational needs of the organization. So, the
auditor has to perform audit procedures particularly having regard to the fact that maintaining such
huge balance is highly prone to misappropriation and other forms of fraud. Accordingly since the
entity is maintaining consistently huge cash balance which is not required for its operational needs,
the auditor should carry out the surprise verification of cash more frequently to ascertain whether the
actual cash in hand agrees with the balance as per cash book. If the actual cash balance is not in
agreement with the book balance, he should seek explanations from senior official of the entity. In
case any material difference is not satisfactorily explained, the auditor should state this fact
appropriately in his audit report. In any case, he should satisfy himself regarding the necessity for
such huge cash balance having regard to the normal working requirements of the entity. The entity
may also be advised to deposit the whole or major part of the cash balance in the bank at reasonable
interval.
Material cash on hand if found during the audit in relation to the financial statements taken as a
whole, or if there are significant negotiable securities in the custody of the client, consider performing
the following additional procedures:
- Count the cash fund or observe and list the securities in the presence of a client representative.
- Tie amount counted to general ledger balances.
- In most of small businesses, cash on hand is immaterial and should not be counted, unless it is at
the clients' request.
f) Raman Mahaseth, the auditor of a company has signed the audit report on 15 Asoj 2071. He has
obtained written representation from the management of the company dated 15 kartick 2071; i.e. the
date of the annual general meeting of the company. ( July 2015) (5 Marks)
Answer
Because written representations are necessary audit evidence, the auditor‟s opinion cannot be
expressed, and the auditor‟s report cannot be dated, before the date of the written representations.
Furthermore, because the auditor is concerned with events occurring up to the date of the auditor‟s
report that may require adjustment to or disclosure in the financial statements, the written
representations are dated as near as practicable to, but not after, the date of the auditor‟s report on the
financial statements.
In some circumstances, it may be appropriate for the auditor to obtain a written representation about a
specific assertion in the financial statements during the course of the audit. Where this is the case, it
may be necessary to request an updated written representation.
So, in the given case the written representation cannot be considered as appropriate audit evidence
because it was not obtained on or before the audit report date.
g) You have attended physical verification of Supreme Garments Limited and noted no discrepancies
between the physical quantity and the Store Register for the year ending 15 July, 2010. The

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management provides a statement of value of stocks but refuses to provide with the cost sheet and
calculations regarding how the value has been arrived. The company discloses that the value of
stocks is as “certified by the management” in the Financial Statement. The management is ready to
disclose the same in the Management Representation letter.
Answer
As per NSA-500 “Audit Evidence”, Audit evidence regarding an assertion of existence of inventory
will not compensate for failure to obtain assertion regarding valuation. The auditor should satisfy
himself that the valuation of inventories is in accordance with the Nepal Accounting Standard -02
“Inventories”. The auditor should examine the methods of applying the basis of inventory valuation
which include examination of stock sheets, costing records and treatment of overhead expenses as a
part of cost of inventories. In the given case, it will be construed as limitation on the scope of auditors.
Accordingly, the auditor will have to issue a qualified opinion.
Certification by Management of Supreme Garments Ltd. cannot be taken as conclusive evidence and
it cannot relieve the duty of auditors when there are other procedures and means of gathering audit
evidence. Just because management had owned responsibility for the correctness of its valuation of
Stock/inventory, the auditor cannot shirk his responsibility. This is negligence on his part if he relies
on the management representation without assessing the corroborative available evidences
h) Mr. Alex Pitt, partner of M/s Pitt Marwick & Associates, a Chartered Accountant firm was appointed
as an auditor of Cosmopolitan Commercial Bank Ltd. One of the shareholders of the bank lodged a
complain against the auditor for not assuming the responsibilities to consider laws and regulations
with regards to lending to a business house in an audit of financial statements of the bank. 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? (December 2011)(5
Marks)
Answer
In accordance with NSA 200: “Objective and General Principles Governing an Audit of Financial
Statements,” the auditor should 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. 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. Section
115(3) (e) of the Nepal Company Act, 2063 specially states that the auditor should report any non
compliance of prevailing laws. Further, Banks and financial Institutions Act 2063 also requires report
of auditors on certain matters. Thus, Here, in given situation, the auditor should plan his audit and
report for lending to a business house in accordance with the prevailing banking rules and regulations.
He should have sufficient knowledge of statutory provisions of lending and its reporting in prescribed
format.
i) On being appointed, the auditor of a company for the first time you find that the cashier also handles
the books of account and the cash receipt are not being banked intact but parts of these are being
utilized for cash payments. What are the risks involved? What could be your recommendations to
mitigate the risks envisaged? (December 2011)(5 Marks)
Answer
Since the cashier handles books of accounts and cash is not deposited intact in the bank account the
internal control system of the company is found very weak. There are the risks of cash being
misappropriated. Examples could be:
 failure to record purchases properly in order to misappropriate cash.

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 misappropriation cash from a machine or whilst cash is in transit.

 acceptance or solicitation of money or a benefit to provide cash to a third party.
 acceptance or solicitation of money or a benefit to provide goods or services to a third party
without taking a cash payment from that party.
This may create significant risk to the company that may erupt from the weak internal control system.
Recommendations to company for the enhancement of the internal control system of the company are
as follows:
i. The cashier should not have access to the books of accounts. The books of account should be
handled by the accountants who should not be directly involved with the cash transaction.
ii. All the cash collections should be deposited to the bank.
iii. Cash payments should be made through the Bank.
iv. Petty expenses should be managed through the Petty cash book, for which purpose the petty
cash, imprest should be provided to the petty cashier through the bank.
j) Xylocain Communications Company is one of the leading companies dealing with various
telecommunication services, wireless networking and internet related services. It receives huge
collection of cash daily from its customer on various accounts. Everything looked well, until one day
it was noticed that large amount was missing in the bank account. In fact that said amount was not
credited in the bank account at all and it was missing since last few years. When the case was
revealed, probably it was too late to recover the money. Considering the above case, what are the
likely documents you would like to examine as an auditor of the company?
Answer
Considering the case presented the auditor of Xylocain Communications Company should check all
the books of accounts and documents related with the cash and bank transactions. Hence, the likely
documents the auditor should examine in the circumstances presented are mentioned hereunder:
i. Separate Cash receipt register for different services like tele-communication, wireless
networking and internet related services
ii. Prenumbered Receipt pad for collecting cash.
iii. Security arrangement in the counter area.
iv. Procedures followed to deposit the amount in the bank
v. Special arrangements with bank for transferring funds, if any
vi. Bank reconciliation statement
vii. Duty rotation of the personnel, directly handling cash collection
viii. Reporting arrangement to central office
ix. Fidelity Insurance etc
x. Bank deposit slips
Question No 2:
Write short Note on
a. Management representation as an audit evidence (June 2010)(5 Marks)
Answer
 During the course of an audit, management makes many representations to the auditor, either
unsolicited or in response to some specific enquiries.
 The auditor also should obtain representation from management, where considered appropriate
and necessary.
 The management representation is taken to corroborate audit evidence, but representations by
management can not be a substitute for other audit evidences that the auditor could reasonably
expect to be reasonably available.
 In certain cases, where knowledge of facts is confined to management, a representation by
management may be the only audit evidence, which can reasonably be expected to be available.

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 If a management representation is contradicted by an available other audit evidence, the auditor

should examine the circumstances and, when necessary, reconsider the reliability of other
representations made by management.
b. External Confirmation Process to obtain audit evidence at the assertion level

Answer
Para 30 of NSA 505: When confirming confirmation procedures, the auditor should maintain control
over the process of selecting those to whom a request will be sent, the preparation and sending of
confirmation requests and the responses to those requests. Control is maintained over communications
between the intended recipients and the auditor to minimise the possibility that the results of the
confirmation process will be biased because of the interception and alteration of confirmation requests
or responses. The auditor ensures that it is the auditor who sends out the confirmation requests, that
the requests are properly addressed, and that it is requested that all replies are sent directly to the
auditor. The auditor considers whether replies have come from the purported senders.
c. Audit trail in a computerized accounting environment (December 2011)(5 Marks)

Answer
An audit trail refers to a situation where it is possible to relate „one-to-one‟ basis, the original input
along with the final output. The work of an auditor would be hardly affected if “Audit Trail” is
maintained i.e. if it were still possible to relate, on a „one-to-one‟ basis, the original input with the
final output. It refers to a simplified representation of the documentation in a manually created audit
trail. The particular credit notes may be located by the auditor at any time he may wish to examine
them, even months after the balance sheet date. He also has the means, should he so wish, of directly
verifying the accuracy of the totals and sub-totals that feature in the control listing, by reference to
individual credit notes. He can, of course, check all detailed calculations, casts and postings in the
accounting records, at any time. In first and early second-generation computer systems, such a
complete and trail was generally available, no doubt, to management‟s own healthy skepticism of
what the new machine could be relied upon to achieve – an attitude obviously shared by the auditor.
In such a system (i) the output itself is as complete and as detailed as in any manual system. (ii) The
trail, from beginning to end, is complete, so that all documents may be identified by located for
purposes of vouching, totaling and cross-referencing.
Any form of audit checking is possible, including depth testing in either direction. In case audit trail is
missing, the auditor employs Computer Assisted Techniques (CAATs) to ensure the validity of
accounting data.
d. Management representation (December 2011)(5 Marks)

Answer
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, Management Representation 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 and has approved the financial statements.
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 possibility
of misunderstandings between the auditor and management is reduced when oral representations are
confirmed by management in writing. However, representations 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 regarding a matter which has, or may
have, a material effect on the financial statements and such evidence is expected to be available; this

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will constitute a limitation in the scope of the audit, even if a representation from management has
been received on the matter.
e. Treatment of foreign currency monetary items on balance sheet date. (June 2012)(5 Marks)
Answer
Foreign Currency Monetary Items and its Treatment on Balance Sheet date: As per NAS- 11 on
“Accounting for the Effects of Changes in Foreign Exchange Rates” monetary items are money held
and assets and liabilities to be received or paid in fixed or determinable amounts of money, e.g., cash,
receivable, payables, etc. Regarding foreign currency transactions, NAS 11 requires that while
reporting effects of changes in exchange rates subsequent to initial recognition, at each balance sheet
date, monetary items denominated in a foreign currency, (e.g., foreign currency notes, balances in
bank accounts denominated in a foreign currency, and receivables, payables and loans denominated in
a foreign currency) should be reported using the closing rate prevailing on balance sheet date.
However in certain circumstances the closing rate may not reflect, with reasonable accuracy, the
amount in reporting currency that is likely to be realized from or required to be disbursed to because
the rate is unrealistic. In such circumstances, the relevant monetary item should be reported in the
reporting currency at the amount which is likely to be realized from or required to be disbursed to at
the balance sheet date.
f. Contingent assets (June 2012) ( 5 Marks)

Answer
The contingent assets are those which may arise on the happening of an uncertain event. As a general
practice, contingent assets are not recorded in the balance sheet because that would imply taking
credit for revenue which has not accrued. But it is logical as the contingent liabilities are shown in the
balance sheet the contingent assets should also be shown. The Companies Act does not require
disclosure of contingent assets in the balance sheet. However, if contingent asset have a significant
value, it may be advisable to disclose such assets in a note to the balance sheet.
As regards valuation of contingent assets, it may be noted that ordinarily no valuation would be
required. However, if such assets were disclosed by way of a note, a proper valuation based on the
related contract would be made. Where full realization of such assets is doubtful even on the face of
contingency occurring, it would be safer to value the assets on a realisable basis.
g. Three important characteristics of an effective system of computer audit programme (June 2012)
( 5 Maks)
Answer
Important characteristics of an effective system of computer audit program:
(i) Should be simple to use and eliminate the need to remember countless details normally
required in writing or revising computer programs.
(ii) Should be easily understandable even by those with little computer expertise and easyto use.
(iii) Should be capable of being used with different configuration of computers.
(iv) (iv)The package has to include adequate support at the time of installation, provideadequate
training to the staff and to provide documentation. There should be a provision for future
revision of the program.
(v) The package should have statistical sampling capability.
(vi) The system has to be acceptable to all users in terms of easy execution and compatible with
the existing system.
(vii) The program has to be capable of processing different types of applications.
(viii) The program should have strong report writing function including the ability to prepare
multiple reports in a single program run and to generate flexible output report formats.

