Audit All Past Suggested Paper ICAN

Suggested Answers December 2022 Examination (CAP II - Group I)
Paper 2: Audit and Assurance

Marks
Attempt all questions.
1. As an auditor, give your opinion with explanations on the following cases: (45=20)
a) Subhakamana Sugar Mills Limited is closed from last 11 months due to outdated technology and
has no sales as old technology produces inferior products. The company will take minimum 2
years’ time with substantial modification of technology to restart production and make sales. Cost
is very substantial for upgrading technology. Due to factory closure, company defaults in loan
repayment and bank have issued notice for auction if loan is not repaid within 3 months’ time.
Management is doubtful that funding can be arranged.
CFO is of view that financial statements shall be prepared in going concern basis as there is little
hope that funding will be received.
b) In the books of Palpa Limited, it is found that inventory costing Rs. 8,500 of item was accidentally
destroyed in Bhadra 2078, inventory costing Rs. 7,000 which was given to local NGO for free in
Mangsir 2078 and inventory costing Rs. 5,400 which relates to the cost of damaged inventory
which can be reworked at a cost of Rs. 900, and which can then be sold for Rs. 4,300. These events
were not considered by the accountants in the books of accounts.
c) Dharan Limited has acquired a machine in Shrawan 2071 for Rs. 80,000. Useful life of the machine
was estimated for 8 years and straight line method is used to depreciate the machine. In the
reporting date of FY 2078/79, as per technical examination of the machine useful life of the
machine is expected to be for next 5 years. However, the accountant of Dharan Limited has argued
that machinery has been fully depreciated in this year and no depreciation will be charged from
the next fiscal year.
d) You are the auditor of Himalaya Fashion Pvt. Ltd. (the company) for the FY 2075/76. Total
number of shareholders of the company since FY 2074/75 is 115 which include 11 employees.
Answer:
1 a) As per NAS 1 Presentation of Financial Statements, an entity shall prepare its financial statements on
a going concern basis unless management intends to liquidate the entity or to cease trading, or that
it has no realistic alternative but to do so. When preparing financial statements, management shall
make an assessment of an entity’s ability to continue as a going concern. In making assessment, if
management is aware of material uncertainties related to events or conditions that may cast
significant doubt upon the entity’s ability to continue as a going concern, the entity shall disclose
those uncertainties. When financial statements are not prepared on going concern basis, it shall
disclose the fact, together with the basis on which it prepared the Financial Statements and the
reasons of doing so.
NSA 570 “Going Concern” requires that the auditor shall consider whether there are events or
conditions that may cast significant doubt on the entity’s ability to continue as a going concern. In
the given case, entity’s inability to operate the business for more than 11 months’ time, substantial
time to be required for upgrading technology and significant doubt on availability of the fund are
the examples of conditions casting uncertainties. If the financial statements have been prepared on
a going concern basis but, in the auditor’s judgment, management’s use of the going concern
assumption in the financial statements is inappropriate, the auditor shall express a modified opinion.
In the given case, as there is significant doubt that entity will be operational and going concern
assumptions is questionable, The auditor shall evaluate the data on which basis the management has
made assessment and come to the conclusion of the appropriateness of use of going concern
assumption. Based on evaluation, the auditor should form an appropriate opinion of the Financial
Statements.
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1 b) As per NAS 2: Inventories, any amount of write-down of inventories to net realisable value and all
losses of inventories shall be recognised as an expense in the period when write down or losses occurs.
Since the accountant of Palpa Limited did not record these write offs and losses in the books of
account, following amount should be recorded as expenses in FY 2078-79;
S.N. Particulars Amount Expenses (Rs.)
1 Accidentally destroyed inventory 8,500
Cost Price 8,500
Net Realisable Value -
2 Inventories given to Local NGO for free of cost 7,000
Cost Price 7,000
Net Realisable Value -
3 Damaged Inventories 2,000
Cost Price 5,400
Net Realisable value (4300-900) 3,400
Total Expenses 17,500
Hence, Palpa Limited shall recognise NPR 17,500 as expense in FY 2078-79 in accordance with the
Nepal Accounting Standards -2: Inventories. If this is not corrected in financial statements the auditor
should consider the impact of such audit observations to the fairness of financial statements and form
an appropriate opinion.
1c) As per Nepal Accounting Standards 16: Property, Plant and Equipment; para 51, the residual value
and the useful life of an asset should be reviewed at least each financial year-end. If expectations
differ from previous estimates, the changes shall be accounted for as a change in an accounting
estimate in accordance with NAS 8 Accounting Policies, Changes in Accounting Estimates and
Errors. In the given case, useful life is being revised, so resultant impact should be accounted for
prospectively as follows.
S.N. Particulars Amount (Rs.)

1 Cost of Machinery 80,000
2 Initial Useful Life 8
3 Accumulated Depreciation till 2077-78 (7 years) 70,000
4 Carrying amount as on Ashad end 2077-78 10,000
5 Revised useful life of machinery 5
6 Revised Depreciation in FY 2078-79 2,000
In FY 2078-79, Dharan Limited shall charge Rs. 2,000 as depreciation based on revised useful life
of 5 years. Therefore, contention of the accountant that no deprecation will be charged from the next
fiscal year on the asset is not correct as per Nepal Financial Reporting Standards.
1d) Pursuant to Section 9(1) of the Companies Act (with amendment 2074), a private company cannot
have more than One Hundred one shareholders. The threshold of maximum number of the
shareholders does not apply in case of the existing Transportation Business Committees forming a
private company within given period (Section 9(1ka)) and employee shareholders getting shares
under defined scheme (Section 9(3)).
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In the light of foresaid changes of Companies Act 2063(amended 2074), The maximum shareholders
to be maintained for FY 2074/075 & 2075/76 is 101 (excluding employee shareholders). The
shareholders of the company excluding employee shareholders for FY 2074/75 and 2075/76 are 104.
Accordingly, the company has breached the provision of amended Company’s Act 2063. As an
auditor, I would like to suggest the company to regularize it without any further delay. Otherwise, it
shall imply non-compliance with laws.
2. Give your comments on the following cases: (45=20)

a) After the completion of statutory audit of Rara Holidays 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.
b) The auditor of a company is unable to obtain audit evidence relating to business promotion
expenditures of Rs. 1 lakh. The company has earned net profit of Rs. 1 billion and has net asset
base of Rs. 10 billion. The management explains that the expenditure is genuine although the said
invoices are misplaced. However, auditor requests the management either not to charge the said
promotional expenditure to profit or loss statement or he will qualify his audit report. The auditor
does not have any other issue raising question on the faithful presentation and preparation of the
financial statements.
c) CA. K is reappointed as the auditor of B Ltd. He wants to re-confirm certain matters relating to
responsibility of management regarding preparation of financial statements and has asked the
management to give written representations for the same. Under what circumstances can an auditor
ask the management to reconfirm its acknowledgement and understanding of responsibilities in
written representations?
d) During the audit of FY 2078-79, the auditor has requested the client to pay 70% of the overdue fee
of previous audit before signing the audit report. The client has lodged complaint against the
auditor for disciplinary action.
Answer:
2 a) As per NSA 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 NSAs 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 NSAs. 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 of 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.
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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.
2 b) As per NSA 705, “Modification to the opinion in the independent Auditor’s Report’, the auditor shall
express a qualified opinion when:
i. The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements,
individually or in the aggregate are material, but not pervasive, to the financial statements; or
ii. The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion,
but the auditor concludes that the possible effects on the financial statements of undetected
misstatements, if any, could be material but not pervasive.
Rs. 1 lakh expenses for a company which earns net profit of Rs. 1 billion and having net assets base
of Rs. 10 billion seems to be immaterial/ insignificant because omission or misstatement of
expenditure by Rs. 1 lakh in this case is unlikely to affect the decision of the users due to this
omission/misstatement. Since the auditor does not have any other issue on faithful preparation and
presentation of the financial statements, qualifying audit opinion for immaterial impact does not seem
to be appropriate. The auditor should however communicate the finding through management letter
with the recommendation to strengthen the system of proper maintenance and retention of supporting
evidence.
2c) NSA 580 Written Representations governs the provisions about written representations from
management. Written Representations are written statement by management provided to the auditor
to confirm certain matters or to support other audit evidence. Other NSAs also require the auditor to
request written representations. If in addition to such required representations, the auditor determines
that it is necessary to obtain one or more written representations to support other audit evidence
relevant to the financial statements or one or more specific assertions in the financial statements, the
auditor shall request such other written representations.
The written representations draw on the agreed acknowledgement and understanding of management
of its responsibilities by requesting confirmation that it has fulfilled them. The auditor, CA. K of B
Ltd, may also ask management of B Ltd to reconfirm its acknowledgement and understandingof those
responsibilities in written representations. This is particularly appropriate when:
• Those who signed the terms of the audit engagement on the behalf of the entity no longer have
the relevant responsibilities
• The terms of audit engagement were prepared in a previous year
• There is any indication that management misunderstands those responsibilities or
• Changes in circumstances make it appropriate to do so.
2 d) As per subsection 410.7: Fees – Overdue, of Handbook of Code of Ethics for Professional
Accountants, overdue of previous professional service fee might create self-interest threat for the
audit of following year. Therefore, it is generally expected to clear the overdue amount before the
issuance of audit report of following year. In order to safeguard from the self-interest threat, the
auditor can obtain partial payment of overdue fee or have appropriate reviewer who did not take part
in the audit engagement review the work performed. In the given case, contention of the auditor is
correct as per code of ethics for professional accountants that the previous year due should be paid
by the client before the signing of audit report of current period to safeguard of self-interest threat
to independence for audit. In case the client refuses to pay the overdue audit fee. auditor can take
other safeguard measure or withdraw the appointment as an auditor. Therefore, the complaint against
the auditor for not singing the audit report is not valid.
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3. Answer the following: (35=15)

a) Explain the circumstances when the work of the internal audit function can be used by External
Auditor.
b) Define error. Briefly discuss the types of errors.
c) Define external confirmation as audit evidence and its type.
Answer:
3a) The external auditor’s evaluation of whether the internal audit function’s organizational status and
relevant policies and procedures adequately support the objectivity of the internal auditors, the level
of competence of the internal audit function, and whether it applies a systematic and disciplined
approach may provide a basis to the external auditors as to whether to use the work of internal
auditors. In cases where external auditor cannot obtain reliable evidences as to effective internal audit
function, that indicates the risks to the quality of the work of the internal audit functions. Therefore,
it is not appropriate to use any of the work of the function as audit evidence in such cases.
Consideration of the factors of NSA 610 individually and in aggregate is important because an
individual factor is often not sufficient to conclude that the work of the internal audit function cannot
be used for purposes of the audit. For example, the internal audit function’s organizational status is
particularly important in evaluating threats to the objectivity of the internal auditors.
If the internal audit function reports to management, this would be considered a significant threat to
the function’s objectivity.
This is because of the possibility that the engagement team will use the results of the internal audit
service without properly evaluating those results or without exercising the same level of professional
skepticism as would be exercised when the internal audit work is performed by individuals who are
not members of the firm.
So, the external auditors should evaluate the organizational status of internal audit function,
competence and the approach that internal audit function applies in conducting quality internal audits
before deciding whether to use the work of internal audit for his external audit purposes.
3b) NSA 240 on ‘The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements'
provides that misstatements in the financial statements can arise from fraud or error.
Error refers to an unintentional misstatement in financial statements, including the omission of an
amount or a disclosure, such as:
• A mistake in gathering or processing data,
• An incorrect accounting estimate arising from oversight or misinterpretation of facts and
• A mistake in the application of accounting principles relating to measurement, recognition etc.
Errors can be classified as:-
i. Self-revealing and not self-revealing:- These are such errors the existence of which becomes
apparent in the process of compilation of accounts. Unrecorded cheque details are apparent while
preparing bank reconciliations. If errors could not be noticed during normal course, such errors
are not self-revealing errors. If an item of expense which should have been charged to repairs
account has been charged by mistake to the building account or if the amount of depreciation is
calculated incorrectly, there is nothing in the book-keeping system which will bring the error to
notice. Such errors are not self-revealing errors.
ii. Unintentional and intentional: - Errors are normally considered as unintentional. It may be due
to human errors, lack of knowledge or lack of guidance. However, Fraud is the word used to
mean intentional act. 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 dishonesty which accompanies
them.
iii. Unconcealed and concealed: - Mistakes are unconcealed but frauds are deliberately concealed.
Mistakes become concealed if compensated by another or more mistakes in the opposite
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direction. Mistakes may as well be concealed for wrong arithmetical calculations or for a faulty
process of verification.
3 c) External confirmation is a process of obtaining and evaluating audit evidence through a direct
communication from a third party in response to a request for the information about a particular item
affecting assertions made by management in the financial statements. External confirmations are
frequently used in relation to account balance and their components but need not be restricted to
these items. External confirmation may be of following two types;
i) Positive confirmation
Positive external confirmation request asks the respondent to reply to the auditor in all case
either by indicating the respondent’s agreement with the given information or by asking the
respondent to fill in the information. A response to a positive conformation request is ordinarily
expected to provide reliable audit evidence.
ii) Negative confirmation
Negative external confirmation request asks the respondent to reply only in the event of
disagreement with the information provided in the request. However, when no response has
been received to a negative confirmation request, the auditor remains aware that there will be
no explicit evidence that indented third party have received the confirmation request and
verified that the information contained therein is correct.
4. Answer/Comment on the following: (35=15)

a) Lalita sports club is organizing a sports event and has approached a Chartered Accountants firm
for sponsorship of the event. Is the firm allowed to sponsor as per ICAN Code of Ethics?
b) PRR & Associates published its website with client portfolio details which illustrates various
clients, testimonial of client regarding the service provided by the firm and variety of services it
serves.
c) Kriti Associates, Chartered Accountants has been appointed by Big Bank Ltd to provide Risk
Management Service. The Bank has agreed to pay fee of Rs. 32 Lakh if consultant can fix the
operational risk below 5 out of rank 10. Comment on this in the light of ICAN Code of Ethics.
Answer:
4 a) ICAN Code of Ethics, 2018 and Guidelines on Marketing Professional Services by professional
accountants in public practice provides guidance to the professional accountants as to what is
expected and what not.
When undertaking marketing or promotional activities, a professional accountant shall not bring the
profession into disrepute. A professional accountant shall be honest and truthful and shall not make:
(a) Exaggerated claims for the services offered by, or the qualifications or experience of, the
accountant; or
(b) Disparaging references or unsubstantiated comparisons to the work of others.
Marketing, publicity or advertisement may create threat to compliance with the fundamental
principles of the Code of Ethics.
Publicity is meant to reach out to the potential or even not potential clients to make them known that
a particular professional accountant seeks clients to provide them her or his professional services.
The guidelines in regards to publicity includes the provision for sponsoring charitable events/
organizations that engage in social welfare e.g. health organizations, sports clubs and displaying
simple banner during such event. In the given case, Lalita sports club is an organization that is
engaged in social welfare and sponsoring the sports event is a publicity activity so sponsoring the
event and displaying a simple banner during the event is permissible according to the Code of Ethics
and related Guidelines. If a firm is in doubt about whether a form of advertising or marketing is
appropriate, the firm is encouraged to consult with the relevant professional body.
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4 b) As per provision specified in the Code of Ethics and related Guidelines on marketing professional
services issued by the ICAN prohibits solicitation of client or professional work either directly or
indirectly by circular, advertisement, personal communication, or interview or by any other means
because it shall constitute professional misconduct. However, in the given case PRR & Associates
published its website with client portfolio, detail of its clients and testimonial of client regarding the
service provided by the firm and other services the firm provides which is not permitted by the Code
of ethics. Hence, PRR & associates in way to promote its services and quality being offered to client
is considered as misconduct by PRR & Associates and the firm shall be liable for disciplinary action.
4 c) In the given case, Bank is offering contingent fees which are calculated on a predetermined basis
relating to the outcome of a transaction or the result of the services performed by the firm.
As per section 34 (10), the member holding COP should not base his remuneration as a percentage
of profit or any uncertain results.
Further, the case is examined as follows in the light of the provisions of Code of Ethics.
A contingent fee charged directly or indirectly, for example through an intermediary, by a firm in
respect of an audit engagement creates a self-interest threat that is so significant that no safeguards
could reduce the threat to an acceptable level. Accordingly, a firm shall not enter into any such fee
arrangement.
A contingent fee charged directly or indirectly, for example through an intermediary, by a firm in
respect of a non-assurance service provided to an audit client may also create a self-interest threat.
The threat created would be so significant that no safeguards could reduce the threat to an acceptable
level if:
(a) The fee is charged by the firm expressing the opinion on the financial statements and the fee is
material or expected to be material to that firm;
(b) The fee is charged by a network firm that participates in a significant part of the audit and the
fee is material or expected to be material to that firm; or
(c) The outcome of the non-assurance service, and therefore the amount of the fee, is dependent on
a future or contemporary judgment related to the audit of a material amount in the financial
statements.
In the given case, the accountant should not accept such engagements that will result in non-
compliance with code of ethics.

a) Kohalpur Limited having substantial investment (more than 50 percent) of the Government of
Nepal and has completed its AGM for FY 2078-79 in Asoj 2079, however the company fails to
appoint the auditor through AGM because the company has not received the consultation from the
office of Auditor General. As a professional accountant, please suggest how the company can
appoint the auditor.
b) CBB & Associates has issued the audit report of Butwal Limited on 15th Bhadra 2079; however
later it was revealed that the auditor has not renewed the membership and the certificate of practice
of the firm on 30th Asoj 2079.
Answer:
5 a) As per Section 11 of Audit Act, 2075, corporate bodies having substantial investment (more than 50
percent) of the Government of Nepal should appoint the auditor after taking consultation from the
Auditor General and have its accounts audited subject to the principles specified by the auditor
General. Corporate bodies should forward the report presented by the auditor to the office of Auditor
General. Similarly, as per section 113 of Companies Act, 2063 states that if a company fails to appoint
an auditor due to any reason or the appointed auditor discontinues the appointment, the office of the
company registrar may appoint an auditor upon request of board of directors of the company.
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In the given case, Kohalpur Limited has completed its AGM for FY 2078-79 in Asoj 2079; however
the appointment of auditor could not be done by the AGM due to unavailability of consultation from
the office of Auditor General. Therefore, the company should obtain the consultation from the
Auditor General regarding appointment of the auditor and the board of directors of the company
should sent a request letter to the Office of the Company registrar under section 113 for the
appointment of the auditor specifying the reason.
5 b) As per section 29 of Nepal Chartered Accountants Act, 2053, no member shall provide auditing service
without obtaining certificate of practice. As per the clause, person appointed as an auditor shall be a
member of Institute of Chartered Accountants of Nepal and having valid certificate of practice.
At the time when audit report was issued, the COP has already expired but there was time left for
renewal of membership and certificate of practice. But, for issuance of any reports in the capacity of
a member holding COP, the auditor should be careful whether it has made all renewal in time and
ensure that the Certificate of Practice remains valid
In the given question, the auditor of Butwal Limited has signed the audit report on 15th Bhadra 2079
when he has no valid certificate of practice which is contrary to the clause of the act. Therefore, the
auditor shall be liable for disciplinary action.
6. Write short notes on the following: (42.5=10)
a) Examination in Depth
b) Peer Review
c) Government Audit
d) Tolerable misstatement
Answer:
6 a) It implies examination of a few selected transactions from the beginning to the end through the entire
flow of the transaction, i.e., from initiation to the completion of the transaction by receipt of payment
of cash and delivery or receipt of the goods. This examination consists of studying the recording of
transactions at the various stages through which they have passed. At each stage, relevant records and
authorities are examined; it is also judged whether the person who has exercised the authority in
relation to the transactions is fit to do so in terms of the prescribed procedure. For example, if payment
to a creditor is to be verified "in depth", it would be necessary to examine the following documents:
▪ The invoice and statements of accrual from the supplier
▪ The entry in stock register showing the goods were received
▪ Goods received Note and inspection certificate showing that goods on receipt were verified and
inspected.
▪ The copy of original order and authority showing that the goods in fact were ordered by an
authority which was competent to do so.
6 b) Peer review means an examination and review of the system and procedures to determine whether
they have been put in place by the practice unit for ensuring the quality of attestation service as
envisaged and implied/mandated by the Technical Standards and whether these were effective or
not during the period under review.
Peer review is directed towards maintenance as well as enhancement of quality of attestation services
and to provide guidance to members to improve their performance and adhere to various statutory
and other regulatory requirements. Essentially, through a review of attestation services engagement
records, peer review identifies the areas where a practicing member may require guidance in
improving the quality of his/her performance and adherence to various requirements as per
applicable Technical Standards.
The main objective of Peer Review is to ensure that in carrying out their attestation services
assignments; the members of the Institute (a) comply with the Technical Standards made mandatory
for application by the Institute and (b) have in place proper systems (including documentation
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systems) for maintaining the quality of the attestation services they perform. The Council has issued
the Statement on Peer Review which provides guidance on scope and authority of the Technical
Standards to be complied with while performing audit and assurance services. However, of late, the
Quality Assurance for Audit has been replacing the concept and practice of Peer Review in many
jurisdictions.
6 c) Government Audit is the audit of government offices to promote good governance through an
independent, efficient and effective audit service and it is governed by Audit Act, 2075. Office of
Auditor General is responsible to carry out the audits of all receipt, expenditure and other matters as
specified in mandate from various aspects such as regularity, economy, efficiency and effectiveness
and propriety.
The auditor general is empowered and made independent through constitutional provisions.
Government audit not only include financial audit but includes other audits such as performance and
compliance audits. It may also include special audits such as IT audit, environmental audit.
6 d) Tolerable misstatement is 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.
When designing a sample, the auditor determines tolerable misstatement in order to address the risk
that the aggregate of individually immaterial misstatements may cause the financial statements to be
materially misstated and provide a margin for possible undetected misstatements.
7. Distinguish between: (25=10)

a) Batch Processing and Online Real Time Processing System in computerized environment
b) Accounting policies and accounting estimate.
Answer:
7 a) The major differences between Batch Processing and online real time processing system in
computerized environment is as follows:
Batch Processing On-Line Real Time (OLRT) Processing
 Transactions are accumulated and  Transactions are processed as on
processed in group when they occur
 Two types of files are maintained  Only master file is maintained. It
master file is updated when batch keeps updating
processing is run
 Updating does not take place as  Though updating takes place
quickly as in On-Line Real time immediately the processing becomes
system complex.
 Not useful when instant and updated  Useful for immediate reporting
results are required system
 Generally provides Audit trail  Generally, does not provide audit trail
and hence requires more attention of
auditor
7 b) Accounting policies and accounting estimate

Particulars Accounting Policies Accounting Estimate
1. Nature Accounting policies are the Accounting estimate relates
specific principles, rules, bases, to judgments made based on
conventions and practices most up to date information
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adopted by an entity for available at the time of

preparation and presentation of preparation and presentation
financial statements. of financials. So, estimates
having inherent uncertainties
2. Changes under The change in accounting The changes in Accounting
NAS 8 policies should be made only if: estimates are applicable if the
a) The change is required by changes will results into more
NFRS standard reliable preparation and
b) The changes will results into presentation of information.
more appropriate presentation of
financials. i.e. more reliable and
relevant
3. Application of Change accounting policy is change in accounting
Change accounted for retrospectively estimate is accounted for
prospectively
4. Example Example of change in accounting Example of change in
policy is change in valuation of accounting estimate is
inventory from FIFO to weighted change in depreciation
average cost method by the company
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HDL Ceramics Ltd, Bhaktapur purchased and assembled plant at Madhyapur which has been
declared by municipality as not meeting the requirements of environment laws of municipality
which have been recently enacted. The asset has to be destroyed as per the law. The asset is carried
in the Balance Sheet at the year end at Rs. 55,00,000. The estimated cost of destroying the asset is
Rs. 7,00,000. The accountant wishes to charge off assets in next 7 years.
a) In the financial statements of PQR limited, carrying amount of Land and building is Rs. 10 lakh as
on year end 2078. In FY 2078-79 land and building has been revalued and the revalued amount of land
and building is Rs. 14 Lakh. The company wants to recognize revaluation gain in profit or loss
b) Mr. Prem accountant of Small Limited argued that the company has been in operation for 20
years, therefore there is no need to make assessment of going concern while preparing the financial
statements.
c) GOT Resort Pvt. Ltd. has taken loan to construct its building. However, before the assets could be
completely constructed and put to use, the construction got delayed due to lockdown as a result of
COVID-19 pandemic. Now, as the statutory auditor, you need to give your opinion on the treatment
of the interest on the loan during the lockdown period.
Answer:
a) As per NAS 36 on Impairment of Assets, impairment loss is the amount by which the carrying
amount of an asset exceeds its recoverable amount, where recoverable amount is the higher of an
asset‟s net selling price and its value in use·. In the given case, recoverable amount will be nil [higher
of value in use (nil) and net selling price (Nil)]. Thus, impairment loss will be calculated as Rs.
55,00,000 [carrying amount (Rs. 5500,000) – recoverable amount (nil)].
Therefore, asset is to be fully impaired and impairment loss of Rs. 55,00,000 has to be recognized as an
expense immediately in the statement of Income as per NAS. Further, cost of destroying the assets shall
also be recognized as expense.
b) As per Nepal Accounting Standards -16 “Property, Plant and Equipment” if an asset‟s carrying
amount is increased as a result of a revaluation, the increase shall be recognised in other comprehensive
income and accumulated in equity under the heading of revaluation surplus. However, the increase
shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset
previously recognised in profit or loss.
In the given case carrying amount of land and building of PQR limited has been increased after
revaluation and the company wants to recognise such revaluation gain in profit or loss which is not
correct as per NAS 16. Revaluation gain should be recognised in other comprehensive income and such
amount should be accumulated in revaluation reserve. Recognition of revaluation gain in profit or loss
is permitted only to the extent revaluation loss previously recognised in profit or loss. Hence the
contention of the company to recognise the revaluation gain in profit or loss is not correct as per NAS
16.
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c) Going concern is an underlying assumption that is used by an entity while preparing financial
statements. Under the going concern assumption entity is viewed as continuing business for the
foreseeable future. As per NAS 1 “Presentation of Financial Statements” entity shall make assessment
of entity‟s ability to continue as going concern while preparing financial statements. An entity shall
prepare its financial statements on a going concern basis unless management either intends to liquidate
the entity or to cease trading or has no realistic alternative but to do so. While doing assessment
management shall consider all available information about the future, which is at least, but not limited
to, twelve months from the end of the reporting date. Hence, contention of the accountant of Small
Limited is not correct as per NAS-1, the company shall make assessment of going concern assumption
while preparing the financial statements.
d) Interest on loan taken to acquire qualifying assets can be termed as borrowing cost. Nepal
Accounting Standard – 23 deals with the accounting of borrowing cost. It states that borrowing costs
should be recognized as an expense in the period in which they are incurred. However, as per
alternative treatment, borrowing costs that are directly attributable to the acquisition or construction of
any asset should be capitalized as part of the cost of that asset. In the above case the loan has been
solely taken for the purpose of constructing the asset and hence needs to be capitalized up to the put-to-
use phase. However, the standard also specifies that an entity shall suspend capitalization of
borrowing costs during extended periods in which it suspends active development of a qualifying
asset. An entity may incur borrowing costs during an extended period in which it suspends the
activities necessary to prepare an asset for its intended use or sale. Such costs are costs of holding
partially completed assets and do not qualify for capitalization. Hence in the above case, the interest on
loan during the lockdown period should not be capitalized and should be charged to the profit & loss
account.
2.
Give your comments on the following cases: (45=20)
a) ABC Associates, Chartered Accountants is entrusted with keeping track of money received from
international agency including handling the money belonging to such agency. ABC Associates
deposited such amount in bank account of ABC itself; however, record is kept separately.
b) BTS & Associates, Chartered Accountants, were appointed as the auditor by the annual general
meeting of DMK Ltd. for the financial year 2078/79. This was their first appointment as an auditor of
this company. During the course of the audit, after performing all required audit procedures, the auditor
was unable to obtain sufficient appropriate audit evidence concerning opening balances. Briefly outline
your role as an auditor.
c) Mr. Ram, an auditor of Cold Drink Company has obtained the trade secret formula during audit
process. A Case was lodged against Cold Drink Company for putting non-edible components in the
drink. Subsequently, auditor was called by Supreme Court to provide documents and his knowing in
the cold drink formulae. He shared the information; he has received on formula of Cold Drink
Company. Mr. Hari lodged complaints to ICAN that, Mr. Ram has violated the Code of Ethics on the
ground of breach of confidentiality.
d) PQ Ltd is engaged in trading of electronic goods and having huge debtors. For analysing the whole
accounts receivables, auditor wanted to use sampling technique. In considering the characteristics of the
population from which the sample will be drawn, the auditor determines that stratification or value-
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weighted selection technique is appropriate. NSA 530 provides guidance to the auditor on the use of
stratification and value-weighted sampling techniques. Advise the auditor in accordance with NSA 530.
Answer:
a) As per section 350 of the code of ethics, 2018 issued by the Institute, a professional accountant in
public practice entrusted with money (or other assets) belonging to others shall:
 Keep such assets separately from personal or firm assets;
 Use such assets only for the purpose for which they are intended;
 At all times be ready to account for those assets and any income, dividends, or gains generated, to
any persons entitled to such accounting; and
 Comply with all relevant laws and regulations relevant to the holding of and accounting for such
assets
On backdrop of above ethical requirements, the ABC Association‟s act of mixing up the clients‟
moneys with their own money (depositing in same bank account) cannot considered appropriate. So,
they cannot deposit the amount in same account.
b) As stated in NSA 510 "Initial Engagements-Opening Balances", for initial audit engagements, the
auditor should obtain sufficient appropriate audit evidence that: i) The opening balances do not contain
misstatements that materially affect the current period‟s financial statements; ii) The prior period‟s
closing balances have been correctly brought forward to the current period or, when appropriate, have
been restated; and iii) Appropriate accounting policies are consistently applied or changes in accounting
policies have been properly accounted for and adequately presented and disclosed.
As per para 10 of NSA 510, if the auditor is unable to obtain sufficient appropriate audit evidence
regarding the opening balances, the auditor shall express a qualified opinion, or disclaim an opinion on
So, considering the effect of such unavailability of audit evidence, the auditor should modify his audit
report.
c) Section 114 of Code of Ethics of ICAN, specifies about the Confidentiality to be observed by
members and professional accountants. The principle of confidentiality imposes an obligation on all
professional accountants to refrain from: (a) Disclosing outside the firm or employing organization
confidential information acquired as a result of professional and business relationships without proper
and specific authority or unless there is a legal or professional right or duty to disclose; and (b) Using
confidential information acquired as a result of professional and business relationships to their personal
advantage or the advantage of third parties.
However, section 114.1 A1, outlines circumstances where professional accountants is required to
disclose confidential information or when such disclosure is appropriate and once such circumstances
arise as required by law, for example i.e. production of documents or other provision evidence in the
course of legal proceedings.
In the given case, as auditor was called on by the court. Therefore, he has legal responsibility to give
information to the court purposes. So, this cannot be considered as breach of confidentiality.
d) Stratification and Value-Weighted Selection: In considering the characteristics of the population

from which the sample will be drawn, the auditor may determine that stratification or value-weighted
selection technique is appropriate. NSA 530 provides guidance to the auditor on the use of stratification
and value-weighted sampling techniques.
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Stratification: Audit efficiency may be improved if the auditor stratifies a population by dividing it
into discrete sub-populations which have an identifying characteristic. The objective of stratification is
to reduce the variability of items within each stratum and therefore allow sample size to be reduced
without increasing sampling risk.
When performing tests of details, the population is often stratified by monetary value. This allows
greater audit effort to be directed to the larger value items, as these items may contain the greatest
potential misstatement in terms of overstatement. Similarly, a population may be stratified according to
a characteristic that indicates a higher risk of misstatement, for example, when testing the allowance for
doubtful accounts in the valuation of accounts receivable, balances may be stratified by age.
The results of audit procedures applied to a sample of items within a stratum can only be projected to
the items that make up that stratum. To draw a conclusion on the entire population, the auditor will
need to consider the risk of material misstatement in relation to whatever other strata make up the entire
population. If a class of transactions or account balance has been divided into strata, the misstatement is
projected for each stratum separately. Projected misstatements for each stratum are then combined
when considering the possible effect of misstatements on the total class of transactions or account
balance.
Value-Weighted Selection: When performing tests of details, it may be efficient to identify the
sampling unit as the individual monetary units that make up the population. Having selected specific
monetary units from within the population, for example, the accounts receivable balance, the auditor
may then examine the items, for example, individual balances, that contain those monetary units. One
benefit of this approach to defining the sampling unit is that audit effort is directed to the larger value
items because they have a greater chance of selection and can result in smaller sample sizes.
This approach may be used in conjunction with the systematic method of sample selection and is most
efficient when selecting items using random selection.

a) “Sampling risk can lead to erroneous conclusion”. Discuss in Brief.
b) Obtaining an understanding of the entity and its environment, including the entity‟s internal
control, is a continuous, dynamic process of gathering, updating and analysing information
throughout the audit. Explain giving examples.
c) What are Analytical Audit procedures? Briefly describe the basic types of Analytical procedures.
Answer:
a) As per Nepal Standards on Auditing 530 “Audit Sampling”, Audit Sampling involves the
application of audit procedures to less than 100% of items within an account balance or class of
transaction such that all sampling units have a chance of selection. Audit sampling enables the auditor
to obtain and evaluate audit evidence about some characteristic of the items selected in order to form or
assist in forming a conclusion concerning the population from which sample is drawn.
Sampling risk represents the possibility that an auditor‟s conclusion based on a sample is different from
conclusion if the entire population were subject to audit. Auditor only apply audit procedures on
transactions covered in sample taken from the population while using audit sampling technique and
transaction not covered in sample shall be ignored. Sample should represent the population from which
sample is being drawn. If the sample is not representative of population, it is true that sampling risk
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could lead to incorrect conclusion that material misstatement exists in financial statements in fact, they
do not exist at all, this type of risk affects audit efficiency and usually lead to additional work to
establish that initial concern were incorrect or auditor may conclude that material misstatements do not
exist but in fact they do exist in the financial statements. Auditor can lower the sampling risk by
increasing sampling size.
b) Obtaining an understanding of the entity and its environment, including the entity‟s internal
control, is a continuous, dynamic process of gathering, updating and analysing information
throughout the audit. The understanding establishes a frame of reference within which the auditor
plans the audit and exercises professional judgment throughout the audit, for example, when:
 Assessing risks of material misstatement of the financial statements as per NSA 315;
 Determining materiality in accordance with NSA 320;
 Considering the appropriateness of the selection and application of accounting policies;
 Identifying areas where special audit consideration may be necessary, for example, related
party transactions, the appropriateness of management‟s use of the going concern assumption, or
considering the business purpose of transactions;
 Developing expectations for use when performing analytical procedures as per NSA 520;
 Evaluating the sufficiency and appropriateness of audit evidence obtained, such as the
appropriateness of assumptions and of management‟s oral and written representations.
c) As per NSA 520, Analytical procedure involves evaluations of financial information through
analysis of plausible relationships among both financial and non-financial data. Analytical procedures
also encompass such investigation as is necessary of identified fluctuations or relationships that are
inconsistent with other relevant information or that differ from expected values by a significant amount.
Following are the basic types of analytical procedures:
i. Simple Mathematical Comparison – General arithmetical increase or decrease in absolute terms
or in percentage gives idea about class of transaction or amounts presented and disclosed in financial
statements. Year to year basis or in relation to other items of the same year.
ii. Ratio Analysis
Ratios are expressed as one financial statement data in relation to another. For example, current ratio is
calculated by dividing current assets with current liabilities. Auditors use ratio analysis in their audit to
compare ratios for the current year with ratios for a prior year, budget or an industrial average. Any
material differences in the ratios must be explained by the auditors.
iii. Trend Analysis
Trend analysis refers to the comparison of a current balance with a previous year‟s balance. An auditor
may choose to use either the diagnostic or casual approach. The diagnostic approach is used to evaluate
if a balance of a current account deviates significantly from the trend established in the previous year‟s
balances for that account. In the casual approach, the auditor calculates a balance expected for the
account then compared to the actual amount.

a) “The rendering of two or more types of professional services concurrently does not by itself
impair the integrity, objectivity or independence”. Comment.
b) Mr. X, a Chartered Accountant in practice enters into an agreement with Mr. Y, an individual
who has passed one group of CAP-III few years back. The agreement provides that Mr. Y shall work
in all professional engagements of Mr. X and shall receive 15 percent of fee received from such
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assignments as remuneration. Explain whether the agreement is in compliance with the prevailing
law and the Code of Ethics or any other relevant reference?
c) Offer from audit client as costly gifts may create threats to compliance with the fundamental
principles. In this context, explain the provision on „Gift and hospitality‟ as explained in Code of
Ethics.
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Answer
a) A firm might provide multiple services to the client concurrently. Providing two or more
professional services to the client in itself does not impair integrity, objectivity or independence of the
auditor. However, there are more chances that fundamental ethical principles are in threat in such
circumstances.
While doing so, the auditor shall be alert whether there arises the threat to the fundamental principles.
In such situation, a conflict of interest may create threats to compliance with the fundamental principles
of integrity, objectivity, and independence. The auditors shall not engage in activities incompatible with
the Practice of Public Accountancy.
Professional accountant in public practice should not concurrently engage in any business, occupation
or activity which impairs or might impair integrity, objectivity or independence, or the good reputation
of the profession and therefore would be incompatible with the rendering of professional services.
Simultaneous engagement in another business, occupation or activity unrelated to professional services
which have the effect of not allowing the professional accountant in public practice properly to conduct
a) professional practice in accordance with the fundamental ethical principles of the accountancy
profession should be regarded as inconsistent with the practice of public accountancy.
So, professional accountants shall always be alert while accepting two or more services concurrently to
the clients.
b) As per section 34(3) of Nepal Chartered Accountants Act, 1997, one shall not share the auditing fees
or remuneration or distribute as profit with any person other than a member of the institute and shall not
pay any commission, brokerage, etc. out of the professional fees earned to any person or member.
Agreeing into agreement with the person who is not a member of the institute is also against the legal
provision and code of ethics.
In the above case also, Mr. X a Chartered Accountant in practice enter into agreement to share auditing
fees. So, Mr. X would be held guilty of professional misconduct.
c) Section 340 of the code of ethics provides guidance on inducements, including the gifts and
hospitality. A professional accountant in public practice, or an immediate or close family member, may
be offered gifts and hospitality from a client. Such an offer may create threats to compliance with the
fundamental principles. For example, a self-interest or familiarity threat to objectivity may be created if
a gift from a client is accepted; an intimidation threat to objectivity may result from the possibility of
such offers being made public.
The existence and significance of any threat will depend on the nature, value, and intent of the offer.
Where gifts or hospitality are offered that a reasonable and informed third party, weighing all the
specific facts and circumstances, would consider trivial and in consequential, a professional accountant
in public practice may conclude that the offer is made in the normal course of business without the
specific intent to influence decision making or to obtain information. In such cases, the professional
accountant in public practice may generally conclude that any threat to compliance with the
fundamental principles is at an acceptable level.
A professional accountant in public practice shall evaluate the significance of any threats and apply
safeguards when necessary to eliminate the threats or reduce them to an acceptable level. When the
threats cannot be eliminated or reduced to an acceptable level through the application of safeguards, a
professional accountant in public practice shall not accept such an offer.
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a) CLL & Associates, a chartered accountant‟s firm has a history of more than 10 years in auditing and
accounting services in Nepal. Mr. Big and Mr. Small were partners of CLL & Associates. However,
they have recently discontinued their partnership and opened separate audit firm by each partner in FY
2078-79. Nepal Limited was the client of CLL & Associates and the firm has completed the 3 rd term of
appointment with the company in FY 2077-78. Nepal Limited wants to appoint Mr. Big as an auditor
for FY 2078-79.
b) Discuss about the provisions relating to appointment of auditors for corporate bodies substantially
owned by the government.
Answer:
a) As per provision specified in the section 111 of Companies Act, 2063, companies shall appoint
auditor for the audit amongst the auditors licensed to carry out audit. However, in case of public
company, no auditor or his/her partner or ex-partner or employee or ex-employee shall be appointed as
auditor for more than three consecutive terms to perform the audit provided, however that this
restriction shall not apply to any partner who ended partnership or any employee who left the service of
such auditor 3 years before. In the given case CLL & Associates has already been appointed as auditor
of Nepal Limited for 3 consecutive years. In the given case, for FY 2078-79, Nepal Limited wants to
appoint ex-partner of CLL & Associates as auditor which results to non-compliance of section 111(3)
of Companies Act, 2063. Hence Nepal Limited should not appoint Mr. Big as an auditor of the
company for FY 2078-79.
b) Audit of corporate bodies substantially owned by the government:

As per section 11 of Audit Act, 2075 (2019), a corporate body substantially owned by the government
may appoint an auditor and have its accounts audited by the auditor subject to the principles specified
by the Auditor General. In appointing an auditor pursuant, the corporate body shall consult the Auditor
General. The concerned corporate body shall forward a copy of the report presented by the auditor
appointed to the Office of the Auditor General, as well.
If, from the report received, there appears any error in the accounts of such a corporate body, the
Auditor General may give necessary directives to the concerned corporate body and the auditor in
respect of such error, and it shall be the duty of the concerned body and auditor to abide by such
directives. The concerned corporate body shall submit progress details of implementation, within the
specified period by the Auditor General in respect of the matters indicated by the report received and
the directives given by the Auditor General.

a) Professional skepticism
b) Internal Check
c) Audit Working Papers
d) Written (Management) Representation Letter
Answer:
a) It is a state of mind having a questioning mind and refers to being alert to anything that may indicate
misstatement due to error or fraud. It involves critically assessing audit evidence.
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It is a requirement of NSA 200 that, when planning and performing an audit, the auditor should adopt
an attitude of professional skepticism. Professional skepticism is defined by NSA 200 as an attitude that
includes a questioning mind, being alert to conditions which may indicate possible misstatement due to
error or fraud, and a critical assessment of audit evidence.
This does not mean that the auditors should disbelieve everything they are told, but they should view
what they are told with a sceptical attitude and consider whether it appears reasonable and whether it
conflicts with any other evidence. In other words, they must not simply believe everything management
tells them.
b) Internal check means the management of duties in such a manner that the work of one person is
automatically checked by other person during execution of normal duty. It is a part of overall control
system and operates basically as a built-in-device as far as organisation and job-allocation aspects of
the controls are concerned. The system provides existence of checks on the day-to-day transactions
which operate continuously as part of the routine system whereby the work of each person is either
proved independently or is made complimentary to the work of another.
c) Audit working papers are the evidenced obtained/ created by the auditor during the audit. It
constitutes the link between the auditor‟s report and the client‟s record. These documents are
considered as the property of the auditor. Audit working papers are documents prepared or obtained
from the client and retained by auditor in connection with the audit. Audit working papers are means of
controlling audit work, evidence of work performed by the auditor, information about the client and
supporting documents related to accounts under audit.
d) NSA 580 “Written Representations” establishes standards and provide guidance on the use of
management representations as audit evidence, the procedures to be applied in evaluating and
documenting management representations, and the action to be taken if management refuses to provide
appropriate representations.
The management representation as audit evidence:
 During an audit, management makes many representations to the auditor, either unsolicited or in
response to some specific enquiries.
 The auditor also should obtain representation from management, where considered appropriate
and necessary.
 The management representation is taken to corroborate audit evidence, but representations by
management cannot be a substitute for other audit evidence that the auditor could reasonably expect to
be reasonably available.
 In certain cases, where knowledge of facts is confined to management, a representation by
management may be the only audit evidence, which can reasonably be expected to be available.

