May 21

INTERMEDIATE COURSE
(UNDER REVISED SCHEME OF

EDUCATION AND TRAINING)
GROUP – II
REVISION TEST PAPERS

MAY, 2021
BOARD OF STUDIES
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA
(Set up by an Act of Parliament)
New Delhi
© The Institute of Chartered Accountants of India

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Edition : March, 2021
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Contents
Page Nos.
Objective & Approach ................................................................................................... i –viii
Objective of Revision Test Paper ........................................................................................... i
Planning & Preparing for Examination ....................................................................................ii
Subject-wise Guidance – An Overview .................................................................................. iii
Paper-wise RTPs
Paper 5: Advanced Accounting ................................................................................ 1 – 40
Part – I : Announcements Stating Applicability & Non-Applicability ................ 1 – 3
Part – II : Questions and Answers ............................................................... 3 – 40
Paper 6: Auditing and Assurance ......................................................................... 41 – 184
Part – I : Academic Update ..................................................................... 41 – 154
Part – II : Questions and Answers ......................................................... 155 – 184
Paper 7: Enterprise Information Systems and Strategic Management .................. 185 – 208
Section A: Enterprise Information Systems ................................................... 185 – 196
Section B: Strategic Management ................................................................. 197 – 208
Paper 8: Financial Management and Economics for Finance ...................................209 – 237
Section A: Financial Management ..................................................................209 – 230
Section B: Economics for Finance..................................................................231 – 237
Applicability of Standards/Guidance Notes/Legislative Amendments etc.
for May, 2021 – Intermediate (New) Examination ..........................................................238 – 241

REVISION TEST PAPER, MAY, 2021 – OBJECTIVE & APPROACH
(Students are advised to go through the following paragraphs carefully to derive
maximum benefit out of this RTP)
I Objective of Revision Test Paper
Revision Test Papers are one among the many educational inputs provided by the Board
of Studies (BOS) to its students. Popularly referred to as RTP by the students, it is one of
the very old publications of the BOS whose significance and relevance from th e
examination perspective has stood the test of time.
RTPs provide glimpses of not only the desirable ways in which examination questions are
to be answered but also of the professional quality and standard of the answers expected
of students in the examination. Further, aspirants can assess their level of preparation for
the examination by answering various questions given in the RTP and can also update
themselves with the latest developments in the various subjects relevant from the
examination point of view.
The primary objectives of the RTP are:
• To help students get an insight of their preparedness for the forthcoming examination;
• To provide an opportunity for a student to find all the latest developments relevant for
the forthcoming examination at one place;
• To supplement earlier studies;
• To enhance the confidence level of the students adequately; and
• To leverage the preparation of the students by giving guidance on how to approach
the examinations.
RTPs contain the following:
(i) Planning and preparing for examination
(ii) Subject-wise guidance – An overview
(iii) Updates applicable for a particular exam in the relevant subjects
(iv) Topic-wise questions and detailed answers thereof in respect of each paper
(v) Relevant announcement applicable for the particular examination
Students must bear in mind that the RTP contains a variety of questions based on different
sections of the syllabi and thus a comprehensive study of the entire syllabus is a pre -
requisite before answering the questions of the RTP. In other words, in order to derive
maximum benefit out of the RTPs, it is advised that before proceeding to solve the
questions given in the RTP, students ought to have thoroughly read the Study Materials.

REVISION TEST PAPER ii
The topics on which the questions are set herein have been carefully selected and
meticulous attention has been paid in framing different types of questions. Detailed
answers are provided to enable the students to do a self-assessment and have a focused
approach for effective preparation.
Students are welcome to send their suggestions for fine tuning the RTP to the Director,
Board of Studies, The Institute of Chartered Accountants of India, A-29, Sector-62, Noida
201 309 (Uttar Pradesh). RTP is also available on the Institute’s website www.icai.org
under the BOS knowledge portal in students section for downloading.
II. Planning and preparing for examination
Ideally, when the RTP reaches your hand, you must have finished reading the relevant
Study Materials of all the subjects. Make sure that you have read the Study Materials
thoroughly as they cover the syllabus comprehensively. Get a good grasp of the concepts/
provisions discussed therein. Solve each and every question/illustration given therein to
understand the application of the concepts and provisions.
After reading the Study Materials thoroughly, you should go through the Updates pr ovided
in the RTP and then proceed to solve the questions given in the RTP on your own. RTP
is in an effective tool to revise and refresh the concepts and provisions discussed in the
Study Material. RTPs are provided to you to help you assess your level o f preparation.
Hence you must solve the questions given therein on your own and thereafter compare
your answers with the answers given therein.
Examination tips
How well a student fares in the examination depends upon the level and depth of his
preparation. However, there are certain important points which can help a student better
his performance in the examination. These useful tips are given below:
 Reach the examination hall well in time.
 As soon as you get the question paper, read it carefully and thoroughly. You are
given separate 15 minutes for reading the question paper.
 Plan your time so that appropriate time is awarded for each question. Keep sometime
for checking the answers as well.
 First impression is the last impression. The question which you can answer in the
best manner should be attempted first.
 Always attempt to do all questions. Therefore, it is important that you must finish
each question within allocated time.
 Read the question carefully more than once before starting the answer to understand
very clearly as to what is required.

iii INTERMEDIATE (NEW) EXAMINATION: MAY, 2021
 Answer all parts of a question one after the other; do not answer different parts of the
same question at different places.
 Write in a neat and legible hand-writing.
 Always be concise and write to the point and do not try to fill pages unnecessarily.
 There must be logical expression of the answer.
 In case a question is not clear, you may state your assumptions and then answer the
question.
 Check your answers carefully and underline important points before leaving the
examination hall.
III. Subject-wise Guidance – An Overview
PAPER 5: ADVANCED ACCOUNTING

The Revisionary Test Paper (RTP) of Advanced Accounting is divided into two parts viz
Part I - Relevant Announcements, Amendments and Notifications for May, 2021
examination and Part II –Questions and Answers.
It may be noted that the October, 2020 edition of the Study Material is relevant for May,
2021 Examination.
Part I of the Revisionary Test Paper consists of the ‘Relevant Amendments and
Notifications - applicable and not applicable’ for May, 2021 examination. The purpose of
this information in the RTP is to apprise the students with the latest developments
applicable for May, 2021 examination. The brief summary of the same has been given as
under:
A. Applicable for May, 2021 examination:
I. Amendments in Schedule III (Division I) to the Companies Act, 2013
II. Sale of Securities held in Held to Maturity (HTM) Category
III. Merging three categories of NBFCs viz. Asset Finance Companies (AFC), Loan
Companies (LCs) and Investment Companies (ICs) into a new category called
Investment and Credit Company (NBFC-ICC)
B. Not applicable for May, 2021 examination:
I. Ind ASs issued by the Ministry of Corporate Affairs.
Part II of the Revisionary Test Paper consists of twenty questions together with their
answers. First eleven questions are based on different topics discussed in the study
material. Last nine questions of this RTP are based on Accounting Standards. For easy
reference, the topic / accounting standard number on which the question is based has been

REVISION TEST PAPER iv
quoted at the top of each question. The details of topics, on which questions in the RTP
are based, are as under:
Question Topic
No.
1 Conversion of Partnership into Company and Sale to a Company
2. Dissolution of Partnership Firm and Limited Liability Partnerships
3 Accounting for ESOPs
4 Buy Back of Securities
5 Equity Shares with Differential Rights
6 Amalgamation of Companies
7 Internal Reconstruction of a Company
8 Liquidation of a Company
9 Banking Companies
10 NBFCs
11 Consolidated Financial Statements
12 to 20 Accounting Standards
Answers to the questions have been given in detail along with the working notes for easy
understanding and comprehending the steps in solving the problems. The answers to the
questions have been presented in the manner which is expected from the students in the
examination. The students are expected to solve the questions under examination
conditions and then compare their solutions with the solutions given in the Revisionary
Test Paper and further strategize their preparation for scoring more marks in the
examination.
PAPER – 6: AUDITING AND ASSURANCE
RTP is a tool to refresh your knowledge which you have acquired while doing your
conceptual study from Study Material and other modes of knowledge like student journal,
bare acts etc.
The Revisionary Test Paper (RTP) of Auditing and Assurance for May, 2021 carries twenty
eight descriptive questions along with Case Scenarios followed by MCQs and standalone
MCQs along with their answers. These questions have been taken from the entire syllabus
which is divided into thirteen chapters along with engagement and quality control standards
etc. discussed in the study material.
The various Chapters/topics as mentioned above are Standards on Auditing, Nature,
Objective and Scope of Audit, Audit Strategy, Audit Planning and Audit Programme, Audit
Documentation and Audit Evidence, Risk Assessment and Internal Control, Fraud and
Responsibilities of Auditor in this Regard, Audit in an Automated Environment, Audit
Sampling, Analytical Procedures, Audit of Items of Financial Statements, The Company

v INTERMEDIATE (NEW) EXAMINATION: MAY, 2021
Audit, Audit Report, Audit of Banks and Audit of Different Types of Entities. The chapter’s
name is also clearly indicated before each question. The questions in the RTP have been
arranged in the same sequence as prescribed in the study material to facilitate easy
revision by the students. An attempt has been made to cover the syllabus
comprehensively.
This RTP of Auditing and Assurance has been divided into two parts viz Part I – Legislative
Amendments / Notifications / Circulars / Rules / Guidelines issued by Regulating Authority
relevant for May, 2021 examination and Part II – Questions and Answers.
The relevant notified sections of the Companies Act, 2013 and other legislative
amendments including relevant Notifications / Circulars / Rules / Guidelines issued by
Regulating Authorities up to 31st October, 2020 are applicable for May, 2021 Examination.
The questions have been answered in this RTP keeping in view latest amendments as per
above mentioned date.
PAPER – 7: ENTERPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT

Section – A: Enterprise Information Systems
The Revision Test Paper on Enterprise Information Systems is a supplementary tool that
provides comprehensive view of the entire syllabus which is divided into five chapters. It is
based on the study material that is already provided to the students. The chapter -wise
questions and answers are provided so that students could test their preparation level for
the examination.
The RTP for May 2021 examination contains total 15 questions out of which first 5
questions are Multiple Choice Questions (MCQ) based on Integrated Case Scenario to test
Analysis and Application skillset of the student. Each MCQ has four options out of which
only one option is correct.
Remaining 10 Descriptive questions numbered 6 to 15 are provided chapter -wise with 2
questions from each chapter. These questions have been selected from various topics
keeping in view the complete and uniform coverage of the complete syllabus to check the
students’ preparedness on answering the questions based on different skill levels
“Comprehension & Knowledge” as well as “Analysis & Application”. The questions provide
an insight to the students on evaluate their understanding of the fundamental concepts of
Information Systems and Business Process flows, Financial and Accounting Systems,
Core Banking Systems and e-Commerce/m-Commerce transactions. Full answer to each
descriptive question is provided so that students would be benefited without searching the
answers in the study material.

REVISION TEST PAPER vi
Section – B: Strategic Management

The Revision Test Paper in the subject of Strategic Management for the May, 2021 examination
contains twenty two questions. The questions have been selected from all the sections/chapters
uniformly to cover whole syllabus. Questions are based on different skill levels, i.e.,
“Comprehension & Knowledge” as well as “Analysis & Application”.
The questions included are of different categories – multiple choice questions based on case
scenario, application based and simple multiple choice questions, distinguish between, short
notes, descriptive and questions based on practical scenarios. The first question contains
multiple choice questions based on case scenario are subdivided into five different parts.
Questions from two to six are mixed of application based and simple multiple choice questions.
All multiple choice questions are given with four alternatives and the student has to opt the
correct option. Subsequently, sixteen different questions have been included to cover all the
eight chapters of the syllabus. Chapter names have been mentioned before questions. A
descriptive question based on practical scenario has been included from each section. Another
descriptive question has also been included from each section of the syllabus.
The students should take up this Revision test paper as a tool to check their preparedness in
the subject. Mere reading of Revision Test Paper will not be helpful. To properly self-assess the
preparation in the subject, students must attempt the questions on their own. Compare your
answers with the suggested answers and hints given to assess the level of preparation and
identify areas where more focus is required. Then you may work on these areas to improve the
quality of answers that you write.
Work hard and perform well in the examination!
PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE
PAPER – 8A: FINANCIAL MANAGEMENT

The Revision Test Paper (RTP) of Financial Management comprises of ten questions for
full coverage of the syllabus. Theoretical questions along with computational problems
have also been incorporated so that you can give emphasis to the theoretical portion of
the syllabus as well. Since this paper’s inclination is more towards numerical -oriented
questions which involve mathematical calculations, therefore, it is very important that you
have thoroughly studied the theoretical aspects of the subject and are also clear about the
concepts and logic behind the mathematical workings and formulae.

vii INTERMEDIATE (NEW) EXAMINATION: MAY, 2021
A summary of the questions both theoretical and computational has been given for your
reference:
Q. No. Topic About the Problem
1. Ratio Analysis Calculation of different ratios for financing
policies.
2. Cost of Capital Calculation of Cost of sources of capital and
Marginal Cost of capital.
3. Capital Structure Calculation of amount of Debt by traditional
approach and Equity capitalization rate by MM
approach.
4. Leverage Using the concept of Leverage, finding out the
percentage change in taxable Income, EBIT
along with verification.
5. Investment Decisions Decision between modernizing or buying new
machine.
6. Risk Analysis in Capital Calculation of expected NPV and impact on NPV
Budgeting due to change in variables.
7. Dividend Decisions Analyzing company’s dividend policy and
Calculation of P/E Ratio.
8. Management of working Calculation of additional Working Capital
capital Requirement.
9. Management of working Calculation of Estimated Working Capital
capital requirement on cash cost basis.
10 (a) Introduction to Financial Profit Maximization objective.
Management
10 (b) Type of Financing Issue of Preference Shares.
Section B: Economics for Finance

At the intermediate level, you are expected to acquire not only professional knowledge but
also the ability to apply such knowledge in problem solving. Therefore, the questions have
been framed in such a manner that not only your knowledge and understanding are tested
but also how you apply this knowledge in solving problems.
The first question relates to calculating GDP Deflator and also about differentiation of
excess demand from deficient demand.
Second question is about calculation of the National Income by expenditure method and
income method.

REVISION TEST PAPER viii
Third question relates to the redistribution effect of a tax and transfer policy with an
example. It also asks about the importance of the distinction between private costs and
social costs.
In the Fourth question direct government actions to solve negative externalities have been
asked. It part “b” relates to the simple calculation of equilibrium of income and the value of
expenditure multiplier.
Fifth question relates to finding out the velocity of money and the outcome if volume of
transaction increases. It also asks about the role of bank rate as an instrument of monetary
policy.
Sixth question enquires about the concept of liquidity trap. It also asks about the
relationship between purchasing power of money and general price level, and why people
demand money for precautionary motive.
Seventh question is concerned about how real GDP is a better measure of economic well
being.
Eighth question relates to the new trade theory and its importance.
Ninth question relates to different technical barriers to trade (TBT) and their effect on trade.
Its part “b” relates to export duties.
Tenth question is concerned about the arbitrage and its outcome and the types of
transactions in the foreign exchange market.
Some answers have been given in detail so as to enable you to understand and
comprehend the steps involved in answering/solving the problems; for others only hints
have been provided. Students must attempt the questions themselves under examination
conditions and then see the answers. This will help you in knowing your level of
preparedness and further strategize your final preparation and presentation.

PAPER – 5: ADVANCED ACCOUNTING
PART – I: ANNOUNCEMENTS STATING APPLICABILITY & NON-APPLICABILITY

FOR MAY, 2021 EXAMINATION
A. Applicable for May, 2021 Examination

I. Amendments in Schedule III (Division I) to the Companies Act, 2013
In exercise of the powers conferred by sub-section (1) of section 467 of the
Companies Act, 2013), the Central Government made the following amendments in
Division I of the Schedule III with effect from the date of publication of this notification
in the Official Gazette:
(A) under the heading “II Assets”, under sub-heading “Non-current assets”, for the
words “Fixed assets”, the words “Property, Plant and Equipment” shall be
substituted;
(B) in the “Notes”, under the heading “General Instructions for preparation of
Balance Sheet”, in paragraph 6,-
(I) under the heading “B. Reserves and Surplus”, in item (i), in sub- item (c),
the word “Reserve” shall be omitted;
(II) in clause W., for the words “fixed assets”, the words “Property, Plant and
Equipment” shall be substituted.
II. Sale of Securities held in Held to Maturity (HTM) Category
Accounting treatment
Investments by Primary (Urban) Co-operative Banks (UCBs) if securities acquired by
banks with the intention to hold them up to maturity will be classified under HTM
category. As per Circular no. RBI/2018-19/205 DCBR.BPD. (PCB)
Cir.No.10/16.20.000/2018-19 dated 10th June, 2019, it is reiterated that UCBs are
not expected to resort to sale of securities held in HTM category. However, if due to
liquidity stress, UCBs are required to sell securities from HTM portfolio, they may do
so with the permission of their Board of Directors and rationale for such sale may be
clearly recorded. Profit on sale of investments from HTM category shall first be taken
to the Profit and Loss account and, thereafter, the amount of such profit shall be
appropriated to ‘Capital Reserve’ from the net profit for the year after statutory
appropriations. Loss on sale shall be recognized in the Profit and Loss account in the
year of sale.
Prudential Norms for Classification, Valuation and Operation of Investment
Portfolio by Banks
As per Circular no. RBI/2018-19/204 DBR.No.BP.BC.46/21.04.141/2018-19 dated
10th June, 2019 (referring to RBI circular DBR No BP.BC.6/21.04.141/2015 -16 dated

2 INTERMEDIATE (NEW) EXAMINATION: MAY, 2021
July 1, 2015 advising banks that if the value of sales and transfer of securities to /
from HTM category exceeds 5 per cent of the book value of investments held in HTM
category at the beginning of the year) banks should disclose the market value of the
investments held in the HTM category and indicate the excess of book value over
market value for which provision is not made. Apart from transactions that are already
exempted from inclusion in the 5 per cent cap, it has been decided that repurchase
of State Development Loans (SDLs) by the concerned state government shall also be
exempted.
III. Merging three categories of NBFCs viz. Asset Finance Companies (AFC), Loan
Companies (LCs) and Investment Companies (ICs) into a new category called
Investment and Credit Company (NBFC-ICC)
As per circular RBI/2018-19/130 DNBR (PD) CC.No.097/03.10.001/2018-19 dated
February 22, 2019, in order to provide NBFCs with greater operational flexibility, it
has been decided that harmonisation of different categories of NBFCs into fewer ones
shall be carried out based on the principle of regulation by activity rather than
regulation by entity. Accordingly, it has been decided to merge the three categories
of NBFCs viz. Asset Finance Companies (AFC), Loan Companies (LCs) and
Investment Companies (ICs) into a new category called NBFC - Investment and Credit
Company (NBFC-ICC). Investment and Credit Company (NBFC-ICC) means any
company which is a financial institution carrying on as its principal business - asset
finance, the providing of finance whether by making loans or advances or otherwise
for any activity other than its own and the acquisition of securities; and is not any
other category of NBFC as defined by the RBI in any of its Master Directions. (Circular
DBR.BP.BC.No.25/21.06.001/2018-19 dated 22 February 2019)
Differential regulations relating to bank’s exposure to the three categories of NBFCs
viz., AFCs, LCs and ICs stand harmonized vide Bank’s circular
DBR.BP.BC.No.25/21.06.001/2018-19 dated February 22, 2019. Further, a deposit
taking NBFC-ICC shall invest in unquoted shares of another company which is not a
subsidiary company or a company in the same group of the NBFC, an amount not
exceeding twenty per cent of its owned fund. All related Master Directions (Non -
Banking Financial Company – Non-Systemically Important Non-Deposit taking
Company (Reserve Bank) Directions, 2016, Non-Banking Financial Company -
Systemically Important Non-Deposit taking Company and Deposit taking Company
(Reserve Bank) Directions, 2016, Non-Banking Financial Companies Acceptance of
Public Deposits (Reserve Bank) Directions, 2016, Standalone Primary Dealers
(Reserve Bank) Directions, 2016 and Residuary Non-Banking Companies (Reserve
Bank) Directions, 2016) have also been updated accordingly.
NOTE: October, 2020 Edition of the Study Material on Paper 5 Advanced Accounting is
applicable for May, 2021 Examination which incorporates the above amendments. The
students who have editions prior to October, 2020 may refer above amendments.

PAPER – 5 : ADVANCED ACCOUNTING 3
B. Not applicable for May, 2021 examination

Non-Applicability of Ind AS for May, 2021 Examination
The Ministry of Corporate Affairs has notified Companies (Indian Accounting Standards)
Rules, 2015 on 16th February, 2015, for compliance by certain class of companies. These
Ind AS are not applicable for May, 2021 Examination.
PART – II : QUESTIONS AND ANSWERS
QUESTIONS
Conversion of partnership firm into Company and Sale to a Company
1. Om, Sai and Radhe share profits and losses of a business as to 3:2:1 respectively.
Their balance sheet as at 31 st March, 2020 was as follows:
Liabilities ` Assets `
Capital Accounts: Land and Building 1,40,000
Om 70,000 Machinery 50,000
Sai 80,000 Motor Car 28,000
Radhe 10,000 Furniture 12,000
General Reserve 22,000 Investments 18,000
Radhe’s Loan 33,000 Stock 18,000
Mrs. Om’s loan 15,000 Bills receivable 20,000
Creditors 96,000 Loose tools 7,000
Bills Payable 14,000 Debtors 38,000
Bank overdraft 60,000 Cash 1,000
Radhe’s current A/c 56,000
Profit and Loss A/c 12,000
4,00,000 4,00,000
The partners decide to convert their firm into a Joint Stock Company. For this purpose
ABC Ltd. was formed with an authorized capital of ` 10,00,000 divided into ` 100
equity Shares. The business of the firm was sold to the company as at the date of
balance sheet given above on the following terms:
(i) Motor car, furniture, investments, loose tools, debtors and cash are not to be
taken over by the company.

(ii) Liabilities for bills payable and bank overdraft are to be taken over by the
company.
(iii) The purchase price is settled at ` 1,95,500 payable as to ` 75,500 in cash and
the balance in company’s fully paid shares of ` 100 each.
(iv) The remaining assets and liabilities of the firm are directly disposed of by the
firm as per details given below:
Investments are taken over by Om for ` 13,000; debtors realize in all ` 20,000;
Motor Car, furniture and loose tools fetch ` 24,000, ` 4,000, and ` 1,000
respectively. Om agrees to pay his wife’s loan. The creditors were paid
` 94,000 in final settlement of their claims. The realization expenses amount to
` 500. Radhe’s loan was transferred to his capital account.
(v) The equity share received from the vendor company are to be divided among
the partners in profit-sharing ratio.
You are required to prepare Realization account, Partners’ capital accounts, Cash
account, ABC Ltd. account and Shares in ABC Ltd. account in the books of the
partnership firm.
Dissolution of partnership firm
2. (a) X, Y and Z are in partnership sharing profits and losses in the ratio of 5:4:4. The
Balance Sheet of the firm as on 31 st March, 2020 is as below:
Liabilities ` Assets `
X’s Capital 60,000 Factory Building 96,640
Y’s Capital 40,000 Plant and Machinery 65,100
Z’s Capital 50,000 Trade Receivable 21,600
Y’s Loan 18,000 Inventories 49,560
Creditors 66,000 Cash at Bank 1,100
2,34,000 2,34,000
On Balance Sheet date, all the three partners have decided to dissolve their
partnership. Since the realisation of assets was protracted, they decided to distribute
amounts as and when feasible and for this purpose they appoint Z who was to get as
his remuneration 1% of the value of the assets realised other than cash at bank and
10% of the amount distributed to the partners.
Assets were realised piecemeal as under:
`
First instalment 74,600
Second instalment 69,301

Third instalment 40,000

Last instalment 28,000
Dissolution expenses were provided for estimated amount of ` 12,000

The creditors were settled finally for ` 63,600
You are required to prepare a statement showing distribution of cash amongst the
partners by "Highest Relative Capital Method".
Limited Liability Partnerships
(b) Write short note on Designated Partners in a Limited Liability Partnership and what
are their liabilities.
Accounting for ESOPs
3. (a) Define the following terms:
(i) Vesting Period;
(ii) Grant Date.
(b) PQ Ltd. grants 100 stock options to each of its 1,000 employees on 1-4-2018,
conditional upon the employee remaining in the company for 2 years. The fair value
of the option is ` 18 on the grant date and the exercise price is ` 55 per share.
Number of employees expected to satisfy service conditions are 930 in the
1st year and 850 in the 2 nd year. However, 880 employees actually completed 2 year
vesting period.
You are required to calculate ESOP cost to be amortized by PQ Ltd. in the years
2018-2019 and 2019-2020.
Buy Back of Securities
4. M/s. Vriddhi Infra Ltd. (a non-listed company) provide the following information as on
31.3.2020:
( `)
Land and Building 21,50,000
Plant & Machinery 15,00,000
Non- current Investment 2,00,000
Trade Receivables 5,50,000
Inventories 1,80,000
Cash and Cash Equivalents 40,000
Share capital:1,00,000 Equity Shares of ` 10 each fully paid up 10,00,000
Securities Premium 3,00,000

General Reserve 2,50,000

Profit & Loss Account (Surplus) 1,50,000
10% Debentures (Secured by floating charge on all assets) 20,00,000
Unsecured Loans 8,00,000
Tarde Payables 1,20,000
On 21st April, 2020 the Company announced the buy back of 15,000 of its equity shares
@ ` 15 per share. For this purpose, it sold all its investment for ` 2.50 lakhs.
On 25th April, 2020, the company achieved the target of buy back. On 1 st May, 2020 the
company issued one fully paid up share of ` 10 each by way of bonus for every eight equity
shares held by the equity shareholders.
You are required to pass necessary Journal Entries for the above transactions.
Equity Shares with Differential Rights
5. (a) What do you mean by equity shares with differential rights. Explain in brief
(b) E, F, G and H hold Equity Capital in Alpha Co. in the proportion of 30:30:20:20. S, T,
U and V hold preference share capital in the proportion of 40:30:10:20. If the paid up
capital of the company is ` 120 Lakh and Preference share capital is ` 60 Lakh, You
are required to calculate their voting rights in case of resolution of winding up of the
company.
Amalgamation of Companies
6. Mohan Ltd. gives you the following information as on 31st March, 2020:
`
Share capital:
Equity shares of ` 10 each 3,00,000
6,000, 9% cumulative preference shares of ` 10 each 60,000
Profit and Loss Account (Dr. balance) 1,70,000
10% Debentures of ` 100 each 2,00,000
Interest payable on Debentures 20,000
Trade Payables 1,50,000
Property, Plant and Equipment 3,40,000
Goodwill 10,000
Inventory 80,000
Trade Receivables 1,10,000
Bank Balance 20,000

A new company Ravi Ltd. is formed with authorised share capital of ` 4,00,000 divided
into 40,000 Equity Shares of ` 10 each. The new company will acquire the assets and
liabilities of Mohan Ltd. on the following terms:
(i) (a) Mohan Ltd.'s debentures are paid by similar debentures in new company and for
outstanding accrued interest on debentures, equity shares of equal amount are
issued at par.
(b) The trade payables are paid by issue of 12,000 equity shares at par in full and
final settlement of their claims.
(c) Preference shareholders are to get equal number of equity shares issued at par.
Dividend on preference shares is in arrears for three years. Preference
shareholders to forgo dividend for two years. For balance dividend, equity
shares of equal amount are issued at par.
(d) Equity shareholders are issued one share at par for every three shares held in
Mohan Ltd.
(ii) Current Assets are to be taken at book value (except inventory, which is to be reduced
by 10%). Goodwill is to be eliminated. The Property, plant and equipment is taken
over at ` 3,08,400.
(iii) Remaining equity shares of the new company are issued to public at par fully paid
up.
(iv) Expenses of ` 5,000 to be met from bank balance of Mohan Ltd. This is to be adjusted
from the bank balance of Mohan Ltd. before acquisition by Ravi Ltd.
You are required to prepare:
(a) Realisation account and Equity Shareholders' account in the books of Mohan Ltd.
(b) Bank Account and Balance Sheet with notes to accounts in the books of Ravi Ltd.
Internal Reconstruction of a Company
7. Recover Ltd decided to reorganize its capital structure owing to accumulated losses and
adverse market condition. The Balance Sheet of the company as on 31 st March 2020 is as
follows-
Particulars Notes `
Equity and Liabilities
1 Shareholders’ funds
A Share capital 1 3,50,000
B Reserves and surplus 2 (70,000)
2 Non-current liabilities
A Long-term borrowings 3 55,000

3 Current liabilities
A Trade Payables 80,000
B Short term Borrowings – Bank overdraft 90,000
5,05,000
Assets
1 Non-current assets
A Property, Plant Equipment 4 3,35,000
B Intangible assets 5 50,000
C Non-current investments 6 40,000
2 Current assets
A Inventories 30,000
B Trade receivables 50,000
5,05,000
Notes to accounts:
1 Share Capital `
Equity share capital:
20,000 Equity Shares of ` 10 each 2,00,000
Preference share capital:
15,000 8% Cumulative Preference Shares of ` 10 each
(preference dividend has been in arrears for 4 years) 1,50,000
3,50,000
2 Reserves and surplus
Securities premium 10,000
Profit and loss account (debit balance) (80,000)
(70,000)
3 Long-term borrowings
Secured
9% Debentures (secured on the freehold property 50,000
Accrued interest on 9% debentures 5,000
55,000
4 Property, Plant and Equipment
Freehold property 1,20,000
Leasehold property 85,000
Plant and machinery 1,30,000
3,35,000

5 Intangible assets
Goodwill 50,000
50,000
6 Non-current investments
Non-Trade investments at cost 40,000
40,000
Subsequent to approval by court of a scheme for the reduction of capital, the following
steps were taken:
i. The preference shares were reduced to ` 2.5 per share, and the equity shares to ` 1
per share.
ii. One new equity share of ` 1 was issued for the arrears of preferred dividend for past
4 years.
iii. The balance on Securities Premium Account was utilized and was transferred to
capital reduction account.
iv. The debenture holders took over the freehold property at an agreed figure of
` 75,000 and paid the balance to the company after deducting the amount due to
them.
v. Plant and Machinery was written down to ` 1,00,000.
vi. Non-trade Investments were sold for ` 32,000.
vii. Goodwill and obsolete stock (included in the value of inventories) of ` 10,000 were
written off.
viii. A contingent liability of which no provision had been made was settled at ` 7,000 and
of this amount, ` 6,300 was recovered from the insurance.
You are required (a) to show the Journal Entries, necessary to record the above
transactions in the company’s books and (b) to prepare the Balance Sheet, after
completion of the scheme.
Liquidation of Company
8. From the following Trial Balance of All Rounder Ltd., on 1 st January, 2021, prepare
liquidator’s final statement of account:
Particulars Debit (`) Credit (`)
9% Preference Share Capital (2,500 Preference 2,50,000
Shares at `100 each, fully paid)
Equity Share Capital: 4,000 Equity Shares at `100 4,00,000
each, fully paid.
4,000 Equity Shares at `100 each, `50 paid up 2,00,000

Plant 6,00,000
Stock-in-Trade 7,20,000
Sundry Debtors 1,70,000
Sundry Creditors 4,42,000
Bank Balance 2,40,000
Preliminary Expenses 12,000
6% Mortgage Loan 4,60,000
Outstanding Liabilities for Expenses - 50,000
Profit and Loss A/c (Trading Loss for the previous 60,000 -
accounting year)
Total 18,02,000 18,02,000
Following points should be kept in mind:
1. On 21st January, 2021, the Liquidator sold plant for `5,90,000 and stock-in-trade
at 10% less than the Book Value. He realized 80% of Sundry Debtors, and
incurred cost of collection of `3,700 (remaining Debtors are to be treated as
bad).
2. The Loan Mortgage was discharged as on 31 st January, 2021, along with interest
for 6 months. Creditors were discharged subject to 5% discount. Outstanding
Expenses paid at 20% less.
3. Preference Share Dividend is due for one year and paid with final payment.
4. Liquidation Expenses incurred are `3,600, and Liquidator’s Remuneration is
settled at 4% on disbursement to shareholders (preference and equity)
excluding preference dividend, subject to minimum of `20,000. Liquidator’s
Remuneration to be rounded off to the multiple of `10.
Banking Companies
9. (a) Forward Bank Ltd furnishes the following information as on 31 st March, 2020.
Amount in `
Bills Discounted 82,23,000
Rebate on bills discounted as on 1st April, 2019 1,32,960
Discount received 6,33,990
Details of bills discounted is as given below:
Value of Bills (`) Due Date Rate of Discount
10,95,000 15th June, 2020 14%
30,00,000 25th June, 2020 12%

16,92,000 5th July, 2020 16%

24,36,000 15th July, 2020 16%
(i) Calculate the rebate on bills discounted as on 31 st March, 2020. Take 365 days
in year.
(ii) Pass necessary Journal Entries.
(b) State with reason whether the following cash credit account is NPA or not:
`s
Sanctioned limit 50,00,000
Drawing power 44,00,000
Amount outstanding continuously 01-01-20 to 31-03-20 40,00,000
Total interest debited for the above period 3,20,000
Total credits for the above period 1,80,000
NBFCs
10. (a) Calculate ‘Owned Fund’ of a NBFC based on the following facts:
Paid up share capital: ` 400 lakhs
Free reserves: ` 200 lakhs
Securities Premium: ` 50 lakhs
Capital Reserves (surplus arising due to sale of assets): `100 lakhs
Compulsory convertible preference shares (CCPS): ` 50 lakhs
Revaluation Reserve: ` 100 lakhs
(b) Omega Financiers Ltd. is an NBFC providing Hire Purchase Solutions for acquiring
consumer durables. The following information is extracted from its books for the year
ended 31st March, 2020:
Assets Funded Interest Overdue but recognized in Net Book Value of
Profit & Loss Assets Outstanding
Period Overdue Interest Amount
(` In crore) (` In crore)
LCD Televisions Up to 12 Months 100.00 4,000
Washing Machines For 24 Months 20.00 400
Refrigerators For 30 Months 10.00 250
Air Conditioners For 45 Months 5.00 120
Mobile Phones For 60 Months 1.00 10
You are required to calculate the amount of provision to be made.

Consolidated Financial Statements

11. A Ltd. acquired 70% equity shares of B Ltd. @ `20 per share (Face value - `10) on 31st
March, 2021 at a cost of ` 140 lakhs. Calculate the amount of share of A Ltd. and minority
interest in the net assets of B Ltd. on this date. Also compute goodwill/capital reserve for
A Ltd. on acquisition of shares of B Ltd. from the following information available from the
balance sheet of B Ltd. as on 31st March, 2021:
` in lakhs
Property, plant and equipment 360
Investments 90
Current Assets 140
Loans & Advances 30
15% Debentures 180
Current Liabilities 100
AS 4 Contingencies and Events occurring after the Balance Sheet Date
12. (a) A case is going on between ABC Ltd. and Tax department on claiming the exemption
for certain items, for the year 2019-2020. The court has issued the order on
15th April and rejected the claim of the company. Accordingly, company is liable to
pay the additional tax. The financial statements were approved on 31 st May, 2020.
Shall company account for such tax in the year 2019-2020 or shall it account for in
the year 2020-2021?
AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting
Policies
(b) XYZ Ltd. is in the process of finalizing its account for the year ended
31st March, 2020. The company seeks your advice on the following:
The company's tax assessment for assessment year 2017-18 has been completed on
14th February, 2020 with a demand of `5.40 crore. The company paid the entire due
under protest without prejudice to its right of appeal. The company files its appeal
before the appellate authority wherein the grounds of appeal cover tax on additions
made in the assessment order for a sum of `3.70 crore.
AS 7 Construction Contracts
13. (a) Sky Limited belongs to Heavy Engineering Contractors specializing in construction of
Flyovers. The company just entered into a contract with a local municipal corporation
for building a flyover. No activity has started on this contract.
As per the terms of the contract, Sky Limited will receive an additional ` 50 lakhs if
the construction of the flyover were to be finished within a period of two years from

the commencement of the contract. The Accountant of the entity wants to recognize
this revenue since in the past the company has been able to meet similar targets very
easily. Give your opinion on this treatment.
(b) ABC Ltd., a construction contractor, undertakes the construction of commercial
complex for XYZ Ltd. ABC Ltd. submitted separate proposals for each of 3 units of
commercial complex. A single agreement is entered into between the two parties.
The agreement lays down the value of each of the 3 units i.e. ` 50 lakh, ` 60 lakh
and ` 75 lakh respectively. Agreement also lays down the completion time for each
unit.
Comment, with reference to AS 7, whether ABC Ltd., should treat it as a single
contract or three separate contracts.
AS 9 Revenue Recognition
14. (a) Tonk Tanners is engaged in manufacturing of leather shoes. They provide you the
following information for the year ended 31 st March,2020:
(i) On 31st December, 2019 shoes worth ` 3,20,000 were sent to Mohan Shoes for
sale on consignment basis of which 25% shoes were unsold and lying with
Mohan Shoes as on 31 st March, 2020.
(ii) On 10th January, 2020, Tonk Tanner supplied shoes worth ` 4,50,000 to Shani
Shoes and concurrently agrees to re-purchase the same goods on 11 th April.
2020.
(iii) On 21st March, 2020 shoes worth ` 1,60,000 were sold to Shoe Shine but due
to refurbishing of their showroom being underway, on their request, shoes were
delivered on 12 th April, 2020.
You are required to advise the accountant of Tonk Tanners, when amount is to be
recognised as revenue in 2019 -20 in above cases in the context of AS 9.
AS 14 Accounting for Amalgamations
(b) Astha Ltd. is absorbed by Nistha Ltd.; the consideration being the takeover of
liabilities, the payment of cost of absorption not exceeding ` 10,000 (actual cost
` 9,000); the payment of the 9% debentures of ` 50,000 at a premium of 20% through
8% debentures issued at a premium of 25% of face value and the payment of `15 per
share in cash and allotment of three 11% preference shares of ` 10 each and four
equity shares of `10 each at a premium of 20% fully paid for every five shares in
Astha Ltd.
The number of shares of the vendor company are 1,50,000 of ` 10 each fully paid.
Calculate purchase consideration as per AS 14.
AS 17 Segment Reporting
15. (a) A Company has an inter-segment transfer pricing policy of charging at cost less 5%.

The market prices are generally 20% above cost.

You are required to examine whether the policy adopted by the company is correct or
not?
AS 18 Related Party Transactions
(b) R Ltd. has 60% voting right in S Ltd. S Ltd. has 15% voting right in T Ltd. R Ltd.
directly enjoys voting right of 10% in T Ltd. T Ltd. is a listed company and regularly
supplies goods to R Ltd. The management of T Ltd. has not disclosed its rel ationship
with R Ltd. You are required to assess the situation from the view point of AS 18 on
Related Party Disclosures.
AS 19 Leases
16. Sooraj Limited wishes to obtain a machine costing ` 30 lakhs by way of lease. The
effective life of the machine is 14 years, but the company requires it only for the first
3 years. It enters into an agreement with Star Ltd., for a lease rental for ` 3 lakhs p.a.
payable in arrears and the implicit rate of interest is 15%. The chief accountant of
Sooraj Limited is not sure about the treatment of these lease rentals and seeks your
advice. (use annuity factor at @ 15% for 3 years as 3.36)
AS 20 Earnings Per Share
17. In the following list of shares issued, for the purpose of calculation of weighted average
number of shares, from which date, weight is to be considered:
(i) Equity Shares issued in exchange of cash,
(ii) Equity Shares issued as a result of conversion of a debt instrument,
(iii) Equity Shares issued in exchange for the settlement of a liability of the enterprise,
(iv) Equity Shares issued for rendering of services to the enterprise,
(v) Equity Shares issued in lieu of interest and/or principal of an other financial
instrument,
(vi) Equity Shares issued as consideration for the acquisition of an asset other than in
cash.
AS 22 Accounting for Taxes on Income
18. (a) The following information is furnished in respect of Slate Ltd. for the year ending
31-3-2019:
(i) Depreciation as per books ` 2,80,000
Depreciation for tax purpose ` 1,90,000
The above depreciation does not include depreciation on new additions.
(ii) A new machinery purchased on 1.4.18 costing ` 1,20,000 on which 100%
depreciation is allowed in the 1 st year for tax purpose whereas Straight-line

method is considered appropriate for accounting purpose with a life estimation

of 4 years.
(iii) The company has made a profit of ` 6,40,000 before depreciation and taxes.
(iv) Corporate tax rate of 40%.
Prepare relevant extract of statement of Profit and Loss for the year ending 31-3-2019
and also show the effect of above items on deferred tax liability/asset as per AS 22.
(b) What are the disclosure requirements for deferred tax assets and deferred tax
liabilities in the balance sheet as per AS 22?
AS 24 Discontinuing Operations
19. (a) Arzoo Ltd. is in the business of manufacture of passenger cars and commercial
vehicles. The company is working on a strategic plan to shift from the passenger car
segment to the commercial vehicles segment over the coming 5 years. However, no
specific plans have been drawn up for sale of neither the division nor its assets. As
part of its plan, it has planned that it will reduce the production of passenger cars by
20% annually. It also plans to commence another new factory for the manufacture of
commercial vehicles plus transfer of employees in a phased manner. These plans
have not approved from the Board of Directors and the new factory for manufacture
of commercial vehicles has not yet started. You are required to comment if mere
gradual phasing out in itself can be considered as a ‘Discontinuing Operation' within
the meaning of AS 24.
AS 26 Intangible Assets
(b) Naresh Ltd. had the following transactions during the financial year 2019 -2020:
(i) Naresh Ltd. acquired running business of Sunil Ltd. for ` 10,80,000 on 15th May,
2019. The fair value of Sunil Ltd.'s net assets was ` 5,16,000. Naresh Ltd. is of the
view that due to popularity of Sunil Ltd.’s product in the market, its goodwill exists.
(ii) Naresh Ltd. had taken a franchise on July 2019 to operate a restaurant from Sankalp
Ltd. for ` 1,80,000 and at an annual fee of 10% of net revenues (after deducting
expenditure). The franchise expires after 6 years. Net revenues were ` 60,000 during
the financial year 2019-2020.
(iii) On 20th August, 2019, Naresh Ltd, incurred costs of ` 2,40,000 to register the patent
for its product. Naresh Ltd. expects the patent’s economic life to be 8 years.
Naresh Ltd. follows an accounting policy to amortize all intangibles on straight line basis
over the maximum period permitted by accounting standards taking a full year amortization
in the year of acquisition. Goodwill on acquisition of business to be amortized over 5 years
(SLM) as per AS 14.
Prepare a schedule showing the intangible assets section in Naresh Ltd. Balance Sheet at
31st March, 2020.

AS 29 Provisions, Contingent Liabilities and Contingent Assets

20. (a) The company has not made provision for warranty in respect of certain goods
considering that the company can claim the warranty cost from the original supplier.
You are required to examine in line with the provisions of AS 29.
(b) Explain whether provision is required in the following situations in li ne with AS 29:
(i) There is a present obligation that probably requires an outflow of resources and
a reliable estimate can be made of the amount of obligation;
(ii) There is a possible obligation or a present obligation that may, but probably will
not, require an outflow of resources.
(iii) There is a possible obligation or a present obligation where the likelihood of an
outflow of resources is remote.
SUGGESTED ANSWERS
1. In the books of Partnership Firm

Realization Account
Particulars ` ` Particulars ` `
To Land and Building 1,40,000 By Trade creditors 96,000
To Machinery 50,000 By Bills Payable 14,000
To Motor Car 28,000 By Bank overdraft 60,000
To Furniture 12,000 By Mrs. Om’s loan 15,000
To Investments 18,000 By ABC Ltd. 1,95,500
(Purchase price)
To Loose tools 7,000 By Om’s Capital A/c 13,000
(Investments taken over)
To Stock 18,000 By Cash A/c:
To Bill receivable 20,000 Debtors 20,000
To Debtors 38,000 Motor Car 24,000
Furniture 4,000
To Om’s Capital A/c 15,000 Loose tools 1,000 49,000
(Mrs. Om’s Loan)
To Cash A/c:
Creditors 94,000
Realization expenses 500 94,500

To Profit on Realization
transferred to:
Om’s Capital A/c 1,000
Sai’s Capital A/c 667
Radhe’s Capital A/c 333 2,000
4,42,500 4,42,500
ABC Ltd. Account
Particulars ` Particulars `
To Realization A/c 1,95,500 By Cash A/c 75,500
By Shares in ABC Ltd. 1,20,000
1,95,500 1,95,500
Partners’ Capital Accounts
Particulars Om Sai Radhe Particulars Om Sai Radhe
` ` ` ` ` `
To Profit and 6,000 4,000 2,000 By Balance b/d 70,000 80,000 10,000
Loss A/c
To Realization 13,000 - - By Radhe’s Loan - - 33,000
A/c A/c
To Radhe’s - - 56,000 By General
Current A/c reserve 11,000 7,333 3,667
To shares in By Realization 1,000 667 333
ABC Ltd. 60,000 40,000 20,000 A/c
To Cash A/c 18,000 44,000 - By Realization
A/c (Mrs. Om’s
loan A/c) 15,000 - -
By Cash A/c - 31,000
97,000 88,000 78,000 97,000 88,000 78,000
Shares in ABC Ltd. Account
To ABC Ltd. Account 1,20,000 By Om’s Capital A/c 60,000
By Sai’s Capital A/c 40,000
By Radhe’s Capital A/c 20,000
1,20,000 1,20,000

Cash Account
To Balance b/d 1,000 By Realization A/c (Liabilities 94,500
and expenses)
To ABC Ltd. 75,500 By Om’s Capital A/c 18,000
To Realization A/c (realization 49,000 By Sai’s Capital A/c 44,000
of assets)
To Radhe’s Capital A/c 31,000 -
1,56,500 1,56,500
2. (a) Statement showing distribution of cash amongst the partners

Creditors Y’s Capitals
Loan
X ( `) Y ( `) Z (`)
Balance Due 66,000 18,000 60,000 40,000 50,000
Including 1st Instalment
amount with the firm 75,700
` (1100 + 74,600)
Less: Dissolution
expenses provided for (12,000)
63,700
Less: Z’s remuneration
of 1% on assets realized
(74,600 x 1%) (746)
62,954
Less: Payment made to
creditors (62,954) (62,954)
Balance due Nil 3046
2nd instalment realised 69,301
(69,301 x 1%)
(693)
68,608
Less: Payment made to
creditors (646) (646)

Transferred to P& L A/c 2,400

67,962
Less: Payment for Y’s (18,000) (18,000)
loan A/c
Amount available for
distribution to partners 49,962 nil
of 10% of the amount (4,542)
distributed to partners
(49,962 x 10/110)
Balance to be distributed
to partners on the basis 45,420
of HRCM
Less: Paid to Z (W.N.) (2,000) (2,000)
43,420 48,000
Less: Paid to X and Z in (18,000) (10,000) - (8,000)
5:4 (W.N.)
Balance due 25,420 50,000 40,000 40,000
Less: Paid to X, Y & Z in
5:4:4 25,420 (9,778) (7,821) (7,821)
Nil
Amount of 3rd instalment 40,000 40,222 32,179 32,179
(40,000 x 1%) (400)
39,600
of 10% of the amount
(39,600 x 10/110) (3,600)
36,000
Less: Paid to X, Y, Z in
5:4:4 for (W.N.) (36,000) (13,846) (11,077) (11,077)
Nil 26,376 21,102 21,102
Amount of 4th and last 28,000
instalment


(28,000 x 1%) (280)
27,720
of 10% of the amount
(27,720 x 10/110) (2,520)
25,200
Less: Paid to X, Y and Z
in 5:4:4 (25,200) (9,692) (7,754) (7,754)
Nil
Loss suffered by 16,684 13,348 13,348
partners
Working Note:
(i) ` 1100 added to the first instalment received on sale of assets represents the
Cash in Bank
(ii) The amount due to Creditors at the end of the utilization of First Instalment is
` 3046. However, since the creditors were settled for ` 63,600 only the balance
`646 were paid and the balance ` 2400 was transferred to the Profit & Loss
Account.
(iii) Highest Relative Capital Basis
X Y Z
` ` `
Balance of Capital Accounts (A) 60,000 40,000 50,000
Profit sharing ratio 5 4 4
Capital Profit sharing ratio 12,000 10,000 12,500
Capital in profit sharing
ratio taking Y’s Capital as base (B) 50,000 40,000 40,000
Excess of X’s Capital and Z’s Capital 10,000 nil 10,000
(A-B) = (C)
Again repeating the process
Profit sharing ratio 5 4
Capital Profit sharing ratio 2,000 2,500

Capital in profit sharing

ratio taking X’s Capital as base (D) 10,000 8,000
Excess of Z’s Capital (C-D) = (E) nil 2,000
Therefore, firstly `2,000 is to be paid to Z, then X and Z to be paid in proportion of
5:4 upto ` 18,000 to bring the capital of all partners X, Y and Z in proportion to their
profit sharing ratio. Thereafter, balance available will be paid in the profit sharing
ratio 5:4:4 to all partners viz X, Y and Z.
(b) “Designated partner” means any partner designated as such pursuant to section 7
of the Limited Liability Partnerships (LLPs) Act, 2008. As per section 7 of the LLP Act,
every limited Liability Partnership shall have at least 2 designated Partners who are
individuals and at least one of them shall be a resident in India.
Provided that in case of Limited Liability Partnership in which all the partners are
bodies corporate or in which one or more partners are Individuals and bodies
corporate, at least 2 individuals who are partners of such limited liability Partnership
or Nominees of such Bodies corporate shall act as designated partners.
“Liabilities of designated partners”
As per Section 8 of LLP Act, unless expressly provided otherwise in this Act, a
designated partner shall be-
(a) responsible for the doing of all acts, matters and things as are required to be
done by the limited liability partnership in respect of compliance of the provisions
of this Act including filing of any document, return, statement and the like report
pursuant to the provisions of this Act and as may be specified in the limited
liability partnership agreement; and;
(b) liable to all penalties imposed on the limited liability partnership for any
contravention of those provisions.
3. (a) (i) Vesting Period: It is the time period between grant date and the date on which
all the specified vesting conditions of an employee share-based payment plan
is to be satisfied.
(ii) Grant Date: It is the date at which the enterprise and its employees agree to the
terms of an employee share-based payment plan. At grant date, the enterprise
confers on the employees the right to cash or shares of the enterprise, provided
the specified vesting conditions, if any, are met. If that agreement is subject to
an approval process, (for example, by shareholders), grant date is the date when
that approval is obtained.