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h. “During payments vouching, the auditor does not merely check proof that money has been paid
away".
(December2012)(2.5Marks)
Answer
Vouching is a substantive audit procedure which aims at verifying the genuineness and validity of a
transaction contained in the accounting records. It involves examination of documentary evidence to
support the genuineness of transaction.
Thus the object of vouching the payments of a business is not merely to ascertain that money has been
paid away; but the auditor aims to obtain reasonable assurance in respect of following assertions in
regard to transactions recorded in the books of account that :
i) a transaction is recorded in the proper account and revenue or expense is properly allocated to the
accounting period;
ii) a transaction pertains to entity and took place during the relevant period;
iii) all transactions which have actually occurred have been recorded;
iv) all transactions were properly authorized; and
v) transactions have been classified and disclosed in accordance with recognizedaccounting policies
and practices.
Thus, it is through vouching that the auditor comes to know the genuineness of transactions recorded
in the client‟s books of account wherefrom the financial statements are drawn up.
Thus, the auditor‟s basic duty is to examine the accounts, not merely to see its arithmetical accuracy
but also to see its substantial accuracy and then to make a report thereon.
i. Use of positive confirmations (June 2014)(2.5 Marks)

Answer
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. A response to a positive confirmation request is ordinarily expected to provide
reliable audit evidence. There is a risk; however, that a respondent may reply to the confirmation
request without verifying that the information is correct. The auditor is not ordinarily able to detect
whether this has occurred. The auditor may reduce this risk, however, by using positive confirmation
requests that do not state the amount (or other information) on the confirmation request, but ask the
respondent to fill in the amount or furnish other information. On the other hand, use of this type of
“blank” confirmation request may result in lower response rates because additional effort is required
of the respondents.
j. Audit of contingent liabilities ( July 2015) (2.5 Marks)

Answer
The auditor may take following steps to verify the contingent liabilities:
(i) Inspect the minute books of the company to ascertain all contingent liabilities known to the
company.
(ii) Examine the contracts entered into by the company and the likelihood of contingent liabilities
emanating there from.
(iii) Scrutinize the lawyer‟s bills to track unreported contingent liabilities.
(iv) Examine bank letters in respect of bills discounted and not matured.
(v) Examine bank letters to ascertain guarantees on behalf of other companies or individuals.
(vi) Discuss with various functional officers of the company about the possibility of contingent
liability existing in their respective field.
(vii) Obtain a certificate from the management that all known contingent liabilities have been
included in the accounts and they have been properly disclosed.

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(viii) Ensure that proper disclosure has been made as per NAS 12, Provisions, Contingent
Liabilities and Contingent Assets.
Question No 3:
a. Tagging and Tracing (December 2011)(5 Marks)
Answer
It is a technique better than Integrated Test Data Facility. It involves tagging the client`s input data in
such a way that relevant information is displayed at key points. It uses the actual data, and so the
question of elimination of special entries test data designed under Integrated Test Data Facility does
not arise. The hard copy, so produced is available only to the auditor and may describe such inputs as
hours worked in a pay period in excess of 60; or sales orders processed in excess of Rs. 200,000 etc.
This enables the auditor to examine transactions at the intermediate steps in processing.
The advantage of tagging and tracing approach lies in the use of actual data and elimination of the
need for reversing journal entries. The disadvantage is that the erroneous data will not necessarily be
tagged. An effective combination approach may be to use the ITF approach (Integrated Test Facility)
for a few hypothetical transactions and the tagging and tracing approach to follow line data through a
complex system.
b. Evidence Vs. validity of transaction (June 2012) ( 5 Marks)

Answer
Entries in the books are usually made on the basis of some kind of documentary evidence. It generally
exists in a variety of forms e.g. payees receipts, suppliers invoices, statements of account of parties,
minutes of Board of Directors or shareholders, contract documents etc. These all form documentary
evidence for transactions. On the other hand, it is also the function of audit to establish that payments
have been made validly to the person who is shown to be recipients e.g. salary is paid to partners
according to provision contained in the partnership deed, director's fee is paid according to the minute
of shareholders meeting, suppliers are paid according to their invoices etc. It is termed as the
validation of the transactions.
c. Computerized and manual accounting system (June 2013)(5 Marks)

Answer
Distinction between computerized and Manual Accounting System:
i. Faster and efficient in processing of information in computerized system and no such faster and
efficient in processing of information in manual system
ii. Automatic generation of accounting documents like invoices, cheques and statement of account
which manual system cannot produce.
iii. With the larger reductions in the cost of hardware and software and availability of user-friendly
accounting software package, it is relatively cheaper like maintaining a manual accounting
system;
iv. More timely information can be produced than manual system
v. No more manual processing of the data- all automatically posted to the various ledgers/accounts
and many types of useful reports can be automatically generated for management to make
decisions where as such reports cannot generated on manual system
vi. Power failure, computer viruses and hackers are the inherent problems of using computerized
systems, such risk not remain in manual system
vii. Once data been input into the system, automatically the output are obtained hence the data being
input needs to be validated for accuracy and completeness, we should not forget concept of
GIGO (Garbage In(Input) Garbage out ( Output) where validation in manual system can be
checked on inception

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viii. Accounting system not properly set up to meet the requirement of the business due to badly
programmed or inappropriate software or hardware or personnel problems can caused more
havoc , where manual system does not have such problem.
ix. Danger of computer fraud if proper level of control and security whether internal and external
are not properly been instituted, where manual system does not have such problem.
d. Test checking and routine checking (June 2013)(5 Marks)

Answer
Test checking and routine checking can be distinguished on the basis of following points:
i. Concept: Test checking involves selecting a few transactions on the basis of auditor‟s judgment
and examining them. But routine checking involves checking of books and records.
ii. Object: The main object of test checking is to form an opinion on the financial statements on the
basis of examination of selected sample. While the main object of routine checking is ensuring
arithmetical accuracy of the entries in the original books and ledgers and posting to correct
ledgers accounts.
iii. Relationship: Routine checks may be performed on the basis of test checking.
e. Compliance Procedure and Substantial Procedures (June 2014)(2.5 Marks)

Answer
Auditor should obtain sufficient and appropriate audit evidences and test them before framing an
opinion about the assertions the financial statements reveal. For this, the auditor checks evidences
through
 Compliance procedure and
 Substantial procedure.
Compliance procedures are tests designed to obtain reasonable assurance that those internal control on
which audit reliance is to be placed are in effect. It seeks to test that
 there exists internal control,
 the existing internal control is effective and
 the internal control is working without break or lacunae during the period under review.
When internal control is found to be to an acceptable level, the accounting entries generated in such a
system is more reliable than in one where the control is weak.
Mere satisfaction about the existence of internal control may not be sufficient for auditors to express
opinion about the assertions the financial data in the form of balances and transactions.
These i.e. transactions and balances need to be tested. This is done by audit procedure called
substantive checking. Substantive procedures are designed to obtain audit evidence as to the
completeness, accuracy and validity of the data produced by the accounting system.
The substantive procedures involve
 checking of transactions and balances and
 analytical review.
The checking of transaction and balances involves vouching of sales, purchases, payments, receipts
and scrutiny of ledgers. The analytical procedure involves critically examining the accounts in an
overall manner and it may entail computation of ratios, trend analysis so as to dwell in length for
examination of unusual or unexplained deviations.
f. Batch Processing and On-Line Real Time System (December 2014)(5 Marks)
Answer
Data processing system in computerized environment is generally Batch Processing or On-Line Real
Time (OLRT) system which can be distinguished as under:
Batch Processing On-Line Real Time (OLRT) system

 Transactions are accumulated and processed in
 Transactions are processed as and when
group. they occur.

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 Two types of files are maintained master file is

 Only master file is maintained. It keeps
updated when batch processing is run. updating.
 Updating does not take place as quickly as in  Though updating takes place immediately
On-Line Real time system. the processing becomes complex.
 Not useful when instant and updated results are
 Useful for immediate reporting system.
required.
 Generally provides Audit trail.  Generally, does not provide audit trail and
hence requires more attention of auditor.
g. Vouching and Verification ( July 2015) (2.5 Marks)

Answer
1. Meaning : The act of examining the vouchers is known as vouching. A voucher is any
documentary evidence in support of a transaction entered in the books of account.
Verification and be explained as establishing the truth or securing some kind of confirmation
with respect to the assets and liabilities appearing in the balance Sheet of a concern.
2. Nature & Purpose : Vouching involves establishing the arithmetical accuracy and the
authenticity of the transactions of a concern. Vouching proves that an asset ought to exist.
Verification goes beyond vouching. It seeks to establish that assets as stated in the Balance Sheet
of a concern exist in fact and that the liabilities are properly disclosed. Verification proves that
an asset does exist.
3. Time: It is done during the whole year. It is done at the end of the year.
4. Utility : Certifies correctness of records. Certifies correctness of assets and liabilities.
5. Personnel : It is done by the junior staff of the auditor under the supervision of a senior person.
It is done by the auditor himself assisted by senior.
Question No 4:
What are the assertions with which an auditor is concerned with while obtaining audit evidence from
substantive procedures? (June 2010)(5 Marks)
Answer
An auditor is concerned with following assertions:-
i. Existence:That an asset or liability exists at a given date.
ii. Rights and obligations: That an asset is a right of the concern and a liability is an obligation at a
given date.
iii. Occurrence: That a transaction or event which took place pertains to the entity during the
relevant period.
iv. Completeness: That there are no unrecorded assets, liabilities or transaction.
v. Valuation: That an asset or liability is recorded at an appropriate carrying value.
vi. Measurement: That a transaction is recorded in the proper amount and revenue or expense is
allocated to the proper period.
vii. Presentation and disclosure: That an item is disclosed classified and described in accordance
with recognised accounting policies and practices and relevant statutory requirements.
Question No 5:
How will you vouch and verify the followings
i. Provision for income tax (June 2010)(5 Marks)
Answer
(ii) Obtain the computation of income prepared by the auditee and verify whether it is as per the
Income-tax Act, 1961 and Rules made there under.
(iii) Review adjustments, expenses, disallowed special rebates, etc. with particular reference to the
last available completed assessment.
(iv) Examine relevant records and documents pertaining to advance tax, self assessment tax and other
demands.