a) Verification and Vouching in Audit
b) Audit Reports and Audit Certificates
Answer:
a) The distinction between vouching and verification can be made as under:
S.N. Vouching Verification
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1 It pertains to entries relating to Verification relates to the assets and liabilities
transaction recorded in books appearing in the balance sheet.
2 Vouching is usually done throughout Verification is generally carried out at the end of
the year year.
3 To verify the completeness, accuracy To confirm the existence, ownership, possession,
and validity of transactions completeness, valuation and disclosure of items
relating to balance sheet.
4 vouching is based only on Verification is based on observation as well as
documentary examination documentary examination.
5 Vouching is a routine matter, which is Verification requires experienced people and done by
generally conducted by junior staff of the senior staff.
audit clerks
6 Vouching does not include valuation Verification includes valuation.
b) The term „certificate‟ is a written confirmation of the accuracy of the facts stated therein and does
not involve any estimate or opinion. When an auditor certifies a financial statement, it implies that the
contents of that statement can be measured, and that the auditor has vouchsafed the exactness of the
data. The term certificate is, therefore, used where the auditor verifies certain exact facts. An auditor
may thus, certify the circulation figures of a newspaper or the value of imports or exports of a
company. An auditor's certificate represents that he has verified certain precise figures and is in a
position to vouch safe their accuracy as per the examination of documents and books of account.
An auditor's report, on the other hand, is an expression of opinion. When we say that an auditor is
reporting, we imply that he is expressing an opinion on the financial statements. The term report
implies that the auditor has examined relevant records in accordance with generally accepted auditing
standards and that he is expressing an opinion whether or not the financial statements represent a true
and fair view of the state of affairs and of the working results of an enterprise. Since an auditor cannot
guarantee that the figures in the balance sheet and profit and loss account are absolutely precise, he
cannot certify them. This is primarily because the accounts itself are product of observance of several
accounting policies, the selection of which may vary from one professional to another and, thus, he can
only have an overall view of the accounts through normal audit procedures.
Therefore, the term certificate cannot be used in connection with these, statements. Thus, when a
reporting auditor issues a certificate, he is responsible for the factual accuracy of what is stated therein.
On the other hand, when a reporting auditor gives a report, he is responsible for ensuring that the report
is based factual data, that his opinion is in due accordance with facts, and that it is arrived at by the
application of due care and skill.
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1. As an auditor, give your opinion with explanations on the following cases:
(45=20)
a) The management tells you that the work-in-process is not valued since it is
difficult to ascertain the same in view of the multiple processes involved and in
any case the value of opening and closing work-in-process would be more or less
the same.
Answer:
According to NAS 2, Inventories, the inventories also include (para 6) those assets which
are in the process of production for sale in the ordinary course of business apart from
finished goods. The materials or supplies are consumed in such production process. It is,
thus, necessary for a company to ensure that each and every component of inventory is
measured and valued properly. The argument advanced by the company that it is difficult
to ascertain the same in view of the multiple processes involved is not acceptable. In
general, the audit procedures regarding work-in-process are similar to those used for raw
materials and finished goods. The auditor has to carefully assess the stage of completion
of the work-in-process for assessing the appropriateness of its valuation.
The argument that the opening and closing work-in-process would be more or less the
same is also not justified because the omission of those would lead to distortion of true
and fair view. Further, costs incurred for raw materials and the overheads would normally
be different and would give rise to different values of opening and closing inventory. In
view of the above, the auditor shall consider its overall impact on financial statements
and conclude as to how it should be reported in his audit report.
b) ABC Limited with paid up capital of Rs.1 crore has appointed an individual firm, Suresh
Associates, Chartered Accountants, as auditor of the company at the Annual General
Meeting held on 30th Poush, 2076. Mrs. Kamala, wife of Mr. Suresh, invested in the
equity shares having face value of Rs.1 lakh of ABC Limited. However, Suresh &
Associates accepted engagement and continued to function as statutory auditors of the
company.
Answer:
According to section 112(1)(e) of Companies Act 2063, a substantial shareholder of the
company or a shareholder holding 1% or more of the paid-up capital of the company or
his close relative shall be disqualified for being appointed as an auditor of the company.
In this case, Mr. Suresh, Chartered Accountant, did not hold any shares in the company.
However, his wife held equity shares of ABC Limited of face value of Rs.1 lakh which
is 1% of paid up capital of the company.
Further, section 112(2) provides that the auditor shall, prior to his appointment, give
information in writing to the company that he is not disqualified for being appointed as
an auditor of the company. Where any auditor becomes disqualified to audit the accounts
of a company or there arises a situation where he becomes disqualified for appointment
or can no longer continue to act as an auditor of the company, he shall immediately stop
performing audit which is required to be performed or is being performed by him and
give information thereof to the company in writing. The audit performed by an auditor
who has been appointed in contravention of this Section shall be invalid.
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Hence, Suresh & Associates cannot continue to function as auditor of the company with
the investment made by his wife in the equity shares of ABC Limited which is 1% of the
paid-up capital of the company.
c) Chitle International Ltd.’s total turnover for the FY 2075/76 is Rs.1crore and it
includes Rs. 2.7 lakhs from sale of by-products. Whereas, the by-product sales
are included under the miscellaneous income in the financial statements and is not
separately disclosed in the income head.
Answer:
As per NAS 1, Presentation of Financial Statements information is material if its
omission or misstatement could influence the economic decisions of users taken on the
basis of the financial statements. Materiality depends on size of the item or error judged
in the particular circumstances of its omission or misstatement. Thus, materiality provides
a threshold or cut-off point rather than being a primary qualitative characteristic which
information must have if it is to be useful.
As per NAS 1, each material item shall be presented separately in the financial statements.
Immaterial amounts shall be aggregated with amounts of a similar nature or function and
need not be presented separately.
In this case, income from sale of by-product shall be disclosed separately in the revenue
item as the income from by-product is considered material items since it is more than two
percent of total turnover of the company. Similarly, the auditor has to ensure that a
material item is disclosed separately and distinctly or at least clear information about the
item is available in the financial statements. In this case, he is required to request company
to disclose information about revenue from sale of by-product, as the income from by-
product is material in giving or distorting a true and fair view of financial statements.
d) During the financial year 2077/78, SR Private Limited, a service providing company
purchased generator of Rs.20 lakhs for smooth functioning of its office. The accountant
claims that there is no necessity to provide for depreciation in respect of generator as it
was kept standby but not used at all during the financial year.
Answer:
As per NAS 16, Property, Plant and Equipment, depreciation of assets begins when it is
available for use, i.e. when it is in the location and condition necessary for it to be capable
of operating in the manner intended by the management. Depreciation is the systematic
allocation of the cost of an item of property, plant & equipment (less its residual value)
over its useful life. Thus, depreciation has to be charged even in case of these assets which
are not used at all during the year but by mere efflux of time provided such assets qualify
as depreciable assets.
When the generator was kept ready for use as stand-by, it means it was intended to be
used for the purpose of business. Depreciation in respect of this generator would have
been provided in the accounts for the year ended 31st Ashadh 2078. If there is an intention
to use an asset, though it may not have actually been used, it is a 'constructive' or 'passive'
use and eligible for charging depreciation.

a) Mr. T Pandey, Senior Accountant of M/s Preeti Finance Co. Ltd. produced the
photocopies of fixed deposit receipts of Rs. 5,05,000/- to the auditor during the course of
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audit as the managing director who kept original receipts in safe vault was presently out
of the country to attend the seminar abroad.
Answer:
An auditor should obtain sufficient appropriate audit evidence, evaluate the same and
draw reasonable conclusions therefrom as required by NSA 500, Audit Evidence. In the
given case, photocopies of fixed deposit receipts were made available by Mr. T Pandey,
Senior Accountant to the auditors as the original receipts could not be verified, which
were kept in the safe vault.
The auditor is generally required to inspect and physically verify the fixed deposit
receipts (FDRs) representing the assets. Such verification is necessary to ensure that no
unauthorized charge has been created or the fixed deposits receipts have been lodged with
a bank to secure a loan or an overdraft. Thus, the photocopies of FDRs cannot serve the
desired purpose. Alternatively, reliance can be placed by the auditor on such evidence
provided photocopies are certified as true copies by the management as also backed by a
letter of representation. Managing director may also be asked to confirm in writing from
abroad that no unauthorized charge has been created on the fixed deposits receipts and
same shall be produced to auditors as soon as he returns from seminar abroad. The auditor
may also obtain independent confirmation from the respective bank that no charge has
been created on such fixed deposit receipts.
The auditor should consider the materiality of the amount involved and its overall impact
on the financial statements while forming an opinion. In case the auditor is satisfied after
extending the substantive audit procedure and if amount involved is reasonable in his
opinion, he need not state anything in his report after getting appropriate confirmation in
writing from managing director about the status of fixed deposit receipts.
b) The financial statements of Everest Ltd. for the FY 2076/77 has been approved
by its Board of Directors on 1st Kartik 2077, however, auditor has issued his audit
report on 25th Aswin 2077.
Answer:
As per NSA 700, Forming an Opinion and Reporting on Financial Statements, the
auditor should date the report as of the completion date of the audit. This informs the
reader that the auditor has considered the effect on the financial statements and on the
reports of events and transactions of which the auditor become aware and that occurred
up to that date. Since the auditor`s responsibility is to report on the financial statements
as prepared and presented by management, the auditor should not date the report earlier
than the date on which the financial statements are signed or approved by Board of
Directors. So, the act done by the auditor in this case is not appropriate in line with
provision of NSA 700.
c) While reporting on the consolidated financial statements, the principal auditor has
to evaluate the financial statements of the subsidiary company also. At times when
such financial statements were audited by other auditors, the principal auditor
relied on the audit reports submitted by the company without further audit
procedures.
Answer:
As per NSA 600, Special Considerations – Audits of Group Financial Statements
(including the work of Component Auditors), when the principal auditor (group
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engagement partner) uses the work of another auditor, the principal auditor should
determine how the work of the other auditor will affect the audit of group financial
statements. 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.
The principal auditor may conclude that it is not necessary to apply any substantive or
quality check procedures because sufficient appropriate audit evidence previously
obtained that acceptable quality control policies and procedures are complied with in the
conduct of the other auditor’s practice.
In the given case, the principal auditor has to ensure that other auditor has complied with
applicable ethical and technical requirements while conducting audit.
d) As statutory Auditor of XYZ Pvt., Ltd. you requested your client for sending letter
for balance confirmations from certain debtors.The client argued that since the
said balances with debtors were under dispute and the matter was pending in the
court, it was not necessary to ask balance confirmation.
Answer:
NSA 505, External Confirmations, establishes standards on the auditor’s use of external
confirmation as a means of obtaining audit evidence. It requires that the auditor should
employ external confirmation procedures in consultation with the management. The
auditor may come across certain situations in which the management may request him
not to seek external confirmation from certain parties because of dispute with the debtors,
etc. The management, for example, might make such a request on the grounds that due to
a dispute with the particular debtor, the request for confirmation might aggravate the
sensitive negotiations between the entity and the debtor. In such cases, when an auditor
agrees to management’s request not to seek external confirmation regarding a particular
debtor, the auditor should consider validity of grounds for such a request and assess
management’s integrity and obtain other evidence to support the same. The auditor
should also ask the management to submit its request in a written form, dealing therein
the reasons for such a request. When auditor agrees to management’s request not to seek
external confirmation regarding a particular matter, the auditor should document the
reasons for accepting to the management’s request and should apply alternative
procedures to obtain sufficient appropriate evidence regarding that matter. While
considering the validity of request, in case the auditor reaches at a conclusion that the
same was not valid, he may appropriately modify the report.

a) List out the analytical procedures that you would adopt in audit of revenue of an
entity. What are the factors that determine the extent of reliance on such analytical
procedures?
Answer:
Analytical procedures are one of audit procedures which help an auditor to understand the
client's business and changes in the business, and to identify potential risk areas to plan
other audit procedures. It includes comparison of financial information, relating financial
and nonfinancial information and consideration of predictable relationship of data.
The analytical procedures that will be adopted in obtaining audit evidence regarding the
various assertions relating to revenue are as follows:
i. Comparison of Gross-profit ratio to sales for the current year with the corresponding
figures of the previous years.
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ii. Comparison of ratio of sales returns to sales for the current year with the corresponding
figures for previous years.
iii. Comparison of trade discount to sales for the current year with previous year.
iv. Review of Reconciliation of Excise/VAT booked during the year with Excise/VAT
returns submitted with the total sales booked.
v. Comparison of dividend/interest/royalty for the current year with the corresponding
figures for previous years.
vi. Comparison of ratio of income on investments to average investment for the current
year with corresponding figures for the previous year.
The factors that affect the extent of reliance on analytical procedures are as follows:
i. Materiality: When items are material, the auditor doesn’t solely rely on the analytical
procedures in forming conclusions but will carry other substantive procedures also.
ii. Other procedures: When other procedures are also directed towards the same
objective, it might confirm or dispel the questions raised from the application of
analytical procedures.
iii. Weak controls: When internal controls are weak, greater reliance is placed on tests of
balances and tests of details of transactions rather than on analytical procedures.
iv. Accuracy: The accuracy with which expected results of analytical procedures can be
predicted. For example, greater reliance is placed on gross profit ratio compared to
previous year than in comparing discretionary expenses such as donation.
b) Briefly discuss about the limitations of Internal Controls.

Answer:
Limitations of Internal Control:
Internal control can provide only reasonable assurance. Internal control, no matter how
effective, can provide an entity with only reasonable assurance about achieving the
entity's compliance, operational and financial reporting objectives. The likelihood of
their achievement is affected by inherent limitations of internal control. Such limitations
are discussed as below:
(i) Human judgment in decision-making: Realities that human judgment in decision-
making can be faulty and that breakdowns in internal control can occur because of
human error.
(ii) Lack of understanding the purpose: Equally, the operation of a control may not be
effective, such as where information produced for the purposes of internal control
(for example, an exception report) is not effectively used because the individual
responsible for reviewing the information does not understand its purpose or fails to
take appropriate action.
(iii) Collusion among people: Additionally, controls can be circumvented by the
collusion of two or more people or inappropriate management override of internal
controls. For example, management may enter into side agreements with customers
that alter the terms and conditions of the entity’s standard sales contracts, which may
result in improper revenue recognition. Also, edit checks in a software program that
are designed to identify and report transactions that exceed specified credit limits
may be overridden or disabled.
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(iv) Judgements by Management: Further, in designing and implementing controls,
management may make judgments on the nature and extent of the controls it chooses
to implement, and the nature and extent of the risks it chooses to assume.
(v) Limitations in case of small entities: Smaller entities often have fewer employees
due to which segregation of duties is not practicable. However, in a small owner-
managed entity, the owner-manager may be able to exercise more effective
oversight than in a larger entity. This oversight may compensate for the generally
more limited opportunities for segregation of duties.
On the other hand, the owner-manager may be more able to override controls because
the system of internal control is less structured. This is taken into account by the auditor
when identifying the risks of material misstatement due to fraud.
c) Describe the necessity of "Other Matter Paragraph" and how it is presented in the
Auditor`s Report?
Answer :
NSA 706, Emphasis of Matter Paragraphs and Other Matter Paragraphs in the
Independent Auditor's Report deals with additional communication in the auditor`s report
when the auditor consider it necessary to:
(i) Draw users’ attention to a matter or matters presented or disclosed in the financial
statements that are of such importance that they are fundamental to users’
understanding of the financial statements; or
(ii) Draw users’ attention to any matter or matters other than those presented or disclosed
in the financial statements that are relevant to users’ understanding of the audit, the
auditor’s responsibilities or the auditor’s report.
The other matter paragraph is used in second scenario discussed above where it relates
to a matter other than those presented or disclosed in the financial statements.
The "Other Matter Paragraph" is presented in the Auditor`s Report as follows:
i. When a Key Audit Matters section is presented in the auditor’s report and an Other
Matter paragraph is also considered necessary, the auditor may add further context to
the heading “Other Matter”, such as “Other Matter – Scope of the Audit”, to
differentiate the Other Matter paragraph from the individual matters described in the
Key Audit Matters section.
ii. When an Other Matter paragraph is included to draw users’ attention to a matter
relating to Other Reporting Responsibilities addressed in the auditor’s report, the
paragraph may be included in the Report on Other Legal and Regulatory
Requirements section.
iii. When relevant to all the auditor’s responsibilities or users’ understanding of the
auditor’s report, the Other Matter paragraph may be included as a separate section
following the Report on the Audit of the Financial Statements and the Report on Other
Legal and Regulatory Requirements.
a) R Baral & Associates has been operating a separate bank account for keeping
client's fund in course of providing fund manager service to the client. The interest
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earned on such account during financial year 2077/78 amounting Rs. 85,000 has
been transferred to firm's bank account and booked as miscellaneous income,
subsequently with corresponding miscellaneous income in client's account and
miscellaneous expenditure in firm's account.
Answer:
As per Section 350 “Custody of Client Assets” of Code of Ethics of the Institute of
Chartered Accountants of Nepal, and Guidelines on assuming custody of clients' money
by professional Accountants in public practice, it is necessary that “All interest earned on
clients' monies should be credited to the client's account".
The accounting entries made by R Baral & Associates for interest income transferring to
firms account is incorrect. However, subsequent transfer of interest income to client's
account by booking as miscellaneous expense in firm's account is correct.
In the light of the provision contained in Section 350 of Code of Ethics, a professional
accountant in public practice entrusted with money (or other assets) belonging to others
shall therefore:
(i) Keep such assets separately from personal or firm assets;
(ii) Use such assets only for the intended purpose;
(iii) Be ready to present accounting of those assets and any income generated from such
assets at all time to the client; and
(iv) Comply with all the relevant laws and regulations applicable for the custody of
client\s assets.
Hence, R Baral & Associates should comply with the code of ethics as prescribed by
ICAN and save the firm away from the disciplinary action for non-compliance of ICAN
code of ethics.
b) A partner of a firm of Chartered Accountants during a T.V. interview handed over

a bio-data of his firm to the chairperson. Such bio-data detailed the standing of
the international firm with which the firm was associated. It also detailed the
achievements of the concerned partner and his recognition as an expert in the field
of taxation. The chairperson read out the said bio-data during the interview.
Answer:
Code of Ethics and related Guidelines on marketing professional services issued by the
Institute prohibits solicitation of client or professional work either directly or indirectly
by circular, advertisement, personal communication or interview or by any other means
because it shall constitute professional misconduct. The bio-data was handed over to the
chairperson during the T.V. interview by the Chartered Accountant which included
details about the firm and the achievements of the partner as an expert in the field of
taxation. The chairperson read out the same in detail about association with the
international firm as also the achievements of the partner and his recognition as an expert
in the field of taxation. Professional accountants in practice while participating in such
interview should be careful in giving details about firm and himself/ herself that may be
considered as publicity. When such publicity attracts non-compliance with code of ethics
and related Guidelines, such act would lead to professional misconduct attracting the
penalty there of.
c) How the concept of "related party" has been defined in Nepal Standards on
Auditing (NSA)?
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Answer:
NSA 550, in para 10 (b) provides the definition of related party as a party that is either:
(i) A related party as defined in the applicable financial reporting framework; or
(ii) Where the applicable financial reporting framework establishes minimal or no related
party requirements:
i. A person or other entity that has control or significant influence, directly or
indirectly through one or more intermediaries, over the reporting entity;
ii. Another entity over which the reporting entity has control or significant
influence, directly or indirectly through one or more intermediaries; or
iii. Another entity that is under common control with the reporting entity through
having:
a. Common controlling ownership;
b. Owners who are close family members; or
c. Common key management.
However, entities that are under common control by a state (that is, a national, regional
or local government) are not considered related unless they engage in significant
transactions or share resources to a significant extent with one another.

a) Explain the Propriety aspect of Audit in line with Section 9 of Audit Act, 2075.
Answer:
Section 9 of the Audit Act, 2075 requires the Auditor General to audit following matters
considering the propriety thereof:
(1) The Auditor General shall, as required, audit the following matters in view of the
propriety thereof:
(a) If it is seen that any expenditure, though it confirms to the authorization, has been
made unreasonably or in a manner to cause loss and damage to the national
property, with respect to such expenditure and its authorization,
(b) With respect to any grant of national property whether movable or immovable or
underwriting of revenue or any lease, permit, license or rights relating to mining,
forest, hydropower etc. and all authorizations issued in a manner to abandon any
revenue or national property, whether movable or immovable,
(c) With respect to the subject-matters of various financial transactions including
contracts and agreements relating to public works, repair and maintenance,
procurement and supply, consultancy service, service delivery, public expenditure
and revenue mobilization.
(2) The Auditor General may, if he or she deems it appropriate, examine, in accordance
with the recognized principles of accounting, as to whether or not any official within
his or her scope of competence has borne financial accountability.
(3) The Auditor General may not include in his or her report minor items of
irregular amounts or other items deemed
b) Annual General Meeting of Surya Ltd. could not appoint the auditor for the FY
2077-78. Suggest how Surya Ltd. can appoint the auditor for the FY 2077-78?
Answer:
Section 113 of the Companies Act, 2063 empowers the Office of Company Registrar
(OCR) to fill a vacancy in case no auditors are appointed or reappointed at an annual
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general meeting. Since the auditor could not be appointed in AGM, OCR at the request
of the board of directors shall appoint a person to fill the vacancy as provided in Section
113. The non-appointment of auditor by AGM does not result in any casual vacancy.
Moreover, even if the auditor is existing one would not make any difference since the
appointment has to be made at each AGM and the auditor must accept the same. As a
general principle, the shareholders have to exercise this power in all cases, except in the
case of filling a casual vacancy or appointing the first auditors.
Thus, as per the provision of Companies Act as stated above, Surya Ltd. have to follow
the required procedures for appointing the auditor for the FY 2077-78.

a) Uses of Negative External Confirmation Requests
Answer:
A negative external confirmation request asks the respondent to reply only in the event
of disagreement with the information provided in the request. However, when no
response has been received to a negative confirmation request, the auditor remains aware
that there will be no explicit evidence that intended third parties have received the
confirmation requests and verified that the information contained therein is correct.
Accordingly, the use of negative confirmation requests ordinarily provides less reliable
evidence than the use of positive confirmation requests, and the auditor considers
performing other substantive procedures to supplement the use of negative confirmations.
Negative confirmation requests may be used to reduce audit risk to an acceptable level
when:
i. the assessed level of inherent and control risk is low;
ii. a large number of small balances is involved;
iii. a substantial number of errors is not expected; and
iv. the auditor has no reason to believe that respondents will disregard these requests.
b) Professional Skepticism
Answer:
Professional skepticism is an attitude which means that the auditor should recognize the
fact that circumstances may exist that may cause the financial statements to be materially
misstated. It includes a questioning mind, being alert to conditions which may indicate
possible misstatement due to error or fraud, and a critical assessment of audit evidence.
c) Computer Assisted Audit Techniques
Answer:
Computer assisted audit techniques (CAATs) includes tools used by auditors during their
work. These tools allow auditors to receive data in any form and analyze it better. CAATs
include various methods that can help auditors in many ways. For example, auditors can
use them to identify trends or signal out anomalies in the provided information. These
tools are available for both external and internal audit uses. In essence, computer-assisted
audit techniques refer to the use of technology in auditing. Using these tools, auditors can
assess several aspects of their audit engagement. Whether it is evaluating the
client’s internal controls or extracting specific information, CAATs can be significantly
valuable. While some people assume CAATs apply to large audits only, these tools are
beneficial in any size audits. Traditionally, auditors spend most of their time analyzing
data. With CAATs, they don’t have to take the same time. Instead, they can focus on
other more prominent audit matters.
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d) Teeming and Lading
Answer:
Teeming and lading is a term that describes a practice whereby organizations attempt to
hide an information in one customer’s account by moving in money from another
customer’s account. It is sometimes referred to as lapping, short banking, or delayed
accounting. Essentially, teeming and lading is a strategy that delays a payment deficit
from showing up on a customer’s account by moving money around. Hence, older
payments appear to have been covered before customers, or other organization members
might notice any disparity. Most often, teeming and lading is a strategy used by
employees who have used a customer’s money for personal purposes to cover their tracks.
It may also be used by an employee that has used one customer’s money for another
customer’s benefit. In both examples, teeming and lading helps keep the activity from
being found out by delaying a deficit from showing up in the books and manipulating the
company accounts.

a) Audit, Review and Compilation Level of assurance :
Answer:
The level of assurance that the financial statements of a client are fairly presented is at its
highest for an audit and at its lowest (none at all) for a compilation, with a review
somewhere in between.
i. Reliance on management: In all three cases, the auditor begins with the account
balances provided by management, but an audit requires in a significant amount of
corroboration of this information. A review requires some testing of the information,
while a compilation almost entirely relies on the presented information.
ii. Understanding of internal controls: The auditor only tests the internal controls of
the client in an audit; no testing is conducted for a review or a compilation.
iii. Work performed: An audit requires a significant number of hours to complete, since
there are many audit procedures to be performed. A review requires substantially
fewer hours, while the effort associated with a compilation is relatively minor.
iv. Price: It requires vastly more effort for an auditor to complete an audit, so audits are
much more expensive than a review, which in turn is more expensive than a
compilation.
Another issue is the level of demand for each of these services. The users of financial
statements, such as investors and lenders, nearly always demand an audit, since it
provides the greatest assurance that what they are reading is a fair representation of
the financial results, financial position, and cash flows of the reporting entity.
b) Differentiate between Performance audit and Propriety audit.
Answer:
S. No. PePerformance Audit Propriety Audit
Meaning Performance audit is an Propriety audit has been described
independent examination of the as an audit of the actions and
economy, efficiency and decisions of the executives.
effectiveness of government
undertakings, programmes or
organisations, with due regard to
economy, and the aim of leading to
improvements.
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Focus Performance audit is focused to The focus of such an audit is on
improve the system of management the financial discipline, the
to ensure genuine output/outcome authority structure, efficiency,
from resources employed. rules and regulations and the
protection of public interest.
Objective In this, auditor focus on whether the In this, auditor focus on whether
operations of audit entities were the expenditure is improper,
conducted in a way that ensures the avoidable, or infructuous
best possible use of resources or expenditure even though the
considering the 3Es and officials in expenditure has been incurred in
the public sector have met their conformity with the existing rules
accountability obligations. and regulations.
Scope This type of audit examines: a) the Audit against propriety seeks to
economy in the acquisition of the ensure that expenditure conforms
appropriate quality and quantity of to principles of a) the expenditure
human, financial, physical and should not be prima facie more
information resources at the than the occasion demands; b)
appropriate times and at the lower every public officer is expected to
cost; b) “Efficiency” of utilization exercise the same vigilance in
of human, financial, physical and respect of expenditure incurred
information resources such that the from public moneys as a person
output is maximized for any given of ordinary prudence would
set of resource inputs, or input is exercise in respect of expenditure
minimized for any given quantity of his own money; c) no authority
and quality of output and c) should exercise its powers of
“Effectiveness” in the achievement sanctioning expenditure to pass an
of the objectives or other intended order which will be directly or
effects of activities whether policy indirectly to its own advantage
objectives or goals have been met and d) public moneys should not
and whether this can be attributed to be utilized for the benefit of a
the policy pursued. particular person or section of the
community.
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1. As an auditor, give your opinion with explanations on the following cases: (45=20 marks)
a) XYZ Limited has provided Rs. 50 lakhs for Inventory obsolescence in 2076/77. In the subsequent
year, it was determined that 45% of such inventory was usable. The Board of Directors is in the
view of adjusting same through prior period adjustment.
b) The ABC Ltd., while valuing its finished goods inventory at the year-end wants to include interest
on Bank Overdraft as an element of cost, for the reason that overdraft has been taken specifically
for the purpose of financing current assets like inventory and for meeting day to day working
expenses.
c) XYZ is a manufacturing company. There was huge fire in the factory of XYZ on 1 Ashoj 2077 and
fixed assets having written down value of Rs. 10 crores out of total fixed assets of Rs. 20 crores of
the company were destroyed. The financial statements of the company for the year 2076/77 was
approved by the Board on 30 Ashoj 2077 in which fixed assets have been presented at WDV of Rs.
20 crores despite the severe loss due to fire and the information about the loss due to fire is properly
explained in the Notes to the financial statements.
d) You are the auditor of Success Ltd. some shareholders of Success Ltd. lodged complain against you
citing that you failed to send the auditor’s report to them.
Answer
a) As per NAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, prior period
errors are omissions from and misstatement in an entity’s financial statements for one or more prior
periods arising from a failure to use or misuse of reliable information that was available when
financial statements for those period where authorized for issue and could reasonably be expected
to have been obtained and taken into account in the preparation and presentation of those financial
statements. Such errors include the effects of mathematical mistakes, mistakes in applying
accounting polices oversights or misrepresentations of facts, and fraud. In light of these facts, the
write-back of provision made in respect of inventories in the earlier year does not constitute prior
period errors (adjustment) since it neither constitutes error nor omission but it merely involves
making estimates based on prevailing circumstances when financial statements were being
prepared. It is a mere estimate process involving judgment based on the latest information available
at that particular time.
An estimate may have to be revised if changes occur regarding the circumstances on which the
estimate was based, or as a result of new information, more experience or subsequent
developments. The revision of the estimate, by its nature, does not bring the adjustment within the
definitions of prior period errors discussed above.
In this case, XYZ Ltd. provided Rs 50 lakhs for inventory obsolescence in 2076/77. In the
subsequent year, due to change in circumstances, it was determined that 45% of such inventory
was usable. Revision of such an estimate does not bring the resulting amount of Rs.22.5 lakhs
within the definition of a prior period errors requiring adjustment in prior period. The amount,
however, involved is material and requires separate disclosure to understand the financial position
and performance of an enterprise. Accordingly, adjustment in the value of the inventory through
prior period item would not be appropriate.
b) As per NAS 2, Inventories, cost of inventories comprises all costs of purchase, costs of conversion
and other costs incurred in bringing the inventories to their present location and condition. NAS
23, Borrowing Costs includes inventories as qualifying assets and borrowing cost that are directly
attributable to the acquisition, construction or production of qualifying assets are included in the
cost of that asset. In the given case, Bank overdraft was taken for the purpose of financing current
assets not especially for the inventories. Therefore, the proposal of ABC Ltd. to include interest
on bank overdraft as an element of cost of inventories is not acceptable because it does not form
part of cost of production.
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c) As per NAS 10, Events After the Reporting Period, events after the reporting period are those
events, favorable and unfavorable, that occur between the end of the reporting period and the date
when the financial statements are authorized for issue. Two types of events can be identified:
 those that provide evidence of conditions that existed at the end of the reporting period
(adjusting events after the reporting period); and
 those that are indicative of conditions that arose after the reporting period (non-adjusting
events after the reporting period)
So, the event in the given case (fire after reporting period) is a non-adjusting event. An entity shall
not adjust the amounts recognized in its financial statements to reflect non-adjusting events after
the reporting period.
If events after the reporting date impacts going concern status of the entity, the entity is required to
prepare its financial statements on break-up value basis. This does not seem to be the case here.
If non-adjusting events after the reporting period are material, non-disclosure could influence the
economic decisions that users make on the basis of the financial statements. Accordingly, an entity
shall disclose the following for each material category of non-adjusting event after the reporting
period:
 the nature of the event; and

 an estimate of its financial effect, or a statement that such an estimate cannot be made.
So, presenting fixed assets at Rs 20 crores in the balance sheet with appropriate disclosure in the
Notes to Accounts seems to be appropriate.
d) Section 115 of the Company Act, 2063 lays down the functions and duties of auditor. As per
provisions of the law, it is no part of the auditor’s duty to send a copy of his report to members
(shareholders) of the company individually. The auditor’s duty concludes once he forwards his
report to the company. It is the responsibility of company to send the report to every member
(shareholders) of the company. In Re Allen Craig and Company (London) Ltd., 1934 it was held
that duty of the auditor after having signed the report to be annexed to a balance sheet is confirmed
only to forwarding his report to the secretary of the company. It will be for the secretary or the
director to convene a general meeting and send the balance sheet and report to the members (or
other person) entitled to receive it. Hence in the given case, the auditor cannot be held liable for the
failure to send the report to the shareholders.
2. Give your comments on the following cases: (45=20 marks)
a) You are appointed as manager of quality control section in one of the leading audit firms of Nepal.
The senior partner of the firm instructs you to draft objectives statement for quality control policies
and procedures.
b) The auditor of a company is unable to obtain audit evidence relating to business promotion
expenses of Rs. 1 lakh. The company has earned net profit of Rs. 1 Arab and has net asset base of
Rs. 10 Arab. The management explains that the expense is genuine although the said invoices are
misplaced. However, auditor requests the management either not to charge the said promotional
expenses to profit or loss statement or he will qualify his audit report. The auditor does not have
any other issue on the faithful presentation and preparation of the financial statements.
c) Mr. Small, auditor of Big Ltd., has his office and residence in the building owned by Big Ltd. Mr.
Small has been given 10% concession in rent by the company as compared to other tenants.
d) Mr. R Pandey and Mr. H Pahari are the two chartered accountants who just qualified their exams
and took membership from ICAN in Bhadra 2076. Mr. R Pandey, who without holding the
Certificate of Practice, signed a document in capacity of the member holding Certificate of Practice
and Mr. H Pahari, as being a member of ICAN, committed an act contrary to the provisions of
Nepal Chartered Accountants Act, 2053.
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Answer
a) As per Nepal Standards on Quality Control (NSQC) 1, it is necessary for the firms that perform
audits and review of historical financial information and other services to design appropriate quality
control system to ensure quality of services they provide. The relevance of quality control issue in
auditing services is equally important like in other services. If quality control could not be done in
auditing work, quality services could not be provided to client which may result in negative
consequences both for auditor and client including in overall economy. Hence, every auditor should
carry out the audit work based on formal quality control policy and procedures. The objective
statement of quality control policies and procedures would be:
i. Professional Requirements
Personnel in the firm should adhere to the principles of independence, integrity, objectivity,
confidentiality and professional behaviour. Particular procedures may be framed to achieve this
objective. For example, a firm may require all its personnel to make a written statement every
year as to whether they hold any shares or any other interest in the entity being audited by the
firm.
ii. Skills and Competence
The firm should be staffed with personnel who have attained the professional qualification and
maintain and enhance the knowledge and skill attained earlier. For example, a firm can achieve
this objective through proper recruitment procedures, periodic staff evaluation and a system of
training whereby latest information relating to current development in professional standards,
law, etc. is regularly communicated to audit staff.
iii. Assignment
Audit work should be assigned to such personnel who have the knowledge and experience
required in the circumstances.
iv. Delegation
There should be sufficient direction, supervision and review of work at all levels to provide
reasonable assurance that the work performed meets appropriate quality standards. For
example, a firm may establish guidelines relating to the form and content of working papers;
use of standardized forms, etc. similarly, the audit plans may identify the staffing requirements
and timing of various phases of audit to facilitate delegation of audit.
v. Consultation
Where ever necessary, persons having appropriate expertise, within or outside the firm, should
be consulted.
vi. Acceptance and Retention of Clients
Before accepting an audit, the firm should evaluate its independence and ability to serve the
prospective client properly. A similar review should be made, on-going basis, of association
with the existing clients.
vii. Monitoring
The continued adequacy and operational effectiveness of the quality control policies and
procedures should be developed and applied constantly.
b) As per NSA 705, Modification to the Opinion in the Independent Auditor's Report, the auditor shall
express a qualified opinion when:
i) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements,
individually or in the aggregate, are material, but not pervasive, to the financial statements; or
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ii) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the
opinion, but the auditor concludes that the possible effects on the financial statements of
undetected misstatements, if any, could be material but not pervasive.
Rs 1 lakh expenses for a company which earns net profit of Rs 1 Arab and having net assets base
of Rs 10 Arab seems to be immaterial/insignificant because omission or misstatement of expenses
by Rs 1 lakh in this case is unlikely to affect the decision of the users due to this
omission/misstatement. Since the auditor does not have any other issue on faithful preparation and
presentation of the financial statements, qualifying audit opinion for immaterial impact does not
seem to be appropriate. The auditor should however communicate the finding through management
letter with the recommendation to strengthen the system of proper maintenance and retention of
supporting evidence.
c) As per NSA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in
accordance with Nepal Standards on Auditing, in the case of an audit engagement which is of
public interest requires by the code of ethics that the auditor should be independent of the entity
subject to audit. The code describes independence as comprising both independence of mind and
in appearance. The auditor's independence from the entity safeguards the auditor's ability to form
an audit opinion without being affected by influences that might compromise the opinion.
Independence enhances the auditor’s ability to act with integrity, to be objective and to maintain
an attitude of professional skepticism.
In the instant case, Mr. Small has his office and residence in the building owned by Big Ltd. who
are subject to audit by Mr. Small. Giving 10% concession in rent may be due to some other reasons
other than holding auditor-ship of Big Ltd. It may be due to being very old tenant or due to occupy
of large space in same building or Mr. Small might have carried out major renovation and so on.
Thus, in the instant case, unless and until there is direct proof, giving 10% concession in rent does
not affect independence of the auditor in expressing his opinion on the audit of Big Ltd. However,
the auditor should always be alert on his/her independence and fundamental ethical principles and
make appropriate safeguard needed.
d) Section 41 of Nepal Chartered Accountants Act, 2053 has made different levels of punishment for
different levels of culpability. Here in case of R Pandey, If a person, who has not obtained a
Certificate of Practice is proved to have signed any document in capacity of the member holding
Certificate of Practice, shall be liable to punishment with a penalty up to two thousand rupees or
imprisonment for a period of up to three months or both.
In case of H Pahari, if a member, who commits any act contrary to the provisions of this Act or
Regulations framed under this Act other than the provisions of this section, shall be suspended for
a maximum period of five years and shall be liable of punishment with a maximum penalty of two
thousand rupees or imprisonment for a maximum period of three months or both.
So, R Pandey and H Pahari are to be punished accordingly.
3. Answer the following: (3 5=15 marks)
a) While planning the audit of S Ltd., you want to apply sampling techniques. What are the risk factors
you should keep in mind?
b) What are the elements that an auditor has to consider while evaluating the design of the entity’s
control environment?
c) Is it not necessary to sign audit engagement letter every year in case of recurring audits?
Answer
a) Risk Factors while applying Sampling Techniques: As per NSA 530, Audit Sampling, sampling
risk is the risk that the auditor’s conclusion based on a sample may be different from the conclusion
if the entire population were subjected to the same audit procedure. Sampling risk can lead to two
types of erroneous conclusions-
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 In the case of a test of controls, that controls are more effective than they actually are, or in the
case of tests of details, that a material misstatement does not exists when in fact it does. The
auditor is primarily concerned with this type of erroneous conclusion because it affects audit
effectiveness and is more likely to lead to an inappropriate audit opinion.
 In the case of test of controls, the controls are less effective than they actually are, or in the
case of tests of details, that a material misstatement exists when in fact it does not. This type of
erroneous conclusion affects audit efficiency as it would usually lead to additional work to
establish that initial conclusions were incorrect.
The auditor should also consider about appropriate design, size and selection of items for testing.
b) As per NSA 315, Identifying and Assessing the Risk of Material Misstatement through
Understanding the Entity and Its Environment, the auditor should obtain an understanding of the
control environment. The control environment includes the governance and management functions
and the attitudes, awareness, and actions of those charged with governance and management
concerning the entity’s internal control and its importance in the entity. The control environment
sets the tone of an organization, influencing the control consciousness of its people. It is the
foundation for effective internal control, providing discipline and structure.
The primary responsibility for the prevention and detection of fraud and error rests with both those
charged with governance and the management of an entity. In evaluating the design of the control
environment and determining whether it has been implemented, the auditor understands how
management, with the oversight of those charged with governance, has created and maintained a
culture of honesty and ethical behavior, and established appropriate controls to prevent and detect
fraud and error within the entity.
In evaluating the design of the entity’s control environment, the auditor considers the following
elements and how they have been incorporated into the entity’s processes:
i. Communication and enforcement of integrity and ethical values – essential elements which
influence the effectiveness of the design, administration and monitoring of controls.
ii. Commitment to competence – management’s consideration of the competence levels for
particular jobs and how those levels translate into requisite skills and knowledge.
iii. Participation by those charged with governance – independence from management, their
experience and stature, the extent of their involvement and scrutiny of activities, the
information they receive, the degree to which difficult questions are raised and pursued with
management and their interaction with internal and external auditors.
iv. Management’s philosophy and operating style – management’s approach to taking and
managing business risks, and management’s attitudes and actions toward financial reporting,
information processing and accounting functions and personnel.
v. Organizational structure – the framework within which an entity’s activities for achieving its
objectives are planned, executed, controlled and reviewed.
vi. Assignment of authority and responsibility – how authority and responsibility for operating
activities are assigned and how reporting relationships and authorization hierarchies are
established.
vii. Human resource policies and practices – recruitment, orientation, training, evaluating,
counselling, promoting, compensating and remedial actions.
c) Audit Engagement Letter in Recurring Audit: As per NSA 210, Agreeing the Terms of Audit
Engagement, 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.
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However, the following factors may make it appropriate to revise the terms of the audit engagement
or to remind the entity of existing terms:
i. Any indication that the entity misunderstands the objective and scope of the audit.
ii. Any revised or special terms of the audit engagement.
iii. A recent change of senior management.
iv. A significant change in ownership.
v. A significant change in nature or size of the entity’s business.
vi. A change in legal or regulatory requirements.
vii. A change in the financial reporting framework adopted in the preparation of the financial
statements.
viii. A change in other reporting requirements.
4. Answer/Comment on the following: (3  5=15 marks)
a) Mr. Dipen, a chartered accountant prepared a project report for one of his clients to obtain bank
finance (long-term) of Rs. 90 lakhs from a commercial bank. Consequent to the sanction of the loan
by the bank, Mr. Dipen charged 1% fee on the figures of loan sanctioned.
b) What are the threats that professional accountants face in performing their engagement? Further,
define Advocacy and Familiarity threats.
c) What are the various penalties prescribed under section 14 of Nepal Chartered Accountants Act,
2053, which may be imposed on recommendation of Disciplinary Committee, by Council against a
member?
Answer
a) As per the ICAN's Handbook of the Code of Ethics for Professional Accountants, 2018,
Professional fees should be a fair reflection of the value of the professional services performed for
the client, taking into account:
i. The skill and knowledge required for the type of professional services involved.
ii. The level of training and experience of the persons necessarily engaged in performing the
professional services.
iii. The time necessarily occupied by each person engaged in performing the professional services.
iv. The degree of responsibility that performing those services entails.
Professional fees should normally be computed on the basis of appropriate rates per hour or per
day for the time of each person engaged in performing professional services. These rates should be
based on the fundamental premise that the organization and conduct of the professional accountant
in public practice and the services provided to clients are well planned, controlled and managed. It
is for each professional accountant in public practice to determine the appropriate rates.
A professional accountant in public practice should not make a representation that specific
professional services in current or future periods will be performed for either a stated fee, estimated
fee, or fee range if it is likely at the time of the representation that such fees will be substantially
increased and the prospective client is not advised of that likelihood.
When performing professional services for a client it may be necessary or expedient to charge a
pre-arranged fee, in which event the professional accountant in public practice should estimate a
fee taking into account the referred matters.
Section 34(10) of Nepal Chartered Accountants Act, 2053 states that members holding Certificate
of Practice shall not base their remuneration as a percentage on the profit or on any other uncertain
results.
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Entering into a contingent fee arrangement relating to an assurance engagement is an example of
self-interest threat. In the present case, fee is contingent upon the approval or sanction of loan by
the bank. So, this is against the legal provision and also the situation of self-interest threat to the
auditor and hence it is advisable for the auditor not to accept the engagement under such fee
arrangement.
b) Section 100 (12) of ICAN's Handbook of the Code of Ethics for Professional Accountants, 2018
defines that threats may be created by a broad range of relationships and circumstances. When a
relationship or circumstance creates a threat, such a threat could compromise, or could be perceived
to compromise, a professional accountant’s compliance with the fundamental principles. A
circumstance or relationship may create more than one threat, and a threat may affect compliance
with more than one fundamental principle. Such threats include self-interest threat, self-review
threat, advocacy threat, familiarity threat and intimidation threat.
Advocacy threat is the threat that a professional accountant will promote a client’s or employer’s
position to the point that the professional accountant’s objectivity is compromised.
Familiarity threat is the threat that due to a long or close relationship with a client or employer, a
professional accountant will be too sympathetic to their interests or too accepting of their work.
c) According to section 14 Nepal Chartered Accountants Act, 2053, the Disciplinary committee shall
be formed to inquire into a complaint and recommend the Council for necessary action, where any
one lodges a complaint in the Institute that any member has done any act or action contrary to the
Nepal Chartered Accountants Act or the Rules or code of ethics framed under this Act or where the
Institute itself receives such information.
Further, as per section 14(5) of Nepal Chartered Accountants Act, 2053, the disciplinary committee
shall make recommendation, along with its opinion and finding, to the Council for taking necessary
action against a member if found guilty from its investigation and in view of such recommendation
the council may, impose any of the following penalties on the concerned member, according to the
gravity of the offence:
a) Reprimanding;
b) Removing from the membership for a period not exceeding 5 years;
c) Prohibiting from carrying on the accounting profession for any specific period;
d) Canceling the professional certificate or membership.
5. Answer/Comment on the following: (2  5=10 marks)
a) Describe the process for appointing auditor of a company by the Registrar of Company.
b) Discuss about the provision relating to removal of appointed auditor under Company Act, 2063.
Answer
a) According to section 113 of the Company Act, 2063 on request of the Board of Directors, the Office
of the Company Registrar may appoint auditor in following cases:
i. If the auditor is not appointed in Annual General Meeting of a company, or Annual General
Meeting could not be held, or
ii. The auditor appointed under the Company Act cannot continue due to whatever reason,
In view of above, if any of the situations prevails, Board of Directors may request to appoint an
auditor to the Office of the Company Registrar. The Office of the Company Registrar may appoint
an auditor on receiving such request.
b) As per section 119 of company Act 2063, no auditor appointed pursuant to provision in the Act
shall be removed pending the completion of audit of accounts of any financial year for which he/she
was appointed as the auditor.
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However, if any auditor breaches the code of conduct of auditors or does any act against the interest
of the company which has appointed him as the auditor or commits any act contrary to the
prevailing law, such auditor may be removed through the same process whereby he/she was
appointed as auditor, by giving prior information to the Institute of Chartered Accountants of Nepal,
and with the approval of the regulatory authority, if any authorized by the prevailing law for the
regulation of business of the company concerned , and failing such authority, with the approval of
the Office.
While removing an auditor pursuant to Sub-section (2), the auditor shall be provided with a
reasonable opportunity to defend him/herself.
6. Write short notes on the following: (42.5=10 marks)
a) Key Audit Matters
b) Key Management Personnel
c) Audit Strategy
d) Cost Audit
Answer
a) Those matters that, in auditor's professional judgment, are of most significant in the audit of
financial statements of the current period are referred as key audit matters. Such key audit matters
are selected from matters communicated with those charged with governance. The auditor is
required to communicate such matters to those charged with governance and include in audit report
in the Key Audit Matters Section.
The purpose of communicating key audit matters is to enhance the communicative value of
auditor's report by providing greater transparency about the audit that was performed.
Communicating key audit matters provides additional information to intended users of the financial
statements to assist them in understanding those matters which are of most significance in the audit
of the financial statements. Communicating key audit matters is not a substitute for disclosure in
the financial statements or the substitute for the auditor expressing a modified opinion. In
determining key audit matters, auditor may take into account the areas of higher assessed risks and
areas requiring significant management judgment.
b) Key management personnel are those persons who have the authority and responsibility for
planning, directing and controlling the activities of the reporting entity.
It may be noted here that non-executive directors of a company will not be considered as key
management personnel under NAS 24 by virtue of merely their being directors, unless they have
the authority and responsibility for planning, directing and controlling the activities of the reporting
entity.
Further, the requirements of NAS 24 should not be applied in respect of a non-executive director
even if he participates in the financial and/or operating policy decision of the enterprise unless he
falls in any of the categories discussed in other NASs.
c) Audit strategy is concerned with designing optimized audit approaches that seek to achieve the
necessary audit assurances at the lowest cost within the constraints of the information available.
Audit procedures should be relevant to the important assertions, and as cost effective as possible to
perform. Audit strategy generally involves the following steps:
i. Obtaining knowledge of business.
ii. Performing analytical procedures at initial stages.
iii. Evaluating inherent risks.
iv. Evaluating internal control system for strategy purpose.
v. Formulating the strategy.
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d) Cost Audit represents the verification of cost accounts and check on the adherence to cost
accounting plan. It ascertains the accuracy of cost accounting records to ensure that they are in
conformity with Cost Accounting principles, plans, procedures and objective. Cost audit provides
useful information to the management regarding regulating production, economical method of
operation, reducing cost of operation and reformulating Cost accounting plans. It aims to identify
the undue wastage or losses and ensure that costing system determines the correct and realistic cost
of production.
Cost Audit comprises following;
 Verification of the cost accounting records such as the accuracy of the cost accounts, cost
reports, cost statements, cost data and costing technique and
 Examination of these records to ensure that they adhere to the cost accounting principles,
plans, procedures and objective.
7. Distinguish between: (2 5=10 marks)
a) Verification and Valuation
b) Internal Audit and External Audit
Answer
a) Distinction between verification and valuation:
1. Meaning: verification establishes existence, ownership and acquisition of assets and liability
whereas valuation certifies correctness of the value of assets and liabilities.
2. Time: Verification is done at the end of the year whereas valuation is done during the year.
3. Personnel: Verification is done by auditor whereas valuation is done by the proprietor himself
or by the professional valuators.
4. Evidence: The title deeds, receipts of payments constitute documentary evidence for
verification whereas certificate given by the proprietor or valuator is the documentary evidence
for valuation.
5. Basis: Verification can rely on valuation to some extent but valuation does not rely on
verification.
6. Expertise: Valuation requires technical expertise beyond accounting.
b)
Bases Internal Audit External Audit
Appointing Management of the entity Owner of the entity (shareholder)
authority
Approach To ensure adherence to To collect sufficient appropriate audit
management, safeguard of assets, evidence as to express, “true and fair”
completeness and accuracy of view on financial statement
accounting records
Independence Less independent Complete independent
Reporting To management or to Audit To shareholder, or appointing authority
responsibility committee
Conducted by Employee or outsourced consultant Member holding Certificate of practice
Coverage All categories of risk, their Financial reports, financial reporting
management, including reporting on risks.
them
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1. As an auditor, give your opinion with explanations on the following cases: (4 5=20 marks)
a) Upto previous year 2076, Sharma & Co. were the auditors of Fishtail Bank Ltd.
Principal auditor of Sharma & Co., Mr. Kumar Sharma, has retired from the practice in
the fiscal year then ended. The Bank is looking to appoint Independent Director and
applications were sought for this purpose. You were asked if Mr. Kumar Sharma could be
potential candidate.
b) During the previous year ABC Limited has followed the straight line method of
depreciation. During the current year it has been changed to written down value
method.
c) You are the financial consultant of Corona Distillery Ltd. The accountant is in dilemma
for booking the revenue from interest, royalty and dividend. Suggest him in this regard.
d) Miss Deepa is a partner at BD & Associates which is the external auditor of ABC Ltd.,
public company. During the audit, she identified a regulatory non-compliance. She is
supposed to report it to the audit committee. Suggest her in the light of NSA 250, what
should be taken into consideration for reporting the same to the audit committee.
Answer:
a) Section 89(2)(d) of Companies Act 2063 states that the person who is an officer, auditor or
employee of the concerned company and a period of three years has not lapsed after his/her
retirement from any such office shall not be eligible to be appointed to the office of
independent director. Hence, Mr. Kumar Sharma cannot be a potential candidate for the post
of Independent Director.
b) NAS 8, Accounting Policies, Changes in Accounting Estimates & Errors, describes about
the criteria for selecting and changing accounting policies; treatment and disclosures
together with changes in accounting estimates and corrections of errors.
Para 32(d) provides that due to uncertainties inherent in business, management shall exercise
judgments to estimate amount involved with particular items of Financial Statements.
Accordingly, the useful life of, or expected pattern of consumption of future economic
benefits embodied in depreciable assets requires management estimation. This estimation
may not be measured with precision due to uncertainties involved therein. The estimation
may change in future as new information emerge. So, the change from SLM to WDV is a
changes in accounting estimate.
Therefore, the auditor must ensure that the change in method of depreciation on plant and
machinery from SLM to WDV basis from the current year is made in accordance therewith.
When such a change in the method of depreciation is made, depreciation is recalculated in
accordance with the new method and any changes should be recognized prospectively. So, it
should be ensured that the deficiency (since change is from SLM to WDV) arising to be
adjusted in the year of change by way of a charge to the Statement of Profit and Loss. The
auditor may also ascertain that the change in the method and the effect thereof on the profits
of the entity is quantified and disclosed. If it is not done by the management, the auditor has
to bring it to the notice of the shareholders through qualification in the audit report.
c) NAS 18, Revenue states that Revenue arising from the use by others of entity assets yielding
interest, royalties and dividends shall be recognized on the following bases:
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(a) interest shall be recognized using the effective interest method;
(b) royalties shall be recognized on an accrual basis in accordance with the substance of the
relevant agreement; and
(c) dividends shall be recognized when the shareholder’s right to receive payment is
established.
Aforesaid revenue shall be booked when (a) it is probable that the economic benefits
associated with the transaction will flow to the entity; and (b) the amount of the revenue can
be measured reliably.
Based on the aforesaid provision of NAS 18, I as a financial consultant, will guide the
accountant of Corona Distillery Ltd.
d) Miss Deepa should follow the procedures prescribed by NSA 250, Consideration of Laws
and Regulations in an Audit of Financial Statements.
If she becomes aware of information concerning an instance of non-compliance or suspected
non-compliance with laws and regulations, she shall obtain:
a. An understanding of the nature of the act and the circumstances in which it has occurred;
and
b. Further, information to evaluate the possible effect on the financial statements.
Following points should be considered for reporting identified non-compliance to audit
committee:-
 Miss Deepa should evaluate the implications of non-compliance in relation to other
aspects of the audit, including the auditor’s risk assessment and the reliability of written
representations, and take appropriate action.
 Unless all the members of audit committee are aware of such non-compliance, she should
communicate non-compliance with laws and regulation that come to his attention during
the course of audit.
2. Give your comments on the following cases: (45=20 marks)