(b) Calculation of ESOP cost to be amortized

2018-2019 2019-2020
Fair value of options per share ` 18 ` 18
No. of options expected to vest 93,000 (930 x 100) 88,000 (880 x 100)
under the scheme
Fair value of options ` 16,74,000 ` 15,84,000
Value of options recognized as 8,37,000 7,47,000
expenses (` 16,74,000 / 2) (` 15,84,000 – ` 8,37,000)
4. In the books of Vriddhi Infra Ltd.
Journal Entries
Date Particulars Dr. Cr.
2020 ` `
April 21 Bank A/c Dr. 2,50,000
To Investment A/c 2,00,000
To Profit on sale of investment 50,000
(Being investment sold on profit)
April 25 Equity share capital A/c Dr. 1,50,000
Securities premium A/c Dr. 75,000
To Equity shares buy back A/c 2,25,000
(Being the amount due to equity shareholders
on buy back)
Equity shares buy back A/c Dr. 2,25,000
To Bank A/c 2,25,000
(Being the payment made on account of buy
back of 15,000 Equity Shares)
General Reserve A/c OR P&L A/c Dr. 1,50,000
To Capital redemption reserve A/c 1,50,000
(Being amount equal to nominal value of buy
back shares transferred from free reserves to
capital redemption reserve account as per the
law)
May 1 Capital redemption reserve A/c Dr. 1,06,250

To Bonus shares A/c (W.N.1) 1,06,250

(Being the utilization of capital redemption
reserve to issue bonus shares)
Bonus shares A/c Dr. 1,06,250
To Equity share capital A/c 1,06,250
(Being issue of one bonus equity share for
every ten equity shares held)
Working Note:
1
Amount of bonus shares = [(1,00,000 - 15,000) × ] × 10
8
= ` 1,06,250
5. (a) Equity shares with Differential Rights means the share with dissimilar rights as to
dividend, voting or otherwise.
(b) E, F, G and H hold Equity capital is held by in the proportion of 30:30:20:20 and S,T,U
and V hold preference share capital in the proportion of 40:30:10:20. As the paid up
equity share capital of the company is ` 120 Lakhs and Preference share capital is
` 60 Lakhs (2:1), then relative weights in the voting right of equity shareholders and
preference shareholders will be 2/3 and 1/3. The respective voting right of various
shareholders will be
E = 2/3X30/100 = 3/15
F = 2/3X30/100 = 3/15
G = 2/3X20/100 = 2/15
H = 2/3X20/100 = 2/15
S = 1/3X40/100 = 2/15
T = 1/3X30/100 = 1/10
U = 1/3X10/100 = 1/30
V = 1/3X20/100 = 1/15
6. In the books of Mohan Ltd.
(i) Realisation Account
` `
To Goodwill 10,000 By 10% Debentures 2,00,000
To Property, plant and 3,40,000 By Interest accrued on 20,000
equipment debentures

To Inventory 80,000 By Trade payables 1,50,000

To Trade receivables 1,10,000 By Ravi Ltd. (Purchase 1,65,400
consideration) (W.N. 1)
To Bank By Equity shareholders A/c
(20,000 - 5,000) 15,000 (loss on realization) (Bal. 25,000
fig.)
To Preference share
holders A/c (W.N.2)
5,400
5,60,400 5,60,400
(ii) Equity shareholders’ Account
` `
To Profit & loss A/c 1,70,000 By Equity Share capital 3,00,000
To Expenses* 5,000
To Equity shares in Ravi Ltd. 1,00,000
To Realization A/c 25,000
3,00,000 3,00,000
*Alternatively, expenses may be routed through Realization account.

In the books of Ravi Ltd.
(i) Bank Account
` `
To Business Purchase 15,000 By Balance c/d (Bal. fig.) 1,09,600
To Equity shares
application & allotment
A/c (W.N. 3) 94,600
1,09,600 1,09,600
(ii) Balance Sheet as at 31st March, 2020
Particulars Note No. `
I. Equity and Liabilities
(1) Shareholder's Funds
Share Capital 1 4,00,000
(2) Non-Current Liabilities

Long-term borrowings 2 2,00,000

Total 6,00,000
II. Assets
(1) Non-current assets
(a) Property, plant and equipment 3,08,400
(2) Current assets
(a) Inventories 72,000
(b) Trade receivables 1,10,000
(c) Cash and cash equivalents 1,09,600
Total 6,00,000
Notes to Accounts
`
1. Share Capital
Authorised share capital
40,000 equity shares of ` 10 each 4,00,000
Issued and Subscribed
40,000 shares of ` 10 each fully paid up 4,00,000
(out of the above, 30,540 (W.N.3) shares have been allotted
as fully paid-up pursuant to contract without payment being
received in cash)
2. Long Term Borrowings
10% Debentures 2,00,000
Working Notes:
1. Calculation of Purchase consideration
`
Payment to preference shareholders
6,000 equity shares @ ` 10 60,000
For arrears of dividend: (6,000 x ` 10) x 9% 5,400
Payment to equity shareholders
(30,000 shares x 1/3) @ ` 10 1,00,000
Total purchase consideration 1,65,400

2. Preference shareholders’ Account in books of Mohan Ltd.

` `
To Equity Shares in By Preference Share
Ravi Ltd. 65,400 capital 60,000
By Realization A/c (Bal.
fig.) 5,400
65,400 65,400
3. Calculation of number of Equity shares issued to public
Number of shares
Authorized equity shares 40,000
Less: Equity shares issued for
Interest accrued on debentures 2,000
Trade payables of Mohan Ltd. 12,000
Preference shareholders of Mohan Ltd. 6,000
Arrears of preference dividend 540
Equity shareholders of Mohan Ltd. 10,000 (30,540)
Number of equity shares issued to public at par for cash 9,460
7. In the books of Recover Ltd
Journal entries
Particulars Dr. Cr.
` `
8% Cumulative Preference share capital (` 10) A/c Dr. 1,50,000
To 8% Cumulative Preference share capital 37,500
(`2.5) A/c
To Capital reduction (` 7.5) A/c 1,12,500
(Preference shares being reduced to shares of ` 2.5
per share and remaining transferred to capital
reduction account as per capital reduction scheme)
Equity share capital A/c (`10) Dr. 2,00,000
To Equity Share capital A/c (` 1) 20,000
To Capital reduction A/c (` 9) 1,80,000
(Equity shares reduced to ` 1 per share with the
remaining amount transferred to capital reduction ac
as a part of the internal reconstruction scheme.)

Capital reduction A/c Dr. 48,000

To Equity share capital A/c 48,000
(Equity shares of ` 1 issued in lieu of the arrears of
preference dividend for 4 years as a part of the
internal reconstruction scheme)
Securities Premium A/c Dr. 10,000
To Capital reduction A/c 10,000
(Amount from the securities premium utilized towards
the capital reduction a/c as a part of the internal
reconstruction scheme)
9% Debentures A/c Dr. 50,000
Accrued interest on debentures A/c Dr 5,000
Bank A/c Dr. 20,000
To Freehold property A/c 1,20,000
(Debenture holders being paid by the sale of property,
which is sold at a loss debited to the capital reduction
account. Amount received in excess being refunded
to company by debenture holders as a part of the
internal reconstruction scheme.)
To Plant and Machinery Ac 30,000
To Goodwill A/c 50,000
To Inventory A/c 10,000
(The assets written off as a part of the internal
Bank A/c Dr. 32,000
To Investments A/c 40,000
(Investments sold at a loss debited to capital
reduction account as a part of the internal
Contingent Liability A/c Dr. 7,000
To Bank A/c 7,000

(Contingent liability paid as a part of the internal

Bank A/c Dr. 6,300
Capital reduction A/c Dr. 700
To Contingent Liability A/c 7,000
(The insurance company remitting part of the
contingency payment amount)
To Profit and loss A/c 80,000
(Accumulated losses written off to capital reduction
account as a part of the internal reconstruction
scheme).
To Capital reserve A/c 30,800
(The balance in capital reduction account transferred
to capital reserve as a part of the internal
Balance sheet of Recover Ltd. as at 31st March 2020 (and reduced)
Particulars Notes `
Equity and Liabilities
1 Shareholders’ funds
A Share capital 1 1,05,500
B Reserves and surplus 2 30,800
2 Non-current liabilities
A Long-term borrowings -
3 Current liabilities
A Trade Payables 80,000
B Bank Overdraft 90,000
3,06,300
Total
Assets
1 Non-current assets
A Property, Plant and Equipment 3 1,85,000

2 Current assets
A Inventories 20,000
B Trade receivables 50,000
C Cash and cash equivalents 4 51,300
Total 3,06,300
Notes to accounts:
1 Share Capital `
Equity share capital
68,000 Equity Shares of ` 1 each 68,000
Preference share capital
15,000 8% Cumulative Preference Shares of ` 2.5 each 37,500
1,05,500
2 Reserves and surplus
Capital reserve 30,800
3 Property, Plant and Equipment
Leasehold property 85,000
Plant and machinery 1,00,000
1,85,000
4 Cash and cash equivalents
Bank A/c (20,000+32,000-7000+6,300) 51,300
8. Liquidator’s Final Statement of Account
Receipts ` Payments `
Sundry Assets realized: Liquidator’s Remuneration 25,020
(Working note)
Bank Balance 2,40,000 Liquidation Expenses (given) 3,600
Plant 5,90,000 Secured Creditors:
6% Mortgage
Debtors 1,36,000 Loan 4,60,000
(1,70,000 X 80%)
Less: Realization Expenses (3,700) Add: Interest 13,800 4,73,800
1,32,300 (4,60,000 × 6% × 6/12)
Stock 6,48,000 Unsecured Creditors:
(7,20,000× 90%) Creditors 4,19,900

(4,42,000 X 95%)
Outstanding Expenses 40,000 4,59,900
Preference Shareholders:
Capital 2,50,000
Dividend 22,500 2,72,500
(for 1 year @ 9%)
Equity Shareholders:
(Working note)
Fully Paid Shares 2,87,740
(4,000×71.935)
Partly Paid Shares 87,740 3,75,480
(4,000×21.935)
16,10,300 16,10,300
Working Note:
Computation of Liquidations’ Remuneration and Payment to Equity Shareholders
`
(a) Total of Receipts (from above account) 16,10,300
(b) Total Payments before Final Payment to Members (excluding
Preference Capital) and Liquidator’s Remuneration (3,600 +
4,73,800 + 4,59,900 + Pref Dividend 22,500) (9,59,800)
(c) Balance left for Liquidator’s Remuneration, Pref. Capital and Equity 6,50,500
Shareholders
(d) Liquidator’s Remuneration (6,50,500 × 4/104 = `25,020 or `20,000
whichever is higher) (25,020)
(e) Refund of Capital to Preference Shareholders (2,50,000)
(f) Balance money before Notional Call 3,75,480
(g) Notional Call on 4,000 Partly Paid Shares at `50 each (to make all
Shares `100 paid up) 2,00,000
(h) Surplus Cash balance after Notional Call 5,75,480
(i) Number of Equity Shares deemed fully paid (4,000 + 4,000) 8,000
(j) Hence, Refund on every `100 paid up Share (h ÷ i) = `5,75,480 ÷ `71.935
8,000
(k) Loss per `100 paid up Equity Share = Paid Up Value `100 – Refund 28.065
as above `71.935
(l) Refund per `50 Partly Paid-Up Equity Share = Paid Up Value `50 21.935
– Loss as above `28.065

9. (a) In order to determine the amount to be credited to the Profit and Loss A/c it is
necessary to first ascertain the amount attributable to the unexpired portion of the
period of the respective bills. The workings are as given below:
Value (`) Due Date Days after 31-03-2020 Discount % Discount
Amount `
10,95,000 15-06-2020 (30+31 + 15) = 76 14% 31,920
30,00,000 25-06-2020 (30 + 31 + 25) = 86 12% 84,822
16,92,000 05-07-2020 (30 + 31 + 30 + 5) = 96 16% 71,203
24,36,000 15-07-2020 (30 + 31 + 30 + 15) = 106 16% 1,13,191
Rebate on bills discounted
as on 31.3.2020 3,01,136
The journal entries will be as follows :
Dr. Cr.
` `
Rebate on Bills Discounted A/c Dr. 1,32,960
To Discount on Bills A/c 1,32,960
(Being the transfer of Rebate on Bills Discounted
on 1.4.2019 to Discount on Bills Account)
Discount on Bills A/c Dr. 3,01,136
To Rebate on Bills Discounted A/c 3,01,136
(Being the transfer of rebate on bills discounted
required on 1.4.2020 from discount on Bills
Account)
Discount on Bills A/c Dr. 4,65,814
To Profit and Loss A/c 4,65,814
(Being the amount of discount on Bills transferred
to Profit and Loss Account)
Working Note:
The amount of discount to be credited to the Profit and Loss Account will be:
Transfer from Rebate on bills discount as on 1.4.19 1,32,960
Add: Discount received during the year ended 31-3-2020 6,33,990
7,66,950
Less: Rebate on bills discounted as on 31.3.2020 (3,01,136)
4,65,814

(b)
`Rs
Sanctioned limit 50,00,000
Drawing power 44,00,000
Amount outstanding continuously from 1.01.2020 to 31.03.2020 40,00,000
Total interest debited 3,20,000
Total credits 1,80,000
Is credit in the account is sufficient to cover the interest debited No
during the period or
Amount is ‘overdue’ for a continuous period of 90 days. Yes
The cash credit account is NPA because the credit in the account is not sufficient to
cover the interest debited during the period and the amount is ‘overdue’ for a
continuous period of 90 days.
10. (a) Owned fund calculation:
Paid up share capital: ` 400 lakhs
Free reserves: ` 200 lakhs
Compulsory convertible preference shares (CCPS): ` 50 lakhs
Securities Premium: ` 50 lakhs
Capital reserve: ` 100 lakhs
Total Owned fund: ` 800 lakhs ie. ` (400+200+50+50+100) lakhs
(b) On the basis of the information, in respect of hire purchase and leased assets,
additional provision shall be made as under:
(` in crore)
(a) Where hire charges are Nil -
overdue upto 12 months
(b) Where hire charges are 10% of the net book value 40
overdue for more than 12 (10% x 400)
months but upto 24 months
(c) Where hire charges are 40 percent of the net book value 100
overdue for more than 24 (40% x 250)
months but upto 36 months
(d) Where hire charges or lease 70 percent of the net book value 84
rentals are overdue for more (70% x 120)

than 36 months but upto 48

months
(e) Where hire charges or lease 100% of net book value 10
rentals are overdue for more (100% x 10)
than 48 months
Total 234
11. Net assets of B Ltd. as on 31st March, 2021
` in lakhs ` in lakhs
Property, plant and equipment 360
Investments 90
Current Assets 140
Loans and Advances 30
Total Assets 620
Less: 15% Debentures 180.0
Current Liabilities 100.0 (280)
Equity / Net Worth 340
Share of Minority Interest in net assets (30% of 340) 102
A Ltd.’s share in net assets (70% of 340) 238
A Ltd.’s cost of acquisition of shares of B Ltd.
(`140 lakhs) (140)
Capital reserve 98
12. (a) To decide whether, the event is adjusting or not adjusting two conditions need to be
satisfied,
(a) There has to be evidence
(b) The event must have been related to period ending on reporting date.
Here both the conditions are satisfied. Court order is a conclusive evidence which
has been received before approval of the financial statements since the liability is
related to earlier year. The event will be considered as an adjusting event and
accordingly the amount will be adjusted in accounts of 2019-2020.
(b) Since the company is not appealing against the addition of ` 1.70 crore (` 5.40 crore
less ` 3.70 crore), therefore, the same should be provided/ expensed off in its
accounts for the year ended on 31 st March, 2020. However, the amount paid under
protest can be kept under the heading ‘Long-term Loans & Advances / Short-term
Loans and Advances’ as the case may be alongwith disclosure as contingent liability
of ` 3.70 crore.

13. (a) According to AS 7 ‘Construction Contracts’, incentive payments are additional

amounts payable to the contractor if specified performance standards are met or
exceeded. For example, a contract may allow for an incentive payment to the
contractor for early completion of the contract. Incentive payments are included in
contract revenue when both the conditions are met:
(i) the contract is sufficiently advanced that it is probable that the specified
performance standards will be met or exceeded; and
(ii) the amount of the incentive payment can be measured reliably.
In the given problem, the contract has not even begun and hence the contractor (Sky
Limited) should not recognize any revenue of this contract. Therefore, the
accountant’s contention for recognizing ` 50 lakhs as revenue is not correct.
(b) As per AS 7 ‘Construction Contracts’, when a contract covers a number of assets, the
construction of each asset should be treated as a separate construction contract
when:
(a) separate proposals have been submitted for each asset;
(b) each asset has been subject to separate negotiation and the contractor and
customer have been able to accept or reject that part of the contract relating to
each asset; and
(c) the costs and revenues of each asset can be identified.
ABC Ltd. has submitted separate proposals for each of the 3 units of commercial
complex. Also the revenue and completion time has been laid down for each unit
separately which implies separate negotiation for them.
Therefore, ABC Ltd. is required to treat construction of each unit as a separate
construction contract as the above-mentioned conditions of AS 7 are fulfilled in the
given case.
14. (a) (i) Shoes sent to Mohan Shoes (consignee) for consignment sale
In case goods are sent for consignment sale, revenue is recognized when
significant risks of ownership have passed from seller to the buyer.
In the given case, Mohan Shoes is the consignee i.e. an agent of Tonk Tanners
and not the buyer. Therefore, the risk and reward is considered to vest with
Tonk Tanners only till the time the sale is made to the third party by Mohan
Shoes; although the goods are held by Mohan Shoes. Hence, in the year 2019-
2020, the sale will be recognized for the amount of goods sold by Mohan Shoes
to the third party i.e. for ` 3,20,000 x 75% = ` 2,40,000.
(ii) Sale/repurchase agreements i.e. where seller concurrently agrees to
repurchase the same goods at a later date
For such transactions that are in substance a financing agreement, the resulting

cash inflow is not revenue and should not be recognised as revenue in the year
2019-2020. Hence, sale of ` 4,50,000 to Shani Shoes should not be recognized
as revenue.
(iii) Delivery is delayed at buyer’s request
On 21st March, 2020, if Shoe Shine takes title and accepts billing for the goods
then it is implied that the sale is complete and all the risk and rewards of
ownership has been transferred to the buyer. In case no significant uncertainty
exists regarding the amount of consideration for sale, revenue shall be
recognized in the year 2019-2020 irrespective of the fact that the delivery is
delayed on the request of Shoe Shine.
(b) As per AS 14 ‘Accounting for Amalgamations’, the term ‘consideration’ has been
defined as the aggregate of the shares and other securities issued and the payment
made in the form of cash or other assets by the transferee company to the
shareholders of the transferor company.
The payment made by transferee company to discharge the Debenture holders and
outside liabilities and cost of winding up of transferor company shall not be considered
as part of purchase consideration.
Computation of Purchase Consideration
`
Cash payment `15 x 1,50,000 22,50,000
11% Preference Shares of ` 10 each [(1,50,000 x 3/5) x ` 10] 9,00,000
Equity shares of ` 10 each @ 20% premium
[(1,50,000 x 4/5) x ` 12] 14,40,000
Total Purchase consideration 45,90,000
15. (a) AS 17 ‘Segment Reporting’ requires that inter-segment transfers should be measured
on the basis that the enterprise actually used to price these transfers. The basis of
pricing inter-segment transfers and any change therein should be disclosed in the
financial statements. Hence, the enterprise can have its own policy for pricing inter-
segment transfers and hence, inter-segment transfers may be based on cost, below
cost or market price. However, whichever policy is followed, the same should be
disclosed and applied consistently. Therefore, in the given case inter -segment
transfer pricing policy adopted by the company is correct if followed consistently.
(b) AS 18 ‘Related Party Disclosures’, defines related party as one that has at any time
during the reporting period, the ability to control the other party or exercise significant
influence over the other party in making financial and/or operating decisions.

Definition for Control

Here, control is defined as ownership directly or indirectly of more than one -half of
the voting power of an enterprise; and Significant Influence is defined as participation
in the financial and/or operating policy decisions of an enterprise but not control of
those policies.
Nature of Relationship
R Ltd. has direct economic interest in T Ltd. to the extent of 10%, and through S Ltd.
in which it is the majority shareholders, it has further control of 9% in T Ltd. (60% of
S Ltd.’s 15%). These two taken together (10% + 9%) make the total control of 19%.
Conclusion
In the present case, control of R Ltd. in T Ltd. directly and through S Ltd., is only 19%.
Significant influence may also not be exercised as an investing party (R Ltd.) holds,
directly or indirectly through intermediaries only 19% of the voting power of the T Ltd.
Accordingly, R Ltd. and T Ltd. are not related parties. Hence related party disclosure,
as per AS 18, is not required.
16. As per AS 19 ‘leases’, a lease will be classified as finance lease if at the inception of
the lease, the present value of minimum lease payment • amounts to at least
substantially all of the fair value of leased asset. In the given case, the implicit rate
of interest is given at 15%. The present value of minimum lease payments at 15%
using PV- Annuity Factor can be computed as:
Annuity Factor (Year 1 to Year 3) 3.36
Present Value of minimum lease payments ` 10.08 lakhs
(` 3 lakhs each year)
Thus present value of minimum lease payments is `10.08 lakhs and the fair value of
the machine is ` 30 lakhs. In a finance lease, lease term should be for the major part
of the economic life of the asset even if title is not transferred. However, in the given
case, the effective useful life of the machine is 14 years while the lease is only for
three years. Therefore, lease agreement is an operating lease. Lease payments
under an operating lease should be recognized as an expense in the statement of
profit and loss on a straight line basis over the lease term unless another systematic
basis is more representative of the time pattern of the user’s benefit.
•
In calculating the present value of the of minimum lease payments, the discount rate is the interest rate
implicit in the lease.

17. The following dates should be considered for consideration of weights for the purpose of
calculation of weighted average number of shares in the given situations:
(i) Date of Cash receivable
(ii) Date of conversion
(iii) Date on which settlement becomes effective
(iv) When the services are rendered
(v) Date when interest ceases to accrue
(vi) Date on which the acquisition is recognised.
18. (a) Statement of Profit and Loss for the year ended 31 st March, 2019 (Extract)
`
Profit before depreciation and taxes 6,40,000
Less: Depreciation for accounting purposes
(2,80,000+30,000) (3,10,000)
Profit before taxes (A) 3,30,000
Less: Tax expense (B)
Current tax (W.N.1) (3,30,000 x 40%) 1,32,000
Deferred tax (W.N.2) NIL (1,32,000)
Profit after tax (A-B) 1,98,000
Working Notes:
1. Computation of taxable income
Amount (`)
Profit before depreciation and tax 6,40,000
Less: Depreciation for tax purpose (1,90,000 + 1,20,000) (3,10,000)
Taxable income 3,30,000
Tax on taxable income @ 40% 1,32,000
2. Impact of various items in terms of deferred tax liability / deferred tax asset
S. Transactions Analysis Nature of Effect Amount
No. difference (`)
(i) Difference in Generally, Responding Reversal (2,80,000 -
depreciation written down timing of DTL 1,90,000) x
value method of difference 40%
depreciation is = (36,000)

adopted under
IT Act which
leads to higher
depreciation in
earlier years of
useful life of the
asset in
comparison to
later years.
(ii) Depreciation Due to Timing Creation (1,20,000
on new allowance of full difference of DTL – 30,000) x
machinery amount as 40%
expenditure = 36,000
under IT Act, tax
payable in the
earlier years is
less.
Net impact NIL
(b) The break-up of deferred tax assets and deferred tax liabilities into major components
of the respective balance should be disclosed in the notes to accounts. Deferred tax
assets and liabilities should be distinguished from assets and liabilities represent ing
current tax for the period. Deferred tax assets and liabilities should be disclosed under
a separate heading in the balance sheet of the enterprise, separately from current
assets and current liabilities. The nature of the evidence supporting the reco gnition
of deferred tax assets should be disclosed, if an enterprise has unabsorbed
depreciation or carry forward of losses under tax laws.
19. (a) Mere gradual phasing out is not considered as discontinuing operation as defined
under AS 24, ‘Discontinuing Operations’.
Examples of activities that do not necessarily satisfy criterion of the definition, but
that might do so in combination with other circumstances, include:
(1) Gradual or evolutionary phasing out of a product line or class of service;
(2) Discontinuing, even if relatively abruptly, several products within an ongoing line
of business;
(3) Shifting of some production or marketing activities for a particular line of
business from one location to another; and
(4) Closing of a facility to achieve productivity improvements or other cost savings.

In view of the above, mere gradual phasing out in itself cannot be considered as
discontinuing operation. The companies’ strategic plan also has no final approval from
the board through a resolution and there is no specific time bound activities like
shifting of assets and employees. Moreover, the new segment i.e. commercial vehicle
production line in a new factory has not started.
(b) Naresh Ltd.
Balance Sheet (Extract relating to intangible asset) as on 31 st March 2020
Note No. `
Assets
(1) Non-current assets
Intangible assets 1 8,11,200
Notes to Accounts (Extract)
` `
1. Intangible assets
Goodwill (Refer to note 1) 4,51,200
Franchise (Refer to Note 2) 1,50,000
Patents (Refer to Note 3) 2,10,000 8,11,200
Working Notes:
`
(1) Goodwill on acquisition of business
Cash paid for acquiring the business (purchase consideration) 10,80,000
Less: Fair value of net assets acquired (5,16,000)
Goodwill 5,64,000
Less: Amortisation as per AS 14 ie. over 5 years (as per SLM) (1,12,800)
Balance to be shown in the balance sheet 4,51,200
(2) Franchise 1,80,000
Less: Amortisation (over 6 years) (30,000)
(3) Patent 2,40,000
Less: Amortisation (over 8 years as per SLM) (30,000)

20. (a) As per provisions of AS 29 “Provisions, Contingent Liabilities and Contingent Assets”,
where some or all of the expenditure required to settle a provision is expected to be
reimbursed by another party, the reimbursement should be recognized when, and only
when, it is virtually certain that reimbursement will be received if the enterprise settles
the obligation. The reimbursement should be treated as a separate asset. The amount
recognized for the reimbursement should not exceed the amount of the provision.
It is apparent from the question that the company had not made provision for warranty
in respect of certain goods considering that the company can claim the warranty cost
from the original supplier. However, the provision for warranty should have been
made as per AS 29 and the amount claimable as reimbursement should be treated
as a separate asset in the financial statements of the company rather than omitting
the disclosure of such liability. Accordingly, it can be said that the accounting
treatment adopted by the company with respect to warranty is not correct.
(b) (i) There is a present obligation that probably requires an outflow of resources and
a reliable estimate can be made of the amount of obligation – Provision is
recognised. Disclosures are required for the provision.
(ii) There is a possible obligation or a present obligation that may, but probably will
not, require an outflow of resources – No provision is recognised. Disclosures
are required for the contingent liability.
(iii) There is a possible obligation or a present obligation where the likelihood of an
outflow of resources is remote – No provision is recognised. No disclosure is
required.

PAPER – 6: AUDITING AND ASSURANCE
PART – I : ACADEMIC UPDATE
(Legislative Amendments / Notifications / Circulars / Rules / Guidelines issued by
Regulating Authority)
Chapter 5- Fraud and Responsibilities of the Auditor in this Regard
Chapter 10- Company Audit
CHAPTER 5
FRAUD AND RESPONSIBILITIES OF THE
AUDITOR IN THIS REGARD
LEARNING OUTCOMES
After studying this chapter, you will be able to:
❑ Understand the types of errors and frauds.
❑ Definition of fraud as given under the Standards on
Auditing and its meaning.
❑ Understand reasons behind management/ employees
committing fraud/ error.
❑ Analyse the duty of an auditor regarding detection of fraud and
error.
❑ Determine fraud risk factors and circumstances relating to
possibility of fraud.
❑ Understand responsibility of an auditor in case of withdrawal from
the engagement if encounter any circumstances that bring into
question his ability to continue due to fraud.

42 INTERMEDIATE (NEW) EXAMINATION : MAY, 2021
1. MEANING OF FRAUD
The Standard on Auditing (SA) 240 “The Auditor’s Responsibilities Relating to
Fraud in an Audit of Financial Statements” defines the term ‘fraud’ as-
“an intentional act by one or more individuals among management, those
charged with governance, employees, or third parties, involving the use of
deception to obtain an unjust or illegal advantage”.
Although fraud is a broad legal concept, for the purposes of the SAs, the
auditor is concerned with fraud that causes a material misstatement in the
financial statements.
Two types of intentional misstatements are relevant to the auditor–
 misstatements resulting from fraudulent financial reporting and

PAPER – 6: AUDITING AND ASSURANCE 43
 misstatements resulting from misappropriation of assets.

Although the auditor may suspect or, in rare cases, identify the occurrence of
fraud, the auditor does not make legal determinations of whether fraud has
actually occurred.
2. CHARACTERISTICS OF FRAUD
2.1 Fraud is Intentional
Misstatements in the financial statements can arise from either fraud or error.
The distinguishing factor between fraud and error is whether the underlying
action that results in the misstatement of the financial statements is intentional
or unintentional.
2.2 Fraud is a broad legal concept

The auditor is concerned with fraud that causes a material misstatement in the
Fraud, whether fraudulent financial reporting or misappropriation of

assets, involves incentive or pressure to commit fraud, a perceived
opportunity to do so and some rationalization of the act. For example:
 Incentive or pressure to commit fraudulent financial reporting may exist
when management is under pressure, from sources outside or inside the
entity, to achieve an expected (and perhaps unrealistic) earnings target or
financial outcome.
 A perceived opportunity to commit fraud may exist when an individual
believes internal control can be overridden, for example, because the

individual is in a position of trust or has knowledge of specific deficiencies

in internal control.
 Individuals may be able to rationalize committing a fraudulent act. Some
individuals possess an attitude, character or set of ethical values that allow
them knowingly and intentionally to commit a dishonest act. However,
even otherwise, honest individuals can commit fraud in an environment
that imposes sufficient pressure on them.
2.2.1 Fraudulent financial reporting involves intentional
misstatements including omissions of amounts or disclosures in
financial statements to deceive financial statement users.
Fraudulent financial reporting may be accomplished by the following:
Manipulation, falsification (including forgery), or alteration of accounting

records or supporting documentation from which the financial statements are
prepared.
Manipulation of Accounts: Detection of manipulation of accounts with a view
to presenting a false state of affairs is a task requiring great tact and intelligence
because generally management personnel in higher management cadre are
associated with this type of fraud and this is perpetrated in methodical way. This
type of fraud is generally committed:
(a) to avoid incidence of income-tax or other taxes;
(b) for declaring a dividend when there are insufficient profits;
(c) to withhold declaration of dividend even when there is adequate profit
(this is often done to manipulate the value of shares in stock market to
make it possible for selected persons to acquire shares at a lower cost);
and

(d) for receiving higher remuneration where managerial remuneration is

payable by reference to profits.
There are numerous ways of committing this type of fraud. Some of the
methods are given below:
(i) inflating or suppressing purchases and expenses;
(ii) inflating or suppressing sales and other items of income,
(iii) inflating or deflating the value of closing inventory;
(iv) failing to adjust outstanding liabilities or prepaid expenses; and
(v) charging items of capital expenditure to revenue or by capitalising
revenue expenses.
Misrepresentation in or intentional omission from, the financial statements of
events, transactions or other significant information.
Intentional misapplication of accounting principles relating to amounts,
classification, manner of presentation, or disclosure.
Fraudulent financial reporting often involves management override of
controls that otherwise may appear to be operating effectively. Fraud can
be committed by management overriding controls using such techniques as:
 Recording fictitious journal entries, particularly close to the end of an

accounting period, to manipulate operating results or achieve other
objectives.
 Inappropriately adjusting assumptions and changing judgments used to
estimate account balances.

 Omitting, advancing or delaying recognition in the financial statements of

events and transactions that have occurred during the reporting period.
 Concealing, or not disclosing, facts that could affect the amounts
recorded in the financial statements.
 Engaging in complex transactions that are structured to misrepresent the
financial position or financial performance of the entity.
 Altering records and terms related to significant and unusual transactions.
Why do Management/ Employees commit fraud? What induces
Management/ Employees to commit fraud? Following are certain instances
which will help to understand these questions:
 Financial obligations/ Pressure.

 Management’s unrealistic goals.
 Dissatisfied Employees or Lack of motivation among employees.
 Name game (eg. management using power of authority by asking
employees to do something illegal).
 Opportunity to commit fraud.

2.2.2 Misappropriation of Assets:

It involves the theft of an entity’s assets and is often perpetrated by employees
in relatively small and immaterial amounts.
However, it can also involve management
who are usually more able to disguise or
conceal misappropriations in ways that are
difficult to detect. Misappropriation of
assets can be accomplished in a variety of
ways including:
Fig.: Theft of Assets
 Embezzling receipts (for example,
misappropriating collections on accounts receivable or diverting receipts
in respect of written-off accounts to personal bank accounts).
 Stealing physical assets or intellectual property (for example, stealing
inventory for personal use or for sale, stealing scrap for resale, colluding
with a competitor by disclosing technological data in return for payment).
 Causing an entity to pay for goods and services not received (for example,
payments to fictitious vendors, kickbacks paid by vendors to the entity’s
purchasing agents in return for inflating prices, payments to fictitious
employees).
 Using an entity’s assets for personal use (for example, using the entity’s
assets as collateral for a personal loan or a loan to a related party).
Example
Vineet is a manager in Zed Ex Ltd. He is having authority to sign cheques up to
` 10,000. While performing the audit, Rajan, the auditor, noticed that there were
many cheques of ` 9,999 which had been signed by Vineet. Further Vineet had
split large payments (amounting to more than ` 10,000 each, into two or more
cheques less than ` 10,000 each so that he may authorize the payments). This
raised suspicion in the auditor’s mind.
The auditor found that the cheques of ` 9,999 were deposited in Vineet’s
personal account i.e. Vineet had misappropriated the amount.
Splitting the cheques into lower amounts involves manipulation of accounts.
The fraud was committed by an employee.

Misappropriation of assets is often

accompanied by false or misleading records
or documents in order to conceal the fact
that the assets are missing or have been
pledged without proper authorization. 1
2.2.2.1 Misappropriation of Goods
Fraud in the form of misappropriation of
goods is still more difficult to detect; for
this, management has to rely on various
measures. Apart from the various
requirements of record keeping about the Fig.: Theft of Goods*
physical quantities and their periodic
checks, there must be rules and procedures for allowing persons inside the area
where goods are kept. In addition there should be external security
arrangements to see that no goods are taken out without proper authority.
Goods can be anything in the premises; it may be machinery. It may even be
the daily necessities of the office like stationery. The goods may be removed by
subordinate employees or even by persons quite higher up in the management.
Auditors can detect this by undertaking a thorough and strenuous checking of
records followed by physical verification process. Also, by resorting to
intelligent ratio analysis, auditors may be able to form an idea whether such
fraud exists.
Therefore, it is clear from the above that the ‘fraud’ deals with intentional
misrepresentation but, ‘error’, on the other hand, refers to unintentional
mistakes in financial information.
Intentional errors are most difficult to detect and auditors generally devote
greater attention to this type because out of long and sometimes unfortunate
experience, auditors have developed a point of view that, if they direct their
procedures of discovering the more difficult intentional errors, they are
reasonably certain to locate the more simple and far more common
unintentional errors on the way.
*
Source of image: www.clipartster.com

2.2.2.2 Defalcation of Cash

Defalcation of cash has been found to perpetrate generally in the following
ways:
(a) By inflating cash payments:

Examples of inflation of payments:
(1) Making payments against fictitious vouchers.
(2)Making payments against vouchers, the amounts whereof have been
inflated.
(3) Manipulating totals of wage rolls either by including therein names
of dummy workers or by inflating them in any other manner.
(4) Casting a larger totals for petty cash expenditure and adjusting the
excess in the totals of the detailed columns so that cross totals show
agreement.
(b) By suppressing cash receipts:
Few techniques of how receipts are suppressed are:
(1) Teeming and Lading: 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.

(2) Adjusting unauthorised or fictitious rebates, allowances, discounts,

etc. to customer’ accounts and misappropriating amount paid by
them.
(3) Writing off as debts in respect of such balances against which cash
has already been received but has been misappropriated.
(4) Not accounting for cash sales fully.
(5) Not accounting for miscellaneous receipts, e.g., sale of scrap,
quarters allotted to the employees, etc.
(6) Writing down asset values in entirety, selling them subsequently and
misappropriating the proceeds.
(c) By casting wrong totals in the cashbook.
3. DETECTION OF FRAUD AND ERROR–DUTY

OF AN AUDITOR
As per SA 240 “The Auditor’s
Responsibilities Relating to
Fraud in an Audit of Financial
Statements”, the primary
responsibility for the prevention
and detection of fraud rests
with both those charged with
governance of the entity and
management. It is important Fig.: Meticulous Analysis by Auditor for
that management, with the detection of Fraud/Error***
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. This involves a commitment to
creating a culture of honesty and ethical behavior which can be reinforced by
an active oversight by those charged with governance.
Broadly, the general principles laid down in the SA may be noted as under:
1. An auditor conducting an audit in accordance with SAs is responsible for
obtaining reasonable assurance that the financial statements taken as a whole

are free from material misstatement, whether caused by fraud or error. As

described in SA200, “Overall Objectives of the Independent Auditor and
the Conduct of an Audit in Accordance with Standards on Auditing,”
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
the SAs.
2. The risk of not detecting a material misstatement resulting from fraud is
higher than the risk of not detecting one resulting from error. This is because,
fraud may involve sophisticated and carefully organized schemes designed
to conceal it, such as forgery, deliberate failure to record transactions, or
intentional misrepresentations being made to the auditor. Such attempts at
concealment may be even more difficult to detect when accompanied by
collusion. Collusion may cause the auditor to believe that audit evidence is
persuasive when it is, in fact, false. The auditor’s ability to detect a fraud
depends on factors such as the skillfulness of the perpetrator, the frequency
and extent of manipulation, the degree of collusion involved, the relative size
of individual amounts manipulated, and the seniority of those individuals
involved. While the auditor may be able to identify potential opportunities
for fraud to be perpetrated, it is difficult for the auditor to determine whether
misstatements in judgment areas such as accounting estimates are caused
by fraud or error.
3. Furthermore, the risk of the auditor not detecting a material misstatement
resulting from management fraud is greater than for employee fraud,
because management is frequently in a position to directly or indirectly
manipulate accounting records, present fraudulent financial information
or override control procedures designed to prevent similar frauds by
other employees.
4. When obtaining reasonable assurance, the auditor is responsible for
maintaining an attitude of professional skepticism throughout the audit,
considering the potential for management override of controls and
recognizing the fact that audit procedures that are effective for detecting
error may not be effective in detecting fraud. The requirements in this SA are
designed to assist the auditor in identifying and assessing the risks of
material misstatement due to fraud and in designing procedures to detect
such misstatement.

Case Study 1
While auditing XYZ Ltd., the auditor was told by Mr. Mahesh, the CEO of
the company, that he would be responsible for the fraud & errors, if any,
occurring in the books of accounts of the company.
Auditor’s Responsibilities for Detection of Fraud and Error: As per SA 240
“The Auditor’s Responsibilities relating to fraud in an audit of Financial
Statements”, an auditor conducting an audit in accordance with SAs is
responsible for obtaining reasonable assurance that the financial statements
taken as a whole are free from material misstatement, whether caused by fraud
or error.
Owing to the inherent limitations of an audit, there is an unavoidable risk that
some material misstatements of the financial statements will not be detected,
even though the audit is properly planned and performed in accordance with
the SAs.
When obtaining reasonable assurance, the auditor is responsible for maintaining
an attitude of professional skepticism throughout the audit, considering the
potential for management override of controls and recognizing the fact that audit
procedures that are effective for detecting error may not be effective in detecting
fraud.
An auditor conducting an audit in accordance with SAs is responsible for
are free from material misstatement, whether caused by fraud or error.
The auditor also has the responsibility to communicate the misstatement to the
appropriate level of management on a timely basis and consider the need to
report to it to those charged with governance. He may also obtain legal advice
before reporting on the financial information or before withdrawing from the
engagement. The auditor should satisfy himself that the effect of fraud is
properly reflected in the financial information or the error is corrected in case
the modified procedures performed by the auditor confirms the existence of
the fraud.
The auditor should also consider the implications of the frauds and errors, and
frame his report appropriately. In case of a fraud, the same should be disclosed
in the financial statement. If adequate disclosure is not made, there should be
a suitable disclosure in his audit report.

Case Study 2
After the completion of statutory audit of ABC Ltd., a fraud was detected
at the office of the auditee. The management of the company alleged that
there is a failure on the part of the auditor to detect fraud and that auditor
would be responsible for not detecting fraud in the company.
Detection of Fraud after Completion of Statutory Audit: As per SA 240, the
primary responsibility for the prevention and detection of fraud rests with both
those charged with governance of the entity and management. 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. Such
a system reduces but does not eliminate the possibility of fraud and error.
An auditor conducting an audit in accordance with SAs is responsible for
are free from material misstatement, whether caused by fraud or error. Owing to
the inherent limitations of an audit, there is an unavoidable risk that some
material misstatements of the financial statements will not be detected, even
though the audit is properly planned and performed in accordance with the SAs.
The risk of not detecting a material misstatement resulting from fraud is higher
than the risk of not detecting one resulting from error. This is because fraud may
involve sophisticated and carefully organized schemes designed to conceal it,
such as forgery, deliberate failure to record transactions, or intentional
misrepresentations being made to the auditor. Such attempts at concealment
may be even more difficult to detect when accompanied by collusion.
The subsequent discovery of material misstatement of the financial information
resulting from fraud or error existing during the period covered by the auditor’s
report does not, in itself, indicate that whether the auditor has adhered to the
basic principles governing an audit. The question of whether the auditor has
adhered to the basic principles governing an audit (such as performance of the
audit work with requisite skills and competence, documentation of important
matters, details of the audit plan and reliance placed on internal controls, nature
and extent of compliance and substantive tests carried out, etc.) is determined
by the adequacy of the procedures undertaken in the circumstances and the
suitability of the auditor’s report based on the results of these procedures.

The liability of the auditor for failure to detect fraud exists only when such failure is
clearly due to not exercising reasonable care and skill. Thus, in the instant case, after
the completion of the statutory audit, if a fraud has been detected, the same by itself
can not mean that the auditor did not perform his duty properly. If the auditor can
prove with the help of his papers (documentation) that he has followed adequate
procedures necessary for the proper conduct of an audit, he cannot be held
responsible for the same. If however, the same cannot be proved, he would be held
responsible.
4. FRAUD RISK FACTORS AND POSSIBILITY

OF FRAUD
SA 240, further, explains by way of examples, certain risk factors and
circumstances relating to possibility of fraud as may be considered by the
auditor which are dealt in the following paragraphs.
4.1 Fraud Risk Factors

Fraud Risk Factors may be defined as events or conditions that indicate an
incentive or pressure to commit fraud or provide an opportunity to commit
fraud.
Examples of Fraud Risk Factors: The fraud risk factors identified here are
examples of such factors that may be faced by auditors in a broad range of
situations. Separately presented are examples relating to the two types of fraud
relevant to the auditor’s consideration, i.e.,
(A) fraudulent financial reporting, and
(B) misappropriation of assets.
For each of these types of fraud, the risk factors are further classified based on
the three conditions generally present when material misstatements due to
fraud occur:
(a) incentives/pressures,
(b) opportunities, and

(c) attitudes/rationalizations.
Although the risk factors cover a broad range of situations, they are only
examples and, accordingly, the auditor may identify additional or different risk
factors. Not all of these examples are relevant in all circumstances, and some
may be of greater or lesser significance in entities of different size or with
different ownership characteristics or circumstances. Also, the order of the
examples of risk factors provided is not intended to reflect their relative
importance or frequency of occurrence.
(A) Risk Factors Relating to Misstatements Arising from Fraudulent
Financial Reporting: The following are examples of risk factors relating to
misstatements arising from fraudulent financial reporting-
Incentives/Pressures: Financial stability or profitability is threatened by
economic, industry, or entity operating conditions, such as (or as indicated by):
1. High degree of competition or market saturation, accompanied by
declining margins.
2. High vulnerability to rapid changes, such as changes in technology,
product obsolescence, or interest rates.
3. Significant declines in customer demand and increasing business failures
in either the industry or overall economy.
4. Operating losses making the threat of bankruptcy, foreclosure, or hostile
takeover imminent.

5. Recurring negative cash flows from operations or an inability to generate

cash flows from operations while reporting earnings and earnings growth.
6. New accounting, statutory, or regulatory requirements.
Opportunities: The nature of the industry or the entity’s operations provides
opportunities to engage in fraudulent financial reporting that can arise from
the following:
1. Significant related-party transactions not in the ordinary course of
business or with related entities not audited or audited by another firm.
2. A strong financial presence or ability to dominate a certain industry sector
that allows the entity to dictate terms or conditions to suppliers or
customers that may result in inappropriate or non-arm’s-length
transactions.
3. Assets, liabilities, revenues, or expenses based on significant estimates
that involve subjective judgments or uncertainties that are difficult to
corroborate.
4. Significant, unusual, or highly complex transactions, especially those close
to period end that pose difficult “substance over form” questions.
5. Significant bank accounts or subsidiary or branch operations in tax-haven
jurisdictions for which there appears to be no clear business justification.
Attitudes/Rationalizations: Communication, implementation, support, or
enforcement of the entity’s values or ethical standards by management, or the
communication of inappropriate values or ethical standards, that are not
effective.
1. Known history of violations of securities laws or other laws and
regulations.
2. Excessive interest by management in maintaining or increasing the
entity’s inventory price or earnings trend.
3. Management failing to remedy known significant deficiencies in internal
control on a timely basis.
4. An interest by management in employing inappropriate means to
minimize reported earnings for tax-motivated reasons.