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(v) Compute tax payable as per the latest applicable rates in the Finance Act.
(vi) Ensure that overall provisions on the date of the balance sheet is adequate having regard to
current year provision, advance tax paid, assessment orders, etc.
ii. Bank Borrowings (June 2010)(5 Marks)

Answer
Borrowings from the banks may be either in the form of overdraft limit or fixed loans.
In each case, borrowings should be verified as follows:
1. Reconcile the balances in the overdraft or loan account with that shown in the pass books and
confirm the last mentioned balance by obtaining balance confirmation certificate from the bank.
2. Obtain certificate from the bank showing particulars of securities deposited with the bank as
security for the loans or of the charge created on an asset / assets of the concern and confirm the
same has been correctly disclosed and duly registered with the Registrar of Companies and
recorded in the Register of Charges.
3. Verify the authority under which the loan or overdraft has been raised. In case of the company,
only the Board of Directors is authorised to raise a loan or borrow from a bank.
4. In case of company, confirm restraint of Company Act regarding the maximum amount of loan
that the company can raise has not been contravened.
5. Ascertain the purpose for which the loan has been raised and the manner in which it has been
utilized and that this has not prejudicially affected the concern.
iii. Premium paid for insurance of a Motor car. (June 2010)(5 Marks)
Answer
(i) Check insurance cover note issued by Insurance Company. Verify car no., period of Insurance
etc.
(ii) See that “No claim Bonus” is given, where entitled, by the Insurance Company.
(iii) Ensure that proper adjustment is made for pre-paid insurance premium.
Question No 6:
Management of MNO production House argues that the auditor should accept the figure of stock
verification conducted by internal audit. The management is willing to certify this figure. The
engagement partner, however, insists that stock verification should be carried out again by
management in presence of his assistants on 25% of locations. (December 2010)(5 Marks)
Answer
The auditor should obtain sufficient and appropriate audit evidence from compliance and substantive
procedures to form his opinion. Accordingly, the auditor can demand the physical verification be done
in the presence of his assistants to obtain a level assurance of the inventory system in place. However,
auditor should also consider the reliance that may be placed in the report of internal audit in
accordance with NSA 610 considering the work of Internal Auditing. Where such reliance may be
placed in the work of an internal audit, the physical verification is not necessary.
Question No 7:
What is accounting estimates? Provide eight examples of accounting estimates.
Answer
Accounting estimate means an approximation of the amount of an item in the absence of a precise
means of measurement. On this ICAN has issued NSA 540. The examples are:
i. Allowances to reduce inventory and accounts receivable to their estimated realizable value.
ii. Provisions to allocate the cost of fixed assets over their estimated useful life.
iii. Accrued Revenue.
iv. Provision for taxation.
v. Provision for a loss from lawsuit.
vi. Insurer`s liability for outstanding claim.

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vii. Losses on construction contracts in progress.

viii. Amortization of certain items like goodwill and deferred revenue expenditure.
Question No 8:
List out the circumstances, where auditing is done through the computer.
Answer
The auditor can use the computer to test the logic and controls prevalent within the system and the
records generated by the system. Depending upon the complexity of the application system being
audited, the approach may be different. It may be fairly simple or may require extensive technical
competence on the part of the auditor. Circumstances that may cause to conduct audit through the
computer are as follows:
i. The application system processes large volume of input and produces large volumes of output
that make extensive direct examination of the validity of input and output difficult.
ii. Significant parts of the internal control system are embodied in the computer system.
iii. The logic of the system is complex and there are large portions that facilitate use of the system
or efficient processing.
iv. Because of cost-benefit considerations, there are substantial gaps in the visible audit trail.
Question No 9:
XYZ Hotels Ltd. has incurred loss and one of its illiterate director wants your assistance to find out
exactly what happened in the company. He suspects that the company has paid excessive interest on
its borrowing. He has found average of 12 month end borrowing balance was Rs. 120 million and
prevailing interest rate was 10% for the year. Interest paid for 12 month was Rs. 12 million. Suggest
to the director on this matter how he can verify this matter. (December 2010)(5 Marks)
Answer
Average interest cost on the average borrowing by XYZ Hotels Ltd. is matching with prevailing
interest rate. However, detailed verification of borrowing and interest expenses booked need to be
carried out as following:
i. Examine the date, rate and amount of borrowing with reference to borrowing documents.
ii. Verify booking date of the balances in individual accounts and total of borrowing balance.
iii. Examine whether there is a procedure for obtaining confirmation of balance periodically.
iv. Check calculations of interest and examine whether interest expenses has been accurately
provided for with reference to the duration of borrowing.
v. Trace the amount of borrowing in to bank account and interest and loan repayment from bank
account.
vi. Examine whether borrowing is properly authorized and whether internal control procedures
have been followed.
vii. Examine that other items of liability is not booked as borrowing.
Question No 10
Babarmahal Trading Ltd (BTL) is a wholesaler of Chinese goods and all accounting information is
stored on BTL‟s computer. You are the audit senior in charge of the audit of the receivables balance.
Explain the audit procedures that should be carried out on the receivables balance at BTL.
Answer
Procedures for verification of receivable balance of BTL are prescribed below:
 Cast the receivables ledger to ensure it agrees with the total on the receivables control account.
 Compare the balance on each receivable account with its credit limit to ensure this has not been
exceeded.

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 Review the balances in the receivables ledger to ensure no balance exceeds total sales to that
customer.
 Calculate receivables days for each month end to monitor control of receivables over the year.
 Stratify receivables balances to show all material items and select appropriate sample for testing.
 Produce an aged receivables analysis to assist with the identification of irrecoverable receivables.
 Obtaining the external confirmations as per NSA 505 and evaluating whether the results of the
external confirmation process together with the results from any other audit procedures
performed, provide sufficient appropriate audit evidence regarding the assertion being audited. In
conducting this evaluation the auditor considers the guidance provided by NSA 330 and NSA
530, “Audit Sampling and Other Selective Procedures.”
Question No 11:
Nepal Standards on Auditing relating to "Management Representation" provides guidance on the use
of management representation as audit evidence. Enumerate five items that could be included in a
management representation letter. (June 2011)(5 Marks)
Answer
Following matters form part of the management representation letter as per NSA 580 „Management
Representations‟:
 It is management's responsibility for the fair presentation of the financial statements in accordance
with Nepal Accounting Standards or relevant practices.
 No irregularities involving management or employees that could have a material effect on the
financial statements
 All books of account and supporting documentation have been made available to the auditors
 Information and disclosures with reference to related parties is complete
 Financial statements are free from material misstatements including omissions
 No non-compliance with any statute or regulatory authority requirements.
 No plans that will materially alter the carrying value or classification of assets or liabilities in the
financial statements
 No events, unless already disclosed, after the end of the reporting period that needs disclosure in
the financial statements.
Question No 12
Balance confirmation from debtors/creditors can only be obtained at the end of the financial year.
Answer
The statement is false. Direct confirmation of balances from debtors/creditors in respect of balances
standing in their accounts at end of the financial year end is perhaps the best method of ascertaining
whether the balances are genuine accurately stated and undisputed where internal control system is
relatively weak. The conformation date, methods of obtaining confirmation etc. are to be determined
by the auditor. Debtors/creditors may be requested to confirm balance either as at the date of balance
sheet or any other selected date which reasonably close to the date of balance sheet. The date should
be settled by the auditor in consultation with the entity. Therefore, it is not necessary that balances of
debtors/creditors should be obtained and verified at the end of financial year.
Question No 13
List out the analytical procedures that you would adopt in audit of Revenue of an entity. What are the
factors that determine the extent of reliance on such analytical procedures?
Answer
Analytical procedures are one of many audit processes which help an auditor understand the client's
business and changes in the business, and to identify potential risk areas to plan other audit

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procedures. It includes comparison of financial information, relating financial and non financial
information and consideration of practicable relationship of data.
The analytical procedures that will be adopted in obtaining audit evidence regarding the various
assertions relating to revenue are as follows:
i. Comparison of Gross-profit ratio to sales for the current year with the corresponding figures of
the previous years.
ii. Comparison of ratio of sales returns to sales for the current year with the corresponding figures
for previous years.
iii. Comparison of trade discount to sales for the current year with previous year.
iv. Review of Reconciliation of Excise/VAT booked during the year with Excise/VAT returns
submitted with the total sales booked.
v. Comparison of dividend/interest/royalty for the current year with the corresponding figures for
previous years.
vi. Comparison of ratio of income on investments to average investment for the current year with
corresponding figures for the previous year.
The factors that affect the extent of reliance on analytical procedures are as follows:
ii. Materiality: When items are material, the auditor doesn‟t solely rely on the analytical procedures
in forming conclusions but will carry other substantive procedures also.
iii. Other procedures: When other procedures are also directed towards the same objective, it might
confirm or dispel the questions raised from the application of analytical procedures.
iv. Weak controls: When internal controls are weak, greater reliance is placed on tests of balances
and tests of details of transactions rather than on analytical procedures.
v. Accuracy: The accuracy with which expected results of analytical procedures can be predicted.
For example greater reliance is place on gross profit ratio compared to previous year than in
comparing discretionary expenses such as donation.
Question No 14
What are the steps followed while conducting audit of incomplete records? (December 2011)(5
Marks)
Answer
Incomplete records emanate risk of misstatement of financial statement due to omission and wrong
recording of transactions. Therefore, the auditor should be careful in this regard. Steps that are
followed in audit of incomplete records are as below:
1. Ascertain the exact status of accounting records available including memoranda records.
2. Ensure that the management compiles / reconstructs accounting records to the extent
practicable.
3. Perform compliance procedure to assess whether any control system is in operation.
4. Vouch transactions recorded in books of account with reference to appropriate audit evidence.
Check posting, casting etc.
5. Examine the system in operation in respect of custody managed cash memos, receipts, check
books etc.
6. Verify fixed assets by observing physical verification.
7. Conduct surprise checks to verify cash in hand, inventory etc.
8. Apply analytical review procedures in depth and notice deviations to investigate in detail.
9. Formulate an appropriate audit opinion based on above findings.
Question No 15
While compiling the financial statements of a concern, you observed that the input information
supplied by the concern is incomplete, incorrect and few of the Accounting Standards have not been
followed. Describe, in brief, the procedure you will follow in the given circumstances.