a) During the auditing assignment of financial statements of Axon Nepal Pvt. Ltd., you came
to notice that the supplementary information that is not required by the applicable
financial reporting framework is presented with the financial statements to comply with
the Axon Global Group of Companies (Group Company) disclosure guidelines.
b) During the course of audit Mr. A, auditor of Hydro Company observed a serious non-
compliance (substantiated by a valid evidence) of Mr. XYZ; one of the staff of the
organization. Mr. XYZ requested not to disclose or communicate it to any other person
even in audit observation.
c) "When determining whether data is reliable for the purpose of designing substantive
analytical procedures, the reliability of data is influenced by its source and nature and is
dependent on the circumstances under which it is obtained".
d) Mr. Acharya, a practicing chartered accountant was appointed as auditor of Riverside
Ltd. He mentioned his remuneration as Rs. 5 lakhs in engagement letter whereas the
audit fee of previous year was Rs. 5.75 lakhs.
Answer:
a) As per Para 54 of NSA 700: If the supplementary information is not required by the
applicable financial reporting framework and which is not considered an integral part of
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the audited financial statements but presented with the audited financial statements, the
auditor shall evaluate whether such supplementary information is presented in a way that
sufficiently and clearly differentiates it from the audited financial statements. If this is not
the case, the auditor shall ask management to change how the unaudited supplementary
information is presented. If management refuses to do so, the auditor shall identify the
unaudited supplementary information and explain in auditor's report that such
supplementary information has not been audited. So, the auditor of Axon Nepal Pvt. Ltd.
is required to perform these procedures in his audit.
b) As per NSA 250, Consideration of Laws and Regulation in an Audit of Financial
Statements, if any non-compliance is reported then it should be communicated to
appropriate level of authority that may be management or those charged with governance,
to the user of the audit report on the financial statement or to the regulatory and
enforcement authorities.
 The auditor should as soon as practicable, either communicate with those charged
with governance or obtain audit evidence that they are appropriately informed
regarding non-compliance that comes to the auditor's attention.
 If in the auditor’s judgment the non-compliance is believed to be intentional and
material, the auditor should communicate the finding without delay.
 If auditor suspects that the members of senior management including the board of
directors are involved in non-compliance, the auditor should report to the higher level
of authority at the entity if that exits. If no higher authority exits or auditors believe
that report may not be acted upon or is unsure to whom to report, the auditor should
consider legal action.
In the given case when Mr A has found serious non-compliance with the evidence, he
should communicate it to appropriate authority of the company immediately.
c) This statement is correct in line with NSA 520, Analytical Procedures. It has been
justified with examples as follows:
(i) Source of the information available. For example, information may be more reliable
when it is obtained from independent sources outside the entity;
(ii) Comparability of the information available. For example, broad industry data may
need to be supplemented to be comparable to that of an entity that produces and
sells specialized products;
(iii) Nature and relevance of the information available. For example, whether budgets
have been established as results to be expected rather than as goals to be achieved;
and
(iv) Controls over the preparation of the information that are designed to ensure its
completeness, accuracy and validity. For example, controls over the preparation,
review and maintenance of budgets.
d) As per the Handbook of the Code of Ethics, 2018 Section 330 and 410, the nature and
level of fees quoted might impact a professional accountant’s ability to perform
professional services in accordance with professional standards. A professional
accountant might quote whatever fee is considered appropriate. Quoting a fee, which is
lower than another auditor, is not itself unethical. However, the level of fees quoted
creates a self-interest threat to compliance with the principle of professional competence
and due care if the fee quoted is so low that it might be difficult to perform the
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engagement in accordance with applicable technical and professional standards. Factors
that are relevant in evaluating the level of such a threat include:
 Whether the client is aware of the terms of the engagement and, in particular, the
basis on which fees are charged and which professional services the quoted fee
covers.
 Whether the level of the fee is set by an independent third party such as a regulatory
body.
Examples of actions that might be safeguards to address such a self-interest threat
include:
 Adjusting the level of fees or the scope of the engagement
 Having an appropriate reviewer review the work performed.
Thus, in the given case, if the remuneration fixed by the auditor is based on the scope of
audit as mentioned in engagement letter and accordingly the auditor can comply with the
principle of professional competence and get audit reviewed from appropriate reviewer,
the quotation of fee is not unethical.
3. Answer the following: (35=15 marks)
a) What is fraud as per NSA 240? Give few techniques of fraud committed by management
overriding controls.
b) Elaborate the circumstances/events when the reconfirming the written representation
would be appropriate.
c) "The nature and timing of the audit procedures to be used may be affected by the fact that
some of the accounting data and other information may be available only in electronic
form or only at certain points or periods in time". Elaborate it.
Answer:
a) As per NSA 240, fraud refers to 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.
Examples of fraud committed by management overriding control
 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
 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.
b) NSA 580 deals with the auditor’s responsibilities to obtain written representation from
the management of the entity. The written representations in NSA 580 require the
acknowledgement and understanding of management of its responsibilities of preparation
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and presentation of financial statements and exercise appropriate level of control over this
process.
The auditor may also ask management to reconfirm its acknowledgement and
understanding of those responsibilities in written representations. This may be
particularly appropriate when:
• Those who signed the terms of the audit engagement on behalf of the entity no longer
have the relevant responsibilities;
• The terms of the audit engagement were prepared in a previous year;
• There is any indication that management misunderstands those responsibilities; or
 Changes in circumstances make it appropriate to do so.
c) NSA 500, Audit Evidence states the audit procedures for obtaining audit evidence. The
nature and timing of the audit procedures to be used may be affected by the fact that
some of the accounting data and other information may be available only in electronic
form or only at certain points or periods in time.
For example, source documents, such as purchase orders and invoices, may exist only in
electronic form when an entity uses electronic commerce, or may be discarded after
scanning when an entity uses image processing systems to facilitate storage and
reference.
Certain electronic information may not be retrievable after a specified period of time, for
example, if files are changed and if backup files do not exist. Accordingly, the auditor
may find it necessary as a result of an entity’s data retention policies to request retention
of some information for the auditor’s review or to perform audit procedures at a time
when the information is available.
4. Answer/Comment on the following: (3 5=15 marks)
a) During the previous year the auditor of Paint Company was Mr. A. During the year Mr.
B was appointed as auditor and Mr. B received an appointment letter from the company.
What are the responsibilities of Professional Accountant when they receive the
information about the changes in professional appointment?
b) The brother of Principal auditor of Adhikari & Co. has taken a vehicle loan of NPR 5
Million from ABC Bank Limited. Adhikari & Co. is the auditor of such Bank.
c) CA. Surili Kant, is the proprietor of Kant Associates, Chartered Accountants since 2070.
In 2077 she wants to join ANLA Associates, Chartered Accountants in the capacity of
partner together with existing three partners.
Answer:
a) As per Section 320.4 of Code of Ethics, 2018 in the event of any information received
about the changes in professional appointment, the professional accountant:
 shall think seriously whether there is any reason that might indicate not to accept
engagement. There could be reasons of self-interest threat and also accepting the
engagement without knowing all relevant facts might create non-compliance of
fundamental principles relating to professional competence and due care. Therefore, it
becomes the responsibility of the professional Accountant, before communicating or
responding to the client’s request, to verify seriously all relevant facts that caused to
changes in the professional engagements;
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 shall be allowed, as explicitly mentioned in the tender or mode of requesting
documents of the proposed client, to contact the predecessor accountant to get
information about the reason responsible for such change in the profession
engagement. Such contact gives the professional accountant the opportunity to
enquire whether there are any reasons why the engagement should not be accepted;
 shall, in the event if asked to undertake work that is complementary or additional to
work of an existing predecessor accountant, gather all relevant information and find
out whether any reason exists which might create self -interest threat to compliance
with the principle of professional competence and due care might be created as a
result of incomplete information.
 shall not undertake any step to respond to the client’s offer through any means
without verifying reasons for changes in professional engagements or complete
information of the activities of the client for example whether the client is indulging
in illegal activities such as tax evasion or manipulation, money laundering etc.
b) Code of Ethics, 2018 Section 900 requires auditors to be an independent. There are two
interlinked perspectives of independence of auditors, one, independence of mind; and
two, independence in appearance.
(i) Independence of mind – the state of mind that permits the provision of an opinion
without being affected by influences that compromise professional judgement,
allowing an individual to act with integrity, and exercise objectivity and professional
skepticism; and
(ii) Independence in appearance – the avoidance of facts and circumstances that are so
significant that a reasonable and informed third party, having knowledge of all
relevant information, including any safeguards applied, would reasonably conclude a
firm's, or a member of the assurance team's integrity, objectivity or professional
skepticism had been compromised of.
A loan from an assurance client that is a bank or a similar institution, to a member of the
assurance team or their immediate family would not create a threat to independence
provided the loan, or guarantee, is made under normal lending procedures, terms and
requirements. Examples of such loans include home mortgages, bank overdrafts, car
loans and credit card balances.
c) As per Rule 62 of Nepal Chartered Accountants Rules, 2061 a member of ICAN cannot
open a more than one firm or be partner of more than one firm at one time. If any
member having proprietorship firm wants to be partner of a firm, the member should
suspend the proprietorship firm. The proprietorship firm can be renewed. However, one
cannot do any work in the capacity of COP holder of ICAN till the time the member is in
partnership at other firm.
In the given case, CA. Surili Kant has a proprietorship firm and she want to join a
partnership ANLA Associates, Chartered Accountant. CA. Surili Kant has to suspend the
Kant Associates, Chartered Accountants if she want to join the partnership firm. She
cannot be proprietor of Kant Associates and partner of ANLA Associates at the same
time.
5. Answer/Comment on the following: (2 5=10 marks)
a) Explain the procedures for appointment of auditor of corporate bodies wholly owned by
Government of Nepal.
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b) The auditor A of CA & Associates, a firm of Chartered Accountants is conducting audit
of X Ltd. The auditor requests management to provide Bank certificate in support of fixed
deposits whereas management provides only written representation on the matter.
Answer:
a) Section 10 of Audit Act 2075 deals with the provision for appointing auditor of corporate
bodies wholly owned by Government of Nepal. The related provisions are:
(i) Notwithstanding anything contained in the existing laws, the audit of the corporate
bodies wholly owned by Government of Nepal shall be audited by the Auditor
General pursuant to this Act.
(ii) If the Auditor General is constrained by time and resources to audit the corporate
bodies wholly owned by Government of Nepal, he/she may appoint the auditors
licensed under the prevailing laws as an assistant. While appointing auditor as such,
he/she shall give priority to Nepali citizens.
(iii) The auditor so appointed shall act under the direction, supervision and control of
the Auditor General.
(iv) The powers, functions, duties and responsibilities of the auditors so appointed and
the procedures to be followed by them in course of audit and provisions relating to
their report shall be as prescribed by the Auditor General.
(v) The remuneration to be paid by the concerned organization to the auditors so
appointed shall be fixed by the Auditor General keeping in view the volume of
financial transactions, status of accounts, number of branches and sub-branches,
work load and work progress of the concerned organization.
b) Although written representations provide necessary audit evidence, they do not provide
sufficient appropriate audit evidence on their own about any of the matters with which
they deal. Furthermore, the fact that management has provided reliable written
representations does not affect the nature or extent of other audit evidence that the
auditor obtains about the fulfilment of management’s responsibilities, or about specific
assertions.
Applying the above to the given case, the auditor would further request the
management to provide him with the Bank certificate in support of fixed deposits held
by the company. If such evidence is significant to the audit, the auditor should find
other alternative procedures and consider the fact while forming an audit opinion, in the
event management does not provide bank certificates.
6. Write short notes on the following: (4 2.5=10 marks)
a) Performance Audit
b) Those Charged with Governance
c) EDP Audit
d) Environmental Audit
Answer:
a) Performance Audit
A performance audit is an objective and systematic examination of evidence for the
purpose of providing an independent assessment of the performance of a government
organization, program, activity or function in order to provide information to improve
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public accountability and facilitate decision making by the parties with responsibility to
oversee or initiate corrective action.
Elements of Performance Audit:
 Economy,
 Efficiency, and
 Effectiveness
b) Those Charged with Governance
Those charged with governance mean the person(s) or organization(s) with responsibility
for overseeing the strategic direction of the entity and obligations related to the
accountability of the entity. This includes overseeing the financial reporting process. It
describes the role of persons entrusted with the supervision, control and direction of an
entity. Those charged with governance ordinarily are accountable for ensuring that the
entity achieves its objectives, financial reporting, and reporting to interested parties.
Those charged with governance include management only when it performs such
functions. In some cases, those charged with governance are responsible for approving
the entity’s financial statements (in other cases management has this responsibility). For
entities with a board of directors, this term encompasses the term board of directors or
audit committee used elsewhere in generally accepted auditing standards.
c) EDP Audit
The prime objective of EDP audit is to determine whether computer systems safeguard
assets, maintain data integrity, achieve organizational goals effectively and consume
resources efficiently. A proper system of internal control is necessary to ensure that the
objectives are met. It may be remembered that the overall objectives and scope of an
audit does not change in an EDP environment. However, the use of a computer changes
the processing and storage of financial information and may affect the organization and
procedure employed by the entity to achieve adequate internal control. Similarly; EDP
environment may affect auditor's procedures to be applied in conduct of audit.
d) Environmental Audit
It is a general term that can reflect various types of evaluations intended to identify
environmental compliance and management system implementation gaps, along with
related corrective actions. A management tool comprising a systematic, documented
periodic and objective evaluation of how well environmental issues have been organized
and managed by the entity to safeguard the environment by:
a) Facilitating management control of environmental practices; and
b) Assessing compliance with related national and international laws, conventions and
the company policies, which would include meeting regulatory requirements.
7. Distinguish between: (2 5=10 marks)
a) Reasonable Assurance Engagements and Limited Assurance Engagements
b) Audit Plan and Audit Programme
Answer:
a) Distinction between Reasonable Assurance Engagements & Limited Assurance
Engagements:
Reasonable Assurance Engagements:
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Objectives: A reduction in assurance engagement risk to an acceptably low level in the
circumstances of the engagement, as the basis for a positive form of expression of the
practitioner’s conclusion
Evidence-gathering procedures: Sufficient appropriate evidence is obtained as part of a
systematic engagement process that includes: Obtaining an understanding of the
engagement circumstances; Assessing risks; Responding to assessed risks; Performing
further procedures using a combination of inspection, observation, confirmation,
recalculation, re-performance, analytical procedures and inquiry. Such further procedures
involve substantive procedures, including, where applicable, obtaining corroborating
information, and depending on the nature of the subject matter, tests of the operating
effectiveness of controls; and evaluating the evidence obtained.
The assurance report: Description of the engagement circumstances, and a positive
form of expression of the conclusion.
Limited Assurance Engagements:
Objectives: A reduction in assurance engagement risk to a level that is acceptable in the
circumstances of the engagement but where that risk is greater than for a reasonable
assurance engagement, as the basis for a negative form of expression of the practitioner’s
conclusion.
Evidence-gathering procedures: Sufficient appropriate evidence is obtained as part of a
systematic engagement process that includes obtaining an understanding of the subject
matter and other engagement circumstances, but in which procedures are deliberately
limited relative to a reasonable assurance engagement.
The assurance report: Description of the engagement circumstances, and a negative
form of expression of the conclusion.
b) The distinction between Audit Plan and Audit Program are outlined as follows:
Audit plan is described as developing a general strategy and a detailed approach for the
expected nature, timing and extent of the audit. The auditor plans to perform the audit in
efficient and timely manner whereas audit program is the step and guidance and works as
a tool for performing or implementing audit at the execution level. The distinctions of
those two are:
 Audit plan is prepared before preparing audit program.
 Audit plan is broader in scope than audit program.
 Audit plan assists acquiring knowledge of client's business and concentrating on risk
areas which will help for preparing effective audit program.
 Audit plan is generally prepared by senior auditors and program may be prepared by
juniors based on plan and duly approved by seniors.
 Audit plan focuses on broader area whereas programme breaks them into small areas
or in form of audit questions, checklists or time frames etc.
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Suggested Answer Paper Group I

1. As an auditor, give your opinion with explanations on the following cases: (4×5=20 marks)
a) Ax Ltd. sold the flats to Ke Ltd. for Rs. 30 lakhs on 30/10/2075 and gave possession of
the property to Ke Ltd. However, Malpot documentation and legal formalities are
pending. Due to this, the company has not recorded the sale and has shown the amount
received as an advance. The book value of the building is Rs. 25 lakhs as on Ashadh
end 2076.
b) Agri Nepal Pvt. Ltd. has a business of agricultural farm. The Government of Nepal has
provided grant of Rs. 10 lakhs against the bank guarantee with a condition that the
company has to export its product worth of Rs. 50 lakhs per year in next two fiscal
year. Guide the accountant of the company for the accounting of the grant.
c) TCIN Pvt. Ltd. has been fighting a legal case since last three years. The legal team of
the company has assured that company will win the case. During the year some new
facts have developed and these facts are not in favor of the company. If the company
loses the case it has to pay Rs. 25 lakhs to other party. The company has approached
to you for dealing with the situation.
d) You are the auditor of Nepal Fashion Pvt. Ltd. (the company) for the FY 2075/076.
Total number of shareholder of the company since financial year 2074/075 are 115
which includes 11 employees.
Answer:
a) Principles of prudence, substance over form and materiality should be looked into, to
ensure true and fair consideration in a transaction. In the given case, the economic
reality and substance of the transaction is that the rights and beneficial interest in the
property has been transferred although legal title has not been transferred. Hence, Ax
Ltd. should record the sale and recognize the profit in its financial statements for the
year ended Ashadh 2076; value of building should be removed from the balance sheet.
Therefore, the treatment given by the company is not correct.
b) As per NAS 20, Accounting for Government Grants and Disclosure of Government
Assistance, government grants shall not be recognized until there is reasonable
assurance that:
• The entity will comply with the condition attaching to them and
• The grants shall be received.
Receipt of grant does not itself provide conclusive evidence that the conditions
attaching to the grant have been or will be fulfilled.
In the given case, the Government of Nepal has provided grant of Rs. 10 lakhs with the
condition that the company need to export its produce worth of Rs. 50 lakhs in next two
years. The grant received shall only be recognized as income if the company can export
Rs. 50 lakh in next two years. In this case, the government grant shall be recognised in
profit and loss on systematic basis over the periods in which the entity recognises as
expenses the related costs for which the grants are intended. So the company shall book
Rs. 5 lakhs as income in first year if it has exported Rs. 50 lakhs. If it has reasonable
© The Institute of Chartered Accountants of Nepal 21
583
assurance that it will be able to export Rs. 50 lakhs in second year it can book income
of next Rs. 5 lakhs in second year.
c) As per NAS 37, Provisions, Contingent Liabilities and Contingent Assets, a provision
shall be recognized when:
• An entity has a present obligation as a result of past obligation;
• It is probable that outflow of resources embodying economic benefits will be
required to settle the obligation and
• A reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision shall be recognized.
In the given case, the company was fighting a legal case since last three years. During
the year, new facts were developed against the company. Since the new facts are not in
favour of the company, it has to make provision of Rs. 25 lakh in profit and loss account
because it has met all the condition of recognition of provision.
d) Pursuant to Section 9 of the Companies Act (with amendment 2074) a private company
cannot have more than One Hundred and One (101) shareholders. A private company
can now have a maximum of 101 shareholders. It is tradition to define the companies
as public companies or private companies in terms of the minimum or maximum
number of promoters or shareholders. Though the Companies Act and the Amendment
still retain this conventional concept, the Amendment has provided flexibility to the
private companies in terms of the maximum number of the shareholders. The threshold
of maximum number of the shareholders does not apply in case of the employee
shareholders.
In the light of foresaid changes of Companies Act, 2063 (amended 2074). The
maximum shareholders to be maintained for FY 2074/075 & 2075/076 is 101
(excluding employees shareholders). The shareholders of the company excluding
employees shareholders for FY 2074/075 and 2075/076 are 104. Accordingly the
company has breached the provision of amended Company's Act 2063. As the auditor,
I would like to suggest the company to regularize it without any further delay.
2. Give your comments on the following cases: (4× 5=20 marks)
a) Inland Expeditions Ltd. is a travel company engaged in the trekking of tourists. Dara
and Associates has been appointed as the auditors to carry out its audit. Auditor thinks
that planning an audit would involve establishing the overall audit strategy for the
engagement and developing an audit plan. Also, adequate planning benefits the audit
of financial statements in several ways.
b) Mr. HKA, Chartered Accountants has used the expert’s work on the audit of Biotech
Company Ltd. In the audit report he wants to use the reference of the expert's work.
c) The statutory auditor of Nara Pvt. Ltd. was not able to get the confirmation about the
existence and value of certain machineries. However, the management gave him a
certificate proving the existence and value of the machinery as appeared in the books
of account. The auditor accepted it without carrying out any further procedure and
signed the audit report.
d) Mrs. Y, a statutory auditor of MNP Ltd., wants to verify cash on hand on 31st Ashadh,
2076. The management informs auditor that it is not possible to co-operate, as cashier
has been hospitalized.
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Answer:
a) Planning an audit involves establishing the overall audit strategy for the engagement
and developing an audit plan. Adequate planning benefits the audit of financial
statements in several ways, including the following:
a. Helping the auditor to devote appropriate attention to important areas of the audit.
b. Helping the auditor identify and resolve potential problems on a timely basis.
c. Helping the auditor properly organize and manage the audit engagement so that it
is performed in an effective and efficient manner.
d. Assisting in the selection of engagement team members with appropriate levels of
capabilities and competence to respond to anticipated risks, and the proper
assignment of work to them.
e. Facilitating the direction and supervision of engagement team members and the
review of their work.
f. Assisting, where applicable, in coordination of work done by auditors of
components and experts.
b) As per NSA 620, Using the Work of an Auditor's Expert, when issuing an unmodified
auditor’s report, the auditor should not refer the work of an expert. Further as a result
of the work of expert, the auditor decides to issue a modified auditor’s report in some
circumstances it may be appropriate in explaining the nature of the modification, to
refer to or describe the work of the expert (including the identity of the expert and the
extent of the expert’s involvement). In these circumstances, the auditor would obtain
the permission of the expert before making such a reference. If permission is refused
and the auditor believes a reference is necessary, the auditors may need to seek legal
advices.
In the given case, if unmodified report is being issued then the reference of the expert
work cannot be used. If modified audit report is being issued as a result of the work of
the expert, then auditor may use the reference of expert work only after the permission
from the expert. If the permission is denied by the expert then the auditor believes a
reference is necessary, the auditors may need to seek legal advices and do accordingly.
c) The physical verification of fixed assets is the primary responsibility of the
management. The auditor, however, is required to examine the verification programme
adopted by the management. He must satisfy himself about the existence, ownership
and valuation of fixed assets. In the case of Nara Ltd., the auditor has not been able to
verify the existence and value of some machinery despite the verification procedure
followed in routine audit. He accepted the certificate given to him by the management
without making any further enquiry. As per NSA 580, when representation relate to
matters which are material to the financial information, then the auditor should seek
corroborative audit evidence for other sources inside or outside the entity. He should
evaluate whether such representations are reasonable and consistent with other
evidences and should consider whether individuals making such representations can be
expected to be well informed on the matter. “Written Representations” cannot be a
substitute for other audit evidence that the auditor could reasonably expect to be
available. If the auditor is unable to obtain sufficient appropriate audit evidence that he
believes would be available regarding a matter, which has or may have a material effect
on the financial information, this will constitute a limitation on the scope of his
585
examination even if he has obtained a representation from management on the matter.

Therefore, the approach adopted by the auditor is not correct.
d) Limitation on the scope of Audit
The scope of audit may be limited for varied reasons:
i) The entity may impose restriction on scope of audit.
ii) The limitation may be imposed by circumstances.
When the audit is carried out as per law, the auditor should not accept the assignment
when his duties are curtailed by agreement, unless required by any law.
When audit is carried out in accordance with the entity’s terms voluntarily, the audit
may indicate his scope in his audit report.
Sometimes, the circumstances may impose restrictions on audit scope. For example, if
the auditor is appointed after the year end, he may not be able to participate in inventory
checking. Likewise, the records required may not be available so that the auditor may
not be able to check the details in the manner he liked. Such limitations in scope may
warrant an auditor to express disclaimer of opinion or qualified opinion in his audit
report depending upon the circumstances. In the given case, since cashier is
hospitalized, management says its inability to cooperate with auditor.
In general, non-cooperation of MNP limited will amount to limitation on scope of
auditors. However, the auditor should try to employ other alternative audit procedures
to verify cash. Auditor further should consider materiality of the fact and conclude
accordingly.
3. Answer the following: (3×5=15 marks)
a) Explain the relationship between Materiality and Audit Risk.
b) What are the factors that may assist the auditor in determining whether external
confirmation procedures are to be performed as substantive audit procedures while
responding the assessed risks?
c) Explain the basic elements of an assurance engagement.
Answer:
a) In conducting an audit of financial statements, the overall objectives of the auditor are
to obtain reasonable assurance about whether the financial statements as a whole are
free from material misstatement, whether due to fraud or error, thereby enabling the
auditor to express an opinion on whether the financial statements are prepared, in all
material respects, in accordance with an applicable financial reporting framework; and
to report on the financial statements, and communicate as required by the NSAs, in
accordance with the auditor’s findings.
The auditor obtains reasonable assurance by obtaining sufficient appropriate audit
evidence to reduce audit risk to an acceptably low level. Audit risk is the risk that the
auditor expresses an inappropriate audit opinion when the financial statements are
materially misstated. Audit risk is a function of the risks of material misstatement and
detection risk. Materiality and audit risk are considered throughout the audit when:
1. Identifying and assessing the risks of material misstatement;
586
2. Determining the nature, timing and extent of further audit procedures; and
3. Evaluating the effect of uncorrected misstatements, if any, on the financial
Statements and in forming the opinion in the auditor’s report.
b) Para A51 of NSA 330, The Auditor’s Responses to Assessed Risks deals with the factors
that may assist the auditor in determining whether external confirmation procedures are
to be performed as substantive audit procedures while responding to the assessed risks.
Such factors include:
a. The confirming party’s knowledge of the subject matter – responses may be more
reliable if provided by a person at the confirming party who has the requisite
knowledge about the information being confirmed.
b. The ability or willingness of the intended confirming party to respond – for
example, the confirming party:
• May not accept responsibility for responding to a confirmation request;
• May consider responding too costly or time consuming;
• May have concerns about the potential legal liability resulting from responding;
• May account for transactions in different currencies; or
• May operate in an environment where responding to confirmation requests is
not a significant aspect of day-to-day operations.
In such situations, confirming parties may not respond, may respond in a casual manner
or may attempt to restrict the reliance placed on the response.
The objectivity of the intended confirming party – if the confirming party is a related
party of the entity, responses to confirmation requests may be less reliable.
c) The assurance engagement has the following basic elements:
i) Three party relationship:
Assurance engagements involve three separate parties: a practitioner, a responsible
party and intended users.
ii) An appropriate subject matter:
Subject matter information may be the reorganization, measurement, presentation
and disclosers represented in financial statements, key indicators, special
documents, assertion about effectiveness or statement of compliance depending on
the nature of assurance engagements.
iii) Suitable criteria:
Criteria can be formal or informal depending on the nature of assurance
engagement. It may be Nepal Standards on Auditing or an established internal
control framework or individual control objectives specifically designed for the
engagement or applicable law, regulation or contract.
iv) Sufficient appropriate evidence:
The practitioner plans and performs an assurance engagement with an attitude of
professional scepticism to obtain sufficient appropriate evidence about whether the
subject matter information is free of material misstatement. The practitioner
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considers materiality, assurance engagement risk, and the quantity and quality of
available evidence when planning and performing the engagement.
v) Assurance report:
The practitioner provides a written report containing a conclusion that conveys the
assurance obtained about the subject matter information.
4. Answer/Comment on the following: (3× 5=15 marks)
a) Gayatri Associates, Chartered Accountants has been appointed by Gandaki Bank
Limited to provide merger consulting service. The Bank has agreed to pay fee of Rs. 1
crore if consultant can fix merger with any top 10 banks. Comment on this in the light
of ICAN Code of Ethics.
b) CA. Ram is the practicing chartered accountant, proprietor of Ram & Associates.
Rajdhani Ltd., his ex-audit client asked his opinion regarding application of Nepal
Financial Reporting Standards in certain financial components. What will be the duty
of CA. Ram in this situation?
c) What are the factors that could impair the firm's independence for the engagements?
Answer:
a) In the given case, Bank is offering contingent fees which are calculated on a
predetermined basis relating to the outcome of a transaction or the result of the services
performed by the firm.
A contingent fee charged directly or indirectly, for example through an intermediary,
by a firm in respect of an audit engagement creates a self-interest threat that is so
significant that no safeguards could reduce the threat to an acceptable level.
Accordingly, a firm shall not enter into any such fee arrangement.
A contingent fee charged directly or indirectly, for example through an intermediary,
by a firm in respect of a non-assurance service provided to an audit client may also
create a self-interest threat. The threat created would be so significant that no safeguards
could reduce the threat to an acceptable level if:
(a) The fee is charged by the firm expressing the opinion on the financial statements
and the fee is material or expected to be material to that firm;
(b) The fee is charged by a network firm that participates in a significant part of the
audit and the fee is material or expected to be material to that firm; or
(c) The outcome of the non-assurance service, and therefore the amount of the fee, is
dependent on a future or contemporary judgment related to the audit of a material
amount in the financial statements.
Accordingly, such arrangements shall not be accepted.
b) Section 230 (1 to 3) of ICAN Code of Ethics deals with the matter. The duty of CA.
Ram on such situation would be :
i) Ensuring the existence and significance of any threat will depend on the
circumstances of the request and all the other available facts and assumptions
relevant to the expression of a professional judgment.
ii) Evaluate the significance of any threats and apply safeguards when necessary to
eliminate them or reduce them to an acceptable level.
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iii) Seeking client permission to contact the existing accountant, describing the
limitations surrounding any opinion in communications with the client and
providing the existing accountant with a copy of the opinion.
iv) If the company or entity seeking the opinion will not permit communication with
the existing accountant, a professional accountant in public practice shall determine
whether, taking all the circumstances into account, it is appropriate to provide the
opinion sought.
c) Auditor while accepting the audit engagement should consider all factors that could
impair the firm's independence for his engagement including ICAN code of ethics.
Determine if any of the following challenges are present:
(a) Other services provided to the entity and its related entities in the previous years.
(b) Proposed or prospective services
(c) Firm financial or business relationships with the client
(d) Ex-firm staff working for the client in a position of influence
(e) Firm professionals who were formerly employed by the client with involvement
in the audit engagement
(f) Audit team's and other covered persons' family members employed by the client
(g) Long association of a senior team member with the client
(h) Acceptance of hospitality that is not clearly insignificant
(i) Threat of replacement over a disagreement with an accounting policy.
5. Answer/Comment on the following: (2× 5=10 marks)
a) Explain the procedures for appointment of auditor of corporate bodies wholly owned
by Government of Nepal, Provincial Government and Local Level.
b) CA. Ram Sharma is a partner of Ram & Shyam Associate, Chartered Accountants. CA.
Ram is nominated in the Board of Sagarmatha Securities Ltd. as professional director
with effect from 30th Jestha 2074 for three years. Subsequently his firm has been
appointed as auditor for the financial year 2075/76. Give your opinion on the validity
of appointing his firm as auditor in line with the provision of Securities Act.
Answer:
a) Section 10 of Audit Act 2075, deals with the provision for appointing Auditor of
Corporate Bodies Wholly Owned by Government of Nepal, Provincial government and
local level. The related provisions are:
1. As per Section 10 (1), the Auditor General may appoint license holder auditors
under the prevailing laws his assistant as required to conduct the audit of corporate
bodies wholly owned by as Government of Nepal, Provincial government and local
level.
2. The auditor appointed pursuant to this Section shall act under the direction,
supervision and control of the Auditor General.
3. As per section 10 (3), the powers, functions, duties and responsibilities of the
auditors appointed pursuant this Section and the procedures to be followed by them
in course audit and provisions relating to their report shall be as prescribed by the
Audit Act and the Auditor General.
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4. As per section 10 (4), the remuneration to be paid by the concerned organization to

the auditors appointed pursuant to this Section shall be fixed by the Auditor General
keeping in view the volume of financial transactions, status of accounts, number of
branches and sub-branches, work load and work progress of the concerned
organization.
b) As per section 80 of the Securities Act 2063, following provision has been mentioned
regarding appointment of the auditor of the security company:
(1) A securities business person shall appoint an auditor from amongst the auditors
enlisted by the Board.
(2) Any director, shareholder, officer employee or partner of a securities business
company or body shall be deemed disqualified to be appointed as the auditor of
that securities business company or body.
(3) A securities business person shall give information, indicating the name and
address also of the auditor appointed by it, to the Board within seven days from
the date of such appointment.
(4) If a securities business person removes any auditor from office or such an auditor
resigns from office, the securities business person shall give information thereof
to the Board within seven days from the date of such removal.
(5) Notwithstanding anything contained elsewhere in this Act, no employee of a stock
exchange shall be eligible to be appointed as an auditor of any securities business
company or body.
In the light of the aforesaid provision of Securities Act 2063, Section 80 (2), since CA.
Ram (Partner of Audit Firm) is the professional director of Sagarmatha Securities Ltd.,
appointment of Ram & Shyam Associates; Chartered Accountants as auditor for FY
2075/76 is invalid.
6. Write short notes on the following: (4×2.5=10 marks)
a) Permanent Audit File
b) Statistical Sampling in Auditing
c) Uses of Negative External Confirmation Requests
d) Objectivity in an Audit.
Answer:
a) In a recurring audit, the file of working papers that are relevant to more than one audit
engagement or core documents are often kept separately in a file known as permanent
audit file. Permanent audit file is updated regularly with information of continuing
importance to succeeding audit. As per NSA 230, Audit Documentation a permanent
audit file normally includes:
i) Information concerning the legal and organizational structure of the client. In the
case of a company, this includes the memorandum and articles of association. In
the case of a statutory corporation, this includes the Act and Regulations under
which the corporation operates.
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ii) Extracts or copies of important legal documents, agreements and minutes relevant
to the audit.
iii) A record of the study and evaluation of the internal controls related to the
accounting system.
iv) Copies of audited financial statements of previous years.
v) Analysis of significant ratios and trends.
vi) Copies of management letters issued by the auditor if any.
vii) Record of communication with the retiring auditor, if any before acceptance of
the appointment as the auditor and
viii) Notes regarding significant accounting policies.
b) Statistical Sampling in auditing stands for the technique of forming an opinion about a
group of items on the basis of an examination of a few of the items. On the basis of
audit carried out, an auditor is required to give a report containing his opinion about the
truth and fairness of the accounting statements. Thus, audit sampling involves the
application of audit procedures to less than 100% of the items within an account balance
or class of transactions to enable the auditor to obtain and evaluate audit evidence about
some characteristics of the items selected in order to form or assist in forming a
conclusion concerning the population.
c) A negative external confirmation request asks the respondent to reply only in the event
of disagreement with the information provided in the request. However, when no
response has been received to a negative confirmation request, the auditor remains
aware that there will be no explicit evidence that intended third parties have received
the confirmation requests and verified that the information contained therein is correct.
Accordingly, the use of negative confirmation requests ordinarily provides less reliable
evidence than the use of positive confirmation requests, and the auditor considers
performing other substantive procedures to supplement the use of negative
confirmations.
Negative confirmation requests may be used to reduce audit risk to an acceptable level
when:
i) The assessed level of inherent and control risk is low;
ii) A large number of small balances is involved;
iii) A substantial number of errors is not expected; and
iv) The auditor has no reason to believe that respondents will disregard these requests.
d) The principle of objectivity imposes the obligation on all professional accountants not
to compromise their professional or business judgement because of bias, conflict of
interest or the undue influence of others.
Professional accountants may be exposed to situations that may impair objectivity
which involve the possibility of pressures being exerted on them. These pressures may
impair their objectivity.
It is impracticable to define and prescribe all such situations where these possible
pressures exist. Reasonableness should prevail in establishing standards for identifying
relationships that are likely to, or appear to, impair a professional accountant’s
objectivity.
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7. Distinguish between: (2×5=10 marks)

a) Audit and Investigation
b) Test of Controls and Substantive Procedure
Answer:
Bases Audit Investigation
Description Auditing is the independent Investigation means an inquiry, or

examination of financial is the act of detail examination of
information of any entity, whether activities so as to achieve certain
profit oriented or not, and objectives.
irrespective of its size or legal form,
when such an examination is
conducted with a view to expressing
an opinion thereon
Owners Audit is conducted on behalf of Investigation may be conducted

owners only and they make the either by owner of the undertaking
appointment. or by an outsider.
Purpose To determine the true and fair view. Varies from business to business
Process Routine process Investigation is not a regular

process
Scope It includes only an examination of It covers an examination of the

the accounts of a business accounts bur also covers an inquiry
into other matter that are connected
with the purpose for which it
is undertaken
Employees Does not examine personally May examine personally
Sequence Usually conducted before Usually conducted after the audit of

investigation of accounts accounts
Person Audit is to be conducted by a Investigation may be take on even

performing chartered accountant or person by a non-chartered accountant
work recognized by regulatory body.
Legal Audit is mandatory under law There is no such legal obligations