5. The owner-manager makes no distinction between personal and business

transactions.
6. The relationship between management and the current or predecessor
auditor is strained, as exhibited by the following:
• Frequent disputes with the current or predecessor auditor on
accounting, auditing, or reporting matters.
• Unreasonable demands on the auditor, such as unrealistic time
constraints regarding the completion of the audit or the issuance of
the auditor’s report.
• Restrictions on the auditor that inappropriately limit access to
people or information or the ability to communicate effectively with
those charged with governance.
• Domineering management behavior in dealing with the auditor,
especially involving attempts to influence the scope of the auditor’s
work or the selection or continuance of personnel assigned to or
consulted on the audit engagement.
(B) Risk Factors Arising from Misstatements Arising from
Misappropriation of Assets: Risk factors that relate to misstatements arising
from misappropriation of assets are also classified according to the three
conditions generally present when fraud exists: incentives/ pressures,
opportunities, and attitudes/ rationalization. Some of the risk factors related to
misstatements arising from fraudulent financial reporting also may be present
when misstatements arising from misappropriation of assets occur.
The following are examples of risk factors related to misstatements arising
from misappropriation of assets-
Incentives/Pressures: Personal financial obligations may create pressure on
management or employees with access to cash or other assets susceptible to
theft to misappropriate those assets.
Adverse relationships between the entity and employees with access to cash or
other assets susceptible to theft may motivate those employees to
misappropriate those assets. For example, adverse relationships may be created
by the following:
1. Known or anticipated future employee layoffs.

2. Recent or anticipated changes to employee compensation or benefit

plans.
3. Promotions, compensation, or other rewards inconsistent with
expectations.
Opportunities: Certain characteristics or circumstances may increase the
susceptibility of assets to misappropriation. For example, opportunities to
misappropriate assets increase when there are the following:
1. Large amounts of cash on hand or processed.
2. Inventory items that are small in size, of high value, or in high demand.
3. Easily convertible assets, such as bearer bonds, diamonds, or computer
chips.
4. Fixed assets which are small in size, marketable, or lacking observable
identification of ownership.
Inadequate internal control over assets may increase the susceptibility of
misappropriation of those assets. For example, misappropriation of assets
may occur because there is the following:
 Inadequate segregation of duties or independent checks.
 Inadequate oversight of senior management expenditures, such as travel
and other reimbursements.
 Inadequate record keeping with respect to assets.
 Inadequate system of authorization and approval of transactions (for
example, in purchasing).
 Inadequate physical safeguards over cash, investments, inventory, or fixed
assets.
 Lack of complete and timely reconciliations of assets.
 Lack of timely and appropriate documentation of transactions, for
example, credits for merchandise returns.
 Lack of mandatory vacations for employees performing key control
functions.

 Inadequate management understanding of information technology,

which enables information technology employees to perpetrate a
misappropriation.
 Inadequate access controls over automated records, including controls
over and review of computer systems event logs.
Attitudes/Rationalizations: Disregard for the need for monitoring or reducing
risks related to misappropriations of assets.
 Disregard for internal control over misappropriation of assets by
overriding existing controls or by failing to take appropriate remedial
action on known deficiencies in internal control.
 Behavior indicating displeasure or dissatisfaction with the entity or its
treatment of the employee.
 Changes in behavior or lifestyle that may indicate assets have been
misappropriated
 Tolerance of petty theft.
4.2 Circumstances Relating to Possibility of Fraud

Examples of circumstances that indicate the possibility of fraud: The
following are examples of circumstances that may indicate the possibility that
the financial statements may contain a material misstatement resulting from
fraud-

(A) Discrepancies in the accounting records, including:

• Transactions that are not recorded in a complete or timely manner
or are improperly recorded as to amount, accounting period,
classification, or entity policy.
• Unsupported or unauthorized balances or transactions.
• Last-minute adjustments that significantly affect financial results.
• Evidence of employees’ access to systems and records inconsistent
with that necessary to perform their authorized duties.
• Tips or complaints to the auditor about alleged fraud.
(B) Conflicting or missing evidence, including:
• Missing documents.
• Documents that appear to have been altered.
• Significant unexplained items on reconciliations.
• Unusual discrepancies between the entity’s records and confirmation
replies.
• Large numbers of credit entries and other adjustments made to
accounts receivable records.
• Missing or non-existent cancelled cheques in circumstances where
cancelled cheques are ordinarily returned to the entity with the bank
statement.
• Missing inventory or physical assets of significant magnitude.
• Unavailable or missing electronic evidence, inconsistent with the
entity’s record retention practices or policies.
Example
Raj is the auditor of XYZ Ltd. Raj is analysing the financial statements of the
company by studying significant ratios. Some of the ratios that he studied were
the gross profit ratio and net profit ratio. The gross profit ratio for the current
year 2019-20 is 19% and for the previous year 2018-19 was 25%. Similarly, net
profit ratio for the current year 2019-20 is 7%, where as in previous year 2018-
19 it was 11%.
There is a large variation in the gross profit ratio and net profit ratio over the

two years. Hence, the auditor has reason to believe that there may be
something unusual. He will consider the results of such analytical procedures
while drawing up his audit plan and allot more time to studying purchases.
Example
Analytical procedures exhibiting unusual ratios and trend e.g. unusually large
transactions reported in the last month of the reporting period.
(C) Problematic or unusual relationships between the auditor and

management, including:
• Denial of access to records, facilities, certain employees, customers,
vendors, or others from whom audit evidence might be sought.
• Undue time pressures imposed by management to resolve complex
or contentious issues.
• Unusual delays by the entity in providing requested information.
• Unwillingness to facilitate auditor access to key electronic files for
testing through the use of computer-assisted audit techniques.
• Denial of access to key IT operations staff and facilities, including
security, operations, and systems development personnel.
• An unwillingness to add or revise disclosures in the financial
statements to make them more complete and understandable.
• An un willingness to address identified deficiencies in internal
control on a timely basis.
(D) Other
• Unwillingness by management to permit the auditor to meet
privately with those charged with governance.
• Accounting policies that appear to be at variance with industry
norms.
• Frequent changes in accounting estimates that do not appear to
result from changed circumstances.
• Tolerance of violations of the entity’s Code of Conduct.

5. FRAUD REPORTING
Reporting to the Central Government: As per sub-section (12) of section 143
of the Companies Act, 2013, if an auditor of a company in the course of the
performance of his duties as auditor, has reason to believe that an offence of
fraud involving such amount or amounts as may be prescribed, is being or has
been committed in the company by its officers or employees, the auditor shall
report the matter to the Central Government within such time and in such
manner as may be prescribed.
In this regard, Rule 13 of the Companies (Audit and Auditors) Rules, 2014 has
been prescribed. Sub-rule (1) of the said rule states that if an auditor of a
company, in the course of the performance of his duties as statutory auditor,
has reason to believe that an offence of fraud, which involves or is expected to
involve individually an amount of ` 1 crore or above, is being or has been
committed against the company by its officers or employees, the auditor shall
report the matter to the Central Government.
The manner of reporting the matter to the Central Government is as
follows:
(a) the auditor shall report the matter to the Board or the Audit Committee,
as the case may be, immediately but not later than 2 days of his
knowledge of the fraud, seeking their reply or observations within 45 days;
(b) on receipt of such reply or observations, the auditor shall forward his
report and the reply or observations of the Board or the Audit Committee
along with his comments (on such reply or observations of the Board or
the Audit Committee) to the Central Government within 15 days from the
date of receipt of such reply or observations;
(c) in case the auditor fails to get any reply or observations from the Board
or the Audit Committee within the stipulated period of 45 days, he shall
forward his report to the Central Government along with a note
containing the details of his report that was earlier forwarded to the Board
or the Audit Committee for which he has not received any reply or
observations;

(d) the report shall be sent to the Secretary, Ministry of Corporate Affairs in
a sealed cover by Registered Post with Acknowledgement Due or by Speed
Post followed by an e-mail in confirmation of the same;
(e) the report shall be on the letter-head of the auditor containing postal
address, e-mail address and contact telephone number or mobile number
and be signed by the auditor with his seal and shall indicate his
Membership Number; and
(f) the report shall be in the form of a statement as specified in Form ADT-4.
II. Reporting to the Audit Committee or Board: Sub-section (12) of
section 143 of the Companies Act, 2013 further prescribes that in case of a fraud
involving lesser than the specified amount [i.e. less than ` 1 crore], the auditor
shall report the matter to the audit committee constituted under section 177 or
to the Board in other cases within such time and in such manner as may be
prescribed.
In this regard, sub-rule (3) of Rule 13 of the Companies (Audit and Auditors)
Rules, 2014 states that in case of a fraud involving lesser than the amount
specified in sub- rule (1) [i.e. less than ` 1 crore], the auditor shall report the
matter to Audit Committee constituted under section 177 or to the Board
immediately but not later than 2 days of his knowledge of the fraud and he shall
report the matter specifying the following:
(a) Nature of Fraud with description;
(b) Approximate amount involved; and
(c) Parties involved.
III Disclosure in the Board’s Report: Sub-section (12) of section 143 of

the Companies Act, 2013 furthermore prescribes that the companies, whose
auditors have reported frauds under this sub-section (12) to the audit
committee or the Board, but not reported to the Central Government, shall
disclose the details about such frauds in the Board’s report in such manner as
may be prescribed.
In this regard, sub-rule (4) of Rule 13 of the Companies (Audit and Auditors)
Rules, 2014 states that the auditor is also required to disclose in the Board’s

Report the following details of each of the fraud reported to the Audit
Committee or the Board under sub- rule (3) during the year:
(a) Nature of Fraud with description;
(b) Approximate Amount involved;
(c) Parties involved, if remedial action not taken; and
(d) Remedial actions taken.
Sub-section (13) of section 143 of the Companies Act, 2013 safeguards the act
of fraud reporting by the auditor if it is done in good faith. It states that no duty
to which an auditor of a company may be subject to shall be regarded as having
been contravened by reason of his reporting the matter above if it is done in

good faith.
It is very important to note that these provisions shall also apply, mutatis
mutandis, to a cost auditor and a secretarial auditor during the performance
of his duties under section 148 and section 204 respectively. If any auditor, cost
accountant or company secretary in practice do not comply with the provisions
of sub-section (12) of section 143, he shall be punishable with fine which shall
not be less than one lakh rupees but which may extend to twenty-five lakh
rupees.
Reporting on Frauds already detected and reported: The auditor should
apply professional skepticism to evaluate/verify that the fraud was indeed
identified/detected in all aspects by the management or through the company’s
vigil/whistle blower mechanism so that distinction can be clearly made with
respect to frauds identified/detected due to matters raised by the auditor vis-
à-vis those identified/detected by the company through its internal control
mechanism.
Since reporting on fraud under section 143(12) is required even by the cost
auditor and the secretarial auditor of the company, it is possible that a
suspected offence involving fraud may have been reported by them even before
the auditor became aware of the fraud. Here too, if a suspected offence of fraud
has already been reported under section 143(12) by such other person, and the
auditor becomes aware of such suspected offence involving fraud, he need not
report the same since he has not per se identified the suspected offence of
fraud.
However, in case of a fraud which involves or is expected to involve individually,
an amount of ` 1 crore or more, the auditor should review the steps taken by
the management/those charged with governance with respect to the reported
instance of suspected offence of fraud stated above, and if he is not satisfied
with such steps, he should state the reasons for his dissatisfaction in writing and
request the management/ those charged with governance to perform
additional procedures to enable the auditor to satisfy himself that the matter
has been appropriately addressed. If the management/those charged with
governance fail to undertake appropriate additional procedures within 45 days
of his request, the auditor would need to evaluate if he should report the matter
to the Central Government in accordance with Rule 13 of the Companies (Audit
and Auditors) Rules, 2014.

Reporting under Companies (Auditor’s Report) Order, 2016 [CARO, 2016]:

The auditor is also required to report under clause (x) of paragraph 3 of
Companies (Auditor’s Report) Order, 2016, whether any fraud by the company
or any fraud on the Company by its officers or employees has been noticed or
reported during the year. If yes, the nature and the amount involved is to be
indicated.
The scope of auditor’s inquiry under this clause is restricted to frauds ‘noticed
or reported’ during the year. It may be noted that this clause of the Order, by
requiring the auditor to report whether any fraud by the company or on the
company by its Officer or employees has been noticed or reported, does not
relieve the auditor from his responsibility to consider fraud and error in an audit
of financial statements. In other words, irrespective of the auditor’s comments
under this clause, the auditor is also required to comply with the requirements
of SA 240, “The Auditor’s Responsibility Relating to Fraud in an Audit of
Financial Statements”.
Audit Procedures and Reporting under CARO:
(1) While planning the audit, the auditor should discuss with other members
of the audit team, the susceptibility of the company to material
misstatements in the financial statements resulting from fraud. While
planning, the auditor should also make inquiries of management to
determine whether management is aware of any known fraud or
suspected fraud that the company is investigating.
(2) The auditor should examine the reports of the internal auditor with a view
to ascertain whether any fraud has been reported or noticed by the
management. The auditor should examine the minutes of the audit
committee, if available, to ascertain whether any instance of fraud
pertaining to the company has been reported and actions taken thereon.
The auditor should enquire from the management about any frauds on
the company that it has noticed or that have been reported to it. The
auditor should also discuss the matter with other employees including
officers of the company. The auditor should also examine the minute book
of the board meeting of the company in this regard.

(3) The auditor should obtain written representations from management that:
(i) it acknowledges its responsibility for the implementation and
operation of accounting and internal control systems that are
designed to prevent and detect fraud and error;
(ii) it believes the effects of those uncorrected misstatements in
financial statements, aggregated by the auditor during the audit are
immaterial, both individually and in the aggregate, to the financial
statements taken as a whole. A summary of such items should be
included in or attached to the written representation;
(iii) it has
(a) disclosed to the auditor all significant facts relating to any
frauds or suspected frauds known to management that may
have affected the entity; and
(b) it has disclosed to the auditor the results of its assessment of
the risk that the financial statements may be materially
misstated as a result of fraud.
4. Because management is responsible for adjusting the financial statements
to correct material misstatements, it is important that the auditor obtains
written representation from management that any uncorrected
misstatements resulting from fraud are, in management’s opinion,
immaterial, both individually and in the aggregate. Such representations
are not a substitute for obtaining sufficient appropriate audit evidence. In
some circumstances, management may not believe that certain of the
uncorrected financial statement misstatements aggregated by the auditor
during the audit are misstatements. For that reason, management may
want to add to their written representation words such as, “We do not
agree that items constitute misstatements because [description of
reasons].”
The auditor should consider if any fraud has been reported by them
during the year under section 143(12) of the Act and if so whether that
same would be reported under this Clause. It may be mentioned here that
section 143(12) of the Act requires the auditor to have reasons to believe
that a fraud is being committed or has been committed by an employee
or officer. In such a case the, auditor needs to report to the Central

Government or the Audit Committee. However, this Clause will include

only the reported frauds and not suspected fraud.
5. Where the auditor notices that any fraud by the company or on the
company by its officers or employees has been noticed by or reported
during the year, the auditor should, apart from reporting the existence of
fraud, also required to report, the nature of fraud and amount involved.
For reporting under this clause, the auditor may consider the following:
(i) This clause requires all frauds noticed or reported during the year
shall be reported indicating the nature and amount involved. As
specified the fraud by the company or on the company by its officers
or employees are only covered.
(ii) Of the frauds covered under section 143(12) of the Act, only noticed
frauds shall be included here and not the suspected frauds.
(iii) While reporting under this clause with regard to the nature and the
amount involved of the frauds noticed or reported, the auditor may
also consider the principles of materiality outlined in Standards on
Auditing.
6. AUDITOR UNABLE TO CONTINUE THE

ENGAGEMENT
If, as a result of a misstatement resulting from fraud or suspected fraud, the
auditor encounters exceptional circumstances that bring into question the
auditor’s ability to continue performing the audit, the auditor shall:
(a) Determine the professional and legal responsibilities applicable in the
circumstances, including whether there is a requirement for the auditor to
report to the person or persons who made the audit appointment or, in
some cases, to regulatory authorities;
(b) Consider whether it is appropriate to withdraw from the engagement,
where withdrawal is possible under applicable law or regulation; and
(c) If the auditor withdraws:
(i) Discuss with the appropriate level of management and those
charged with governance the auditor’s withdrawal from the
engagement and the reasons for the withdrawal; and

(ii) Determine whether there is a professional or legal requirement to

report to the person or persons who made the audit appointment
or, in some cases, to regulatory authorities, the auditor’s withdrawal
from the engagement and the reasons for the withdrawal.
SUMMARY
SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial
Statements” defines the term ‘fraud’ as “an intentional act by one or more
individuals among management, those charged with governance, employees,
or third parties, involving the use of deception to obtain an unjust or illegal
advantage”.
Two types of intentional misstatements are relevant to the auditor–
misstatements resulting from fraudulent financial reporting and misstatements
resulting from misappropriation of assets. Misstatements in the financial
statements can arise from either fraud or error. The distinguishing factor
between fraud and error is whether the underlying action that results in the
misstatement of the financial statements is intentional or unintentional.
Fraud, whether fraudulent financial reporting or misappropriation of assets,
involves incentive or pressure to commit fraud, a perceived opportunity to do
so and some rationalization of the act. Fraudulent financial reporting involves
intentional misstatements including omissions of amounts or disclosures in
financial statements to deceive financial statement users. Misappropriation of
Assets involves the theft of an entity’s assets and is often perpetrated by
employees in relatively small and immaterial amounts.
As per SA 240 the primary responsibility for the prevention and detection of
fraud rests with management. An auditor conducting an audit in accordance
with SAs is responsible for obtaining reasonable assurance that the financial
statements are free from material misstatement, whether caused by fraud or
error.
Fraud Risk Factors may be defined as events or conditions that indicate an
incentive or pressure to commit fraud or provide an opportunity to commit
fraud.
Fraud Reporting [Section 143(12) of Companies Act, 2013 & Rule 13 of CAAR,
2014]

A. Reporting of Fraud involving amount of less than 1 crore rupees: Auditor

to Report Board/Audit Committee within 2 days of knowledge of fraud.
The auditor should Report the following matters:
(a) Nature of Fraud with description; (b) Approximate amount involved; and (c)
Parties involved.
Company is bound to disclose certain specified details in Board’s Report as (a)
Nature of Fraud with description; (b) Approximate amount involved; (c) Parties
involved, if remedial action not taken; and (d) Remedial actions taken.
B. Reporting of Fraud involving amount of rupees 1 crore or above: The
auditor shall report the matter to the Board or the Audit Committee, as the
case may be, immediately but not later than 2 days of his knowledge of the
fraud, seeking their reply or observations within 45 days;
 In case reply/observations received within stipulated time, the auditor is
required to forward report along with reply/observations and comments
to Central Government within 15 days of receipt of such
reply/observations.
 Incase reply/observations not received within stipulated time
(within45days) the auditor should forward the report along with note
containing details of report for which failed to receive any
reply/observations to Central Government.
TEST YOUR KNOWLEDGE

Correct/Incorrect
State with reasons (in short) whether the following statement is correct or
incorrect:
(i) Teeming and lading is one of the techniques of inflating cash payments.
(ii) Fraud can be termed as intentional error.
(iii) Auditor needs to report to Central Government in case of fraud involving
20 lakhs rupees.
(iv) The primary responsibility for the prevention and detection of fraud rests
with both those charged with governance of the entity and management.

(v) Fraudulent financial reporting only involves manipulation, falsification or

alteration of accounting records or supporting documents from which
financial statements are prepared.
(vi) Unusual delays by the entity in providing requested information shows
problematic or unusual relationships between the auditor and
management.
(vii) In comparing management fraud with employee fraud, the auditor’s risk
of failing to discover the fraud is less for management fraud.
(viii) Excessive interest by management in maintaining or increasing the
entity’s inventory price or earnings trend is an example of Fraud Risk
Factor related to Opportunities.
(ix) Misstatements in the financial statements can arise from fraud only.
(x) Misappropriation of Assets involves the theft of an entity’s assets and is
often perpetrated by employees in relatively large and material amounts.
(xi) An auditor conducting an audit in accordance with SAs is responsible for
obtaining absolute assurance that the financial statements taken as a
whole are free from material misstatement, whether caused by fraud or
error.
Theoretical Questions
1. What do you understand by the term ‘fraud’? Provide its meaning as given
as under the Standard on Auditing (SA) 240.
2. Briefly explain self-revealing errors with the help of some illustration.
3. There are many ways for cash defalcation, one of which is suppressing
cash receipts. List out few techniques of how the receipts are suppressed.
4. Fraud Risk Factors are the events or conditions that indicate an incentive
or pressure to commit fraud or provide an opportunity to commit fraud.
Further, the nature of the industry or the entity’s operations also provides
opportunities to engage in fraudulent financial reporting. List out some
of the cases from where these opportunities may arise.
5. You notice a misstatement resulting from fraud or suspected fraud during
the audit and conclude that it is not possible to continue the performance
of audit. As a statutory Auditor, how would you deal?

6. Explain the scope of a Company Auditor’s enquiry on Fraud matters as

enshrined in the Companies (Auditor’s Report) Order, 2016.
7. During the Statutory Audit of a Public Limited Company , XYZ Ltd. its
auditor, Mr. Bajaj , the engagement partner of Bajaj Chopra & Associates
, encounters some exceptional circumstances that bring into question his
ability to continue performing the audit while suspecting a fraud arising
from material misstatements. Explain the steps to be taken in such a case.
8. Inadequate internal control over assets may increase the susceptibility of
misappropriation of those assets. Enlist some examples of such
circumstances.
9. In an audit of Financial statements of PQR Ltd., CA Vikas Khemka finds
that the Cash receipts have been suppressed. Give examples of such
techniques which may have led him suspect this.
10. Enlist the instances which induce Management/Employees to commit
fraud?
11. Fraudulent financial reporting often involves management override of
controls that otherwise may appear to be operating effectively. Explain
some techniques by which fraud can be committed by management
overriding controls.
ANSWERS/SOLUTIONS
Answers to Correct/Incorrect
(i) Incorrect: Teeming and Lading is one of the techniques of suppressing
cash receipts and not of inflating cash payments. Money received from
one customer is misappropriated and the account is adjusted with the
subsequent receipt from another customer and so on.
(ii) Correct: Fraud is the word used to mean intentional error. This is done
deliberately which implies that there is intent to deceive, to mislead or at
least to conceal the truth. It follows that other things being equal they are
more serious than unintentional errors because of the implication of
dishonestly which accompanies them.
(iii) Incorrect: As per section 143(12) of the Companies Act, 2013, if an auditor
of a company, in the course of the performance of his duties as auditor,

has reason to believe that an offence involving fraud is being or has been
committed against the company by officers or employees of the company,
he shall immediately report the matter to the Central Government (in case
amount of fraud is ` 1 crore or above) or Audit Committee or Board in
other cases (in case the amount of fraud involved is less than 1 crore)
within such time and in such manner as may be prescribed.
Thus, fraud involving amount of 20 lakh rupees should be reported to
Audit Committee.
(iv) Correct: As per SA 240 “The Auditor’s Responsibilities Relating to Fraud
in an Audit of Financial Statements’. 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 detention and punishment. This
involves a commitment to create a culture of honesty and ethical behavior
which can be reinforced by an active oversight by those charged with
governance.
(v) Incorrect: As per SA 240, ”The Auditor’s Responsibilities Relating to fraud
in an Audit of Financial Statements’, fraudulent financial reporting may
involve manipulation, falsification or alteration of accounting records or
supporting documents from which financial statements are prepared,
misrepresentation in or intentional omission from, financial statements of
events, transaction or other significant information or intentional
misapplication of accounting principles relating to amounts, classification,
manner of presentation or disclosure.
(vi) Correct: It is a strong example of circumstances that indicate the
possibility of fraud. This happiness only because of the Management’s
intolerance towards the auditor’s Professional skepticism
(vii) Incorrect: In comparing management fraud with employee fraud, the
auditor’s risk of failing to discover the fraud is greater for management
fraud because of management’s ability to override existing internal
controls
(viii) Incorrect: Excessive interest by management in maintaining or increasing
the entity’s inventory price or earnings trend is an example of Fraud Risk
Factor related to Rationalization.

(ix) Incorrect: Misstatements in the financial statements can arise from either
fraud or error. The distinguishing factor between fraud and error is
whether the underlying action that results in the misstatement of the
financial statements is intentional or unintentional.
(x) Incorrect:- Misappropriation of Assets involves the theft of an entity’s
assets and is often perpetrated by employees in relatively small and
immaterial amounts.
(xi) Incorrect:- An auditor conducting an audit in accordance with SAs is
responsible for obtaining reasonable assurance that the financial
statements taken as a whole are free from material misstatement, whether
caused by fraud or error. As described in SA200, “Overall Objectives of
the Independent Auditor and the Conduct of an Audit in Accordance
with Standards on Auditing,” 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 the SAs.
Answer to Theoretical Questions

1. Meaning of Fraud: The SA 240 ‘The Auditor’s Responsibilities Relating
to Fraud in an Audit of Financial Statements; defines the term fraud as an
intentional act by one or more individuals among management, those
charged with governance, employees, or third parties, involving the use
of deception to obtain an unjust or illegal advantage.
2. Self Revealing Errors: These are such errors the existence of which
becomes apparent in the process of compilation of account. A few
illustrations of such errors are given hereunder, showing how they
become apparent.
(i) Omission to post a part of a Trial balance is thrown out of
journal entry to the ledger. agreement
(ii) Wrong totaling of the Control Account [e.g. the Sundry
Purchase Register Trade payables Account) balances
and the aggregate of the balance in
the personal ledger will disagree.

(iii) A failure to record in the Bank reconciliation statement will

cash book amounts paid show up error.
into or withdrawn from the
bank.
(iv) A mistake in recording Statements of account of parties will
amount received from X in reveal mistake.
the account of Y.
From the above, it is clear that certain apparent errors balance almost
automatically by double entry accounting procedure and by following
established practices that lie within the accounting system but not being
generally considered to be a part of it, like bank reconciliation or sending
monthly statements of account for confirmation.
3. Declaration of Cash by Supporting Cash Receipts: Refer Para 2.2.2.2
4. Fraud Risk Factors-Opportunities. Refer 4.1
5. Impossible to Continue the Performance of Audit: Refer Para 6.
6. The auditor is also required to report under clause (x) of paragraph 3 of
Companies (Auditor’s Report) Order, 2016, whether any fraud by the
company or any fraud on the Company by its officers or employees has
been noticed or reported during the year. If yes, the nature and the
amount involved is to be indicated.
The scope of auditor’s inquiry under this clause is restricted to frauds
‘noticed or reported’ during the year. It may be noted that this clause of
the Order, by requiring the auditor to report whether any fraud by the
company or on the company by its Officer or employees has been noticed
or reported, does not relieve the auditor from his responsibility to
consider fraud and error in an audit of financial statements. In other
words, irrespective of the auditor’s comments under this clause, the
auditor is also required to comply with the requirements of SA 240, “The
Auditor’s Responsibility Relating to Fraud in an Audit of Financial
Statements”.
7. If, as a result of a misstatement resulting from fraud or suspected fraud,
the auditor encounters exceptional circumstances that bring into question
the auditor’s ability to continue performing the audit, the auditor shall:

(a) Determine the professional and legal responsibilities applicable in

the circumstances, including whether there is a requirement for the
auditor to report to the person or persons who made the audit
appointment or, in some cases, to regulatory authorities;
(b) Consider whether it is appropriate to withdraw from the
engagement, where withdrawal is possible under applicable law or
regulation; and
(c) If the auditor withdraws:
(i) Discuss with the appropriate level of management and those
charged with governance the auditor’s withdrawal from the
engagement and the reasons for the withdrawal; and
(ii) Determine whether there is a professional or legal
requirement to report to the person or persons who made the
audit appointment or, in some cases, to regulatory authorities,
the auditor’s withdrawal from the engagement and the
reasons for the withdrawal.
8. Inadequate internal control over assets may increase the susceptibility of
misappropriation of those assets. For example, misappropriation of
assets may occur because there is the following:
• Inadequate segregation of duties or independent checks.
• Inadequate oversight of senior management expenditures, such as
travel and other reimbursements.
• Inadequate record keeping with respect to assets.
• Inadequate system of authorization and approval of transactions
(for example, in purchasing).
• Inadequate physical safeguards over cash, investments, inventory,
or fixed assets.
• Lack of complete and timely reconciliations of assets.
• Lack of timely and appropriate documentation of transactions, for
example, credits for merchandise returns.
• Lack of mandatory vacations for employees performing key control
functions.

• Inadequate management understanding of information technology,

which enables information technology employees to perpetrate a
misappropriation.
• Inadequate access controls over automated records, including
controls over and review of computer systems event logs.
9. (1) Teeming and Lading: 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.
(2) Adjusting unauthorised or fictitious rebates, allowances, discounts,
etc. to customer’ accounts and misappropriating amount paid by
them.
(3) Writing off as debts in respect of such balances against which cash
has already been received but has been misappropriated.
(4) Not accounting for cash sales fully.
(5) Not accounting for miscellaneous receipts, e.g., sale of scrap,
quarters allotted to the employees, etc.
(6) Writing down asset values in entirety, selling them subsequently and
misappropriating the proceeds.
10. Following are such certain instances:-
• Financial obligations/ Pressure.
• Management’s unrealistic goals.
• Dissatisfied Employees or Lack of motivation among employees.
• Name game (e.g management using power of authority by asking
employees to do something illegal).
• Opportunity to commit fraud.

11. Fraud can be committed by management overriding controls using such

techniques as:
• Recording fictitious journal entries, particularly close to the end of
an accounting period, to manipulate operating results or achieve
other objectives.
• Inappropriately adjusting assumptions and changing judgments
used to estimate account balances.
• Omitting, advancing or delaying recognition in the financial
statements of events and transactions that have occurred during the
reporting period.
• Concealing, or not disclosing, facts that could affect the amounts
recorded in the financial statements.
• Engaging in complex transactions that are structured to
misrepresent the financial position or financial performance of the
entity.
• Altering records and terms related to significant and unusual
transactions.

CHAPTER
10
THE COMPANY AUDIT
LEARNING OUTCOMES
After studying this chapter, you will be able to:
❑ Understand qualification and disqualification of an auditor.
❑ Know the procedures of appointment, reappointment, filling up of the
casual vacancies and removal of auditor.
❑ Understand powers and duties of auditor.
❑ Understand the provisions relating to rotational retirement.

Company Audit
• Appointment of Auditor
• Rotation of Auditor
• Audit Committee
• Auditor's Remuneration
• Removal of Auditor
• Ceiling Limit
• Powers & Duties of Auditor
• Audit Report as per Co., Act 2013
• Joint Audit
• Audit of Branch
• Cost Audit
• Punishment for non-compliance
INTRODUCTION
Companies Act, 2013 is rule based Act. Sections 139 to 148 of the Companies
Act, 2013 (hereinafter referred to as the Act unless otherwise mentioned) deal
SECTIONS COVERED IN THIS CHAPTER
139. Appointment of auditors.

140. Removal, resignation of auditor and giving of special notice.
141. Eligibility, qualifications and disqualifications of auditors.
142. Remuneration of auditors.
143. Powers and duties of auditors and auditing standards.
144. Auditor not to render certain services.
145. Auditors to sign audit reports, etc.
146. Auditors to attend general meeting.
147. Punishment for contravention.
148. Central Government to specify audit of items of cost in respect of certain
companies.

with provisions relating to audit of companies. Therefore, it is quite important

to understand these provisions very carefully. You may also study sections 128
to 138 relating to “Accounts” of companies for better understanding of the
subject. The provisions relating to ‘audit’ broadly deal with who can be
appointed as an auditor under the Act, i.e., qualifications and disqualifications,
the manner of appointment and removal of an auditor and rights and duties of
an auditor. A scheme of the provisions of the Act relating to audit is given below
for quick reference:
1. ELIGIBILITY, QUALIFICATIONS AND

DISQUALIFICATIONS OF AN AUDITOR
The provisions relating to eligibility, qualifications and disqualifications of an
auditor are governed by section 141 of the Companies Act, 2013 (hereinafter
referred as the Act). The main provisions are stated below:
(1) A person shall be eligible for appointment as an auditor of a company
only if he is a chartered accountant.
It may be noted that a firm whereof majority of partners practising in India
are qualified for appointment as aforesaid may be appointed by its firm
name to be auditor of a company.
(2) Where a firm including a limited
liability partnership is appointed as
an auditor of a company, only the
partners who are chartered
accountants shall be authorised to
act and sign on behalf of the firm.
(3) Under sub-section (3) of section
141 along with Rule 10 of the
Companies (Audit and Auditors) Fig.: Is the person eligible for
Rules, 2014 (hereinafter referred as appointment as auditor?*
CAAR), the following persons shall not
be eligible for appointment as an
auditor of a company, namely-
(a) a body corporate other than a limited liability partnership registered
under the Limited Liability Partnership Act, 2008;

(b) an officer or employee of the company;

(c) a person who is a partner, or who is in the employment, of an officer
or employee of the company;
(d) a person who, or his relative or partner -
(i) is holding any security of or interest in the company or its
subsidiary, or of its holding or associate company or a
subsidiary of such holding company;
It may be noted that the relative may hold security or interest
in the company of face value not exceeding Rupees 1,00,000.
It may also be noted that the condition of Rupees 1,00,000
shall, wherever relevant, be also applicable in the case of a
company not having share capital or other securities.
Students may also note that in the event of acquiring any
security or interest by a relative, above the threshold
prescribed, the corrective action to maintain the limits as
specified above shall be taken by the auditor within 60 days
of such acquisition or interest.
The following points merit consideration in this regard:
(a) The value of shares of Rupees 1,00,000 that can be held
by relative is the face value not the market value.
(b) The limit of Rupees 1,00,000 would be applicable where
the securities are held by the relative of an auditor and
not where the securities are held by an auditor himself
or his partner. In case of an auditor or his partner,
securities of even small value shall be a disqualification.
(c) Grace period of 60 days for corrective action shall apply
only in respect of securities held by relatives. This would
not apply to auditor or his partner.
[The term “relative”, as defined under the Companies Act,
2013, means anyone who is related to another as members of
a Hindu Undivided Family; husband and wife; Father (including
step- father), Mother (including step-mother), Son (including

step- son), Son’s wife, Daughter, Daughter’s husband, Brother

(including step- brother), Sister (including step-sister).]
Example
Ex 1: Mr. A, a practicing Chartered Accountant, is holding securities

of XYZ Ltd. having face value of ` 900. Whether Mr. A is qualified for
appointment as an auditor of XYZ Ltd.?
As per section 141(3)(d)(i), an auditor is disqualified to be appointed
as an auditor if he, or his relative or partner holding any security of
or interest in the company or its subsidiary, or of its holding or
associate company or a subsidiary of such holding company.
In the present case, Mr. A is holding security of ` 900 in XYZ Ltd.
Therefore, he is not eligible for appointment as an auditor of XYZ Ltd.
Ex 2: Mr. P is a practicing Chartered Accountant and Mr. Q, the
relative of Mr. P, is holding securities of ABC Ltd. having face value of
` 90,000. Whether Mr. P is qualified from being appointed as an
auditor of ABC Ltd.?
As per section 141(3)(d)(i), a person is disqualified to be appointed as
an auditor if he, or his relative or partner is holding any security of or
interest in the company or its subsidiary, or of its holding or associate
company or a subsidiary of such holding company. Further, as per
proviso to this section, the relative of the person may hold the
securities or interest in the company of face value not exceeding of
` 1,00,000.
In the present case, Mr. Q. (relative of Mr. P), is having securities of
` 90,000 face value in ABC Ltd., which is as per requirement of proviso
to section 141(3)(d)(i). Therefore, Mr. P will not be disqualified to be
appointed as an auditor of ABC Ltd.
Ex 3: M/s BC & Co. is an Audit Firm having partners Mr. B and Mr. C,
and Mr. A the relative of Mr. C, is holding securities of MWF Ltd.
having face value of ` 1,01,000. Whether M/s BC & Co. is qualified
from being appointed as an auditor of MWF Ltd.?
As per section 141(3)(d)(i), a person is disqualified to be appointed as
an auditor if he, or his relative or partner is holding any security of or
interest in the company or its subsidiary, or of its holding or associate

company or a subsidiary of such holding company. Further as per

proviso to this section, the relative of the person may hold the
securities or interest in the company of face value not exceeding of
` 1,00,000.
In the instant case, M/s BC & Co, will be disqualified for appointment
as an auditor of MWF Ltd. as the relative of Mr. C (i.e. partner of M/s
BC & Co.) is holding the securities in MWF Ltd. which is exceeding the
limit mentioned in proviso to section 141(3)(d)(i).
Ex 4: M/s RM & Co. is an audit firm having partners CA. R and CA. M.
The firm has been offered the appointment as an auditor of Enn Ltd.
for the Financial Year 2016-17. Mr. Bee, the relative of CA. R, is
holding 5,000 shares (face value of ` 10 each) in Enn Ltd. having
market value of ` 1,50,000. Whether M/s RM & Co. is disqualified to
be appointed as auditors of Enn Ltd.?
As per section 141(3)(d)(i), a person shall not be eligible for
appointment as an auditor of a company, who, or his relative or
partner is holding any security of or interest in the company or its
subsidiary, or of its holding or associate company or a subsidiary of
such holding company. However, as per proviso to this section, the
relative of the person may hold the securities or interest in the
company of face value not exceeding of ` 1,00,000.
In the instant case, M/s RM & Co. is an audit firm having partners CA.
R and CA.
M. Mr. Bee is a relative of CA. R and he is holding shares of Enn Ltd.
of face value of ` 50,000 only (5,000 shares x ` 10 per share).
Therefore, M/s RM & Co. is not disqualified for appointment as an
auditors of Enn Ltd. as the relative of CA. R (i.e. partner of M/s RM &
Co.) is holding the securities in Enn Ltd. which is within the limit
mentioned in proviso to section 141(3)(d)(i) of the Companies Act,
2013.
(ii) is indebted to the company, or its subsidiary, or its holding or
associate company or a subsidiary of such holding company,
in excess of Rupees 5,00,000; or

(iii) has given a guarantee or provided any security in connection

with the indebtedness of any third person to the Company or
its Subsidiary, or its Holding or Associate Company or a
Subsidiary of such Holding Company, in excess of Rupees
1,00,000.
(e) a person or a firm who, whether directly or indirectly has business
relationship with the Company, or its Subsidiary, or its Holding or
Associate Company or Subsidiary of such holding company or
associate company, of such nature as may be prescribed;
Students may note that for the purpose of clause (e) above, the term
“business relationship” shall be construed as any transaction
entered into for a commercial purpose, except –
(i) commercial transactions which are in the nature of
professional services permitted to be rendered by an auditor
or audit firm under the Act and the Chartered Accountants Act,
1949 and the rules or the regulations made under those Acts;
(ii) commercial transactions which are in the ordinary course of
business of the company at arm’s length price - like sale of
products or services to the auditor, as customer, in the
ordinary course of business, by companies engaged in the
business of telecommunications, airlines, hospitals, hotels and
such other similar businesses.
(f) a person whose relative is a Director or is in the employment of the
Company as a director or key Managerial Personnel.
(g) a person who is in full time employment elsewhere or a person or a
partner of a firm holding appointment as its auditor, if such person
or partner is at the date of such appointment or reappointment
holding appointment as auditor of more than twenty companies
other than one person companies, dormant companies, small
companies and private companies having paid-up share capital less
than Rupees 100 crore.
(h) a person who has been convicted by a Court of an offence involving
fraud and a period of ten years has not elapsed from the date of
such conviction.

(i) a person who, directly or indirectly, renders any service referred

to in section 144 to the company or its holding company or its
subsidiary company.
It may be noted that, for the purposes of this clause, the term
"directly or indirectly" shall have the same meaning as assigned
to it in the Explanation to section 144, i.e.
In case of auditor being an individual, either himself or through
his relative or any other person connected or associated with
such individual or through any other entity, whatsoever, in
which such individual has significant influence or control, or
whose name or trade mark or brand is used by such individual,
shall be termed as rendering of services directly or indirectly by
the auditor; and
In case of auditor being a firm, either itself or through any of its
partners or through its parent, subsidiary or associate entity or
through any other entity, whatsoever,
in which the firm or any partner of the firm has significant
influence or control, or whose name or trade mark or brand is
used by the firm or any of its partners, shall be termed as
rendering of services directly or indirectly by the auditor.
Section 144 of the Companies Act, 2013 prescribes certain services not
to be rendered by the auditor. An auditor appointed under this Act shall
provide to the company only such other services as are approved by the
Board of Directors or the audit committee, as the case may be, but which
shall not include any of the following services
(whether such services are rendered directly or
indirectly to the company or its holding company or
subsidiary company), namely:
*
Fig.: Auditor restrained from entering into certain services
(i) accounting and book keeping services;

(ii) internal audit;
(iii) design and implementation of any financial information system;
(iv) actuarial services*;

(v) investment advisory services;

(vi) investment banking services;
(vii) rendering of outsourced financial services;
(viii) management services; and
(ix) any other kind of services as may be prescribed.
*Actuarial services broadly pertain to services relating to evaluation of
financial impact of risks using range of mathematical and statistical
methods
It may be noted that an auditor or audit firm who or which has been
performing any non- audit services on or before the commencement of
this Act shall comply with the provisions of this section before the closure
of the first financial year after the date of such commencement.
Example
CA. Poshin is providing the services of investment banking to C Ltd. Later
on, he was also offered to be appointed as an auditor of the company for
the current financial year. Advise.
Section 141(3)(i) of the Companies Act, 2013 disqualifies a person for
appointment as an auditor of a company who, directly or indirectly, renders
any service referred to in section 144 to the company or its holding
company or its subsidiary company. Section 144 of the Companies Act, 2013
prescribes certain services not to be rendered by the auditor which includes
investment banking services.
Therefore, CA. Poshin is advised not to accept the assignment of auditing as
the investment banking service is specifically notified in the list of services
not to be rendered by him as per section 141(3)(i) read with section 144 of
the Companies Act, 2013.
(4) Where a person appointed as an auditor of a company incurs any of the
disqualifications mentioned in sub-section (3) after his appointment, he
shall vacate his office as such auditor and such vacation shall be deemed
to be a casual vacancy in the office of the auditor.

CASE STUDY
Facts of the Case: Mr. A, a chartered accountant, has been appointed as an auditor
of Laxman Ltd. in the Annual General Meeting of the company held in September,
2016, which assignment he accepted. Subsequently in January, 2017 he joined Mr. B,
another chartered accountant, who is the Manager Finance of Laxman Ltd., as partner.
Provisions and Explanation: Section 141(3)(c) of the Companies Act, 2013
prescribes that any person who is a partner or in employment of an officer or
employee of the company will be disqualified to act as an auditor of a company.
Sub-section (4) of Section 141 provides that an auditor who becomes subject, after
his appointment, to any of the disqualifications specified in sub-sections (3) of
Section 141, he shall be deemed to have vacated his office as an auditor.
Conclusion: In the present case, Mr. A, an auditor of Laxman Ltd., joined as partner
with Mr. B, who is Manager Finance of Laxman Limited. The given situation has
attracted sub- section (3)(c) of Section 141 and, therefore, he shall be deemed to have
vacated office of the auditor of Laxman Limited in accordance with sub-section (4) of
section 141.
2. APPOINTMENT OF AUDITOR
Section 139 of the Companies Act, 2013 contains provisions regarding
Appointment of Auditors. Discussion on appointment of auditors may be
grouped under two broad headings-
(I) Appointment of First Auditors.
(II) Appointment of Subsequent Auditors.
Fig: Meeting for appointment of Auditor*
*
Source of image : http://newhavenscience.org

Appointment of
Auditor [Section 139]
Subsequent
First Auditor
Auditor
Other than Government Other than Government

Government Company Government Company
Company defined u/s Company defined u/s
[Section 2(45) [Section [Section 2(45) [Section
139(6)] 139(7) 139(1)] 139(5)
Appointment
by BOD Appointment by Appointment Appointment by
C&AG within 60 by Members in C & AG within
days from the AGM 180 days from
within 30 days DOR
from DOR
the
commencement
of year
in case of failure
in case of BOD within 30 Hold the
failure: days office from 1st
Members in AGM to 6th
EGM within 90 AGM subject Hold the
days in case of failure office till the
to fulfillment
Members in conclusion of
of certain
EGM with in 60 the AGM
days conditions
Hold the office
till the
conclusion of
the first AGMS
Hold the office
till the
conclusion of
the first AGM

2.1 Appointment of First Auditor

2.1.1 Appointment of First Auditors in the case of a company, other
than a Government Company
As per Section 139(6), the first auditor of a company, other than a Government
company, shall be appointed by the Board of Directors within 30 days from the
date of registration of the company.
In the case of failure of the Board to appoint the auditor, it shall inform the
members of the company.
The members of the company shall within 90 days at an extraordinary general
meeting appoint the auditor. Appointed auditor shall hold office till the
conclusion of the first annual general meeting.
CASE STUDY
Facts of the Case: Managing Director of Pigeon Ltd. himself wants to appoint
CA. Champ, a practicing Chartered Accountant, as first auditor of the company.
Provisions and Explanation: Section 139(6) of the Companies Act, 2013 lays
down that the first auditor of a company shall be appointed by the Board of
Directors within 30 days from the date of registration of the company. In the
instant case, the proposed appointment of CA. Champ, a practicing Chartered
Accountant, as first auditor by the Managing Director of Pigeon Ltd. by himself is
in violation of Section 139(6) of the Companies Act, 2013, which authorizes the
Board of Directors to appoint the first auditor of the company.
Conclusion: In view of the above, the Managing Director of Pigeon Ltd. should
be advised not to appoint the first auditor of the company.
2.1.2 Appointment of First Auditors in the case of Government

Company:
A “Government company” is a company in which not less than 51% of the paid-up
share capital is held by the Central Government or by any State Government or
Governments or partly by the Central Government and partly by one or more State
Governments, and includes a company which is a subsidiary company of such a
Government company.
Section 139(7) provides that in the case of a Government company or any
other company owned or controlled, directly or indirectly, by the Central

Government, or by any State Government, or Governments, or partly by the

Central Government and partly by one or more State Governments, the first
auditor shall be appointed by the Comptroller and Auditor-General of India
within 60 days from the date of registration of the company.
In case the Comptroller and Auditor-General of India does not appoint such
auditor within the above said period, the Board of Directors of the company
shall appoint such auditor within the next 30 days. Further, in the case of failure
of the Board to appoint such auditor within next 30 days, it shall inform the
members of the company who shall appoint such auditor within 60 days at an
extraordinary general meeting. Auditors shall hold office till the conclusion of
the first annual general meeting.
CASE STUDY
Facts of the Case: The first auditor of Bhartiya Petrol Ltd., a Government
company, was appointed by the Board of Directors.
Provisions and Explanation: In the case of a Government Company, the
appointment of first auditor is governed by the provisions of Section 139(7) of the
Companies Act, 2013 which states that in the case of a Government company, the
first auditor shall be appointed by the Comptroller and Auditor-General of India
within 60 days from the date of registration of the company. Hence, in the case of
Bhartiya Petrol Ltd., being a government company, the first auditor shall be
appointed by the Comptroller and Auditor General of India.
Conclusion: Thus, the appointment of first auditor made by the Board of
Directors of Bhartiya Petrol Ltd., is null and void.
2.2 Appointment of Subsequent

Auditor/Reappointment of Auditor
2.2.1 Appointment of Subsequent Auditors in case of Non Government
Companies:
Section 139(1) of the Companies Act, 2013 provides that every company shall,
at the first annual general meeting appoint an individual or a firm as an auditor
who shall hold office from the conclusion of that meeting till the conclusion of
its sixth annual general meeting and thereafter till the conclusion of every sixth
meeting.