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Answer
According to AAS 31(SA 4410) “Engagements to Compile Financial Information”, an accountant
would normally have to rely upon the management for information to compile the financial statements
in a compilation engagement. If in the course of compilation of financial statements, it is observed
that the information supplied by the entity is incorrect, incomplete or otherwise unsatisfactory, the
accountant should perform following procedures:
i. Make any enquiries of management to assess the reliability and completeness of the information
provided;
ii. Assess internal controls prevailing in the entity; and
iii. Verify any matters or explanations.
The accountant may also request the management to provide additional information. This may be
asked in the form of management representation letter. If the management refuses to provide
additional information, the accountant should withdraw from the engagement, informing the entity of
the reasons for such withdrawal.
If one or more accounting standards are not complied with, the same should be brought to the notice
of the management and if the same is not rectified by the management, the accountant should include
the same in notes to the accounts and the compilation report to the management.
Question No 16
Discuss “Audit through the computer”. (June 2012)(5 Marks)
Answer
Computerization of accounts does not affect the basic objectives of auditing. However, the auditor
would need to modify his audit procedures, approach and technical capabilities so as to be able to
form an opinion on the accounts processed in a computerized environment.
Audit through the Computer is the audit, with the help of computer technology in the audit of
accounts processed in a computerized environment.Audit through the computer requires that the
auditor submits data to the computer for processing. The results are then analyzed for the processing
reliability and accuracy of the computer program. Technical and other developments that necessitated
this approach include the following;
i. On line data entry
ii. Elimination or reduction of print outs
iii. Real time files up dating
The auditor can use the computer to test:

i. The logic and controls existing within the system, and
ii. The records produced by the system
Depending upon the complexity of the application system being audited, the approach may be fairly
simple or require extensive technical competence on the part of the auditor.
There are several circumstances where auditing through the computer must be used:
a. The application system processes large volumes of input and produces large volumes of output
that make extensive direct examination of the validity of input and output difficult.
b. Significant parts of the internal control system are embodied in the computer system. For
example, in on line banking system a computer programme may batch transactions for individual
tellers to provide control totals for reconciliation at the end of the day‟s processing.
c. The logic of the system is complex and there are large portions that facilitate use of the system for
efficient processing.
d. There are substantial gaps in the visible audit trail.
The primary advantage of this approach is that the auditor has increased power to effectively test the
computer system. The range and capability of tests that can be performed increases and the auditor
acquires greater confidence that data processing is correct. By examining the system‟s processing, the
auditor also can assess the system‟s ability to cope with environment change.

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The primary disadvantages of the approach are generally high costs and the need for extensive
technical expertise when systems are complex. However, these disadvantages are really not that
important if auditing through the computer is the only viable method of carrying out the audit.
Auditing through computer may be conducted through test data, computer programme, etc.
Question No 17
Comment on the following situations/statements.
On final audit of Hattiban Limited, the physical verification of fixed assets was conducted. However
the auditor was not able to confirm the existence of valuable items and costly equipments. Though,
the auditor received a certificate from the management to prove its existence and value and accepted
the same blindly without applying any further procedures. (June 2012) ( 5 Maks)
Answer
The physical verification of fixed assets is the primary responsibility of the management. The auditor,
however, is required to examine the verification programme. Further, he must satisfy himself about
the existence, ownership, procession and valuation of fixed assets. It appears from the facts of the case
that the auditor has not been able to verify either existence or valuation of significant fixed assets
despite conducting physical verification audit procedure himself. Ultimately, he accepted the
certificate from the management without performing further procedures. As per NSA 580, “Written
Representations”, representation by management cannot be a substitute for other audit evidence that
the auditor could reasonably expect to be available. Thus, a representation by management as to the
existence of valuables and machinery is no substitute for adopting normal audit procedures regarding
verification of valuable and important machinery. If the auditor is unable to obtain sufficient
appropriate audit evidence that he believes will be available, this will constitute a limitation on the
scope of his examination even if he has obtained a representation from management on the matter.
Question No 18
As an auditor, give your opinions with reasons on the following cases:
Your client has computed the deferred tax assets or liabilities on: i. Fixed assets as per financial base
Rs. 500,000, as per tax base Rs. 600,000; ii. Other assets as per financial base 300,000 as per tax base
Rs. 200,000 and other liabilities as per financial base Rs. 100,000 as per tax base Rs. 50,000. Consider
applicable tax rate 5% and opening balance of deferred tax asset is Rs.5,000As a Auditor how would
be check the accounting treatment made on deferred tax by your client (show your computation as
well)? (December 2012)(5 Marks)
Answer
Nepal Accounting Standard 9 (NAS) defined on deferred tax assets and liabilities. The NAS
suggested for computing deferred tax assets or liabilities on temporary differences on tax base and
financial base and booking corresponding income or expenses. The computation of deferred tax has
been as follows:
Particulars Financial Tax Base Deferred (Assets) Applicab Deferred Tax (Assets)
Base (A) (B) /Liabilities C= (A- le /Liabilities @ 5% D=
B) C*5%
1.Fixed Assets (100,000) Yes (5,000)
500,000 600,000
2.Other Assets 100,000 Yes 5,000
300,000 200,000
3. Liabilities (50,000) Yes (2,500)
100,000 50,000
Net Asset (2,500)
Previous year Asset (5,000)
Balance
Decrease in Asset (50,000) (2,500)
(Charged to PL) 900,000 850,000

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Accordingly closing balance of deferred tax should be Rs. 2,500 and deferred tax asset should be
credited by Rs. 2,500 by charging corresponding amount to profit & loss account as deferred tax
expenses.
Question No 19
You have taken up the assignment for Due Diligence Review of the financial statement as of 31
Asadh 2069 of Das Dhunga Bank Ltd for facilitating the merger process with Lucky Finance Co. Ltd.
Write down any seven points you have to pay due consideration on carrying out the review on assets
side (covering each asset category) of the financial statement. (December 2012)(7 Marks)
Answer:
Upon taking up the assignment for due diligence review of the Das Dhunga Bank Ltd; i have to pay
due following due consideration on review assets side of the financial statement:
i. Loan & Advances: The due consideration to be paid on loan and advances is whether the
adequate loan loss provision has been made in line with Nepal Rastra Banks Directive
applicable to the bank.
ii. Investment: The due consideration to be paid on investment is that whether the investment has
been made in line with Nepal Rastra Banks Directive in eligible portfolio. If investment is
doubtful of recovery to see whether necessary provision has been set aside or otherwise.
Further in applicable cases have to see whether required reserves/funds against the investment
been set aside.
iii. Fixed Assets: The due consideration to be paid on fixed assets is that whether all the fixed
assets appearing in financial statement legally owned by the entity, physically available and are
in working condition. The major fixed assets should be revalued with the help of expert for the
purposes of DDA.
iv. Advance Tax: The due consideration to be paid on Advance Tax is to see whether the amount
shown as advance tax are really an existed asset representing the cash deposits made and
advance tax made by parties and are not time barred for claiming for assessment of tax
purposes.
v. Non-Banking Assets (NBA): To see whether the NBA are on the possession and ownership of
the bank. See whether disposal (sales) process of NBA has not been suffered any hindrances
like NBA is insufficient for covering dues recoverable, NBA is subject to lien of others ,
NBA is under legal cases. Further should be ensured that NBA is adequately provisioned as
per NRB Directives.
vi. Advances: To see the recoverability of advances. If advances are doubtful of recoverability,
ensure that whether adequate provision against possible loss has been made.
vii. Deposits : To see the existence of various deposits . If deposits are doubtful of refund and
are not backed up with sufficient documents, ensure that whether adequate provision against
possible loss has been made.
Question No 20
How will you verify the retirement gratuity to employees? (December 2012)(5 Marks)
Answer
 Examine the basis on which payable to employees is worked out. The liability for gratuity may
either be worked on actuarial rules or agreement or the presumption that all employees retire on
the balance sheet date.
 Verify computation of liability of gratuity on the aggregate basis.
 Check the amount of gratuity paid to employees who retired during the year with reference to
number of years of services rendered by them.
 See that the annual premium has been charged to profit and loss account in cash the concern has
taken a policy from the insurance companies.
 Ensure that the basis of computing gratuity is valid.
 Ensure that the accounting treatment is in accordance with NSA 24 Accounting and Reporting by
Retirement Benefits Plans'.

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Question No 21
As statutory Auditor of XYZ Pvt. Ltd. you requested your client for sending letter for balance
confirmations from certain debtors, the client argue that since the said balances with debtors are under
dispute and the matter is pending in the court it is not necessary to ask balance confirmation.
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. The
auditor agrees to management‟s request not to seek external confirmation regarding a particular
matter, the auditor should document the reasons for accepting 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 22
How would you safeguard your client against the payment for fictitious purchases?
Answer
The auditor has to be very cautious while verifying the purchases that no payments have been made
for the fictitious purchases. For this purpose, he may have to take the following actions:
i) He should examine first the internal control system in connection with purchases and satisfy
himself with regard to its effectiveness.
ii) He should ensure that before passing the invoices for payment, they are checked with the original
order, with goods received book and the stock records.
iii) He should inspect the invoices and see that the authorities responsible for passing them for
payment have duly checked them and initialed.
iv) He should test check the invoices to see that dates given in the invoices are for the period
concerned and they have been addressed in the name of the client.
v) He should also compare a number of invoices with the records in the goods received book and
stock records.
vi) He can make physical verification of the goods purchased, if a part of it is still in the stock.
vii) He should also compare the supplier‟s statement with the supplier‟s account.
viii) Postings in the various suppliers‟ accounts should also be checked and compared with the
statement received from them.
Question No 23
Explain different methods of obtaining audit evidence. (December 2013)(7 marks)
Answer
Different methods of obtaining audit evidence are described below:
i) Inspection of Records or Documents: Inspection consists of examining records or documents,
whether internal or external, in paper form, electronic form, or other media. Inspection of records and
documents provides audit evidence of varying degrees of reliability, depending on their nature and
source and, in the case of internal records and documents, on the effectiveness of the controls over
their production. An example of inspection used as a test of controls is inspection of records or
documents for evidence of authorization.

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ii) Inspection of Tangible Assets: Inspection of tangible assets consists of physical examination of
the assets. Inspection of tangible assets may provide reliable audit evidence with respect to their
existence, but not necessarily about the entity‟s rights and obligations or the valuation of the assets.
Inspection of individual inventory items ordinarily accompanies the observation of inventory
counting.
iii) Observation: Observation consists of looking at a process or procedure being performed by

others. Examples include observation of the counting of inventories by the entity‟s personnel and
observation of the performance of control activities. Observation provides audit evidence about the
performance of a process or procedure, but is limited to the point in time at which the observation
takes place and by the fact that the act of being observed may affect how the process or procedure is
performed.
iv) Inquiry: Inquiry consists of seeking information of knowledgeable persons, both financial and
non-financial, throughout the entity or outside the entity. Inquiry is an audit procedure that is used
extensively throughout the audit and often is complementary to performing other audit procedures.
Inquiries may range from formal written inquiries to informal oral inquiries. Evaluating responses to
inquiries is an integral part of the inquiry process.
v) Confirmation: Confirmation, which is a specific type of inquiry, is the process of obtaining a

representation of information or of an existing condition directly from a third party. For example, the
auditor may seek direct confirmation of receivables by communication with debtors. Confirmations
are frequently used in relation to account balances and their components, but need not be restricted to
these items. For example, the auditor may request confirmation of the terms of agreements or
transactions an entity has with third parties; the confirmation request is designed to ask if any
modifications have been made to the agreement and, if so, what the relevant details are.
vi) Recalculation: Recalculation consists of checking the mathematical accuracy of documents or

records. Recalculation can be performed through the use of information technology, for example, by
obtaining an electronic file from the entity and using CAATs to check the accuracy of the
summarization of the file.
vii) 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.
viii) Analytical Procedures: Analytical procedures consist of evaluations of financial information

made by a study of plausible relationships among both financial and non-financial data. Analytical
procedures also encompass the investigation of identified fluctuations and relationships that are
inconsistent with other relevant information or deviate significantly from predicted amounts.
Question No 24
Auditor of Elephant Ltd. was unable to confirm the existence and valuation of stock lying at the
remote project site and accepted a certificate from the management without obtaining other audit
evidence. (June 2014)(5 Marks)
Answer
As per NSA 580 on “ Management Representation” in the course of audit, an auditor comes across
various matters in respect of which he is not able to obtain sufficient appropriate audit evidence. In
such a situation he may rely on the submission by the management but he should seek corroborative
audit evidence from sources inside or outside the entity and evaluate the representation made by
management.
Management representation is not a substitute for other audit evidence. The auditor should seek and
apply normal audit procedure. Mere possession of a certificate does not absolve the auditor from his