Obligations with regard to investigation
b)
Auditor should obtain sufficient and appropriate audit evidences and test them before
framing an opinion about the assertions the financial statements reveal. For this, the
auditor checks evidences through:
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• Test of controls and

• Substantive procedure.
Test of controls are procedures designed to evaluate the operating effectiveness of
controls in preventing, or detecting and correcting material misstatements at the
assertion level. It seeks to test that:
• there exists internal control,
• the existing internal control is effective and
• the internal control is working without break or lacunae during the period under
review.
When internal control is found to be to an acceptable level, the accounting entries
generated in such a system is more reliable than in one where the control is weak.
Mere satisfaction about the existence of internal control may not be sufficient for
auditors to express opinion about the assertions the financial data in the form of account
balances and class of transactions.
These transactions and balances need to be tested in detail. This is done by audit
\
procedure called substantive procedure. Substantive procedures are designed to obtain

audit evidence as to the completeness, accuracy and validity of the data produced by
the accounting system.
The substantive procedures involve.
 Test of detail of classes of transactions, account balances and disclosures, and
 Substantive analytical procedure.
The checking of transaction and balances involves vouching of sales, purchases,
payments, receipts and scrutiny of ledgers. The analytical procedure involves critically
examining the accounts in an overall manner and it may entail computation of ratios,
trend analysis so as to dwell in length for examination of unusual or unexplained
deviations.
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702
CAP II Paper 2: Audit and Assurance
Marks
a) Surendra Clothing Pvt. Ltd. has been assessed to Income-tax, in which a demand of
Rs. 10 lakhs has been made. The company has gone in appeal. The company has
deposited Rs. 6 lakhs against the demand, on being pursued by the department. The
company has been advised by its counsel that there is 80% chance of losing in respect
of one of the grounds which may end up confirming the demand of rest Rs. 4 lakhs.
How the company should treat the same while preparing the final accounts for the
year ending Asadh end, 2076?
b) At the year-end (2075-03-31), Chitwan Biscuits P. Ltd. revealed an inventory of Rs.
3.5 crores at its godown. Due to a fire on 2075-04-01, inventory worth Rs. 2 crores
were destroyed. The salvage value and insurance claim were estimated at Rs. 1.25
crores before the commencement of audit. No provision was made in the books of
company for the year ended 2075-03-31 for Rs. 0.75 crore.
c) During the previous year ABC Limited has followed the straight line method of
depreciation. During the current year it has been changed to written down value
method.
d) The ABC Ltd., while valuing its finished inventory at the year-end wants to include
interest on Bank Overdraft as an element of cost, for the reason that overdraft has
been taken specifically for the purpose of financing current assets like inventory and
for meeting day to day working expenses.
Answer:
a) As per paragraph 14 of NAS 37, an entity shall recognise a provision if and only
if:
 a present obligation (legal or constructive) has arisen as a result of past event (the
obligating event),
 payment is probable („more likely than not‟)
 the amount can be estimated reliably
Here, the obligating event is an event that creates a legal or constructive obligation and
therefore results in an entity having no realistic alternative but to settle the obligation.
Contingent liability is a possible obligation depending on whether some uncertain future
event occurs or a present obligation but payment is not probable or the amount cannot be
measured reliably. Contingent liability is not recognised; rather it is disclosed in the
notes to accounts in financial statements.
In the given case, there is an assessment by income tax authority of Rs. 10 lakhs. This
situation has arisen as a result of past event resulting in present obligation of the entity
and there is an 80% chance of losing the case. This extent of probability is substantial.
The amount of obligation can also be estimated reliably. Therefore the company shall
make provision for Rs. 10 lakhs. If the provision of Rs. 6 lakhs already deposited has
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been accounted for as provision, additional provision of Rs. 4 lakhs should be made and
presented in financial statements accordingly.
b) NSA 560 "Subsequent events" requires that the auditor should consider the effects of
subsequent events on the financial statements and the auditor's report. However, the exact
manner and treatment would depend upon whether the event falls in the category of
adjusting event or non-adjusting event as mentioned in NAS 10 Events after Reporting
Date. The event took place after the close of accounting year and does not relate to
conditions existing at the Balance Sheet Date. Thus, it is a non-adjusting event after the
reporting period as per NAS 10. Therefore, an entity shall not adjust the amounts in
Financial Statements for this case. However, an entity shall disclose for each material
category of non-adjusting events the nature of event and its financial effect.
In this case, as the company has correctly accounted by not providing provision, the
auditor is required to ensure whether the proper disclosure of the event has been made in
c) As per NAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors”

defines accounting policy and a change in accounting estimates.
An entity shall change the accounting policy only if the change:
 is required by Standards; or
 results in the financial statements providing reliable and more relevant information
about the effects of transactions, other events or conditions on the entity‟s financial
position, financial performance or cash flows.
A change in accounting estimate is an adjustment of carrying amount of an asset or
liability, or an amount of the periodic consumption of assets, which results from the
assessment of present status of, and expected future benefits and obligations associated
with, assets and liabilities.
As per NAS 16 Property, Plant and Equipment para 5, the residual value and the useful life
of an assets shall be reviewed at least at each financial year-end, if expectation differs from
previous estimates, the changes shall be accounted for as a change in an accounting
estimate in accordance with NAS 8. Para 60 and 61 further describe that depreciation
method used shall reflect the pattern in which the asset‟s future economic benefits are
expected to be consumed by the entity and shall be reviewed at least at each financial year-
end, if there has been a significant change in the expected pattern of consumption of the
future economic benefits embodied in the assets, the method shall be changed to reflect the
changed pattern. Such a change shall be accounted for as a change in accounting estimate
in accordance with NAS 8.
In light of provisions laid down in NASs as discussed above, the change in depreciation
method by the entity is a change in accounting estimate, not the changes in accounting
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policy. Therefore, as per NAS 8, effect of such changes in accounting estimate shall be
recognised prospectively by including it in profit or loss in the period of the change or in
the period of change and future periods, if such change affects both. The entity shall
disclose the nature and amount of such change in an accounting estimate that has an effect
in current period or is expected to have an effect in future periods.
d) As per NAS 2 “Inventories”, cost of inventories comprises all costs of purchase, costs of
conversion and other costs incurred in bringing the inventories to their present location
and condition. NAS 23 borrowing costs identifies circumstance where borrowing costs
can be included in the cost of inventories. Such borrowing cost shall be directly
attributable to the inventories and would have been avoided if the expenditure on
inventory had not been made. In light of these provisions, in given case, overdraft was
taken for financing current assets and meeting day to day working expenses, not
necessarily directly for inventory only. Therefore, the proposal of ABC Ltd. to include
interest on bank overdraft as an element of cost of inventory is not acceptable because
it does not form part of cost of production.

a) Binaya Bhandari & Co. is appointed as statutory auditor of Sagarmatha
Development Bank Ltd. by an Annual General Meeting. As a partner at
Binaya Bhandari & Co., describe the process Binaya Bhandari & Co. should
undertake to assess whether the preconditions for an audit are present when
accepting the audit of Sagarmatha Development Bank Ltd.
b) Mr. Kumar, a practicing Chartered Accountant was ordered to surrender his

Certificate of Practice and he was suspended for one year on certain
professional misconduct against him. During the period of suspension, Mr.
Kumar, designating himself as Tax Consultant, did the work of filing of tax
returns and made appearance as a consultant before various related authorities.
He contended that there is nothing wrong in it as he, like any other tax
consultant, could take such work and his engagement as such in no way
violates the order of suspension inflicted on him.
c) A Ltd. has the total Assets of Rs. 1.2 Arab up to Chaitra end 2075 for financial
year 2075/76. It has been estimated that its total assets would be Rs.1.5 Arab
for FY 2075/76. A Ltd. has appointed Ramesh & Associates, the B class audit
firm for the audit of financial year 2075/76, during its AGM held on 2nd
Baishakh 2076.
d) H Ltd. declared dividend amounting to Rs. 3 lakhs out of profits for the year ended
2074/75. Subsequently, it was noticed that company had failed to make provisions for
outstanding expenses of Rs. 4.2 lakhs and the stock was also overvalued, which was
not reported by auditors of the company. Management of H Ltd. held auditors
responsible for this situation.
Answer:
a) NSA 210 prescribes the procedures to establish whether the pre-conditions for an audit
are present in order to accept or continue an audit engagement. Following steps have to be
followed by partner of Binaya Bhandari & Co. to ascertain the same:
(a) Determine whether the financial reporting framework to be applied in the preparation
of the financial statements is acceptable;
705
(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, including where relevant their fair presentation;
(ii) for such internal control as management determines is necessary to enable the
preparation of financial statements that are free from material misstatement,
whether due to fraud or error; and
(iii) to provide Binaya Bhandari & Co. with:
a. Access to all information of which management is aware that is relevant to the
preparation of the financial statements such as records, documentation and
other matters;
b. Additional information that Binaya Bhandari & Co. may request from
management for the purpose of the audit; and
c. Unrestricted access to persons within the entity from whom Binaya Bhandari
& Co determines it necessary to obtain audit evidence
b) A chartered accountant not holding certificate of practice cannot take up any other work
in the capacity of Chartered Accountant in practice because it would amount to
violation of the relevant provisions of the Nepal Chartered Accountants Act, 2053 and
Code of Ethics. In case a member is suspended and is not holding Certificate of
Practice, he cannot in any other capacity to practice as a member of the Institute. This is
because once a person becomes a member of the Institute; he is bound by the provisions
of the Act and its Regulations.
In the instant case, Mr. Kumar was a practicing chartered accountant and he was ordered
to surrender his certificate of practice and was suspended for one year. Mr. Kumar is
doing the work of filing tax returns and has appeared as a consultant before various
related authorities as tax Consultant which is not in capacity of a practicing chartered
accountant rather in capacity of authorized representative. Any person who has been
authorized to act as a tax practitioner on behalf of the concerned registered person can
become authorized representative. Thus, filing tax return and appearing as tax consultant
by Mr. Kumar is not professional misconduct under Nepal Chartered Accountants Act,
2053 and Regulation therein and the code of ethics. Therefore, Mr. Kumar will not be
held guilty for misconduct.
c) As per rule 53 of ICAN Rule 2061 (amended in 2075), the B class registered auditor is
allowed to carry out the audit of company having total assets or liabilities upto Rs.
1Arab. In the light of such changes in ICAN Rule, since A Ltd. has actual total Assets
of Rs. 1.2 arab during the financial year 2075/76 till Chaitra end 2075 and total
estimated assets would be Rs. 1.5 Arab for FY 2075/76, the appointment of Ramesh &
Associates, the B class audit firm for the audit of financial year 2075/76 is invalid.
d) Failure to detect incorrect financial position of a company: In the given case, profit of
the company has been inflated by non-provisioning for expenses of Rs. 4.2 lakhs and by
overvaluation of stock and based on such inflated profit, the company has declared and
paid dividend of Rs. 3 Lakhs. Thus, it can be said that dividend has not been paid out of
706
real profit. If there is insufficient profit after adjustment of outstanding expenses and
correctness of stock valuation and there is no past reserve, it would amount to payment
of dividend out of capital.
It was the duty of auditor to ascertain whether the Balance sheet and Statement of Profit
and Loss of the company show a true and fair view of the financial position and its
performance. For that, he has to exercise proper audit procedure of substantive test and
evaluation of various items of Balance sheet and Statement of profit and loss. The auditor
should have checked whether all the outstanding expenses have been provided or not and
whether closing stock has been properly valued as per NAS 2. If he was not satisfied, he
should have issued a qualified report or adverse report.
In the instant case, the auditor has failed to do so; he will be guilty of gross negligence in
the performance of his duty.

a) Mr. Ashish Basnet is a partner at Basnet & Shrestha Associates which is the
external auditor of PQR Ltd., public company. During the audit, he identified
a regulatory non-compliance. He is considering reporting it to the audit
committee. Suggest him in the light of NSA 250, what should be taken into
consideration for reporting the same to the audit committee.
b) What are the factors auditors need to consider while evaluating the adequacy
of the auditor‟s expert‟s work?
c) Explain what is meant by “Written Representations” and indicate to what extent an
auditor can place reliance on such representations.
Answer:
a) Mr. Basnet should follow the procedures prescribed by NSA 250 Consideration of Laws
and Regulations in the Audit of Financial Statements.
If Mr. Basnet becomes aware of information concerning an instance of non-compliance or
suspected non-compliance with laws and regulations, he shall obtain:
a. An understanding of the nature of the act and the circumstances in which it has
occurred; and
b. Further information to evaluate the possible effect on the financial statements.
Following points should be considered for reporting identified non-compliance to audit

committee:-
 Mr. Basnet should evaluate the implications of non-compliance in relation to other
aspects of the audit, including the auditor‟s risk assessment and the reliability of
written representations, and take appropriate action.
 Unless all the members of audit committee are aware of such non-compliance, Mr.
Basnet should communicate non-compliance with laws and regulation that come to
his attention during the course of audit.
707
 If in Mr. Basnet‟s judgment, the non-compliance is believed to be intentional and

material, he should communicate the matter to the audit committee as soon as
practicable.
 If the Mr. Basnet suspects that members of the audit committee are involved in non-
compliance, he should communicate the non-compliance to other members of the
Board of Directors. Where he suspects that everyone in position of governance
including Board of Directors are involved or the communication may not be acted
upon, he should consider the need to obtain legal advice.
b) As per NSA 620, the auditor should evaluate the adequacy of auditor‟s expert‟s work as
audit evidence regarding the assertions being considered. This will involve evaluation
of whether the substance of the expert‟s finding is properly reflected in the financial
statements or supports the assertions, and consideration of :
 The relevance and reasonableness of expert‟s findings and conclusions and their
consistency with other audit evidence,
 If expert‟s work involves use of significant assumptions and methods, the relevance
and reasonableness of those assumptions and methods in the circumstances,
 Source data used,
 Results of expert‟s work in the light of the auditors‟ overall knowledge of the business
and of the result of other audit procedures.
While considering whether the expert has used source data which is appropriate in the
circumstances, the auditor consider the following procedure
 Making inquiries regarding any procedures undertaken by the expert to establish
whether the source data is relevant and reliable.
 Reviewing or testing the data used by the expert.
The auditor need to obtain an understanding of the assumptions and methods used and to
consider whether they are appropriate and reasonable based on the auditors knowledge of
the business and the results of other audit procedures. If the result of the expert‟s work
does not provide sufficient appropriate audit evidence or if the results are not consistent
with other audit evidence the auditor should resolve the matter by applying additional
audit procedures including possibly engaging another expert or modifying the auditor‟s
report.
c) Written Representation: The management is responsible for the preparation and

presentation of financial statements. Thus it is quite natural that during the course of
audit, management would be required to make several representations on various matters
relating to financial statements. The representation by management constitutes
acknowledgement by the management about its responsibility for the preparation and
approval of the financial information. A written representation may either take the form
of a letter from the management or letter by auditor outlining auditor‟s understanding
and confirmation of the same by the management.
708
Extent of Reliance: Written representations are necessary information that auditor

requires in connection with the audit of the entity‟s financial statements. Accordingly, this
is similar to responses to inquiries, hence, written representation are audit evidence.
Although they provide necessary audit evidence, they do not provide sufficient appropriate
audit evidence on their own about any of the matter with which they deal. Furthermore, the
fact that management has provided reliable written representation does not affect the
nature or extent of other audit evidence that the auditor obtains about the fulfillment of
management‟s responsibilities, or about specific assertions.
Therefore, the auditor should:
(a) seek corroborative evidence from sources inside or outside the entity,
(b) evaluate whether the representations made by the management appear reasonable and
consistent with other audit evidence obtained, including other representations; and
(c) consider whether the individuals making the representations are expected to be well
informed on the matter.
It must be noted that representations by the management cannot be the substitute for other
audit evidence that the auditor could reasonably expected to be available. For example, a
representation by the management as to existence, quantity and cost of inventories is not
substitute for adopting audit procedures regarding verification and valuation of
inventories. If a representation by management is contradicted by other evidence, the
auditor should examine the circumstances and, when necessary, reconsider the reliability
of other representations made by the management as well.

a) Dayahang & Co. is being considered as external auditor for audit of Nischal
Pvt. Ltd. Dayahang quoted an audit fee of Rs. 3 Lakhs plus 5% of profit.
b) Write down the provision for "Marketing Professional Services" for
professional accountant in public practice.
c) A Chartered Accountancy Firm has known that before issuing audit report of certain
client "the independence" has breached. How the audit firm shall ensure the
significance of such breach?
Answer:
a) In the given case, Dayahang & Co. is quoting a fee which is based on percentage of
profit. Contingent fees may create a self-interest threat to objectivity. The existence
and significance of such threats will depend on factors such as the nature of the
engagement, range of possible fee amounts, basis for determining the fee, whether
the outcome or result of the transaction is to be reviewed by an independent third
party etc.
Code of ethics requires that professional accountant in public practice shall not
quote contingent fees for any professional services.
Also as per Section 34 of Nepal Chartered Accountants‟ Act, Members holding
Certificate of Practice shall not base their remuneration as a percentage on the profit
or on any other uncertain results. Hence, quoting of contingent fee is not allowed by
code of ethics and Nepal Chartered Accountant‟s Act. If the Dayahang & Co. does
so they will be liable for professional misconduct.
709
b) Section 250 of ICAN Code of Ethics has stated the provision regarding Marketing
Professional Services". Such provisions are:
When a professional accountant in public practice solicits new work through
advertising or other forms of marketing, there may be a threat to compliance with the
fundamental principles. For example, a self-interest threat to compliance with the
principle of professional behavior is created if services, achievements, or products are
marketed in a way that is inconsistent with that principle.
A professional accountant in public practice shall not bring the profession into
disrepute when marketing professional services. The professional accountant in public
practice shall be honest and truthful, and not:
(a) Make exaggerated claims for services offered, qualifications possessed, or
experience gained; or
(b) Make disparaging references or unsubstantiated comparisons to the work of
another.
If the professional accountant in public practice is in doubt about whether a proposed

form of advertising or marketing is appropriate, the professional accountant in public
practice shall consider consulting with the relevant professional body.
Notwithstanding anything mentioned hereinbefore, no professional accountant in
public practice shall solicit clients through any manner such as advertisement,
designing web site etc. except in accordance with the Guidelines on Ethical Marketing
& Publicity Practices By Professional Accountants issued by the ICAN.
c) Section 290 (42) of ICAN Code of Ethics deals with the matter. Accordingly, the
audit firm shall ensure the significance breach of independence considering the
following factors:
 The nature and duration of the breach;
 The number and nature of any previous breaches with respect to the current audit
engagement;
 Whether a member of the audit team had knowledge of the interest or relationship
that caused the breach;
 Whether the individual who caused the breach is a member of the audit team or
another individual for whom there are independence requirements;
 If the breach relates to a member of the audit team, the role of that individual;
 If the breach was caused by the provision of a professional service, the impact of
that service, if any, on the accounting records or the amounts recorded in the
financial statements on which the firm will express an opinion; and
 The extent of the self-interest, advocacy, intimidation or other threats created by
the breach.

a) Explain the disqualifications of auditors as per Section 64 of Banks and
Financial Institutions Act, 2073.
710
b) RGS & Co. a firm of Chartered Accountants has three partners, namely, R, G & S.
The firm is allotted the audit of BY Ltd. Mr. R, partner in the firm subsequently holds
100 shares in BY Ltd. Comment.
Answer:
a) Disqualifications for appointment as auditor:
Following persons or any firm or company in which such person is a promoter or partner
shall not be eligible to be appointed as an auditor of a licensed institution and shall in de
facto cease to hold office of auditor even though such person is already appointed:
i) A promoter, director, chief executive officer of bank or financial institution or his or
her family member;
ii) An officer, employee, or internal auditor of the bank or financial institution;
iii) A person working as a partner of any director or employee or chief executive officer
of the bank of financial institution;
iv) A borrower, substantial shareholder or associated person or any person with
financial interest of the bank or financial institution;
v) A person who has been punished in an offense relating to audit, and a period of five
years has not elapsed after he or she has served the punishment;
vi) A person who is insolvent in Nepal or foreign country;
vii) A person, firm, company or institution having subscribed one percent or more of the
shares in the concerned bank of financial institution;
viii) A person who has been punished by the court for a criminal offense involving moral
turpitude, and a period of five years has not elapsed after he or she has served the
punishment; and
ix) A person who is disqualified to be appointed as an auditor as per relevant laws.
b) As per section 112(1)(g) of the Companies act, a substantial shareholder of the company
or a shareholder holding one percent or more of the paid up capital of the company or
his close relative is disqualified from being an auditor.
In the given case, Mr. R is a partner of RGS & Co, Chartered Accountants and RGS &
Co. has been allotted the auditor of the BY Ltd. Mr. R partner of the firm has 100 shares
of By Ltd. As per the company act, a substantial shareholder of the company or his
close relative is disqualified from being an auditor. Mr. R holds only 100 shares which
is not substantial shareholder of the company. So, RGS & Co. can be auditor of the
company.

a) Limited Assurance Engagement
b) Contents of Permanent Audit File
c) External Confirmation
d) Audit Strategy
711
Answer:
a) Limited Assurance Engagement
A limited assurance engagement is an assurance engagement in which the practitioner
reduces engagement risk to a level that is acceptable in the circumstances of the
engagement but in which the risk is greater than for a reasonable assurance engagement.
For a limited assurance engagement, the team must understand the subject matter
sufficiently to identify areas where a significant deviation is most likely to arise.
Further, obtaining an understanding of internal control relevant to the engagement is
usually not required. The evidence needed in a limited assurance engagement would
normally be limited to that obtained by inquiry, analytical procedures, and discussion,
to enable the practitioner to conclude that the subject matter is plausible in the
circumstances. In contrast to reasonable assurance engagements, the practitioner in a
limited assurance engagement would not normally seek to corroborate evidence
obtained as long as the information obtained from carrying out the audit procedures
appears plausible in the circumstances to the practitioner. The conclusion for a limited
assurance engagement is in the negative form, i.e. “based on the procedures performed
and evidence obtained, nothing has come to our attention (…).”
b) Contents of Permanent Audit File
Contents of Permanent Audit Files:
 Information concerning the legal and organizational structure of the entity. In the case
of a company, this includes the Memorandum and Articles of Association. In the case
of a statutory corporation, this includes the Act and Regulations under which the
corporation functions.
 Extracts or copies of important legal documents, agreements and minutes relevant to
the audit.
 A record of the study and evaluation of the internal controls related to the accounting
system. This might be in the form of narrative descriptions, questionnaires or flow
charts, or some combination thereof.
 Copies of audited financial statements for previous years.
 Analysis of significant ratios and trends.
 Copies of management letters issued by the auditor, if any.
 Record of communication with the retiring auditor, if any, before acceptance of the
appointment as auditor.
 Notes regarding significant accounting policies.
 Significant audit observations of earlier years.
c) External confirmation
An external confirmation represents audit evidence obtained by the auditor as a direct
written response to the auditor from a third party (the confirming party), in paper form, or
by electronic or other medium. External confirmation procedures frequently are relevant
when addressing assertions associated with certain account balances and their elements.
However, external confirmations need not be restricted to account balances only. For
example, the auditor may request confirmation of the terms of agreements or transactions
an entity has with third parties; the confirmation request may be designed to ask if any
modifications have been made to the agreement and, if so, what the relevant details are.
712
External confirmation procedures also are used to obtain audit evidence about the absence
of certain conditions, for example, the absence of a “side agreement” that may influence
revenue recognition.
d) Audit Strategy
Audit strategy is concerned with designing optimized audit approaches that seek to
achieve the necessary audit assurances at the lowest cost within the constraints of the
information available.
Audit procedures should be relevant to the important assertions, and as cost effective as
possible to perform. Audit strategy generally involves the following steps:
i) Obtaining knowledge of business.
ii) Performing analytical procedures at initial stages.
iii) Evaluating inherent risks.
iv) Evaluating internal control system for strategy purpose.
v) Formulating the strategy – identifying risk areas, development of appropriate audit
strategy for those areas.

b) Test Check & Internal Check
Answer:
a) Audit and Investigation:
Basis Audit Investigation
Description Auditing is the independent Investigation means an inquiry,

examination of financial information of or is the act of detail
any entity, whether profit oriented or examination of activities so as
not, and irrespective of its size or legal to achieve certain objectives.
form, when such an examination is
conducted with a view to expressing an
opinion thereon
Owners Audit is conducted for accountability Investigation may be conducted

purposes on behalf of owners who either by owner of the
make the appointment. undertaking or by an outsider.
Purpose To determine the true and fair view. Varies from business to
business
Process Routine process Investigation is not a regular

process
Scope It includes only an examination of the It covers an examination of the

accounts of a business accounts bur also covers an
inquiry into other matter that
are connected with the purpose
for which it is undertaken
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Employees Does not examine personally May examine personally
Person Audit is to be conducted by a chartered Investigation may be take on

performing accountant or person recognized by even by a non-chartered
work regulatory body. accountant
Legal Audit is mandatory under law There is no such legal

Obligations obligations with regard to
investigation
b) Distinction between Test Check & Internal Check

Sn. Particulars Test Check Internal check
1 Meaning It stands for the method of It refers to a system of
auditing when instead of a book-keeping and
complete examination of arrangement of staff
all the transaction duties in the organization
recorded in the books of in such a manner that no
account only some of the one person can
transaction are selected completely carry through a
and verified. transaction and record
every aspect thereof.
2 Instituted It is an audit procedures It is a series of procedures
by performed by the auditor laid down by the
in respect of only selected management.
group of transactions.
3 Objectives The purpose is to aid Its objective is to facilitate
auditors to check and management functions.
draw conclusions about
the voluminous
transactions.
4 Fraud & It helps the auditor to It is instituted to prevent
Errors unearth frauds and errors frauds and errors.
without checking all the
transactions.
5 Management Management has no Internal check are
Control control over the test subject to review,
checks carried out by the appraisal and changed by
auditors. the management.
714
Suggested Answer- December 2018
Paper 2:
Audit & Assurance
The Institute of Chartered Accountants of Nepal 20

819
Audit & Assurance

Suggested
Roll No……………. Maximum Marks - 100
Total No. of Questions- 7 Total No. of Printed Pages- 10
Time Allowed - 3 Hours

Marks
a) Haribhakti Sugar Mills Limited is closed from last 11 months due to
outdated technology and has no sales as old technology produces inferior
products. The company will take minimum 2 years' time with substantial
modification of technology to restart production and make sales. Cost is very
substantial for upgrading technology. Due to factory closure, company
defaults in loan repayment and bank has issued notice for auction if loan is
not repaid within 3 months' time. Management is doubtful that funding can
be arranged.
CFO is of view that financial statement shall be prepared in going concern
basis as there is little hope that funding will be received.
b) The annual general meeting of Nepal Hydropower Limited failed to appoint
the auditor for the fiscal year 2074/75 due to time constraint and delegated
power to the board under the terms recommended by the audit committee.
The board of directors appoints M/s ABC & Co., Chartered Accountants as
auditor. Do you think the appointment is valid?
c) The total assets of Rs. 250 million of Y & Z Limited includes inventory
amounting to Rs. 50 million. The inventories were valued at cost. The
market price of the inventories was Rs. 42 million. The company has
disclosed this fact in the notes to accounts.
d) A Co. Ltd. has not included in the Balance Sheet as on 32-03-2075 a sum of
Rs. 1,500,000 being amount in the arrears of salaries and wages payable to
the staff for the last 2 years because the negotiations were going since last 18
months which concluded on 30-04-2075. The auditor wants to sign the said
financial statement and give the audit report on 31-05-2075. The auditor
came to know the result of the negotiations on 15-05-2075.
Answer:
a) As per NAS 1, an entity shall prepare its financial statements on a going concern
basis unless management intends to liquidate the entity or to cease trading, or that it
has no realistic alternative but to do so. When preparing Financial Statements,
management shall make an assessment of an entity's ability to continue as a going
concern. In making assessment, management is aware of material uncertainties
related to events or conditions that may cast significant doubt upon the entity's
ability to continue as a going concern, the entity shall disclose those uncertainties.
When financial statements are not prepared on going concern basis, It shall disclose
the fact, together with the basis on which it prepared the Financial Statements and
the reasons of doing so.

820
NSA 570 ―Going Concern‖ requires that the auditor shall consider whether there are
events or conditions that may cast significant doubt on the entity‘s ability to
continue as a going concern. In the given case, entity's inability to operate the
business for more than 11 months' time and significant doubt on availability of the
fund is one such example. If the financial statements have been prepared on a going
concern basis but, in the auditor‘s judgment, management‘s use of the going
concern assumption in the financial statements is inappropriate, the auditor shall
express a modified opinion.
In the given case, as there is significant doubt that entity will be operational and
going concern assumptions is questionable. The auditor shall evaluate the data on
which basis the management has made assessment and come to the conclusion of
the appropriateness of use of going concern assumption. Based on evaluation, the
auditor should form an appropriate opinion of the Financial Statements.
b) According to Section 110 of the Companies Act 2063, every company shall appoint
auditor under the act to have its accounts audited. As per the Section 111, the
general meeting shall appoint the auditor of the company from the amongst the
auditors licensed to carry out audit under the prevailing laws subject to Chapter 18
of the act in case of a public limited company. The act also provides that the board
of directors may appoint the auditor prior to holding first annual general meeting.
There is no any provision to delegate the authority to anyone for appointment of an
auditor. In the case of a public limited company the annual general meeting has
authority to appoint the auditor under the terms and conditions as recommended by
the Audit Committee as per Section 165 of the act.
As per section 113 of the act, in case of failure to appoint an auditor in the general
meeting of the company for any reason or where annual general meeting cannot be
held, the auditor is appointed by the Company Registrar‘s Office at the request of
the board of directors of the company.
Hence, the companies Act does not have any provision of delegating power of the
appointment of the auditor and no one can appoint auditor except the annual general
meeting and Company Register's Office in case of failure to appoint the auditors by
the AGM.
In the above context, the appointment of M/s ABC & Co., Chartered Accountants
by the board of Nepal Hydropower Limited is not valid. The Company Register's
Office can only appoint the auditor at the request of board of directors where annual
general meeting fails to appoint auditor.
c) As per Nepal Accounting Standards (NAS) 2, Inventories should be measured at

lower of cost and net realizable value. In the present case the cost price of the
inventories is Rs. 50 million and net realizable value is Rs. 42 million and hence the
inventories should be presented at Rs. 42 million in the balance sheet. However, the
company has presented the inventories at Rs. 50 million and disclosed in the notes
to accounts that the inventories have been presented at cost although its net
realizable value is lower than the cost. Mere disclosure of this fact in the notes
however does not result into compliance with the accounting standard.
Hence as an auditor, I will qualify my audit report because inventory in the present
case represents material item of the assets of the company and it has been materially
misstated in the balance sheet.

821
d) As per NAS 10 ―Events after the reporting period‖, adjustments to assets and
liabilities are required for events after the reporting date that provide additional
information materially affecting the determination of the amounts relating to
conditions existing at the reporting date. Similarly as per NAS 37 "Provisions,
Contingent liabilities and Contingent Assets", future events that may affect the
amount required to settle an obligation should be reflected in the amount of a
provision where there is sufficient objective evidence that will occur.
The amount of Rs 1,500,000 is a material amount and it is the result of an event,
which has occurred after the reporting date. The facts have become known to the
auditor before the date of issue of the Audit Report and Financial Statements. The
auditor has to perform the procedure to obtain sufficient, appropriate evidence about
the events occuring from the date of the financial statements i.e. 32-3-2075 to the
date of Auditors Report i.e. 31-05-2075. It is observed that as a result of long
pending negotiations a sum of Rs. 1,500,000 representing arrears of salaries of last
two years have not been included in the financial statements. It is quite clear that the
obligation requires provision for outstanding expenses. So the auditor should
request the management to adjust the sum of Rs. 1,500,000 by making provision for
expenses. If the management does not accept the request the auditor should qualify
the audit report.

a) Mr. A, an auditor of Cold Drink Company has obtained trade secret formula
during audit process. A Case was lodged against Cold Drink Company for
putting non-edible components in the drink. Subsequently, auditor was
called by Supreme Court to provide documents and his knowing in the
formulae. He shared the information he has received on formula of Cold
Drink Company. Mr. B, lodged complaints to ICAN that, Mr. A has violated
Code of Ethics on the ground of breach of confidentiality.
b) National Company Limited had definite plan of its business being closed
within a short period from the close of the accounting year ended on
32ndAshadh, 2075. The Financial Statements for the year ended 32ndAshadh,
2075 had been prepared on the same basis as it had been in earlier periods
with an additional note that the business of the Company shall cease in near
future and the assets shall be disposed off in accordance with a plan of
disposal as decided by the management. The Statutory Auditors of the
Company indicated this aspect in "Key Audit Matters" only by a reference as
to a possible cessation of business and making of adjustments, if any, thereto
to be made at the time of cessation only. Comment on the reporting by the
Statutory Auditor as above.
c) Mr. Ajay, a practicing Chartered Accountant receives commission from Mr.
Sanjay, another practicing Chartered Accountant Rs. 175,000 being 25% of
the audit fee for the referral of statutory audit of company limited, a listed
company.
d) You are the auditor of Special Mart Ltd. for FY 2074/75. Your audit team
has approached to you on how to judge whether the particular risk is
significant or not. As a principal auditor how do you guide your audit team?

822
Answer:
a) Section 140.1 of Code of Ethics of ICAN, specifies about the Confidentiality to be
observed by members and professional accountants. The principle of confidentiality
imposes an obligation on all professional accountants to refrain from: (a) Disclosing
outside the firm or employing organization confidential information acquired as a
result of professional and business relationships without proper and specific
authority or unless there is a legal or professional right or duty to disclose; and (b)
Using confidential information acquired as a result of professional and business
relationships to their personal advantage or the advantage of third parties.
However, section 140.07, outlines circumstances where professional accountants is
required to disclose confidential information or when such disclosure is appropriate
and once such circumstances arise as required by law, for example i.e production of
documents or other provision of evidence in the course of legal proceedings.
Hence, in given case, complaint of Mr. B is not valid, as Mr. A has well followed
the code of Ethics and release confidential information on trade secret only upon
order of supreme court and such release of trade secret is allowed by Ethical Code
of ICAN and cannot be construed as release of confidential information by
breaching Ethical Code of ICAN for professional accountants.
b) As per NSA 570 ―Going Concern‖, management intentions to liquidate the entity or
to cease operations is one of the event or condition that may cast significant doubt
on the entity‘s ability to continue as going concern. If events or conditions have
been identified that may cast significant doubt on the entity‘s ability to continue as a
going concern but, based on the audit evidence obtained the auditor concludes that
no material uncertainty exists, the auditor shall evaluate whether, in view of the
requirements of the applicable financial reporting framework, the financial
statements provide adequate disclosures about these events or conditions
Further, as per NSA 701 ―Communicating Key Audit Matters in the Independent
Auditor‘s Report‖, when matters relating to going concern may be determined to be
key audit matters, and explains that a material uncertainty related to events or
conditions that may cast significant doubt on the entity‘s ability to continue as a
going concern is, by its nature, a key audit matter. NSA 701 also emphasizes on
auditor‘s responsibility to communicate key audit matters in the auditor‘s report.
As per the facts given in the case, intention of the National Company Limited had
definite plan of its business being closed down within short period from 32ndAshad,
2075. However, financial statements for the year ended 32ndAshad, 2075 had been
prepared on the same basis as it had been in earlier periods with an additional note.
Thus, management intentions to liquidate the entity or to cease operations is one of
the event or condition that may cast significant doubt on the entity‘s ability to
continue as going concern is a key audit matter. Therefore, the auditor is required to
communicate the Key Audit Matters in accordance with NSA 570 in above stated
manner. Simple reference as to a possible cessation of business and making of
adjustments, if any, be made at the time of cessation only by the auditor in his report
is not sufficient.
c) Section 240.5 of Code of Ethics of ICAN, accepting certain a referral fee or

commission creates a self-interest threat to objectivity and professional competence
and due care. According to Code of Ethics issued by ICAN, the payment or receipt

823
of commission by a professional accountant in public practice could impair

objectivity and independence. A professional accountant in public practice should
not therefore pay a commission to obtain a client nor should a commission be
accepted for referral of a client to a third party. The payment and receipt of
commission are permitted only for such engagements for which independence is not
required and the professional accountant in practice should nonetheless disclose the
facts to the client.
In the above case since the above assignments requires independence, Mr. Ajay and
Mr. Sanjay both are not complying with ethical requirements under Code of Ethics
issued by ICAN. The disciplinary action can be taken against Mr. Ajay and Mr.
Sanjay.
d) As per NSA 315 (Identifying and Assessing the Risks of Material Misstatement
through Understanding the Entity and Its Environment), in exercising judgment as
to which risks are significant risks, the auditor shall consider at least the following:
 Whether the risk is a risk of fraud;
 Whether the risk is related to recent significant economic, accounting or other
developments and, therefore, requires specific attention;
 The complexity of transactions;
 Whether the risk involves significant transactions with related parties;
 The degree of subjectivity in the measurement of financial information related to
the risk, especially those measurements involving a wide range of measurement
uncertainty; and
 Whether the risk involves significant transactions that are outside the normal
course of business for the entity, or that otherwise appear to be unusual. (Ref:
Para. A141–A145)
In the light of the aforesaid provision of NSA 315, I will guide my audit team to
ensure the risk identified by them are significant risk or otherwise.

a) In the light of NSA 315, explain understanding the entity and its
environment.
b) ―The auditor shall exercise professional judgment in planning and
performing an audit of financial statements‖. Comment.
c) What are the assertions with which an auditor is concerned with while
obtaining audit evidence from substantive procedures?
Answer:
a) The auditor‘s understanding of the entity and its environment consists of an
understanding of the following aspects:
 Industry, regulatory, and other external factors, including the applicable financial
reporting framework.
 Nature of the entity, including the entity‘s selection and application of accounting
policies.
 Objectives and strategies and the related business risks that may result in a
material misstatement of the financial statements.
 Measurement and review of the entity‘s financial performance.