The following points need to be noted in this regard-

(i) Before such appointment is made, the written consent of the auditor to
such appointment, and a certificate from him or it that the appointment,
if made, shall be in accordance with the conditions as may be prescribed,
shall be obtained from the auditor.
(ii) Under Rule 4 of The Companies (Audit and Auditors) Rules, 2014, the said
certificate shall state the following:-
(a) the individual or the firm, as the case may be, is eligible for
appointment and is not disqualified for appointment under the Act,
the Chartered Accountants Act, 1949 and the rules or regulations
made thereunder;
(b) the proposed appointment is as per the term provided under the
Act;
(c) the proposed appointment is within the limits laid down by or under
the authority of the Act;
(d) the list of proceedings against the auditor or audit firm or any
partner of the audit firm pending with respect to professional
matters of conduct, as disclosed in the certificate, is true and correct.
(iii) The company shall inform the auditor concerned of his or its appointment,
and also file a notice of such appointment with the Registrar within 15
days of the meeting in which the auditor is appointed.
2.2.2 Appointment of Subsequent Auditors in case of Government
Companies:
As per section 139(5), in the case of a Government company or any other
company owned or controlled, directly or indirectly, by the Central Government,
or by any State Government or Governments, or partly by the Central
Government and partly by one or more State Governments, the Comptroller
and Auditor-General of India shall, in respect of a financial year, appoint an
auditor duly qualified to be appointed as an auditor of companies under this
Act, within a period of 180 days from the commencement of the financial year,
who shall hold office till the conclusion of the annual general meeting.
Therefore, it is to be clearly understood that in case of government companies
or companies controlled by government, auditor is appointed by Comptroller

and Auditor general of India in the manner provided in Section 139(5) and
139(7). It is to be remembered that Comptroller and auditor general of India is
independent constitutional authority which audits all receipts and expenditure
of Government of India and state governments including those of bodies,
corporations financed by government.
2.3 Filling of a Casual Vacancy

As per Section 139(8), any casual vacancy in the office of an auditor shall-
(i) In the case of a company other than a company whose accounts are
subject to audit by an auditor appointed by the Comptroller and
Auditor-General of India, be filled by the Board of Directors within 30
days.
If such casual vacancy is as a result of the resignation of an auditor, such
appointment shall also be approved by the company at a general meeting
convened within three months of the recommendation of the Board and
he shall hold the office till the conclusion of the next annual general
meeting.
(ii) In the case of a company whose accounts are subject to audit by an
auditor appointed by the Comptroller and Auditor-General of India,
be filled by the Comptroller and Auditor-General of India within 30 days.
It may be noted that in case the Comptroller and Auditor-General of India does
not fill the vacancy within the said period the Board of Directors shall fill the
vacancy within next 30 days.

2.3.1 Casual Vacancy by Resignation:

As per section 140(2) of the Act, the auditor who has resigned from the
company shall file within a period of 30 days from the date of resignation, a
statement in the prescribed Form ADT–3 (as per Rule 8 of CAAR) with the
company and the Registrar.
In case of the companies referred to in section 139(5) i.e. Government company,
the auditor shall also file such statement with the CAG along with the company
and the Registrar.
The auditor shall indicate the reasons and other facts as may be relevant with
regard to his resignation.
In case of failure, the auditor shall be liable to a penalty of fifty thousand rupees or
the remuneration of the auditor, whichever is less, and in case of continuing failure,
with further penalty of five hundred rupees for each day after the first during which
such failure continues, subject to a maximum of five lakh rupees as per section
140(3).
CASE STUDY
Facts of the Case: CA. Donald was appointed as the auditor of PS Ltd. at
the remuneration of ` 30,000. However, after 4 months of continuing his
services, he could not continue to hold his office of the auditor as his wife
got a government job at a distant place and he needs to shift along with
her to the new place. Thus, he resigned from the company and did not
perform his responsibilities relating to filing of statement to the company
and the registrar indicating the reasons and other facts as may be relevant
with regard to his resignation.
How much fine may he be punishable with under section 140(3) for non-
compliance of section 140(2) of the Companies Act, 2013?
Provisions and Explanation: For non-compliance of sub-section (2) of
section 140 of the Companies Act, 2013, the auditor shall be punishable
with fine, which shall not be less than fifty thousand rupees or the
remuneration of the auditor, whichever is less but which may extend to five
lakh rupees, under section 140(3) of the said Act.
Conclusion: Thus, the fine under section 140(3) of the Companies Act, 2013
shall not be less than ` 30,000 but which may extend to ` 5,00,000 .

Other Important Provisions Regarding Appointment of Auditors

(1) A retiring auditor may be re-appointed at an annual general meeting, if-
(a) he is not disqualified for re-appointment;
(b) he has not given the company a notice in writing of his unwillingness to
be re - appointed; and
(c) a special resolution has not been passed at that meeting appointing
some other auditor or providing expressly that he shall not be re-
appointed.
(2) Where at any annual general meeting, no auditor is appointed or re-
appointed, the existing auditor shall continue to be the auditor of the
company.
3 ROTATION OF AUDITOR
3.1 Applicability of Section 139(2) Rotation of Auditor:
As per rules prescribed in Companies (Audit and
Auditors) Rules, 2014, for applicability of section 139(2)
the class of companies shall mean the following
classes of companies excluding one person companies
and small companies-
Fig: Rotation of Auditors*
*
Source of image: the hindu business line.com

Class of Companies for Rotation of Auditor

↓
including Listed Companies
+
excluding OPC (One Person Company) and Small Companies
All companies having

paid up share capital of
below threshold limit
All unlisted public All private limited
companies having paid companies having paid up mentioned,
up share capital share capital but
≥` 10 crore ≥ ` 50 crore
having public borrowings
from financial
institutions, banks or
public deposits
≥ ` 50 crore
(i) all unlisted public companies having paid up share capital of rupees ten
crore or more;
(ii) all private limited companies having paid up share capital of rupees fifty
crore or more;
(iii) all companies having paid up share capital of below threshold limit
mentioned above, but having public borrowings from financial
institutions, banks or public deposits of rupees fifty crores or more.
Example
Rano Pvt. Ltd. is a private limited Company, having paid up share capital of ` 42
crore but having public borrowing from nationalized banks and financial
institutions of ` 72 crore, manner of rotation of auditor will be applicable.
As per section 139(2), no listed company or a company belonging to such class
or classes of companies as mentioned above, shall appoint or re-appoint-
(a) an individual as auditor for more than one term of five consecutive years;
and
(b) an audit firm as auditor for more than two terms of five consecutive years.
Provided that -

(i) an individual auditor who has completed his term under clause (a)
shall not be eligible for re-appointment as auditor in the same
company for five years from the completion of his term;
(ii) an audit firm which has completed its term under clause (b), shall
not be eligible for re-appointment as auditor in the same company
for five years from the completion of such term.
Therefore, provisions of Section 139(2) relating to rotation of
auditors are applicable only to listed companies and class of
companies satisfying conditions stated in para 3.1 above.
Example
Jolly Ltd., a listed company, appointed M/s Polly & Co., a Chartered Accountant
firm, as the statutory auditor in its AGM held at the end of September, 2016 for
11 years. Here, the appointment of M/s Polly & Co. is not valid as the
appointment can be made only for one term of five consecutive years and then
another one more term of five consecutive years. It can’t be appointed for two
terms in one AGM only. Further, a cooling period of five years from the
completion of term is required i.e. the firm can’t be re-appointed for further 5
years after completion of two terms of five consecutive years.
The following points merit consideration in this regard-

(1) As on the date of appointment, no audit firm having a common partner
or partners to the other audit firm, whose tenure has expired in a company
immediately preceding the financial year, shall be appointed as auditor of
the same company for a period of five years.
Example
M/s XYZ & Co., is an audit firm having partner Mrs. X, Mr. Y and Mr. Z,
whose tenure has expired in the company immediately preceding the
financial year. M/s ABZ & Co., another audit firm in which Mr. Z is a
common partner, will also be disqualified for the same company along
with M/S XYZ & Co. for the period of five years.
(2) Every company, existing on or before the commencement of this Act

which is required to comply with provisions of this sub-section, shall
comply with the requirements of this sub- section within a period which
shall not be later than the date of the first annual general meeting of the

company held, within the period specified under sub-section (1) of section
96, after three years from the date of commencement of this Act.
Examples
Ex 1: Mr. Raj, a Chartered Accountant, is an individual auditor of Binaca

Limited for last 5 years as on March, 2013 (i.e. existing on or before the date
of Commencement of Companies Act, 2013). Keeping in view the transition
period as stated in the Companies Act, 2013, Mr. Raj can continue the audit
of Binaca Ltd. upto the first annual general meeting to be held after three
years from the date of commencement of the Act.
Ex 2: M/s Raj & Associates, a Chartered Accountants Audit Firm, is doing
audit of Binaca Limited for last 11 years as on March, 2013 (i.e. existing on
or before the date of Commencement of Companies Act, 2013). Keeping in
view the transition period as stated in the Companies Act, 2013, M/s Raj
Associates can continue the audit of Binaca Ltd. upto the first annual general
meeting to be held after three years from the date of commencement of the
Act.
Students may interlink the above example with Illustrative table

explaining rotation in case of individual auditor as well as audit firm
which has been given after the 3.2 i.e. Manner of rotation of Auditors
by the Companies on Expiry of their Term.*
(3) It has also been provided that right of the company to remove an auditor
or the right of the auditor to resign from such office of the company shall
not be prejudiced.
(4) Subject to the provisions of this Act, members of a company may resolve
to provide that -
(a) in the audit firm appointed by it, the auditing partner and his team
shall be rotated at such intervals as may be resolved by members;
or
(b) the audit shall be conducted by more than one auditor.
(5) The Central Government may, by rules, prescribe the manner in which the
companies shall rotate their auditors.

3.2 Manner of Rotation of Auditors by the Companies

on Expiry of their Term:
Rule 6 of the Companies (Audit and Auditors) Rules, 2014 prescribes the manner
of rotation of auditors on expiry of their term which is given below-
(1) The Audit Committee shall recommend to the Board, the name of an
individual auditor or of an audit firm who may replace the incumbent
auditor on expiry of the term of such incumbent.
(2) Where a company is required to constitute an Audit Committee, the Board
shall consider the recommendation of such committee, and in other
cases, the Board shall itself consider the matter of rotation of auditors and
make its recommendation for appointment of the next auditor by the
members in annual general meeting.
(3) For the purpose of the rotation of auditors-
(i) in case of an auditor (whether an individual or audit firm), the period
for which the individual or the firm has held office as auditor prior
to the commencement of the Act shall be taken into account for
calculating the period of five consecutive years or ten consecutive
years, as the case may be;
(ii) the incoming auditor or audit firm shall not be eligible if such
auditor or audit firm is associated with the outgoing auditor or audit
firm under the same network of audit firms.
Explanation I - For the purposes of these rules the term “same
network” includes the firms operating or functioning, hitherto or in
future, under the same brand name, trade name or common control.
Explanation II - For the purpose of rotation of auditors,
(a) a break in the term for a continuous period of five years shall
be considered as fulfilling the requirement of rotation;
(b) if a partner, who is in charge of an audit firm and also certifies
the financial statements of the company, retires from the said
firm and joins another firm of chartered accountants, such
other firm shall also be ineligible to be appointed for a period
of five years.

*Illustration explaining rotation in case of individual auditor
Number of consecutive Maximum number of Aggregate period

years for which an consecutive years for which the auditor
individual auditor has which he may be would complete in
been functioning as appointed in the the same company in
auditor in the same same company view of column I and
company [in the first AGM (including II
held after the transitional period)
commencement of
provisions of section
139(2)]
I II III
5 Years (or more than 5 3 years 8 years or more

years)
4 years 3 years 7 years
1 year 4 years 5 years
Note:
(1) Individual auditor shall include other individuals or firms whose
name or trade mark or brand is used by such individual, if any.
(2) Consecutive years shall mean all the preceding financial years for
which the individual auditor has been the auditor until there has
been a break by five years or more.
*Illustration explaining rotation in case of audit firm
Number of consecutive years Maximum number Aggregate period

for which an audit firm has of consecutive years which the firm
been functioning as auditor for which the firm would complete
in the same company [in the may be appointed in in the same

first AGM held after the the same company company in view
commencement of (including of column I and II
provisions of section 139(2)] transitional period)
I II III
10 Years (or more than 3 years 13 years or more
10years)
Note:
(i) Audit Firm shall include other firms whose name or trade mark or
brand is used by the firm or any of its partners.
(ii) Consecutive years shall mean all the preceding financial years for
which the firm has been the auditor until there has been a break by
five years or more.
(4) Where a company has appointed two or more individuals or firms or a
combination thereof as joint auditors, the company may follow the
rotation of auditors in such a manner that both or all of the joint auditors,
as the case may be, do not complete their term in the same year.
As you would have noticed, the provisions relating to
disqualifications and rotation of auditors are meant to ensure that
audit function remains unbiased. These legal provisions also provide
enough safeguards so that auditors can form their opinion in an
independent and highly professional manner without any bias.

4 PROVISIONS RELATING TO AUDIT

COMMITTEE
4.1 Applicability of section 177 i.e. Constitution of Audit
Committee:
Where a company is required to constitute an Audit Committee under section
177, all appointments, including the filling of a casual vacancy of an auditor
under this section shall be made after taking into account the recommendations
of such committee.
all public
companies with a
paid up capital  `
10 crore
Class of
Companies to
constitute Audit
Committee
[including Listed
Public
Companies]
all public companies,
having in aggregate, all public
outstanding loans or companies having
borrowings or turnover  ` 100
debentures or crore
deposits >` 50 crore
Diagram showing class of companies to constitute Audit Committee
As per provisions of Section 177 of Companies Act, audit committee performs

important functions including making recommendation for appointment,
remuneration and terms of appointment of auditor of the company, reviewing
and monitoring auditor’s independence and performance & effectiveness of audit
process, examination of financial statements and auditor’s report thereon.
It is to be remembered that audit committee consists of directors of the company.

It consists of minimum 3 directors with independent directors forming majority.

Besides, audit committee also performs other important functions. Audit
committee helps in ensuring better standards of corporate governance.
It is important to know that in addition to listed public companies, following

classes of companies shall constitute an Audit Committee -
(i) all public companies with a paid up capital of ten crore rupees or more;
(ii) all public companies having turnover of one hundred crore rupees or
more;
(iii) all public companies, having in aggregate, outstanding loans or
borrowings or debentures or deposits exceeding fifty crore rupees or
more.
Explanation: The paid up share capital or turnover or outstanding loans, or
borrowings or debentures or deposits, as the case may be, as existing on the
date of last audited Financial Statements shall be taken into account for the
purposes of this rule.
Therefore, provisions of constitution of audit committee are applicable
only to listed companies and public companies satisfying criteria as stated
above.
Example
XYZ Ltd., a public company having paid up capital of ` 9 crore but having turnover
of ` 150 crore, will be required to constitute an Audit Committee under section
177 because the requirement for constitution of Audit Committee arises if the
company falls into any of the prescribed category.
4.2 Manner and procedure of selection and appointment

of auditors
Rule 3 of CAAR, 2014 prescribes the following manner and procedure of
selection and appointment of auditors-
(1) In case of a company that is required to constitute an Audit Committee
under section 177, the committee, and, in cases where such a committee
is not required to be constituted, the Board, shall take into consideration
the qualifications and experience of the individual or the firm proposed
to be considered for appointment as auditor and whether such

qualifications and experience are commensurate with the size and

requirements of the company.
It may be noted that while considering the appointment, the Audit
Committee or the Board, as the case may be, shall have regard to any
order or pending proceeding relating to professional matters of conduct
against the proposed auditor before the Institute of Chartered
Accountants of India or any competent authority or any Court.
(2) The Audit Committee or the Board, as the case may be, may call for such
other information from the proposed auditor as it may deem fit.
(3) Subject to the provisions of sub-rule (1), where a company is required to
constitute the Audit Committee, the committee shall recommend the
name of an individual or a firm as auditor to the Board for consideration
and in other cases, the Board shall consider and recommend an individual
or a firm as auditor to the members in the annual general meeting for
appointment.
(4) If the Board agrees with the recommendation of the Audit Committee, it
shall further recommend the appointment of an individual or a firm as
auditor to the members in the annual general meeting.
(5) If the Board disagrees with the recommendation of the Audit Committee,
it shall refer back the recommendation to the committee for
reconsideration citing reasons for such disagreement.
(6) If the Audit Committee, after considering the reasons given by the Board,
decides not to reconsider its original recommendation, the Board shall
record reasons for its disagreement with the committee and send its own
recommendation for consideration of the members in the annual general
meeting; and if the Board agrees with the recommendations of the Audit
Committee, it shall place the matter for consideration by members in the
annual general meeting.
(7) The auditor appointed in the annual general meeting shall hold office
from the conclusion of that meeting till the conclusion of the sixth annual
general meeting, with the meeting wherein such appointment has been
made being counted as the first meeting.
5 AUDITOR’S REMUNERATION
As per section 142 of the Act, the remuneration of the auditor of a company

shall be fixed in its general meeting or in such manner as may be determined

therein. However, board may fix remuneration of the first auditor appointed by
it.
Further, the remuneration, in addition to the fee payable to an auditor, include
the expenses, if any, incurred by the auditor in connection with the audit of the
company and any facility extended to him but does not include any
remuneration paid to him for any other service rendered by him at the request
of the company. Therefore, it has been clarified that the remuneration to
Auditor shall also include any facility provided to him.
6 REMOVAL OF AUDITORS
6.1 Removal of Auditor Before Expiry of Term
According to Section 140(1), the auditor appointed
under section 139 may be removed from his office
before the expiry of his term only by a special
resolution of the company, after obtaining the
previous approval of the Central Government in
that behalf as per Rule 7 of CAAR, 2014-
Fig: Auditor leaving office of the auditor*
(1) The application to the Central Government for removal of auditor shall be
made in Form ADT-2 and shall be accompanied with fees as provided for
this purpose under the Companies (Registration Offices and Fees) Rules,
2014.
(2) The application shall be made to the Central Government within 30 days
of the resolution passed by the Board.
(3) The company shall hold the general meeting within 60 days of receipt of
approval of the Central Government for passing the special resolution.
It is important to note that before taking any action for removal before expiry
of terms, the auditor concerned shall be given a reasonable opportunity of
being heard.
Direction by Tribunal in case Auditor acted in a Fraudulent Manner:

As per sub-section (5) of the section 140, the Tribunal either suo motu or on an
application made to it by the Central Government or by any person concerned, if it

is satisfied that the auditor of a company has, whether directly or indirectly, acted in
a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the
company or its directors or officers, it may, by order, direct the company to change
its auditors.
However, if the application is made by the Central Government and the Tribunal
is satisfied that any change of the auditor is required, it shall within fifteen days
of receipt of such application, make an order that he shall not function as an
auditor and the Central Government may appoint another auditor in his place.
It may be noted that an auditor, whether individual or firm, against whom final
order has been passed by the Tribunal under this section shall not be eligible
to be appointed as an auditor of any company for a period of five years from
the date of passing of the order and the auditor shall also be liable for action
under
section 447.
It is hereby clarified that in the case of a firm, the liability shall be of the firm
and that of every partner or partners who acted in a fraudulent manner or
abetted or colluded in any fraud by, or in relation to, the company or its director
or officers.
As you would notice, the provisions of removal of auditor before expiry of
his term are also meant to safeguard auditor’s independence by imposing
strict conditions like prior approval of Central government.
6.2 Appointment of Auditor Other Than Retiring

Auditor
Section 140(4) lays down procedure to appoint an auditor other than retiring
auditor who was removed-
(1) Special notice shall be required for a resolution at an annual general
meeting appointing as auditor a person other than a retiring auditor, or
providing expressly that a retiring auditor shall not be re-appointed,
except where the retiring auditor has completed a consecutive tenure of
five years or as the case may be, ten years, as provided under sub-section
(2) of section 139.
(2) On receipt of notice of such a resolution, the company shall forthwith send
a copy thereof to the retiring auditor.

(3) Where notice is given of such a resolution and the retiring auditor makes
with respect thereto representation in writing to the company (not
exceeding a reasonable length) and requests its notification to members
of the company, the company shall, unless the representation is received
by it too late for it to do so,-
(a) in any notice of the resolution given to members of the company,
state the fact of the representation having been made; and
(b) send a copy of the representation to every member of the company
to whom notice of the meeting is sent, whether before or after the
receipt of the representation by the company. and if a copy of the
representation is not sent as aforesaid because it was received too
late or because of the company's default, the auditor may (without
prejudice to his right to be heard orally) require that the
representation shall be read out at the meeting.
Students may note that if a copy of representation is not sent as aforesaid, a
copy thereof shall be field with the Registrar.
Curtailing right of the auditor regarding circulation of copy of
representation in the case of appointment of auditor other than retiring
auditor under section 140(4) of the companies act, 2013:
If the Tribunal is satisfied on an application either of the company or of any
other aggrieved person that the rights conferred by section 140(4) of the
Companies Act, 2013 are being abused by the auditor, then, the copy of the
representation may not be sent and the representation need not be read out at
the meeting.
7. CEILING ON NUMBER OF AUDITS

It has been mentioned earlier that before appointment is given to any auditor,
the company must obtain a certificate from him to the effect that the
appointment, if made, will not result in an excess holding of company audit by
the auditor concerned over the limit laid down in section 141(3)(g) of the
Companies Act, 2013 which prescribes that a person who is in full time
employment elsewhere or a person or a partner of a firm holding appointment
as its auditor, if such person or partner is at the date of such appointment or
reappointment holding appointment as auditor of more than twenty
companies other than one person companies, dormant companies, small

companies and private companies having paid-up share capital less than ` 100
crore, shall not be eligible for appointment as an Auditor of a Company.
In the case of a firm of auditors, it has been further provided that ‘specified
number of companies’ shall be construed as the number of companies specified
for every partner of the firm who is not in full time employment elsewhere.
This limit of 20 company audits is per person. In the case of an audit firm having
3 partners, the overall ceiling will be 3 × 20 = 60 company audits. Sometimes,
a chartered accountant is a partner in a number of auditing firms. In such a case,
all the firms in which he is partner or proprietor will be together entitled to 20
company audits on his account. Subject to the overall ceiling of company audits,
how they allocate the 20 audits between themselves is their affairs.
CASE STUDY
“ABC & Co.” is an Audit Firm having partners “Mr. A”, “Mr. B” and “Mr. C”,
Chartered Accountants. “Mr. A”, “Mr. B” and “Mr. C” are holding appointment as
an Auditor in 4, 6 and 10 Companies respectively.
(i) Provide the maximum number of Audits remaining in the name of “ABC &
Co.”
(ii) Provide the maximum number of Audits remaining in the name of
individual partner i.e. Mr. A, Mr. B and Mr. C.
(iii) Can ABC & Co. accept the appointment as an auditor in 60 private
companies having paid- up share capital less than ` 100 crore, 2 small
companies and 1 dormant company?
(iv) Would your answer be different, if out of those 60 private companies, 45
companies are having paid-up share capital of ` 110 crore each?
Fact of the Case: In the instant case, Mr. A is holding appointment in 4
companies, whereas Mr. B is having appointment in 6 Companies and Mr. C is
having appointment in 10 Companies. In aggregate all three partners are having
20 audits.
Provisions and Explanations: Section 141(3)(g) of the Companies Act, 2013 states
that the following persons shall not be eligible for appointment as an auditor of a
company i.e. a person who is in full time employment elsewhere; or a person, or a
partner of a firm holding appointment as its auditor, if such person, or partner is at
the date of such appointment, or reappointment holding appointment as auditor of

more than twenty companies other than one person companies, dormant companies,
small companies and private companies having paid-up share capital less than
` 100 crore.
As per section 141(3)(g), this limit of 20 company audits is per person. In the case
of an audit firm having 3 partners, the overall ceiling will be 3 × 20 = 60 company
audits. Sometimes, a chartered accountant is a partner in a number of auditing
firms. In such a case, all the firms in which he is partner or proprietor will be
together entitled to 20 company audits on his account.
Conclusion:
(i) Therefore, ABC & Co. can hold appointment as an auditor of 40 more
companies:
Total Number of Audits available to the Firm Number = 20*3= 60
of Audits already taken by all the partners
In their individual capacity = 4+6+10= 20
Remaining number of Audits available to the Firm = 40
(ii) With reference to above provisions an auditor can hold more appointment
as auditor = ceiling limit as per section 141(3)(g)- already holding
appointments as an auditor. Hence (1)Mr. A can hold: 20 - 4 = 16 more
audits. (2) Mr. B can hold 20-6 = 14 more audits and (3) Mr. C can hold
20-10 = 10 more audits.
(iii) In view of above discussed provisions, ABC & Co. can hold appointment as
an auditor in all the 60 private companies having paid-up share capital less
than ` 100 crore, 2 small companies and 1 dormant company as these are
excluded from the ceiling limit of company audits given under section
141(3)(g) of the Companies Act, 2013.
(iv) As per fact of the case, ABC & Co. is already having 20 company audits and
they can also accept 40 more company audits. In addition they can also
conduct the audit of one person companies, small companies, dormant
companies and private companies having paid up share capital less than
` 100 crores. In the given case, out of the 60 private companies, ABC & Co.
is offered 45 companies having paid-up share capital of ` 110 crore each.
Therefore, ABC & Co. can also accept the appointment as an auditor for 2
small companies, 1 dormant company, 15 private companies having paid-
up share capital less than ` 100 crore and 40 private companies having

paid-up share capital of ` 110 crore each in addition to above 20 company

audits already holding.
Council General Guidelines, 2008 (Chapter VIII): In exercise of the powers
conferred by clause (ii) of Part II of the Second Schedule to the Chartered
Accountants Act, 1949, the Council of the Institute of Chartered Accountants of
India hereby specifies that a member of the Institute in practice shall be deemed
to be guilty of professional misconduct, if he holds at any time appointment of
more than the “specified number of audit assignments of the companies under
Section 224 and /or Section 226 of the Companies Act, 1956 (now section
141(3)(g) of the Companies Act, 2013).
It may be noted that in the case of a firm of chartered accountants in practice,
the specified number of audit assignments shall be construed as the specified
number of audit assignments for every partner of the firm.
It may also be noted that where any partner of the firm of chartered accountants
in practice is also a partner of any other firm or firms of chartered accountants
in practice, the number of audit assignments which may be taken for all the
firms together in relation to such partner shall not exceed the specified number
of audit assignments in the aggregate.
It is further provided that where any partner of a firm or firms of chartered
accountants in practice accepts one or more audit assignments in his individual
capacity, or in the name of his proprietary firm, the total number of such
assignment which may be accepted by all firms in relation to such chartered
accountant and by him shall not exceed the specified number of audit
assignments in the aggregate.
(1) In computing the specified number of audit assignments-
(a) the number of such assignments, which he or any partner of his firm
has accepted whether singly or in combination with any other
chartered accountant in practice or firm of such chartered
accountants, shall be taken into account.
(b) the number of partners of a firm on the date of acceptance of audit
assignment shall be taken into account.
(c) a chartered accountant in full time employment elsewhere shall not
be taken into account.

(2) A chartered accountant in practice as well as firm of chartered accountants

in practice shall maintain a record of the audit assignments accepted by
him or by the firm of chartered accountants, or by any of the partner of
the firm in his individual name or as a partner of any other firm as far as
possible, in the prescribed manner.
Ceiling on Tax Audit Assignments: The specified number of tax audit

assignments that an auditor, as an individual or as a partner of a firm, can
accept is 60 numbers. ICAI has notified that a chartered accountant in practice
shall be deemed to be guilty of professional misconduct, if he accepts in a
financial year, more than the specified number of tax audit assignments u/s
44AB.
8. POWERS/RIGHTS OF AUDITORS
The auditor has the following powers/rights while conducting an audit:
(a) Right of access to books, etc. – Section 143(1) of the Act provides that
the auditor of a company, at all times, shall have a right of access to the books
of account and vouchers of the company, whether kept at the registered office
of the company or at any other place and he is entitled to require from the
officers of the company such information and explanation as he may consider
necessary for the performance of his duties as auditor.
It may be noted that according to section 2(59) of the Act, the term ‘officer’
includes any director, manager or key managerial personnel or any person in
accordance with whose directions or instructions the Board of Directors or any
one or more of the directors is or are accustomed to act;
The phrase ‘books, accounts and vouchers’ includes all books which have any
bearing, or are likely to have any bearing on the accounts, whether these be the
usual financial books or the statutory or statistical books; memoranda books,
e.g., inventory books, costing records and the like may also be inspected by the
auditor. Similarly the term ‘voucher’ includes all or any of the correspondence
which may in any way serve to vouch for the accuracy of the accounts. Thus, the
right of access is not restricted to books of account alone and it is for the
auditor to determine what record or document is necessary for the purpose of
the audit.

The right of access is not limited to those books and records maintained at the
registered or head office so that in the case of a company with branches, the
right also extends to the branch records, if the auditor considers it necessary to
have access thereto as per Section143(8).
Example
X Ltd. restrains its company auditor from visiting another branch at different
location and having access to the inventory records maintained at that branch
because the branch is already audited by another auditor and the report has been
received. Here, it may be noted that the company auditor has right to visit the
branch, even if the branch accounts are audited by another auditor, if he considers
it necessary to do so for the performance of his duties as auditor.
(b) Right to obtain information and explanation from officers - This
right of the auditor to obtain from the officers of the company such information
and explanations as he may think necessary for the performance of his duties
as auditor is a wide and important power. In the absence of such power, the
auditor would not be able to obtain details of amount collected by the
directors, etc. from any other company, firm or person as well as of any benefits
in kind derived by the directors from the company, which may not be known
from an examination of the books. It is for the auditor to decide the matters in
respect of which information and explanations are required by him. When the
auditor is not provided the information required by him or is denied access to
books, etc., his only remedy would be to report to the members that he could
not obtain all the information and explanations he had required or considered
necessary for the performance of his duties as auditors.
(c) Right to receive notices and to attend general meeting – The auditors of
a company are entitled to attend any general meeting of the company (the right is
not restricted to those at which the accounts audited by them are to be discussed);
also to receive all the notices and other communications relating to the general
meetings, which members are entitled to receive and to be heard at any general
meeting in any part of the business of the meeting which concerns them as auditors.
Section 146 of the Companies Act, 2013 discusses right as well as duty of the
auditor. According to the section 146:
“all notices of, and other communications relating to, any general meeting shall
be forwarded to the auditor of the company, and the auditor shall, unless
otherwise exempted by the company, attend either by himself or through his

authorised representative, who shall also be qualified to be an auditor, any

general meeting and shall have right to be heard at such meeting on any part of
the business which concerns him as the auditor.”
Thus, it is right of the auditor to receive notices and other communications
relating to any general meeting and to be heard at such meeting, relating to
the matter of his concern, however, it is duty of the auditor to attend the same
or through his authorised representative unless otherwise exempted.
(d) Right to report to the members of the company on the accounts
examined by him – The auditor shall make a report to the members of the
company on the accounts examined by him and on every financial statements
which are required by or under this Act to be laid before the company in
general meeting and the report shall after taking into account the provisions of
this Act, the accounting and auditing standards and matters which are required
to be included in the audit report under the provisions of this Act or any rules
made there under or under any order made under this section and to the best
of his information and knowledge, the said accounts, financial statements give
a true and fair view of the state of the company’ s affairs as at the end of its
financial year and profit or loss and cash flow for the year and such other
matters as may be prescribed.
(e) Right to Lien – In terms of the general principles of law, any person
having the lawful possession of somebody else’s property, on which he has
worked, may retain the property for non-payment of his dues on account of the
work done on the property. On this premise, auditor can exercise lien on books
and documents placed at his possession by the client for non payment of fees,
for work done on the books and documents. The Institute of Chartered
Accountants in England and Wales has expressed a similar view on the following
conditions:
(i) Documents retained must belong to the client who owes the money.
(ii) Documents must have come into possession of the auditor on the
authority of the client. They must not have been received through
irregular or illegal means. In case of a company client, they must be
received on the authority of the Board of Directors.
(iii) The auditor can retain the documents only if he has done work on the
documents assigned to him.

(iv) Such of the documents can be retained which are connected with the work
on which fees have not been paid.
Under section 128 of the Act, books of account of a company must be kept at
the registered office. These provisions ordinarily make it impracticable for the
auditor to have possession of the books and documents. The company provides
reasonable facility to auditor for inspection of the books of account by directors
and others authorised to inspect under the Act. Taking an overall view of the
matter, it seems that though legally, auditor may exercise right of lien in cases
of companies, it is mostly impracticable for legal and practicable constraints.
His working papers being his own property, the question of lien, on them does
not arise.
SA 230 issued by ICAI on Audit Documentation (explanatory text, A- 25),
“Standard on Quality Control (SQC) 1, “Quality Control for Firms that Perform
Audits and Reviews of Historical Financial Information, and Other Assurance and
Related Services Engagements”, issued by the Institute, provides that, unless
otherwise specified by law or regulation, audit documentation is the property
of the auditor. He may at his discretion, make portions of, or extracts from, audit
documentation available to clients, provided such disclosure does not
undermine the validity of the work performed, or, in the case of assurance
engagements, the independence of the auditor or of his personnel.”
9. DUTIES OF AUDITORS
Sections 143 of the Companies Act, 2013 specifies the duties of an auditor of
a company in a quite comprehensive manner. It is noteworthy that scope of
duties of an auditor has generally been extending over all these years.
(1) Duty of Auditor to Inquire on certain matters: Under provisions of
section 143(1), it is the duty of auditor to inquire into the following
matters-
(a) whether loans and advances made by the company on the basis of
security have been properly secured and whether the terms on
which they have been made are prejudicial to the interests of the
company or its members;
(b) whether transactions of the company which are represented merely
by book entries are prejudicial to the interests of the company;

(c) where the company not being an investment company or a banking

company, whether so much of the assets of the company as consist
of shares, debentures and other securities have been sold at a price
less than that at which they were purchased by the company;
(d) whether loans and advances made by the company have been
shown as deposits;
(e) whether personal expenses have been charged to revenue account;
(f) where it is stated in the books and documents of the company that
any shares have been allotted for cash, whether cash has actually
been received in respect of such allotment, and if no cash has
actually been so received, whether the position as stated in the
account books and the balance sheet is correct, regular and not
misleading.
The opinion of the Research Committee of the Institute of Chartered
Accountants of India on section 143(1) is reproduced below:
“The auditor is not required to report on the matters specified in sub-
section (1) unless he has any special comments to make on any of the
items referred to therein. If he is satisfied as a result of the inquiries, he
has no further duty to report that he is so satisfied. In such a case, the
content of the Auditor’s Report will remain exactly the same as the auditor
has to inquire and apply his mind to the information elicited by the
enquiry, in deciding whether or not any reference needs to be made in
his report. In our opinion, it is in this light that
the auditor has to consider his duties under section 143(1).”
Therefore, it could be said that the auditor should make a report to the
members in case he finds answer to any of these matters in adverse.
(2) Duty to report:
Under provisions of Section 143(2), the auditor shall make a report to the
members of the company on the accounts examined by him and on every
financial statements which are required by or under this Act to be laid
before the company in general meeting and the report shall after taking
into account the provisions of this Act, the accounting and auditing
standards and matters which are required to be included in the audit

report under the provisions of this Act or any rules made thereunder or
under any order made under sub-section (11).
Further, auditor has to report whether to best of his information and
knowledge, the said accounts, financial statements give a true and fair
view of the state of the company’s affairs as at the end of its financial
year and profit or loss and cash flow for the year and following
matters as prescribed under relevant rules:-
(a) whether the company has disclosed the impact, if any, of pending
litigations on its financial position in its financial statement;
(b) whether the company has made provision, as required under any
law or accounting standards, for material foreseeable losses, if any,
on long term contracts including derivative contracts;
(c) whether there has been any delay in transferring amounts, required
to be transferred, to the Investor Education and Protection Fund by
the company.
As per section 143(3), the auditor’s report shall also state–
(a) whether he has sought and obtained all the information and
explanations which to the best of his knowledge and belief were
necessary for the purpose of his audit and if not, the details thereof
and the effect of such information on the financial statements;
(b) whether, in his opinion, proper books of account as required by law have
been kept by the company so far as appears from his examination of
those books and proper returns adequate for the purposes of his audit
have been received from branches not visited by him;
(c) whether the report on the accounts of any branch office of the company
audited under sub-section (8) by a person other than the company’s
auditors has been sent to him under the proviso to that sub-section and
the manner in which he has dealt with it in preparing his report;
(d) whether the company’s balance sheet and profit and loss account dealt
with in the report are in agreement with the books of account and
returns;
(e) whether, in his opinion, the financial statements comply with the
accounting standards;

(f) the observations or comments of the auditors on financial transactions

or matters which have any adverse effect on the functioning of the
company;
(g) whether any director is disqualified from being appointed as a director
under sub- section (2) of the section 164;
(h) any qualification, reservation or adverse remark relating to the
maintenance of accounts and other matters connected therewith;
(i) whether the company has adequate internal financial controls with
reference to financial statements in place and the operating
effectiveness of such controls;
However, it may be noted that the reporting requirement on
adequacy of internal financial controls (IFCs) with reference to
financial statements shall not be applicable to a private company
which is a–
(i) One person company; or
(ii) Small company; or
(iii) Company having turnover less than ` 50 crore as per latest
audited financial statement and having aggregate
borrowings from banks or financial institutions or any body
corporate at any point of time during the financial year less
than ` 25 crore.
(j) such other matters as may be prescribed. Rule 11 of the Companies
(Audit and Auditors) Rules, 2014 prescribes the other matters to be
included in auditor’s report. The auditor’s report shall also include
their views and comments on the following matters, namely:-
(i) whether the company has disclosed the impact, if any, of
pending litigations on its financial position in its financial
statement;
(ii) whether the company has made provision, as required under
any law or accounting standards, for material foreseeable
losses, if any, on long term contracts including derivative
contracts;

(iii) whether there has been any delay in transferring amounts,

required to be transferred, to the Investor Education and
Protection Fund by the company.
One Person Company

Private
Exemption from Company Small Company
reporting on
adequacy of IFCs Having turnover
< ` 50 crore and
Borrowings < ` 25 crore
[Notes: (1) Students may note that the auditor is also required to
report on certain additional matters specified under CARO, 2016
which is discussed later under Para 10 Reporting under Companies
(Auditor’s Report) Order, 2016.
(2) Students are also required to refer Guidance note on Reporting
under section 143(3)(f) and (h) of the Companies Act, 2013.]
Further, in case of government companies and companies controlled by
government, the Comptroller and auditor general of India shall direct the
auditor of such companies the manner in which accounts of such
companies are required to be audited. The copy of such report shall be
submitted to the Comptroller and auditor general of India. It is to be
further noted that Comptroller and auditor general of India has a right to
conduct supplementary audit of financial statements of such companies
within 60 days of receipt of audit report.
[Notes: For detailed provisions of CARO, 2016, students may refer
Para 10 Reporting under Companies (Auditor’s Report) Order, 2016
which is discussed subsequently]
(3) Duty to Sign the Audit Report: As per section 145 of the Companies Act,
2013, the person appointed as an auditor of the company shall sign the
auditor's report or sign or certify any other document of the company, in
accordance with the provisions of section 141(2).
Section 141(2) of the Companies Act, 2013 states that where a firm
including a limited liability partnership is appointed as an auditor of a
company, only the partners who are chartered accountants shall be
authorised to act and sign on behalf of the firm.

The qualifications, observations or comments on financial transactions or

matters, which have any adverse effect on the functioning of the company
mentioned in the auditor's report shall be read before the company in
general meeting.
(4) Duty to comply with Auditing Standards: As per section 143(9) of the
Companies Act, 2013, every auditor shall comply with the auditing
standards. Further, as per section 143(10) of the Act, the Central
Government may prescribe the standards of auditing as recommended by
the Institute of Chartered Accountants of India, in consultation with and
after examination of the recommendations made by the National
Financial Reporting Authority.
(5) Duty to report on frauds:
A. Reporting to the Central Government- As per section 143(12) of the
Companies Act, 2013 read with Rule 13 of the Companies (Audit and
Auditors) Rules, 2014, if an auditor of a company in the course of the
performance of his duties as auditor, has reason to believe that an offence
of fraud, which involves or is expected to involve individually an amount
of ` 1 crore or above, is being or has been committed in the company by
its officers or employees, the auditor shall report the matter to the Central
Government within such time and in such manner as prescribed.
B. Reporting to the Audit Committee or Board- In case of a fraud involving
lesser than the specified amount [i.e. less than ` 1 crore], the auditor shall report
the matter to the audit committee constituted under section 177 or to the Board
in other cases within such time and in such manner as prescribed.
C. Disclosure in the Board's Report: The companies, whose auditors have
reported frauds under this sub-section (12) to the audit committee or the
Board, but not reported to the Central Government, shall disclose the
details about such frauds in the Board's report in such manner as
prescribed.
Sub-section (13) of section 143 of the Companies Act, 2013 safeguards
the act of fraud reporting by the auditor if it is done in good faith. It
states that no duty to which an auditor of a company may be subject to
shall be regarded as having been contravened by reason of his reporting
the matter above if it is done in good faith.
It is very important to note that the provisions regarding fraud reporting

shall also apply, mutatis mutandis, to a cost auditor and a secretarial

auditor during the performance of his duties under section 148 and
section 204 respectively. If any auditor, cost accountant or company
secretary in practice do not comply with the provisions of sub-section
(12) of section 143, he shall be punishable with fine which shall not be
less than ` 1 lakh but which may extend to ` 25 lakh.
The auditor is also required to report under clause (x) of paragraph 3 of
Companies (Auditor’s Report) Order, 2016 [CARO, 2016], whether any
fraud by the company or any fraud on the Company by its officers or
employees has been noticed or reported during the year. If yes, the nature
and the amount involved is to be indicated.
[Notes: For detailed provisions of CARO, 2016, students may refer
Para 10 Reporting under Companies (Auditor’s Report) Order, 2016]
Example: The head accountant of a company entered fake invoices of credit
purchases in the books of account aggregate of ` 50 lakh and cleared all the
payments to such bogus creditor. Here, the auditor of the company is
required to report the fraudulent activity to the Board or Audit Committee
(as the case may be) within 2 days of his knowledge of fraud. Further, the
company is also required to disclose the same in Board’s Report.
It may be noted that the auditor need not to report the central government
as the amount of fraud involved is less than ` 1 crore, however, reporting
under CARO, 2016 is required.
(6) Duty to report on any other matter specified by Central Government:
The Central Government may, in consultation with the National Financial
Reporting Authority (NFRA), by general or special order, direct, in respect
of such class or description of companies, as may be specified in the order,
that the auditor's report shall also include a statement on such matters
as may be specified therein.
However, as per the notification dated 29.03.2016, till the time NFRA is
constituted, the Central Government may hold consultation required
under this sub-section with the Committee chaired by an officer of the
rank of Joint Secretary or equivalent in the MCA and the Committee shall
have the representatives from the ICAI and Industry Chambers and also
special invitees from the National Advisory Committee on Accounting
Standards (NACAS) and the office of the C&AG.

[Note: Students may note that Companies (Auditor’s Report) Order,

2016 has been notified in this perspective which is discussed later
under Para 10 Reporting under Companies (Auditor’s Report) Order,
2016]
(7) Duties and powers of the company’s auditor with reference to the
audit of the branch and the branch auditor are discussed separately
in the chapter under heading 13 branch audit.
(8) Duty to state the reason for qualification or negative report: As per
section 143(4), where any of the matters required to be included in the
audit report is answered in the negative or with a qualification, the report
shall state the reasons there for.
10. REPORTING UNDER COMPANIES (AUDITOR’S

REPORT) ORDER, 2016 [CARO, 2016]
The Central Government, after consultation with the committee constituted
under proviso to section 143(11) of the Companies Act, 2013, and in
supersession of the Companies (Auditor's Report) Order, 2015 dated the 10th
April, 2015, has issued the Companies (Auditor’s Report) Order, 2016, (CARO,
2016) under section 143(11) of the Companies Act, 2013, dated 29th March,
2016. The requirements of the Order are supplemental to the existing provisions
of section 143 of the Act regarding the auditor’s report.
The Order is not intended to limit the duties and responsibilities of auditors but
only requires a statement to be included in the audit report in respect of the
matters specified therein.
Applicability of the Order: The CARO, 2016 is an additional reporting
requirement Order. The order applies to every company including a foreign
company as defined in clause (42) of section 2 of the Companies Act, 2013.
However, the Order specifically exempts the following class of companies-
(i) a banking company as defined in clause (c) of section 5 of the Banking
Regulation Act, 1949;
(ii) an insurance company as defined under the Insurance Act,1938;
(iii) a company licensed to operate under section 8 of the Companies Act;

(iv) a One Person Company as defined under clause (62) of section 2 of the
Companies Act;
(v) a small company as defined under clause (85) of section 2 of the
Companies Act; and
(vi) a private limited company, not being a subsidiary or holding company of
a public company, having a paid up capital and reserves and surplus not
more than ` 1 crore as on the balance sheet date and which does not have
total borrowings exceeding ` 1 crore from any bank or financial institution
at any point of time during the financial year and which does not have a
total revenue as disclosed in Scheduled III to the Companies Act, 2013
(including revenue from discontinuing operations) exceeding ` 10 crore
during the financial year as per the financial statements.
It may be noted that the Order shall not be applicable to the auditor’s report
on consolidated financial statements.
Banking company
Private limited
company subject
Insurance
to fulfilment of
company
specified
conditions
Exempted
Class of
Companies
Company licensed
Small Company to operate under
section 8 of the
Companies Act
One Person
Company
EXAMPLES
Ex. 1: ‘Educating Child’ is a limited company registered under section 8 of the
Companies Act, 2013.