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liability. He should not seek or accept certificates when subject matter is such that it is capable of
verification from internal and/or external evidences.
In the instant case, the stock site material lying with the remote project site can be easily verified with
purchase order, invoice, bill of entry, custom document, physical verification report from independent
authority, visual means for observing stock etc.
Therefore the auditor in this instant case has not used available evidences. He should not have rested
with the certificate obtained from the management and could have evaluated other evidences. He may
be held liable for negligence and professional misjudgment. But, if the stock is not material to the
financial statement because of low value, the auditor can accept management representation as
evidence if there are no reasons to question the authenticity of representation made by the
management.
Question No 25
As an auditor, how will you verify application and allotment money received on shares issued for
cash? (June 2014)(5 Marks)
Answer
Verification of application and allotment money received on Shares Issued for Cash shall be carried
out as under:
On Application
Verify the amount received along with the applications for shares in the following manner:
 Check entries in the Application and Allotment Book (or Sheets) with the original applications;
 Check entries in the Application and the Allotment Book as regards deposits of money, received
with the applications, with those in the Cash Book;
 Vouch amounts refunded to the unsuccessful applicants with copies of Letters of Regret;
 Check the totals columns in the Application and Allotment Book and confirm the journal entry
debiting Share Application Account and crediting Share Capital Account.
On Allotment
 Examine Director‟s Minutes Book to verify approval of allotments.
 Compare copies of letters of allotment with entries in the Application and Allotment Book.
 Trace entries in the Cash book into the Application and Allotment Book for the verification of
amounts collected on allotment.
 Trace the amount collected on application as well as those on allotment from the Application
and Allotment Book into the Share Register.
Check totals of amounts payable on allotment and verify the journal entry debiting Share Allotment
Account and crediting Share Capital Account.
Question No 26
Based on study and evaluation of internal control system, auditor concludes that internal controls are
well designed and functioning effectively. Still auditor performs appropriate substantive audit
procedures to form an opinion on the financial statements before issuance of audit report. Explain
why auditor has to perform appropriate substantive audit procedures in such an ideal situation also.
Answer
An internal control system can provide only reasonable assurance that the management‟s objectives in
establishing the system are achieved. This is due to the fact that internal control system has the
following inherent limitations:
i. Controls have to be cost effective. So, some controls may not be instituted because they are not
cost effective.
ii. Most controls are directed at transactions of usual or routine nature. Therefore transactions of
unusual nature may escape from ambit of internal control.
iii. The potential of human error remains in any system of control.
iv. Controls may not prevent frauds through collusion between two or more persons.
v. Management may override controls.

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vi. Controls may not keep pace with changing circumstances.

vii. Management itself may manipulate transactions or accounting estimates.
Above inherent limitations of internal control system makes it necessary for the auditor to perform
substantive procedures to express an appropriate opinion on the financial statements. But if the "Test
of Control" conducted by the auditor concludes that internal control system is in existence, operated
throughout the period and functioning effectively, the auditor may not consider necessary to perform
substantive audit procedure for that particular area. Substantive procedures though cannot be fully
eliminated and the auditor determines the area where substantive procedures should be used.
Question No 27
Chitale Limited has declared dividend of 12% for FY 2069/70 in the month of Ashoj 2070. The
company has booked this as Interim Dividend in Financial Statement of 2069/70.
Answer
Dividend has been declared at year end so this should be final dividend.
Further, Nepal Accounting Standards 05 on Events after the Balance Sheet Date provides that if an
entity declares dividends to holders of equity instruments after the balance sheet date, the entity shall
not recognise those dividends as a liability at the balance sheet date.
If dividends are declared after the balance sheet date but before the financial statements are authorised
for issue, the dividends are not recognised 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.
Thus, the treatment followed by Chitale limited is not in line with NAS.
Question No 28
Explain “Responsibility for properly determining the quantity and value of inventories rests with the
management of the entity”. (December 2014)(5 Marks)
Answer
As per NSA 200; "Objectives and General Principles Governing an Audit of Financial Statements"
the responsibility for preparing and presenting the financial statements is that of the management of
the entity. Accordingly the responsibility for properly determining the quantity and value of
inventories rests with the management of the entity. Therefore, it is the responsibility of the
management of the entity to ensure that inventories included in the financial information are
physically in existence and represent all owned by the entity.
The management can satisfy this responsibility by carrying out appropriate procedures such as
verification of all items of inventory at least once in every financial year. The auditor is expected to
examine the adequacy of the methods and procedures of physical verification followed by the entity.
He is also required to determine whether the procedures for identifying defective, damaged, obsolete,
excess and slow-moving items are well-designed and operate properly.
This responsibility of the management is not reduced even where the auditor attends any physical
count of inventories in order to obtain audit evidence. The entities usually maintain detailed stock
records in the form of Stores/Stock ledgers showing in respect of each major item the receipts, issues
and balances. The extent of examination of these records by an auditor with reference to the relevant
basic documents (e.g., goods received notes, inspection reports, material issue notes, bin cards, etc.)
depends upon the facts and circumstances of each case. In valuation aspects, compliance with NAS 4
should also be ensured.
Question No 29
Write down any five audit steps for the audit of Debtors. (December 2014)(5 Marks)
Answer
Five audit steps for the audit of Debtors out of various possible steps are presented below:
i. Verify the opening balances with last year closing audited balances
ii. Obtain a schedule of receivables and determine whether the total agrees with the trial balance.

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iii. Obtain and consider explanations of significant variations in Debtor‟s turnover ratio of current
period and prior period and anticipated debtor turnover ratio.
iv. Select a sample of debtors and obtain direct confirmation from the parties concerned.
v. Obtain an aged analysis of the debtors. Inquire about the reason for unusually large accounts,
credit balances on accounts or any other unusual balances and inquire about the collectability
of receivables.
Question No 30
Explain the analytical procedures that an auditor can adopt to verify inventories.
Answer
The auditor can adopt the following analytical procedures to verify inventories.
 Quantitative reconciliation of opening stock, purchases, production, sales and closing stock
 Comparison of closing stock quantities and values with those of previous year.
 Comparison the inventory turnover ratio with that of the previous year and industry average,
if available.
 Comparison of the current year gross profit ratio with that of previous year.
 Comparison of actual stock, purchase and sales figures with the budgeted one.
 Comparison of raw material yield/wastage with previous year.
Question No 31
Help- SIPA, a NGO registered in Nepal raises funds from members, donors or contributors to support
victims of Earthquake of Sindhupalchok. Explain the points which you will consider in preparing the
Audit Programme of this NGO. ( July 2015) (5 Marks)
Answer
The audit programme should include in a sequential order all assets, liabilities, receipts and
expenditures ensuring that no material item is omitted.
i. Corpus Fund: The contributions / grants received towards corpus be vouched with special
reference to the letters from the donor(s). The interest income be checked with Investment
Register and Physical Investments in hand.
ii. Reserves: Vouch transfers from projects / programmes with donors letters and board resolutions
of NGO. Also check transfer of gross value of asset sold from capital reserve to general reserve
and adjustments during the year.
iii. Ear-marked Funds: Check requirements of donors institutions, board resolution of NGO, rules and
regulations of the schemes of the ear-marked funds.
iv. Project / Agency Balances: Vouch disbursements and expenditure as per agreements with donors
for each of the balances.
v. Loans: Vouch loans with loan agreements, receipt counter-foil issued.
vi. Fixed Assets: Vouch all acquisitions / sale or disposal of assets including depreciation and the
authorizations for the same. Also check donor's letters/agreements for the grant. In the case of
immovable property check title, etc.
vii. Investments: Check Investment Register and the investments physically ensuring that investments
are in the name of the NGO. Verify further investments and disinvestments for approval by the
appropriate authority and reference in the bank accounts for the principal amount and interest.
viii. Cash in Hand: Physically verify the cash in hand and impress balances, at the close of the year
and whether it tallies with the books of account.
ix. Bank Balance: Check the bank reconciliation statements and ascertain details for old outstanding
and unadjusted amounts.
x. Stock in Hand: Verify stock in hand and obtain certificate from the management for the quantities
and valuation of the same.

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xi. Programme and Project Expenses: Verify agreement with donor/contributor(s) supporting the
particular programme or project to ascertain the conditions with respect to undertaking the
programme / project and accordingly, in the case of programmes/projects involving contracts,
ensure that income tax is deducted, deposited and returns filed and verify the terms of the
contract.
xii. Establishment Expenses: Verify that provident fund, life insurance premium, employee‟s
insurance and their administrative charges are deducted, contributed and deposited within the
prescribed time. Also check other office and administrative expenses such as postage, stationery,
travelling, etc.
Question No 32
Explain the compliance procedure and substantial procedures as Audit methods of collecting
evidences for forming an audit opinion. ( July 2015) (5 Marks)
Answer
Auditor should obtain sufficient and appropriate audit evidences and test them before framing an
opinion about the assertions the financial statements reveal. For this, the auditor checks evidences
through
 Compliance procedure/test of control and
 Substantial procedure.
 Compliance procedures are tests designed to obtain reasonable assurance that those
internal control on which audit reliance is to be placed are in effect. It seeks to test that
 there exists internal control,
 the existing internal control is effective and
 the internal control is in full force / continues during the period under review.
When internal control is found to be to an acceptable level, the accounting entries generated in such a
system is more reliable than in one where the control is weak.
Mere satisfaction about the existence of internal control may not be sufficient for auditors to express
opinion about the assertions the financial data in the form of balances and transactions. These i.e.
transactions and balances need to be tested. This is done by audit procedure called substantial
checking. Substantial procedures are designed to obtain audit evidence as to the completeness,
accuracy and validity of the data produced by the accounting system.
The substantial procedures involve

(a) Checking of transactions and balances and
(b) Analytical review. The checking of transaction and balances involves vouching of sales,
purchases, payments, receipts and scrutiny of ledgers.
The analytical procedure involves critically examining the accounts in an overall manner and it may
entail computation of ratios, trend analysis so as to dwell in length for examination of unusual or
unexplained deviations.
Question No 33
Mr. Abhyudaya has been appointed as an Auditor of Kashvi Enterprises. After appointment, the books
of Kashvi Enterprises have been destroyed by earthquake. State the extensive procedures to be
followed for audit in such scenario. (December 2015)(5 Marks)
Answer
The scenario is guided by the audit of incomplete records. Audit of incomplete records are generally
required under the following two circumstances.
i. When accounts have been maintained on single entry basis or
ii. Accounting record may be destroyed by fire, flood etc. or seized by government authorities.
The auditor may be required to follow extensive procedures, which include:

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CAP II Examination
i. obtain list of records available

ii. Ensure that management reconstructs/compile records to the extent possible.
iii. Perform compliance procedure to assess whether internal control system is in operation.
iv. Vouch transactions in books of accounts with appropriate evidence.
v. Examine system of custody of cash receipts, cheque book etc.
vi. Conduct surprise verification of cash & inventory.
vii. Verify fixed assets by physical verification.
viii. Formulate appropriate audit opinion.
A disclaimer of opinion may be necessary if any restriction on scope of audit is enforced.
Question No 34
What do you mean by the term 'Sufficient Appropriate Audit Evidence'? State various factors that
help the auditor to ascertain as to what is sufficient appropriate audit evidence.
Answer
The auditor shall design and perform audit procedures that are appropriate in the circumstances for the
purpose of obtaining sufficient appropriate audit evidence. NSA 500 on „Audit Evidence‟ further
expounds this concept. According to it, the sufficiency and appropriateness of audit evidence are
interrelated.
Sufficiency is themeasure of the quantity of audit evidence. The quantity of audit evidence needed is
affected by the auditor‟s assessment of the risks of misstatement (the higher the assessed risks, the
more audit evidence is likely to be required) and also by the quality of such audit evidence (the higher
the quality, the less may be required). Obtaining more audit evidence, however, may not compensate
for its poor quality.
Appropriateness is the measure of the quality of audit evidence; that is, it srelevance and its reliability
in providing support for the conclusions on which the auditor‟s opinion is based. The reliability of
evidence is influenced by its source and by its nature, and is dependent on the individual
circumstances under which it isobtained.
NSA 330 requires the auditor to conclude whether sufficient appropriate audit evidence has been
obtained. Whether sufficient appropriate audit evidence has been obtained to reduce audit risk to an
acceptably low level, and thereby enablethe auditor to draw reasonable conclusions on which to base
the auditor‟s opinion,is a matter of professional judgment. Further, NSA 200 contains discussion of
such matters as the nature of audit procedures, the timeliness of financial reporting, andthe balance
between benefit and cost, which are relevant factors when the auditorexercises professional judgment
regarding whether sufficient appropriate audit evidence has been obtained.
In general the various factors which may influence the auditor‟s judgment as to what is sufficient and
appropriate audit evidence are as under:
 Degree of risk of misstatements which may be affected by factors such as the nature of items,
adequacy of internal control, nature and size of businesses carried out by the entity, situations
which may exert an unusual influence on management and the financial position of the entity.
 The materiality of the item.
 The experience gained during previous audits.
 The results of auditing procedures, including fraud and errors which may have been found.
 The type of information available.
 The trend indicated by accounting ratios and analysis.

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Chapter 4: Using work of Other
Audit and Assurance
CAP II Examination
Question No 1
How the work of an expert should be evaluated before accepting the same as Audit evidence?
Answer
As per the NSA 620, when the auditor intends to use the work of an expert he should evaluate the
following before accepting the same as audit evidence:
i. Professional qualification of the expert;
ii. Experience and reputation of expert in related field;
iii. Independence and objectivity of the expert;
iv. The objectives and scope of the expert‟s work;
v. Expert‟s relationship with the client, if any;
vi. The source data used;
vii. (vii)Assumptions and method used;
viii. The results of the expert‟s work in the light of auditor‟s overall knowledge of the business
and of the result of his audit procedures.
Question No 2
What are the points to be considered while using the work of an expert? (December 2011)(5 Marks)
Answer
NSA 620 Nepal Standards on Auditing using the work of an expert prescribes that when using the
work performed by an expert, the auditor should obtain sufficient appropriate audit evidence that such
work is adequate for the purposes of the audit. 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. Examples are:
i. Valuations of certain types of assets, for example, land and buildings, plant and machinery, works
of art, and precious stones.
ii. Determination of quantities or physical condition of assets, for example, minerals 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 opinions concerning interpretations of agreements, statutes, regulations, notifications
circulars, etc.
When determining whether to use the work of an expert or not, the auditor should consider:
i. The materiality of the item being examined in relation to the financial information as a whole.
ii. the nature and complexity of the item including the risk of error therein, and
iii. the other audit evidence available with respect to the item.
When the auditor plans to use the expert‟s work as audit evidence, he should satisfy himself as to the
expert‟s skills and competence by considering the expert‟s professional certification, license or
membership in an appropriate professional body and experience and reputation in the field in which
the auditor is seeking evidence.
However, when the auditor uses the work of an expert employed by him, he will not need to inquire
into his skills and competence.
The auditor should also consider the objectivity of the expert. The risk that an expert‟s objectivity will
be impaired increases when the expert is employed by the client, or related in some other manner to
the client.
Accordingly, in these circumstances, the auditor should (after taking into account the factors stated
above) consider performing more extensive procedures than would otherwise have been planned, or
lie might consider engaging another expert.

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CAP II Examination
Question No 3
CA. Khari Adhikari heads the internal audit department of Tee limited. The external audit firm
decided to rely on the internal auditor‟s work relevant for external audit because of the professional
competency of the chief of internal audit of Tee Limited. Later it was found that the external auditor
had conducted audit procedures himself instead of relying on internal auditor‟s work; however
claimed that he should not be made responsible for inappropriate audit opinion because he had relied
on the work of qualified internal auditor. (June 2013)(5 Marks)
Answer
The role of internal auditing is determined by management, and its objectives differ from those of the
external auditor who is appointed to report independently on the financial statements. The internal
audit function‟s objectives vary according to management‟s requirements. The external auditor‟s
primary concern is whether the financial statements are free from material misstatements.
Nevertheless some of the means of achieving their respective objectives are often similar and thus
certain aspects of internal auditing may be useful in determining the nature, timing and extent of
external audit procedures. Internal auditing is part of the entity. Irrespective of the degree of
autonomy and objectivity of internal auditing, it cannot achieve the same degree of independence as
required of the external auditor when expressing an opinion on the financial statements. The external
auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced
by any use made of internal auditing. All judgments relating to the audit of the financial statements
are those of the external auditor.
The external auditor has sole responsibility for the audit opinion expressed, and that responsibility is
not reduced by any use made of internal auditing. All judgments relating to the audit of the financial
statements are those of the external auditor. Hence the external audit firm in the given situation cannot
be relieved of its duty to express opinion on the financial statements by relying on the work of internal
auditor.

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Chapter 5: Internal Audit and Corporate Governance
Question No 1
Write short notes on Internal Audit (December 2012)(2.5 Marks)
Answer
Internal audit is an independent, objective assurance and consulting activity designed to add value and
improve an organization's operations. It helps an organization accomplish its objectives by bringing a
systematic, disciplined approach to evaluate and improve the effectiveness of risk management,
control, and governance processes.
Question No 2
a. Veri Ltd. is the Public Ltd. Company. It has not appointed Company Secretary. As an internal auditor
of the Company suggest whether the company has to appoint the Company Secretary including for the
required qualification of the Company Secretary. (June 2014)(5 Marks)
Answer
Section 185 of the company act deals with the provision for appointment of company secretary:
Section 185 (1) states that public company with the paid –up capital of ten million rupees or more
shall appoint the company secretary a Nepalese citizen who has the qualification mentioned in Sub-
section (2) . Section (2) states that a Nepalese citizen who has worked in the related field for at least
two years after obtaining the professional certificate of company secretary issued by a native or
foreign body authorized to issue the professional certificate of company secretary pursuant to the
prevailing law or who has worked in the related field or in the field of company management for at
least three years after doing at least bachelor degree in law, management ,commerce or economics
may be appointed to the post of company secretary. Provided, however, that this provision shall not
apply to the company secretary who is incumbent at the time of commencement of this Act for three
years after the date of commencement of this Act.
In the light of above provision of company act, I have to suggest the applicability of aforesaid
provision for Veri Ltd. if its paid up capital is Rs. 10 million or more
b. Firm of Ms. KD was appointed as auditor in 10th AGM of Neupane Limited. She was removed by
Board of Directors when she was out of Nepal on personal visit. (June 2014)(5 Marks)
Answer
Section 119 (1) of the Company Act, 2063 provides that no auditor appointed pursuant to Companies
Act shall be removed pending the completion of audit of accounts of any financial year for which
he/she was appointed as the auditor.
As per Sub-section (2), notwithstanding anything contained in Sub-section (1) , if any auditor
breaches the code of conduct of auditors or does any act against the interest of the company which has
appointed him/her as the auditor or commits any act contrary to the prevailing law, such auditor may
be removed through the same process whereby he/she was appointed as auditor, by giving prior
information to the ICAN, and with the approval of the regulatory authority, if any authorized by the
prevailing law for the regulation of business of the company concerned , and failing such authority,
with the approval of the Office of Registrar.
While removing an auditor pursuant to Sub-section (2) above, the auditor shall be provided with a
reasonable opportunity to defend him/herself.
Thus, Board of Directors cannot remove if auditor has been appointed through AGM. Further,
reasonable opportunity to defend herself should be provided.
Question No 3
Distinguish between
Internal Audit and Statutory Audit( July 2015) (5 Marks)
Answer
Internal audit is the arrangement within the organization to verify on continuous basis the correctness
and truthfulness of the transactions by the salaried staff/outsourced.
Audit and Assurance
CAP II Examination
Statutory audit is the examination of the books of accounts of the business by an external auditor and
to report that the profit and loss account and balance sheet are drawn according to provisions of
law and the financial statements reveal the true and fair view of the results of operations and financial
state of affairs of the business.
i. Internal audit is not compulsory.
ii. Statutory audit is compulsory as per applicable law.
iii. Internal audit is carried out by the person appointed by the business enterprises. It is not
necessary that the internal auditor should possess the qualification prescribed for professional
auditor.
iv. Statutory audit can be carried out only by those who are qualified for appointment as per the
provision of the Companies Act and other Acts.
v. Internal auditor is answerable to the management. His duties, responsibilities etc. regarding audit
work are determined by the management. The management can increase the powers and
authority of the internal auditor. Similarly it can also curtail his powers.
vi. The rights, duties, responsibilities and liabilities of statutory auditors are governed by the
provisions of law. The auditor is independent of management.
vii. The internal auditor points out irregularities in the procedural aspects and suggests ways and
means to rectify the same. He assures that the financial operations and other types of control in
force are carried out in conformity with the accounting systems.
viii. The statutory auditor is concerned with the legality and validity of the transactions of business.
His audit work is based on the financial statement prepared by the business.
Question No 4
Explain the circumstances when work of the internal audit function cannot be used by External
Auditor. (December 2015)(5 Marks)
Answer
The external auditor‟s evaluation of whether the internal audit function of organizational status and
relevant policies and procedures adequately support the objectivity of the internal auditors, the level
of competence of the internal audit function, and whether it applies a systematic and disciplined
approach may indicate that the risks to the quality of the work of the function are too significant and
therefore it is not appropriate to use any of the work of the function as audit evidence.
Consideration of the factors of NSA 610 individually and in aggregate is important because an
individual factor is often not sufficient to conclude that the work of the internal audit function cannot
be used for purposes of the audit. For example, the internal audit function‟s organizational status is
particularly important in evaluating threats to the objectivity of the internal auditors.
If the internal audit function reports to management, this would be considered a significant threat to
the function‟s objectivity.
This is because of the possibility that the engagement team will use the results of the internal audit
service without properly evaluating those results or without exercising the same level of professional
skepticism as would be exercised when the internal audit work is performed by individuals who are
not members of the firm.