824
 Internal control.
b) Nepal Standard on Auditing 300 (Planning an audit of financial statements) stated

that the manner in which the auditor emphasizes to engagement team members
the need to maintain a questioning mind and to exercise professional skepticism
in gathering and evaluating audit evidence.
Professional Judgment is the application of relevant training, knowledge and
experience, within the context provided by auditing, accounting and ethical
standards, in making informed decisions about the courses of action that are
appropriate in the circumstances of the audit engagement. That the auditor shall
exercise professional judgment in planning and performing an audit of financial
statements. Exercise of professional judgment depends on facts & circumstances
known to the auditor. It is to be exercised throughout the audit and to be
appropriately documented. It is important when deciding about:
 Materiality & audit risk.

 Nature, time and extent of audit procedures.
 Evaluating sufficiency & appropriateness of audit procedures.
 Evaluating management judgment in applying applicable Financial Reporting
Framework.
 Drawing conclusions based on audit evidence.
c) Nepal Standard on Auditing 500 (Audit Evidence) prescribes audit procedures for
obtaining audit evidences. Accordingly an auditor is concerned with following
assertions while obtaining audit evidences from substantive procedures:
 Existence: That an asset or liability exists at a given date.
 Rights and obligations: That an asset is a right of the concern and a liability is
an obligation at a given date.
 Occurrence: That a transaction or event which took place pertains to the entity
during the relevant period.
 Completeness: That there are no unrecorded assets, liabilities or transaction.
 Valuation: That an asset or liability is recorded at an appropriate carrying value.
 Measurement: That a transaction is recorded in the proper amount and revenue
or expense is allocated to the proper period.
 Presentation and disclosure: That an item is disclosed classified and described in
accordance with recognized accounting policies and practices and relevant
statutory

a) Significant Familiarity and self-interest threats are noted due to using of
same senior personnel on an audit engagement over a long period of time.
What are the safeguards to be applied to eliminate such threats or reduce
them to an acceptable level?
b) Explain situation resulting in threat to objectivity and threat to fundamental
principles arising from conflict of interest with examples.
c) During the fiscal year 2073/74 ABC & Co., Chartered Accountants, a
proprietor Firm have done the following Statutory Audits.

825
Listed Company: 3
Limited Company: 10
Private Limited Company: 75
INGOs: 5
In the fiscal year 2074/75, one existing listed company did not continue as
auditor and other two companies has approached to the firm to appoint as
auditor. In addition, 2 other limited company and 2 NGOs approached to the
firm for the audit of FY 2074/75.
Answer:
a) Section 290.148 of ICAN Code of Ethics deals with this matter. The significance of
threat depends on time duration the individual has been a member of audit team,
role given to her/him, structure of Firm, nature of audit engagement, whether the
entity's management team is same or changed and the nature or complexity of the
Client's accounting and reporting issues. Accordingly, the safeguards to be applied
to eliminate such threats or reduce them to an acceptable level are:
 Rotating the senior personnel off the audit team;
 Having a professional accountant who was not a member of the audit team
review the work of the senior personnel; or
 Regular independent internal or external quality reviews of the engagement.
b) Section 220.1 of ICAN Code of Ethics deals with this matter. A professional
accountant in public practice may be faced with a conflict of interest when
performing a professional service. A conflict of interest creates a threat to
objectivity and may create threats to the other fundamental principles. Such threats may
be created when:
i. The professional accountant provides a professional service related to a
particular matter for two or more clients whose interests with respect to that
matter are in conflict; or
ii. The interests of the professional accountant with respect to a particular matter
and the interests of the client for whom the professional accountant provides a
professional service related to that matter are in conflict.
Examples of Conflicts of interest may include but not limited to:
 Providing a transaction advisory service to a client seeking to acquire an audit
client of the firm, where the firm has obtained confidential information during
the course of the audit that may be relevant to the transaction.
 Advising two clients at the same time who are competing to acquire the same
company where the advice might be relevant to the parties‘ competitive
positions.
 Providing services to both a vendor and a purchaser in relation to the same
transaction.
 Preparing valuations of assets for two parties who are in an adversarial position
with respect to the assets.
 Representing two clients regarding the same matter that is in a legal dispute
with each other, such as during divorce proceedings or the dissolution of a
partnership.

826
 Providing an assurance report for a licensor on royalties due under a license

agreement when at the same time advising the licensee of the correctness of the
amounts payable.
 Advising a client to invest in a business in which, for example, the spouse of the
professional accountant in public practice has a financial interest.
 Providing strategic advice to a client on its competitive position while having a
joint venture or similar interest with a major competitor of the client.
 Advising a client on the acquisition of a business which the firm is also
interested in acquiring.
 Advising a client on the purchase of a product or service while having a royalty
or commission agreement with one of the potential vendors of that product or
service.
c) 194th ICAN Council meeting dated 16th February 2015 had revised the earlier
council decision for the number of audits that can be carried out by the ICAN COP
holder with effect from 17th July 2015. As per revised decision, a member in
practice can conduct the audit of 100 organizations in a fiscal year including the
maximum 10 public companies.
In the given case the number of audit engagements of ABC & Co for the fiscal year
2074/75 as are follows:
Listed Company 3-1+2= 4

Limited Company: 10+2= 12
Private Limited Company: 75
INGOs: 5
NGOs: 2
Total: 98
Public Limited Company: 4+12 = 16.
As per the provision, a member in practice can audit 100 numbers of organizations
however the public limited company shall not exceed 10. In the given case, the total
number is below 100 however the public limited company has exceeded 10. So he
can accept only 10 audit engagements of public companies. He should not accept
the audit of either 6 public companies.
a) Miss Shristi, a Chartered Accountant, has been appointed as an auditor in the
22nd AGM of M/s Kantipur Ltd. She was removed by Board of Directors
when she was abroad for her personal visit.
b) Mr. Kumar KC is practicing as a Chartered Accountant from his
proprietorship firm. He nominated Mr. LK Khatri as partner on profit
sharing basis. Mr. Khatri, is not the member of ICAN.
Answer:
a) Section 119 (1) of the Company Act, 2063 provides that no auditor appointed
pursuant to Companies Act shall be removed pending the completion of audit of
accounts of any financial year for which he/she was appointed as the auditor.
As per Sub-section (2), notwithstanding anything contained in sub-section (1), if
any auditor breaches the code of conduct of auditors or does any act against the
interest of the company which has appointed him/her as the auditor or commits any

827
act contrary to the prevailing law, such auditor may be removed through the same
process whereby he/she was appointed as auditor, by giving prior information to the
ICAN, and with the approval of the regulatory authority, if any authorized by the
prevailing law for the regulation of business of the company concerned , and if there
is no such authority, with the approval of the Office of Registrar. While removing
an auditor pursuant to sub-section (2) above, the auditor shall be provided with a
reasonable opportunity to defend him/herself.
Thus, Board of Directors cannot remove if auditor has been appointed through
AGM. Further, reasonable opportunity to defend should be provided.
b) Chapter VIII of Section 34.3 of Nepal Chartered Accountant Act, 1997 states that
one shall not share or distribute as profit the auditing fees or remuneration with any
person other than a member of the Institute; and shall not pay any commission,
brokerage etc. out of the professional fees earned to any person or member.
In the given instance; Mr. Kumar, has nominated Mr. Khatri as a partner, who is not
member of ICAN on profit sharing basis, which is against the code of conduct
prescribed by ICAN.
Given the facts, Mr. Kumar is not allowed to nominate Mr. Khatri, who is not
member of ICAN as partner on profit sharing basis. Upon complaint to the Institute
against Mr., Kumar, for not upholding the conduct mentioned in this Act or the
Regulations framed under this Act, the Executive Director shall, if he finds
convincing information that proves Mr. Kumar, is not observing the conduct, submit
the proposal along with the related facts to the Council for further action against
such member or member holding Certificate of Practice, and Mr. Kumar, may face
disciplinary action by ICAN.
6. Write short notes on the following:

(42.5=10)
a) Employment with an Audit Client
b) Professional Skepticism
c) Peer Review
d) Independence of Internal Auditor
Answer:
a) Employment with an audit client may create self-interest and self-review threats.
Later on, familiarity or intimidation threats may be created if a director or officer of
the audit client, or an employee in a position to exert significant influence over the
preparation of the client‘s accounting records or the financial statements on which
the firm will express an opinion, has been a member of the audit team or partner of
the firm.
b) Professional skepticism is an attitude which includes a questioning mind, being alert

to conditions which may indicate possible misstatement due to error or fraud, and a
critical assessment of evidence. Therefore, the auditor should recognize the fact
that circumstances may exist that may cause the financial statements to be
materially misstated throughout the audit process.

828
c) This is a critical independent review of one public accounting firm's practices by

another public accounting firm. It is a review of the firm‘s accounting and auditing
practices. It is intended that the review be done by practitioners upon fellow
practitioners. Such an external review offers a more objective evaluation of the
quality of performance than could be done by self-review.
Peer review studies the adequacy of the firm's established quality control policies
and tests to determine the extent of the firm's compliance to these policies.
Suggestions for improvement to the system are outlined in a letter of comments
issued by peer reviewers to the reviewed firm. If a firm fails to take appropriate
corrective action, various actions may be imposed e.g. suspension from
membership.
In carrying out the review it is limited to:-
 Professional aspects of the practice.

 The overall total quality control policies.
 Professional aspect of the firms accounting and auditing practices
d) The concept of independence is equally relevant for internal auditor too. Internal
auditing is an independent, objective assurance and consulting activity designed to
add value and improve an organization‘s operations.
Internal auditor is part of the management but s/he evaluates the functioning of the
management at different levels. Therefore, to be efficient and effective, the internal
auditor must have adequate independence. It may be noted that by its very nature,
the internal audit function cannot be expected to have the same degree of
independence as is essential when the external auditor expresses his opinion on the
financial information. To ensure his independence, he is made responsible directly
to the Board of Directors through audit committee.
Such a channel of communication provides an independence whereby an internal
auditor can communicate and share his views on the scope of internal audit,
findings, etc. If internal auditor is made subordinate to lower level, his
independence will be effected which will affect his functioning and effectiveness.

a) Audit Report and Audit Certificate
b) Test Checking and Routine Checking
Answer:
a)
Basis Audit Report Audit Certificate
Meaning An Audit Report is an expression of Certificate is a written
opinion on the true and fair view confirmation of the accuracy of
presented by financial statements the fact stated therein and does
not involve any estimate of
opinion.

829
Utility The term audit report is used when The term certificate is used when
the auditor expresses his opinion on the auditor verifies certain exact
the financial statements fact e.g. Royalty payment made
to foreign collaborators, value of
import/exports of a company
during a financial year.
Implication Audit report implies that the auditor A certificate implies that the
- Has examined relevant records in Auditor
accordance with generally accepted - Has verified certain precise
auditing standards; and figures; and
- Is expressing an opinion whether or - Is in a position to vouch their
not the financial statements accuracy as per the examination
representing a true and fair view of of documents and books of
the state of affairs and of the account produced before him.
working results of the enterprise.
Accuracy The Auditor is responsible for The Auditor is responsible for the
ensuring that the report is based on factual accuracy of what is stated
factual data that his opinion is in therein.
accordance with facts, and that it is
arrived at by application of due care
& Skill.
b)
Criteria Test Checking Routine Checking
Concept Test checking involves selecting a Routine checking involves
few transactions on the basis of checking of books and records on
auditor‘s judgment and examining regular basis.
them.
User Generally Auditor (Internal/external) Generally Accountants (Lower &
etc. Middle level).
Objectives The main object of test checking is to The main object of routine
form an opinion on the financial checking is ensuring arithmetical
statements on the basis of accuracy of the entries in the
original books and ledgers and
examination of selected sample.
posting to correct ledgers
accounts.
Scope Limited Wide
Time Lesser time consuming Higher time consuming
Reliance Certain reliance can be taken on Reliance cannot be taken on test
routine checking checking
Risk Higher risk of improper result if Lesser risk of improper result if
internal control system is weak. internal control system is strong.

830
Suggested Answer - June 2018
Paper 2:
Audit & Assurance
942
CAP II Paper 2: Audit & Assurance
Maximum Marks - 100

Marks
As an auditor, give your opinion with explanations on the following cases: (45=20)
a) AJ Limited has an investment worth NPR 1,000,000 in its financial statements at 31st
Ashadh 2074. Due to the continuing recession, the investment reduced in value to NPR
900,000 by 15th Shrawan 2074.
b) MNS Ltd. (The Company) is engaged in manufacturing business. The book value of
plant & machinery of the company was Rs. 900 million as on Ashadh end 2073
(purchased at Rs. 1,000 million on 1st Shrawan 2072). It provided depreciation on
straight line basis at 10% per annum based on useful life of the plant & machinery.
Imported asset of Rs. 100 million, the component of above plant & machinery was
acquired on 1st Shrawan 2073 that would be obsolete in 2 years. The company wants to
write off this asset over 2 years. Can the company do so?
c) X Ltd. entered into an agreement with Y Ltd. to dispatch goods valuing Rs. one lakh
every month for six months upon receipt of entire payments. Y Ltd. accordingly made
the payment. In third month due to a natural calamity Y Ltd. requested X Ltd. not to
dispatch until further notice.
d) During the financial year 2073/74, Y & R Private Limited, a service providing company
purchased generator of Rs. 2 million for smooth functioning of its office. The accountant
claims that there is no necessity to provide for depreciation in respect of generator as it
was kept standby but not used at all during the financial year.
Answer:
a) NAS 10 Events after the Reporting Period provides guidance whether an entity should
adjust its financial statements or shall disclose for the events after reporting period.
Since reduction in investment value occurred only after the reporting period, it is
indicative of condition that arose after the reporting period which is a non-adjusting event
as per para 3 of NAS 10. An entity shall not adjust the amounts recognised in financial
statement to reflect non-adjusting events after the reporting period. The decline in fair
value does not normally relate to the condition of the investments at the end of the
reporting period, but reflects circumstances that have arisen subsequently.
Therefore, the entity does not update the amounts disclosed for the investments as at the
end of the reporting period, however it may need to give additional disclosure about the
943
nature of event and an estimate of its financial effect , or a statement that such an estimate
cannot be made.
b) As per Nepal Accounting Standard 16 (Property, Plant and Equipment), each part of an
item of property, plant and equipment with a cost that is significant in relation to the total
cost of the item shall be depreciated separately.
An entity shall allocate the amount initially recognised in respect of an item of property,
plant and equipment to its significant parts and depreciate separately each such part. To
the extent that an entity depreciates separately some parts of an item of PPE it also can
depreciate separately the remainder of the item. As it appears that imported assets of Rs.
100 million, which is component of plant and machinery, is having independent useful
life.
Therefore, the company can choose to depreciate the significant parts at 10% p.a. and
remainder imported assets over two years.
c) NAS 18 ―Revenue‖ specifies that revenue from sale of goods should be recognized when
following conditions have been fulfilled:
i) The seller of the goods has transferred all significant risks and rewards of ownership
to the buyer.
ii) the seller retain no effective control of the goods sold usually associated with
ownership;
iii) The amount of revenue can be measured reliably.
iv) It is probable that the economic benefits associated with the transaction will flow to
the entity and
v) The cost in respect of the transaction can be measured reliably.
In this case X Ltd had transferred the significant risk and rewards of the property at an
agreed price. As such sale has been fully completed because upon receipt of the entire
payment. X Ltd was required to dispatch goods valuing Rs 100,000 for six month out of
its inventory. However, in the third month, Y Ltd requested to stop dispatch until further
intimation due to a natural calamity. X Ltd had transferred the goods at an agreed price
and all significant risks and rewards. The delivery was to be effected as per the schedules
indicated by Y Ltd. As per NAS 18, Revenue, mere postponement of delivery at buyers
request does not alter the period in which revenue should be recognized. Accordingly X
Ltd should recognize the entire 600,000 as Sales.
d) As per para 55 of NAS 16 "Property, Plant and Equipment", depreciation of an assets

begin when it is available for use, i.e. when it is in the location and condition necessary
for it to be capable of operating in the manner intended by the management.
Depreciation is a measure of the wearing out, consumption or other loss of value of a
depreciable asset arising from use, efflux of time or obsolescence through technology and
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market changes. Thus, depreciation has to be charged even in case of these assets which
are not used at all during the year but by mere efflux of time provided such assets qualify
as depreciable assets.
When the generator was kept ready for use as stand-by, it means it was intended to be
used for the purpose of business. Depreciation in respect of this generator would have
been provided in the accounts for the year ended 31st Ashadh 2074. If there is an
intention to use an asset, though it may not have actually been used, it is a 'constructive'
or 'passive' use and eligible for charging depreciation.

a) Mr. KC, Partner of CA firm involved in Audit of X Limited was offered with luxury
car by X Limited for his personal use till financial statements is approved in AGM.
b) Your firm has been appointed as the statutory auditor of Super Express Bank Ltd. for
the financial year 2074/75. You, as the engagement partner, are in the process of
drafting audit plan of the said audit. When obtaining an understanding and
performing a preliminary assessment of the internal audit function for drafting your
audit plan, what are the important criteria to be considered.
c) While auditing accounts of a public limited company for the year ended 31st Ashadh
2074, an auditor found out an error in the valuation of inventory, which affects the
financial statement materially.
d) Auditor of Maya Limited was unable to confirm the existence and valuation of
imported inventory lying with the transporter and accepted a certificate from the
management without obtaining audit evidence. The inventory lying with the
transporter is material to the financial statements.
Answer:
a) A professional accountant in public practice or an immediate or close family member may
be offered gifts and hospitality from a client that may create threats to compliance with
the fundamental principles of code of ethics.
When a professional accountant in public practice or an immediate or close family
member is offered gift and hospitality, the situation shall be evaluated. In the instant case,
an offer of using luxury car for personal use may influence the opinion of professional
accountant in public practicee. Self-interest threats to objectivity or confidentiality are
created when gifts and hospitality is made to unduly influence actions or decisions,
encourage illegal or dishonest behavior, or obtain confidential information. Intimidation
threats to objectivity or confidentiality are created if such gifts & hospitality is accepted
by the professional accountant in public practice or an immediate or close family
member.
A professional accountant in public practice shall evaluate the significance of such
threats and apply safeguards when necessary to eliminate the threats or reduce them to an
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acceptable level. Accordingly, when the threats cannot be eliminated or reduced to an

acceptable level through the application of safeguards, such offer shall not be accepted. .
b) As per NSA 610; "Using the work of internal auditors" the statutory auditor should
consider the activities of internal auditors and their effect, if any, on statutory audit
procedures. In the light of aforesaid provision of NSA, the following aspects should be
considered for drafting the audit plan of Super Express Bank Ltd. for the financial year
2074/75:
1. Organizational Status: specific status of internal auditing in the entity and the effect
this has on its ability to be objective. In the ideal situation, internal auditing will
report to the highest level of management and be free of any other operating
responsibility. Any constraints or restrictions placed on internal auditing by
management would need to be carefully considered. In particular, the internal auditors
should be free to communicate fully with the external auditor.
2. Scope of Function: the nature and extent of internal auditing assignments performed.
The external auditor would also need to consider whether management acts on
internal audit recommendations and how this is evidenced.
3. Technical Competence: whether internal auditing is performed by persons having

adequate technical training and proficiency as internal auditors. The external auditor
may, for example, review the policies for hiring and training the internal auditing staff
and their experience and professional qualifications.
4. Due Professional Care: whether internal auditing is properly planned, supervised,

reviewed and documented. The existence of adequate audit manuals, work programs
and working papers would be considered.
c) NSA 450 ―Evaluation of Misstatements identified during the audit‖ deals with the
auditor‘s responsibility to evaluate the effect of identified misstatements on the audit and
of uncorrected misstatements, if any, on the financial statements. The auditor should
consider requesting the management to adjust the financial information or consider
extending his audit procedures. If the management refuses to adjust the financial
information and the results of extended audit procedures do not enable the auditor to
conclude that the aggregate of uncorrected misstatements is not material, the auditor
should express a qualified or adverse opinion, as appropriate.
In the instant case, the auditor has detected the material errors affecting the financial
statements; the auditor should communicate his findings to the management on a timely
basis, consider the implications on true and fair view and think about modifying the
report.
d) As per NSA 580 ―Written Representations‖ auditor may rely on the representation by
the management but he should seek corroborative audit evidence. The management
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representation cannot substitute other evidence that the auditor could reasonably expect
to be available to the auditors.
Also, NSA 501 ―Audit Evidence‖ Specific Consideration for Selected items‖ requires
obtaining sufficient and appropriate evidence regarding the existence and condition of
inventory lying with third party if material to the financial statement.
Supporting evidences can be obtained from inside or outside sources. The audit evidence
for verification of inventory lying with the transporter - say purchase order, invoice,
custom clearance certificate, inspection, confirmation from transporter etc. are available
evidences which auditor should verify.
Just because the management had confirmed the existence and valuation of imported
inventory lying with the transporter the auditor cannot shrink his responsibility. This is
negligence on his part.

a) What are the provisions on ‗Timing of Liaison and Coordination‘ amongst internal
audit and external audit in NSA 610?
b) Mr. Shyam was appointed as the auditor of M/s Himalayan Ltd. and intends to apply
the concept of materiality for the financial statements as a whole. Please guide him as
to the factors that may affect the identification of an appropriate benchmark for this
purpose.
c) Explain the concept of True and Fair View.
Answer:
a) When planning to use the work of internal auditing, the external auditor will need to
consider internal auditing‘s tentative plan for the period and discuss it at as early a stage
as possible.
Where the work of internal auditing is to be a factor in determining the nature, timing
and extent of the external auditor‘s procedures, it is desirable to agree in advance the
timing of such work, the extent of audit coverage, test levels and proposed methods of
sample selection, documentation of the work performed and review and reporting
procedures.
Liaison with internal auditing is more effective when meetings are held at appropriate
intervals during the period. The external auditor would need to be advised of and have
access to relevant internal auditing reports and be kept informed of any significant
matter that comes to the internal auditor‘s attention which may affect the work of the
external auditor. Similarly, the external auditor would ordinarily inform the internal
auditor of any significant matters which may affect internal auditing.
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b) Use of benchmark in determining Materiality: NSA 320 Materiality in planning and

performing an audit prescribes the use of benchmarks in determining materiality for the
Financial Statements as a Whole. Accordingly determining materiality involves the
exercise of professional judgment. A percentage is often applied to a chosen benchmark
as a starting point in determining materiality for the financial statements as a whole.
Factors that may affect the identification of an appropriate benchmark include the
following:
i. The elements of the financial statements (for example, assets, liabilities, equity,
revenue, expenses);
ii. Whether there are items on which the attention of the users of the particular entity‘s
financial statements tends to be focused (for example, for the purpose of evaluating
financial performance users may tend to focus on profit, revenue or net assets);
iii. The nature of the entity, where the entity is at in its life cycle, and the industry and
economic environment in which the entity operates;
iv. The entity‘s ownership structure and the way it is financed (for example, if an entity is
financed solely by debt rather than equity, users may put more emphasis on assets,
and claims on them, than on the entity‘s earnings); and
v. The relative volatility of the benchmark.
c) 'True and fair view' is a phrase usually auditors use to express audit opinion on the
financial statements of an entity. It implies that the financial statements are presented
fairly in all materials respect; the position, performance, cash flows and changes in
equity of the entity. The auditor expresses such opinion upon assessment of the internal
control system of the entity and test checking the financial transactions carried out
during the fiscal year. The auditor's act is guided by the provisions set forth in the Nepal
Standards on Auditing together with the Code of Ethics applicable to the professional
accountants.
As per NSA 200 ―Overall Objectives of the Independent Auditor and the Conduct of an
Audit in accordance with NSA‖, the auditor‘s expression of true and fair view is
supposed to be received as only the ―reasonable assurance and not the absolute
assurance‖ of the state of the financial statements. This implies that the users are not
supposed to absolutely rely on auditor‘s judgment for making their financial decisions
relating to the entity. This is because the auditor is not expected to, and cannot, reduce
audit risk to zero and cannot therefore obtain absolute assurance that the financial
statements are free from material misstatement due to fraud or error. This is because there
are inherent limitations of an audit, which result in most of the audit evidence on which
the auditor draws conclusions and bases the auditor‘s opinion being persuasive rather than
conclusive.
Broadly speaking, the financial statements are considered as presenting to true and fair
view if:
 The information contained in them are not materially misstated;
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 There is an appropriate application of Nepal Accounting Standards, with additional

disclosure in the case of companies registered under Companies Act. In the case of
other entities there is an appropriate application of generally accepted accounting
principles as is applicable; and
 They comply with the provisions of applicable laws and regulations of the company.

a) What is ‗Independence of Mind‘ and ‗Independence in Appearance‘?
b) You are the statutory auditor of PQR Ltd., while carrying out the audit you found
existence of certain threats to objectivity at significant level. What is your duty in
such situation? Give the examples of safeguards you will apply in such situation?
c) Explain the provision relating to 'Conflicts of Interest' with reference to Part B of
Code of Ethics.
Answer:
a) In case of audit engagements, it is in the public interest and, therefore, required by section
290 0f Code of ethics, that members of audit teams, firms and network firms shall be
independent of audit clients.
Independence of Mind
Independence is a state of mind and personal character and an enlightened view of the
professional duties involved. The state of mind that permits the expression of a
conclusion without being affected by influences that compromise professional judgment,
thereby allowing an individual to act with integrity and exercise objectivity and
professional skepticism.
Independence in Appearance
Independence of auditor must not only exist in fact, but should also appear to exist to all
reasonable persons. The avoidance of facts and circumstances that are so significant that a
reasonable and informed third party would be likely to conclude, weighing all the specific
facts and circumstances, that a firm‘s, or a member of the audit team‘s, integrity,
objectivity or professional skepticism has been compromised.
b) As per Section 280 (4) of ICAN Code of Ethics, I should evaluate the significance of such
threats and should apply safeguards when necessary to eliminate them or reduce them to
an acceptable level. The safeguards that should be applied are:
i. Withdrawing from the engagement team;
ii. Supervisory procedures;
iii. Terminating the financial or business relationship giving rise to the threat;
iv. Discussing the issue with higher levels of management within the firm;
v. Discussing the issue with those charged with governance of the client.
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If safeguards cannot eliminate or reduce the threat to an acceptable level, I should decline
or terminate the audit engagement of PQR Ltd.
Section 220 of Code of Ethics contains the provision relating to Conflict of Interest. A
professional accountant in public practice may be faced with a conflict of interest when
performing a professional service. A conflict of interest creates a threat to objectivity and
may create threats to other fundamental principles.
Such threats may be created when:

 The professional accountant provides a professional service related to a particular
matter for two or more clients whose interests with respect to that matter are in
conflict or
 The interests of the professional accountant with respect to a particular matter and the
interests of the client for whom the professional accountant provides a professional
service related to that matter are in conflict.
A professional accountant shall not allow a conflict of interest to compromise

professional or business judgement. The professional accountant in public practice shall
apply safeguards, when necessary, to eliminate the threats to compliance or reduce them
to acceptable level.

a) What are the matters to be audited in view of propriety as per Audit Act,
2048 as amended in 2073?
b) Describe the functions and duties of auditors as per Companies Act, 2063.
Answer:
a) Section 5 of the Audit Act 2048 (As amended in 2073) states that ; the Auditor General
shall audit following matters considering the propriety thereof :
(i) On the propriety of any expenditure and its authorization, if in the opinion of the
Auditor General such expenditure is a reckless one or is an abuse of national property,
whether fixed or current, despite that the expenditure conforms to the authorization,
and
(ii) On the propriety of all authorizations issued in respect of any grant of national
property whether fixed or current, or underwriting of any revenue, or any contract,
license or permits relating to mining, forest, water resources, etc. and any other act of
abandoning fixed or current assets of the nation.
Though the Auditor General may not include in his report minor items of discrepancy and
other items deemed by him as insignificant in view of their propriety which were
observed during the audit of income and expenditures.
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b) The function and duties of auditors as per section 115 of the Companies Act,
2063 are as follows:
(1) The auditor shall, addressing the shareholders or the appointing authority, submit to the
company his/her report, certifying the balance sheet, profit and loss account and cash
flow statement based on the books of account, records and accounts audited by
him/her.
(2) The audit report shall be prepared in accordance with the prevailing law or in
consonance with the audit standards prescribed by the competent body; and such
report shall state the matters to be set out under this Act, as per necessity.
(3) The audit report as referred to in Sub-section (2) shall also indicate the following
matters, inter alia:
(i) Whether such information and explanations have been made available as were
required for the completion of audit;
(ii) Whether the books of account as required by this Act have been properly
maintained by the company in a manner to reflect the real affairs of its business;
(iii) Whether the balance sheet, profit and loss account and cash flow statements
received have been prepared in compliance with the accounting standards
prescribed under the prevailing law and whether such statements are in agreement
with the books of account maintained by the company;
(iv) Whether, in the opinion of the auditor based on the explanations and information
made available in the course of auditing, the present balance sheet properly
reflects the financial situation of the company, and the profit and loss account and
cash flow statement for the year ended on the same date properly reflect the profit
and loss, cash flow of the company, respectively;
(v) Whether the board of directors or any representative or any employee has acted
contrary to law or misappropriated any property of the company or caused any
loss or damage to the company or not;
(vi) Whether any accounting fraud has been committed in the company
(vii) Suggestion, if any

a) Audit Risk
b) Audit Committee
c) Cut Off Procedure
d) Corporate Governance
Answer:
a) Audit Risk
The risk that the auditor expresses an inappropriate audit opinion when the financial
statements are materially misstated. Audit risk is a function of the risks of material
misstatement and detection risk. Risk of material misstatement is a product of inherent
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risk and control risk whereas detection risk is a situation where auditors audit procedures
fail to detect material misstatement. To reduce audit risk at acceptable level, the auditor
should appropriately respond to the assessed risk.
b) Audit Committee
As per Section 164 of Companies Act as amended, a listed company with paid up capital
of thirty million rupees or more or a company which is fully or partly owned by the
Government of Nepal shall form an audit committee under the Chairpersonship of a
director who is not involved in the day-to–day operations of the company and consisting
of at least three members. At least one member of the audit committee shall be an
experienced person having obtained professional certificate in accounting or a person
having gained experience in accounting and financial field after having obtained at least
bachelor’s degree in accounts, commerce, management, finance or economics. The
committee is responsible to review internal control systems of the company.
c) Cut Off Procedure

Cut-off procedures mean procedures employed to ensure the separation of transactions at
the end of one year from those in the commencement of the next year. For the cut off
procedure of inventory, the auditor should satisfy himself by examination and test check
that these procedures adequately ensure that:
 Goods purchased for which property has passed to the client have in fact been
included in inventories and that the liability if any, has been provided for.
 Goods sold have been excluded from the inventories and credit has been taken for
sales.
The auditor may examine a sample of documents evidencing the movement of stocks into
and out of stores, including documents pertaining to period shortly before and shortly
after the cutoff date, and check whether the stocks represented by those documents were
included or excluded, as appropriate, during the stock-taking.
d) Corporate Governance
Corporate Governance is a system by which the business organizations are directed and
controlled. It is a set of processes, customs, policies, laws, and institutions affecting the
way an organization is directed, administered or controlled. The corporate governance
structure specifies the allocation of rights and responsibilities among board, managers,
shareholders, employees, suppliers, customers, government etc. and spells out the rules
and procedures for making decisions on corporate affairs.
Corporate governance is thus 'an internal system encompassing policies, processes and
people, which serves the needs of shareholders and other stakeholders, by directing and
controlling management activities with corporate fairness, transparency, independence,
integrity and accountability. Further, it influences how the objectives of the company are
set and achieved, how risk is monitored and assessed, and how performance is optimized.
It encourages companies to create value (through entrepreneurism, innovation,
development and exploration) and provide accountability and control systems
commensurate with the risks involved
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a) Cost Accounting and Financial Accounting
b) Reserves and Provisions
Answer:
a) Distinction between Cost Accounting and Financial Accounting
Cost Accounting is a close follower of financial accounting. It is not independent of
financial accounting. Though there are common grounds between the two, the important
differences are given below:
(i) Reporting: The major objective of financial accounting is external reporting whereas the
focus of cost accounting has been essentially internal i.e. management.
(ii) Flexibility: Financial accounting is mostly historical or after the event while cost
accounting is much more flexible and open minded and includes in both retrospective
and anticipatory calculations.
(iii)Nature: Financial accounting classifies records, presents and interprets in terms of
money transactions whereas cost accounting classifies, records, presents and interprets
in a significant manner the material, labour and overhead costs involved in
manufacturing and selling each product.
(iv) Financial accounting uses Relevant Accounting Standards while recording, classifying
summarizing and reputing business transactions whereas cost accounting is not bound
to use such Accounting Standards and it can use any technique or practice which
generates useful information.
(v) Time Span: Financial accounting data are developed for a definite period, usually a
year, half year or a quarter, but cost accounting reports and statements can be prepared
whenever needed.
(vi) Accounting Method: Financial Accounting follows the double-entry system for
recording, classifying and summarizing business transactions.
The data under Cost Accounting can be gathered for small or large segments or activities
of an organization and monetary as well as other measures can be used for different
activities in the organization.
b) Reserves and Provisions

(i) Reserve is an appropriation of profit whereas provision is a charge against Profit.
(ii) Reserves are not intended to meet specific liability, contingency or diminution in the
value of assets. Provisions are made to provide for depreciation, renewal or a known
liability or a disputed claim.
(iii) Reserves cannot be created unless there is a profit except revaluation reserve and
capital subsidy. Provisions must be created whether or not there is profit.
(iv) Reserves are generally optional except in certain situations – Capital Redemption
reserve, Debenture Redemption Reserve, etc. Provisions are not optional and have to
953
be made as per generally accepted accounting principles.

(v) Reserves are shown on the liability side. Provisions for depreciation and provision for
doubtful debts are shown as deduction from respective assets. Provision for liability is
shown on the liability side.
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Audit and Assurance
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Maximum Marks - 100

Marks
a) You are an engagement manager for an audit team for M/s Sun Life Ltd. for
financial statements as on Ashadh 31, 2073. Your team is about to drafting
management letter after all transaction testing and review; the board of director of
M/s Sun Life Ltd. has appointed new CEO. After assuming his office, he decided to
change few general managers and auditor for FY 2072-73 with immediate effect.
b) M/s Raddison Hotel on 15.4.2073 imported two Mercedes Benz from Germany at a
price Euro 200 thousand each upon terms of credit that price should be settled
within three months from the date of purchase. The company capitalized the asset
and created a liability for the capital goods converting the foreign currency liability
to Nepalese Rupees at a rate of exchange prevailing as on 15.4.2073. When the
company settled the liability on 30.8.2073, it had to incur an additional amount of
Rs.15,00,000 due to foreign exchange rate on the date of settlement. It added this
additional amount of exchange variation in the capital cost of the asset and charged
depreciation upon an enhanced amount of asset value from 30.8.2073.
c) Mr. A Kumar and Mr. B Kumar are the two chartered accountants just qualified
their exams and took membership from ICAN in Bhadra 2074. A Kumar, who
without holding the Certificate of Practice, signed a document in capacity of the
member holding Certificate of Practice and B Kumar, as being a member of ICAN,
committed an act contrary to the provisions of Section 41of ICAN Act.
d) Mr. Rajaram is a director in M/s P Ltd. and also in M/s Q Ltd. M/s Q Ltd. purchases
goods from M/s P Ltd. The two companies reported the transaction as transaction
with related party as on Ashadh 31, 2074 under NAS-24.
Answer:
a) As per provision contained in Section 119 of companies Act 2063 relating to removal of
appointed auditor, no auditor appointed pursuant to Companies Act shall be removed pending
the completion of audit of accounts of any financial year for which he/she was appointed as the
auditor.
However, if any auditor breaches the code of conduct of auditors or does any act against the
interest of the company which has appointed him as the auditor or commits any act contrary to
the prevailing law, such auditor may be removed through the same process whereby he/she was
appointed as auditor, by giving prior information to the Nepal Chartered Accountants Institute,
and with the approval of the regulatory authority, if any authorized by the prevailing law for the
regulation of business of the company concerned , and failing such authority, with the approval
of the Office of company registrar.
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In case of M/s Sun Life Ltd, CEO is not the person to appoint and remove statutory auditor
and the actions taken by the CEO is null and void and additionally, an appropriate
communication to those charged with governance is required.
b) Nepal Accounting Standards (NAS) 21 states that the exchange differences on the settlement of
monetary items at a rate different from those at which they were translated on initial
recognition during the period or in previous financial statements shall be recognized in profit or
loss in the period in which they arise. Therefore, in view of the above, the M/s Raddison Hotel
should charge the additional amount of Rs.15,00,000 to profit and loss account in accordance
with the said standard and not to capitalize.
c) Section 41 of Nepal Chartered Accountants Act, 2053 has made different level of punishment
for different levels of culpability. Here in case of A Kumar, If a person, who has not obtained a
Certificate of Practice and is proved to have signed any document in capacity of the member
holding Certificate of Practice, shall be liable to punishment with a penalty up to two thousand
rupees or imprisonment for a period of up to three months or both.
In case of B Kumar, if a member, who commits any act contrary to the provisions of this Act or
Regulations framed under this Act other than the provisions of this section, shall be suspended
for a maximum period of five years and shall be liable of punishment with a maximum penalty
of two thousand rupees or imprisonment for a maximum period of three months or both.
So, A Kumar and B Kumar are to be punished accordingly.
d) According to the Provisions of NAS-24, the given transaction between P Ltd. and Q Ltd. is not
a related party transaction. According to the standard, related party relationship includes
enterprises owned by directors or major shareholders of the reporting enterprise and enterprises
that have a member of key management in common with the reporting enterprise. In the given
case, none of the enterprises is owned by Rajaram. He is only a director in both the enterprises
not a Key Management Personnel (Such as Managing Director, Whole time Director, etc).
Therefore, P Ltd should not report the transaction as related party transaction.

a) A proprietary audit firm of Fellow Chartered Accountants has accepted the
engagement to audit the accounts of a company with annual turnover of Rs. 10
million at the audit fee of Rs. 12,000. The firm anticipates that the audit will
consume estimated time of 3 man days of the Chartered Accountant.
b) During the course of audit of a company for fiscal year 2073/74, the finance director
of the company offered your audit team a free weekend at Fulbari Resort Pokhara.
c) The auditor of H Ltd. wanted to obtain confirmation from its creditors. But the
management made a request to the auditor not to seek confirmation from certain
creditors citing disputes. Can the auditor of H Ltd. accept to this request?
d) M/s KBC Associates, a Chartered Accountant was engaged by Hanuman& Co.
Ltd. for auditing their accounts. He sent his letter of engagement to the Board of
Directors, which was accepted by the company. In the course of audit ofthe
company, the auditor was unable to obtain appropriate sufficient audit evidence
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regarding receivables. The client requested for a change in the terms of engagement.
Offer your comments in this regard for acceptance of changes in terms of
engagement.
Answer:
a) As per the decision of the council, a FCA member holding COP shall charge the audit fee to his
clients and the fee shall not be less than Rs. 15,000. In the present case, the FCA member has
charged Rs. 12,000 to a private company is less than the minimum fee. The auditor should have
charged at least Rs. 15,000 as the audit fee. Hence the member seems to have not followed the
directives of the council and accordingly may be subject to disciplinary action.
b) As per the Section 260 of code of ethics issued by ICAN, accepting gifts or hospitality from
an audit client may create self-interest threat and familiarity threats. If a firm or member of
audit team accepts gifts or hospitality unless the value is nominal and inconsequential the threat
created would be so significant that no safeguard could reduce the threats to an acceptable low
level. Consequently a firm or member of the audit team shall not accept such gifts or
hospitality.
The given case represents a self-interest threat as the acceptance of goods and services unless
value of such goods or service offered is very insignificant .As it is unlikely that a weekend at a
luxury hotel for whole audit team has an insignificant value, then, this offer should politely be
declined.
c) NSA 505, ―External Confirmations‖, establishes standards on the auditor‘s use of external
confirmation as a means of obtaining audit evidence. It requires that the auditor should employ
external confirmation procedures in consultation with the management.
The auditor may come across certain situations in which the management may request him not
to seek external confirmation from certain parties because of some reasons, for example, due to
a dispute with the particular creditor or debtor.
If the management refuses to allow the auditor to a send a confirmation request, the auditor shall
 Inquire as to Management‘s reasons for the refusal, and seek audit evidence as to their
validity and reasonableness,
 Evaluate the implications of management‘s refusal on the auditor‘s assessment of the
relevant risks of material misstatement, including the risk of fraud, and on the nature,
timing and extent of other audit procedures, and
 Perform alternative audit procedures designed to obtain relevant and reliable
audit evidence.
If the auditor concludes that management‘s refusal to allow the auditor to send a confirmation
request is unreasonable or the auditor is unable to obtain relevant and reliable audit evidence
from alternative audit procedures, the auditor shall communicate with Those Charged With
Governance (TCWG) and also determine its implication for the audit and his opinion.
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d) NSA 210 ―Agreeing the Terms of Audit Engagement‖ deals with the auditor‘s responsibilities
in agreeing the terms of the audit engagement with management. As per NSA 210, if prior to
completing the audit engagement, the auditor is requested to change the audit engagement to an
engagement that conveys a lower level of assurance, the auditor shall determine whether there
is reasonable justification for doing so.
The auditor shall not agree to a change in the terms of the audit engagement where there is no
reasonable justification for doing so. If the terms of the audit engagement are changed, the
auditor and management shall agree on and record the new terms of the engagement in an
engagement letter or other suitable form of written agreement.
If the auditor is unable to agree to a change of the terms of the audit engagement and is not
permitted by management to continue the original audit engagement, the auditor shall:
 Withdraw from the audit engagement where possible under applicable law or regulation;
and
 Determine whether there is any obligation, either contractual or otherwise, to report the
circumstances to other parties, such as Those Charged With Governance (TCWG), owners
or regulators.

a) What are the general limitations of audit?
b) Pandit & Associates is the firm of practicing chartered accountants. The firm accept
the audit of Siddhartha Ltd. where Government of Nepal (GoN) holds 60 %
ownership. What is the responsibility of Pandit & Associates before accepting such
audit.
c) Write down examples of situations where external confirmations may be used by the
auditor.
Answer:
a) An audit in accordance with NSA is designed to provide reasonable assurance, so a degree of
imprecision is inevitable due to some inherent limitations as mentioned below:
i. Test Checking/Sampling:- Auditor uses sampling during performance of audit. Audit based
on test nature does not detect all frauds and errors.
ii. Nature of evidence:- The evidence obtained by the auditor are persuasive rather than
conclusive. They only enable auditor to provide reasonable assurance (not absolute
conclusion).
iii. Judgement: - Auditor uses professional judgement while obtaining audit evidence and
evaluating the reasonableness of assertion and estimates made by the management. The
judgement made by the auditor may not always be correct.
iv. Inherent limitation of internal control: - Internal controls suffer from limitation such as
collusion among the employees or abuse of authority by management.
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vi. Constraint of Time:- Since most of the audits are carried out only after the year end and
have similar deadlines. Provided limited time period auditor may not able to observe all the
transactions resulting possibilities of oversight.
b) As per the provision of section 7 (2) Audit Act 2048, the auditor of companies where GoN
holds majorities of share should be done in consultation with the Office of Auditor General of
Nepal. Further the practicing chartered accountant as per section 34 (13) of ICAN Act 2053
should not accept his appointment as an auditor of an organization without ascertaining that all
required procedures for appointment as the auditor under the prevailing law has been duly
fulfilled.
In the light of aforesaid provisions of Audit Act 2048, Pandit & Associates before accepting
appointment, should ensure that whether Siddhartha Ltd. has consulted with the Office of
Auditor General of Nepal for their appointment.
c) As per provision sated in NSA 505 (External Confirmations); external confirmations are
frequently used in relation to account balances and their components, but need not be restricted
to these items. Accordingly examples of situations where external confirmations may be used
by the auditor are:
i. bank balances and other information from bankers,

ii. accounts receivable balances,
iii. stocks held by third parties at bonded warehouses for processing or on consignment,
iv. property title deeds held by lawyers or financiers for safe custody or as security,
v. investments purchased from stockbrokers but not delivered at the balance sheet date,
vi. loans from lenders, and
vii. accounts payable balances.