In the given case, ‘Educating Child’ is licensed to operate under section 8 of the
Companies Act, 2013. Therefore, CARO, 2016 shall not be applicable to
‘Educating Child’ accordingly.
Ex. 2: Ashu Pvt. Ltd. has fully paid capital and reserves of ` 50 lakh. During the
year, the company had borrowed ` 70 lakh each from a bank and a financial
institution independently. It has the turnover of ` 900 lakh.
In the given case of Ashu Pvt. Ltd., it has paid capital and reserves of ` 50 lakh
i.e. less than ` 1 crore, turnover of ` 9 crore i.e. less than ` 10 crore. However,
it has maximum outstanding borrowings of ` 1.40 crore (` 70 lakh + ` 70 lakh)
collectively from bank and financial institution.
Therefore, it fails to fulfill the condition relating to borrowings. Thus, CARO,
2016 shall be applicable to Ashu Pvt. Ltd. accordingly.
Matters to be included in the Auditor’s Report: Paragraph 3 of the Order
requires the auditor to include a statement in the auditor’s report on the
following matters, namely-
(i) (a) whether the company is maintaining proper records showing full
particulars, including quantitative details and situation of fixed
assets;
(b) whether these fixed assets have been physically verified by the
management at reasonable intervals; whether any material
discrepancies were noticed on such verification and if so, whether
the same have been properly dealt with in the books of account;
(c) whether the title deeds of immovable properties are held in the
name of the company. If not, provide the details thereof;
(ii) whether physical verification of inventory has been conducted at
reasonable intervals by the management and whether any material
discrepancies were noticed and if so, whether they have been properly
dealt with in the books of account;
(iii) whether the company has granted any loans, secured or unsecured to
companies, firms, Limited Liability Partnerships or other parties covered
in the register maintained under section 189 of the Companies Act, 2013.
If so,
(a) whether the terms and conditions of the grant of such loans are not

prejudicial to the company’s interest;

(b) whether the schedule of repayment of principal and payment of
interest has been stipulated and whether the repayments or receipts
are regular;
(c) if the amount is overdue, state the total amount overdue for more
than ninety days, and whether reasonable steps have been taken by
the company for recovery of the principal and interest;
(iv) in respect of loans, investments, guarantees, and security whether
provisions of section 185 and 186 of the Companies Act, 2013 have been
complied with. If not, provide the details thereof.
(v) in case the company has accepted deposits, whether the directives issued
by the Reserve Bank of India and the provisions of sections 73 to 76 or
any other relevant provisions of the Companies Act, 2013 and the rules
framed there under, where applicable, have been complied with? If not,
the nature of such contraventions be stated; If an order has been passed
by Company Law Board or National Company Law Tribunal or Reserve
Bank of India or any court or any other tribunal, whether the same has
been complied with or not?
(vi) where maintenance of cost records has been specified by the Central
Government under sub-section (1) of section 148 of the Companies Act,
2013 and whether such accounts and records have been so made and
maintained.
(vii) (a) whether the company is regular in depositing undisputed statutory
dues including provident fund, employees' state insurance, income-
tax, sales-tax, service tax, duty of customs, duty of excise, value
added tax, cess and any other statutory dues with the appropriate
authorities and if not, the extent of the arrears of outstanding
statutory dues as at the last day of the financial year concerned for
a period of more than six months from the date they became
payable, shall be indicated;
(b) where dues of income tax or sales tax or service tax or duty of
customs or duty of excise or value added tax have not been
deposited on account of any dispute, then the amounts involved
and the forum where dispute is pending shall be mentioned. (A

mere representation to the concerned Department shall not

constitute a dispute).
(viii) whether the company has defaulted in repayment of loans or borrowing
to a financial institution, bank, Government or dues to debenture holders?
If yes, the period and the amount of default to be reported (in case of
defaults to banks, financial institutions, and Government, lender wise
details to be provided).
(ix) whether moneys raised by way of initial public offer or further public offer
(including debt instruments) and term loans were applied for the
purposes for which those are raised. If not, the details together with delays
or default and subsequent rectification, if any, as may be applicable, be
reported;
(x) whether any fraud by the company or any fraud on the Company by its
officers or employees has been noticed or reported during the year; If yes,
the nature and the amount involved is to be indicated;
(xi) whether managerial remuneration has been paid or provided in
accordance with the requisite approvals mandated by the provisions of
section 197 read with Schedule V to the Companies Act, 2013? If not, state
the amount involved and steps taken by the company for securing refund
of the same;
(xii) whether the Nidhi Company has complied with the Net Owned Funds to
Deposits in the ratio of 1:20 to meet out the liability and whether the Nidhi
Company is maintaining ten per cent unencumbered term deposits as
specified in the Nidhi Rules, 2014 to meet out the liability;
(xiii) whether all transactions with the related parties are in compliance with
sections 177 and 188 of Companies Act, 2013 where applicable and the
details have been disclosed in the Financial Statements etc., as required
by the applicable accounting standards;
(xiv) whether the company has made any preferential allotment or private
placement of shares or fully or partly convertible debentures during the
year under review and if so, as to whether the requirement of section 42
of the Companies Act, 2013 have been complied with and the amount
raised have been used for the purposes for which the funds were raised.
If not, provide the details in respect of the amount involved and nature of

non-compliance;
(xv) whether the company has entered into any non-cash transactions with
directors or persons connected with him and if so, whether the provisions
of section 192 of Companies Act, 2013 have been complied with;
(xvi) whether the company is required to be registered under section 45-IA of
the Reserve Bank of India Act, 1934 and if so, whether the registration has
been obtained.
Reasons to be Stated for Unfavourable or Qualified Answers: Where the
answer to any of the questions referred to in paragraph 3 of the Order is
unfavourable or qualified, in the auditor's report, the auditor shall also state the
basis for such unfavourable or qualified answer, as the case may be.
Further, where the auditor is unable to express any opinion on any specified
matter, his report shall indicate such fact together with the reasons why it is not
possible for him to give his opinion on the same.
Example: The company has dispensed with the practice of taking inventory of
their inventories at the year-end as in their opinion the exercise is redundant,
time consuming and intrusion to normal functioning of the operations. Explain
reporting requirement under CARO, 2016.
Reporting for Physical Verification of Inventory: Clause (ii) of Para 3 of
CARO, 2016, requires the auditor to report whether physical verification of
inventory has been conducted at reasonable intervals by the management and
whether any material discrepancies were noticed and if so, whether they have
been properly dealt with in the books of account.
The physical verification of inventory is the responsibility of the management
of the company which should verify all material items at least once in a year
and more often in appropriate cases.
In the given case, the above requirement of physical verification of inventory by
the management has not been taken place and therefore the auditor should point
out the same under CARO, 2016. He may consider the impact on financial
statement and report accordingly.

11. DISCLOSURE IN THE AUDITOR’S REPORT

The following paragraphs deal with the manner of qualification and the
manner of disclosure, if any, to be made in the auditor’s report.
AS-1 – Disclosure of Accounting Policies

In the case of a company, members should qualify their audit reports in case –
(a) accounting policies required to be disclosed under Schedule III or any
other provisions of the Companies Act, 2013 have not been disclosed, or
(b) accounts have not been prepared on accrual basis, or
(c) the fundamental accounting assumption of going concern has not been
followed and this fact has not been disclosed in the financial statements,
or
(d) proper disclosures regarding changes in the accounting policies have not
been made.
Where a company has been given a specific exemption regarding any of the
matters stated above but the fact of such exemption has not been adequately
disclosed in the accounts, the member should mention the fact of exemption in
his audit report without necessarily making it a subject matter of audit
qualification.
In view of the above, the auditor will have to consider different circumstances
whether the audit report has to be qualified or only disclosures have to be
given.
In the case of enterprises not governed by the Companies Act, the member
should examine the relevant statute and make suitable qualification in his audit
report in case adequate disclosures regarding accounting policies have not been
made as per the statutory requirements. Similarly, the member should examine if
the fundamental accounting assumptions have been followed in preparing the
financial statements or not. In appropriate cases, he should consider whether,
keeping in view the requirements of the applicable laws, a qualification in his
report is necessary.
In the event of non-compliance by enterprises not governed by the Companies
Act, in situations where the relevant statute does not require such disclosures
to be made, the member should make adequate disclosure in his audit report

without necessarily making it a subject matter of audit qualification.

In making a qualification / disclosure in the audit report, the auditor should
consider the materiality of the relevant item. Thus, the auditor need not make
qualification / disclosure in respect of items which, in his judgement, are not
material.
A disclosure, which is not a subject matter of audit qualification, should be made
in the auditor’s report in a manner that it is clear to the reader that the
disclosure does not constitute an audit qualification. The paragraph containing
the auditor’s opinion on true and fair view should not include a reference to the
paragraph containing the aforesaid disclosure.
12. JOINT AUDIT

The practice of appointing Chartered Accountants as joint auditors is quite
widespread in big companies and corporations. Joint audit basically implies
pooling together the resources and expertise of more than one firm of auditors
to render an expert job in a given time period which may be difficult to
accomplish acting individually. It essentially involves sharing of the total work.
This is by itself a great advantage.
In specific terms the advantages that flow may be the following:
(i) Sharing of expertise.
(ii) Advantage of mutual consultation.
(iii) Lower workload.
(iv) Better quality of performance.
(v) Improved service to the client.
(vi) Displacement of the auditor of the company taken over in a take - over
often obviated.
(vii) In respect of multi-national companies, the work can be spread using the
expertise of the local firms which are in a better position to deal with
detailed work and the local laws and regulations.
(viii) Lower staff development costs.
(ix) Lower costs to carry out the work.

(x) A sense of healthy competition towards a better performance.

The general disadvantages may be the following:
(i) The fees being shared.
(ii) Psychological problem where firms of different standing are associated in
the joint audit.
(iii) General superiority complexes of some auditors.
(iv) Problems of co-ordination of the work.
(v) Areas of work of common concern being neglected.
(vi) Uncertainty about the liability for the work done.
The Institute of Chartered Accountants of India has issued Standard on Auditing
(SA) 299 (Revised), “Joint Audit of Financial Statements” which lays down the
principles for effective conduct of joint audit to achieve the overall objectives
of the auditor as laid down in SA 200 “Overall Objectives of the Independent
Auditor and the conduct of an audit in accordance with Standards on Auditing”.
This Standard deals with the special considerations in carrying out audit by joint
auditors. It requires that–
(i) the engagement partner and other key members of the engagement team
from each of the joint auditors should be involved in planning the audit.
(ii) the joint auditors should jointly establish an overall audit strategy which
sets the scope, timing and direction of the audit, and also guides the
development of the audit plan.
(iii) before the commencement of the audit, the joint auditors should discuss
and develop a joint audit plan. In developing the joint audit plan, the joint
auditors should:
(a) identify division of audit areas and common audit areas;
(b) ascertain the reporting objectives of the engagement;
(c) consider and communicate among all joint auditors the factors that
are significant
(d) in directing the engagement team’s efforts;
(e) consider the results of preliminary engagement activities, or similar
engagements performed earlier.

(f) ascertain the nature, timing and extent of resources necessary to

accomplish the engagement.
(iv) each of the joint auditors should consider and assess the risks of material
misstatement and communicate to other joint auditors.
(v) the joint auditors should discuss and document the nature, timing, and
the extent of the audit procedures for (I) common and (II) specific allotted
areas of audit to be performed.
(vi) the joint auditors should obtain common engagement letter and common
management representation letter.
(vii) the work allocation document should be signed by all the joint auditors
and communicated to those charged with governance.
It further states that, in respect of audit work divided among the joint auditors,
each joint auditor shall be responsible only for the work allocated to such joint
auditor including proper execution of the audit procedures. On the other hand,
all the joint auditors shall be jointly and severally responsible for:
(i) the audit work which is not divided among the joint auditors and is carried
out by all joint auditors;
(ii) decisions taken by all the joint auditors under audit planning in respect of
common audit areas;
(iii) matters which are brought to the notice of the joint auditors by any one of
them and there is an agreement among the joint auditors on such matters;
(iv) examining that the financial statements of the entity comply with the
requirements of the relevant statutes;
(v) presentation and disclosure of the financial statements as required by the
applicable financial reporting framework;
(vi) ensuring that the audit report complies with the requirements of the
relevant statutes, applicable Standards on Auditing and other relevant
pronouncements issued by ICAI.
In case a joint auditor comes across matters which are relevant to the areas of
responsibility of other joint auditors and which deserve their attention, or which
require disclosure or require discussion with, or application of judgment by other
joint auditors, the said joint auditor shall communicate the same to all the other

joint auditors in writing prior to the completion of the audit.

It may be noted that the joint auditors are required to issue common audit report.
However, where the joint auditors are in disagreement with regard to the opinion
or any matters to be covered by the audit report, they shall express their opinion
in a separate audit report. In such circumstances, the audit report(s) issued by the
joint auditor(s) shall make a reference to each other’s audit report(s).
[Note: Student may refer SA 299 (revised) “Joint Audit of Financial Statements”
reproduced in “Auditing Pronouncements” for comprehensive knowledge.]
13. AUDIT OF BRANCH OFFICE ACCOUNTS

As per section 128(1) of the Companies Act, 2013, every company shall prepare
and keep at its registered office books of account and other relevant books
and papers and financial statement for every financial year which give a true
and fair view of the state of the affairs of the company, including that of its
branch office or offices, if any, and explain the transactions effected both at the
registered office and its branches and such books shall be kept on accrual basis
and according to the double entry system of accounting.
It may be noted that all or any of the books of account aforesaid and other
relevant papers may be kept at such other place in India as the Board of
Directors may decide and where such a decision is taken, the company shall,
within 7 days thereof, file with the Registrar a notice in writing giving the full
address of that other place.
Students may also note that the company may keep such books of account or
other relevant papers in electronic mode in such manner as may be prescribed.
Sub-section (2) provides that where a company has a branch office in India or
outside India, it shall be deemed to have complied with the provisions of sub-
section (1), if proper books of account relating to the transactions effected at
the branch office are kept at that office and proper summarised returns
periodically are sent by the branch office to the company at its registered office
or the other place referred in (1).
Further, sub-section (8) of section 143 of the Companies Act, 2013, prescribes
the duties and powers of the company’s auditor with reference to the audit of
the branch and the branch auditor. Where a company has a branch office, the
accounts of that office shall be audited either by the auditor appointed for the

company (herein referred to as the company's auditor) under this Act or by any
other person qualified for appointment as an auditor of the company under this
Act and appointed as such under section 139, or where the branch office is
situated in a country outside India, the accounts of the branch office shall be
audited either by the company's auditor or by an accountant or by any other
person duly qualified to act as an auditor of the accounts of the branch office in
accordance with the laws of that country and the duties and powers of the
company' s auditor with reference to the audit of the branch and the branch
auditor, if any, shall be such as may be prescribed:
It may be noted that the branch auditor shall prepare a report on the accounts
of the branch examined by him and send it to the auditor of the company who
shall deal with it in his report in such manner as he considers necessary.
Further as per rule 12 of the Companies (Audit and Auditors) Rules, 2014,
the branch auditor shall submit his report to the company’s auditor and
reporting of fraud by the auditor shall also extend to such branch auditor to the
extent it relates to the concerned branch.
Using the Work of another Auditor: When the accounts of the branch are
audited by a person other than the company’s auditor, there is need for a clear
understanding of the role of such auditor and the company’s auditor in relation
to the audit of the accounts of the branch and the audit of the company as a
whole; also, there is great necessity for a proper rapport between these two
auditors for the purpose of an effective audit. In recognition of these needs, the
Council of the Institute of Chartered Accountants of India has dealt with these
issues in SA 600, “Using the Work of another Auditor”. It makes clear that in
certain situations, the statute governing the entity may confer a right on the
principal auditor to visit a component and examine the books of account and
other records of the said component, if he thinks it necessary to do so. Where
another auditor has been appointed for the component, the principal auditor
would normally be entitled to rely upon the work of such auditor unless there
are special circumstances to make it essential for him to visit the component
and/or to examine the books of account and other records of the said
component. Further, it requires that the principal auditor should perform
procedures to obtain sufficient appropriate audit evidence, that the work of the
other auditor is adequate for the principal auditor's purposes, in the context of
the specific assignment. When using the work of another auditor, the principal
auditor should ordinarily perform the following procedures:

(a) advise the other auditor of the use that is to be made of the other
auditor's work and report and make sufficient arrangements for co-
ordination of their efforts at the planning stage of the audit. The principal
auditor would inform the other auditor of matters such as are as requiring
special consideration, procedures for the identification of inter -
component transactions that may require disclosure and the time-table
for completion of audit; and
(b) advise the other auditor of the significant accounting, auditing and
reporting requirements and obtain representation as to compliance with
them.
The principal auditor might discuss with the other auditor the audit procedures
applied or review a written summary of the other auditor’s procedures and
findings which may be in the form of a completed questionnaire or check-list.
The principal auditor may also wish to visit the other auditor. The nature, timing
and extent of procedures will depend on the circumstances of the engagement
and the principal auditor's knowledge of the professional competence of the
other auditor. This knowledge may have been enhanced from the review of the
previous audit work of the other auditor.
14. COST AUDIT

Cost Audit is an audit process for verifying the cost of manufacture or
production of any article, on the basis of accounts as regards utilisation of
material or labour or other items of costs, maintained by the company.
It is covered by Section 148 of the Companies Act, 2013. The audit conducted
under this section shall be in addition to the audit conducted under section
143.
As per section 148 the Central Government may by order specify audit of items
of cost in respect of certain companies.
Further, the Central Government may, by order, in respect of such class of
companies engaged in the production of such goods or providing such services
as may be prescribed, direct that particulars relating to the utilisation of
material or labour or to other items of cost as may be prescribed shall also be
included in the books of account kept by that c lass of companies.
In this regard, the Central Government has notified the Companies (Cost

Records and Audit) Rules, 2014 which prescribes the classes of companies
required to include cost records in their books of account, applicability of cost
audit, maintenance of records etc.
Applicability for Maintenance of Cost Records: Rule 3 of the Companies (Cost
Records and Audit) Rules, 2014 provides the classes of companies, engaged in
the production of goods or providing services, having an overall turnover from
all its products and services of ` 35 crore or more during the immediately
preceding financial year, required to include cost records in their books of
account. These companies include Foreign Companies defined in sub-section
(42) of section 2 of the Act, but exclude a company classified as a Micro
enterprise or a Small enterprise including as per the turnover criteria provided
under Micro, Small and Medium Enterprises Development Act, 2006. The said
rule has divided the list of companies into (A) Regulated sectors and (B) Non-
regulated sectors.
Maintenance of Cost Records: As per Rule 5 of the Companies (Cost Records
and Audit) Rules, 2014, every company under these rules including all units and
branches thereof, shall, in respect of each of its financial year, is required to
maintain cost records in Form CRA-1. The cost records shall be maintained on
regular basis in such manner as to facilitate calculation of per unit cost of
production or cost of operations, cost of sales and margin for each of its
products and activities for every financial year on monthly or quarterly or half-
yearly or annual basis.
Additionally, as per clause (vi) to Paragraph 3 of the CARO, 2016, the auditor
has to report whether maintenance of cost records has been specified by the
Central Government under section 148(1) of the Companies Act, 2013 and
whether such accounts and records have been so made and maintained.
Applicability of Cost Audit: Rule 4 of the Companies (Cost Records and Audit)
Rules, 2014 states the provisions related to the applicability of cost audit
depending on the turnover of the company as follows-
(i) Classes of companies specified under item (A) “Regulated Sectors” are
required to get its cost records audited if the overall annual turnover of
the company from all its products and services during the immediately
preceding financial year is ` 50 crore or more and the aggregate turnover
of the individual product(s) or service(s) for which cost records are
required to be maintained under rule 3 is ` 25 crore or more.

(ii) Classes of companies specified under item (B) “Non-Regulated Sectors”

are required to get its cost records audited if the overall annual turnover
of the company from all its products and services during the immediately
preceding financial year is ` 100 crore or more and the aggregate turnover
of the individual product(s) or service(s) for which cost records are
required to be maintained under rule 3 is ` 35 crore or more.
Who can be Cost Auditor: The audit shall be conducted by a Cost Accountant
who shall be appointed by the Board of such remuneration as may be
determined by the members in such manner as may be prescribed.
It may be noted that no person appointed under section 139 as an auditor of
the company shall be appointed for conducting the audit of cost records.
It may also be noted that the auditor conducting the cost audit shall comply
with the cost auditing standards ("cost auditing standards" mean such
standards as are issued by the Institute of Cost Accountants of India, constituted
under the Cost and Works Accountants Act, 1959, with the approval of the
Central Government).
Appointment of Cost Auditor: Rule 6 of the Companies (Cost Records and
Audit) Rules, 2014 requires the companies prescribed under the said Rules to
appoint an Auditor within 180 days of the commencement of every financial
year. However, before such appointment is made, the written consent of the
cost auditor to such appointment and a certificate from him or it shall be
obtained.
The certificate to be obtained from the cost auditor shall certify that the-
(a) the individual or the firm, as the case may be, is eligible for appointment
and is not disqualified for appointment under the Companies Act, 2013,
the Cost and Works Accountants Act, 1959 and the rules or regulations
made thereunder;
(b) the individual or the firm, as the case may be, satisfies the criteria provided
in section 141 of the Companies Act, 2013 so far as may be applicable;
(c) the proposed appointment is within the limits laid down by or under the
authority of the Companies Act, 2013; and
(d) the list of proceedings against the cost auditor or audit firm or any partner
of the audit firm pending with respect to professional matters of conduct,
as disclosed in the certificate, is true and correct.

Every referred company shall inform the cost auditor concerned of his or its
appointment as such and file a notice of such appointment with the Central
Government within a period of 30 days of the Board meeting in which such
appointment is made or within a period of 180 days of the commencement of
the financial year, whichever is earlier, through electronic mode, in Form CRA-
2, along with the fee as specified in Companies (Registration Offices and Fees)
Rules, 2014.
The cost auditor appointed as such shall continue in such capacity till the expiry
of 180 days from the closure of the financial year or till he submits the cost
audit report, for the financial year for which he has been appointed.
Removal of Cost Auditor: The cost auditor may be removed from his office before
the expiry of his term, through a board resolution after giving a reasonable
opportunity of being heard to the cost auditor and recording the reasons for such
removal in writing.
It may be noted that the Form CRA-2 to be filed with the Central Government
for intimating appointment of another cost auditor shall enclose the relevant
Board Resolution to the effect.
It may further be noted that the above provisions shall not prejudice the right
of the cost auditor to resign from such office of the company.
Casual Vacancy in the Office of a Cost Auditor: Any casual vacancy in the
office of a Cost Auditor, whether due to resignation, death or removal, shall be
filled by the Board of Directors within 30 days of occurrence of such vacancy
and the company shall inform the central government in Form CRA-2 within 30
days of such appointment of cost auditor.
Remuneration of Cost Auditor: As per rule 14 of the Companies (Audit and
Auditors) Rules, 2014-
(a) in the case of companies which are required to constitute an audit
committee-
(i) the Board shall appoint an individual, who is a cost accountant, or a
firm of cost accountants in practice, as cost auditor on the
recommendations of the Audit committee, which shall also
recommend remuneration for such cost auditor;

(ii) the remuneration recommended by the Audit Committee under (i)

shall be considered and approved by the Board of Directors and
ratified subsequently by the shareholders;
(b) in the case of other companies which are not required to constitute an
audit committee, the Board shall appoint an individual who is a cost
accountant or a firm of cost accountants in practice as cost auditor and
the remuneration of such cost auditor shall be ratified by shareholders
subsequently.
Qualification, Disqualification, Rights, Duties and Obligations of Cost
Auditor: The qualifications, disqualifications, rights, duties and obligations
applicable to auditors under this Chapter shall, so far as may be applicable,
apply to a cost auditor appointed under this section and it shall be the duty of
the company to give all assistance and facilities to the cost auditor appointed
under this section for auditing the cost records of the company.
Submission of Cost Audit Report:

(i) To the Board of Directors of the Company- The cost auditor shall submit
the cost audit report along with his reservations or qualifications or observations or
suggestions, if any, in Form CRA-3. He shall forward his report to the Board of
Directors of the company within a period of 180 days from the closure of the financial
year to which the report relates and the Board of Directors shall consider and
examine such report particularly any reservation or qualification contained therein.
(ii) To the Central Government- The company shall within 30 days from
the date of receipt of a copy of the cost audit report prepared (in pursuance of
a direction issued by Central Government) furnish the Central Government with
such report along with full information and explanation on every reservation or
qualification contained therein in Form CRA-4 in Extensible Business Reporting
Language (XBRL) format in the manner as specified in the Companies (Filing of
Documents and Forms in Extensible Business Reporting language) Rules, 2015
along with fees specified in the Companies (Registration Offices and Fees)
Rules, 2014.
Provided that the companies which have got extension of time of holding AGM
under section 96 (1) of the Companies Act, 2013, may file form CRA-4 within
resultant extended period of filing financial statements under section 137 of the

If, after considering the cost audit report and the, information and explanation
furnished by the company as above, the Central Government is of the opinion,
that any further information or explanation is necessary, it may call for such
further information and explanation and the company shall furnish the same
within such time as may be specified by that Government.
Duty to Report on Fraud: The provisions of section 143(12) of the Companies
Act, 2013 and the relevant rules on duty to report on fraud shall apply mutatis
mutandis to a cost auditor during performance of his functions under section
148 of the Act and these rules.
Cost Audit Rules Not to Apply in Certain Cases: The requirement for cost audit
under these rules shall not be applicable to a company which is covered under Rule
3, and,
(i) whose revenue from exports, in foreign exchange, exceeds 75% of its total
revenue; or
(ii) which is operating from a special economic zone.
(iii) which is engaged in generation of electricity for captive consumption
through Captive Generating Plant.
Penal Provisions in Case of Default: If any default is made in complying with
the provisions of this section,
(a) the company and every officer of the company who is in default shall be
punishable in the manner as provided in sub-section (1) of section 147;
(b) the cost auditor of the company who is in default shall be punishable in
the manner as provided in sub-sections (2) to (4) of section 147.
15. PUNISHMENT FOR NON-COMPLIANCE

Section 147 of the Companies Act, 2013 prescribes following punishments for
contravention:
(1) If any of the provisions of sections 139 to 146 (both inclusive) is
contravened, the company shall be punishable with fine which shall not
be less than twenty-five thousand rupees but which may extend to five
lakh rupees and every officer of the company who is in default shall be
punishable with imprisonment for a term which may extend to one year

or with fine which shall not be less than ten thousand rupees but which
may extend to one lakh rupees, or with both.
(2) If an auditor of a company contravenes any of the provisions of section
139 section 143, section 144 or section 145, the auditor shall be
punishable with fine which shall not be less than twenty-five thousand
rupees but which may extend to five lakh rupees or four times the
remuneration of the auditor, whichever is less.
It may be noted that if an auditor has contravened such provisions
knowingly or willfully with the intention to deceive the company or its
shareholders or creditors or tax authorities, he shall be punishable with
imprisonment for a term which may extend to one year and with fine
which shall not be less than fifty thousand rupees but which may extend
to twenty-five lakh rupees or eight times the remuneration of the
auditor, whichever is less .
(3) Where an auditor has been convicted under sub-section (2), he shall be liable
to-
(i) refund the remuneration received by him to the company;
(ii) and pay for damages to the company statutory bodies or authorities
or to members or creditors of the company for loss arising out of
incorrect or misleading statements of particulars made in his audit
report.
(4) The Central Government shall, by notification, specify any statutory body
or authority of an officer for ensuring prompt payment of damages to the
company or the persons under clause (ii) of sub-section (3) and such
body, authority or officer shall after payment of damages the such
company or persons file a report with the Central Government in respect
of making such damages in such manner as may be specified in the said
notification.
(5) Where, in case of audit of a company being conducted by an audit firm,
it is proved that the partner or partners of the audit firm has or have
acted in a fraudulent manner or abetted or colluded in an fraud by, or in
relation to or by, the company or its directors or officers, the liability,
whether civil or criminal as provided in this Act or in any other law for the

time being in force, for such act shall be of the partner or partners
concerned of the audit firm and of the firm jointly and severally.
It may be noted that in case of criminal liability of an audit firm, in respect of
liability other than fine, the concerned partner(s), who acted in a fraudulent
manner or abetted or, as the case may be, colluded in any fraud shall only be
liable.
TEST YOUR KNOWLEDGE

Correct/Incorrect:
State with reasons (in short) whether the following statements are correct or
incorrect:
(i) The first auditor of a Government company was appointed by the Board
in its meeting after 10 days from the date of registration.
(ii) Director's relative can act as an auditor of the company.
(iii) If an LLP (Limited Liability Partnership Firm) is appointed as an auditor of
a company, every partner of a firm shall be authorized to act as an auditor.
(iv) AB & Co. is an audit firm having partners Mr. A and Mr. B. Mr. C, the
relative of Mr. B is holding securities having face value of ` 2,00,000 in
XYZ Ltd. AB & Co. is qualified for being appointed as an auditor of XYZ
Ltd.
(v) The auditor of a Ltd. Company wanted to refer to the minute books during
audit but board of directors refused to show the minute books to the
auditors.
(vi) Manner of rotation of auditor will not be applicable to company A, which
is having paid up share capital of ` 15 crores and having public borrowing
from nationalized bank of ` 50 crore because it is a Private Limited
Company.
(vii) The auditor should study the Memorandum and Articles of Association to
see the validity of his appointment.
(viii) Managing director of A Ltd. himself appointed the first auditor of the company.
(ix) A Chartered Accountant holding securities of S Ltd. having face value of
` 950 is qualified for appointment as an auditor of S Ltd.

(x) Mr. N, a member of the Institute of Company Secretary of India, is

qualified to be appointed as auditor of XYZ Limited.
(xi) The Board of Director of ABC Ltd., a listed company at Bombay Stock
Exchange, is required to fill the casual vacancy of an auditor only after
taking into account the recommendations of the audit committee.
(xii) Bhartiya Gas Ltd. a Government Company, the Comptroller and Auditor-
General of India shall, in respect of a financial year, appoint an auditor
duly qualified to be appointed as an auditor of companies under this Act,
within a period of 180 days from the end of the financial year, who shall
hold office till the end of the next Financial year.
(xiii) CA K has resigned as an auditor after 2 months of his appointment in NML
Ltd. He needs to file ADT-3 with the Registrar within 60 days from the
date of resignation.
(xiv) The Board of Director of ABC Ltd., a listed company at Bombay Stock
Exchange, is required to fill the casual vacancy of an auditor only after
taking into account the recommendations of the audit committee.
(xv) Any partner of an LLP, who is appointed as an auditor of a company, can
sign the audit report.
(xvi) Audit committee is to be constituted by every public company to ensure
better standards of corporate governance.
(xvii) XYZ Ltd is engaged in manufacture of textiles specified under prescribed
rules having total revenue of Rs.100 crore (including export turnover of
Rs.88 crores in foreign exchange) in immediately preceding financial year.
The said company is required to get cost audit conducted for immediately
preceding financial year.
(xviii) The auditor has to report under section 143 of companies act, 2013
whether company has adequate internal controls in place and overall
effectiveness of such internal controls.
(xix) Discovery of an offence of a fraud of Rs.100 lakh by auditor against the
company committed by its officers is to be reported to Serious Fraud
Investigation office(SFIO).
(xx) The concept of “joint audit” has legal foothold under the Companies Act,
2013.

Theoretical Questions
1. An auditor purchased goods worth ` 501,500 on credit from a company
being audited by him. The company allowed him one month’s credit,
which it normally allowed to all known customers. Comment.
2. (a) Ram and Hanuman Associates, Chartered Accountants in practice
have been appointed as Statutory Auditor of Krishna Ltd. for the
accounting year 2017-2018. Mr. Hanuman holds 100 equity shares
of Shiva Ltd., a subsidiary company of Krishna Ltd. Comment.
(b) Managing Director of PQR Ltd. himself wants to appoint Shri
Ganpati, a practicing Chartered Accountant, as first auditor of the
company. Comment on the proposed action of the Managing
Director.
3. Under what circumstances the retiring Auditor cannot be reappointed?
4. Discuss the following:
(a) Ceiling on number of audits in a company to be accepted by an
auditor.
(b) Filling of a casual vacancy of auditor in respect of a company audit.
(c) In Joint Audit, "Each Joint Auditor is responsible only for the work
allocated to him".
5. ABC Ltd is a company incorporated in India. It has branches within and
outside India. Explain who can be appointed as an auditor of these
branches within and outside India. Also explain to whom branch auditor
is required to report.
6. Before the commencement of the audit, the joint auditors should discuss
and develop a joint audit plan. In developing the joint audit plan, the joint
auditors should identify division of audit areas and common audit
areas. Explain stating the other relevant considerations in this regard.
7. Board of Directors of MN Ltd. wants to appoint CA B, a practicing
Chartered Accountant, as an internal auditor of the company as they
believe that they could not appoint any other person as an internal
auditor other than practicing chartered accountant.
Examine the correctness of the statement of Board of Directors of MN Ltd.
with respect to provisions of Companies Act, 2013.

8. "CA. NM who is rendering management consultancy service to LA Ltd.

wants to accept offer letter for appointment as an auditor of the LA Ltd.
for the next financial year." Discuss with reference to the provision of the
9. Why Central Government permission is required, when the auditors are to
be removed before expiry of their term, but the same is not needed when
the auditors are changed after expiry of their term?
10. The practice of appointing Chartered Accountants as joint auditors is
quite widespread in big companies and corporations. Explain stating the
advantages of the joint audit.
11. According to Companies Act, 2013, the person appointed as an auditor of
the company shall sign the auditor's report in accordance with the
relevant provisions of the Act. Explain clearly the relevant provisions
relating to signing of report.
12. The auditor shall make a report to the members of the company on the
accounts examined by him. Explain with reference to relevant provisions
of the Companies Act, 2013.
13. “The role of audit committee in corporate governance is not limited to
making recommendation for appointment of auditors only.” Discuss.
14. The auditor has to make inquires on certain matters under section 143(1)
of Companies Act, 2013. Discuss these matters.
15. Discuss the purpose of cost audit. What are the legal provisions regarding
applicability of cost audit?
ANSWERS/SOLUTIONS
Answers to Correct/Incorrect
(i) Incorrect: According to section 139(7) of the Companies Act, 2013, in the
case of a Government company, the first auditor shall be appointed by
the Comptroller and Auditor- General of India within 60 days from the
date of registration of the company. If CAG fails to make the appointment
within 60 days, the Board shall appoint in next 30 days.
(ii) Incorrect: As per section 141(3) of the Companies Act, 2013, a person
shall not be eligible for appointment as an auditor of a company whose
relative is a Director or is in the employment of the Company as a director
or key Managerial Personnel.

(iii) Incorrect: As per section 141(2) of the Companies Act, 2013, where a firm
including a limited liability partnership (LLP) is appointed as an auditor of
a company, only the partners who are Chartered Accountants shall be
(iv) Incorrect: As per the provisions of the Companies Act, 2013, a person is
disqualified to be appointed as an auditor of a company if his relative is
holding any security of or interest in the company of face value exceeding
` 1 lakh.
Therefore, AB & Co. shall be disqualified for being appointed as an auditor
of XYZ Ltd. as Mr. C, the relative of Mr. B who is a partner in AB & Co., is
holding securities in XYZ Ltd. having face value of ` 2 lakh.
(v) Incorrect: The provisions of Companies Act, 2013 grant rights to the
auditor to access books of account and vouchers of the company. He is
also entitled to require information and explanations from the company.
Therefore, he has a statutory right to inspect the minute book.
(vi) Incorrect: According to section 139 of the Companies Act, 2013, the
provisions related to rotation of auditor are applicable to all private
limited companies having paid up share capital of ` 20 crore or more; and
all companies having paid up share capital of below threshold limit
mentioned above, but having public borrowings from financial
institutions, banks or public deposits of ` 50 crore or more.
Although company A is a private limited company yet it is having public
borrowings from nationalized bank of ` 50 crores, therefore it would be
governed by provisions of rotation of auditor.
(vii) Incorrect: The auditor should study the Memorandum of Association to
check the objective of the company to be carried on, amount of
authorized share capital etc. and Articles of Association to check the
internal rules, regulations and ensuring the validity of transactions relating
to accounts of the company.
To see the validity of appointment, the auditor should ensure the
compliance of the provisions of section 139, 140 and 141 of the
In addition, the auditor should study the appointment letter & the
prescribed Form submitted to the Registrar of the Companies to see the
validity of his appointment.

(viii) Incorrect: As per section 139(6) of the Companies Act, 2013, the first
auditor of a company, other than a government company, shall be
appointed by the Board of directors within 30 days from the date of
registration of the company.
Therefore, the appointment of first auditor made by the managing
director of A Ltd. is in violation of the provisions of the Companies Act,
2013.
(ix) Incorrect: As per the provisions of the Companies Act, 2013, a person is
disqualified to be appointed as an auditor of a company if he is holding
any security of or interest in the company.
As the chartered accountant is holding securities of S Ltd. having face
value of ` 950, he is not eligible for appointment as an auditor of S Ltd.
(x) Incorrect: As per section 141 of the Companies Act, 2013, a person shall
be eligible for appointment as an auditor of a company only if he is a
chartered accountant.
Thus, Mr. N is disqualified to be appointed as an auditor of XYZ Limited.
(xi) Correct: Where a company is required to constitute an Audit Committee
under section 177, all appointments, including the filling of a casual
vacancy of an auditor under this section shall be made after taking into
account the recommendations of such committee.
(xii) Incorrect- As per section 139(5), in the case of a Government company
or any other company owned or controlled, directly or indirectly, by the
Central Government, or by any State Government or Governments, or
partly by the Central Government and partly by one or more State
Governments, the Comptroller and Auditor-General of India shall, in
respect of a financial year, appoint an auditor duly qualified to be
appointed as an auditor of companies under this Act, within a period of
180 days from the commencement of the financial year, who shall hold
office till the conclusion of the annual general meeting.
(xiii) Incorrect: As per section140(2) of the Companies Act, 2013, the auditor
who has resigned from the company shall file within a period of 30 days
from the date of resignation, a statement in the prescribed Form ADT–
3(as per Rule 8 of CAAR) with the company and the Registrar.
(xiv) Correct: Where a company is required to constitute an Audit Committee
under section 177, all appointments, including the filling of a casual

vacancy of an auditor under this section shall be made after taking into
account the recommendations of such committee.
(xv) Incorrect: Section 141(2) of the Companies Act, 2013 states that where
a firm including a limited liability partnership is appointed as an auditor
of a company, only the partners who are chartered accountants shall be
(xvi) Incorrect. Under Section 177 of Companies Act, 2013 read together with
Rule 4 of Companies( Appointment and qualification of Directors) Rules,
2014 prescribe that audit committee is to be constituted by every listed
public company and following classes of public companies only:-
(i) the Public Companies having paid up share capital of ten crore
rupees or more; or
(ii) the Public Companies having turnover of one hundred crore rupees
or more; or
(iii) the Public Companies which have, in aggregate, outstanding loans,
debentures and deposits, exceeding fifty crore rupees:
Hence, the statement that all public companies are required to constitute
audit committee is incorrect.
(xvii) Incorrect. The provisions of cost audit are not applicable in case of
companies having revenue from exports in foreign exchange being more
than 75% of its total revenue. As the company is having export turnover
of Rs.88 crore in total revenues of Rs.100 core, the provisions of cost audit
are not applicable to the said company.
(xviii) Incorrect: Under provisions of Section 143 of the companies Act, 2013,
auditor has to report whether the company has adequate internal financial
controls with reference to financial statements in place and operating
effectiveness of such controls. The auditor has to report on adequacy and
effectiveness of internal financial controls only and not internal controls.
(xix) Incorrect: Fraud of Rs.100.00 lakhs or above (i.e. Rs.1.00 crore or above)
has to be reported to Central government ( precisely to Secretary, Ministry
of Corporate affairs) in Form ADT-4.
(xx) Correct: Under provisions of section 139(3), the members of a company
may resolve to provide that audit shall be conducted by more than one
auditor. Hence, the concept of “joint audit” has legal foothold also under

Answers to Theoretical Questions

1. Purchase of Goods on Credit by the Auditor: Section 141(3)(d)(ii) of the
Companies Act, 2013 specifies that a person shall be disqualified to act as an
auditor if he is indebted to the company for an amount exceeding five lakh
rupees.
Where an auditor purchases goods or services from a company audited
by him on credit, he is definitely indebted to the company and if the
amount outstanding exceeds rupees five lakh, he is disqualified for
appointment as an auditor of the company.
It will not make any difference if the company allows him the same period
of credit as it allows to other customers on the normal terms and
conditions of the business. The auditor cannot argue that he is enjoying
only the normal credit period allowed to other customers. In fact, in such
a case he has become indebted to the company and consequently he has
deemed to have vacated his office.
2. (a) Auditor Holding Securities of a Company: As per sub-section
(3)(d)(i) of Section 141 of the Companies Act, 2013 read with Rule
10 of the Companies (Audit and Auditors) Rule, 2014, a person shall
not be eligible for appointment as an auditor of a company, who, or
his relative or partner is holding any security of or interest in the
company or its subsidiary, or of its holding or associate company or
a subsidiary of such holding company. However, the relative may
hold security or interest in the company of face value not exceeding
` 1 lakh.
Also, as per sub-section 4 of Section 141 of the Companies Act,
2013, where a person appointed as an auditor of a company incurs
any of the disqualifications mentioned in sub-section (3) after his
appointment, he shall vacate his office as such auditor and such
vacation shall be deemed to be a casual vacancy in the office of the
auditor.
In the present case, Mr. Hanuman, Chartered Accountant, a partner
of M/s Ram and Hanuman Associates, holds 100 equity shares of
Shiva Ltd. which is a subsidiary of Krishna Ltd. Therefore, the firm,
M/s Ram and Hanuman Associates would be disqualified to be
appointed as statutory auditor of Krishna Ltd., which is the holding

company of Shiva Ltd., because one of the partners Mr. Hanuman is

holding equity shares of its subsidiary.
(b) Appointment of First Auditor of Company: Section 139(6) of the
Companies Act, 2013 lays down that the first auditor or auditors of
a company shall be appointed by the Board of directors within 30
days from the date of registration of the company.
In the instant case, the appointment of Shri Ganapati, a practicing
Chartered Accountant as first auditors by the Managing Director of
PQR Ltd. by himself is in violation of Section 139(6) of the
Companies Act, 2013, which authorizes the Board of Directors to
appoint the first auditor of the company within 30 days of
In view of the above, the Managing Director of PQR Ltd. should be
advised not to appoint the first auditor of the company.
3. Circumstances where Retiring Auditor Cannot be Reappointed: In the
following circumstances, the retiring auditor cannot be reappointed-
(i) A specific resolution has not been passed to reappoint the retiring
auditor.
(ii) The auditor proposed to be reappointed does not possess the
qualification prescribed under section 141 of the Companies Act,
2013.
(iii) The proposed auditor suffers from the disqualifications under
section 141(3), 141(4) and 144 of the Companies Act, 2013.
(iv) He has given to the company notice in writing of his unwillingness
to be reappointed.
(v) A resolution has been passed in AGM appointing somebody else or
providing expressly that the retiring auditor shall not be
reappointed.
(vi) A written certificate has not been obtained from the proposed
auditor to the effect that the appointment or reappointment, if
made, will be in accordance within the limits specified under section
141(3)(g) of the Companies Act, 2013.
4. Hints:
(a) Refer Para 7 Ceiling on number of Audits.

(b) Refer Para 2.3 Filling of a Casual Vacancy

(c) Refer Para 12 Joint Audit.
5. Sub-section (8) of section 143 of the Companies Act, 2013, prescribes the
duties and powers of the company’s auditor with reference to the audit
of the branch and the branch auditor. Where a company has a branch
office, the accounts of that office shall be audited either by the auditor
appointed for the company (herein referred to as the company's auditor)
under this Act or by any other person qualified for appointment as an
auditor of the company under this Act and appointed as such under
section 139, or where the branch office is situated in a country outside
India, the accounts of the branch office shall be audited either by the
company's auditor or by an accountant or by any other person duly
qualified to act as an auditor of the accounts of the branch office in
accordance with the laws of that country and the duties and powers of
the company' s auditor with reference to the audit of the branch and the
branch auditor, if any, shall be such as may be prescribed:
It may be noted that the branch auditor shall prepare a report on the
accounts of the branch examined by him and send it to the auditor of the
company who shall deal with it in his report in such manner as he
considers necessary.
Further as per rule 12 of the Companies (Audit and Auditors) Rules, 2014,
the branch auditor shall submit his report to the company’s auditor and
reporting of fraud by the auditor shall also extend to such branch auditor
to the extent it relates to the concerned branch.
6. Before the commencement of the audit, the joint auditors should
discuss and develop a joint audit plan. In developing the joint audit
plan, the joint auditors should:
(a) identify division of audit areas and common audit areas;
(b) ascertain the reporting objectives of the engagement;
(c) consider and communicate among all joint auditors the factors that
are significant
(d) in directing the engagement team’s efforts;
(e) consider the results of preliminary engagement activities, or similar
engagements performed earlier.

(f) ascertain the nature, timing and extent of resources necessary to

accomplish the engagement.
(7) 1. As per section 138, the internal auditor shall either be a chartered
accountant or a cost accountant (whether engaged in practice or
not).
2. Or such other professional as may be decided by the Board to
conduct internal audit of the functions and activities of the
companies.
3. The internal auditor may or may not be an employee of the
company.
Hence, the belief of Company is not correct.
8. Section 141(3)(i) of the Companies Act, 2013 disqualifies a person for
appointment as an auditor of a company who is engaged as on the date
of appointment in management consultancy service as provided in
section 144. Section 144 of the Companies Act, 2013 prescribes certain
services not to be rendered by the auditor which are as under:
(i) Accounting and book keeping services
(ii) Internal audit.
(iii) Design and implementation of any financially information system.
(iv) Actuarial services
(v) Investment advisory services.
(vi) Investment banking services.
(vii) Rendering of outsourced financial services
(viii) Management services and
(ix) Any other kind of services as may be prescribed
Therefore, CA. NM is advised not to accept the assignment of auditing as
the management consultancy service is specifically notified in the list of
services not to be rendered by him as per section 141(3)(i) read with
section 144 of the Companies Act, 2013.
9. Permission of Central Government for Removal of Auditor Under
Section 140(1) of the Companies Act, 2013: Removal of auditor before
expiry of his term i.e. before he has submitted his report is a serious
matter and may adversely affect his independence.

Further, in case of conflict of interest the shareholders may remove the

auditors in their own interest.
Therefore, law has provided this safeguard so that central government
may know the reasons for such an action and if not satisfied, may not
accord approval.
On the other hand if auditor has completed his term i.e. has submitted his
report and thereafter he is not re-appointed then the matter is not serious
enough for central government to call for its intervention.
In view of the above, the permission of the Central Government is required
when auditors are removed before expiry of their term and the same is
not needed when they are not re-appointed after expiry of their term.
10. Joint Audit: The practice of appointing Chartered Accountants as joint
auditors is quite widespread in big companies and corporations. Joint
audit basically implies pooling together the resources and expertise of
more than one firm of auditors to render an expert job in a given time
period which may be difficult to accomplish acting individually. It
essentially involves sharing of the total work. This is by itself a great
advantage.
In specific terms the advantages that flow may be the following:
(i) Sharing of expertise.
(ii) Advantage of mutual consultation.
(iii) Lower workload.
(iv) Better quality of performance.
(v) Improved service to the client.
(vi) Displacement of the auditor of the company taken over in a
takeover often obviated.
(vii) In respect of multi-national companies, the work can be spread
using the expertise of the local firms which are in a better position
to deal with detailed work and the local laws and regulations.
(viii) Lower staff development costs.
(ix) Lower costs to carry out the work.
(x) A sense of healthy competition towards a better performance

11. Duty to Sign the Audit Report: As per section 145 of the Companies
Act, 2013, the person appointed as an auditor of the company shall sign
the auditor's report or sign or certify any other document of the company,
in accordance with the provisions of section 141(2).
Section 141(2) of the Companies Act, 2013 states that where a firm
including a limited liability partnership is appointed as an auditor of a
company, only the partners who are chartered accountants shall be
The qualifications, observations or comments on financial transactions or
matters, which have any adverse effect on the functioning of the company
mentioned in the auditor's report shall be read before the company in
general meeting.
12. Right to report to the members of the company on the accounts
examined by him – The auditor shall make a report to the members of
the company on the accounts examined by him and on every financial
statements which are required by or under this Act to be laid before the
company in general meeting and the report shall after taking into account
the provisions of this Act, the accounting and auditing standards and
matters which are required to be included in the audit report under the
provisions of this Act or any rules made there under or under any order
made under this section and to the best of his information and
knowledge, the said accounts, financial statements give a true and fair
view of the state of the company’ s affairs as at the end of its financial
year and profit or loss and cash flow for the year and such other matters
as may be prescribed.
13. Audit committee performs wide functions. The recommendation for
appointment of auditors is only one of the several functions performed
by audit committee. Under section 177 of companies Act, 2013, audit
committee is responsible for following actions :-
(i) the recommendation for appointment, remuneration and terms of
appointment of auditors of the company;]
(ii) review and monitor the auditor’s independence and performance,
and effectiveness of audit process;
(iii) examination of the financial statement and the auditors’ report
thereon;

(iv) approval or any subsequent modification of transactions of the

company with related parties;
(v) scrutiny of inter-corporate loans and investments;
(vi) valuation of undertakings or assets of the company, wherever it is
necessary;
(vii) evaluation of internal financial controls and risk management
systems;
(viii) monitoring the end use of funds raised through public offers and
related matters.
Hence, audit committee oversees range of matters including those related
to making recommendation for appointment of auditors etc.
14. The auditor has to make inquires on following matters under section
143(1) of Companies Act, 2013:-
(a) whether loans and advances made by the company on the basis of
security have been properly secured and whether the terms on
which they have been made are prejudicial to the interests of the
company or its members;
(b) whether transactions of the company which are represented merely
by book entries are prejudicial to the interests of the company;
(c) where the company not being an investment company or a banking
company, whether so much of the assets of the company as consist
of shares, debentures and other securities have been sold at a price
less than that at which they were purchased by the company;
(d) whether loans and advances made by the company have been
shown as deposits;
(e) whether personal expenses have been charged to revenue account;
(f) where it is stated in the books and documents of the company that
any shares have been allotted for cash, whether cash has actually
been received in respect of such allotment, and if no cash has
actually been so received, whether the position as stated in the
account books and the balance sheet is correct, regular and not
misleading

15. The purpose of cost audit is to verify the cost of manufacture or

production of any article, on the basis of accounts as regards utilisation
of material or labour or other items of costs, maintained by the company.
Rule 4 of the Companies (Cost Records and Audit) Rules, 2014 states the
provisions related to cost audit are applicable depending on the turnover
of the company as follows-
(i) Classes of companies specified under item (A) “Regulated Sectors”
are required to get its cost records audited if the overall annual
turnover of the company from all its products and services during
the immediately preceding financial year is ` 50 crore or more and
the aggregate turnover of the individual product(s) or service(s) for
which cost records are required to be maintained under rule 3 is
` 25 crore or more.
(ii) Classes of companies specified under item (B) “Non-Regulated
Sectors” are required to get its cost records audited if the overall
annual turnover of the company from all its products and services
during the immediately preceding financial year is ` 100 crore or
more and the aggregate turnover of the individual product(s) or
service(s) for which cost records are required to be maintained
under rule 3 is ` 35 crore or more.
However, the requirement for cost audit does not apply to the following
companies:-
(i) whose revenue from exports, in foreign exchange, exceeds seventy
five per cent of its total revenue; or
(ii) Which is operating from a special economic Zone.
(iii) which is engaged in generation of electricity for captive
consumption through Captive Generating PIant.