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Chapter 6: Audit Conclusion and Reporting
Audit and Assurance
CAP II Examination
Question No 1:
Comment on the following:
What is clean audit report? Explain how it is different from qualified report? (June 2010)(5 Marks)
Answer
A clean audit report is a report issued by an auditor in case he does not have any reservation in respect
of matters contained in the financial statements. In such a case, the audit report may state that the
financial statements give a true and fair view of the state of affairs and of profit and loss account
during the period. A clean report may be without any modifications or with modifications which are
just for matter of emphasis. Under the following circumstances an auditor is justified in issuing a
clean report:
(i) the financial information has been prepared using acceptable accounting policies, which have
been consistently applied;
(ii) the financial information complies with relevant regulations and statutory requirements; and
(iii) there is adequate disclosure of all material matters relevant to the proper presentation of the
financial information, subject to statutory requirements, where applicable.
Qualified audit report, on the other hand, is one when auditor does not give a clean chit about the
truthfulness and fairness of the financial statements but makes certain reservations. A qualified report
is a modified report as to the auditor‟s opinion. A qualified report is issued when there is limitation on
the scope of audit or disagreement with management, regarding the acceptability of accounting
policies selected or the method of application or the adequacy of financial statement disclosure.
The auditor uses the word to indicate his qualification or reservation by placing the word “subject to”
or “except to”. The qualifications should indicate impact on profits and account balances and should
be specific, clear and self explanatory. The auditor should also give reasons for qualification. In case
of companies, there is also a legal requirement of the Company Act which provides that where the
auditor answers any of the statutory affirmations in negative or with qualification, his report shall
state the reasons for such answer.
Thus, it is clear from the above that in case of a clean report, the auditor has no reservation in respect
of various matters contained in the financial statements but a qualified report may involve certain
matters involving difference of opinion between the auditor and the management.
Question No 2
Write short note on
a. Disclaimer of opinion (June 2012) ( 5 Marks)
Answer
Depending upon the circumstances, an auditor expresses an opinion on the financial statement. A
disclaimer of opinion should be expressed when the possible effect of a limitation on scope is so
material and pervasive that the auditor has not been able to obtain sufficient appropriate audit
evidence and accordingly is unable to express an opinion on the financial statements.
b. Adverse opinion (December 2013)(5 marks)

Answer
An adverse opinion should be expressed by the auditor when the effect of a disagreement is so
material and pervasive to the financial statements that the auditor concludes that a qualification of the
report is not adequate to disclose the misleading or incomplete nature of the financial statements.
Whenever the auditor expresses an opinion that is other than unqualified, a clear description of all the
substantive reasons should be included in the report and, unless impracticable, a quantification of the
possible effect(s) on the financial statements. Ordinarily, this information would be set out in a
separate paragraph preceding the opinion or disclaimer of opinion on the financial statements and may
include a reference to a more extensive discussion, if any, in a note to the financial statements.
c. Date of auditor‟s report(December 2015)(2.5 Marks)

Answer

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CAP II Examination
The auditor should date the audit report no earlier than the date on which the auditor has obtained
sufficient appropriate audit evidence on which to base the opinion on the financial statements.
Sufficient appropriate audit evidence should include evidence that the entity‟s complete set of
financial statements has been prepared and that those with the recognized authority have asserted that
they have taken responsibility for them.
Question No 3
Distinguish between Peer review, hot review and cold review (December 2012)(5 Marks)
Answer
This is a critical independent review of one public accounting firm practices by another public
accounting firm. It is a review of the firm‟s accounting and auditing practices. It is intended that the
review be done by practitioners upon fellow practitioners.
Such an external review offers a more objective evaluation of the quality of performance than could
be done by self review.
Peer review study the adequacy of the firms established quality control policies and tests to determine
the extent of the firms compliance to these policies.
Suggestions for improvement to the system are outlined in a letter of comments issued by peer
reviewers to the reviewed firm. If a firm fails to take appropriate corrective action, various actions
may be imposed e.g. suspension from membership.
In carrying out the review it is limited to:-
 Professional aspects of the practice.
 The overall total quality control policies.
 Professional aspect of the firms accounting and auditing practices like maintenance of working
papers and work products such as report to the financial statements.
Hot Review
Is an independent review of an audit by a suitably qualified firm of auditors before the issue of the
audit report? The review includes evaluation of the engagement, working papers, reports and the firm
compliance with established quality control policies and professional standards.
Hot review helps the reviewed firm to make necessary changes on their report or have confidence that
what they are reporting was well conducted and no liability can result from their report.
Hot reviewers assess how the firm accepted their engagement i.e. whether they followed professional
ethics and whether they were qualified to act as auditors for the entity. Secondly they review the firms
audit plans and audit programs to consider how duties were assigned delegated and directed. They
address the critical areas by evaluating the working papers and how the audit evidence was gathered
i.e. audit tests and procedures were well performed according to the established standards.
Finally the reviewers will evaluate the report and make conclusion in writing as to whether all the
matters raised have been satisfactorily satisfied/resolved by the firm. They will also recommend
whether further tests are necessary to come up with comprehensive reports.
Cold Review
It is the involvement of an independent accounting firm or a partner to provide assurance that all the
firms‟ in house quality control policies have been complied with as well as provide a second opinion
that the audit was performed in accordance with generally accepted audit standards.
Cold review is an objective examination of an audit assignment after its completion referred to as post
audit review.
Cold review assess the policies and procedures the firm used to conduct its audit. This involves audit
planning and ascertaining that the audit team followed the audit plans together with audit programs. It

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CAP II Examination
also ascertains that work was well documented through working papers and judgment or conclusion
made.
Cold review report to staff adherence to ISAS and review work done by each staff and see that it is
according to the policies of the firm.
Question No 4
Under what circumstances an independent auditor can issue comfort letter to his/her client?
Answer
A letter from independent auditor including in a preliminary prospectus stating that, while a full audit
has not undertaken, the auditor has done a review sufficient to assure that financial statement
information in the preliminary prospectus is correctly prepared to the best of the auditor knowledge.
The auditor in effort states that, had a full audit been done, they are comfortable that the audited
financial statements would not be materially different from the ones presented in the preliminary
prospectus.
Before or during a new issue, a statement by an auditor stating that, while a full audit has not been
done, a review of the issue's prospectus has revealed nothing inaccurate or misleading. The comfort
letter also states that the auditor is confident that a full audit would not uncover anything unusual that
would negatively affect the issue.
In other word, a letter is given to organizations or persons of interest by external auditors regarding
statutory audits, statements and reports used in a prospectus. The comfort letter will be attached to the
preliminary statements as assurance that it will not be materially different from the final version.
Question No 6
Distinguish between Audit report and certificate (December 2013)(5 marks)
Answer
i. The term „report‟ is used where an expression of opinion is involved. The term „certificate‟ is
preferable where the auditor comments on or verifies facts
ii. The Auditor Report is based on facts, estimates and assumptions whereas Auditor's Certificate is
based on actual facts
iii. Auditor Report is not a guarantee of the absolute correctness & accuracy of the books of accounts.
But the auditor certificate serves as a guarantee of the absolute correctness & accuracy of the
books of accounts
iv. If the Auditor Report is later on found to be wrong, he cannot be held responsible since he has
given merely his opinion on the state of affairs of the company. But if the duly signed
certificate is found as wrong, he will be held responsible
Question No 7:
Explain the situations of modifying the auditor‟s report as per NSA.
Answer
There are the following situations of modifying the auditor‟s report wording:
I. Matters that Do Not Affect the Auditor’s Opinion
Emphasis of matter: In certain circumstances, an auditor‟s report may be modified by adding an
emphasis of matter paragraph to highlight a matter affecting the financial statements which is
included in a note to the financial statements that more extensively discusses the matter. The addition
of such an emphasis of matter paragraph does not affect the auditor‟s opinion. The paragraph would
preferably be included after the paragraph containing the auditor‟s opinion but before the section on
any other reporting responsibilities, if any. The emphasis of matter paragraph would ordinarily refer
to the fact that the auditor‟s opinion is not qualified in this respect.

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II. Matters that Do Affect the Auditor’s Opinion

i. Qualified opinion: A qualified opinion should be expressed when the auditor concludes that
an unqualified opinion cannot be expressed but that the effect of any disagreement with
management, or limitation on scope is not so material and pervasive as to require an adverse
opinion or a disclaimer of opinion. A qualified opinion should be expressed as being „except
for‟ the effects of the matter to which the qualification relates.
ii. Disclaimer of opinion: A disclaimer of opinion should be expressed when the possible effect
of a limitation on scope is so material and pervasive that the auditor has not been able to
obtain sufficient appropriate audit evidence and accordingly is unable to express an opinion
on the financial statements.
iii. Adverse opinion: An adverse opinion should be expressed when the effect of a disagreement
is so material and pervasive to the financial statements that the auditor concludes that a
qualification of the report is not adequate to disclose the misleading or incomplete nature of
the financial statements.
Question No 8:
Explain „Assurance Report‟ as an element of assurance. (December 2015)(5 Marks)
Answer
Assurance engagement is an engagement in which a practitioner auditor expresses a conclusion
designed to enhance the degree of confidence of the intended users other than the responsible party
about the outcome of the evaluation or measurement of a subject matter against criteria.
The practitioner auditor provides a written report containing a conclusion that conveys the assurance
obtained about the subject matter information. NSAs, NSREs and NSAEs establish basic elements for
assurance reports. In addition, the practitioner considers other reporting responsibilities, including
communicating with those charged with governance when it is appropriate to do so. In an assertion-
based engagement, the practitioner's conclusion can be worded either:
In terms of the responsible party's assertion (for example: "In our opinion the responsible party's
assertion that internal control is effective, in all material respects, based on XYZ criteria, is fairly
stated"); or
Directly in terms of the subject matter and the criteria (for example: "In our opinion internal control is
effective, in all material respects, based on XYZ criteria").
In a direct reporting engagement, the practitioner's conclusion is worded directly in terms of the
subject matter and the criteria.In a reasonable assurance engagement, the practitioner expresses the
conclusion in the positive form, for example: "In our opinion internal control is effective, in all
material respects, based on XYZ criteria." This form of expression conveys "reasonable assurance."
Having performed evidence gathering procedures of a nature, timing and extent that were reasonable
given the characteristics of the subject matter and other relevant engagement circumstances described
in the assurance report, the practitioner has obtained sufficient appropriate evidence to reduce
assurance engagement risk to an acceptably low level. In a limited assurance engagement, the
practitioner expresses the conclusion in the negative form, for example, "Based on our work described
in this report, nothing has come to our attention that causes us to believe that internal control is not
effective, in all material respects, based on XYZ criteria."
This form of expression conveys a level of "limited assurance" that is proportional to the level of the
practitioner's evidence-gathering procedures given the characteristics of the subject matter and other
engagement circumstances described in the assurance report.
Question No 9
Distinguish between
Qualified report and adverse report(December 2015)(5 Marks)
Answer

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CAP II Examination
i. A qualified opinion should be expressed when the auditor concludes that an unqualified opinion
cannot be expressed but that the effect of any disagreement with management is not so material
and pervasive as to require an adverse opinion, or limitation on scope is not so material and
pervasive as to require a disclaimer of opinion. An adverse opinion should be expressed when
a effect of a disagreement is so material and pervasive to the financial statements that the auditor
concludes that the qualification of the report is not adequate , to disclose the misleading or
incomplete nature of the financial statement.
ii. In qualified report, auditor`s reservation generally written as "subject to or except for, we
report that the financial statements shows the true & fair view". Whereas in case of adverse
report, the auditor states that " the financial statements do not present a true and fair view of the
state of affairs and working results".
iii. In qualified report, auditor gives an opinion subject to certain reservations whereas in the case
of adverse report the auditor concludes that on the basis of his examination he is not satisfied with
the affirmation made in the financial statements.