a) Explain the provision related to Second Opinions with reference to Code of Ethics.
b) Explain the various types of threat explained in ICAN Code of Ethics along with
examples.
c) Pradhan Ghimire & Associates, a firm of chartered accountant has two partners. The
firm is already holding audit of 100 companies including audit of 20 public limited
companies. The firm is further offered for the audit of Premier Investment Limited.
Answer:
a) Section 230 of Code of Ethics contains the provision relating to Second Opinions.
When asked to provide second opinion on the application of accounting, auditing, reporting or
other standards or principles to specific circumstances or transactions by a company or on
behalf of a company or any entity that is not an existing client, a professional accountant in
public practice shall evaluate the significance of any threats and apply safeguards where
necessary to eliminate them or reduce them to an acceptable level.
The existence and significance of the threat will depend on the circumstances of the request and
all the other available facts and assumptions relevant to the expression of professional
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judgment. Examples of such safeguards include seeking client permission to contact the
existing accountant, describing the limitations surrounding any opinion on communications
with the client and providing the existing accountant with a copy of the opinion. If the company
or entity seeking the opinion will not permit communication with the existing accountant, a
professional accountant in public practice shall determine whether, taking all the circumstances
into account, it is appropriate to provide the opinion sought.
b) The various kinds of threats as explained in Section 200 of ICAN code of ethics are as follows:
Self Interest Threat: The threat which occur when an auditing firm, its partner or associate
could benefit from a financial interest in an audit client Examples include direct financial
interest or materially significant indirect financial interest in a client, loan or guarantee from
concerned client, close business relationship with an audit client, potential employment with
client.
Self-Review Threat: The threat that a professional accountant will inappropriately evaluate the
result of a previous judgment made or service performed by the professional accountant or
another individual within the professional accountant‘s firm or employing organization on
which the accountant will rely when forming a judgement as part of providing a current service.
For eg: valuation service along with audit service, accounting service.
Advocacy Threat: The threat that a professional accountant will promote client‘s opinion to the
point where people may believe that objectivity is getting compromised. For eg: Auditor acting
as an advocate on behalf of audit client in litigation or dispute with the third parties.
Familiarity Threat: The threat that a profession accountant due to a long or close relationship
with a client, will be too sympathetic to their interests or too accepting of their work. For eg:
participation in client‘s affair, family and personal relationship, audit partners leaving to join
the clients etc.
Intimidation Threat: The threat that a professional accountant will be deterred from acting
objectively because of actual or perceived pressure, including attempts to exercise undue
influence over professional accountant. For eg: A firm being treated with dismissal from a
client engagement.
c) The council vide its meeting no 194 dated Falgun 4, 2071 has amended provision relating to
ceiling over the number of audit. The amended provision is as below and is effective for
appointment from Shrawan 1, 2072.
A member holding Certificate of Practice of can perform the audit of not more than 100 entities
in a financial year, out of which audit of public companies shall not exceed 10. The above limit
is applicable for each member of a partnership firm. However, audit of certain entity having
turnover of less than 20 lacs is not included while calculating the above limit.
Thus, the firm can take maximum of 200 audits (100*2), but the number of public company audit
can‘t exceed 20. As, the firm is already holding audit of 20 public limited companies Pradhan,
Ghimire & Associates can‘t take the audit of the Premier Investment Limited.
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a) What are qualities of statutory auditor.
b) Explain the use of written representation as audit evidence, including its limitations.
Answer:
a) An auditor should adhere to the fundamental principles mentioned in code of ethics. The
fundamental principles are integrity, objectivity, professional competence and due care,
confidentiality and professional behavior. Auditor should be honest, sincere and
straightforward while performing the professional duties. Further, the qualities that an auditor
must possessed are independence, knowledge, technical skills, tact, caution, firmness, good
temper, discretion, industry judgment, patience, clear headedness and good communication
skills. He/She must be able to analyse and interpret the problems so that the situations can be
handled accordingly.
He/she must have a thorough knowledge client‘s business and other disciplines like general
principles of law, economics, taxation, information technology, management, financial
management.
b) The auditor should seek written representation as evidence that management acknowledges its
responsibility for the fair presentation of financial statement. The auditor should obtain written
representations from management on matters material to the financial statement when other
sufficient appropriate audit evidence cannot reasonably expect to exist. Further, the possibility
of misunderstanding between the auditor and management is reduced when oral representations
are confirmed by management in writing. The written representation shall be in the form of
letter addressed to the auditor. If the auditor has concerns about the competence, integrity or
diligence of management, the auditor shall determine their effect on the reliability of written
representation.
However, although written representations are a form of audit evidence, they do have their
limitations. Although written representations provide necessary evidence, they do not provide
sufficient appropriate audit evidence on their own. Furthermore, the fact that management has
provided reliable written representation does not affect the nature or extent of other audit
evidence that the auditor obtains.

a) Impairment of Assets
b) Audit Note-book
c) Subsequent Events
d) Vouching of Advances to the Suppliers
Answer:
a) Impairment of Assets: Besides charging annual depreciation on assets by the reason of normal
wear and tear, affluxion of time and obsolescence to re-instate the correct value of the assets
considering the future cash flows that the assets can generate, impairment loss needs to be
provided. The difference between the carrying amount of an asset and recoverable amount is
termed as impairment loss. The treatment of impairment loss is similar to depreciation except
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the fact that it can be re-instated in future, if the recoverable amount of the asset exceeds
the carrying amount. The auditor must ensure that the provisions of NAS 36 ―Impairment of
Assets‖ are followed.
a) Audit Note-book: An audit note book is usually a bound book in which a large variety of
matters observed during the course of audit are recorded. Audit note books form part of audit
working papers and for each year a fresh audit note book is maintained. In case an auditor
classifies his working paper into permanent and current, then audit note book shall form part of
the current file. It is in any case a part of the permanent record of the auditor available for
reference later on, if required.
The audit note book also provides a valuable help to the auditor in picking up the links of work
when the concerned assistant is away or the work is stopped temporarily. It is also used for
recording the various queries raised in the course of the work and their state of disposal. In
respect of disposed queries, explanation obtained and evidence seen would be recorded in the
said book, while queries remaining un-disposed of would be noted for follow up.
b) Subsequent Events: NSA 560 on ―Subsequent Events‖, defines the term ―subsequent events‖ as
events occurring between the date of the financial statements and the date of the auditor‘s
report, and facts that become known to the auditor after the date of the auditor‘s report.,
―subsequent events‖ also refer to significant events which occurred upto the date of report of
the auditor of that component. Thus, subsequent events are those events which occur after the
date of the balance sheet till the audit report is signed by the auditor.
c) Vouching of Advances to suppliers can be done as follows:
 Obtain schedule of debit balances in trade payables‘ account and pay particular attention to
the age of the balances. Also scrutinize the bought ledger.
 Enquiry should be made for long unadjusted outstanding and check as to whether any of
them would require provisioning.
 Examine that the advances have not been shown as deposits in balance sheet.
 Confirmation of balances should be obtained and reconciliation be done in case of any
discrepancies.

a) Internal Check and Internal Audit
b) Vouching and Verification
Answer:
Distinction between Internal Check & Internal Audit
Internal Check Internal Audit

SN SN
1 Internal check is not a specific check, 1 Internal audit is specifically done to
but the duties of different persons are check that the accounts are properly
so arranged that a person‘s work is maintained and the systems are in
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automatically checked by another control.
person while carrying out the normal
duty.
2 Internal check does the preventive job 2 Internal audit does the detective job of
i.e. internal check is derived so that identifying frauds and errors and
frauds and errors are prevented. rectifying them.
3 It is more of process in a day to day 3 It is specific defined job.
functioning of the business.
4 All the persons in the organization are 4 Specific persons are appointed to the
involved to maintain the internal internal audit.
check system.
5 It is required in all organization in 5 Carrying out internal audit is not
formal or informal. compulsory. It is done based on
management decision.
6 It does not include internal audit. 6 It include internal check.
d) Distinction between Vouching & Verification:
Points of diff. Vouching Verification

Meaning The act of examining the vouchers is Verification van be explained as
known as vouching. A voucher is any establishing the truth or securing
documentary evidence in support of a some kind of confirmation with
transaction entered in the books of account.
respect to the assets and
liabilities appearing in the
Balance Sheet of a concern.
Nature Vouching involves establishing the Verification goes beyond
& arithmetical accuracy and the authenticity vouching. It seeks to establish
Purpose ofthe transactions of a concern. Vouching that assets as stated in the
proves that an asset ought to exist. Balance Sheet of a concern exist
in fact and that the liabilities are
properly disclosed. Verification
proves that an asset does exist.
Time It is done during the whole year. It is done during end of the year.
Utility Certifies correctness of records. Certifies correctness of assets
and liabilities.
Personnel It is done by the junior staff of the auditor It is done by the auditor himself
under the supervision of a senior person. assisted by senior.
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Audit and Assurance
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Suggested

Marks
a) CA Aarjit Dongol has been appointed as statutory auditor of MNO Limited for the fiscal
year 2072/73. He has been holding certain paid up share capital of the company since the
year 2070. Is the appointment of CA Dongol valid?
b) Nice Guy Ltd. sells goods with a cost of Rs. 100,000 to Start-up Co. for Rs. 140,000 and
a credit period of six months. Nice Guy’s normal cash price would have been Rs. 125,000
with a credit period of one month or with a Rs. 5,000 discount for cash on delivery. The
company wishes to book the revenue as Rs. 140,000.
c) AA Ltd. provided Rs 64 lakhs for Inventory obsolescence in 2072/73. In the subsequent
year, it was determined that 50% of such inventory was usable. The Board of Directors
wants to adjust the same through prior period adjustment.
d) A firm of a father and a son is receiving Rs. 2 lakhs towards job work done for XYZ Ltd.
during the year ended on 32.03.2072. The total job work charges paid by XYZ Ltd.
during the year are over Rs. 50 lakhs. The father is a Managing Director of XYZ Ltd.
having substantial holding. The Managing Director told the auditor that since he is not
involved in the activities of the firm and since the amount paid to it is insignificant; there
is no need to disclose the transaction. He further contended that such a payment made in
the last year was not disclosed. Is Managing Director right in his approach?
Answer:
a) Section 112 of the Companies Act, 2063 states the disqualifications of an auditor. As per the
Act, none of the certain persons or the firms or companies in which such persons are partners
shall be qualified for appointment as auditor and shall, despite appointment as auditor, continue
to hold office.
Provision regarding appointing shareholder as auditor as per Section 112 Sub Section c of
Company Act, 2063 states that: persons or the firms or companies who is substantial
shareholder of the company or a shareholder holding one percent or more of the paid up capital
of the company or his close relative cannot be appointed as auditor.
In the given case, the percentage of holding of paid up capital is not mentioned. If CA Dongol
himself or firm or company in which he is partner or shareholder, or his close relative do not
hold one percent or more than one percent of the paid up capital of MNO Limited only then he
is qualified to be appointed as auditor.
b) Effectively, Nice Guy Ltd is financing Start-up Co. for a period of six months. The normal price
would have been Rs. 125,000 as the goods sold with a credit period of six months. Therefore,
cash discount should not be applicable for the goods sold on credit settlement. Sales revenue
should be accounted for Rs. 125000 being the fair value of consideration receivable. The
difference between the nominal amount of Rs. 140,000 and the normal price of goods Rs.
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125000 i.e. Rs. 15,000 would be recognized as interest income over the period of finance of six
months.
As per NAS 18, Revenue is the gross inflow of economic benefits during the period arising in
the course of the ordinary activities of an entity when those inflows result in increases in equity,
other than increases relating to contributions from equity participants. In a given case it has been
shown after deducting in the purchase which is not as per this standard and it should be
disclosed in gross as per this NAS.
c) As per NAS 10 on "Events after the Reporting Date ", prior period items are income or expenses
which arise in the current period as a result of errors or omissions in the preparation of the
financial statements of one or more prior periods. The write-back of provision made in respect
of inventories in the earlier year does not constitute prior period adjustment since it neither
constitutes error nor omission but it merely involves making estimates based on prevailing
circumstances when financial statements were being prepared. It is a mere estimate process
involving judgment based on the latest information available.
An estimate may have to be revised if changes occur regarding the circumstances on which the
estimate was based, or as a result of new information, more experience or subsequent
developments. The revision of the estimate, by its nature, does not bring the adjustment within
the definitions of an extraordinary item or a prior period item.
In this case, AA Ltd. provided Rs 64 lakhs for inventory obsolescence in 2072-73. In the
subsequent year due to change in circumstances, it was determined that 50% of such inventory
was usable. Revision of such an estimate does not bring the resulting amount of Rs.32 lakhs
within the definition either of a prior period item or of an extraordinary item. The amount,
however, involved is material and requires separate disclosure to understand the financial
position and performance of an enterprise. Accordingly, adjustment in the value of the inventory
through prior period item would not be appropriate.
d) Nepal Accounting Standard 24,“Related Party Disclosures” applies to the facts of the case.
NAS 24 requires disclosure of party relationship and transactions between a reporting enterprise
and its related parties. The parties are considered to be related if at any time during the reporting
period, one party has the ability to control the other party or exercise significant influence over
the other party in making decisions.
In the given case, the managing director of XYZ Ltd. is a partner in the firm with his son, which
has been paid Rs. 2 lakhs as job work charges. The managing director is having a substantial
holding in the firm. The case is covered by NAS 24. The approach of the managing director is
not tenable under the standard and accordingly all disclosure requirements have to be complied.
Since there is related party transaction the contention of managing Director is not correct and the
auditor should advise him to make proper disclosure as required by NAS and if the management
refuses, the auditor shall express a qualified report.

a) The Joint Merger Committee of Alpha Bank and Beta Bank has appointed CA Ramarjun
as Due Diligence Auditor of both banks for the merger process. The appointment letter
has following clause regarding fees: “Fees amounting to Rs.300, 000 for each bank
(exclusive of VAT) shall be paid on submission of DDA report. Additional payment of
Rs.150,000 (inclusive of VAT) shall be made, if the merger is successful.”
b) CA Chandan was appointed auditor of Delta Telecom Ltd. He presented audit plan where
in ten teams comprising 4 personnel in each team will be visiting 40 branches (out of 50)
across the country for a total of around 4 months. The finance controller of Delta Telecom
offered SIM cards for all the team members engaged in the audit with one year free 4G
data and voice services and unlimited one year free 10 MB internet to Auditor’s Office as
logistic support so that communication/emails with all the members are uninterrupted
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during the course of audit. It is expected that CA Chandan will be appointed as auditor for
next two years as well. The general one time price of SIM cards and installation charges
for internet however shall have to be paid for. The Finance Controller requests for
replacing some of the branches with others for audit.
c) Verisk Limited has employed an Independent Actuary (Dansk & Co.) for actuarial
valuation of its employees’ long term liabilities for the year end 31st Ashadh 2073. This
was the first year of actuarial valuation. CA Mangesh was statutory auditor for the
company. He was satisfied with the appropriateness and reasonableness of the
assumptions and methods used along with financial data reflected in the financial
statement and decided to issue an unmodified report. He also added following in his
report for more clarity on the subject “The employees’ long term liabilities is based on
actuarial valuation by Dansk & C0.”
d) .Sagar International Ltd. has acquired a solar power system on 01.04.2072 for Rs. 100
lakhs. On 02.04.2072, it applied to Alternative Energy Promotion Board of Nepal for a
50% subsidy. The subsidy application was finally approved on 01.06.2073. While
finalizing the accounts, the company has accounted the subsidy as adjusting event after
reporting period. The board of directors has not yet authorized the financials for issue.
Answer: 2(a)
Section 240 “Fees and other types of remuneration” of Code of Ethics of ICAN , ( Part B) states that
Professional services should not be offered or rendered to a client under an arrangement whereby no
fee will be charged unless a specified finding or result is obtained or when the fee is otherwise
contingent upon the findings or results of such services. Fees charged on a percentage or similar
basis should be regarded as contingent.
In the given instance; though the first part of the clause of fee is straight forward and will be received
on submission of the DDA report, the second part of the fee is contingent upon the successful
merger. The second part of the fee will not be there if the merger is unsuccessful. It is understood
that the success of merger shall be significantly influenced by the DDA Report. This may also cause
self-interest threat on the objectivity of the assignment. Given the facts, CA Ramarjun should not
accept the assignment based on the given terms of fee.
Answer:2(b)
Section 260 “Gifts & Hospitality” of Code of Ethics ICAN, Part B states that acceptance of goods
and services from a client may create a threat to self-interest threat or familiarity threat to objectivity.
Goods and services should not be accepted except on business terms no more favorable than those
generally available to others. The existence and significance of any threat will depend on the nature,
value, and intent of the offer.
In the given case, the purchase of SIM cards at regular price seem no more favorable that to others
and the facility seemed normal in terms of logistic support for smooth conduction of the audit works.
However, the offer for free 4G data charges, voice service and internet for one year which is
extended beyond the normal course (4 months) of audit execution period. Therefore, it may not be
concluded that the offer is in normal course without the specific intent to influence the decision
making. Acceptance of the offer may pose a threat on independence and objectivity and hence should
not be accepted.
Answer:2(c)
NSA 620 “Using the work of an expert” requires that “when issuing an unmodified auditor’s report,
the auditor should not refer to the work of an expert”. Such reference might be misunderstood to be a
qualification of the auditor’s opinion or diversion of responsibility, neither of which is intended.
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In the given context, the reporting by CA Mangesh is more inclined to “emphasis of matter” under
modified reports (matters that do not affect the auditor’s opinion). Hence, CA Mangesh should not
refer the actuarial valuation in his audit report. However, he must ensure that adequate disclosures
about the actuarial valuation and the related figures have been reflected by the Management in the
Financial Statement.
Answer:2(d)
NAS 10 on “events after reporting period” requires the value of assets and liabilities to be adjusted
for events occurring after the balance sheet date which occur upto the date of approval of accounts
by the Board of Directors ( authorized for issue) if they provide evidence of the conditions existing at
the end of the reporting period. Since, in this case books of account have not been approved, grant of
subsidy will be considered as an adjusting event. Hence, the accounts should be adjusted for the
subsidy in 2072-73.
Hence, the subsidy should be either credited to the cost of the system or alternatively may be treated
as deferred income to be written off over the useful life in proportion in which depreciation is written
off.

a) NSA 300 Planning an Audit of Financial Statements provides guidance to assist auditors
in planning an audit. Explain the benefits of audit planning.
b) NSA 210 Agreeing the Terms of Audit Engagements requires auditors to agree the terms
of an engagement with those charged with governance and formalize these in an
engagement letter. Identify and explain the factors which would indicate that an
engagement letter for an existing audit client should be revised.
c) Explain about the factors that influence the reliability of Audit Evidence.
Answer: 3(a)
Benefits of audit planning
Audit planning is addressed by NSA 300 Planning an Audit of Financial Statements. It states that
adequate planning benefits the audit of financial statements in several ways:
 Helping the auditor to devote appropriate attention to important areas of the audit.
 Helping the auditor to identify and resolve potential problems on a timely basis.
 Helping the auditor to properly organize and manage the audit engagement so that it is
performed in an effective and efficient manner.
 Assisting in the selection of engagement team members with appropriate levels of capabilities
and competence to respond to anticipated risks and the proper assignment of work to them.
 Facilitating the direction and supervision of engagement team members and the review of their
work.
 Assisting, where applicable, in coordination of work done by experts.
Answer: 3(b)
Engagement letters for recurring/existing clients should be revised if any of the following factors
are present:
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 Any indication that the entity misunderstands the objective and scope of the audit, as this
misunderstanding would need to be clarified.
 Any revised or special terms of the audit engagement, as these would require inclusion in the
engagement letter.
 A recent change of senior management or significant change in ownership. The letter is
signed by a director on behalf of those charged with governance; if there have been
significant changes in management they need to be made aware of what the audit engagement
letter includes.
 A significant change in nature or size of the entity’s business. The approach taken by the
auditor may need to change to reflect the change in the entity and this should be clarified in
the engagement letter.
 A change in legal or regulatory requirements. The engagement letter is a contract; hence if
legal or regulatory changes occur, then the contract could be out of date.
 A change in the financial reporting framework adopted in the preparation of the financial
statements. The engagement letter clarifies the role of auditors and those charged with
governance, it identifies the reporting framework of the financial statements and if these
changes, then the letter requires updating.
 A change in other reporting requirements. Other reporting requirements may be stipulated in
the engagement letter; hence if these change, the letter should be updated.
Answer: 3(c)
The reliability of information to be used as audit evidence is influenced by its source, nature, and
the circumstances under which it is obtained, including the controls over its preparation and
maintenance. Even when information to be used as audit evidence is obtained from sources
external to the entity, circumstances may exist that could affect its reliability. For example,
information obtained from an independent external source may not be reliable if the expert may
lack objectivity. While recognizing that exceptions may exist, the following generalizations about
the reliability of audit evidence may be useful:
(i) Independent Source - The reliability of audit evidence is increased when it is obtained
from independent sources outside the entity.
(ii) Effective internal control system - The reliability of audit evidence that is generated
internally is increased when the related controls, including its preparation and maintenance,
imposed by the entity are effective.
(iii) Method of obtaining - Audit evidence obtained directly by the auditor (for example,
observation of the application of a control) is more reliable than audit evidence obtained indirectly
or by inference (for example, inquiry about the application of a control).
(iv) Form of Audit Document - Audit evidence in documentary form, whether paper,
electronic, or other medium, is more reliable than evidence obtained orally (for example, a
contemporaneously written record of a meeting is more reliable than a subsequent oral
representation of the matters discussed).
(v) Type of Documents - Audit evidence provided by original documents is more reliable
than audit evidence provided by photocopies or facsimiles, or documents that have been filmed,
digitized or otherwise transformed into electronic form, the reliability of which may depend on the
controls over their preparation and maintenance.
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a) Rabin & Associates; Chartered Accountants has been operating a separate bank account
for keeping client`s money in course of availing fund manager service to the client. The
interest earned on such account during financial year 2072/73 amounting Rs. 100,000 has
been transferred to firm`s bank account and booked as miscellaneous income with
corresponding miscellaneous income & expenditure in client`s bank account.
b) When professional accountant performs services in a country other than Nepal and
differences on specific matters exist between ethical requirements of the two countries,
write down the three provisions to be applied to professional accountant on such situation.
c) You are the auditor of Peace Nepal Ltd. for FY 2072/73. Peace Nepal Ltd. is seeking your
assistance for preparation of accounting records for F.Y. 2072/73.
Answer Q. No.4 (a): :
As per Section 270 “Custody of Client Assets” of Code of Ethics of the Institute of Chartered
Accountants of Nepal, it has been clearly stated that: “All interest earned on clients` monies should be
credited to the client`s account".
The accounting entries made by Rabin & Associates; chartered accountants for interest income in
client`s account is initially correct. But subsequent transfer of interest income to firm's account by
booking as miscellaneous expense in client`s account is not correct.
In the light of the provision contained in Section 270 of Code of Ethics , a professional accountant in
public practice entrusted with money (or other assets) belonging to others shall therefore;
a) Keep such assets separately from personal or firm assets;
b) Use such assets only for the intended purpose;
c) Be ready to present accounting of those assets and any income generated from such assets at all
time to the client; and
d) Comply all the relevant laws and regulations applicable for the custody of client\s assets.
Hence, Rabin & Associates has breached the code of ethics as prescribed by ICAN and is under the
disciplinary action for non-compliance of ICAN code of ethics.
Answer Q. No. 4 (b) :
As per Section 6.3 of the Code of Ethics of the institute of the chartered accountants of Nepal
provisions applied to professional in such situation are:
(i) When the ethical requirements of the country in which the services are being performed are less
strict than the ICAN Code of Ethics, then the ICAN Code of Ethics should be applied.
(ii) When the ethical requirements of the country in which services are being performed are stricter
than the ICAN Code of Ethics, then the ethical requirements in the country where services are
being performed should be applied.
(iii).When the ethical requirements of Nepal are mandatory for services performed outside that country
and are stricter than set out in (i) and (ii) above, then the ethical requirements of Nepal should
be applied. (In the case of cross border advertising and solicitation it should be dealt as per
provision under section 14.)
Answer Q. No. 4 (c):
As per section 8.5 of the code of ethics of ICAN following requirements should be considered by the
independent auditor before assisting client for preparing accounting records:
(i) Should not have any relationship or combination of relationships with the client or any conflict of
interest which would impair integrity or independence.
(ii) The client should accept the responsibility for the statements.
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(iii)Should not assume the role of employee or of management conducting the operations of an
enterprise.
(iv) Staff assigned to the preparation of accounting records ideally should not participate in the
examination of such records. The fact that the professional accountant in public practice has
processed or maintained certain records does not eliminate the need to make sufficient audit tests.
In the light of the provision contained in Section 8.5 of Code of Ethics of the Institute of Chartered
Accountants of Nepal ; I would like to the ensure the compliance of aforesaid provision before
accepting such request of my client.

a) Explain the procedures for appointment of auditor of corporate bodies wholly owned by
Government of Nepal.
b) Define the term "Performance Audit".
Answers Q. No.5 (a):
Section 6 of Audit Act 2048 (1991 AD), deals with the provision for appointing Auditor of Corporate
Bodies Wholly Owned by Government of Nepal. The related provisions are:
 As per Section 6 (1); notwithstanding anything contained in the existing laws, the audit of the
corporate bodies wholly owned by Government of Nepal shall be audited by the Auditor General
pursuant to this Act.
 As per section 6 (2); If the Auditor General is constrained by time and resources to audit the
corporate bodies wholly owned by Government of Nepal pursuant to Sub-section (1) he/she may
appoint license holder auditors under the prevailing laws an assistant. While appointing auditor
as such, he/she shall give priority to the Nepali citizen.
 As per section 6 (3); The auditor appointed pursuant to Sub-section (2) shall act under the direction,
supervision and control of the Auditor General.
 As per section 6 (4); The powers, functions, duties and responsibilities of the auditors appointed
pursuant to Sub-section (2) and the procedures to be followed by them in course audit and provisions
relating to their report shall be as prescribed by the Auditor General.
 As per section 6 (5); The remuneration to be paid by the concerned organization to the auditors
appointed pursuant to Sub-section (2) shall be fixed by the Auditor General keeping in view the
volume of financial transactions, status of accounts, number of branches and sub-branches, work
load and work progress of the concerned organization.
Answers Q. No.5 (b):
According to INTOSAI’s Auditing Standards, performance audit is an independent examination of the

efficiency and effectiveness of government undertakings, programs or organizations, with due regard to
economy, and the aim of leading to improvements.
Performance audit is based on decisions made or goals established by the legislature, and it may be
carried out throughout the whole public sector.
Performance audit is concerned with the audit of economy, efficiency and effectiveness (the three E’s).
A performance audit assignment may include all/one or a combination of two aspects of “3Es”.
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“Economy” means the acquisition of the appropriate quality and quantity of human, financial, physical
and information resources at the appropriate times and at the lower cost possible. It is minimising the
cost of resources used for an activity (input), having due regard to appropriate quality.
“Efficiency” means the use of human, financial, physical and information resources such that the
output is maximized for any given set of resource inputs, or input is minimized for any given
quantity and quality of output.
“Effectiveness” means the achievement of the objectives or other intended effects of activities. It
addresses whether policy objectives or goals have been met and whether this can be attributed to the
policy pursued.
The concept of performance auditing emerged in response to:
 increasing demand for information on efficiency and economy in managing resources and the
effectiveness with which objectives are met;
 need to determine whether :
 the operations of audit entities were conducted in a way that ensures the best possible use of
resources or considering the 3Es;
 officials in the public sector have met their accountability obligations;
 reporting on performance is credible and adequate.
Regularity and propriety related issues which impact performance may be considered in the conduct of
performance audits.

b) Use of Assertion in an Audit of Financial Statements
c) Key Audit Matters
d) Powers to issue Directives by the Auditor General
Answer:
A negative external confirmation request asks the respondent to reply only in the event of
disagreement with the information provided in the request. However, when no response has been
received to a negative confirmation request, the auditor remains aware that there will be no explicit
evidence that intended third parties have received the confirmation requests and verified that the
information contained therein is correct. Accordingly, the use of negative confirmation requests
ordinarily provides less reliable evidence than the use of positive confirmation requests, and the
auditor considers performing other substantive procedures to supplement the use of negative
confirmations.
Negative confirmation requests may be used to reduce audit risk to an acceptable level when: (a) the
assessed level of inherent and control risk is low; (b) a large number of small balances is involved; (c)
a substantial number of errors is not expected; and (d) the auditor has no reason to believe that
respondents will disregard these requests.
b) Use of Assertion in an Audit of Financial Statements

Assertions are the implicit or explicit claims and representations made by the management
responsible for the preparation of financial statements regarding the appropriateness of the
various elements of financial statements and disclosures.
Auditor may use those assertions for audit examination during audit of Financial Statements. In
preparing financial statements, management is making implicit or explicit claims (i.e. assertions)
regarding the recognition, measurement and presentation
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of assets, liabilities, equity, income, expenses and disclosures in accordance with the applicable
financial reporting framework (e.g. NAS/NFRS).
Following Assertions for class of transaction, account balance and disclosures can be used.
 Occurrence,
 Completeness,
 Accuracy cut-off,
 Classification and understandability
 Existence,
 Rights and Obligations
 Valuation and allocation
c) Key Audit Matters

Those matters that, in auditor's professional judgment, are of most significant in the audit of
financial statements of the current period are referred as key audit matters. Such key audit matters
are selected from matters communicated with those charged with governance. The auditor is
required to communicate such matters to those charged with governance and include in audit
report in the Key Audit Matters Section.
The purpose of communicating key audit matters is to enhance the communicative value of
auditor's report by providing greater transparency about the audit that was performed.
Communicating key audit matters provides additional information to intended users of the
financial statements to assist them in understanding those matters which are of most significance
in the audit of the financial statements. Communicating key audit matters is not a substitute for
disclosure in the financial statements or the substitute for the auditor expressing a modified
opinion. In determining key audit matters, auditor may take into account the areas of higher
assessed risks and areas requiring significant management judgment.
d) Powers to issue Directives by the Auditor General

The Auditor General may, subject to the Constitution of Nepal and the prevailing laws,
issue directives to the concerned Government Offices, and Corporate Bodies wholly or
substantially owned by Government of Nepal, from time to time to make proper
arrangements on matters of accounts and to maintain regularity therein. It shall be the
duty of the concerned offices or organizations to abide by such directives.
a) Computerized and manual accounting system
b) Auditing around computer and Audit through computer
Answer:
a) Distinction between computerized and Manual Accounting System:
i. Faster and efficient in processing of information in computerized system and no such faster
and efficient in processing of information in manual system
ii. Automatic generation of accounting documents like invoices, cheques and statement of
account which manual system cannot produce.
iii. With the larger reductions in the cost of hardware and software and availability of user-
friendly accounting software package, it is relatively cheaper like maintaining a manual
accounting system;
iv. More timely information can be produced than manual system
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v. No more manual processing of the data- all automatically posted to the various
ledgers/accounts and many types of useful reports can be automatically generated for
management to make decisions where as such reports cannot generated on manual system
vi. Power failure, computer viruses and hackers are the inherent problems of using computerized
systems, such risk not remain in manual system
vii. Once data been input into the system, automatically the output are obtained hence the data
being input needs to be validated for accuracy and completeness, we should not forget concept
of GIGO (Garbage In(Input) Garbage out ( Output) where validation in manual system can be
checked on inception
viii. Accounting system not properly set up to meet the requirement of the business due to badly
programmed or inappropriate software or hardware or personnel problems can caused more
havoc, where manual system does not have such problem.
ix. Danger of computer fraud if proper level of control and security whether internal and external
b)
i. Audit Around the Computer: Audit around the computer involves forming of an audit opinion
wherein the existence of computer is not taken into account. Rather the principle of
conventional audit like examination of internal controls and substantive testing is done. The
auditor views the computer as a black box, as the application system processing is not
examined directly. The main advantage of auditing around the computer is its simplicity.
Audit around the computer is applicable in the following situations:
ii. The system is simple and uses generalized software that is well tested and widely used.
iii. Processing mainly consists of sorting the input data and updating the master file in sequence.
iv. Audit trail is clear. Detailed reports are prepared at key processing points within the system.
v. Control over input transactions can be maintained through normal methods, i.e. separation of
duties, and management supervision.
Generalized software packages, like payroll and provident fund package, accounts receivable and
payable package, etc. are available, developed by software vendors. Though, the auditor may
decide not to go in details of the processing aspects, if there are well tested widely used packages
provided by a reputed vendor. However, he has to ensure that there are adequate controls to
prevent unauthorized modifications of the package. However, it may be noted that all such
generalized packages do not make the system amenable to audit. Some software packages provide
generalized functions that still must be selected and combined to achieve the required application
system. In such a case, instead of simply examining the systems input and output, the auditor must
check the system in depth to satisfy him about such system. The main disadvantages of the system
of auditing around the computer are:
a) It is not beneficial for complex systems of large scale in very large multi-unit, multi locational
companies, having various inter unit transactions. It can be used only in case of small
organizations having simple operations.
b) It is difficult for the auditor to assess the degradation in the system in case of change in
environment, and whether the system can cope with a changed environment.
(ii) Auditing through the Computer: This approach involves actual use of computer for
processing the information by auditor. The circumstances, where auditing through the computer is
done are as follows:
(i) The organization has developed either in house or through a reputed vendor, a software
package suitable to its requirement, because of inability of a generalized package to cater to the
complex nature of transactions.
(ii) The system processes very large volumes of output. This makes examination of validity of
input and output difficult.
(iii) The major part of the internal control system in the organization is in the computer system
itself, as the majority of the records is processed through the computer. Examples are system in
bank, insurance companies, online booking in case of Railway, etc.
(iv)The logic of the system is quite complex, and there is virtually no visible audit trail. The
auditor has to use the computer to test the logic and controls existing within the system.
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The auditor has to use the computer system itself for verification, for which he has to be
sufficiently computer literate, and should have adequate technical knowledge and expertise. The
auditor can through the computer, increase his performance, and can rely on the data processing by
carrying out the required tests and applying his skill
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Audit & Assurance
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Suggested

Marks
a) CA. M Khatri is Chairman of Dotel Consulting Ltd. AGM of KC Textile Ltd. is
planning to appoint Dotel Consulting Ltd. as an auditor for financial year 2073/74.
b) X Ltd. owns five motors that it uses in its business as property, plant, and equipment.
The entity intends to carry three motors under the cost model and the remaining two
under the revaluation model.
c) A Ltd. company has been valuing its closing inventories under the weighted-average
cost method. In 2072/73, management decided to change its accounting policy
relating to the valuation of inventories to first-in, first-out (FIFO) method since it
was considered to more accurately reflect the usage and flow of inventories in the
economic cycle. Is the change in accounting policy justified?
d) M/s Merita Impex is engaged in the business of manufacturing and trading of

musical instruments. A sum of Rs. 5 lakhs, received from an insurance company as
an insurance claim for loss of goods in transit costing Rs. 4 lakhs, is credited to the
purchase account.
Answer:
a) Section 112 of Companies Act, 2063 has explained the disqualification of auditor as
follows:
(a) A director, advisor appointed with entitlement to regular remuneration or cash

benefit, a person or employee or worker involved in the management of the company
or a partner of any of them or an employee of any of such partners or a close relative of
a director or partner, out of them, or an employee of such relative;
(b) A debtor who has borrowed moneys from the company in any manner, or a person
who has failed to pay any dues payable to the company within the time limit and is in
such arrears or close relative of such person;
(c) A person who has been sentenced to punishment for an offense pertaining to audit
and a period of Three years has not elapsed thereafter;
(d) A person who has been declared insolvent;
(e) A substantial shareholder of the company or a shareholder holding one percent or

more of the paid up capital of the company or his/her close relative;
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(f) A person who has been sentenced to punishment for an offense of corruption, fraud
or a criminal offense involving moral turpitude and a period of five years has not
elapsed thereafter;
(g) A person referred to in Sub-section (3) of Section 111;
(h) In the case of a public company, any person who works, whether full time or part
time, for any governmental body or anybody owned fully or partly by the Government
of Nepal or any other company or a partner of such person or a person who is working
as an employee of such partner or a person who is authorized to sign any documents or
reports to be prepared by the management of the company;
(i) A company or corporate body with limited liability;
(j) A person having interest in any transaction with the company or his/her close
relative or a director, officer or substantial shareholder of another company having any
interest in any transaction with the company.
The auditor shall, prior to his/her appointment ,give information in writing to the
company that he/she is not disqualified pursuant to Subsection(1).
Where any auditor becomes disqualified to audit the accounts of a company or there
arises a situation where he/she becomes disqualified for appointment or can no longer
continue to act as an auditor of the company, he/she shall immediately stop performing
audit which is required to be performed or is being performed by him/her and give
information thereof to the company in writing.
The audit performed by an auditor who has been appointed in contravention of this
Section shall be invalid.
Thus, even though M Khatri is a Chartered Accountant, company cannot be appointed as
auditor of KC Textile Limited.
b) NAS 16 permits an entity to choose between either the cost model or the revaluation model.
It does not allow an entity to apply two different models for the same class of property, plant,
and equipment. Therefore, the company is not allowed to carry three motors under the cost
model while carrying two under the revaluation model, since the standard categorically
prohibits such an accounting treatment.
c) As per NAS 8, an entity shall change an accounting policy only if the change
• Is required by a NFRS; or
• Results in the financial statements providing reliable and more relevant information about
the effects of transactions, other events, or conditions on the entity‟s financial position,
financial performance, or cash flows.
• Reflect the economic substance of transactions, other events and conditions, and not merely
the legal form;
• are neutral, i.e. free from bias;
• are prudent and are complete in all material respect.
In this case, the company has changed its accounting policy in order to accurately reflect the
usage and flow of inventories in the economic cycle. The change in accounting policy is
justified.
d) All items of income and expense which are recognized in a period should be included in the
determination of net profit or loss for the period. The claim for loss of goods in transit is
arising out of ordinary activities of the Impex as a part of its normal course of business.
P.T.O.
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Since the company received Rs. 5 lakhs against goods lost in transit costing Rs. 4 lakhs, there
is profit of Rs. 1 lakh from insurance claim which should be separately recognized in P/L.
Further cost of goods sold should be reduced by Rs. 4 lakhs (i.e. goods lost in transit) so that
gross profit figure is not affected as sales revenue did not arise for these goods.

a) CA. Oli has been appointed as Tax auditor for the year 2072/73 by ABC Private
Limited. He finds that the company has wrongly claimed excess carry-forward loss
of Rs.1 crore in the previous year‟s (2071/72) tax return in which he was not
associated at all. This has no effect in the tax return for the year 2072/73.
b) CA. Ram was appointed as auditor of Alpha Traders Ltd. for 2071/72 for a fee of
Rs.300,000. The turnover for that year was Rs.3 billion, 90 % of the revenue was
from sale of electronic products of “Samsung” for which the company is authorized
distributor. In the early month of 2072/73, the authorized distributorship of
“Samsung” was terminated. Alpha Traders has requested CA Ram to accept the audit
of 2072/73 for a fee of Rs.100,000 as there would be negligible transactions as
compared to previous year and the time to conduct that audit shall be only 1/3 as
compared to previous year audits.
c) LMN Ltd. deals in electronic goods and has 4 warehouses at different locations in
Nepal out of which2 warehouses at Birgunj Custom borders. The major stocks are
generally supplied from warehouse at Birgunj. LMN Ltd. appointed M/s OPQ & Co.
to conduct its audit for the financial year 2072/73. Due to earthquake and subsequent
strike for 3-4 months, the warehouse at Birgunj was inaccessible and the auditors
were not able to conduct physical verification.
d) CA. Renu was working as General Manager of I Ltd. till financial year 2072/73.
With effect from the 1stShrawan 2073 she resigned the I Ltd. and started working as
practicing Chartered Accountant from the name of "Renu& Associates". The Annual
General Meeting of I Ltd. appointed her as statutory auditor for the financial year
2073/74.
Answer:
a) Section 5.8 of Code of Ethics deals with tax practice by professional accountants. It states that
when a professional accountant learns of a material error or omission in a tax return for previous
year (with which the professional accountant may or may not have been associated), the client
should be advised promptly to disclose the fact to tax authority. However, CA Oli is not obliged
to inform the tax authorities.
CA Oli should inform the client that it is not possible to act for them in connection with that
return or other related information submitted to the authorities. Since, the prior error does not
have any effect in tax return for the year in which he is associated, he may continue professional
relation with client but all reasonable steps should be taken to ensure that the error is not
repeated in subsequent returns.
b) As per Section 10.6 of Code of Ethics, It is not improper for a professional accountant in public
practice to charge a client a lower fee than has previously been charged for similar services,
provided the fee has been calculated in accordance with the factors referred to in paragraphs
10.2 through 10.4. It means professional accountant in public practice shall not quote lower
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fees than the previously paid fees without justifiable reasons of reduction in the volume of
transactions or time involvement. In the given case above, it is seen that the company has lost
major distributorship securing 90% of its revenue and hence the work volume and time
involvement is expected to decrease drastically. Hence, CA. Ram may accept the lower fees as
compared to previous year on those justifiable grounds. However, it should be taken care that
the quality of work shall not be impaired and that due care will be applied to comply with all
professional standards and quality control procedures.
c) In some cases, attendance at physical inventory counting may be impracticable. This may be
due to factors such as the nature and location of the inventory, for example, where inventory is
held in a location that may pose threats to the safety of the auditor. The matter of general
inconvenience to the auditor, however, is not sufficient to support a decision by the auditor that
attendance is impracticable. Further, as explained in NSA 200 “Overall Objectives of the
Independent Auditor and the Conduct of an Audit in Accordance with Nepal Standards on
Auditing”, the matter of difficulty, time, or cost involved is not in itself a valid basis for the
auditor to omit an audit procedure for which there is no alternative or to be satisfied with audit
evidence that is less than persuasive. Further, where attendance is impracticable, alternative
audit procedures, for example, inspection of documentation of the subsequent sale of specific
inventory items acquired or purchased prior to the physical inventory counting, may provide
sufficient appropriate audit evidence about the existence and condition of inventory.
In some cases, though, it may not be possible to obtain sufficient appropriate audit evidence
regarding the existence and condition of inventory by performing alternative audit procedures.
In such cases, NSA 705 on Modifications to the Opinion in the Independent Auditor‟s Report,
requires the auditor to modify the opinion in the auditor's report as a result of the scope
limitation.
d) As per Para 8.4 of the code of ethics of the Institute of the Chartered Accountants of Nepal ;
when professional accountants in public practice are or were, within the period under current
review or immediately preceding an assignment: (a) a member of the board, an officer or
employee of a company; or (b) a partner of, or in the employment of, a member of the board or
an officer or employee of a company; they would be regarded as having an interest which could
detract from independence when reporting on that company.
It is common practice to prohibit professional accountants in public practice in such situations
being appointed as auditors of the companies concerned. It is also clearly desirable that they
should not accept from such companies other assignments on which an opinion is required.
In the light of aforesaid provision of ICAN Code of Ethics, CA. Renu should not accept the
appointment for statutory auditor for the FY 2073/74.