PART – II: QUESTIONS AND ANSWERS
QUESTIONS
PART – II A: Multiple Choice Questions based on Case Scenarios

Case Scenario - 1
Suresh Rana & Associates have been appointed as the statutory auditors of HAIL Ltd. by the
Comptroller & Auditor General for the FY 2019-20. HAIL Ltd. is a Government company
engaged in the manufacture of metro train coaches. During the course of audit, CA Suresh
extended his scope of audit to cover efficiency, effectiveness and economy audit. CA Suresh
Rana also asked his audit team to conduct expenditure audit as part of the audit engagement
of HAIL Ltd.
During the course of audit, CA Suresh also found that the company has constructed its new
stockyard for parking its metro coaches and maintenance of its metro coaches. However, the
stockyard was not being used by the company for the designated purpose and the company
continued using the rented stockyard. Suresh considered such expenditure as infructuous and
avoidable expenditure.
The engagement partner also discussed with his team regarding the areas to be covered while
conducting the audit of receipts. The reporting responsibilities of the engagement te am were
also discussed by the engagement partner with his team.
Based on the above facts, answer the following:-
1. Statement 1: Government audit provides public accounting of operational, management
programme and policy aspects of public administration as well as accountability of officials
administering them.
Statement 2: Government audit is equipped and intended to function as an investigating
agency, to pursue every irregularity or misdemeanour to its logical end.
(a) Only statement 1 is correct
(b) Only statement 2 is correct
(c) Both 1 & 2 are correct
(d) Both 1 & 2 are incorrect
2. ………….. is conducted to ensure that the various programmes, schemes, and projects
where large financial expenditure have been incurred are run economically and are yiel ding
results expected of them:-
(a) Propriety audit
(b) Audit against Rules and orders

(c) Performance Audit

(d) Audit against Provision of funds
3. While conducting audit against provision of funds, the statutory auditors, M/s Suresh Rana
& Associates must check:-
(a) That each item of expenditure is covered by a sanction either general or special of a
competent authority.
(b) That the expenditure incurred has been on the purpose for which the grant and
appropriation has been provided and the amount of expenditure does not exceed the
appropriation made.
(c) That the expenditure conforms to the relevant provision of the constitution.
(d) That the expenditure is in accordance with the financial rules, regulations and orders
issued by the competent authority.
4. Which part of expenditure audit covers the scrutiny of the expenditure incurred on the
construction of stockyard by the company which is considered as infructuous and avoidable
by CA Suresh Rana?
(a) Propriety Audit
(b) Audit against provision of funds
(c) Audit of sanctions
(d) Performance Audit
5. While conducting the audit of receipts of HAIL Ltd., which of the following area is to be
covered as part of Audit of Receipts?
1. Whether all revenues or other debts due to government have been correctly
assessed, realised and credited to government account by the designated authorities
of HAIL Ltd.
2. Whether adequate checks are imposed to ensure the prompt detection and
investigation of irregularities, double refunds, fraudulent or forged refund vouchers or
other loss of revenue through fraud or wilful omission or negligence to levy or collect
taxes or to issue refunds.
3. Whether the expenditure incurred has been on the purpose for which the grant and
appropriation had been provided and that the amount of such expenditure does not
exceed the appropriation made.
4. Whether the various schemes/projects are executed and their operations conducted
economically and whether they are yielding the results expected of them.
(b) Statements 1 & 2 are correct

(c) Statements 1,2,3,4 are correct

(d) Statements 1,2,3 are correct
Case Scenario - 2
RS & Associates have been appointed as the statutory auditors of MNO Ltd. for the Financial
Year 2019-20. CA Ramesh is the engagement partner for the assignment. The management of
MNO Ltd. has duly given a written representation letter to CA Ramesh regarding
acknowledgement of its responsibility for the implementation and operation of accounting
system and the internal control system of the company. The management has assured the audit
firm that such accounting and internal control systems are designed and implemented to prevent
and detect any misstatement on account of fraud or error.
During the course of audit, the auditor found that the wages cost has increased substantially as
compared to the last year. On detailed checking CA Ramesh found that many new workers have
been added to the workers list which appear to be dummy workers to CA Ramesh.
Further the auditor found that there was a fraud amounting to Rs. 2 crores committed during the
year under audit by an officer of the company. Such fraud has already been reported by the
Cost Accountant of the company, Mr. Sudesh, to the Central Government. The statutory auditors
are considering their reporting responsibilities in this regard.
The audit team also realized that there is inadequate Internal Control System with respect to
the following:
• The system of authorization and approval of transactions specially in the process of making
purchases.
• The system of record keeping with respect to the assets.
Based on the above facts, answer the following:-
1. As the management of MNO Ltd. has given a written representation regarding its
responsibility for prevention and detection of misstatement on account of fraud and error,
M/s RS & Associates:-
(a) Should rely on such management representation and conduct its audit procedures
without wasting much time and resources towards detection of fraud and error.
(b) Should not consider such management representation as a substitute for obtaining
sufficient and appropriate audit evidence and design its audit procedures accordingly.
(c) Should not rely on such management representation and should obtain written
representation from those charged with governance.
(d) Should concentrate on audit of accounting system and accounting policies so used
by the company as the prevention and detection of fraud and error is the responsibility
of the management.

2. The inclusion of dummy workmen in the workmen list by the management of MNO Ltd. as
noticed by CA Ramesh amounts to:-
(a) Suppressing cash receipts
(b) Casting wrong total in cash book
(c) Inflating cash payment
(d) Misappropriation of goods
3. With respect to the fraud which has already been reported by The Cost acco untant of the
company, Mr. Sudesh, what is the responsibility of M/s RS & Associates in this regard?
(a) Since the reporting has been done to the Central Government by the cost accountant
of the company, the statutory auditor has no responsibility for such fraud and its
reporting.
(b) The cost accountant has detected and reported the fraud to the Central Government.
The statutory auditor should not interfere in the work of the Cost Accountant.
(c) CA Ramesh should review the steps taken by the management with respect to the
reported fraud and if he is not satisfied with such steps, he should request the
management to perform additional procedures to enable him to satisfy himself that
the matter has been appropriately addressed.
(d) CA Ramesh should obtain written representation from the management that once the
matter is appropriately addressed, he will be duly informed by the management.
4. ……………..refers to events or conditions that indicate an incentive or pressure to commit
fraud or provide an opportunity to commit fraud:-
(a) Fraud Risk Factors
(b) Misappropriation of assets
(c) Incentives/ Pressures
(d) Fraud
5. Statement 1: The risk of auditor not detecting a material misstatement resulting from
employee fraud is greater than for management fraud.
Statement 2: The risk of not detecting a material misstatement resulting from fraud is
higher than the risk of not detecting one resulting from error.
(b) Only statement 2 is correct
(c) Both 1 & 2 are correct
(d) Both 1 & 2 are incorrect

General MCQs
1. ………..is a possible obligation that arises from the past events and whose existence will
be confirmed only by the occurrence/ non occurrence of one or more uncertain future
events not wholly within the control of the entity:-
(a) Provisions
(b) Reserves
(c) Contingent Liabilities
(d) Liability
2. In relation to completed engagements, procedures designed to provide evidence of
compliance by engagement teams with the firm’s quality control policies and procedures
is known as :
(a) Monitoring
(b) Inspection
(c) Subsequent Audit procedures
(d) Compliance procedures
3. The concept of materiality is applied by the auditor :
(a) in planning and performing the audit
(b) in evaluating the effect of identified misstatements on the audit
(c) both in planning and performing the audit, and in evaluating the effect of identified
misstatements on the audit
(d) none of the above is correct
4. ___________ in which the auditor selects the sample without following a structured
technique.
(a) Haphazard selection,
(b) Monetary Unit Sampling
(c) Block Sampling
(d) Structured Sampling
5. The persons with responsibility for overseeing the strategic direction of the entity and
obligations related to the accountability of the entity are :
(a) management
(b) those charged with governance
(c) audit committee
(d) board of directors

PART II B – DESCRIPTIVE QUESTIONS

1. State with reason (in short) whether the following statements are true or false:
(i) Familiarity threats, which occur when auditors are deterred from acting objectively
with an adequate degree of professional skepticism. Basically, these could happen
because of threat of replacement over disagreements with the application of
accounting principles, or pressure to disproportionately reduce work in response to
reduced audit fees.
(ii) The auditor’s opinion helps determination of the true and correct view of the financial
position and operating results of an enterprise.
(iii) When establishing the overall audit strategy, the auditor need not determine
materiality for the financial statements as a whole.
(iv) The policy of income recognition, in case of a Bank, should be subjective.
(v) The assignment is the creation of an equitable charge which is created in favor of the
lending bank by execution of hypothecation agreement in respect of the moveable
securities belonging to the borrower.
(vi) As per SA 240 the primary responsibility for the prevention and detection of fraud
rests with Auditors.
(vii) Article 151 of the Constitution provides that the accounts of the Union and of the
States shall be kept in such form as the President may on the advice of the C&AG
prescribe.
(viii) In considering the qualitative aspects of the entity’s accounting practices, the auditor
may become aware of possible bias in management’s judgments.
Chapter 1 - Nature, Objective and Scope of Audit
2. (a) On recurring audits, the auditor shall assess whether circumstances require the terms
of the audit engagement to be revised and whether there is a need to remind the
entity of the existing terms of the audit engagement. The auditor may decide not to
send a new audit engagement letter or other written agreement each period. Explain
the factors an auditor considers to be appropriate to revise the terms of the audit
engagement or to remind the entity of existing terms.
(b) The Chartered Accountant has a responsibility to remain independent by taking into
account the context in which they practice, the threats to independence and the
safeguards available to eliminate the threats. Explain the guiding principles in this
regard.
3. (a) Discuss preconditions for an audit as per SA 210. Explain how would an auditor
proceed to establish the presence of pre conditions for an audit.
(b) Through its policies and procedures, the firm seeks to establish consistency in the
quality of engagement performance. This is often accomplished through written or

electronic manuals, software tools or other forms of standardized documentation,

and industry or subject matter-specific guidance materials. Explain the matters to be
addressed in this context.
Chapter 2 - Audit Strategy, Audit Planning and Audit Programme
4. (a) Without adequate knowledge of client’s business, a proper audit is not possible. It is
one of the important principles in developing an overall audit plan. Explain in context
with relevant SA, knowledge to be obtained by the auditor in establishing overall plan.
Also explain how such an understanding would be helpful to the auditor.
(b) Planning is not a discrete phase of an audit, but rather a continual and iterative
process that often begins shortly after the completion of the previous audit and
continues until the completion of the current audit engagement. Planning includes the
need to consider certain matters prior to the auditor’s identification and assessment
of the risks of material misstatement. Explain clearly stating those matters also .
5. (a) The auditor’s determination of materiality is a matter of professional judgment, and is
affected by the auditor’s perception of the financial information needs of users of the
financial statements. In this context, explain the auditor’s assumptions about users of
the financial statements.
(b) Financial reporting frameworks often discuss the concept of materiality in the context
of the preparation and presentation of financial statements. Explain
Chapter 3 - Audit Documentation and Audit Evidence
6. (a) A new team member of GSR & Co., the auditors of Esteem Limited, was of the view
that Audit Documentation would not serve any purpose at any stage of Audit. Explain.
(b) While documenting the nature, timing and extent of audit procedures performed in
case of audit of PQR Ltd, explain the important matters its auditor should record.
7. (a) When information to be used as audit evidence has been prepared using the work of
a management’s expert and having regard to the significance of expert’s work for the
auditor’s purposes, explain the considerations auditor would consider for the
purposes of his audit.
(b) When performing risk assessment procedures as required by SA 315, the auditor
shall consider whether events or conditions exist that may cast significant doubt on
the entity’s ability to continue as a going concern. In so doing, the auditor has
determined that management of XYZ Ltd has already performed a preliminary
assessment of the entity’s ability to continue as a going concern. Explain how would
auditor of XYZ Ltd proceed in the above case.
Also explain how would the auditor proceed if such an assessment has not yet been
performed by the management.

8. (a) Under the going concern basis of accounting, the financial statements are prepared
on the assumption that the entity is a going concern and will continue its operations
for the foreseeable future. Explain. Also discuss the objectives of an auditor regarding
Going concern as per relevant standard on auditing.
(b) as described in SA 200, the potential effects of inherent limitations on the auditor’s
ability to detect material misstatements are greater for future events or conditions that
may cause an entity to cease to continue as a going concern. Explain stating the
auditor’s responsibilities with regard to going concern.
Chapter 4 - Risk Assessment and Internal Control
9. (a) Auditor GR and Associates have been appointed to conduct audit of PNG Ltd, a
manufacturing company engaged in manufacturing of various food items. While
planning an audit, the auditors do not think that it would be necessary to understand
internal controls. Advise the auditor in this regard explaining clearly the benefits of
understanding the internal control.
(b) Factors relevant to the auditor’s judgment about whether a control, individually or in
combination with others, is relevant to the audit may include such matters as
materiality, the significance of the related risk etc. Explain in detail.
10. (a) The auditor shall obtain an understanding of the information system, including the
related business processes, relevant to financial reporting, including the classes of
transactions in the entity’s operations that are significant to the financial statements,
controls surrounding journal entries etc. Explain the other considerations in this
regard.
(b) The auditor shall obtain an understanding of control activities relevant to the audit,
which the auditor considers necessary to assess the risks of material misstatement.
Explain in detail stating clearly the meaning of control activities and also discuss
control activities that are relevant to the audit.
Chapter 5 - Fraud and Responsibilities of the Auditor in this Regard.
11. Where the auditor notices that any fraud by the company or on the company by its officers
or employees has been noticed by or reported during the year, the auditor should, apart
from reporting the existence of fraud, also report under clause (x) of paragraph 3 of
Companies (Auditor’s Report) Order, 2016, the nature of fraud and amount involved.
Explain the considerations an auditor would keep in mind for reporting under this clause.
12. The primary responsibility for the prevention and detection of fraud rests with both those
charged with governance of the entity and management. Explain.
Chapter 6 - Audit in an Automated Environment
13. Objective of Data Center and Network Operations is to ensure that production systems are
processed to meet financial reporting objectives. Discuss the activities performed by Data
Center and Network operations. Also explain the meaning of General IT Controls in detail.

14. Data analytics can be used in testing of electronic records and data residing in IT systems
using spreadsheets and specialised audit tools viz., IDEA and ACL to perform the selection
of audit samples. Explain giving other relevant points also in the above context of data
analytics.
Chapter 7- Audit Sampling
15. Explain the following terms with reference to Audit Sampling :
(i) Stratification
(ii) Tolerable misstatement
(iii) Tolerable rate of deviation
16. In most of the circumstances, the evidence available is not conclusive and the auditor
always takes a calculated risk in giving his opinion. Even by undertaking hundred percent
checking of the transactions, the auditor does not derive absolute satisfaction. This state
of uneasiness led pragmatic auditors to adopt the statistical theory of sampling to derive
the necessary satisfaction about the state of affairs by checking only a part of the total
population of entries. Explain in detail.
Chapter 8 - Analytical Procedures
17. The design of a substantive analytical procedure is limited only by the availability of reliable
data and the experience and creativity of the audit team. In this context, d iscuss the
techniques available as Substantive Analytical Procedures.
18. Mention the Analytical Review procedures that may be useful as a means of obtaining audit
evidence regarding various assertions relating to Trade receivables, loans and advances.
Chapter 9 - Audit of Items of Financial Statements
19. List out the steps to be taken by auditor while vouching/ verifying the 'Refund of General
Insurance premium paid'.
20. Newton Ltd. has made loans and advances on the basis of following securities to various
borrowers. As an auditor what type of documents can be verified to ensure that the
company holds a legally enforceable security?
(i) Shares and Debentures
(ii) Life Insurance Policy
(iii) Hypothecation of goods.
Chapter 10 - The Company Audit
21. During the audit of PQR Ltd. you as an auditor requested officers of the company to have
access to secretarial records and correspondence which they refused to provide.
Comment.

22. In exercise of the powers conferred by the Chartered Accountants Act, 1949, the Council
of the Institute of Chartered Accountants of India specifies that a member of the Institute
in practice shall be deemed to be guilty of professional misconduct, if he holds at any time
appointment of more than the “specified number of audit assignments of the companies
under Section 141(3)(g) of the Companies Act, 2013).
Explain the provisions prescribed under Companies Act, 2013 in respect of ceili ng on
number of audits in a company to be accepted by an auditor.
23. Discuss the Provisions regarding appointment of Auditors -
(i) First auditor of a Government company and a Non-Government company.
(ii) Subsequent auditor of a Government company and a Non- Government company.
Chapter 11 - Audit Report
24. The Auditor is fully satisfied with the audit of an entity in respect of its systems and
procedures and wants to issue a report without any hesitation. Discuss the type of opinion
that can be given and state giving reasoning.
25. The requirements of SA 700 are aimed at addressing an appropriate balance between the
need for consistency and comparability in auditor reporting globally. Explain
Chapter 12 - Bank Audit
26. Your firm of auditors, SRG & Co., has been appointed as Statutory Central Auditors of
Reliable Bank. Explain the reporting requirements of the Statutory Central Auditors (SCAs)
in addition to their main audit report.
27. Advances generally constitute the major part of the assets of the bank. There are large
number of borrowers to whom variety of advances are granted. The audit of advances
requires the major attention from the auditors. Explain the broad considerations about
which the auditor is primarily concerned with obtaining evidence in carrying out audit of
advances.
Chapter 13- Audit of Different Types of Entities
28. (a) Government audit has not only adopted the basic essentials of auditing as known and
practised in the profession to suit the requirements of governmental transactions but
has also added new concepts, techniques and procedures to the audit profession.
Explain stating clearly the definition of Government auditing as discussed in U.N.
Handbook on Govt Auditing and Developing Countries and also state Objectives of
Govt audit.
(b) Government audit is neither equipped nor intended to function as an investigating
agency, to pursue every irregularity or misdemeanour to its logical end. Explain

SUGGESTED ANSWERS
ANSWERS - MULTIPLE CHOICE QUESTIONS- Case Scenario-1

1. (a)
2. (c)
3. (b)
4. (a)
5. (b)
ANSWERS - MULTIPLE CHOICE QUESTIONS- Case Scenario-2
1. (b)
2. (c)
3. (c)
4. (a)
5. (b)
General MCQ’s
1 (c)
2 (b)
3 (c)
4 (a)
5 (b)
Descriptive Answers
1. (i) Incorrect: Intimidation threats, which occur when auditors are deterred from acting
objectively with an adequate degree of professional skepticism. Basically, these could
happen because of threat of replacement over disagreements with the application of
accounting principles, or pressure to disproportionately reduce work in response to
reduced audit fees.
Familiarity threats are self-evident, and occur when auditors form relationships with
the client where they end up being too sympathetic to the client’s interests.
(ii) Incorrect: The auditor’s opinion helps determination of the true and fair view of the
financial position and operating results of an enterprise.
(iii) Incorrect : When establishing the overall audit strategy, the auditor shall determine
materiality for the financial statements as a whole.

(iv) Incorrect: The policy of income recognition should be objective and based on record
of recovery rather than on any subjective considerations. Income from non-performing
assets (NPA) is not recognized on accrual basis but is booked as income only when
it is actually received.
(v) Incorrect: The hypothecation is the creation of an equitable charge (i.e., a charge
created not by an express enactment but by equity and reason), which is created in
favor of the lending bank by execution of hypothecation agreement in respect of the
moveable securities belonging to the borrower.
Assignment represents a transfer of an existing or future debt, right or property
belonging to a person in favor of another person.
(vi) Incorrect: As per SA 240 the primary responsibility for the prevention and detection
of fraud rests with management. An auditor conducting an audit in accordance with
SAs is responsible for obtaining reasonable assurance that the financial statements
are free from material misstatement, whether caused by fraud or error.
(vii) Incorrect: Article 150 of the Constitution provides that the accounts of the Union and
of the States shall be kept in such form as the President may on the advice of the
C&AG prescribe.
Article 151 requires that the reports of the C&AG relating to the accounts of the
Union/State shall be submitted to the President/Governor who shall cause them to be
laid before House of Parliament/State Legislature.
(viii) Correct: In considering the qualitative aspects of the entity’s accounting practices,
the auditor may become aware of possible bias in management’s judgments. The
auditor may conclude that lack of neutrality together with uncorrected misstatements
causes the financial statements to be materially misstated.
2. (a) On recurring audits, the auditor shall assess whether circumstances require the terms
of the audit engagement to be revised and whether there is a need to remind the
entity of the existing terms of the audit engagement.
The auditor may decide not to send a new audit engagement letter or other written
agreement each period. However, the following factors may make it appropriate to
revise the terms of the audit engagement or to remind the entity of existing terms:
 Any indication that the entity misunderstands the objective and scope of the
audit.
 Any revised or special terms of the audit engagement.
 A recent change of senior management.
 A significant change in ownership.
 A significant change in nature or size of the entity’s business.

 A change in legal or regulatory requirements.

 A change in the financial reporting framework adopted in the preparation of the
 A change in other reporting requirements.
(b) The Chartered Accountant has a responsibility to remain independent by taking into
account the context in which they practice, the threats to independence and the
safeguards available to eliminate the threats.
The following are the guiding principles in this regard: -
(i). For the public to have confidence in the quality of audit, it is essential that
auditors should always be and appears to be independent of the entities that
they are auditing.
(ii). In the case of audit, the key fundamental principles are integrity, objectivity and
professional skepticism, which necessarily require the auditor to be
independent.
(iii). Before taking on any work, an auditor must conscientiously consider whether it
involves threats to his independence.
(iv). When such threats exist, the auditor should either desist from the task or put in
place safeguards that eliminate them.
(v). If the auditor is unable to fully implement credible and adequate safeguards,
then he must not accept the work.
3. (a) As per SA 210 “Agreeing the Terms of Audit Engagements”, preconditions for an
audit may be defined as the use by management of an acceptable financial reporting
framework in the preparation of the financial statements and the agreement of
management and, where appropriate, those charged with governance to the premise
on which an audit is conducted.
In order to establish whether the preconditions for an audit are present, the
auditor shall:
(a) Determine whether the financial reporting framework is acceptable; and
(b) Obtain the agreement of management that it acknowledges and understands its
responsibility:
(i) For the preparation of the financial statements in accordance with the
applicable financial reporting framework;
(ii) For the internal control as management considers necessary; and
(iii) To provide the auditor with:

➢ Access to all information such as records, documentation and other

matters;
➢ Additional information that the auditor may request from management
for the purpose of the audit; and
➢ Unrestricted access to persons within the entity from whom the
auditor determines it necessary to obtain audit evidence.
(b) The firm should establish policies and procedures designed to provide it with
reasonable assurance that engagements are performed in accordance with
professional standards and regulatory and legal requirements, and that the firm or the
engagement partner issues reports that are appropriate in the circumstances.
Through its policies and procedures, the firm seeks to establish consistency in the
quality of engagement performance. This is often accomplished through written or
electronic manuals, software tools or other forms of standardized documentation,
and industry or subject matter-specific guidance materials. Matters addressed include
the following:
 How engagement teams are briefed on the engagement to obtain an
understanding of the objectives of their work.
 Processes for complying with applicable engagement standards.
 Processes of engagement supervision, staff training and coaching.
 Methods of reviewing the work performed, the significant judgments made and
the form of report being issued.
 Appropriate documentation of the work performed and of the timing and extent
of the review.
 Processes to keep all policies and procedures current.
4. (a) Without adequate knowledge of client’s business, a proper audit is not possible. It is
one of the important principles in developing an overall audit plan. As per SA-315,
“Identifying and Assessing the Risk of Material Misstatement through Understanding
the Entity and Its Environment”, the auditor shall obtain an understanding of the
following:
(a) Relevant industry, regulatory and other external factors including the applicable
financial reporting framework.
(b) The nature of the entity, including:
(i) its operations;
(ii) its ownership and governance structures;
(iii) the types of investments that the entity is making and plans to make,

including investments in special-purpose entities; and

(iv) the way that the entity is structured and how it is financed;
to enable the auditor to understand the classes of transactions, account
balances, and disclosures to be expected in the financial statements.
(c) The entity’s selection and application of accounting policies, including the
reasons for changes thereto. The auditor shall evaluate whether the entity’s
accounting policies are appropriate for its business and consistent with the
applicable financial reporting framework and accounting policies used in the
relevant industry.
(d) The entity’s objectives and strategies, and those related business risks that may
result in risks of material misstatement.
(e) The measurement and review of the entity’s financial performance.
In addition to the importance of knowledge of the client’s business in establishing the
overall audit plan, such knowledge helps the auditor to identify areas of special audit
consideration, to evaluate the reasonableness both of accounting estimates and
management representations and to make judgements regarding the appropriateness
of accounting policies and disclosures.
(b) In the context of recurring audits, as per SA-300, “Planning an Audit of Financial
Statements”, Planning is not a discrete phase of an audit, but rather a continual and
iterative process that often begins shortly after (or in connection with) the completion
of the previous audit and continues until the completion of the current audit
engagement. Planning, however, includes consideration of the timing of certain
activities and audit procedures that need to be completed prior to the performance of
further audit procedures. For example, planning includes the need to consider, prior
to the auditor’s identification and assessment of the risks of material misstatement,
such matters as:
1. The analytical procedures to be applied as risk assessment procedures.
2. Obtaining a general understanding of the legal and regulatory framework
applicable to the entity and how the entity is complying with that framework.
3. The determination of materiality.
4. The involvement of experts.
5. The performance of other risk assessment procedures.
5. (a) The auditor’s determination of materiality is a matter of professional judgment, and is
affected by the auditor’s perception of the financial information needs of users of the
financial statements. In this context, it is reasonable for the auditor to assume that
users:
(i) Have a reasonable knowledge of business and economic activities and

accounting and a willingness to study the information in the financial statements

with reasonable diligence;
(ii) Understand that financial statements are prepared, presented and audited to
levels of materiality;
(iii) Recognize the uncertainties inherent in the measurement of amounts based on
the use of estimates, judgment and the consideration of future events; and
(iv) Make reasonable economic decisions on the basis of the information in the
financial statements.
(b) Financial reporting frameworks often discuss the concept of materiality in the context
of the preparation and presentation of financial statements. Although financial
reporting frameworks may discuss materiality in different terms, they generally
explain that:
 Misstatements, including omissions, are considered to be material if they,
individually or in the aggregate, could reasonably be expected to influence the
economic decisions of users taken on the basis of the financial statements;
 Judgments about materiality are made in the light of surrounding circumstances,
and are affected by the size or nature of a misstatement, or a combination of
both; and
3. Judgments about matters that are material to users of the financial statements
are based on a consideration of the common financial information needs of users
as a group. The possible effect of misstatements on specific individual users,
whose needs may vary widely, is not considered.
6. (a) The following are the purpose of Audit documentation:
1. Assisting the engagement team to plan and perform the audit.
2. Assisting members of the engagement team to direct and supervise the audit
work, and to discharge their review responsibilities.
3. Enabling the engagement team to be accountable for its work.
4. Retaining a record of matters of continuing significance to future audits.
5. Enabling the conduct of quality control reviews and inspections in accordance
with SQC 1.
6. Enabling the conduct of external inspections in accordance with applicable legal,
regulatory or other requirements.
From the above, it can be concluded that Audit documentation serves a nu mber of
purposes and hence it would be incorrect to say that audit documentation would not
serve any purpose at any stage of audit.

(b) In documenting the nature, timing and extent of audit procedures performed, the
auditor of PQR Ltd shall record:
(i) The identifying characteristics of the specific items or matters tested.
(ii) Who performed the audit work and the date such work was completed; and
(iii) Who reviewed the audit work performed and the date and extent of such review.
7. (a) When information to be used as audit evidence has been prepared using the work of
a management’s expert, the auditor shall, to the extent necessary, having regard to
the significance of that expert’s work for the auditor’s purposes:
(i) Evaluate the competence, capabilities and objectivity of that expert;
(ii) Obtain an understanding of the work of that expert; and
(iii) Evaluate the appropriateness of that expert’s work as audit evidence for the
relevant assertion.
(b) When performing risk assessment procedures as required by SA 315, the auditor
shall consider whether events or conditions exist that may cast significant doubt on
the entity’s ability to continue as a going concern.
In so doing, the auditor shall determine whether management has already performed
a preliminary assessment of the entity’s ability to continue as a going concern, and:
(i) If such an assessment has been performed, the auditor shall discuss the
assessment with management and determine whether management has
identified events or conditions that, individually or collectively, may cast
significant doubt on the entity’s ability to continue as a going concern and, if so,
management’s plans to address them; or
(ii) If such an assessment has not yet been performed, the auditor shall discuss
with management the basis for the intended use of the going concern basis of
accounting, and inquire of management whether events or conditions exist that,
individually or collectively, may cast significant doubt on the entity’s ability to
continue as a going concern.
8. (a) Under the going concern basis of accounting, the financial statements are prepared
on the assumption that the entity is a going concern and will continue its operations
for the foreseeable future.
General purpose financial statements are prepared using the going concern basis of
accounting, unless management either
(i) intends to liquidate the entity or to cease operations,
(ii) or has no realistic alternative but to do so.

When the use of the going concern basis of accounting is appropriate, 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.
The objectives of the auditor regarding Going Concern are:
(1) To obtain sufficient appropriate audit evidence regarding, and conclude on, the
appropriateness of management’s use of the going concern basis of accounting
in the preparation of the financial statements;
(2) To conclude, based on the audit evidence obtained, whether a material
uncertainty exists related to events or conditions that may cast significant doubt
on the entity’s ability to continue as a going concern; and
(3) To report in accordance with this SA.
(b) The auditor’s responsibilities are:
(1) to obtain sufficient appropriate audit evidence regarding, and conclude on, the
appropriateness of management’s use of the going concern basis of accounting
in the preparation of the financial statements, and
(2) to conclude, based on the audit evidence obtained, whether a material
uncertainty exists about the entity’s ability to continue as a going concern.
However, as described in SA 200, the potential effects of inherent limitations on the
auditor’s ability to detect material misstatements are greater for future events or
conditions that may cause an entity to cease to continue as a going concern. T he
auditor cannot predict such future events or conditions. Accordingly, the absence of
any reference to a material uncertainty about the entity’s ability to continue as a going
concern in an auditor’s report cannot be viewed as a guarantee as to the entit y’s
ability to continue as a going concern.
9. (a) The auditor shall obtain an understanding of internal control relevant to the audit.
Although most controls relevant to the audit are likely to relate to financial reporting,
not all controls that relate to financial reporting are relevant to the audit. It is a matter
of the auditor’s professional judgment whether a control, individually or in combination
with others, is relevant to the audit.
Benefits of Understanding the Internal Control
An understanding of internal control assists the auditor in:
(i) identifying types of potential misstatements;
(ii) identifying factors that affect the risks of material misstatement, and
(iii) designing the nature, timing, and extent of further audit procedures.

(b) Factors relevant to the auditor’s judgment about whether a control, individually
or in combination with others, is relevant to the audit may include such matters
as the following:
 Materiality.
 The significance of the related risk.
 The size of the entity.
 The nature of the entity’s business, including its organisation and ownership
characteristics.
 The diversity and complexity of the entity’s operations.
 Applicable legal and regulatory requirements.
 The circumstances and the applicable component of internal control.
 The nature and complexity of the systems that are part of the entity’s internal
control, including the use of service organisations.
 Whether, and how, a specific control, individually or in combination with others,
prevents, or detects and corrects, material misstatement.
10. (a) The auditor shall obtain an understanding of the information system, including
the related business processes, relevant to financial reporting, including the
following are as:
(a) The classes of transactions in the entity’s operations that are significant to the
financial statements;
(b) The procedures by which those transactions are initiated, recorded, processed,
corrected as necessary, transferred to the general ledger and reported in the
financial statements;
(c) The related accounting records, supporting information and specific accounts in
the financial statements that are used to initiate, record, process and report
transactions;
(d) How the information system captures events and conditions that are significant
to the financial statements;
(e) The financial reporting process used to prepare the entity’s financial statements;
(f) Controls surrounding journal entries.
(b) The auditor shall obtain an understanding of control activities relevant to the audit,
which the auditor considers necessary to assess the risks of material misstatement.
An audit requires an understanding of only those control activities related to
significant class of transactions, account balance, and disclosure in the financial

statements and the assertions which the auditor finds relevant in his risk assessment
process.
Control activities are the policies and procedures that help ensure that management
directives are carried out.
Control activities, whether within IT or manual systems, have various objectives and
are applied at various organisational and functional levels.
Examples of specific control activities include those relating to the following:
Control activities that are relevant to the audit are:

• Control activities that relate to significant risks and those that relate to risks for
which substantive procedures alone do not provide sufficient appropriate audit
evidence; or
• Those that are considered to be relevant in the judgment of the auditor;
• As part of the risk assessment, the auditor shall determine whether any of the
risks identified are, in the auditor’s judgment, a significant risk.
11. Where the auditor notices that any fraud by the company or on the company by its officers
or employees has been noticed by or reported during the year, the auditor should, apart
from reporting the existence of fraud, also required to report under clause (x) of paragraph
3 of Companies (Auditor’s Report) Order, 2016, the nature of fraud and amount involved.
For reporting under this clause, the auditor may consider the following:
(i) This clause requires all frauds noticed or reported during the year shall be reported
indicating the nature and amount involved. As specified the fraud by the company or
on the company by its officers or employees are only covered.

(ii) Of the frauds covered under section 143(12) of the Act, only noticed frauds shall be
included here and not the suspected frauds.
(iii) While reporting under this clause with regard to the nature and the amount invol ved
of the frauds noticed or reported, the auditor may also consider the principles of
materiality outlined in Standards on Auditing.
12. The primary responsibility for the prevention and detection of fraud rests with both those
charged with governance of the entity and management. 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. This involves a commitment to creating a culture of honesty and ethical
behavior which can be reinforced by an active oversight by those charged with governance.
In exercising oversight responsibility, those charged with governance consider the
potential for override of controls or other inappropriate influence over the financial reporting
process, such as efforts by management to manage earnings in order to influence the
perceptions of analysts as to the entity’s performance and profitability.
13. “General IT controls are policies and procedures that relate to many applications and
support the effective functioning of application controls. They apply to mainframe,
miniframe, and end-user environments.
General IT-controls that maintain the integrity of information and security of data
commonly include controls over the following:”
(i) Data center and network operations
(ii) Program change
(iii) Access security
(iv) Application system acquisition, development, and maintenance (Business
Applications)
These are IT controls generally implemented to mitigate the IT specific risks and applied
commonly across multiple IT systems, applications and business proc esses. Hence,
General IT controls are known as “pervasive” controls or “indirect” controls. Let us now
learn about each of the General IT controls in more detail.
Data Center and Network Operations
Objective: To ensure that production systems are processed to meet financial reporting
objectives.

Activities:
1. Overall Management of Computer Operations Activities
2. Batch jobs – preparing, scheduling and executing
3. Backups – monitoring, storage & retention
4. Performance Monitoring – operating system, database and networks
5. Recovery from Failures – BCP, DRP
6. Help Desk Functions – recording, monitoring & tracking
7. Service Level Agreements – monitoring & compliance
8. Documentation – operations manuals, service reports
14. Data analytics can be used in testing of electronic records and data residing in IT systems
using spreadsheets and specialised audit tools viz., IDEA and ACL to perform the
following:
 Check completeness of data and population that is used in either test of controls or
substantive audit tests.
 Selection of audit samples – random sampling, systematic sampling.
 Re-computation of balances – reconstruction of trial balance from transaction data.
 Reperformance of mathematical calculations – depreciation, bank interest
calculation.
 Analysis of journal entries as required by SA 240.
 Fraud investigation.
 Evaluating impact of control deficiencies.
15. (i) Stratification – The process of dividing a population into sub-populations, each of
which is a group of sampling units which have similar characteristics (often monetary
value).
(ii) Tolerable misstatement – A monetary amount set by the auditor in respect of which
the auditor seeks to obtain an appropriate level of assurance that the monetary
amount set by the auditor is not exceeded by the actual misstatement in the
population.
(iii) Tolerable rate of deviation – A rate of deviation from prescribed internal control
procedures set by the auditor in respect of which the auditor seeks to obtain an

appropriate level of assurance that the rate of deviation set by the auditor is not
exceeded by the actual rate of deviation in the population.
16. In most of the circumstances, the evidence available is not conclusive and the auditor
always takes a calculated risk in giving his opinion. Even by undertaking hund red percent
checking of the transactions, the auditor does not derive absolute satisfaction. This state
of uneasiness led pragmatic auditors to adopt the statistical theory of sampling to derive
the necessary satisfaction about the state of affairs by checking only a part of the total
population of entries.
Auditors realised that they can derive good satisfaction by undertaking a much lesser
checking by adoption of this technique in the auditing process. It is a mathematical truth
that the sample, if picked purely on a random basis would reveal the features and
characteristics of the population.
By adopting the sampling technique, the auditor only checks a part of the whole mass of
transactions. The satisfaction he used to derive earlier, by checking all the transactions,
can be derived by a sample checking provided he can put reliance on the internal controls
and checks within the client’s organisation because they provide the reliability of the
records. Sampling is used as a part of Test of controls. Auditor will check few internal
controls and their operating effectiveness. Based on the conclusion derived, he can then
design the sample size for test of details (i.e checking of transactions and balances)
If the internal control is satisfactory in its design and implementation, a much smaller
sample can give the auditor the necessary reliability of the result he obtains.
On the other hand, if in certain areas controls are slack or not properly implemented, the
auditor may have to take a much larger sample for getting satisfactory result.
Another truth about the sampling technique should be noted. It can never bring complete
reliability; it cannot give precisely accurate results. It is a process of estimation. It may
have some error. What error is tolerable for a particular matter under examination is a
matter of the individual’s judgment in that particular case.
17. Techniques available as Substantive Analytical Procedures : The design of a
substantive analytical procedure is limited only by the availability of reliable data and the
experience and creativity of the audit team. Substantive analytical procedures generally
take one of the following forms:
Trend analysis — A commonly used technique is the comparison of current data with the
prior period balance or with a trend in two or more prior period balances. We evaluate
whether the current balance of an account moves in line with the trend established with
previous balances for that account, or based on an understanding of factors that may cause
the account to change.

Ratio analysis — Ratio analysis is useful for analysing asset and liability accounts as well
as revenue and expense accounts. An individual balance sheet account is difficult to
predict on its own, but its relationship to another account is often more predictable (e.g.,
the trade receivables balance related to sales). Ratios can also be compared over time or
to the ratios of separate entities within the group, or with the ratios of other companies in
the same industry.
Reasonableness tests — Unlike trend analysis, this analytical procedure does not rely on
events of prior periods, but upon non-financial data for the audit period under consideration
(e.g., occupancy rates to estimate rental income or interest rates to estimate interest
income or expense). These tests are generally more applicable to income statement
accounts and certain accrual or prepayment accounts.
Structural modelling — A modelling tool constructs a statistical model from financial
and/or non-financial data of prior accounting periods to predict current account balances
(e.g., linear regression).
18. Analytical Review Procedures: The following analytical review procedures may often be
helpful as a means of obtaining audit evidence regarding the various assertions relating to
trade receivables, loans and advances-
(i) comparison of closing balances of trade receivables, loans and advances with the
corresponding figures for the previous year;
(ii) comparison of the relationship between current year trade receivable balances and
the current year sales with the corresponding budgeted figures, if available;
(iii) comparison of actual closing balances of trade receivables, loans and advances with
the corresponding budgeted figures, if available;
(iv) comparison of current year’s ageing schedule with the corresponding figures for the
previous year;
(v) comparison of significant ratios relating to trade receivables, loans and advances with
similar ratios for other firms in the same industry, if available;
(vi) comparison of significant ratios relating to trade receivables, loans and advances with
the industry norms, if available.
19. Refund of General Insurance Premium paid: The refund of insurance premium may be
because of earlier provisional payment of premium or may be a policy might have been
cancelled at a later date. The auditor should take following steps while vouching such
refunds:
(i) Ascertain the reasons for refund of insurance premium.

(ii) Examine insurance policy or cover note to find out the amount of premium.
(iii) Verify advice of refund received from the insurance company. When refund is
admitted, the insurance company sends the advice. This will be evidence as a
covering letter to the cheque for the refund. Sometimes, a cheque is issued after a
receipt is sent in advance to the insurance company.
(iv) Scrutinise correspondence between the insurance company and the client.
(v) Check entries in the bank book or the bank statement. If necessary, the counterfoil of
the pay-in-slips can also be verified.
20. Documents to be seen in case of Securities:
Types of Security Documents etc. to be seen
(i) Shares and debentures The scrip and the endorsement thereon of the
name of the transferee, in the case of transfer.
(ii) Life Insurance Policy. Assignment of policy in favour of the lender, duly
registered with the insurer
(iii) Hypothecation of goods Deed of hypothecation or other document creating
the charge, together with a statement of inventories
held at the Balance Sheet date
21. Right of Access to secretarial records and correspondence:
1. Section 143(1) of the Companies Act, 2013 grants powers to the auditor that every
auditor has a right of access, at all times, to the books of account and vouchers of
the company kept at Registered or Head Office, branches and subsidiaries in the
case of a Holding Company for conducting the audit.
2. Further, he is also entitled to require from the officers of the company such
information and explanations which he considers necessary for the proper
performance of his duties as Auditor. Therefore, he has a statutory right to inspect
the secretarial records and correspondence.
3. In order to verify actions of the company and to vouch and verify some of the
transactions of the company, it is necessary for the auditor to refer to the decisions
of the shareholders and/or the directors of the company. It is, therefore, essential for
the auditor to refer to the secretarial records and correspondence which also includes
Minute book. In the absence of the same, the auditor may not be able to vouch/verify
certain transactions of the company.
4. The refusal to provide access to secretarial records and correspondence shall
constitute limitation of scope as far as the auditor’s duties are concerned.

5. The auditor may examine whether by performing alternative procedures, the auditor
can substantiate the assertions or else he shall have to either qualify the report or
give a disclaimer of opinion.
22. Ceiling on number of Audits:
1. Before appointment is given to any auditor, the company must obtain a certificate
from him to the effect that the appointment, if made, will not result in an excess holding
of company audit by the auditor concerned over the limit laid down in section
141(3)(g) of the Companies Act, 2013 which prescribes that a person who is in full
time employment elsewhere or a person or a partner of a firm holding appointment as
its auditor, if such person or partner is at the date of such appointment or
reappointment holding appointment as auditor of more than twenty companies other
than one person companies, dormant companies, small companies and private
companies having paid-up share capital less than ` 100 crore, shall not be eligible
for appointment as an Auditor of a Company.
2. In the case of a firm of auditors, it has been further provided that ‘specified number
of companies’ shall be construed as the number of companies speci fied for every
partner of the firm who is not in full time employment elsewhere. This limit of 20
company audits is per person. In the case of an audit firm having 3 partners, the
overall ceiling will be 3 × 20 = 60 company audits.
3. Sometimes, a chartered accountant is a partner in a number of auditing firms. In such
a case, all the firms in which he is partner or proprietor will be together entitled to 20
company audits on his account. Subject to the overall ceiling of company audits, how
they allocate the 20 audits between themselves is their affairs.
23. (i) Appointment of First Auditor of a Government Company: Section 139(7) of the
Companies Act, 2013 provides that in the case of a Government company or any
other company owned or controlled, directly or indirectly, by the Central Government,
or by any State Government, or Governments, or partly by the Central Government
and partly by one or more State Governments, the first auditor shall be appointed by
the Comptroller and Auditor-General of India within 60 days from the date of
In case the Comptroller and Auditor-General of India does not appoint such auditor
within the above said period, the Board of Directors of the company shall appoint
such auditor within the next 30 days. Further, in the case of failure of the Board to
appoint such auditor within next 30 days, it shall inform the members of the company
who shall appoint such auditor within 60 days at an extraordinary general meeting.
Auditors shall hold office till the conclusion of the first annual general meeting.
Appointment of First Auditor of a Non-Government Company: As per Section
139(6) of the Companies Act, 2013, the first auditor of a company, other than a

Government company, shall be appointed by the Board of Directors within 30 days

from the date of registration of the company.
In the case of failure of the Board to appoint the auditor, it shall inform the members
of the company.
The members of the company shall within 90 days at an extraordinary general
meeting appoint the auditor. Appointed auditor shall hold office till the conclusion of
the first annual general meeting.
(ii) Appointment of Subsequent Auditor of a Government Company: As per Section
139(5) of the Companies Act, 2013, in the case of a Government company or any
other company owned or controlled, directly or indirectly, by the Central Government,
or by any State Government or Governments, or partly by the Central Government
and partly by one or more State Governments, the Comptroller and Auditor-General
of India shall, in respect of a financial year, appoint an auditor duly qualified to be
appointed as an auditor of companies under this Act, within a period of 180 days from
the commencement of the financial year, who shall hold office till the conclusion of
the annual general meeting.
Appointment of Subsequent Auditor of a Non-Government Company: As per
section 139(1) of the Companies Act, 2013, every company shall, at the first annual
general meeting appoint an individual or a firm as an auditor who shall hold office
from the conclusion of that meeting till the conclusion of its sixth annual general
meeting and thereafter till the conclusion of every sixth meeting.
24. Unqualified Opinion:
1. An unqualified opinion should be expressed when the auditor concludes that the
financial statements give a true and fair view in accordance with the financial reporting
framework used for the preparation and presentation of the financial statements.
2. An unqualified opinion indicates, implicitly, that any changes in the accounting
principles or in the method of their application, and the effects thereof, have been
properly determined and disclosed in the financial statements.
3. An unqualified opinion also indicates that:
(i) the financial statements have been prepared using the generally accepted
accounting principles, which have been consistently applied;
(ii) the financial statements comply with relevant statutory requirements and
regulations; 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.

25. The requirements of SA 700 are aimed at addressing an appropriate balance between the
need for consistency and comparability in auditor reporting globally and the need to
increase the value of auditor reporting by making the information provided in the auditor’s
report more relevant to users. This SA promotes consistency in the auditor’s report but
recognizes the need for flexibility to accommodate particular circumstances of individual
jurisdictions. Consistency in the auditor’s report, when the audit has been conducted in
accordance with SAs, promotes credibility in the global marketplace by making more
readily identifiable those audits that have been conducted in accordance with globally
recognized standards. It also helps to promote the user’s understanding and to identify
unusual circumstances when they occur.
26. Presently, the Statutory Central Auditors (SCAs) have to furnish the following
reports in addition to their main audit report:
(a) Report on adequacy and operating effectiveness of Internal Controls over Financial
Reporting in case of banks which are registered as companies under the Companies
Act in terms of Section 143(3)(i) of the Companies Act, 2013 which is normally to be
given as an Annexure to the main audit report as per the Guidance Note on Audit of
Internal Financial Controls over Financial Reporting issued by the ICAI.
(b) Long Form Audit Report. (LFAR)
(c) Report on compliance with SLR requirements.
(d) Report on whether the treasury operations of the bank have been conducted in
accordance with the instructions issued by the RBI from time to time.
(e) Report on whether the income recognition, asset classification and provisioning have
been made as per the guidelines issued by the RBI from time to time.
(f) Report on whether any serious irregularity was noticed in the working of the bank
which requires immediate attention.
(g) Report on status of the compliance by the bank with regard to the implementation of
recommendations of the Ghosh Committee relating to frauds and malpractices and of the
recommendations of Jilani Committee on internal control and inspection/credit system.
(h) Report on instances of adverse credit-deposit ratio in the rural areas.
27. Advances generally constitute the major part of the assets of the bank. There are large
number of borrowers to whom variety of advances are granted. The audit of advances
requires the major attention from the auditors.
In carrying out audit of advances, the auditor is primarily concerned with obtaining
evidence about the following:
(a) Amounts included in balance sheet in respect of advances which are outs tanding at
the date of the balance sheet.
(b) Advances represent amount due to the bank.