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Chapter 7 Government Audit
Audit and Assurance
CAP II Examination
Question No 1:
Write short note on Features of government audit (June 2013)(5 Marks)
Answer
Citizen of the country are more concern on issues concerning public accountability, including the
misuse of public funds, evaluation of the effectiveness and outcomes of government programs,
information disclosure based on the “right-to-know,” and requests for disclosure of government
financial data through financial statements. To meet these challenges, each government has one
Supreme Audit Institution that is responsible for the public auditing whereas Financial Comptroller
General is responsible to maintain public accounting.
Supreme Audit Institution in Nepal is called the office of the Auditor General (OAGN) who conduct
public audit of the government budget and expenditure. Regarding the aim of auditing, public audits
are carried out as comprehensive audits that include financial auditing and performance auditing or
value-for-money (VFM) auditing.
The aim of audit of government auditing has some audit areas that are completely different from those
concerning the auditing of corporate accounts. In government auditing, the scope of financial auditing
includes audit areas other than the audit of accounts, and performance auditing includes the evaluation
of economy, efficiency, and effectiveness. OAGN also performs the audit of regularity and propriety.
Government auditing was initially conducted as compliance audits, which means accurate account
auditing or financial auditing. Subsequently, government organizations were required to provide
effective public services by efficient management in the performance of their trusteeship obligations,
which in turn necessitated performance auditing.
As a feature of performance auditing, the Auditing Standards of the International Organization of
Supreme Audit Institutions (INTOSAI) point out that “performance audits should not concentrate
solely on criticism of the past but should be constructive.

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Chapter 8: Audit of Specific Organizations
Audit and Assurance
CAP II Examination
Question No 1:
Give your opinions with reasons :
Terai Bank Limited provided a long term loan amounting to Rs. 250 Million to Relax Hotel Pvt.
Limited for hotel operation. The hotel is unable to repay installment (principal & interest) as per
repayment schedule. Accordingly you are appointed by the Bank for special review of the income of
the hotel to ensure whether income procedures are duly complied with and the amount has been fully
accounted for. As a special reviewer how would you plan your review work?
Answer
An efficient and effective review can only be performed if this has been thoroughly and properly
planned. The planning stage of the review should be used to establish an overall strategy for the
review.
Adequate planning will ensure that appropriate attention is given to crucial areas of the review and
that potential problems are identified on a timely basis. At the planning stage the engagement partner
should assign the necessary staffs who possess the skills and ability required in order to ensure the
review is carried out efficiently and in accordance with the Nepal Standards on Auditing.
Planning Activities
At the planning stage the overall audit strategy is developed. The audit strategy sets the scope, timing
and direction of the review. At this stage the reviewer will develop the detailed review plan which
will help identify problem areas and important review areas.
Once the strategy has been established, then the reviewer is able to develop the more detailed review
plan to address the matters identified in the overall strategy.
Contents of the Plan

The review plan should document the nature, timing and extent of the procedures to be adopted which
should be sufficient and effective enough to be able to assess the risks associated with review
engagements.
The detailed plan should also contain a description of the nature, timing and extent of planned further
audit procedures at the assertion level for each material class of transactions, account balances and
disclosures.
Finally, the review plan should also contain details of other procedures to be adopted so that the
review can be carried out effectively.
Typical contents of the detailed plan are:
 Nature of the business and what it does
 Risk and problematic areas (both business risk and financial statement risk)
 Details of any complexities associated with the assignment
 Specific accounting and auditing standards relevant to the assignment
 Budgets
 Planned review procedures
 Details of sampling techniques
 Key personnel employed at the clients
For the purpose of this review of the income of the hotel and purpose of assignment an audit program
with detailed procedures should also be developed to conduct the review work efficiently and
effectively. Audit procedures inter alia includes amongst the following:
i. Whether rack rates has been maintained for different types of rooms (Suit/Deluxe/Superior etc),
banquette rates are formalized with recipe and other rates are formalized & approved by
competent authority.
ii. Whether there are formal discount rates. If discount rate is in excess of formal rate, whether this is
approved by the competent authority.
iii. Whether rate agreements has been entered with regular official & individual parties and duly
signed of both parties. If yes agreed rates have been applied or otherwise to ensure how the rate is
formalized in such cases.
iv. Whether complimentary service provided to guests are within the power of approving authority.

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CAP II Examination
v. Whether the billing are made on timely basis and accounted accordingly on departure of guest
with evidence of acceptance by guests. If bill is to be forwarded to customer through mail, is it
forwarded on timely basis?
vi. Whether there is clear cut credit policy and credit facility provided only to eligible guest backing
with deposition of advance.
vii. Whether revenue as per income of auditor`s report, accounting system and VAT return has been
matched. In case of difference, is proper reconciliation has been made.
viii. Whether rates have been reviewed as per formal policy of hotel and approved by the competent
authority.
ix. Whether record of revenue charged has been reflected in the concerned ledger folios of the guest.
x. Whether accounting system (Software/Manual) for revenue is commensurable with volume of
transactions of the hotel.
xi. Check the closing procedures of the hotel during physical presence on sample night audits.
xii. Make the surprise check on different point of sales and observed if any evidences of concealing
the income (by not issuing bill, by providing huge discounts, by undervaluing the bill etc.)
xiii. Check the recovery rate from debtors and utilization of cash.
Question No 2:
Give your opinions with reasons :
A Donor has appointed you as an auditor for ensuring financial management capacity of the NGO
before funding made to the NGO to rely on the fund operating capability of the NGO. What would be
your special focus area for such assignment? (June 2011)(5 Marks)
Answer
For ensuring financial management capacity of the NGO my special focus area would be:
i. To ensure whether adequate internal control system for accounting administration has been
existed within the organization.
ii. To ensure the required experiences & academic qualification of accounting staff.
iii. To ensure the volume of donors fund previously operated by the NGO.
iv. To ensure the adequacy of policies etc (like accounting manual, chart of account, financial &
administrative regulation, software are in place & adequate).
v. To see the annual audit report, internal audit report & other types of audit report for ensuring
serious and risky areas if any to pay due attention.
vi. To ensure the basic accounting concept of non-accounting staff for handling the advances.
vii. To see overall account of the NGO, whether there is any diversion of project fund to institutional
fund through any unfair means.
viii. To see the composition of program cost & office running cost for ensuring whether office
running cost mainly salary is excessively high than program cost.
ix. To the composition of common cost (cost shared by different donors) in past period to ensure
that whether same cost has been borne by different donors in books of accounts.
x. To ensure whether periodical reconciliation (bank/cash/fund etc) system are in place.
xi. To ensure whether budgetary control system are in place.
xii. To ensure whether there is excessive turnover of the accounting staff.
xiii. To ensure whether proper & adequate delegation of authority has been made and properly
exercised in practice.
Question No 3
District Education Office has appointed you as an auditor for some community schools of Humla
District. What special points do you consider while doing audit of such schools? Explain.
Answer
Audit of Education Institutions i.e. Community Schools of Humla District:
The special steps involved in their audit are the following:
i) Examine the Education Act and Education Rules in these cases as these are the Community
Schools which are under the control of the District Education Office and note all the provisions
affecting accounts. .

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CAP II Examination
ii) Read through the minutes of the meeting of the School Management Committee, noting
resolutions affecting account to see that these have been duly complied with, specially the
decisions as regards the operation of bank account and sanctioning of expenditure.
iii) Check names entered in the Students Fee Register for each month or term, with the respective
Class Registers, showing names of student on rolls and test amount of fees and extra charged; and
verify that there operates a system of internal check which ensures that demands against the
student are properly raised.
iv) Check fees received by comparing counterfoils or receipts granted with entries in the Cash Book
and tracing the collections in the Fee Register to confirm that the revenue from this source has
been duly accounted for.
v) Total up the various columns of the Fees Register for each month or term to ascertain that fees
paid in advance have been carried forward and that the arrears that are irrecoverable have been
written off under the sanction of an appropriate authority.
vi) Check admissions fees with admissions slips signed by the head of the institution and confirm that
the amount has been credited to a Capital Fund, unless the School Management Committee has
taken a decision to the contrary.
vii) See the free studentship and concessions have been granted by a person authorized to do so,
having regard to the Rules prepared by the Management Committee.
viii) Confirm that fines for late payment or absence, etc. have been either collected or remitted under
proper authority.
ix) Confirm that hostel dues were recovered before student's accounts were closed and their deposits
of caution money refunded.
x) Verify rental income from landed property with the rent rolls, etc.
xi) Verify any government or local authority grant with the memo of grant. If any expense has been
disallowed for purposes for grant, ascertain the reasons thereof.
xii) Report any old heavy arrears on account of fees, dormitory rents, etc. to the Management
Committee.
xiii) Confirm that caution moneys and other deposits paid by students on admission, have been shown
as liability in the balance sheet and not transferred to revenue, unless they are not refundable.
xiv) See that the investments representing endowment funds for prizes are kept separate and any
income in excess of the prizes has been accumulated and inappropriate securities.
xv) Check the distribution of scholarship to the students and ensure the same with the receipts of the
students.
xvi) Check the distribution sheet of textbooks, payroll of the PCF teachers with the number of
students.

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THE INSTITUTE OF CHARTERED ACCOUNTANTS OF NEPAL

AUDIT AND ASSURANCE

Chapter 1: General Concept............................................................................................................... 1

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

v. Auditor signed wrong dated financial statement.

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

equivalent governing body of the investee;(b) participation in policy-making processes, including

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

ii) The following information pertains to the trading stock of a company:

The following comparative table may be useful for valuation of inventories

Product Historical cost Rs Net Realizable Presentable

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

Auditing and Assurance

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

ACA Rs. 2,500 Per day/person

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

b) Impairment of assets. (December 2010)(5 Marks)

c) Familiarity threat (June 2012) ( 5 Marks)

The Institute of Chartered Accountants of Nepal

d) Legal liabilities of auditor (December 2012)(2.5 Marks)

e) A qualifying insurance policy (December 2013)(5 marks)

f) Professional skepticism (June 2014)(2.5 Marks)

g) Revaluation of Fixed Assets (December 2014)(5 Marks)

The Institute of Chartered Accountants of Nepal

h) Qualities of an Auditor (December 2014)(5 Marks)

i) Consultation in quality audit (July 2015) (2.5 Marks)

j) Self-review threat ( July 2015) (2.5 Marks)

The Institute of Chartered Accountants of Nepal

and satisfactorily. Management audit is concerned with appraising management‟s accomplishment of

b. Statutory & System Audit (December 2012)(5 Marks)

c. Auditing and Investigation (December 2014)(5 Marks)

The Institute of Chartered Accountants of Nepal

d. Reserves and provisions (December 2015)(5 Marks)

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal

The Institute of Chartered Accountants of Nepal