(c) Amounts due to the bank are appropriately supported by loan documents and other
documents as applicable to the nature of advances.
(d) There are no unrecorded advances.
(e) The stated basis of valuation of advances is appropriate and properly applied and the
recoverability of advances is recognised in their valuation.
(f) The advances are disclosed, classified and described in accordance with recognised
accounting policies and practices and relevant statutory and regulatory requirements.
(g) Appropriate provisions towards advances have been made as per the RBI norms,
Accounting Standards and generally accepted accounting practices.
28. (a) Government audit has not only adopted the basic essentials of auditing as known and
practised in the profession to suit the requirements of governmental transactions but
has also added new concepts, techniques and procedures to the audit profession.
The U.N. Handbook on Government Auditing and Developing Countries defines
government auditing in a comprehensive manner which is as follows:
Government auditing is
 the objective, systematic, professional and independent examination
 of financial, administrative and other operations
 of a public entity
 made subsequently to their execution
 for the purpose of evaluating and verifying them,
 presenting a report containing explanatory comments on audit findings together
with conclusions and recommendations for future actions
 by the responsible officials
 and in the case of examination of financial statements, expressing the
appropriate professional opinion regarding the fairness of the presentation.
OBJECTIVES :-
(a) Accounting for Public Funds:-Government audit serves as a mechanism or
process for public accounting of government funds.
(b) Appraisal of Government policies:-It also provides public accounting of the
operational, management, programme and policy aspects of public
administration as well as accountability of the officials administering them.
(c) Base for Corrective actions:-Audit observations based on factual data collection
also serve to highlight the lapses of the lower hierarchy, thus helping supervisory
level officers to take corrective measures.

(b) Government audit is neither equipped nor intended to function as an investigating

agency, to pursue every irregularity or misdemeanour to its logical end. The main
objective of audit is a combination of ensuring accountability of administration to
legislature and functioning as an aid to administration. In India, the function of
Government Audit is discharged by the independent statutory authority of the
Comptroller and Auditor General through the agency of the Indian Audit and
Accounts Department. Audit is a necessary function to ensure accountability of the
executive to Parliament, and within the executives of the spending agencies to the
sanctioning or controlling authorities. The purpose or objectives of audit need to be
tested at the touchstone of public accountability. The Comptroller and Auditor General
(C&AG), in the discharge of his functions, watches that the various authorities act in
regard to financial matters in accordance with the Constitution and the laws made by
Parliament, and conform to the rules or orders made thereunder.

PAPER – 7: ENTERPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT
SECTION – A: ENTERPRISE INFORMATION SYSTEMS
QUESTIONS
Multiple Choice Questions
SciLabs, is an upcoming robotics company in India providing innovative solutions for different
verticals. The company has adopted the concept of Cloud Computing using the cloud type
which is small, most secure, controlled, maintained internally and used to perform critical
activities of the company.
For every new project undertaken by them; the functional requirement documents are
prepared, and the initial design requirements are communicated to programmers via
algorithms and flowcharts. All the customer requirements are tracked, assembling materia ls
are ordered and the details regarding entire cost incurred for training, research and full-
fledged development of the product are managed through the implemented SAP ERP system.
Furthermore, different versions of all the documents and white papers related to the ongoing
research are stored in the Relational Database Management Systems (RDBMS) Teradata
warehouse periodically to maintain record of all the changes a said project undergoes during
its entire life cycle. Such methodology enables SciLabs to maintain and compare the data
between different time periods based on the time stamps the data is stored in the data
warehouse.
SciLabs has also implemented stringent controls so that the high-level architectural diagrams
of the new project are kept with utmost confidentiality.
Based on the facts of the case scenario given above, choose the most appropriate
answer to Q. Nos 1 to 5.
1. Flowcharts are used by SciLabs to communicate the requirements to the programmers.
Which among the following would be the initial step in developing flowcharts?
(a) Identifying the activities in each process step.
(b) Preparing an initial rough diagram.
(c) Identifying the business processes to be documented.
(d) Identifying the starting point of the process.
2. SciLabs uses a module of SAP ERP system that enables to create detailed scheduling,
material requirement planning, and refine production integration. Which of the following
module of SAP ERP support all these features?
(a) Material Management
(b) Supply Chain

(c) Production Planning

(d) Sales and Distribution
3. The documents and white papers related to the research carried on by the SciLabs
analysts are loaded in Teradata data warehouse so as to have comparisons of the
different version files. Which feature of a Teradata tool is referred here?
(a) Standardized
(b) Time Variant
(c) Non-operational data
(d) Consistency
4. SciLabs initially has adopted the concept of Cloud Computing using the cloud which is
small, most secure, controlled and maintained internally. However, with the expansion in
the SciLabs business, the management decided to deploy another cloud named _____
for its non-critical activities and usage of additional resources. Identify the deployed
cloud.
(a) Private Cloud
(b) Public Cloud
(c) Hybrid Cloud
(d) Community Cloud
5. Though stringent controls are implemented by SciLabs, one of its development team
member Mr. Atul accesses the confidential architectural diagrams of the new project and
download them on his personal computer for wrongful reasons. Under which Section of
the Information Technology Act, 2000; is Mr. Atul punishable?
(a) Section 65
(b) Section 43
(c) Section 66
(d) Section 66D
Descriptive Questions
Chapter 1: Automated Business Processes
6. Though Business Process Automation (BPA) provides many advantages to diverse
businesses in various forms, however, every business is not suitable for automation.
Each business needs a valid reason before it goes for automation. Discuss some
examples of business processes that are best suited to automation.
7. Every business faces all kinds of risks that may cause serious loss or even bankruptcy.
In purview of this statement, state various types of business risks related to business.

PAPER – 7: ENTERRPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT 187
Chapter 2: Financial and Accounting Systems

8. ABC Ltd. is planning to implement some modules of Enterprise Resource Planning (ERP)
system to manage different aspects related to its various business processes. Determine
in specific various Sales and Distribution activities that enterprise may get support from
ERP framework.
9. Mr. Rajesh, a manager of a medium-sized company’s customer service department, uses
MIS reporting tool to obtain the reports that help him evaluating company’s businesses’
daily activities or problems that arise, making decisions and tracking progress. Elaborate
the criterions that the information generated through MIS tool meet so that it is useful to
Mr. Rajesh in discharging his role.
Chapter 3: Information Systems and its Components
10. Data Mining is commonly applied in banking industry to credit ratings and to intelligent
anti-fraud systems to analyze transactions, card transactions, purchasing patterns and
customer financial data etc. The process of Data Mining involves sequential execution of
steps for its implementation. Discuss the steps involved in this process.
11. Due to absence of Logical Access Controls in XYZ Limited; the company’s security
mechanism got attacked by a Logical Access Violator Mr. X leading to potential loss
resulting in total shutdown of the computer functions of the company. Discuss the
categories under which the Logical Access Violator Mr. X may fall into.
Chapter 4: E- Commerce, M-Commerce and Emerging Technologies
12. A business model is adopted by an organization as a framework to describe how it
makes money on a sustainable basis and grows whereas an e-business model utilizes
the benefits of electronic communications. Discuss various e-market models that help
businesses to achieve the value adding processes.
13. DJY is a brand in the field of online supplier of kids’ apparels. As we know that risks
associated with e-commerce transactions are high as compared to general internet
activities, what do you think are the risks that DJY is addressing due to its online
transactions?
Chapter 5: Core Banking Systems
14. Information Security that refers to ensure Confidentiality, Integrity and Availability of
information, is critical in banking industry, to mitigate the risks of Information Technology.
Identify and explain various sub-processes that are involved in Information Security.
15. Current and Savings Account (CASA) is a unique feature which banks offer to their
customers to make them keep their money in their banks. Discuss its business process
flow.

SUGGESTED ANSWERS/HINTS
Multiple Choice Answers

1. (c) Identifying the business processes to be documented.
2. (b) Supply chain
3. (b) Time Variant
4. (b) Public Cloud
5. (b) Section 43
Descriptive Answers
6. The examples of business processes that are best suited to automation are as follows:
 Processes involving high-volume of tasks or repetitive tasks: Many business
processes such as making purchase orders involve high-volume of repetitive tasks.
Automating these processes results in cost and work effort reductions.
 Processes requiring multiple people to execute tasks: A business process
which requires multiple people to execute tasks often results in waiting time that can
lead to increase in costs. E.g. help desk services. Automating these processes
results in reduction of waiting time and in costs.
 Time-sensitive processes: Business process automation results in streamlined
processes and faster turnaround times. The streamlined processes eliminate
wasteful activities and focus on enhancing tasks that add value. Time-sensitive
processes are best suited to automation. For example - online banking system,
railway/aircraft operating and control systems etc.
 Processes involving need for compliance and audit trail: With business process
automation, every detail of a particular process is recorded. These details can be
used to demonstrate compliance during audits. For example- invoice issue to
vendors.
 Processes having significant impact on other processes and systems: Some
processes are cross-functional and have significant impact on other processes and
systems. In cross functional processes, different departments within the same
company work hand in hand to achieve a common goal, e.g., the marketing
department may work with sales department. Automating these processes results in
sharing information resources and improving the efficiency and effectiveness of
business processes.

7. Various types of business risks related to business are as follows:

 Strategic Risks: These are the risks that would prevent an organization from
accomplishing its objectives (meeting its goals). Examples include risks related to
strategy, political, economic relationship issues with suppliers and global market
conditions; also, could include reputation risk, leadership risk, brand risk, and
changing customer needs.
 Financial Risks: Financial risks are those risks that could result in a negative
financial impact to the organization (waste or loss of assets). Examples include risks
from volatility in foreign currencies, interest rates, and commodities; credit risk,
liquidity risk, and market risk.
 Regulatory (Compliance) Risks: This includes risks that could expose the
organization to fines and penalties from a regulatory agency due to non-compliance
with laws and regulations. Examples include Violation of laws or regulations
governing areas such as environmental, employee health and safety, lack of due
diligence, protection of personal data in accordance with global data protection
requirements and local tax or statutory laws. New and emerging regulations can
have a wide-ranging impact on management’s strategic direction, business model
and compliance system. It is, therefore, important to consider regulatory
requirements while evaluating business risks.
 Operational Risks: Operational risks include those risks that could prevent the
organization from operating in the most effective and efficient m anner or be
disruptive to other operations due to inefficiencies or breakdown in internal
processes, people and systems. Examples include risk of loss resulting from
inadequate or failed internal processes, fraud or any criminal activity by an
employee, business continuity, channel effectiveness, customer satisfaction and
product/service failure, efficiency, capacity, and change integration.
 Hazard Risks: Hazard risks include risks that are insurable, such as natural
disasters; various insurable liabilities; impairment of physical assets; terrorism etc.
 Residual Risks: This includes any risk remaining even after the counter measures
are analyzed and implemented. An organization’s management of risk should
consider these two areas: Acceptance of residual risk and Selection of safeguards.
Even when safeguards are applied, there is probably going to be some residual risk.
The risk can be minimized, but it can seldom be eliminated. Residual risk must be
kept at a minimal, acceptable level. As long as it is kept at an acceptable level, (i.e.
the likelihood of the event occurring or the severity of the consequence is
sufficiently reduced) the risk can be managed.

8. Various sales and distribution activities that may get support from ERP framework are as
follows:
 Pre-Sales Activities: Include prospecting of customers, identifying prospective
customers, gathering data, contacting them and fixing appointments, showing
demo, discussion, submission of quotations, etc.
 Sales Order: Sales order is recorded in our books after getting a confirmed
purchased order from our customer. Sales order shall contain details just like
purchase order. E.g. Stock Item Details, Quantity, Rate, Due Date of Delivery, Place
of Delivery, etc.
 Inventory Sourcing: It includes making arrangements before delivery of goods;
ensuring goods are ready and available for delivery.
 Material Delivery: Material is delivered to the customer as per sales order. All
inventory details are copied from Sales Order to Material Delivery for saving user’s
time and efforts. This transaction shall have a linking with Sales Order. Stock
balance shall be reduced on recording of this transaction.
 Billing: This is a transaction of raising an invoice against the delivery of material to
customer. This transaction shall have a linking with Material Delivery and all the
details shall be copied from it. Stock balance shall not affect again.
 Receipt from Customer / Payment: This is a transaction of receiving amount from
customer against sales invoice and shall have a linking with sales invoice.
9. To make the information most useful, Mr. Rajesh needs to ensure that it meets the
following criteria:
 Relevant - MIS reports need to be specific to the business area they address. This
is important because a report that includes unnecessary information might be
ignored.
 Timely - Managers need to know what’s happening now or in the recent past to
make decisions about the future. Be careful not to include information that is old. An
example of timely information for your report might be customer phone calls and
emails going back 12 months from the current date.
 Accurate - It’s critical that numbers add up and that dates and times are correct.
Managers and others who rely on MIS reports can’t make sound decisions with
information that is wrong. Financial information is often required to be accurate to
the dollar. In other cases, it may be OK to round off numbers.
 Structured - Information in an MIS report can be complicated. Making that
information easy to follow helps management understand what the report is saying.
Try to break long passages of information into more readable blocks or chunks and
give these chunks meaningful headings.

10. The steps involved in the Data Mining process are as follows:
a. Data Integration: Firstly, the data are collected and integrated from all the different
sources which could be flat files, relational database, data warehouse or web etc.
b. Data Selection: It may be possible that all the data collected may not be required in
the first step. So, in this step we select only those data which we think is useful for
data mining.
c. Data Cleaning: The data that is collected are not clean and may contain errors,
missing values, noisy or inconsistent data. Thus, we need to apply different
techniques to get rid of such anomalies.
d. Data Transformation: The data even after cleaning are not ready for mining as it
needs to be transformed into an appropriate form for mining using different
techniques like - smoothing, aggregation, normalization etc.
e. Data Mining: In this, various data mining techniques are applied on the data to
discover the interesting patterns. Techniques like clustering and associatio n
analysis are among the many different techniques used for data mining.
f. Pattern Evaluation and Knowledge Presentation: This step involves
visualization, transformation, removing redundant patterns etc. from the patterns we
generated.
g. Decisions / Use of Discovered Knowledge: This step helps user to make use of
the knowledge acquired to take better informed decisions.
11. The Categories under which the logical Access Violator Mr. X may fall into are as follow:
 Hackers: Hackers try their best to overcome restrictions to prove their ability. Ethical
hackers most likely never try to misuse the computer intentionally but assists in
finding the weaknesses in the system;
 Employees (authorized or unauthorized);
 IS Personnel: They have easiest to access to computerized information since they
come across to information during discharging their duties. Segregation of duties
and supervision help to reduce the logical access violations;
 Former Employees: should be cautious of former employees who have left the
organization on unfavorable terms;
 End Users; Interested or Educated Outsiders; Competitors; Foreigners; Organized
Criminals; Crackers; Part-time and Temporary Personnel; Vendors and consultants;
and Accidental Ignorant – Violation done unknowingly.

12. The various e-market models that help businesses to achieve the value adding
processes are as follows:
 e-Shops (e-tailers): An e-shop is a virtual store front that sells products and
services online. E-shop is an online version of retail stores where customers can
shop at any hour of the day or night without leaving home. They are convenient way
of effecting direct sales to customers; allow manufacturers to bypass intermediate
operators and thereby reduce costs and delivery times. For example:
www.sonicnet.com, www.wforwomen.com
 e–Malls: The e-mall is defined as the retailing model of a shopping mall, a
conglomeration of different shops situated in a convenient location in e-commerce.
E-malls help the consumers from a variety of stores. e.g., Yahoo! Stores
 e–auctions: Electronic auctions provide a channel of communication through which
the bidding process for products and services can take place between competing
buyers. At e-auctions, people buy and sell through an auction website. In e-
auctions, almost perfect information is available about products, prices, current
demand, and supply. E-auction has become an increasingly popular tool for the
buyer to access the lowest price the suppliers are willing to charge. Example –
www.onsale.com, www.ebay.com
 Portals: Portal is a website that serves as a gateway or a main entry point on the
internet to a specific field of interest or an industry. It is a website that is positioned
as an entrance to other sites on the internet. A portal consists of web pages that act
as a starting point for using the web or web-based services. The control of content
can be a source of revenue for firms through charging firms for advertising or
charging consumers a subscription for access. Some major general portals include
Yahoo, Excite, and Netscape.
 Buyer Aggregators: The Buyer Aggregator brings together large numbers of
individual buyers so that they can gain the types of savings that are usually the
privilege of large volume buyers. In this, the firm collects the information about
goods/service providers, make the providers their partners, and sell their services
under its own brand. Example - www.zomato.com
 Virtual Communities: Virtual Community is a community of customers who share a
common interest and use the internet to communicate with each other. Amazon.com
provides websites for the exchange of information on a wide range of subjects
relating to their portfolio of products and services. Virtual communities’ benefit from
network externalities whereby the more people who join and contribute to the

community, the greater the benefits that accrue, but without any additional cost to
participants.
 e–marketing: E-marketing (Electronic Marketing) is the process of marketing a
product or service using the Internet. Of course, information on websites also
empowers customers and helps the organizations to achieve their objectives. For
example, they can compare prices of products by rival firms. The internet changes
the relationship between buyers and sellers because market information is available
to all parties in the transaction.
 e-procurement: e-procurement is the management of all procurement activities via
electronic means. Business models based on e-procurement seek efficiency in
accessing information on suppliers, availability, price, quality and delivery times as
well as cost savings by collaborating with partners to pool their buying power and
secure best value deals. E-procurement infomediaries specialize in providing up-to-
date and real-time information on all aspects of the supply of materials to
businesses.
 e–distribution: e-distributor is a company that supplies products and services
directly to individual business. The e-distribution model helps distributors to achieve
efficiency savings by managing large volumes of customers, automating orders,
communicating with partners and facilitating value-adding services such as order
tracking through each point in the supply chain. An example of a firm specializing in
e-distribution is www.wipro.com that uses the internet to provide fully integrated e-
business-enabled solutions that help to unify the information flows across all the
major distribution processes including sales and marketing automation, customer
service, warehouse logistics, purchasing and inventory management, and finance.
13. The risks that DJY is addressing due to its online transactions are as follows:
(i) Privacy and Security: When an organization uses internet to engage in e-
commerce, it exposes itself to additional security threats and privacy issues. There
are often issues of security and privacy due to lack of personalized digital access
and knowledge. The nature of e-commerce operations is an important factor
determining the security risks perceptions of any e-commerce installation. For
example, if the type of industry is banking and finance, it would require more
stringent deployment of security solutions than would be for manufacturing industry.
(ii) Quality issues: There are quality issues raised by customers as the original
product differs from the one that was ordered.

(iii) Delay in goods and Hidden Costs: When goods are ordered from another country,
the shipment may be delayed due to factors such as port congestion, bad weather,
custom clearances, etc. Moreover, e-commerce companies may these hidden costs.
(iv) Needs Access to internet and lack of personal touch: The e-commerce requires
an internet connection which is an extra expense and lacks personal touch.
(v) Security and credit card issues: The credit card and debit card information may
be stolen and misused which poses a security threat. There is also possibility of
cloning of credit cards and debit cards.
(vi) Infrastructure: There is a greater need of not only digital infrastructure but also
network expansion of roads and railways which remains a substantial challenge in
developing countries.
(vii) Problem of anonymity: There is need to identify and authenticate users in the
virtual global market where anyone can sell to or buy from anyone, anything from
anywhere.
(viii) Repudiation of contract: There is possibility that the electronic transaction in the
form of contract, sale order or purchase by the trading partner or customer may be
denied.
(ix) Lack of authenticity of transactions: The electronic documents that are produced
during an e-commerce transaction may not be authentic and reliable.
(x) Data Loss or theft or duplication: The data transmitted over the Internet may be
lost, duplicated, tampered with, or replayed.
(xi) Attack from hackers: Web servers used for e-commerce may be vulnerable to
hackers. A hacker is an unauthorized user who attempts to or gains access to the
system with/without the intention to steal or modify data or to insert viruses or
worms to cause damage to the system.
(xii) Denial of Service: Service to customers may be denied due to non-availability of
system as it may be affected by viruses, e-mail bombs and by transmitting so many
data packets to a server that it cannot process them all. The denial of service may
cause a network to shut down, making it impossible for users to access the site. For
busy e-commerce sites such as Flipkart, these attacks are costly; while the site is
shut down, customers cannot make purchases. Moreover, the longer a site is shut
down, the more damage is done to a site’s reputation.
(xiii) Non-recognition of electronic transactions: e-Commerce transactions, as
electronic records and digital signatures may not be recognized as evidence in
courts of law in some countries.

(xiv) Lack of audit trails: Audit trails in e-Commerce system may be lacking and the
logs may be incomplete, too voluminous or easily tampered with.
(xv) Problem of piracy: Intellectual property such as copyright may not be adequately
protected when such property is transacted through e-Commerce.
14. The various sub-processes that are involved in information Security are as follows:
 Information Security Policies, Procedures and practices: This refers to the
processes relating to approval and implementation of information security. The
security policy is basis on which detailed procedures and practices are developed
and implemented at various units/department and layers of technology, as relevant.
These cover all key areas of securing information at various layers of information
processing and ensure that information is made available safely and securely. For
example – Non-disclosure agreement with employees, vendors etc., KYC
procedures for security.
 User Security Administration: This refers to security for various users of
information systems. The security administration policy documents define how users
are created and granted access as per organization structure and access matrix. It
also covers the complete administration of users right from creation to disabling of
users is defined as part of security policy.
 Application Security: This refers to how security is implemented at various
aspects of application right from configuration, setting of parameters and security
for transactions through various application controls. For example – Event Logging.
 Database Security: This refers to various aspects of implementing security for the
database software. For example - Role based access privileges given to
employees.
 Operating System Security: This refers to security for operating system software
which is installed in the servers and systems which are connected to the servers.
 Network Security: This refers to how security is provided at various layers of
network and connectivity to the servers. For example - Use of virtual private
networks for employees, implementation of firewalls etc.
 Physical Security: This refers to security implemented through physical access
controls. For example - Disabling the USB ports.
15. The Business Process flow of Current and Saving Account (CASA) is as follows:
(i) Either the customer approaches the relationship manager to apply for a CASA
facility or will apply the same through internet banking, the charges/ rates for the

facility are provided by the relationship manager on basis of the request made by
the customer.
(ii) Once the potential customer agrees for availing the facilities/products of the bank,
the relationship manager request for the relevant documents i.e. KYC and other
relevant documents of the customer depending upon the facility/product. KYC
(Know Your Customer) is a process by which banks obtain information about the
identity and address of the customers. KYC documents can be Passport, Driving
License, etc.
(iii) The documents received from the customers are handed over to the Credit team /
Risk team for sanctioning of the facilities/limits of the customers.
(iv) Credit team verifies the document’s, assess the financial and credit worthiness of
the borrowers and updates facilities in the customer account.
(v) Current Account /Saving Account along with the facilities requested are provided to
the customer for daily functioning.
(vi) Customers can avail facilities such as cheque deposits/ withdrawal, Cash deposit/
withdrawal, Real Time Gross Settlement (RTGS), National Electronics Funds
Transfer System (NEFT), Electronic Clearing Service (ECS), Overdraft Fund
Transfer services provided by the bank.

SECTION – B: STRATEGIC MANAGEMENT
Multiple Choice Questions

1. Increasing investment in the share market, mutual funds, and equity/debt investment
plans from the growing salaried middle class gave birth to Scripzy, an Artificial
Intelligence based market predictor and digital brokerage company. The company is
headquartered in Mumbai and has a team of 100+ IT professionals working on building a
safe and secure digital infrastructure.
The market is saturated. There is fierce competition and big brands have all jumped in
with digital offerings for their existing customers. Scripzy, on the other hand, is new and
vulnerable but its organic reach to the young earning set of customers is a winning
streak. This was achieved by project Force.
Project Force was a secret market analysis conducted by internal teams to find
sustainable competitive advantages, focus on final product attributes most valued by
customers and imitate the competitive capabilities of competitors. It was a complete final
product-customer approach which helped them win over youngsters.
Interestingly, the company being AI based has also automated its internal decision
making with in-house AI decision making bots. The top management explains their
requirements to the AI bot and the bot makes functional decisions that are to be executed
by respective teams. It also engages with team leaders and sends regular reports on
fulfilments. This projected a very strong image for the company in the international
market and a Chinese investor offered them a huge undisclosed amount to buy -out the AI
system. Scripzy immediately accepted the offer and earned huge sums from the
unexpected sale.
Repercussions followed and their core customers, the youth, boycotted their product. The
team had to approach the share market leaders to support and with a little influence from
the share market leaders, they were able to regain their “True Indian Company” status in
the media. Nonetheless, damage had been done and they saw their customer base
shattered to an all time low.
Decisions which seem economically attractive are multi-faceted, and this is one lesson
that Scripzy shall remember for times to come. Business for now is low and weak, but a
good strategy can change the landscape for Scripzy’s future.
Based on the above Case Scenario, answer the Multiple Choice Questions.
(i) Which of the following statement by Ansoff is most appropriate for Scripzy’s strategy
in the changing environment?
(a) Preparedness of worst case scenarios
(b) Far fetched planning of leadership
(c) Money has the power to influence environment

198 INTERMEDIATE (NEW) EXAMINATION: MAY 2021
(d) Blend of proactive and reactive actions

(ii) Project Force was crucial in determining Scripzy’s position in the market. However,
which of the following metrics was missed by the team while understanding KSFs?
(a) Crucial product attributes
(b) Sustainable competitive advantage
(c) Resources for competitive success
(d) Competitive capabilities to be competitively successful
(iii) Scripzy’s huge investment in Artificial Intelligence has caused its organisational
structure to be which of the following structures?
(a) SBU Structure
(b) Divisional Structure
(c) Hourglass Structure
(d) Multidivisional Structure
(iv) In future, to fight out uncertainties like geo-political influences, which of the following
can be used by Scripzy?
(a) Strategic Audit
(b) Scenario Analysis
(c) Benchmarking
(d) ADL Matrix
(v) Not all customers can be satisfied, and Scripzy addressed the same by connecting
with the right customers. Arrange the following in the order that Scripzy followed
while pursuing their customer reach out.
(i) Market Positioning
(ii) Market Segmentation
(iii) Market Target
(a) (i), (ii), (iii)
(b) (ii), (iii), (i)
(c) (iii), (ii), (i)
(d) (i), (iii), (ii)
2. Sanjivni Pharmaceuticals Limited manufacturers a cough syrup Zenus. It has modified
Zenus syrup, claiming that the Zenus cough syrup is sugar-free, and the consumer will
not feel drowsiness after consuming this cough syrup. Consumers found this product as
unique. The sales of Zenus cough syrup have increased as expected. The price of this
sugar-free syrup is higher by 20% than the earlier syrup. Identify the strategy adopted by
Sanjivni Pharmaceuticals Limited.

(a) Focus strategy

(b) Best cost provider strategy
(c) Differentiation strategy
(d) Cost leadership strategy
3. Everyouth Beauty Products Limited, the makers of Feel-Fresh soaps have been suffering
from low sales volume from the last six months due to stiff competition. To regain its
position, Everyouth Beauty Products Limited launched various schemes such as ‘win a
phone every hour’, scratch cards, buy 1 get 1 free and contest on social media. This
resulted into increase in sales. Which type of promotional activity did Everyouth Beauty
Products Limited adopted?
(a) Sales promotion
(b) Advertising
(c) Publicity
(d) Personal selling
4. ABC Ltd. has identified that all three of its main products are at the maturity phase of the
product life cycle. Which of the following is ABC Ltd. likely to be experiencing due to this?
(a) High, but declining sales
(b) Growing numbers of competitors
(c) Product diversification and differentiation strategies
(d) Adoption of price skimming strategies
5. A tool by which management identifies and evaluates the various businesses that make
up a company is termed as:
(a) Value chain analysis
(b) Portfolio analysis
(c) Competition analysis
(d) Strategic analysis
6. If suppliers are unreliable or too costly, which of these strategies may be appropriate?
(a) Horizontal integration
(b) Backward integration
(c) Market penetration
(d) Forward integration

Descriptive Questions
Chapter 1-Introduction to Strategic Management
7. Dharam Singh, the procurement department head of Cyclix, a mountain biking equipment
company, was recently promoted to look after sales department along with procurement
department. His seniors at the corporate level have always liked his way of leadership
and are assures that he would ensure the implementation of policies and strategies to the
best of his capacity but have never involved him in decision making for the company.
Do you think this is the right approach? Validate your answer with logical reasoning
around management levels and decision making.
8. Define strategic management. Also discuss the limitations of strategic management.
Chapter 2-Dynamics of Competitive Strategy
9. ABC Ltd. manufactures and sells air purifier ‘Fresh Breath’. The ‘Fresh Breath’ has seen
sales growth of around 1% for the last two years, after strong growth in the previous five
years. This is due to new products entering the market in competition with the ‘Fresh
Breath’. ABC Ltd. is therefore considering cutting its prices to be in line with its major
rivals with a hope to maintain the market share. Market research indicates that this will
now cause a significant increase in the level of sales, even though in previous years price
cuts have had little effect on demand. ABC ltd. is also planning to launch a promotional
campaign to highlight the benefits of the ‘Fresh Breath’ against its rival products.
Identify and explain the stage of the product life cycle in which ‘Fresh Breath’ falls.
10. Write a short note on SWOT analysis.
Chapter 3-Strategic Management Process
11. Explain briefly the key areas in which the strategic planner should concentrate his mind to
achieve desired results.
12. What are 'objectives'? What characteristics it must possess to be mea ningful?
Chapter 4-Corporate Level Strategies
13. Mini theatre Ltd. was a startup venture of three young IIM graduates. They developed an
application to watch web-based content like web series, TV Shows, theatre shows, etc.
after purchasing their exclusive rights. They were successful in getting many consumers
enrolled with them. After a certain span of time, the company realized that some regional
content like ‘bangla movies’, ‘Gujarati shows’ etc. were having high cost and less
viewership. The leadership team of Mini theatre Ltd. decided to sell the rights and curtail
any further content development in these areas.
Identify and explain the corporate strategy adopted by the leadership team of Mini theatre
Ltd.
14. Justify the statement "Stability strategy is opposite of Expansion strategy".

Chapter 5-Business Level Strategies

15. Competitive pressures operate as a composite in five areas of the overall market.
Elaborate.
16. Write a short note on the concept of cost leadership strategy and how to achieve it?
Chapter 6-Functional Level Strategies
17. ABC Ltd is a company that has grown eleven times its size in last five years. With the
increase in size, the company is facing difficulty in managing things. Many a times
functional level is not in sync with the corporate level. What will you like to advise to the
company and why?
18. Write short note on Publicity and Sales Promotion.
Chapter 7-Organisation and Strategic Leadership
19. Suraj Prakash and Chander Prakash are two brothers engaged in the business of spices.
Both have different approaches to management. Suraj Prakash prefers the conventional
and formal approach in which authority is used for explicit rewards and punishment.
While, on the other hand, Chander Prakash believes in democratic participative
management approach, involving employees to give their best.
Analyse the leadership style followed by Suraj Prakash and Chander Prakash.
20. How can management communicate that it is committed to creating a new culture
assuming that the old culture was problematic and not aligned with the company
strategy?
Chapter 8-Strategy Implementation and Control
21. Why is Strategic Control important for organizations? Discuss briefly 4 types of strategic
control that can be implemented to achieve the enterprise goals.
22. Do you agree with the statement that 'Benchmarking is a process of continuous
improvement in search of competitive advantage'? Discuss.
SUGGESTED ANSWERS
1. (i) (d) (ii) (c) (iii) (c) (iv) (b) (v) (b)
2. (c)
3. (a)
4. (c)
5. (b)
6. (b)
7. Functional managers provide most of the information that makes it possible for business
and corporate level managers to formulate realistic and attainable strategies.

This is so because functional managers like Dharam Singh are closer to the customer
than the typical general manager is. A functional manager may generate important ideas
that subsequently may become major strategies for the company. Thus, it is important for
general managers to listen closely to the ideas of their functional managers and in voice
them in decision making.
An equally great responsibility for managers at the operational level is strategy
implementation: the execution of corporate and business level plans, and if they are
involved in formulation, the clarity of thoughts while implementation can benefit too.
Thus, the approach of Cylcix Corporate management is not right. They should involve
Dharam Singh, as well as other functional managers too in strategic management.
8. The term ‘strategic management’ refers to the managerial process of developing a
strategic vision, setting objectives, crafting a strategy, implementing and evaluating the
strategy, and initiating corrective adjustments where deemed appropriate.
The presence of strategic management cannot counter all hindrances and always achieve
success as there are limitations attached to strategic management. These can be
explained in the following lines:
 Environment is highly complex and turbulent. It is difficult to understand the
complex environment and exactly pinpoint how it will shape-up in future. The
organisational estimate about its future shape may awfully go wrong and jeopardise
all strategic plans. The environment affects as the organisationhas to deal with
suppliers, customers, governments and other external factors.
 Strategic management is a time-consuming process. Organisations spend a lot
of time in preparing, communicating the strategies that may impede daily operations
and negatively impact the routine business.
 Strategic management is a costly process. Strategic management adds a lot of
expenses to an organization. Expert strategic planners need to be engaged, efforts
are made for analysis of external and internal environments devise strategies and
properly implement. These can be really costly for organisations with limited
resources particularly when small and medium organisation create strategies to
compete.
 Competition is unpredictable. In a competitive scenario, where all organisations
are trying to move strategically, it is difficult to clearly estimate the competitive
responses to the strategies.
9. Product Life Cycle is a useful concept for guiding strategic choice. PLC is an S-shaped
curve which exhibits the relationship of sales with respect of time for a product that
passes through the four successive stages of introduction (slow sales growth), growth
(rapid market acceptance) maturity (slowdown in growth rate) and decline (sharp
downward drift).
The product ‘Fresh Breath’ of ABC Ltd. falls under Maturity stage of product life cycle. In
this stage, the competition gets tough and market gets stablised. Profit comes down

because of stiff competition. At this stage, ABC Ltd. have to work for maintaining stability
by cutting the prices to be in line with its major rivals with a hope to maintain the market
share and by launching a promotional campaign to highlight the benefits of the ‘Fresh
Breath’ against its rival products.
10. SWOT analysis is a tool used by organizations for evolving strategic options for the
future. The term SWOT refers to the analysis of strengths, weaknesses, opportunities and
threats facing a company. Strengths and weaknesses are identified in the internal
environment, whereas opportunities and threats are located in the external environment.
(a) Strength: Strength is an inherent capability of the organization which it can use to
gain strategic advantage over its competitor.
(b) Weakness: A weakness is an inherent limitation or constraint of the organisation
which creates strategic disadvantage to it.
(c) Opportunity: An opportunity is a favourable condition in the external environment
which enables it to strengthen its position.
(d) Threat: An unfavourable condition in the external environment which causes a risk
for, or damage to the organisation’s position.
The major purpose of SWOT analysis is to enable the management to create a firm -
specific business model that will best align, fit or match an organisational resources and
capabilities to the demands for environment in which it operates.
11. A strategic manager defines the strategic intent of the organisation and take it on the path
of achieving the organisational objectives. There can be a number of areas that a
strategic manager should concentrate on to achieve desired results. They commonly
establish long-term objectives in seven areas as follows:
• Profitability.
• Productivity.
• Competitive Position.
• Employee Development.
• Employee Relations.
• Technological Leadership.
• Public Responsibility.
12. Objectives are organizations performance targets – the results and outcomes it wants to
achieve. They function as yardstick for tracking an organization’s performance and
progress.
Objectives with strategic focus relate to outcomes that strengthen an organization’s
overall business position and competitive vitality. Objectives, to be meaningful to serve
the intended role, must possess the following characteristics:
 Objectives should define the organization’s relationship with its environment.

 Objectives should be facilitative towards achievement of mission and purpose.

 Objectives should provide the basis for strategic decision-making.
 Objectives should provide standards for performance appraisal.
 Objectives should be understandable.
 Objectives should be concrete and specific.
 Objectives should be related to a time frame.
 Objectives should be measurable and controllable.
 Objectives should be challenging.
 Different objectives should correlate with each other.
 Objectives should be set within constraints.
13. The leadership team of Mini theatre Ltd. decided to cuts off the loss -making units,
reduces the functions performed that some of regional content like ‘bangla movies’,
‘Gujarati shows’ etc. were having high cost and less viewership, it adopts a divestment
strategy. The leadership team of Mini theatre Ltd. decided to sell the rights and curtail
any further content development in these areas.
Divestment strategy involves the sale or liquidation of a portion of business, or a major
division, profit centre or SBU. Divestment is usually a part of rehabilitation or restructuring
plan and is adopted when a turnaround has been attempted but has proved to be
unsuccessful. The option of a turnaround may even be ignored if it is obvious that
divestment is the only answer.
14. Stability Strategies, as name suggests, are intended to safeguard the existing interests
and strengths of business. It involves organisations to pursue established and tested
objectives, continue on the chosen path, maintain operational efficiency and so o n. A
stability strategy is pursued when a firm continues to serve in the same or similar markets
and deals in same products and services. In stability strategy, few functional changes are
made in the products or markets, however, it is not a ‘do nothing’ s trategy. This strategy
is typical for mature business organizations. Some small organizations also frequently
use stability as a strategic focus to maintain comfortable market or profit position.
On the other hand, expansion strategy is aggressive strategy as it involves redefining the
business by adding the scope of business substantially, increasing efforts of the current
business. In this sense, it becomes opposite to stability strategy. Expansion is a
promising and popular strategy that tends to be equated with dynamism, vigor, promise
and success. Expansion also includes diversifying, acquiring and merging businesses.
This strategy may take the enterprise along relatively unknown and risky paths, full of
promises and pitfalls.
15. Competition makes organizations work harder, however, it is neither a coincidence nor
bad luck. All organizations have competition and its benefit are enjoyed by the markets.
The customers are able to get better products at lower costs. They get better value for
their money because of competition. A powerful and widely used tool for systematically

diagnosing the significant competitive pressures in a market and assessing the strength
and importance of each is the Porter’s five-forces model of competition. This model holds
that the state of competition in an industry is a composite of competitive pressures
operating in five areas of the overall market as follows:
(i) Rivalry among current players: Competitive pressures associated with the market
manoeuvring and jockeying for buyer patronage that goes on among rival sellers in
the industry.
(ii) Threat of new entrants: Competitive pressures associated with the threat of new
entrants into the market.
(iii) Threats from substitutes: Competitive pressures coming from the attempts of
companies in other industries to win buyers over to their own substitute products.
(iv) Bargaining power of suppliers: Competitive pressures stemming from supplier
bargaining power and supplier-seller collaboration.
(v) Bargaining power of customers: Competitive pressures stemming from buyer
bargaining power and seller-buyer collaboration.
16. Cost leadership strategy requires vigorous pursuit of cost reduction in the areas of
procurement, production, storage and distribution of product or service and als o
economies in overhead costs. Accordingly, the cost leader is able to charge a lower price
for its products than its competitors and still make satisfactory profits. The low cost
leadership should be such that no competitors are able to imitate so that it can result in
sustainable competitive advantage to the cost leader firm.
To achieve cost leadership, following are the actions that could be taken:
1. Forecast the demand of a product or service promptly.
2. Optimum utilization of the resources to get cost advantages.
3. Achieving economies of scale leads to lower per unit cost of product/service.
4. Standardisation of products for mass production to yield lower cost per unit.
5. Invest in cost saving technologies and try using advance technology for smart
working.
6. Resistance to differentiation till it becomes essential.
17. The higher-level corporate strategies need to be segregated into viable plans and policies
that are compatible with each other and communicated down the line. The higher-level
strategies need to be broken into functional strategies for implementation. These
functional strategies, in form of marketing, finance, human resource, production, research
and development help in achieving the organisational objective. The reasons why
functional strategies are needed can be enumerated as follows:
 Functional strategies lay down clearly what is to be done at the functional level.
They provide a sense of direction to the functional staff.

 They are aimed at facilitating the implementation of corporate strategies and the
business strategies formulation at the business level.
 They act as basis for controlling activities in the different functional areas of
business.
 They help in bringing harmony and coordination as they are formulated to achieve
major strategies.
 Similar situations occurring in different functional areas are handled in a consistent
manner by the functional managers.
18. Publicity and Sales promotion are adopted by organizations when they are undertaking
promotion in the overall marketing mix.
Publicity is a non-personal form of promotion similar to advertising. However, no
payments are made to the media as in case of advertising. Organizations skillfully seek to
promote themselves and their product without payment. Publicity is communication of a
product, brand or business by placing information about it in the media without paying for
the time or media space directly.
Thus, it is way of reaching customers with negligible cost. Basic tools for publicity are
press releases, press conferences, reports, stories, and internet releases. These
releases must be of interest to the public.
Sales promotion is an omnibus term that includes all activities that are undertaken to
promote the business but are not specifically included under personal selling, advertising
or publicity. Activities like discounts, contests, money refunds, installments, kiosks,
exhibitions and fairs constitute sales promotion. All these are meant to give a boost to the
sales. Sales promotion done periodically may help in getting a larger market share to an
organization.
19. Suraj Prakesh is a follower of transactional leadership style that focuses on designing
systems and controlling the organization’s activities. Such a leader believes in using
authority of its office to exchange rewards, such as pay and status. They prefer a more
formalized approach to motivation, setting clear goals with explicit rewards or penalties
for achievement or non-achievement. Transactional leaders try to build on the existing
culture and enhance current practices. The style is better suited in persuading people to
work efficiently and run operations smoothly.
On the other hand, Chander Prakash is a follower of transformational leadership style.
The style uses charisma and enthusiasm to inspire people to exert them for the good of
the organization. Transformational leaders offer excitement, vision, intellec tual stimulation
and personal satisfaction. They inspire involvement in a mission, giving followers a
‘dream’ or ‘vision’ of a higher calling so as to elicit more dramatic changes in
organizational performance. Such a leadership motivates followers to do m ore than
originally affected to do by stretching their abilities and increasing their self -confidence,
and also promote innovation throughout the organization.

20. Corporate culture refers to company’s values, beliefs, business principles, traditions,
ways of operating and internal work environment. Changing problem cultures is very
difficult because of deeply held values and habits. It takes concerted management action
over a period of time to replace an unhealthy culture with a healthy culture or to roo t out
certain unwanted cultural obstacles and instil ones that are more strategy -supportive.
 The first step is to diagnose which facets of the present culture are strategy
supportive and which are not.
 Then, managers have to talk openly and forthrightly to all concerned about those
aspects of the culture that have to be changed.
 The talk has to be followed swiftly by visible, aggressive actions to modify the
culture-actions that everyone will understand are intended to establish a new culture
more in tune with the strategy.
Management through communication has to create a shared vision to manage changes.
The menu of culture-changing actions includes revising policies and procedures, altering
incentive compensation, shifting budgetary allocations for substantial resources to new
strategy projects, recruiting and hiring new managers and employees, replacing key
executives, communication on need and benefit to employees and so on.
21. Importance of strategic control: Strategic control is an important process that keeps
organisation on its desired path. It involves evaluating strategy as it is formulated and
implemented. It is directed towards identifying problems and changes in premises and
making necessary adjustments. Strategic control focuses on the dual questions of
whether: (1) the strategy is being implemented as planned; and (2) the results produced
by the strategy are those intended.
There are four types of strategic control:
 Premise control: A strategy is formed on the basis of certain assumptions or
premises about the environment. Premise control is a tool for systematic and
continuous monitoring of the environment to verify the validity and accuracy of the
premises on which the strategy has been built.
 Strategic surveillance: Strategic surveillance is unfocussed. It involves general
monitoring of various sources of information to uncover unanticipated information
having a bearing on the organizational strategy.
 Special alert control: At times, unexpected events may force organizations to
reconsider their strategy. Sudden changes in government, natural calamities,
unexpected merger/acquisition by competitors, industrial disasters and other such
events may trigger an immediate and intense review of strategy.
 Implementation control: Managers implement strategy by converting major plans
into concrete, sequential actions that form incremental steps. Implementation control
is directed towards assessing the need for changes in the overall strategy in light of
unfolding events and results.

22. Yes, benchmarking is a process of continuous improvement in search for competitive

advantage. It measures factors related to products, services and practices against those
of its competitors or other acknowledged leaders in their field.
Benchmarking is an approach of setting goals and measuring productivity based on best
industry practices. It developed out of need to have information against which
performances can be measured. It helps in improving performance by learning from best
practices and the processes by which they are achieved.
Benchmarking involves regularly comparing different aspects of performance with the
best practices, identifying gaps and finding out novel methods to not only reduce the gaps
but to improve the situations so that the gaps are positive for the organization. Better
processes are not merely copied. Efforts are made to learn, improve and evolve them to
suit the organizational circumstances. Further, benchmarking exercises are also repeated
periodically so that the organization does not lag behind in the dynamic environment.
Firms can use benchmarking process to achieve improvement in diverse range of
management function like maintenance operations, assessment of total manufacturing
costs, product development, product distribution, customer services, plant utilisation
levels and human resource management.

PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE
PART A: FINANCIAL MANAGEMENT
QUESTIONS
Ratio Analysis
1. Given below are the estimations for the next year by Niti Ltd.:
Particulars (` in crores)
Fixed Assets 5.20
Current Liabilities 4.68
Current Assets 7.80
Sales 23.00
EBIT 2.30
The company will issue equity funds of ` 5 crores in the next year. It is also considering
the debt alternatives of ` 3.32 crores for financing the assets. The company wants to adopt
one of the policies given below:
(` in crores)
Financing Policy Short term debt @ 12% Long term debt @ 16% Total
Conservative 1.08 2.24 3.32
Moderate 2.00 1.32 3.32
Aggressive 3.00 0.32 3.32
Assuming corporate tax rate at 30%, CALCULATE the following for each of the financing
policy:
(i) Return on total assets
(ii) Return on owner's equity
(iii) Net Working capital
(iv) Current Ratio
Also advise which Financing policy should be adopted if the company wants high returns.
Cost of Capital
2. Indel Ltd. has the following capital structure, which is considered to be optimum as on
31st March, 2021:
Particulars (`)
14% Debentures 60,000

11% Preference shares 20,000

Equity Shares (10,000 shares) 3,20,000
4,00,000
The company share has a market price of ` 47.20. Next year dividend per share is 50% of
year 2020 EPS. The following is the uniform trend of EPS for the preceding 10 years which
is expected to continue in future.
Year EPS (`) Year EPS (`)
2011 2.00 2016 3.22
2012 2.20 2017 3.54
2013 2.42 2018 3.90
2014 2.66 2019 4.29
2015 2.93 2020 4.72
The company issued new debentures carrying 16% rate of interest and the current market
price of debenture is ` 96.
Preference shares of ` 18.50 (with annual dividend of ` 2.22 per share) were also issued.
The company is in 30% tax bracket.
(A) CALCULATE after tax:
(i) Cost of new debt
(ii) Cost of new preference shares
(iii) New equity share (assuming new equity from retained earnings)
(B) CALCULATE marginal cost of capital when no new shares are issued.
(C) DETERMINE the amount that can be spent for capital investment before new ordinary
shares must be sold, assuming that the retained earnings for next year’s investment
is 50 percent of earnings of 2020.
(D) COMPUTE marginal cost of capital when the fund exceeds the amount calculated in
(C), assuming new equity is issued at ` 40 per share?
Capital Structure
3. Zordon Ltd. has net operating income of ` 5,00,000 and total capitalization of ` 50,00,000
during the current year. The company is contemplating to introduce debt financing in capital
structure and has various options for the same. The following information is available at
different levels of debt value:
Debt value Interest rate Equity capitalization rate
(`) (%) (%)
0 - 10.00

PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE 211
5,00,000 6.0 10.50

10,00,000 6.0 11.00
15,00,000 6.2 11.30
20,00,000 7.0 12.40
25,00,000 7.5 13.50
30,00,000 8.0 16.00
Assuming no tax and that the firm always maintains books at book values, you are
REQUIRED to calculate:
(i) Amount of debt to be employed by firm as per traditional approach.
(ii) Equity capitalization rate, if MM approach is followed.
Leverage
4. Following information has been extracted from the accounts of newly incorporated Textyl
Pvt. Ltd. for the Financial Year 2020-21:
Sales ` 15,00,000
P/V ratio 70%
Operating Leverage 1.4 times
Financial Leverage 1.25 times
Using the concept of leverage, find out and verify in each case:
(i) The percentage change in taxable income if sales increase by 15%.
(ii) The percentage change in EBIT if sales decrease by 10%.
(iii) The percentage change in taxable income if EBIT increase by 15%.
Investment Decisions
5. The General Manager of Merry Ltd. is considering the replacement of five -year-old
equipment. The company has to incur excessive maintenance cost of the equipment. The
equipment has zero written down value. It can be modernized at a cost of ` 1,40,000
enhancing its economic life to 5 years. The equipment could be sold for ` 30,000 after 5
years. The modernization would help in material handling and in reducing labour ,
maintenance & repairs costs.
The company has another alternative to buy a new machine at a cost of ` 3,50,000 with
an economic life of 5 years and salvage value of ` 60,000. The new machine is expected
to be more efficient in reducing costs of material handling, labour , maintenance & repairs,
etc.

The annual cost are as follows:

Existing Equipment Modernization New Machine
(`) (`) (`)
Wages & Salaries 45,000 35,500 15,000
Supervision 20,000 10,000 7,000
Maintenance 25,000 5,000 2,500
Power 30,000 20,000 15,000
1,20,000 70,500 39,500
Assuming tax rate of 50% and required rate of return of 10%, should the company
modernize the equipment or buy a new machine?
PV factor at 10% are as follows:
Year
7B 1 2 3 4 5
PV factor 0.909 0.826 0.751 0.683 0.621
Risk Analysis in Capital Budgeting
6. X Ltd is considering installation of new machine with the following details:
Sr. No. Particulars Figures
1 Initial Investment ` 1400 Crore
2 Annual unit sales 100 Crore
3 Selling price per unit ` 40
4 Variable cost per unit ` 20
5 Annual Fixed costs ` 500 Crore
6 Depreciation ` 200 Crore
7 Discount Rate 12%
8 Tax rate 30%
Consider Life of the project as 4 years with no salvage value.
Required:
(i) CALCULATE the expected NPV of the project.
(ii) COMPUTE the impact on the project’s NPV if change in variables is as under and
also compute which variable is having maximum impact on NPV.
Sr. No. Variable Figures
1 Unit sold per year 85 Crore
2 Selling price per unit ` 39

3 Variable cost per unit ` 22

4 Annual Fixed costs ` 575 Crore
PV factor at 12% are as follows:
Year
7B 1 2 3 4
PV factor 0.893 0.797 0.712 0.636
Dividend Decision
7. The following information is supplied to you:
(`)
Total Earnings 2,00,000
No. of equity shares (of ` 100 each) 20,000
Dividend paid 1,50,000
Price/ Earnings ratio 12.5
Applying Walter’s Model:
(i) ANALYSE whether the company is following an optimal dividend policy.
(ii) COMPUTE P/E ratio at which the dividend policy will have no effect on the value of
the share.
(iii) Will your decision change if the P/E ratio is 8 instead of 12.5? ANALYSE.
Management of Working Capital
8. MT Ltd. has been operating its manufacturing facilities till 31.3.202 1 on a single shift
working with the following cost structure:
Per unit (`)
Cost of Materials 24
Wages (out of which 60% variable) 20
Overheads (out of which 20% variable) 20
64
Profit 8
Selling Price 72
As at 31.3.2021 with the sales of ` 17,28,000, the company held:
(`)
Stock of raw materials (at cost) 1,44,000
Work-in-progress (valued at prime cost) 88,000
Finished goods (valued at total cost) 2,88,000
Sundry debtors 4,32,000

In view of increased market demand, it is proposed to double production by working an

extra shift. It is expected that a 10% discount will be available from suppliers of raw
materials in view of increased volume of business. Selling price will remain the same. The
credit period allowed to customers will remain unaltered. Credit availed from suppliers will
continue to remain at the present level i.e. 2 months. Lag in payment of wages and
overheads will continue to remain at one month.
You are required to CALCULATE the additional working capital requirements, if the policy
to increase output is implemented, to assess the impact of double shift for long term as a
matter of production policy.
9. While applying for financing of working capital requirements to a commercial bank, TN
Industries Ltd. projected the following information for the next year:
Cost Element Per unit (`) Per unit (`)
Raw materials
X 30
Y 7
Z 6 43
Direct Labour 25
Manufacturing and administration overheads (excluding 20
depreciation)
Depreciation 10
Selling overheads 15
113
Additional Information:
(a) Raw Materials are purchased from different suppliers leading to different credit period
allowed as follows:
X – 2 months; Y– 1 months; Z – ½ month
(b) Production cycle is of ½ month. Production process requires full unit of X and Y in the
beginning of the production. Z is required only to the extent of half unit in the
beginning and the remaining half unit is needed at a uniform rate during the
production process.
(c) X is required to be stored for 2 months and other materials for 1 month.
(d) Finished goods are held for 1 month.
(e) 25% of the total sales is on cash basis and remaining on credit basis. The credit
allowed by debtors is 2 months.

(f) Average time lag in payment of all overheads is 1 months and ½ months for direct
labour.
(g) Minimum cash balance of ` 8,00,000 is to be maintained.
CALCULATE the estimated working capital required by the company on cash cost basis if
the budgeted level of activity is 1,50,000 units for the next year. The company also intends
to increase the estimated working capital requirement by 10% to meet the contingencies.
(You may assume that production is carried on evenly throughout the year and direct labour
and other overheads accrue similarly.)
Miscellaneous
10. (i) "Profit Maximization cannot be the sole objective of a company". COMMENT.
(ii) DISCUSS the advantages and disadvantages of raising funds by issue of preference
shares.
SUGGESTED ANSWERS
1. (i) Return on total assets

EBIT (1 - T)
Return on total assets =
Total assets (FA CA)
` 2.30 crores (1- 0.3)
=
` 5.20 crores + ` 7.80 crores
` 1.61crores
= = 0.1238 or 12.38%
` 13 crores
(ii) Return on owner's equity
(Amount in `)
Financing policy (`)
Conservative Moderate Aggressive
Expected EBIT 2,30,00,000 2,30,00,000 2,30,00,000
Less: Interest
Short term Debt @ 12% 12,96,000 24,00,000 36,00,000
Long term Debt @ 16% 35,84,000 21,12,000 5,12,000
Earnings before tax (EBT) 1,81,20,000 1,84,88,000 1,88,88,000
Less: Tax @ 30% 54,36,000 55,46,400 56,66,400
Earnings after Tax (EAT) 1,26,84,000 1,29,41,600 1,32,21,600

Owner's Equity 5,00,00,000 5,00,00,000 5,00,00,000

Return on owner's equity 1,26,84,000 1,29,41,600 1,32,21,600
= 5,00,00,000 = 5,00,00,000 = 5,00,00,000
Net Pr ofit after taxes (EAT)

Owners 'equity = 0.2537 or = 0.2588 or = 0.2644 or
25.37% 25.88% 26.44%
(iii) Net Working capital
(` in crores)
Financing policy
Current Liabilities (Excluding 4.68 4.68 4.68
Short Term Debt)
Short term Debt 1.08 2.00 3.00
Total Current Liabilities 5.76 6.68 7.68
Current Assets 7.80 7.80 7.80
Net Working capital 7.80 - 5.76 7.80 - 6.68 7.80 - 7.68
= Current Assets - Current = 2.04 = 1.12 = 0.12
Liabilities
(iv) Current ratio
(` in crores)
Financing policy
Current Ratio 7.80 7.80 7.80
= = 1.35 = = 1.17 = = 1.02
Current Assets 5.76 6.68 7.68
=
Current Liabilities
Advise: It is advisable to adopt aggressive financial policy, if the company wants high
return as the return on owner's equity is maximum in this policy i.e. 26.4 4%.
2. (A) (i) Cost of new debt
I(1- t)
Kd =
P0
` 16(1  0.3)
= = 0.11667
` 96

(ii) Cost of new preference shares

` 2.22
Kp = = 0.12
` 18.5
(iii) Cost of new equity shares
D1
Ke = +g
P0
` 2.36
=  0.10
` 47.20
= 0.05 + 0.10 = 0.15
Calculation of g when there is a uniform trend (on the basis of EPS)
` 2.20 ` 2.00
= EPS (2012) - EPS (2011) = = 0.10 or 10%
EPS (2011) ` 2.00
Calculation of D 1
D1 = 50% of 2020 EPS = 50% of ` 4.72 = ` 2.36
(B) Calculation of marginal cost of capital
Type of Capital Proportion Specific Cost Product
(1) (2) (3) (2) × (3) = (4)
Debentures 0.15 0.11667 0.0175
Preference Share 0.05 0.1200 0.0060
Equity Share 0.80 0.1500 0.1200
Marginal cost of capital 0.1435
(C) The company can spend the following amount without increasing marginal cost of
capital and without selling the new shares:
Retained earnings = 50% of EPS of 2020 × outstanding equity shares
= 50% of ` 4.72 × 10,000 shares = ` 23,600
The ordinary equity (Retained earnings in this case) is 80% of total capital.
S So, ` 23,600 = 80% of Total Capital
` 23,600
∴ Capital investment before issuing equity shares = = ` 29,500
0.80
(D) If the company spends in excess of ` 29,500, it will have to issue new equity shares
at ` 40 per share.

 The cost of new issue of equity shares will be:

D1 ` 2.36
Ke = +g =  0.10 = 0.159
P0 ` 40
The marginal cost of capital will be:
Type of Capital Proportion Specific Cost Product
(1) (2) (3) (2) × (3) = (4)
Debentures 0.15 0.11667 0.0175
Preference Shares 0.05 0.1200 0.0060
Equity Shares (New) 0.80 0.1590 0.1272
Marginal cost of capital 0.1507
3. (a) Amount of debt to be employed by firm as per traditional approach
Calculation of Equity, W d and W e
Total Capital Debt Wd Equity value We
(`) (`) (`)
(a) (b) (b)/(a) (c) = (a) - (b) (c)/(a)
50,00,000 0 - 50,00,000 1.0
50,00,000 5,00,000 0.1 45,00,000 0.9
50,00,000 10,00,000 0.2 40,00,000 0.8
50,00,000 15,00,000 0.3 35,00,000 0.7
50,00,000 20,00,000 0.4 30,00,000 0.6
50,00,000 25,00,000 0.5 25,00,000 0.5
50,00,000 30,00,000 0.6 20,00,000 0.4
Statement of Weighted Average Cost of Capital (WACC)
Ke We Kd Wd Ke W e K d Wd Ko
(1) (2) (3) (4) (5) = (1) x (2) (6) = (3) x (4) (7) = (5) + (6)
0.100 1.0 - - 0.100 - 0.100
0.105 0.9 0.060 0.1 0.095 0.006 0.101
0.110 0.8 0.060 0.2 0.088 0.012 0.100
0.113 0.7 0.062 0.3 0.079 0.019 0.098
0.124 0.6 0.070 0.4 0.074 0.028 0.102
0.135 0.5 0.075 0.5 0.068 0.038 0.106
0.160 0.4 0.080 0.6 0.064 0.048 0.112

So, amount of Debt to be employed = ` 15,00,000 as WACC is minimum at this level

of debt i.e. 9.8%.
(b) As per MM approach, cost of the capital (K o) remains constant and cost of equity
increases linearly with debt.
Net Operating Income (NOI)
Value of a firm =
K0
` 5,00,000
` 50,00,000 =
Ko
Ko = ` 5,00,000 = 10%
` 50,00,000
Statement of Equity Capitalization rate (k e) under MM approach
Debt Equity Debt/Equity Ko Kd Ko - Kd Ke
(`) (`) = Ko +
(Ko - Kd)
Debt
Equity
(1) (2) (3) = (1)/(2) (4) (5) (6) = (4) (7) = (4) +
-(5) (6) x (3)
0 50,00,000 0 0.10 - 0.100 0.100
5,00,000 45,00,000 0.11 0.10 0.060 0.040 0.104
10,00,000 40,00,000 0.25 0.10 0.060 0.040 0.110
15,00,000 35,00,000 0.43 0.10 0.062 0.038 0.116
20,00,000 30,00,000 0.67 0.10 0.070 0.030 0.120
25,00,000 25,00,000 1.00 0.10 0.075 0.025 0.125
30,00,000 20,00,000 1.50 0.10 0.080 0.020 0.130
4. Workings:
1. Contribution = Sales x P/V ratio
= ` 15,00,000 x 70% = ` 10,50,000
Contribution
2. Operating Leverage =
Earnings before interest and tax (EBIT)
` 10,50,000
Or, 1.4 =
EBIT

EBIT = ` 7,50,000
EBIT
3. Financial leverage =
EBT
` 7,50,000
Or, 1.25 =
EBT
EBT = ` 6,00,000
4. Fixed Cost = Contribution – EBIT
= ` 10,50,000 – ` 7,50,000 = ` 3,00,000
5. Interest = EBIT – EBT
= ` 7,50,000 – ` 6,00,000 = ` 1,50,000
6. Income Statement
Particulars Amount (`)
Sales 15,00,000
Less: Variable cost (30% of ` 15,00,000) 4,50,000
Contribution (70% of ` 15,00,000) 10,50,000
Less: Fixed costs 3,00,000
Earnings before interest and tax (EBIT) 7,50,000
Less: Interest 1,50,000
Earnings before tax (EBT) 6,00,000
Contribution ` 10,50,000
(i) Combined Leverage = = = 1.75 times
EBT ` 6,00,000
Or, Combined Leverage = Operating Leverage x Financial Leverage
= 1.4 x 1.25 = 1.75 times
So, if sales is increased by 15% then taxable income (EBT) will be increased by 1.75
× 15% = 26.25%
Verification
Particulars Amount
(`)
New Sales after 15% increase (` 15,00,000 + 15% of 17,25,000
` 15,00,000)

Contribution (70% of ` 17,25,000) 12,07,500

Earnings before interest and tax (EBIT) 9,07,500
Earnings before tax after change (EBT) 7,57,500
Increase in Earnings before tax (EBT) = ` 7,57,500 - ` 6,00,000 = ` 1,57,500
` 1,57,500
So, percentage change in Taxable Income (EBT) = × 100 = 26.25%, hence
` 6,00,000
verified.
(ii) Degree of Operating Leverage (Given) = 1.4 times
So, if sales is decreased by 10% then EBIT will be decreased by 1.4 × 10% = 14%
Verification
Particulars Amount
(`)
New Sales after 10% decrease (` 15,00,000 - 10% of 13,50,000
` 15,00,000)
Contribution (70% of ` 13,50,000) 9,45,000
Earnings before interest and tax after change (EBIT) 6,45,000
Decrease in Earnings before interest and tax (EBIT) = ` 7,50,000 - ` 6,45,000 =
` 1,05,000
` 1,05,000
So, percentage change in EBIT =  100 = 14%, hence verified.
` 7,50,000
(iii) Degree of Financial Leverage (Given) = 1.25 times
So, if EBIT increases by 15% then Taxable Income (EBT) will be increased by 1.25 ×
15% = 18.75%
Verification
Particulars Amount
(`)
New EBIT after 15% increase (` 7,50,000 + 15% of ` 7,50,000) 8,62,500
Earnings before Tax after change (EBT) 7,12,500

Increase in Earnings before Tax = ` 7,12,500 - ` 6,00,000 = ` 1,12,500
So, percentage change in Taxable Income (EBT) = ` 1,12,500  100 = 18.75%,

` 6,00,000
hence verified.
5. Workings:
Calculation of Depreciation:
On Modernized Equipment = ` 1,40,000  ` 30,000  ` 22,000 p.a.

5 years
On New machine = ` 3,50,000  ` 60,000  ` 58,000 p.a.

5 years
(i) Calculation of Incremental annual cash inflows/ savings:

Particulars Existing Modernization New Machine
Equipment
Amount Savings Amount Savings
(`)
(`) (`) (`) (`)
(1) (2) (3)=(1)-(2) (4) (5)=(1)-(4)
Wages & Salaries 45,000 35,500 9,500 15,000 30,000
Supervision 20,000 10,000 10,000 7,000 13,000
Maintenance 25,000 5,000 20,000 2,500 22,500
Power 30,000 20,000 10,000 15,000 15,000
Total 1,20,000 70,500 49,500 39,500 80,500
Less: Depreciation 22,000 58,000
(Refer Workings)
Total Savings 27,500 22,500
Less: Tax @ 50% 13,750 11,250
After Tax Savings 13,750 11,250
Add: Depreciation 22,000 58,000
Incremental Annual 35,750 69,250
Cash Inflows

(ii) Calculation of Net Present Value (NPV)

Particulars Year Modernization New Machine
(`) (`)
Initial Cash outflow (A) 0 1,40,000.00 3,50,000.00
Incremental Cash Inflows 1-5 1,35,492.50 2,62,457.50
(` 35,750 x 3.790) (` 69,250 x 3.790)
Salvage value 5 18,630.00 37,260.00
(` 30,000 x 0.621) (` 60,000 x 0.621)
PV of Cash inflows (B) 1,54,122.50 2,99,717.50
Net Present Value (B - A) 14,122.50 (50,282.50)
Advise: The company should modernize its existing equipment and not buy a new machine
because NPV is positive in modernization of equipment.
6. (i) Calculation of Net Cash Inflow per year :
Particulars Amount (`)
A Selling Price Per Unit (A) 40
B Variable Cost Per Unit (B) 20
C Contribution Per Unit (C = A - B) 20
D Number of Units Sold Per Year 100 Crore
E Total Contribution (E = C × D) 2,000 Crore
F Annual Fixed costs 500 Crore
G Depreciation 200 Crore
H Net Profit before taxes (H = E - F - G) 1,300 Crore
I Tax @ 30% of H 390 Crore
J Net Cash Inflow Per Year (J = H - I + G) 1,110 Crore
Calculation of expected Net Present Value (NPV) of the Project:
Year Year Cash Flow PVAF @ 12% Present Value (PV)

(` in Crore) (` in Crore)
0 (1400.00) 1.000 (1400.00)
1-4 1,110.00 3.038 3,372.18
Net Present Value 1,972.18

(ii) Sensitivity Analysis under variable different value:

Changes in variable Base Units sold Selling Variable Annual
per year price per cost per Fixed costs
is 85 unit is unit is is
Crore ` 39 ` 22 ` 575 Crore
Particulars (`) (`) (`) (`) (`)
A Selling Price Per Unit 40 40 39 40 40
B Variable Cost Per Unit 20 20 20 22 20
C Contribution Per Unit 20 20 19 18 20
(C = A - B)
D Number of Units Sold Per 100 85 100 100 100
Year (in Crores)
E Total Contribution (E = C × 2,000 1,700 1,900 1,800 2,000
D)
F Annual Fixed Cost (in 500 500 500 500 575
Crores)
G Depreciation (in Crores) 200 200 200 200 200
H Net Profit before taxes 1,300 1,000 1,200 1,100 1,225
(H = E - F - G)
I Tax @ 30% of H 390 300 360 330 367.50
J Net Cash Inflow Per Year (J
1,110 900 1,040 970 1,057.50
= H - I + G)
K (J × 3.038) 3,372.18 2,734.20 3,159.52 2,946.86 3,212.69
L Initial Cash Flow 1,400 1,400 1,400 1,400 1,400
M NPV (K - L) 1,972.18 1,334.20 1,759.52 1,546.86 1,812.69
N Change in NPV - (637.98) (212.66) (425.32) (159.50)
O Percentage Change in NPV - -32.35% -10.78% -21.57% -8.09%
The above table shows that by varying one variable at a time while keeping the others
constant, the impact in percentage terms on the NPV of the project. Thus, it can be seen
that the change in units sold per year has the maximum effect on the NPV by 32.35%.
7. (i) The EPS of the firm is ` 10 (i.e., ` 2,00,000/ 20,000) and r = 2,00,000/ (20,000 shares
× `100) = 10%. The P/E Ratio is given at 12.5 and the cost of capital, K e, may be
taken at the inverse of P/E ratio. Therefore, K e is 8 (i.e., 1/12.5). The firm is distributing
total dividends of ` 1,50,000 among 20,000 shares, giving a dividend per share of
` 7.50. the value of the share as per Walter’s model may be found as follows:

r
D+ (E - D) 0.1
Ke 7.5  (10 - 7.5)
P = = 0.08 = ` 132.81
Ke 0.08
The firm has a dividend payout of 75% (i.e., ` 1,50,000) out of total earnings of
` 2,00,000. Since, the rate of return of the firm, r, is 10% and it is more than the K e
of 8%, therefore, by distributing 75% of earnings, the firm is not following an opti mal
dividend policy. The optimal dividend policy for the firm would be to pay zero dividend
and in such a situation, the market price would be-
0.1
0+ (10 - 0)
 0.08 = ` 156.25
0.08
So, theoretically the market price of the share can be increased by adopting a zero
payout.
(ii) The P/E ratio at which the dividend policy will have no effect on the value of the share
is such at which the K e would be equal to the rate of return, r, of the firm. The K e
would be 10% (= r) at the P/E ratio of 10. Therefore, at the P/E ratio of 10, the
dividend policy would have no effect on the value of the share.
(iii) If the P/E is 8 instead of 12.5, then the K e which is the inverse of P/E ratio, would be
12.5 and in such a situation k e> r and the market price, as per Walter’s model would
be:
r
D+ (E - D) 7.5 + 0.1 (10 - 7.5)
P = Ke 0.125
= = ` 76
Ke 0.125
8. Workings:
(1) Statement of cost at single shift and double shift working
24,000 units 48,000 Units
Per unit Total Per unit Total
(`) (`) (`) (`)
Raw materials 24 5,76,000 21.6 10,36,000
Wages:
Variable 12 2,88,000 12 5,76,000
Fixed 8 1,92,000 4 1,92,000
Overheads:
Variable 4 96,000 4 1,92,000

Fixed 16 3,84,000 8 3,84,000

Total cost 64 15,36,000 49.6 23,80,800
Profit 8 1,92,000 22.4 10,75,200
Sales 72 17,28,000 72 34,56,000
(2) Sales in units 2020-21 = Sales ` 17,28,000

= = 24,000 units
Unit selling price ` 72
(3) Stock of Raw Materials in units on 31.3.2021
= Value of stock = ` 1,44,000 = 6,000 units

Cost per unit ` 24
(4) Stock of work-in-progress in units on 31.3.2021
= Value of work - in- progress ` 88,000 2,000units

Pr ime Cost per unit ` (24 20)
(5) Stock of finished goods in units 2020-21

Value of stock ` 2,88,000
   4,500 units.
TotalCost per unit ` 64
Comparative Statement of Working Capital Requirement

Single Shift (24,000 units) Double Shift (48,000 units)
Units Rate Amount Units Rate Amount
(`) (`) (`) (`)
Current Assets
Inventories:
Raw Materials 6,000 24 1,44,000 12,000 21.6 2,59,200
Work-in-Progress 2,000 44 88,000 2,000 37.6 75,200
Finished Goods 4,500 64 2,88,000 9,000 49.6 4,46,400
Sundry Debtors 6,000 64 3,84,000 12,000 49.6 5,95,200
Total Current Assets (A) 9,04,000 13,76,000
Current Liabilities
Creditors for Materials 4,000 24 96,000 8,000 21.6 1,72,800
Creditors for Wages 2,000 20 40,000 4,000 16 64,000
Creditors for Overheads 2,000 20 40,000 4,000 12 48,000
Total Current Liabilities (B) 1,76,000 2,84,800
Working Capital (A) – (B) 7,28,000 10,91,200

Analysis: Additional Working Capital requirement = ` 10,91,200 – ` 7,28,000 = `3,63,200,

if the policy to increase output is implemented.
9. Statement showing Working Capital Requirements of TN Industries Ltd. (on cash
cost basis)
Amount in Amount in
(`) (`)
A. Current Assets
(i) Inventories:
Raw material
X  1,50,000units  ` 30  2 months  7,50,000

 12 months 
Y  1,50,000units  ` 7  1 month  87,500

 12 months 
Z  1,50,000units  ` 6  1 month  75,000

 12 months 
WIP  1,50,000units  ` 64  0.5 month  4,00,000

 12 months 
Finished goods  1,50,000units  ` 88  1 month  11,00,000 24,12,500

 12 months 
(ii) Receivables (Debtors)
 1,50,000units  ` 103  19,31,250
  2 months   0.75
 12 months 
(iii) Cash and bank balance 8,00,000
Total Current Assets 51,43,750
B. Current Liabilities:
(i) Payables (Creditors) for Raw materials
7,50,000
X  1,50,000units  ` 30  2 months 
 12 months 
87,500
Y  1,50,000units  ` 7  1 month 
 12 months 
37,500
Z  1,50,000units× ` 6 × 0.5 month  8,75,000
 12 months 
(ii) Outstanding Direct Labour 1,56,250

 1,50,000units× ` 25 
 × 0.5 month 
 12 months 
(iii) Outstanding Manufacturing and administration
overheads
2,50,000
 1,50,000units× ` 20 
 × 1 month 
 12 months 
(iv) Outstanding Selling overheads
 1,50,000units× ` 15  1,87,500
 × 1 month 
 12 months 
Total Current Liabilities 14,68,750
Net Working Capital Needs (A – B) 36,75,000
Add: Provision for contingencies @ 10% 3,67,500
Working capital requirement 40,42,500
Workings:
1.
(i) Computation of Cash Cost of Production Per unit (`)
Raw Material consumed 43
Direct Labour 25
Manufacturing and administration overheads 20
Cash cost of production 88
(ii) Computation of Cash Cost of Sales Per unit (`)
Cash cost of production as in (i) above 88
Selling overheads 15
Cash cost of sales 103
2. Calculation of cost of WIP
Particulars Per unit (`)
Raw material (added at the beginning):
X 30
Y 7
Z (` 6 x 50%) 3
Cost during the year:
Z {(` 6 x 50%) x 50%} 1.5

Direct Labour (` 25 x 50%) 12.5

Manufacturing and administration overheads (` 20 x 50%) 10
64
10. (i) Following are the reasons due to which Profit Maximization cannot be the sole
objective of a company:
(a) The term profit is vague. It does not clarify what exactly it means. It conveys
a different meaning to different people. For example, profit may be in short term
or long-term period; it may be total profit or rate of profit etc.
(b) Profit maximisation has to be attempted with a realisation of risks involved.
There is a direct relationship between risk and profit. Many risky propositions
yield high profit. Higher the risk, higher is the possibility of profits. If profit
maximisation is the only goal, then risk factor is altogether ignored. This implies
that finance manager will accept highly risky proposals also, if they give high
profits. In practice, however, risk is very important consideration and has to be
balanced with the profit objective.
(c) Profit maximisation as an objective does not take into account the time
pattern of returns. Proposal A may give a higher amount of profits as compared
to proposal B, yet if the returns of proposal A begin to flow say 10 years later,
proposal B may be preferred which may have lower overall profit but the returns
flow is more early and quick.
(d) Profit maximisation as an objective is too narrow. It fails to take into account
the social considerations as also the obligations to various interests of workers,
consumers, society, as well as ethical trade practices. If these factors are
ignored, a company cannot survive for long. Profit maximization at the cost of
social and moral obligations is a short sighted policy.
(ii) Advantages and disadvantages of raising funds by issue of preference shares
Advantages
(i) No dilution in EPS on enlarged capital base – On the other hand if equity shares
are issued it reduces EPS, thus affecting the market perception about the
company.
(ii) There is also the advantage of leverage as it bears a fixed charge (because
companies are required to pay a fixed rate of dividend in case of issue of
preference shares). Non-payment of preference dividends does not force a
company into liquidity.

(iii) There is no risk of takeover as the preference shareholders do not have voting
rights except where dividend payment are in arrears.
(iv) The preference dividends are fixed and pre-decided. Hence preference
shareholders cannot participate in surplus profits as the ordinary shareholders
can except in case of participating preference shareholders.
(v) Preference capital can be redeemed after a specified period.
Disadvantages
(i) One of the major disadvantages of preference shares is that preference dividend
is not tax deductible and so does not provide a tax shield to the company. Hence ,
preference shares are costlier to the company than debt e.g. debenture.
(ii) Preference dividends are cumulative in nature. This means that if in a particular
year preference dividends are not paid they shall be accumulated and paid later.
Also, if these dividends are not paid, no dividend can be paid to ordinary
shareholders. The non-payment of dividend to ordinary shareholders could
seriously impair the reputation of the concerned company.

SECTION: B: ECONOMICS FOR FINANCE

QUESTIONS
1. (a) The nominal and real GDP of a country in a particular year are ` 3000 Crores and
` 4700 Crores respectively. Calculate GDP deflator and comment on the level of
prices of the year in comparison with the base year.
(b) Differentiate excess demand and deficient demand.
2. Calculate National Income by Expenditure method and Income method with the h elp of
following data:
Items ` in Crores
Compensation of employees 1,200
Net factor income from Abroad 20
Net indirect taxes 120
Profit 800
Private final consumption expenditure 2,000
Net domestic capital formation 770
Consumption of fixed capital 130
Rent 400
Interest 620
Mixed income of self-employed 700
Net export 30
Govt. final consumption expenditure 1100
Operating surplus 1820
Employer’s contribution to social security scheme 300
3. (a) Illustrate with an example the redistribution effect of a tax and transfer policy.
(b) Discuss the importance of the distinction between private costs and social costs.
4. (a) Describe direct government actions to solve negative externalities.
(b) For an Economy with the following specifications
Consumption, C = 50+0.75 Y d
Investment, I = 100
Government Expenditure, G = 200

Transfer Payments, R= 110

Income Tax = 0.2Y
Calculate the equilibrium of income and the value of expenditure multiplier.
5. (a) (i) Calculate velocity of money when-
Money Supply = 5000 billion
Price =110
Volume of transaction = 200
(ii) What will be the outcome if volume of transaction increases to 225?
(b) Assess the role of Bank Rate as an instrument of monetary policy.
6. (a) Explain the concept of Liquidity Trap.
(b) (i) Examine the relationship between purchasing power of money and general
price level.
(ii) Why do people demand money for precautionary motive?
7. How real GDP is a better measure of economic well-being? Explain.
8. Briefly explain the New Trade Theory and its importance.
9. (a) Describe different technical barriers to trade (TBT) and their effects on trade?
(b) Explain Export Duties.
10. (a) What is Arbitrage? What is the outcome of Arbitrage?
(b) Mention the types of transactions in the forex market?
SUGGESTED ANSWERS/ HINTS
1. (a) Nominal GDP = ` 3000 Crores

Real GDP = ` 4700 Crores
Nominal GDP
GDP Deflator = × 100
Real GDP
3000
×100 = 63.83
4700
The price level has fallen since GDP deflator is less than 100 at 63.83.

(b) If the aggregate demand for an amount of output is greater than the full employment
level of output, then we say there is excess demand. Excess demand gives rise to
‘inflationary gap’. On the other hand, if the aggregate demand for an amount of
output is less than the full employment level of output, then we say there is deficient
demand. Deficient demand gives rise to a ‘deflationary gap’ or ‘recessionary gap’.
Recessionary gap is also known as ‘contractionary gap’.
2. By Expenditure method
GDPMP = Private final consumption expenditure + Government final consumption
expenditure + Gross domestic capital formation (Net domestic
capital formation + depreciation) + Net export
= 2000 + 1100 + (770+ 130) + 30= 4030 Crores
NNPFC or NI = GDPMP – Depreciation + NFIA – NIT
= 4030 – 130 + 20 – 120= 3800 Crores
By Income method
NNPFC or NI = Compensation of Employees+ Operating Surplus+ Mixed Income
of Self-Employed + NFIA
= 1200+ 1820+ 700+ 20= 3740 Crores
3. (a) Inequality and the resulting loss of social welfare is sought to be tackled by
government through an appropriately framed tax and transfer policy. This involves
progressive taxation combined with provision of subsidy to low-income households.
Proceeds from progressive taxes may be used to finance public services, especially
those such as public housing, which particularly benefit low income households.
Few examples are: supply of essential food grains at highly subsidized prices to
BPL households, free or subsidized education, healthcare, housing, rations and
basic goods etc. to the deserving people.
(b) Private cost is the cost faced by the producer or consumer directly involved in a
transaction. Social costs refer to the total costs to the society on account of a
production or consumption activity and include external costs as well. The actors in
the transaction (consumers or producers) tend to ignore those external costs and
these are not included in firms’ income statements or consumers’ decisions.
However, these external costs are real and important as far as the society is
concerned. If producers do not take into account the externalities, there will be over -
production and market failure. Applying the same logic, negative consumption
externalities lead to a situation where the social benefit of consumption is less than
the private benefit. Therefore, it is important that a distinction be made between
private costs and social costs.

4. (a) Direct controls prohibit specific activities that explicitly create negative externalities
or require that the negative externality be limited to a certain level, for instance
limiting emissions.
Government initiatives towards negative externalities may include
1. Direct controls that openly regulate the actions of those involved in generating
negative externalities, and
2. Market-based policies that would provide economic incentives so that the self-
interest of the market participants would achieve the socially optimal solution.
Direct controls prohibit specific activities that explicitly create negative externalities
or require that the negative externality be limited to a certain level, for instance
limiting emissions. Production, advertising, use and sale of many commodities and
services may be prohibited. Stringent rules may be established in respect of
advertising, packaging and labelling etc. Governments may, through legislation,
stipulate stringent standards such as environmental standards, emissions standards
non adherence of which will invite monetary penalties or/and criminal liabilities.
Another method is to create negative incentives through charging fees on activities
creating negative externalities Governments may also form special bodies/ boards
to specifically address the problem of negative externality. The market-based
approaches (such as environmental taxes and cap-and-trade), operate through
price mechanism to create an incentive for change.
(b) The level of disposable income Y d is given by
Yd = Y-Tax + Transfer Payments
Where, Transfer Payment = 110
= Y-0.2 Y+110 = 0.8Y +110
and C = 50+0.75 Yd
= 50+0.75(0.8Y +110) (where Yd = 0.8Y +110)
= 50+ (0.75×0.8Y) + (0.75X110) =132.50+0.6Y
C = 132.50+0.6 Y
Now Y = C+I+G, Where C = 132.50+0.6Y, I = 100, G = 200 (Given)
Y = (132.50+0.6Y) +100+200
= 432.50+0.6Y
Y-0.6Y = 432.50
0.4Y = 432.50

or Y = 432.50/0.4 = 1,081.25 Crores

1 1 1
Expenditure Multiplier = = = 2.5 (Multiplier in close economy = 1-b)
1-b 1-0.6
 ΔC 
 Here b = MPC = 
 ΔY 
5. (a) (i) MV=PT;
5000 x V = 110x200, Therefore V = 4.4
(ii) If Volume of transaction 225, then V= 4.95
(b) The bank rate has been aligned to the Marginal Standing Facility (MSF) rate and,
therefore, as and when the MSF rate changes alongside policy repo rate changes,
the bank rate also changes automatically. Now bank rate is used only for
calculating penalty on default in the maintenance of Cash Reserve Ratio (CRR) and
the Statutory Liquidity Ratio (SLR).
6. (a) Liquidity trap is a situation where the desire to hold bonds is very low and
approaches zero, and the demand to hold money in liquid form as an altern ative
approaches infinity. People expect a rise in interest rate and the consequent fall in
bond prices and the resulting capital loss. The speculative demand becomes
perfectly elastic with respect to interest rate and the speculative money demand
curve becomes parallel to the X axis.
(b) (i) Value of money is linked to its purchasing power. Purchasing power is the
inverse of the average or general level of prices as measured by the consumer
price index.
(ii) The amount of money demanded under the precautionary motive is to meet
unforeseen and unpredictable contingencies involving money payments and
depends on the size of the income, prevailing economic as well as political
conditions and personal characteristics of the individual such as optimism/
pessimism, farsightedness etc.
7. Real GDP is calculated in such a way that the goods and services produced in a
particular year are evaluated at some constant set of prices or constant prices. In other
words, it is calculated using the prices of a selected ‘base year’. For example, if 2011-12
is selected as the base year, then real GDP for 2020-21 will be calculated by taking the
quantities of all goods and services produced in 2020-21 and multiplying them by their
2011-12 prices. Thus, real GDP or GDP at constant prices refers to the total money value
of the final goods and services produced within the domestic territory of a country during
an accounting year, estimated using base year prices. Real GDP is an inflation -adjusted
measure and is not affected by changes in prices; it changes only when there is change
in the amount of output produced in the economy. Therefore, Real GDP is a better

measure of economic well-being as it shows the true picture of the change in production
of an economy.
The calculation of real GDP gives us a useful measure of inflation known as GDP
deflator. The GDP deflator is the ratio of nominal GDP in a given year to real GDP of that
year.
Nominal GDP
GDP Deflator = X100
Real GDP
8. New Trade Theory (NTT) is an economic theory that was developed in the 1970s as a
way to understand international trade patterns. NTT helps in understanding why
developed and big countries are trade partners when they are trading similar goods and
services. These countries constitute more than 50% of world trade.
This is particularly true in key economic sectors such as electronics, IT, food, and
automotive. We have cars made in the India, yet we purchase many cars made in other
countries.
These are usually products that come from large, global industries that directly impact
international economies. The mobile phones that we use are a good example. India
produces them and also imports them. NTT argues that, because of substantial
economies of scale and network effects, it pays to export phones to sell in another
country. Those countries with the advantages will dominate the market, and the market
takes the form of monopolistic competition.
Monopolistic competition tells us that the firms are producing a similar product that isn 't
exactly the same, but awfully close. According to NTT, two key concepts give advantages
to countries that import goods to compete with products from the home country . These
are:
Economies of Scale: As a firm produces more of a product, its cost per unit keeps going
down. So if the firm serves domestic as well as foreign market instead of just one, then it
can reap the benefit of large scale of production consequently the profits are likely to be
higher.
Network effects refer to the way one person’s value for a good or service is affected by
the value of that good or service to others. The value of the product or service is
enhanced as the number of individuals using it increases. This is also referred to as the
‘bandwagon effect’. Consumers like more choices, but they also want products and
services with high utility, and the network effect increases utility obtained from these
products over others. A good example will be Mobile App such as what’s App and
software like Microsoft Windows.
9. (a) Technical Barriers to Trade (TBT) which cover both food and non-food traded
products refer to mandatory ‘Standards and Technical Regulations’ that define the
specific characteristics that a product should have, such as its size, shape, design,

labelling / marking / packaging, functionality or performance and production

methods, excluding measures covered by the SPS Agreement. The specific
procedures used to check whether a product is really conforming to these
requirements (conformity assessment procedures e.g. testing, inspection and
certification) are also covered in TBT. This involves compulsory quality, quantity and
price control of goods before shipment from the exporting country.
Just as SPS, TBT measures are standards-based measures that countries use to
protect their consumers and preserve natural resources, but these can also be used
effectively as obstacles to imports or to discriminate against imports and protect
domestic products. Altering products and production processes to comply with the
diverse requirements in export markets may be either impossible for the exporting
country or would obviously raise costs, hurting the competitiveness of the exporting
country. Some examples of TBT are: food laws, quality standards, industrial
standards, organic certification, eco-labelling, and marketing and label
requirements.
(b) An export duty tax is a tax collected on exported goods and may be either specific
or ad valorem. The effect of an export tax is to raise the price of the good and to
decrease exports. Since an export tax reduces exports and increases domestic
supply, it also reduces domestic prices and leads to higher domestic consumption.
10. (a) Arbitrage refers to the practice of making risk-less profits by intelligently exploiting
price differences of an asset at different dealing places. On account of arbitrage,
regardless of physical location, at any given moment, all markets tend to have the
same exchange rate for a given currency.
(b) There are two types of transactions in a forex market; current transactions which
are carried out in the spot market and future transactions involving contracts to buy
or sell currencies for future delivery which are carried out in forward and futures
markets.

Applicability of Standards/Guidance Notes/Legislative Amendments etc. for May, 2021
Examination
Intermediate (New Course)
Paper 5: Advanced Accounting
List of Applicable Accounting Standards
AS 4: Contingencies and Events Occurring After the Balance Sheet Date
AS 5: Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies
AS 7: Construction Contracts
AS 9: Revenue Recognition
AS 14: Accounting for Amalgamations
AS 17: Segment Reporting
AS 18: Related Party Disclosures
AS 19: Leases
AS 20: Earnings Per Share
AS 22: Accounting for Taxes on Income
AS 24: Discontinuing Operations
AS 26: Intangible Assets
AS 29: Provisions, Contingent Liabilities and Contingent Assets.
Applicability of the Companies Act, 2013 and other Legislative Amendments for May,
2021 Examination
The relevant notified Sections of the Companies Act, 2013 and legislative amendments
including relevant Notifications / Circulars / Rules / Guidelines issued by Regulating
Authorities up to 31st October, 2020 will be applicable for May, 2021 Examination.
Non-Applicability of Ind AS
The Ministry of Corporate Affairs has notified Companies (Indian Accounting Standards)
Rules, 2015 on 16th February, 2015, for compliance by certain class of companies. These Ind
AS do not form part of the syllabus and hence are not applicable.
Paper 6: Auditing and Assurance
List of topic-wise inclusion in the syllabus
I. List of applicable Engagements and Quality Control Standards on Auditing
S.No SA Title of Standard on Auditing
1 SQC 1 Quality Control for Firms that Perform Audits and Reviews of

REVISION TEST PAPER 239
Historical Financial Information, and Other Assurance and Related

Services Engagements
2 SA 200 Overall Objectives of the Independent Auditor and the Conduct of
an Audit in Accordance with Standards on Auditing
3 SA 210 Agreeing the Terms of Audit Engagements
4 SA 220 Quality Control for Audit of Financial Statements
5 SA 230 Audit Documentation
6 SA 240 The Auditor’s responsibilities Relating to Fraud in an Audit of
Financial Statements
7 SA 250 Consideration of Laws and Regulations in An Audit of Financial
Statements
8 SA 299 Joint Audit of Financial Statements (Revised)
9 SA 300 Planning an Audit of Financial Statements
10 SA 315 Identifying and Assessing the Risks of Material Misstatement
through Understanding the Entity and its Environment
11 SA 320 Materiality in Planning and Performing an Audit
12 SA 500 Audit Evidence
13 SA 501 Audit Evidence - Specific Considerations for Selected Items
14 SA 505 External Confirmations
15 SA 510 Initial Audit Engagements-Opening Balances
16 SA 520 Analytical Procedures
17 SA 530 Audit Sampling
18 SA 550 Related Parties
19 SA 560 Subsequent Events
20 SA 570 Going Concern (Revised)
21 SA 580 Written Representations
22 SA 610 Using the Work of Internal Auditors (Revised)
23 SA 700 Forming an Opinion and Reporting on Financial Statements
(Revised)
24 SA 701 Communicating Key Audit Matters in the Independent Auditor’s
Report (New)
25 SA 705 Modifications to the Opinion in the Independent Auditor’s Report
(Revised)
26 SA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in
the Independent Auditor’s Report (Revised)

27 SA 710 Comparative Information – Corresponding Figures and

Comparative Financial Statements
II Applicability of the Companies Act, 2013 and other Legislative Amendments
(i) The October 2020 Edition of the Study Material on Intermediate Paper 6: Auditing
and Assurance [comprising of 2 Modules – Modules 1 – 2] is relevant for May, 2021
Examinations. This is an integrated Study Material cum Practice Manual. Students
are expected to be updated with the notifications, circulars and other legislative
amendments made upto 6 months prior to the examination. For instance,
for May, 2021 examination, significant notifications and circulars issued upto
31st October, 2020 would be relevant.
The relevant notified Sections of the Companies Act, 2013 and legislative
amendments including relevant Notifications / Circulars / Rules / Guidelines issued by
Regulating Authority up to 30th April, 2020 will be applicable for November, 2020
Examination. It may be noted that the significant notifications and circulars
issued up to 31st October, 2020, which are not covered in the October 2020
Edition of the Study Material, would be given as Academic Update in the
Revision Test Paper for May, 2021 Examination.
(ii) Companies (Auditor’s Report) Order, 2016 issued by Ministry of Corporate Affairs is
applicable for May 2021 Examination.
List of topic-wise exclusion in the syllabus
I. Statement on Reporting under Section 227(1A) of the Companies Act, 1956 (Section
143(1) of the Companies Act, 2013) excluded.
II. Following Engagements and Quality Control Standards on Auditing excluded:
(1) (2) (3)
S. SA Exclusions
No.
1 SA 260 Communication with Those Charged with Governance (Revised)
2 SA 265 Communicating Deficiencies in Internal Control to Those Charged
with Governance and Management
3 SA 330 The Auditor’s Responses to Assessed Risks
4 SA 402 Audit Considerations Relating to an Entity Using a Service
Organization
5 SA 450 Evaluation of Misstatements Identified during the Audits
6 SA 540 Auditing Accounting Estimates, Including Fair Value Accounting
Estimates, and Related Disclosures
7 SA 600 Using the Work of Another Auditor

REVISION TEST PAPER 241
8 SA 620 Using the Work of an Auditor’s Expert

9 SA 720 The Auditor’s Responsibilities Relating to Other Information
III. Following Guidance Notes are excluded:
1. Guidance Note on Audit of Inventories.
2. Guidance Note on Audit of Debtors, Loans and Advances.
3. Guidance Note on Audit of Investments.
4. Guidance Note on Audit of Cash and Bank Balances.
5. Guidance Note on Audit of Liabilities.
6. Guidance Note on Audit of Revenue.
7. Guidance Note on Audit of Expenses.
8. Guidance Note on Reporting under section 143(3)(f) and (h) of the Companies Act,
2013

May 21

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INTERMEDIATE COURSE

(UNDER REVISED SCHEME OF

REVISION TEST PAPERS

© The Institute of Chartered Accountants of India

Edition : March, 2021

Department/Committee : Board of Studies

Published by : The Publication Department on behalf of The Institute of Chartered

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

I Objective of Revision Test Paper

© The Institute of Chartered Accountants of India

II. Planning and preparing for examination

© The Institute of Chartered Accountants of India

III. Subject-wise Guidance – An Overview

PAPER 5: ADVANCED ACCOUNTING

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

PAPER – 7: ENTERPRISE INFORMATION SYSTEMS AND STRATEGIC MANAGEMENT

© The Institute of Chartered Accountants of India

Section – B: Strategic Management

PAPER – 8: FINANCIAL MANAGEMENT AND ECONOMICS FOR FINANCE

PAPER – 8A: FINANCIAL MANAGEMENT

© The Institute of Chartered Accountants of India

Section B: Economics for Finance

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

PART – I: ANNOUNCEMENTS STATING APPLICABILITY & NON-APPLICABILITY

A. Applicable for May, 2021 Examination

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

B. Not applicable for May, 2021 examination

PART – II : QUESTIONS AND ANSWERS

Conversion of partnership firm into Company and Sale to a Company

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

Third instalment 40,000

Dissolution expenses were provided for estimated amount of ` 12,000

© The Institute of Chartered Accountants of India

General Reserve 2,50,000

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

16,92,000 5th July, 2020 16%

© The Institute of Chartered Accountants of India

Consolidated Financial Statements

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

The market prices are generally 20% above cost.

© The Institute of Chartered Accountants of India

method is considered appropriate for accounting purpose with a life estimation

© The Institute of Chartered Accountants of India

AS 29 Provisions, Contingent Liabilities and Contingent Assets

1. In the books of Partnership Firm

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India

2. (a) Statement showing distribution of cash amongst the partners

© The Institute of Chartered Accountants of India

Transferred to P& L A/c 2,400

© The Institute of Chartered Accountants of India

Less: Z’s remuneration

© The Institute of Chartered Accountants of India