a) NSA 315 Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and Its Environment describes the five components of an
entity‟s internal control. Briefly explain the five components of an entity‟s internal
control.
b) Describe substantive procedures you should perform in audit to confirm the
completeness and accuracy of payroll expense.
c) Define audit risk and the components of audit risk.
Answers:
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a) NSA 315 Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and Its Environment considers the components of an entity‟s
internal control. It identifies the following components:
Control environment
The control environment includes the governance and management functions and the
attitudes, awareness, and actions of those charged with governance and management
concerning the entity‟s internal control and its importance in the entity. The control
environment sets the tone of an organization, influencing the control consciousness of its
people.
The control environment has many elements such as communication and enforcement of
integrity and ethical values, commitment to competence, participation of those charged with
governance, management‟s philosophy and operating style, organizational structure,
assignment of authority and responsibility and human resource policies and practices.
Entity’s risk assessment process
For financial reporting purposes, the entity‟s risk assessment process includes how
management identifies business risks relevant to the preparation of financial statements in
accordance with the entity‟s applicable financial reporting framework. It estimates their
significance, assesses the likelihood of their occurrence, and decides upon actions to
respond to and manage them and the results thereof.
Information system, including the related business processes, relevant to financial
reporting, and communication
The information system relevant to financial reporting objectives, which includes the
accounting system, consists of the procedures and records designed and established to
initiate, record, process, and report entity transactions (as well as events and conditions) and
to maintain accountability for the related assets, liabilities, and equity.
Control activities relevant to the audit
Control activities are the policies and procedures which help ensure that management
directives are carried out. Control activities, whether within information technology or
manual systems, have various objectives and are applied at variousorganisational and
functional levels.
Monitoring of controls
Monitoring of controls is a process to assess the effectiveness of internal control
performance over time. It involves assessing the effectiveness of controls on a timely basis
and taking necessary remedial actions. Management accomplishes the monitoring of
controls through ongoing activities, separate evaluations, or a combination of the two.
Ongoing monitoring activities are often built into the normal recurring activities of an entity
and include regular management and supervisory activities.
b) Payroll substantive procedures
 Agree the total wages and salaries expense per the payroll system to the trial balance,
investigate any differences.
 Cast a sample of payroll records to confirm completeness and accuracy of the payroll
expense.
 For a sample of employees, recalculate the gross and net pay and agree to the payroll
records to confirm accuracy.
 Re-perform the calculation of statutory deductions to confirm whether correct
deductions for this year have been made in the payroll.
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 Compare the total payroll expense to the prior year and investigate any significant
differences.
 Review monthly payroll charges, compare this to the prior month and budgets and
discuss with management for any significant variances.
 Perform a proof in total of total wages and salaries, incorporating joiners and leavers
and the annual pay increase.
 Compare this to the actual wages and salaries in the financial statements and
investigate any significant differences.
 Select a sample of joiners and leavers, agree their start/leaving date to supporting
documentation, recalculate that their first/last pay packet was accurately calculated and
recorded.
 Agree the total net as pay per the payroll records to the bank transfer listing of
payments and to the cashbook.
 Agree the individual wages and salaries as per the payroll to the personnel records for
a sample.
 Select a sample of weekly overtime sheets and trace to overtime payment in payroll
records to confirm completeness of overtime paid.
c) Audit risk and its components
Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the
financial statements are materially misstated. Audit risk is a function of two main
components, being the risk of material misstatement and detection risk. Risk of material
misstatement is made up of a further two components, inherent risk and control risk.
Inherent risk is the susceptibility of an assertion about a class of transaction, account balance
or disclosure to a misstatement which could be material, either individually or when
aggregated with other misstatements, before consideration of any related controls.
Control risk is the risk that a misstatement which could occur in an assertion about a class of
transaction, account balance or disclosure and which could be material, either individually or
when aggregated with other misstatements, will not be prevented, or detected and corrected,
on a timely basis by the entity‟s internal control.
Detection risk is the risk that the procedures performed by the auditor to reduce audit risk to
an acceptably low level will not detect a misstatement which exists and which could be
material, either individually or when aggregated with other misstatements. Detection risk is
affected by sampling and non-sampling risk.
a) What are the basic needs to be met to achieve objectives of accounting profession as
per code of ethics?
b) Write briefly on the composition and function of Disciplinary Committee under
ICAN Act, 2053.
c) What due care should a professional accountant in public practice adopt while
handling client‟s monies?
Answer:
a) The code of ethics recognizes that the objectives of the accountancy profession are to work to
the highest standards of professionalism, to attain the highest levels of performance and
generally to meet the public interest requirement set out above. These objectives require four
basis needs to be met:
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Credibility: In the whole of society, there is need for credibility in information and information
systems
Professionalism: There is need for individuals who can be clearly identified by clients,
employers and other interested parties as professional persons in the accountancy field.
Quality of Services: There is a need for assurance that all services obtained from a professional
accountant are carried out to the highest standards of performance
Confidence: Users of the services of professional accountants should be able to feel

confident that there exists a framework of professional ethics which govern the
provision of those services.
b) As per Section 14 of ICAN Act, a disciplinary committee comprising of following members

shall be constituted:
a. FCA member designated by council from amongst elected CA council member-

Chairman
b. three persons nominated by the council from amongst the council members- Member
c. Two persons nominated by the council amongst the members-Member
d. One person nominated by the Auditor General-Member
The main function of the disciplinary committee is to recommend the council to take necessary
actions after investigations upon complaints lodged against any action contrary to the ICAN Act
or regulations, by-laws or code of conduct framed under the ICAN Act rendered by any member
, or the institute receives any information of such kind.
The chairman or members are not allowed to attend any meeting that hears complaint against
the Chairman or member of disciplinary committee. The Disciplinary committee has the
authority, similar to a Judicial Court, in respect of summoning concerned person and
investigating evidences and witnesses.
The disciplinary committee recommends to the council, along with its opinion and finding, for
necessary action against a member.
c) As per ICAN‟s Code of Ethics, a professional accountant in public practice should:
a. not hold client‟s money if there is reason to believe that they were obtained form, or
are to be used for, illegal activities.
b. keep such client‟s monies separately from personal or firms‟s monies
c. use only for the intended purpose and always be ready to account for those monies to
any persons entitled
d. maintain separate bank account for such monies and any monies received should be
deposited without delay to credit of a client account.
e. monies should only be drawn from the client account on instruction form the client
f. fees may be drawn from client‟s monies only after intimating the amount of fees and
client has agreed to such withdrawal.
g. provide a statement of account to client at least once a year
h. if the monies remain for a significant time, place such monies in interest bearing
account with concurrence from such client. All the interest earned should be credited
to the client account.
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a) Discuss about the procedure mentioned in Companies Act, 2063 regarding
appointment of auditors.
b) Discuss about provision relating to removal of appointed auditor as per Companies
Act, 2063.
Answer:
a) As per Section 110 of Companies Act 2063, every company shall appoint an auditor under to
have its accounts audited. In cases where any company has a branch office outside Nepal, the
auditor so appointed may also audit the accounts of that branch office except as otherwise
provided in the prevailing law of the country where such branch office is situated. Similarly,
as persection111, the auditor of a company shall be appointed, from amongst the auditors
licensed to carry out audit under the prevailing law, by the general meeting subject to
provisions contained in chapter 18 of this act, in the case of a public company, and, in
accordance with the provision as contained in the memorandum of association, articles of
association or consensus agreement, any failing such provision, by the general meeting, in the
case of a private company; and his/her name shall be forwarded to the Office within fifteen
days from the date of such appointment.
Provided, however, that the board of directors may appoint the auditor prior to the holding of
the first annual general meeting.
The auditor appointed shall hold office only until the next annual general meeting. No auditor
or his/her partner or ex-partner or employee or ex-employee shall be appointed as auditor for
more than three consecutive terms to perform the audit of a public company.
Provided, however, that this restriction shall not apply to any partner who ended partnership
or any employee who left the service of such audit or three years before.
As per section 113, Where the annual general meeting of a company fails to appoint an
auditor for any reason or where the annual general meeting itself cannot be held or where the
auditor appointed pursuant to this Act ceases to continue his/her office for any reason, the
Office may, at the request of the board of directors of the company, appoint another auditor.
b) As per section 119 of Companies act 2063, no auditor appointed pursuant to provisions laid
down in this act shall be removed pending the completion of audit of accounts of any
financial year for which he/she was appointed as the auditor. Notwithstanding anything
contained in this section, if any auditor breaches the code of conduct of auditors or does any
act against the interest of the company which has appointed him as the auditor or commits
any act contrary to the prevailing law, such auditor may be removed through the same
process whereby he/she was appointed as auditor, by giving prior information to the ICAN,
and with the approval of the regulatory authority, if any authorized by the prevailing law for
the regulation of business of the company concerned , and failing such authority, with the
approval of the Office.
While removing an auditor, the auditor shall be provided with a reasonable opportunity to
defend him/herself.

a) Benefits of implementing IFRS or equivalent national standards
b) Government audit in Nepal
c) Concept of materiality
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d) Written representation
Answers:
a) Benefits of implementing IFRS or equivalent national standards
There are many benefits of implementing IFRS or its national equivalent financial reporting
standards which can be broadly divided into 3 main parts – Economy, Investors and the
Industry.
Benefits to the Economy - As the market expands globally, the need for a global standard is
also increasing. Implementation of IFRS or equivalent standards facilitates the maintenance
of orderly and efficient capital markets and also helps to increase the capital formation and
thereby economic growth.
Benefits to the Investors - Investors who are willing to invest abroad want information
which is more relevant, reliable, timely and comparable across various jurisdictions.
Financial statements prepared using a common set of accounting standards help investors
better understand, at a little cost, the investment opportunities as opposed to financial
statements prepared using a different set of national accounting standards.
Benefits to the Industry - the Industry would be able to raise capital from foreign markets at
a lower cost if it can create confidence in the minds of the foreign investor that their
financial statements comply with globally accepted accounting standards.
b) Government Audit in Nepal
Government audit is as old as history of states. The concept and scope of government audit
has developed in tune with political, social and economic development of the countries.
Government audit aims to promote good governance through an independent, efficient and
effective audit services. To carry out audit in an independent manner, some independent
institutions are set up through constitutional or legal provisions. Such institution is
empowered to carry out audits of all receipts, expenditure and other matters as specified in
mandate from various aspects such as regularity, economy, efficiency, and effectiveness,
and propriety.
In Nepal, government audit is performed by an independent constitutional body, i.e. Office
of Auditor General (OAG). The Constitution of Nepal (2072) provides power to the auditor
General, who is appointed on the recommendation of the Constitutional Council, of
conducting audit of all public sector entities with due regards to regularity, economy,
efficiency, effectiveness and proprietary.
As per the Audit Act, 2048, the Auditor General may conduct final audit of the financial
activities and other activities relating thereto of the offices, bodies or organization under its
jurisdiction, either in detail or sporadically or a random basis and present the facts obtained
there from make critical comments thereon and submit its reports.
The Auditor General submits his/her annual report to the president and which is caused by
the president to be tabled at parliament for discussion through prime minister.
c) Concept of Materiality
The concept of materiality is applied by the auditor both in planning and performing the
audit, and in evaluating the effect of identified misstatements on the audit and of
uncorrected misstatements, if any, on the financial statements.
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The „Framework for the Preparation and Presentation of Financial Statements‟ states that
information is material if its omission or misstatement could influence the economic
decisions of users taken on the basis of the financial statements. Materiality depends on the
size of the item or error judged in the particular circumstances of its omission or
misstatement. Thus, materiality provides a threshold or cut-off point rather than being a
primary qualitative characteristic which information must have if it is to be useful.
The decision to judge the materiality of the item whether in the aggregation of items,
presentation or classification of items shall depend upon the judgment of preparers of the
account on the circumstances of the particular case.
d) Written Representation
This refers to a written statement by management provided to the auditor to confirm certain
matters or to support other audit evidence. Written representations in this context do not
include financial statements, the assertions therein, or supporting books and records. Written
representations are necessary information that the auditor requires in connection with the
audit of the entity‟s financial statements. Accordingly, similar to responses to inquiries,
written representations are audit evidence. Although written representations provide
necessary audit evidence, they do not provide sufficient appropriate audit evidence on their
own about any of the matters with which they deal. Furthermore, the fact that management
has provided reliable written representations does not affect the nature or extent of other
audit evidence that the auditor obtains about the fulfillment of management‟s
responsibilities, or about specific assertions.
The auditor shall request written representations from management with appropriate
responsibilities for the financial statements and knowledge of the matters concerned.
Written Representations about management‟s responsibilities include:
 Preparation of the Financial Statements;
 Information Provided and Completeness of Transactions; and
 Other responsibility

a) Audit plan and audit programme
b) Reasonable assurance and limited assurance
Answers:
a) Audit Plan and Audit Program
The Distinction between Audit Plan and Audit Program are outlined as follows:
Audit plan is described as developing a general strategy and a detailed approach for the
expected nature, timing and extent of the audit. The auditor plans to perform the audit in
efficient and timely manner where as audit program is the step and guidance and works as a
tool for performing/implementing audit at the execution level. The distinctions of those two
are:
 Audit plan is prepared before preparing audit program.
 Audit plan is border scope than audit program.
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 Audit plan assists acquiring knowledge of clients business and concentrating on
risk areas which will help for preparing effective audit program.
 Audit plan is generally prepared by senior auditors and program may be prepared
by juniors based on plan and duly approved by seniors.
 Audit plan focuses on broader area where as programme breaks them into small
area or in form of audit questions, checklists or time frames etc.
b) Reasonable Assurance and Limited Assurance

Reasonable Assurance is a concept relating to the accumulation of the audit evidence
necessary for the auditor to conclude that there are no material misstatements in the
financial statements taken as a whole. An audit in accordance with Nepal Standards on
Auditing is designed to provide reasonable assurance that the financial statements taken as a
whole are free from material misstatement. Audit cannot give an absolute assurance due to
certain inherent limitations that affect the ability of detect material misstatement which may
arise generally due to use of testing, limitation of accounting and control system and mostly
due to the fact that audit evidence is persuasive rather than conclusive.
The objective of a reasonable assurance engagement is a reduction in assurance engagement
risk to an acceptably low level in the circumstances of the engagement as the basis for a
positive form of expression of the practitioner‟s conclusion. In other words, the practitioner
expresses conclusion in the positive form.
The objective of a limited assurance engagement is a reduction in assurance engagement risk

to a level that is acceptable in the circumstances of the engagement, but where that risk is
greater than for a reasonable assurance engagement, as the basis for a negative form of
expression of the practitioner‟s conclusion. In other words, the practitioner expresses
conclusion in the negative form.
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Audit and Assurance
Suggested Answers
Total No. of Questions- 7 Total No. of Pages- 10

Marks
a) M/s DC Limited signed an agreement with workers for increase in wages with
retrospective effect. The outflow on account of arrears was for 2011-12 Rs. 10.00
lakhs, for 2012-13 Rs. 12.00 lakhs and for 2013-14 Rs. 12.00 lakhs. This amount
is payable in September, 2014. The accountant wants to charge Rs. 22.00 lakhs as
prior period charges in financial statement for 2014-15.
b) X Ltd. sold theapartment to M Ltd. for Rs. 60 lakhs on 30.09.2014 and gave
possession of the property to M Ltd. However, Malpotdocumentation and legal
formalities are pending. Due to this, the company has not recorded the sale and
has shown the amount received as an advance. The book value of the building is
Rs. 25 lakhs as on March 31, 2014.
c) Manu Manufacturing Limited acquired an asset which has been declared by
municipality as not meeting the requirements of environment laws which have
been recently enacted. The asset has to be destroyed as per the law. The asset is
carried in the Balance Sheet at the year end at Rs. 6,00,000. The estimated cost of
destroying the asset is Rs. 70,000. The accountant wishes to charge off net
balance of Rs.5,30,000 in next 5 years.
d) KP is Chartered Accountant Member of the Institute of Chartered Accountants of
Nepal. He could not pay off the loan taken from one of the Commercial Bank.
The Bank blacklisted and published the name in national daily newspaper. The
Bank wrote a letter to ICAN for action.
Answer
a) The term prior period item refers only to income or expenses which arise in the current
period as a result of errors or omission in the preparation of the financial statements of
one or more prior periods. The term does not include other adjustments necessitated by
circumstances, which though related to prior periods are determined in the current period.
The full amount of wage arrears paid to workers will be treated as an expense of current
year and it will be charged to profit and loss account as current expenses and not as prior
period expenses. It may be mentioned that additional wages is an expense arising from
the ordinary activities of the company.
Although abnormal in amount, such an expense does not qualify as an extraordinary item.
However, as per NAS, when items of income and expense within profit or loss from
ordinary activities are of such size, nature or incidence that their disclosure is relevant to
explain the performance of the enterprise for the period, the nature and amount of such
items should be disclosed separately.
b) Principles of prudence, substance over form and materiality should be looked into, to
ensure true and fair consideration in a transaction. In the given case, the economic reality
XES P.T.O.
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(2)
and substance of the transaction is that the rights and beneficial interest in the property
has been transferred although legal title has not been transferred. Hence, X Ltd. should
record the sale and recognize the profit of Rs. 35 lakhs in its financial statements for the
year ended 31st March, 2015; value of building should be removed from the balance
sheet.
Therefore the treatment given by the company is not correct.
c) As per NAS on Impairment of Assets, impairment loss is the amount by which the
carrying amount of an asset exceeds its recoverable amount, where, recoverable amount
is the higher of an asset‟s net selling price and its value in use·. In the given case,
recoverable amount will be nil [higher of value in use (nil) and net selling price is also
nil. Thus impairment loss will be the sum of Rs. 670,000 including the cost of disposable
of the fixed assets.
Therefore, asset is to be fully impaired and impairment loss of Rs. 6,70,000 has to be
recognized as an expense immediately in the statement of income as per NAS.
d) As per section 22 of Nepal Chartered Accountants Act, 1997 on provision of removal of

names and re-instatement, the Council may issue an order to remove the name of any
member from the Membership Register on any of the following circumstances:-
 If he is convicted by a court in a criminal offense involving moral turpitude and

punished therefor,
 If he fails to pay any fees required to be paid to the Institute,
 If he fails to abide by the professional conduct referred to in this Act and the Rules
framed under this Act,
 If he becomes unsound-minded, or
 If he is dead.
Based on the above provision, mere on the ground of loan defaulter, ICAN cannot initiate
action.
a) The auditor of a company is unable to obtain audit evidence relating to business
promotion expenditures of Rs. 1 lakh. The company has earned net profit of Rs. 1
billion and has net asset base of Rs. 10 billion. The management explains that the
expenditure is genuine although the said invoices are misplaced. However, auditor
requests the management either not to charge the said promotional expenditure to
profit or loss statement or he will qualify his audit report. The auditor does not
have any issue raising question on the faithful presentation and preparation of the
b) XYZ has trade receivable balance of Rs. 1 crore as on year end date. The cut off
procedure indicates that cheque of Rs 25 lakhs received in the last week of the
year was not entered in the books and it was entered in cheques in hand register.
In the history of the company the cheques are never lost or misappropriated and
the cheques are deposited within the first week of receipt. These cheques were
also deposited and trade receivable balances were accordingly reduced in the next
year.
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c) Quantity of an inventory item as per records was 4 lakhs units as on the year-end
date. Auditor was present during the inventory count at the year-end date and he
noticed that only 350,000 units were there during count. Management explains
that there might be counting error because the record was correct and reconciled
with opening stock, purchases and sales.
d) The audit report and the general purpose financial statements of XYZ Pvt.
Limited for the year 2070/71 were signed by an auditor. The audited financial
statements were submitted to tax authority along with the income tax return and to
a Bank also for loan processing. It was noted that the profit of the company was
Rs 1 crore in the financial statement submitted to tax authority and Rs 10 crores in
the financial statements submitted to Bank in the same financial year which was
audited by the same auditor. Please comment whether auditor shall be held
responsible for professional misconduct.
Answer
a) As per NSA 705,"Modification to the opinion in the independent Auditor's Report', the
auditor shall express a qualified opinion when:
i) The auditor, having obtained sufficient appropriate audit evidence, concludes that
misstatements, individually or in the aggregate, are material, but not pervasive, to
the financial statements; or
ii) The auditor is unable to obtain sufficient appropriate audit evidence on which to
base the opinion, but the auditor concludes that the possible effects on the financial
statements of undetected misstatements, if any, could be material but not pervasive.
Rs 1 lakh expenses for a company which earns net profit of Rs 1 billion and having net
assets base of Rs 10 billion seems to be immaterial/insignificant because omission or
misstatement of expenditure by Rs 1 lakh in this case is unlikely to affect the decision
of the users due to this omission/misstatement. Since the auditor does not have any
other issue on faithful preparation and presentation of the financial statements,
qualifying audit opinion for immaterial impact does not seem to be appropriate. The
auditor should however communicate the finding through management letter with the
recommendation to strengthen the system of proper maintenance and retention of
supporting evidence.
b) Internal control procedure of the company seems to be appropriate to record all cheques
which have not been deposited on the same date and keep it properly till deposited.
However, at the year end all balances should also reflect the true and fair view. In the
given case since no entries are made for cheques in hand, cash balance is understated
and trade receivable balances are overstated by Rs 25 lakhs. So, the company should
deduct the trade receivable balance in the current year itself thereby presenting cheques
in hand under cash and cash equivalents. In the next year when cheques are deposited,
cash in hand balance will be reduced and bank balance should be increased.
c) Certain audit evidences are more reliable than the other audit evidences. Stock quantity
as recorded in the stock ledger was reconciled with opening stock, purchases and sales.
But on physical verification, stock quantity was found to be short. Since the auditor
himself has observed that stock quantity as per physical verification is lower than the
quantity as per record, the evidence as per self-verification of the auditor should be
considered as more reliable than the recorded information. The auditor should consider
whether to conclude based on the evidence he/she has in hand or go further corrective
evidence.
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d) In the given case it seems that either:

Sub section (11) of Section 34 of Nepal Chartered Accountants Act has clearly
explained that no member shall knowingly or recklessly mention any false matter in
any notice, explanation or statement required to be given to any office or department of
Government of Nepal or any organization. In a given case the auditor has signed two
balance sheets of different figures of the same organization of the same financial years
to different party's purpose on the request or pressure of the client. This is a serious
misconduct by the auditor. Hence disciplinary committee will take immediate action
against him.
The auditor has signed both financial statements of the same company for the same
year in which profits are different. It clearly indicates professional misconduct on the
part of the auditor and hence he shall be liable for disciplinary action.
a) Knowledge of client business is important for effective and efficient conduct of
the audit. Please explain the various sources from which the auditor can obtain
such knowledge.
b) Audit evidences collected from different sources and of different nature are not
equally reliable. Please explain.
c) It is not necessary to sign audit engagement letter every year in case of
recurring/ongoing audits. Please explain the statement as per provisions of NSA
210.
Answer
a) Sources for obtaining Knowledge of the client business: The various sources from
which the auditor can obtain knowledge of the client business are:
i) General economic factors and industry conditions affecting the client‟s business.
ii) Important characteristics of the client, its business, its financial performance and
its reporting requirements including changes since the date of the prior audit.
iii) The general level of competence of the management.
iv) The clients annual report to shareholders.
v) Minutes of meetings of shareholders, board of directors and important
committees.
vi) Internal financial management reports for current and previous periods, including
budgets.
vii) The previous year audit working papers and other relevant files.
viii) Firm personnel responsible for non-audit services to the client who may be able
to provide information on matters that may affect audit.
ix) Discussions with the client.
x) The client‟s policy and procedures manual.
xi) Relevant publications of ICAN and other professional bodies, industry
publications, trade journals, magazines, newspapers etc.
xii) Consideration of state of economy and its effect on the client‟s business and
xiii) Visits to the client‟s premises and plant facilities.
b) Reliability of audit evidences: The reliability of audit evidence is influenced by its

source and by its nature and is dependent on the individual circumstances under which it
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is obtained. Generalizations about the reliability of various kinds of audit evidence can
be made; however, such generalizations are subject to important exceptions. (1)
While recognizing that exceptions may exist, the following generalizations about the
reliability of audit evidence may be useful:
o Audit evidence is more reliable when it is obtained from independent sources
outside the entity.
o Audit evidence that is generated internally is more reliable when the related
controls imposed by the entity are effective.
o Audit evidence obtained directly by the auditor (for example, observation of the
application of a control) is more reliable than audit evidence obtained indirectly or
by inference (for example, inquiry about the application of a control).
o Audit evidence is more reliable when it exists in documentary form, whether paper,
electronic, or other medium (for example, a contemporaneously written record of a
meeting is more reliable than a subsequent oral representation of the matters
discussed).
o Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles.
c) Audit Engagement Letter in Recurring Audit: As per NSA 210, 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.
a) What is the requirement of Code of Ethics regarding use and disclosure of
confidential information of client acquired by a professional accountant as a result
of his service to the client?
b) What are the fundamental principles of the Code of Ethics issued by ICAN?
c) A Chartered accountant who is a member of ICAN is a full time employee of
ABCD & Associates (a CA firm registered with ICAN). During the audit of an
INGO from his firm (ABCD), he was requested by the client to audit a partner
organization of INGO in his personal capacity. Shall he accept the appointment of
auditor of Partner Organization of INGO?
Answer
a) Use and Disclosure of Confidential Information of Client: Code of Ethics requires
that a professional accountant shall not use confidential information acquired as a result
of his/her service to the client to his/her personal advantage or the advantage of third
parties. Similarly, a professional accountant shall not disclose confidential information
KHF P.T.O.
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(6)
acquired as a result of his/her service to the client without proper and specific authority
or unless there is a legal or professional right or duty to disclose such information.
b) Fundamental Principles of Code of Ethics: There are the following fundamental
principles:
i. Integrity – to be straightforward and honest in all professional and business

relationships
ii. Objectivity– to not allow bias, conflict of interest or undue influence of others to
override professional or business judgments.
iii. Professional Competence and Due Care – to maintain professional knowledge

and skill at the level required to ensure that a client or employer receives
competent professional service.
iv. Confidentiality– neither discloses any confidential information to third parties

without proper and specific authority nor use the information for the personal
advantage of the professional accountant or third parties.
v. Professional Behavior – to comply with relevant laws and regulations and avoid
any action that discredits the profession.
c) Audit by a CA member in employment: As per decision of the council of ICAN, a

CA member of ICAN who is in full time employment is not entitled to hold active
Certificate of Practice. In other words, a CA member can either be in full time
employment or in practice (also popularly known as one man one profession). So, in
the give case the CA member should not accept the audit assignment in his personal
name.
a) Write down the functions, duties and powers of audit committee Company Act,
2063.
b) Write down the disqualifications of the auditor as per Company Act, 2063.
Answer
a) Section 165 of the company act 2063 has prescribed the functions, duties and powers of
audit committee: The functions, duties and powers of the audit committee formed
pursuant to subsection (1) of Section 164 shall be as follows:
(a) To review the accounts and financial statements of the company and ascertain
the truth of the facts mentioned in such statements;
(b) To review the internal financial control system and the risk management system
of the company;
(c) To supervise and review the internal auditing activity or the company;
(d) To recommend the names of potential auditors for the appointment of the
auditorof the company, fix the remuneration and terms and conditions of
appointment of the auditor and present the same in the general meeting for the
ratification thereof;
(e) To review and supervise as to whether the auditor of the company has observed
such conduct, standards and directives determined by the competent body
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pursuantto theprevailing law as required to be observed in the course of doing
auditing work;
(f) Based on the conduct, standard and directives determined by the competent
body pursuant to the prevailing law, to formulate the polices required to be
observed by the company in respect of the appointment and selection of the
auditor;
(g) To prepare the accounts related policy of the company and enforce, or cause to
be enforced, the same;
(h) Where any regulatory body has provided for the long term audit report to be set
out in the audit report of the company, to comply with the terms required
preparing such report;
(i) To perform such other terms as prescribed by the board of directors in respect of
the accounts, financial management and audit of the company.
b) Section 112 (1) of the company act 2063 stated the disqualification of auditor.
Accordingly none of the following persons or the firms or companies in which such
persons are partners shall be qualified for appointment as auditor and shall, despite
appointment as auditor, continue to hold office:
(a) A director, advisor appointed with entitlement to regular remuneration or cash
benefit, a person or employee or worker involved in the management of the
company or a partner of any of them or an employee of any of such partners or a
close relative of a director or partner, out of them, or an employee of such
relative;
(b) A debtor who has borrowed moneys from the company in any manner, or a
person who has failed to pay any dues payable to the company within the time
limit and is in such arrears or close relative of such person;
(c) A person who has been sentenced to punishment for an offense pertaining to
audit and a period of five years has not elapsed thereafter;
(d) A person who has been declared insolvent;
(e) A substantial shareholder of the company or a shareholder holding one percent
or more of the paid up capital of the company or his close relative;
(f) A person who has been sentenced to punishment for an offense of corruption,
fraud or a criminal offense involving moral turpitude and a period of five years
has not elapsed thereafter;
(g) A person referred to in Sub-section (3) of Section 111;
(h) In the case of a public company, any person who works, whether full time or
part time, for any governmental body or anybody owned fully or partly by the
Government of Nepal or any other company or a partner of such person or a
person who is working as an employee of such partner or a person who is
authorized to sign any documents or reports to be prepared by the management
of the company;
(i) A company or corporate body with limited liability;
(j) A person having interest in any transaction with the company or his/her close
relative or a director, officer or substantial shareholder of another company
having any interest in any transaction with the company.
a) Audit risk at the financial statement level

b) Competence and objectivity of the expert engaged by auditor
c) Competence of the audit engagement team
d) Financial indicators of going concern issue
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Answer
a) Audit risk is considered at the financial statement level during the audit planning
process. At this time, the auditor should undertake an overall audit risk assessment
based on his knowledge of the client‟s business, industry, management, control
environment and operations. Such an assessment provides preliminary information
about the general approach to the engagement, the auditor‟s staffing needs and the
framework within which materiality and audit risk assessments can be made at the
individual account balance or class of transactions level. As part of this overall risk
assessment, the auditor should consider whether there is potential for pervasive
problems, for example, liquidity or going concern problems.
b) i. When planning to use the work of an expert, the auditor should assess the
professional competence of the expert which will involve considering the expert‟s:
a. Professional certification or licensing by, or membership in, an appropriate
professional body;
b. Experience and reputation in the field in which the auditor is seeking audit evidence.
ii. The auditor should assess the objectivity of the expert. The risk that an expert‟s
objectivity will be impaired increases when the expert is:
a. Employed by the entity; or
b. Related in some other manner to the entity, for example, by being financially
dependent upon or having an investment in the entity. If the auditor is concerned
regarding the competence or objectivity of the expert, the auditor needs to discuss any
reservations with management and consider whether sufficient appropriate audit
evidence can be obtained concerning the work of an expert.
The auditor may need to undertake additional audit procedures or seek audit evidence
from another expert.
c) The appropriate capabilities and competence expected of the engagement team as a

whole include the following:
 An understanding of, and practical experience with, audit engagements of a similar
nature and complexity through appropriate training and participation.
 An understanding of professional standards and regulatory and legal requirements.
 Appropriate technical knowledge, including knowledge of relevant information
technology.
 Knowledge of relevant industries in which the client operates.
 Ability to apply professional judgment.
 An understanding of the firm‟s quality control policies and procedures.
d) Financial Indicators
 Net liability or net current liability position.
 Fixed‐term borrowings approaching maturity without realistic prospects of renewal
or repayment; or excessive reliance on short‐term borrowings to finance long‐term
assets.
 Indications of withdrawal of financial support by debtors and other creditors.
 Negative operating cash flows indicated by historical or prospective financial
statements.
 Adverse key financial ratios.
 Substantial operating losses or significant deterioration in the value of assets used
to generate cash flows.
 Arrears or discontinuance of dividends.
 Inability to pay creditors on due dates.
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 Inability to comply with the terms of loan agreements.
 Change from credit to cash‐on‐delivery transactions with suppliers.
 Inability to obtain financing for essential new product development or other
essential investments.

a) Hot review & Cold Review in audit
b) Accounting & Auditing
Answer
a) Hot file review or hot review is conducted usually conducted during the audit and/or audit
work is completed but before the auditor‟s report is issued. This in nature is a detailed review
that is conducted with an aim to find out if there s any weakness in application of audit
procedures or if the results have been misinterpreted. Hot reviews are usually carried out
usually by the senior the audit team or someone with the same authority who is not connected
with the engagement. Such reviews mostly include meetings with audit team personnel and
their individual work so that both work and the skills of members are improved by pointing out
discrepancies and providing recommendations.
The purpose of a hot review is to identify any key areas that need to be addressed prior to
signing the report. The categories for review which may be undertaken can be described as
follows:
i. Comfort reviews
ii. High risk reviews
iii. Training reviews
iv. Independence reviews
v. NSQC reviews
To summarize, hot review is conducted during the audit work is conducted but before the
auditor‟s report is issued with a prime objective to ensure compliance with relevant auditing
standards and achieving engagement‟s objectives
Cold file review or cold review is an objective evaluation on the date of auditor‟s report and is
performed by the auditor i.e. partner himself when all the audit work has been concluded and
the required sufficient appropriate audit evidence has been obtained and conclusions drawn and
reported. This review usually takes place when the auditor‟s report is signed off. The purpose
of this review is to ensure compliance with relevant auditing standards and to analyze
weaknesses in the way whole audit work is conducted and how it can be improved for next
similar assignments by updating firm‟s quality control standards, training the staff etc.
Normally the cold file review would aim to:
 Identify whether the disclosure requirements had been properly met - incorrect disclosures
are the largest subject of complaints to the Institute.
 Identify whether the Auditing Standards and Regulations have been properly complied
with - each audit would be "scored" using a comprehensive file review checklist.
 Assess the effectiveness of any independent manager review and the partner review,
looking for any points that should have been picked up by a manager but had not been, and
likewise with the partner.
To summarize, cold review is conducted with a view to check for the weaknesses in the firm‟s
quality control procedures and system, proficiency of audit team members and how they can be
improved to make later audit assignment more effective and efficient.
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b) Distinction between Accounting and Auditing:

Point of
difference Accounting Auditing
1. Meaning It is recording of all the day to It is the critical examination of
day transactions in the books of the transactions recorded in the
accounts leading to preparation books of accounts.
of financial statements.
2. Nature It is concerned with finalization
It is concerned with establishment
of accounts. of reliability of financial
statements.
3. Objects Accounting commences when Auditing begins when accounting
book keeping ends. ends.
4. It involves various financial It depends upon the agreement or
Commencement statements. It involves upon the provisions of law.
maintenance of books of
accounts.
5. Scope It does not go beyond books of It goes beyond books of accounts.
accounts.
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CAR = Tier I capital + Tier II Capital
Risk weighted assets
 Tier I capital is core capital which includes equity capital and disclosed reserves.
 Tier II capital is supplementary capital which includes items such as revaluation reserves,
undisclosed reserves, hybrid instruments and subordinated term debts.
 Risk weighted assets is banks assets or off balance sheet exposure weighted according to risk.
Question 6(C) Solution

Realization concept in accounting, also known as revenue recognition principle, refers to
the application of accruals concept towards the recognition of revenue (income). Under
this principle, revenue is recognized by the seller when it is earned irrespective of
whether cash from the transaction has been received or not. In case of sale of goods,
revenue must be recognized when the seller transfers the risks and rewards associated
with the ownership of the goods to the buyer. This is generally deemed to occur when the
goods are actually transferred to the buyer. Where goods are sold on credit terms, revenue
is recognized along with a corresponding receivable which is subsequently settled upon
the receipt of the due amount from the customer. In case of the rendering of services,
revenue is recognized on the basis of stage of completion of the services specified in the
contract. Any receipts from the customer in excess or short of the revenue recognized in
accordance with the stage of completion are accounted for as prepaid income or accrued
income as appropriate.
Question 6(D) Solution

Section 45 the Bank and Financial Institution Act, 2063 requires that every Bank
Financial Institution which has obtained a license to deal in foreign exchange must
maintain a Exchange Equalization Fund. The bank and financial institution must transfer
25% of the revaluation profit earned as a result of changes in the exchange rates of
foreign currencies other than the Indian currency every year at the end of the same fiscal
year to the exchange equalization fund. The amount credited to the Exchange
Equalization Fund may not be spent or transferred for any purpose other than the
adjustment of losses resulting from the devaluation of foreign currencies without the
approval of the Nepal Rastra Bank.
Audit & Assurance

Suggested

1. As an auditor, give your opinion with explanations on the following cases:

a) A company has 10 vehicles with carrying amount of 5 crores. The company has
purchased a new machinery worth Rs 8 croreby exchanging with its 10 used vehicles
and making further payment of Rs 2 crores in cash. The company management
derecognizes vehicles from its financial statements and recognizes machinery at Rs 7
crores (5 crores plus 2 crores).
b) A company‘s financial year ends on 31 March 2015 for group accounting purpose.
Due to devastating earthquake in the month of April 2015, the company‘s factory
building with carrying amount of Rs 5 crores was totally destroyed. The board of
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director authorized the financial statements for issue on 30June 2015. The financial
statements include the destroyed building at Rs 5 crore although the Notesto account
makes appropriate disclosure about the earthquake and the destruction of the factory
building.
c) PQR limited has computed the cost of the inventory using last in fast out (LIFO)
method and the value comes to Rs 2 crores (if the cost of the inventory is computed as
per first in first out formula, its cost will be Rs 2.5 crores). Net realizable Value of the
stock is Rs 2.25 crores. Since the policy of the company is to present inventory at
lower of cost or NRV, the company has presented inventory in the financial statement
at Rs 2 crores, being the lowest.
d) A company purchased a plant at the cost of Rs 10 crores on 1 Srawan 2066 and the
company is charging depreciation on straight line basis over 10 years useful life
assuming there will be no scrap. In the year 2071/72 the company decides to charge
depreciation as per written down value method @ 10%. The company management
considers this as the change in accounting estimate and accordingly considers the
effect due to the change prospectively; i.e. depreciation charged in the year 2071/72 is
Rs 50 lakh and no adjustment in retained earnings and carrying amount of machinery.
Answer
a) The company has acquired new machinery by exchanging with used vehicles and making
further payment of Rs 2 croresin cash. As per NAS 16, the assets acquired in such case shall be
recognized at the fair which is Rs 8 crore in this case. So, Machinery should be recognized at Rs
8 crores. Since 2 Crores has been paid in cash, disposal of vehicle should be recognized at Rs 6
crore thereby resulting into gain of Rs 1 crore on disposal of vehicle because the carrying
amount of vehicle in the books of the company is Rs 5 crore. Hence the treatment of
recognizing new machinery at Rs 7 crore and not recognizing gain of Rs 1 croreon disposal of
vehicle by the management does not seem to be appropriate in accordance with NAS 16.
b) Earthquake occurred in the month of April 2015 which is after the end of the accounting year
(31 March 2015) and before the date when the financial statements are authorized for issue (30
June 2015). Hence it is an event after reporting period. Since this event does not provide further
evidence of the condition existed at the end of reporting period (31 March 2015) and it indicates
the conditionthat arose after the reporting period, it is a non-adjusting event. So, the carrying
value of the destroyed factory building need not be adjusted in the financial statements and
appropriate disclosure in the Notes to account seems to be in line with NAS 10.
c) As per NAS 2, cost of inventories should be assigned as per first in first out or weighted average
formula. Determining the cost as per last in first out is not allowed. So, despite the fact the cost
of inventories of PQR will be more if FIFO is used than if LIFO is used, the cost should be
determined as per FIFO. Hence the cost of inventory shall be taken as 2.5 crore in the given
case instead of 2 crore as per LIFO. Since NRV of the inventory is 2.25 crores, lower than the
cost, inventory shall be presented at Rs 2.25 crores in the financial statements.
d) As per NAS 8,
Accounting policies are the specific principles, bases, conventions, rules and practices applied
by an entity in preparing and presenting financial statements.
A change in accounting estimate is an adjustment of the carrying amount of an asset or a

liability, or the amount of the periodic consumption of an asset, that results from the assessment
of the present status of, and expected future benefits and obligations associated with, assets and
liabilities. Examples of estimate provided in the standard includes the useful lives of, or
expected pattern of consumption of future economic benefits embodied in depreciable assets.
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Straight line method or written down value method of depreciation reflects the estimate of
useful life and expected pattern of consumption of future economic benefits from depreciable
assets. Hence change of depreciation method from straight line to WDV is the change in
accounting estimate and not the change in accounting policy. So, the effect of the change
considered by the management in the preparation of the financial statements seems to be
appropriate.
2. Answer the following:

a) Explain ‗Assurance Report‘ as an element of assurance.
b) Explain the circumstances when work of the internal audit function cannot be used by
External Auditor.
c) ‗Doing a statutory audit is full of risk. `Narrate the factors which cause the risk.
Answer
a) Assurance engagement is an engagement in which a practitioner auditor expresses a conclusion

designed to enhance the degree of confidence of the intended users other than the responsible party
about the outcome of the evaluation or measurement of a subject matter against criteria.
The practitioner auditor provides a written report containing a conclusion that conveys the
assurance obtained about the subject matter information. NSAs, NSREs and NSAEs establish basic
elements for assurance reports. In addition, the practitioner considers other reporting
responsibilities, including communicating with those charged with governance when it is
appropriate to do so. In an assertion-based engagement, the practitioner's conclusion can be
worded either:
In terms of the responsible party's assertion (for example: "In our opinion the responsible party's
assertion that internal control is effective, in all material respects, based on XYZ criteria, is fairly
stated"); or
Directly in terms of the subject matter and the criteria (for example: "In our opinion internal
control is effective, in all material respects, based on XYZ criteria").
In a direct reporting engagement, the practitioner's conclusion is worded directly in terms of the
subject matter and the criteria.In a reasonable assurance engagement, the practitioner expresses the
conclusion in the positive form, for example: "In our opinion internal control is effective, in all
material respects, based on XYZ criteria." This form of expression conveys "reasonable
assurance."
Having performed evidence gathering procedures of a nature, timing and extent that were
reasonable given the characteristics of the subject matter and other relevant engagement
circumstances described in the assurance report, the practitioner has obtained sufficient appropriate
evidence to reduce assurance engagement risk to an acceptably low level. In a limited assurance
engagement, the practitioner expresses the conclusion in the negative form, for example, "Based
on our work described in this report, nothing has come to our attention that causes us to believe
that internal control is not effective, in all material respects, based on XYZ criteria."
This form of expression conveys a level of "limited assurance" that is proportional to the level of
the practitioner's evidence-gathering procedures given the characteristics of the subject matter and
other engagement circumstances described in the assurance report.
b) The external auditor‘s evaluation of whether the internal audit function of organizational status
and relevant policies and procedures adequately support the objectivity of the internal auditors, the
level of competence of the internal audit function, and whether it applies a systematic and disciplined
approach may indicate that the risks to the quality of the work of the function are too significant and
therefore it is not appropriate to use any of the work of the function as audit evidence.
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Consideration of the factors of NSA 610 individually and in aggregate is important because an
individual factor is often not sufficient to conclude that the work of the internal audit function cannot be
used for purposes of the audit. For example, the internal audit function‘s organizational status is
particularly important in evaluating threats to the objectivity of the internal auditors.
If the internal audit function reports to management, this would be considered a significant threat to the
function‘s objectivity.
This is because of the possibility that the engagement team will use the results of the internal audit
service without properly evaluating those results or without exercising the same level of professional
skepticism as would be exercised when the internal audit work is performed by individuals who are not
members of the firm.
c) An independent audit whether performed in terms of relevant statutory legislation or in terms of

the engagement, the auditor has to be reasonably satisfied as to whetherthe information contained in the
underlying accounting records and other source datais reliable for the preparation of financial
statements. Since the entire process of auditing is based on the assessment of judgements made by the
management of theentity as well as evaluation of internal controls, the audit suffers certain
inherentrisks. Factors which can such risk in conducting an audit are discussed below:
(i) Exercising judgement on the part of the auditor: The auditor‘s work involvesexercise of judgement,
for example, in deciding the extent of audit procedures andin assessing the reasonableness of the
judgements and estimates made bymanagement in preparing the financial statements.
(ii) Nature of audit evidence: The auditor normally relies upon persuasive evidenc erather than
conclusive evidence. Even in circumstances where conclusive evidenceis available, the cost of
obtaining such an evidence may far exceed the benefits.
(iii) Inherent limitations of internal control: Internal control can provide only reasonable, but not
absolute, assurance on account of several inherent limitations such as potential for human error,
possibility of circumstances of control through collusion, etc.
On account of above, it is quite nature that an audit suffers from control risk on account of inherent
limitations of internal control risk and detection risk on account oftest nature of audit and judgement
and estimates involved in formulating accounting policies.
3. Give your comments on the following:
a) The financial statement of Sagarmatha Ltd. for the fiscal year 2070/71 has been
approved by its Board of Directors on 1 Kartik 2071; auditor has issued his audit
report on 25 Aswin 2071.
b) The management of Sathi Limited suggested for quick completion of the statutory
audit that it would give its representation about the receivables in terms of their
recoverability. The management also acknowledged to the auditors that the
management would give their representation after scrutinizing all accounts diligently
and they own responsibility for any errors in these respects. They wanted auditors to
complete the audit checking all other important areas except receivables. The auditor
certified the account clearly indicating in his report the fact of reliance he placed on
representation of the management.
c) Organo Pvt. Ltd., manufacturing noodles, has valued at the year end its closing stock
of packed finished goods for which firm sales contracts have been received, at
realizable value inclusive of profit and cash incentive. As at the year end, the
ownership of the goods has not been transferred to the buyers.
Answer
a) Per NSA 700 , the auditor should date the report as of the completion date of the audit. This
informs the reader that the auditor has considered the effect on the financial statements and on
the reports of events and transactions of which the auditor become aware and that occurred up
to that date. Since the auditor`s responsibility is to report on the financial statements as prepared
and presented by management, the auditor should not date the report earlier than the date on
which the financial statements are signed or approved by Board of Directors.
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b) The management of Sathi Limited wants the auditor to carry out audit on all areas, except on
area of receivables. There cannot be any restriction on scope of audit in case of statutory audit.
The management representation, according to NSA 580, cannot substitute other audit evidence
that the auditor could reasonably expect to be available to the auditor.
The audit evidence for checking receivables – say, invoices, debt acknowledgement documents,
receipts, statement of accounts, confirmations etc., are available evidences which auditor is duty
bound to verify.
Just because management had owned responsibility for the correctness of its evaluation of
receivables, the auditor cannot shirk his responsibility. This is negligence on his part if he relies
on the management representation without assessing the corroborative available evidences.
c) Valuation of Inventories: NAS 2 requires that inventories should be valued as lower of cost and
Net realizable value(NRV). A departure from the general principle can be made if the NAS is
not applicable or having regard to the nature of industry. NAS 2 also states that (a) work in
progress arising under construction contracts, including directly related service contracts (b)
work in progress arising in the ordinary course of business of service providers;(c) shares,
debentures and other financial instruments held as stock-in-trade; and (d) producers‘ inventories
of livestock, agricultural and forest products are measured as NRV based on established
practices. In the given case the sale is assumed under a forward contract but the goods are not of
a nature covered by the above exceptions taking into account the facts the closing stock of
finished goods should have been valued at cost, as it is lower than the realizable value (as it
includes profit). Further, sale cash incentives should not be included for valuation purposes.
The policy adopted by the Organo Pvt. Ltd. for valuing its closing stock of inventory of finished
goods on selling price plus sale incentives is not correct. The statutory auditor should give a
qualified report.
a) Your CA firm has been allotted with Information Systems Audit of one of the reputed
Commercial Bank of Nepal. How would you assess the reliability of internal control
system in computerized information system?
b) Mr. Abhyudaya has been appointed as an Auditor of Kashvi Enterprises. After
appointment, the books of Kashvi Enterprises have been destroyed by earthquake.
State the extensive procedures to be followed for audit in such scenario.
c) What do you mean by the term 'Sufficient Appropriate Audit Evidence'? State various
factors that help the auditor to ascertain as to what is sufficient appropriate audit
evidence.
Answer
a) For evaluating the reliability ofinternal control system in CIS, the auditor would consider the
followings:-
 That authorised, correct and complete data is made available for processing.
 That it provides for timely detection and corrections of errors.
 That in case of interruption due to mechanical, power or processing failures,the system restarts
without distorting the completion of entries and records.
 That it ensures the accuracy and completeness of output.
 That it provides security to application softwares & data files against fraud etc.
 That it prevents unauthorised amendments to programs.
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b) The scenario is guided by the audit of incomplete records. Audit of incomplete records are
generally required under the following two circumstances.
(i) When accounts have been maintained on single entry basis or
(ii) Accounting record may be destroyed by fire, flood etc. or seized by government authorities.
The auditor may be required to follow extensive procedures, which include:

(a) obtain list of records available
(b) Ensure that management reconstructs/compile records to the extent possible.
(c) Perform compliance procedure to assess whether internal control system is in operation.
(d) Vouch transactions in books of accounts with appropriate evidence.
(e) Examine system of custody of cash receipts, cheque book etc.
(f) Conduct surprise verification of cash & inventory.
(g) Verify fixed assets by physical verification.
(h) Formulate appropriate audit opinion.
A disclaimer of opinion may be necessary if any restriction on scope of audit is enforced.
c) The auditor shall design and perform audit procedures that are appropriate in the circumstances
for the purpose of obtaining sufficient appropriate audit evidence. NSA 500 on ‗Audit Evidence‘
further expounds this concept. According to it, the sufficiency and appropriateness of audit evidence
are interrelated.
Sufficiency is themeasure of the quantity of audit evidence. The quantity of audit evidence needed is
affected by the auditor‘s assessment of the risks of misstatement (the higher the assessed risks, the more
audit evidence is likely to be required) and also by the quality of such audit evidence (the higher the
quality, the less may be required). Obtaining more audit evidence, however, may not compensate for its
poor quality.
Appropriateness is the measure of the quality of audit evidence; that is, it srelevance and its reliability
in providing support for the conclusions on which the auditor‘s opinion is based. The reliability of
evidence is influenced by its source and by its nature, and is dependent on the individual circumstances
under which it isobtained.
NSA 330 requires the auditor to conclude whether sufficient appropriate audit evidence has been
obtained. Whether sufficient appropriate audit evidence has been obtained to reduce audit risk to an
acceptably low level, and thereby enablethe auditor to draw reasonable conclusions on which to base
the auditor‘s opinion,is a matter of professional judgment. Further, NSA 200 contains discussion of
such matters as the nature of audit procedures, the timeliness of financial reporting, andthe balance
between benefit and cost, which are relevant factors when the auditorexercises professional judgment
regarding whether sufficient appropriate audit evidence has been obtained.
In general the various factors which may influence the auditor‘s judgment as to what is sufficient and
appropriate audit evidence are as under:
 Degree of risk of misstatements which may be affected by factors such as the nature of items,
adequacy of internal control, nature and size of businesses carried out by the entity, situations
which may exert an unusual influence on management and the financial position of the entity.
 The materiality of the item.
 The experience gained during previous audits.
 The results of auditing procedures, including fraud and errors which may have been found.
 The type of information available.
 The trend indicated by accounting ratios and analysis.
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a) Elephant Bank Ltd. is the "A" Class Commercial Bank. As per audited financial
statement of FY 2071/72 , its gross loan is Rs. 50,000 million and its gross deposit is
Rs. 63,000 million. The Annual General Meeting of the bank for FY 2071/72 was
conducted on 12 Aswin 2072. The auditor for FY 2072/73 has been appointed by the
bank with audit fees (other than other audit related expenses) of Rs. 1,100,000.
Comment.
b) Is there any conflict of interest if the engagement auditor prepares financial regulation
and internal control system of the same client ?
c) Raman & Associates is the audit firm of registered auditor (B Class). He has carried
out the audit of Prabhu Ltd. for FY 2071/72. The Total Assets or Liabilities of Prabhu
Ltd. for FY 2071/72 as per Financial Statement is Rs. 650 million. Comment.
Answer
a) The decision of 194th Meeting of the Council of the Institute of the Chartered Accountants of
Nepal (ICAN), the minimum fees for listed public financial institutions has been prescribed
which is applicable for appointments made from 1 Shrawan 2072. The fees should be
determined based on Gross Loan or Deposit whichever is higher of immediately preceding year
as follows:
Loan or Deposit Amount (Rs.) Minimum Audit Fees (Rs.)

Exceeding 100,000 Million 25 Lakh
Minimum 01 Lakh
Further it has been mentioned that audit fee of the "A" Class Commercial Bank should not be
less than Rs. 10 Lakh.
In view of the aforesaid council decision, the minimum audit fee (other than other audit related
expenses) of the Elephant Bank Ltd. should be Rs. 20 Lakh since its gross deposit is exceeding
Rs. 50,000 million as of 31 Asadh 2072.
Accordingly decision made by AGM of Elephant Bank Ltd. for audit fees for FY 2072/73 is
not consistent with decision of 194th Meeting of the Council of the Institute of the Chartered
Accountants of Nepal (ICAN).
b) It will not be treated as conflict of interest only on the ground that financial regulation and
internal control system has been prepared by the Auditor. Though auditor has to assess the
effectiveness of such imposed system during the course of audit. Accordingly the chances of
excusing by the auditor on the lapses of implementation of those system observed during
auditing process could not be ruled out which will impair the very efficiency and independence
of the auditor. Hence chances of arising the situation of conflict of interest have been existed in
such circumstances.
c) As per the Rule 53 of the Nepal Chartered Accountants Regulations 2061 (as amended) ; the
limit (threshold) for audit of entities based on volume of total assets or total liabilities has been
prescribed unlimited amount for CA member and upto Rs. 600 million , Rs.150 million and Rs.
20 million for B, C & D class members respectively.
In view of the above amended rule of the ICAN Regulation 2061, Raman & Associates, being B
class audit firm is not eligible for carrying out the audit of Prabhu Ltd. for FY 2071/72 , since
total assets or total liabilities of the company exceeds the prescribed limit of Rs. 600 million.
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6. Write short notes on the following:

a) Detection risk
b) Date of auditor‘s report
c) Materiality
d) Going concern
Answer
a) Detection Risk: It is the risk that the auditor will not detect a misstatement that exists in an
assertion that could be material, either individually or when aggregated with other
misstatements. Detection risk is a function of the effectiveness of an audit procedure and of its
application by the auditor.
b) Date of Auditor’s Report: The auditor should date the audit report no earlier than the date on
which the auditor has obtained sufficient appropriate audit evidence on which to base the
opinion on the financial statements. Sufficient appropriate audit evidence should include
evidence that the entity‘s complete set of financial statements has been prepared and that those
with the recognized authority have asserted that they have taken responsibility for them.
c) Materiality: Information is material if its omission or misstatement could influence the
economic decisions of users taken on the basis of the financial statements. Materiality depends
on the size of the item or error judged in the particular circumstances of its omission or
misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary
qualitative characteristic which information must have if it is to be useful. The assessment of
what is material is a matter of professional judgment. The auditor should consider materiality
and its relationship with audit risk when conducting an audit.
d) Going Concern: The going concern assumption is a fundamental principle in the preparation of
financial statements. Under the going concern assumption, an entity is ordinarily viewed as
continuing in business for the foreseeable future with neither the intention nor the necessity of
liquidation, ceasing trading or seeking protection from creditors pursuant to laws or regulations.
Accordingly, assets and liabilities are recorded on the basis that the entity will be able to realize
its assets and discharge its liabilities in the normal course of business.
7. Distinguish between:
a) Qualified report and adverse report
b) Reserves and provisions
Answer
a) Points of difference between Qualified Report and Adverse Report:
1. A qualified opinion should be expressed when the auditor concludes that an unqualified opinion
cannot be expressed but that the effect of any disagreement with management is not so material
and pervasive as to require an adverse opinion, or limitation on scope is not so material and
pervasive as to require a disclaimer of opinion. An adverse opinion should be expressed
when a effect of a disagreement is so material and pervasive to the financial statements that the
auditor concludes that the qualification of the report is not adequate , to disclose the
misleading or incomplete nature of the financial statement.
2. In qualified report, auditor`s reservation generally written as "subject to or except for, we report
that the financial statements shows the true & fair view". Whereas in case of adverse report, the
auditor states that " the financial statements do not present a true and fair view of the state of
affairs and working results".
3. In qualified report, auditor gives an opinion subject to certain reservations whereas in the case
of adverse report the auditor concludes that on the basis of his examination he is not satisfied
with the affirmation made in the financial statements.
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b) Points of difference between Reserves & Provisions:
1. Reserve is an appropriation of profit whereas provision is a charge against Profit.

2. Reserves are not intended to meet any liability, contingency or diminution in the value
of assets. Provisions are made to provide for depreciation, renewal or a known liability or a
disputed claim.
3. Reserves cannot be created unless there is a profit except revaluation reserve and
capital subsidy. Provisions must be created whether or not there is profit.
4. Reserves are generally optional except in certain situations – Capital Redemption
reserve, Debenture Redemption Reserve, Declaration of dividend higher than 10%
etc. Provisions are not optional and have to be made as per generally accepted accounting
principles.
5. Reserves are shown on the liability side. Provisions for depreciation and provision for
doubtful debts are shown as deduction from respective assets. Provision for liability is
shown on the liability side.
Corporate & Other Laws

Suggested Answer
Total No. of Questions - 7 Total No. of Printed Pages -14

1. Answer the following questions:
a) The Annual General Meeting of Nirman Engineering Pvt. Ltd. with
more than 2/3 majority passed resolution directing the Boards of
Directors to carry on the business of manufacturing high voltage
turbines in joint venture with Benjamin Electrical Accessories Ltd. The
majority of the Directors opposed this resolution and they disapprove
the resolution. Advise the directors about the validity of their action.
b) Blue Sky Air Public Company is a leading airways company with
notable profits. The majority of shareholders have intended to convert
their company into a private limited company, but no idea about the
relevant legal provisions; therefore, the company wants your advice.
Advise them on the issue of conversion of a public limited company into
a private limited company under the provisions of the Companies Act,
2063.
c) XYZ Pvt. Ltd. has classified and issued shares with different rights
amending its memorandum of association and articles of association,
but some of the shareholders are not satisfied with the classification.
What are the provisions to obtain shareholders rights in share back?
Explain referring the provisions of the Companies Act, 2063.
d) Mr. ‘A’, a director of Palpasa Private Limited unable to attend the 10th
AGM of the company and in his place appoints Mr. 'B' porxy to attend
the AGM in the capacity of the director. Is the appointment of proxy
valid? How? Explain what quorum is required for holding a general
meeting of the Private Company under the provisions of the Companies
Act, 2063?
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Audit and Assurance
Suggested

Marks
1. As an auditor, give your opinions with reasons on the following cases: (4×
×5=20)
a) The following information pertains to the trading stock of a company:
Product Historical cost (Rs.) Net Realizable value (Rs.)
Color Tvs 200,000 270,000
Black & White TVs 115,000 150,000
Ordinary Bikes 200,000 185,000
Sport bikes 110,000 115,000
Computers 80,000 100,000
Total 705,000 820,000
The company has a policy to value stock at lower of cost or net realizable value
and accordingly trading stock has been valued at Rs. 705,000 in the balance sheet
of the company.
b) Raman Mahaseth, the auditor of a company has signed the audit report on 15 Asoj
2071. He has obtained written representation from the management of the
company dated 15 kartik 2071; i.e. the date of the annual general meeting of the
company.
c) A company purchased machinery on 1st Asoj 2071 for Rs. 10 crores on credit for
6 months. The seller normally does not sell such machineries on credit and cash
price of the machinery is Rs 9.5 crores. The buying company recognizes
machinery at Rs. 10 crores in the books on 1 st Asoj and the liability is fully paid
on Falgun Masant.
d) Total trade receivable of a company is Rs. 20 crores. It includes receivables from
Maheswary Limited amounting to Rs 2 Crores. Maheswary Limited was declared
bankrupt on 15th Asoj 2071; i.e. after the reporting period of Ashad end 2071 and
before the date when financial statements were authorized for issue; i.e. Asoj
Masant 2071. The company management claims that the carrying amount of trade
receivable does not need to be adjusted because the information about bankruptcy
was known after the reporting period.
Answer
a) Inventories are usually written down to net realizable value (NRV) item by item. In the
given case, cost of all the items on total basis is lower than their NRV. However, if we
compare NRV with cost product-wise, we can note that NRV of ordinary bikes (i.e. Rs
185,000) is lower than its cost (i.e. Rs. 200,000).
The following comparative table may be useful for valuation of inventories
Product Historical cost Rs Net Realizable Presentable

value (Rs.) value (Rs.)
ClourTvs 200,000 270,000 200,000
FHK P.T.O.1582
(2)
Black & White TVs 115,000 150,000 115,000
Ordinary Bikes 200,000 185,000 185,000
Sport bikes 110,000 115,000 110,000
Computers 80,000 100,000 80,000
Total 705,000 820,000 690,000
So, inventory should be presented at Rs. 690,000 in the balance sheet rather than at Rs.
705,000.
b) Because written representations are necessary audit evidence, the auditor’s opinion cannot
be expressed, and the auditor’s report cannot be dated, before the date of the written
representations. Furthermore, because the auditor is concerned with events occurring up to
the date of the auditor’s report that may require adjustment to or disclosure in the financial
statements, the written representations are dated as near as practicable to, but not after, the
date of the auditor’s report on the financial statements.
In some circumstances, it may be appropriate for the auditor to obtain a written
representation about a specific assertion in the financial statements during the course of the
audit. Where this is the case, it may be necessary to request an updated written
representation.
So, in the given case the written representation cannot be considered as appropriate audit
evidence because it was not obtained on or before the audit report date.
c) As per NAS 6, the cost of an item of property, plant and equipment is the cash price
equivalent at the recognition date. If payment is deferred beyond normal credit terms, the
difference between the cash price equivalent and the total payment is recognized as interest
over the period of credit unless such interest is capitalized in accordance with NAS 8.
So, in the given case, the machinery should be recognized at Rs. 9.5 crores in the books and
0.5 crores should be recognized as interest over the 6 months period (Asoj-Falgun)
d) Events after the reporting period are those events, favorable and unfavorable, that occur
between the end of the reporting period and the date when the financial statements are
authorized for issue. Two types of events can be identified:
i) those that provide evidence of conditions that existed at the end of the reporting period
(adjusting events after the reporting period); and
ii) those that are indicative of conditions that arose after the reporting period (non-adjusting
events after the reporting period)
So, the event in the given case (knowing information about bankruptcy of the debtor after
balance sheet date) seems to be an adjusting event because the debtor was bankrupt on the
balance sheet date which was declared by the court later on. Hence the carrying amount of
the trade receivable should be presented at Rs. 18 crores instead of Rs. 20 crores in the
balance sheet.
2. Answer the following: (7+8=15)

a) Explain the analytical procedures that an auditor can adopt to verify inventories.
b) Explain the situations of modifying the auditor’s report as per NSA.
Answer
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a) Analytical procedure for inventories: The auditor can adopt the following analytical
procedures to verify inventories.
i) Quantitative reconciliation of opening stock, purchases, production, sales and
closing stock
ii) Comparison of closing stock quantities and values with those of previous year.
iii) Comparison the inventory turnover ratio with that of the previous year and industry
average, if available.
iv) Comparison of the current year gross profit ratio with that of previous year.
v) Comparison of actual stock, purchase and sales figures with the budgeted one.
vi) Comparison of raw material yield/wastage with previous year.
b) There are the following situations of modifying the auditor’s report wording:
I. Matters that Do Not Affect the Auditor’s Opinion
i. Emphasis of matter: In certain circumstances, an auditor’s report may be modified
by adding an emphasis of matter paragraph to highlight a matter affecting the
financial statements which is included in a note to the financial statements that more
extensively discusses the matter. The addition of such an emphasis of matter
paragraph does not affect the auditor’s opinion. The paragraph would preferably be
included after the paragraph containing the auditor’s opinion but before the section
on any other reporting responsibilities, if any. The emphasis of matter paragraph
would ordinarily refer to the fact that the auditor’s opinion is not qualified in this
respect.
II. Matters that Do Affect the Auditor’s Opinion
i. Qualified opinion: A qualified opinion should be expressed when the auditor
concludes that an unqualified opinion cannot be expressed but that the effect of any
disagreement with management, or limitation on scope is not so material and
pervasive as to require an adverse opinion or a disclaimer of opinion. A qualified
opinion should be expressed as being ‘except for’ the effects of the matter to which
the qualification relates.
ii. Disclaimer of opinion: A disclaimer of opinion should be expressed when the
possible effect of a limitation on scope is so material and pervasive that the auditor
has not been able to obtain sufficient appropriate audit evidence and accordingly is
unable to express an opinion on the financial statements.
iii. Adverse opinion: An adverse opinion should be expressed when the effect of a
disagreement is so material and pervasive to the financial statements that the auditor
concludes that a qualification of the report is not adequate to disclose the
misleading or incomplete nature of the financial statements.
3. Give your comments on the following: (3×
×5=15)
a) PQR Company conducts its business through 3 offices situated in Kathmandu,
Pokhara and Nepalgunj. 50% of the business volumes are conducted through the
offices outside Kathmandu valley. All the vouchers and records of Pokharaand
Nepalgunj offices are maintained at Pokhara and Nepalgunj Offices respectively.
The management of PQR has approached the auditor for audit with the request
that the offices outside Kathmandu valley are not to be visited by the auditor to
save the audit costs. Whether the auditor should accept the appointment.
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b) An INGO invites bid from interested CA firms for audit service for the calendar
year 2014. Upon request by Lakhe & Co, Chartered Accountants, the INGO does
not provide information about the audit fees for the year 2013. Please advise
whether Lakhe & Co should submit his bid for the audit or not.
c) Financial Statements for the year 2069/70 was issued in Paush 2070. While
preparing the financial statements of 2070/71, it was known that the financial
statements of 2069/70 included error. The auditor advises the management to
correct and revise the financial statements of 2069/70 and circulate the revised
financial statements with all the authorities where original financial statements
were submitted.
Answer
a) If management or those charged with governance impose a limitation on the scope of the
auditor’s work in the terms of a proposed audit engagement such that the auditor believes
the limitation will result in the auditor disclaiming an opinion on the financial statements,
the auditor shall not accept such a limited engagement as an audit engagement, unless
required by law or regulation to do so.
In the given case if the auditor accepts the appointment he has to provide his opinion
without verifying the records which constitutes around 50% of business volume of the
company. So, it is better not accept such appointment because it is known in advance that
the limitation put by the management on auditor’s work. However, if he accepts the audit,
he should consider disclaiming opinion based on possible effects of the opinion.
b) As per council decision/code of ethics in relation to minimum audit fee, an audit firm shall
take into account the audit fees of the previous year while quoting audit fees such that the
current year’s fee should not be less than the previous year. If information about the
previous year’s fee cannot be obtained, the auditor shall specify in his proposal that his fee
shall be higher of the proposed audit fee and previous year’s audit fee.
So, in the given case, Lakhe & Co can submit his proposal by clearly mentioning that the
audit fee shall be the higher of the proposed audit fee or previous year’s audit fee.
c) As per NAS 8, prior period errors are corrected in the comparative information presented in
the financial statements. Unless it is impracticable, an entity shall correct material prior
period errors retrospectively in the first set of financial statements authorized for issue after
their discovery by: (a) restating the comparative amounts for the prior period(s) presented
in which the error occurred; or (b) if the error occurred before the earliest prior period
presented, restating the opening balances of assets, liabilities and equity for the earliest
prior period presented.
So, in the given case, the error in the financial statements of 2069/70 can be rectified in the
comparative information of the financial statements of 2070/71. The financial statements of
2069/70 which was already issued need not be revised.
4. Answer the following: (3×

×5=15)
a) Explain the control environment as a part of Internal Control System.
b) Help- SIPA, a NGO registered in Nepal raises funds from members, donors or
contributors to support victims of Earthquake of Sindhupalchok. Explain the
points which you will consider in preparing the Audit Programme of this NGO.
c) Explain the compliance procedure and substantial procedures as Audit methods
of collecting evidences for forming an audit opinion.
Answer
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a) Control environment refers to overall attitude, awareness and actions of governance and
management regarding the internal control system and its importance in the entity. The
control environment has an effect on the effectiveness of the specific control procedures. A
strong control environment, for example, one with tight budgetary controls and an effective
internal audit function, can significantly complement specific control procedures. However, a
strong environment does not, by itself, ensure the effectiveness of the internal control system.
Factors reflected in the control environment include:

• The function of the board of directors and its committees.
• Management’s philosophy and operating style.
• The entity’s organizational structure and methods of assigning authority and responsibility.
• Management’s control system including the internal audit function, personnel policies and
procedures and segregation of duties.
b) The audit programme should include in a sequential order all assets, liabilities, receipts and
expenditures ensuring that no material item is omitted.
(a) Corpus Fund: The contributions / grants received towards corpus be vouched with special
reference to the letters from the donor(s). The interest income be checked with Investment
Register and Physical Investments in hand.
(b) Reserves: Vouch transfers from projects / programmes with donors letters and board
resolutions of NGO. Also check transfer of gross value of asset sold from capital reserve
to general reserve and adjustments during the year.
(c) Ear-marked Funds: Check requirements of donors institutions, board resolution of NGO,
rules and regulations of the schemes of the ear-marked funds.
(d) Project / Agency Balances: Vouch disbursements and expenditure as per agreements with
donors for each of the balances.
(e) Loans: Vouch loans with loan agreements, receipt counter-foil issued.
(f) Fixed Assets: Vouch all acquisitions / sale or disposal of assets including depreciation and
the authorizations for the same. Also check donor's letters/agreements for the grant. In the
case of immovable property check title, etc.
(g) Investments: Check Investment Register and the investments physically ensuring that
investments are in the name of the NGO. Verify further investments and disinvestments
for approval by the appropriate authority and reference in the bank accounts for the
principal amount and interest.
(h) Cash in Hand: Physically verify the cash in hand and imprest balances, at the close of the
year and whether it tallies with the books of account.
(i) Bank Balance: Check the bank reconciliation statements and ascertain details for old
outstanding and unadjusted amounts. Verifiy the transaction with the bank statement
provided by the bank
(j) Stock in Hand: Verify stock in hand and obtain certificate from the management for the
quantities and valuation of the same. Stock should also be physically verified at a specific
period specified by the auditor
(k) Programme and Project Expenses: Verify agreement with donor/contributor(s) supporting
the particular programme or project to ascertain the conditions with respect to undertaking
the programme / project and accordingly, in the case of programmes/projects involving
contracts, ensure that income tax is deducted, deposited and returns filed and verify the
terms of the contract.
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(l) Establishment Expenses: Verify that provident fund, life insurance premium,
employee’s insurance and their administrative charges are deducted, contributed and
deposited within the prescribed time. Also check other office and administrative expenses
such as postage, stationery, travelling, etc.
c) Auditor should obtain sufficient and appropriate audit evidences and test them before framing
an opinion about the assertions the financial statements reveal. For this, the auditor checks
evidences through
• Compliance procedure/test of control and
• Substantial procedure.
Compliance procedures are tests designed to obtain reasonable assurance that those internal
control on which audit reliance is to be placed are in effect. It seeks to test that
• there exists internal control,
• the existing internal control is effective and
• the internal control is in full force / continues during the period under review.
When internal control is found to be at the acceptable level, the accounting entries generated
in such a system is more reliable than the one where the control is weak.
Mere satisfaction about the existence of internal control may not be sufficient for auditors to
express opinion about the assertions the financial data in the form of balances and
transactions. These i.e. transactions and balances need to be tested. This is done by audit
procedure called substantial checking.
Substantial procedures are designed to obtain audit evidence as to the completeness, accuracy
and validity of the data produced by the accounting system.
The substantial procedures involve
(a) Checking of transactions and balances and
(b) Analytical review. The checking of transaction and balances involves vouching of sales,
purchases, payments, receipts and scrutiny of ledgers.
The analytical procedure involves critically examining the accounts in an overall manner and
it may entail computation of ratios, trend analysis so as to dwell in length for examination of
unusual or unexplained deviations.
5. Answer the following: (3×

×5=15)
a) Explain propriety audit in the context of Audit Act, 2048.
b) Explain the provisions of Custody of Client Assets as given in Code of Ethics.
What are the safeguards or measures to be taken to balance this threat?
c) How are ISA, NSA, IAASB and IFAC connected?
Answer
a) (As per section 5 of) the Audit Act, 2048 requires that the Auditor General shall audit
following matters considering the propriety thereof-
I) On the propriety of any expenditure and its authorization, if in the opinion of the Auditor
General such expenditure is a reckless one or is an abuse of national property, whether
movable or immovable, despite that the expenditure confirms to the authorization, and
ii) On the propriety of all authorizations issued in respect of any grant of national property
whether movable or immovable, fixed or current, or underwriting of any revenue, or any
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contract, license or permits relating to mining, forest, water resources, etc. and any other act of
abandoning movable or immovable, assets of the nation.
The Auditor General may not include in the report minor items of discrepancy and other items
deemed as insignificant in view of their property which were observed during the audit of
income and expenditure.
a) While taking custody of Client Assets following things needs to be evaluated:

 Keep such assets separately from personal or firm assets;
 Use such assets only for the purpose for which they are intended;
 At all times be ready to account for those assets and any income, dividends, or gains
generated, to any persons entitled to such accounting;
 Comply with all relevant laws and regulations relevant to the holding of and accounting for
such assets.
 Make appropriate inquiries about the source of such assets and consider legal and
regulatory obligations.
 Consider seeking legal advice where needed.
b) International Standards on Auditing (ISA) are professional standards for the

performance of financial audit of financial information. These standards are issued by
International Federation of Accountants (IFAC) through the International Auditing and
Assurance Standards Board (IAASB). The International Auditing and Assurance Standards
Board (IAASB) is an independent standard-setting body that serves the public interest by
setting high-quality international standards for auditing, assurance, and other related standards,
and by facilitating the convergence of international and national auditing and assurance
standards. In doing so, the IAASB enhances the quality and consistency of practice throughout
the world and strengthens public confidence in the global auditing and assurance profession.
In 2006, the Auditing Standards Board (AuSB) adopted an official position of convergence
to ISAs - aligning its agenda with that of the IAASB and using the ISAs as a base. AuSB
started redrafting Nepal Auditing Standards in line with relevant ISAs, including the Preface
and Framework. 22 out of 30 issued NSAs are already revised and are in the process of issuing
for mandatory application by members of the Institute of Chartered Accountants of Nepal.
6. Write short notes on the following: (4×

×2.5=10)
a) Consultation in quality audit
b) Self-review threat
c) Teeming and lading
d) Audit of contingent liabilities
Answer
a) NSQC 1 and NSA 220 provides that the engagement partner should:
• Be responsible for the engagement team undertaking appropriate consultation on

difficult or contentious/controversial matters;
• Be satisfied that members of the engagement team have undertaken appropriate
consultation during the course of the engagement
• Be satisfied that the nature and scope of, and conclusions resulting from, such
consultations are documented and agreed with the party consulted; and
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• Determine that conclusions resulting from consultations have been implemented
b) It is the threat that a professional accountant will not appropriately evaluate the results of a
previous judgment made or service performed by the professional accountant, or by another
individual within the professional accountant’s firm or employing organization, on which the
accountant will rely when forming a judgment as part of providing a current service.
c) It is a fraud arrangement whereby amount received from a customer being misappropriated;

also to prevent its detection the money received from another customer subsequently being
credited to the account of the customer who has paid earlier. Similarly, moneys received from
the customer who has paid thereafter being credited to the account of the second customer and
such a practice is continued so that no one account is outstanding for payment for any length
of time, which may lead the management to either send out a statement of account to him or
communicate with him.
d) The auditor may take following steps to verify the contingent liabilities:
i. Inspect the minute books of the company to ascertain all contingent liabilities known to
the company.
ii. Examine the contracts entered into by the company and the likelihood of contingent
liabilities emanating there from.
iii. Scrutinize the lawyer’s bills to track unreported contingent liabilities.
iv. Examine bank letters in respect of bills discounted and not matured.
v. Examine bank letters to ascertain guarantees on behalf of other companies or
individuals.
vi. Discuss with various functional officers of the company about the possibility of
contingent liability existing in their respective field.
vii. Obtain a certificate from the management that all known contingent liabilities have
been included in the accounts and they have been properly disclosed.
viii. Ensure that proper disclosure has been made as per NAS 12, Provisions, Contingent
Liabilities and Contingent Assets.
7. Distinguish between (2×

×5=10)
a) Internal Audit and Statutory Audit
b) Vouching and Verification
Answer
a) Audit & Statutory Audit:
1. Internal audit is the arrangement within the organization to verify on continuous basis the
correctness and truthfulness of the transactions by the salaried staff/outsourced.
Statutory audit is the examination of the books of accounts of the business by an external
auditor and to report that the profit and loss account and balance sheet are drawn according
to provisions of law and the financial statements reveal the true and fair view of the results of
operations and financial state of affairs of the business.
2. Internal audit is not compulsory.
Statutory audit is compulsory as per applicable law.
3. Internal audit is carried out by the person appointed by the business enterprises. It is not
necessary that the internal auditor should possess the qualification prescribed for professional
auditor.
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Statutory audit can be carried out only by those who are qualified for appointment as per the
provision of the Companies Act and other Acts.
4. Internal auditor is answerable to the management. His duties, responsibilities etc. regarding
audit work are determined by the management. The management can increase the powers and
authority of the internal auditor. Similarly it can also curtail his powers.
The rights, duties, responsibilities and liabilities of statutory auditors are governed by the
provisions of law. The auditor is independent of management.
5. The internal auditor points out irregularities in the procedural aspects and suggests ways and
means to rectify the same. He assures that the financial operations and other types of control in
force are carried out in conformity with the accounting systems.
The statutory auditor is concerned with the legality and validity of the transactions of business.
His audit work is based on the financial statement prepared by the business.
b) Vouching & Verification:
1. Meaning : The act of examining the vouchers is known as vouching. A voucher is any
documentary evidence in support of a transaction entered in the books of
account.
Verification and be explained as establishing the truth or securing some kind of
confirmation with respect to the assets and liabilities appearing in the balance Sheet of a
concern.
2. Nature & Purpose : Vouching involves establishing the arithmetical accuracy and the
authenticity of the transactions of a concern. Vouching proves that an asset ought to exist.
Verification goes beyond vouching. It seeks to establish that assets as stated in the
Balance Sheet of a concern exist in fact and that the liabilities are properly disclosed.
Verification proves that an asset does exist.
3. Time: Vouching is done during the whole year verification is done on specific date mostly
at the end of the year.
4. Utility : Vouching Certifies correctness of records whereas Verification Certifies
correctness of assets and liabilities.
5. Personnel : Vouching is done by the junior staff of the auditor under the supervision of a
senior person. verification is done by the auditor himself assisted by senior.
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Suggested Answers - Audit & Assurance CAP-II Examination - December 2015
Audit & Assurance
1. As an auditor, give your opinions with reasons on the following cases: (4×5=20)
a) Aashriya& Associates has two Partners holding Certificate of practice. It has 14 Public company clients and other small
clients. The firm is in dilemma as to accept the forthcoming audit request of two Public companies.
b) Smart Pvt. Limited sold a Television worth of Rs. 500,000 (exclusive of all taxes) on 32 Ashadh 2071 which includes Rs.
100,000 for servicing fees of the Television for 5 years from the date of sales. The servicing fee is estimated equal
amount for each guaranteed service years. Smart Pvt. Limited booked entire Rs. 500,000 as revenue for financial year
2070/71.
c) A company purchased a plant for Rs. 20 crores on 1 Shrawan 2070. The company has the policy to charge depreciation
at the rate of 10% on such plants on straight line basis. Due to long dispute between the management and the labour of
the company, the factory was closed from Kartik 1, 2070 to Chaitra end 2070. Management has charged depreciation of
Rs. 1 crore on the said plant to the income statement for the year because the newly purchased plant was not used for 6
months in the year.
d) XYZ is a manufacturing company. There was huge fire in the factory of XYZ on 1 Ashoj 2071 and fixed assets of
written down value Rs. 10 crores was lost out of total fixed assets of Rs. 20 crores of the company. The financial
statements of the company for the year 2070/71 was approved by the Board on 30 Ashoj 2071 in which fixed assets have
been presented at WDV of Rs. 20 crores despite the severe loss due to fire and the information about the loss due to fire
is properly explained in the Notes to the financial statements.
Answer
a) The Directive issued by ICAN on Ceiling over the number of audit requires that a member holding COP can audit the books of
accounts of a maximum100 clients only, in a financial year. Out of these 100 clients, number ofPublic Companies shall not exceed
15.The above limit is applicable for each member of a partnership firm.Provided, organizations whose annual turnover is less than
NRs. 2lakhs, such as small Cooperatives, Religious organizations, SocialOrganizations, Consumer Group, Different Committees,
Trade Unions, Professional Associations and other entities of similar nature are notincluded while calculating the above limit.Thus,
in view of above requirement, new audit can be accommodated subject to total limit for two partners.
b) As per NAS 7 "Revenue" when the selling price of a product includes an identifiable amount for subsequent servicing (for
example, after sales support and product enhancement on the sale of software), that amount is deferred and recognized as revenue
over the period during which the service is performed. The amount deferred is that which will cover the expected costs of the
services under the agreement, together with a reasonable profit on those services.Accordingly in the light of aforesaid provision of
NAS 7; the accounting treatment made by Smart Pvt. Limited is not correct. Smart should book Rs. 400,000 as revenue for FY
2070/71 and Rs. 100,000 should be deferred. For each coming year Rs. 20,000 should be recognized as revenue to match its
services cost.
c) Depreciation of an asset begins when it is available for use, i.e. when it is in the location and condition necessary for it to be
capable of operating in the manner intended by management. Depreciation of an asset ceases at the earlier of the date that the asset
is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with NAS 06 and the
date that the asset is derecognized. Therefore, depreciation does not cease when the asset becomes idle or is retired from active use
unless the asset is fully depreciated. So, in the given case, depreciation expenses to be charged to the income statement for the year
2070/71 should be Rs 2 crores (i.e. for full year) instead of Rs 1 crore.
d) As per NAS-05, Event After the Balance Sheet Date, events after the reporting period are those events, favorable and unfavorable,
thatoccur between the end of the reporting period and the date when the financial statements are authorized for issue. Two types of
events can be identified:
i. those that provide evidence of conditions that existed at the end of the reporting period (adjusting events after the
reporting period); and
ii. those that are indicative of conditions that arose after the reporting period (non-adjusting events after the reporting period)
So, the event in the given case (fire after reporting period) is a non-adjusting event.An entity shall not adjust the amounts
recognized in its financial statements to reflect non-adjusting events after the reporting period.
If events after the balance sheet date impacts going concern status of the entity, the entity is required to prepare its financial
statement on break-up value basis. This does not seem to be the case here.
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If non-adjusting events after the reporting period are material, non-disclosure could influence the economic decisions that users
make on the basis of the financial statements. Accordingly, an entity shall disclose the following for each material category of non-
adjusting event after the reporting period:
i. the nature of the event; and

ii. an estimate of its financial effect, or a statement that such an estimate cannot be made.
So, presenting fixed assets at Rs 20crores in the balance sheet with appropriate disclosure in the Notes to Accounts seems to be
appropriate.
2. Answer the following: (3×5=15)
a) Explain ‘An appropriate subject matter’ as an element of assurance.

b) Explain ‘Audit Sampling’ and ‘Sampling Risk’ in the light of NSA - 530 Audit Sampling and Other Selective Testing
Procedures.
c) Based on study and evaluation of internal control system, auditor concludes that internal controls are well designed
and functioning effectively. Still auditor performs appropriate substantive audit procedures to form an opinion on the
financial statements before issuance of audit report. Explain why auditor has to perform appropriate substantive audit
procedures in such an ideal situation also.
Answer
a) Assurance engagement is an engagement in which a practitioner expresses a conclusion designed to enhance the degree of
confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of a subject
matter against criteria.
The subject matter, and subject matter information, of an assurance engagement can take many forms, such as:
• Financial performance or conditions (for example, historical or prospective financial position, financial performance and
cash flows) for which the subject matter information may be the recognition, measurement, presentation and disclosure
represented in financial statements.
• Non-financial performance or conditions (for example, performance of an entity) for which the subject matter information
may be key indicators of efficiency and effectiveness.
• Physical characteristics (for example, capacity of a facility) for which the subject matter information may be a
specifications document.
• Systems and processes (for example, an entity’s internal control or IT system) for which the subject matter information may
be an assertion about effectiveness.
• Behavior (for example, corporate governance, compliance with regulation, human resource practices) for which the subject
matter information may be a statement of compliance or a statement of effectiveness.
Subject matters have different characteristics, including the degree to which information about them is qualitative versus
quantitative, subjective versus objective, historical versus prospective, and relates to a point in time or covers a period. Such
characteristics affect the:
(a) Precision with which the subject matter can be evaluated or measured against criteria; and
(b) The persuasiveness of available evidence.
(c)
The assurance report notes characteristics of particular relevance to the intended users.
An appropriate subject matter is:
(a) Identifiable, and capable of consistent evaluation or measurement against the identified criteria; and
(b) Such that the information about it can be subjected to procedures for gathering sufficient appropriate evidence to
support a reasonable assurance or limited assurance conclusion, as appropriate.
b) Audit sampling involves the application of audit procedures to less than 100% of items within an account balance or class of
transactions such that all sampling units have a chance of selection. This will enable the auditor to obtain and evaluate audit
evidence about some characteristic of the items selected in order to form or assist in forming a conclusion concerning the
population from which the sample is drawn. Audit sampling can use either a statistical or a non-statistical approach.
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Sampling risk arises from the possibility that the auditor's conclusion, based on a sample may be different from the conclusion
reached if the entire population were subjected to the same audit procedure. There are two types of sampling risk:
i. the risk the auditor will conclude, in the case of a test of control, that control risk is lower than it actually is, or in the
case of a substantive test, that a material error does not exist when in fact it does. This type of risk affects audit
effectiveness and is more likely to lead to an inappropriate audit opinion; and
ii. the risk the auditor will conclude, in the case of a test of control, that control risk is higher than it actually is, or in the
case of a substantive test, that a material error exists when in fact it does not. This type of risk affects audit efficiency
as it would usually lead to additional work to establish that initial conclusions were incorrect.
c) An internal control system can provide only reasonable assurance that the management’s objectives in establishing the system are
achieved. This is due to the fact that internal control system has the following inherent limitations:
i) Controls have to be cost effective. So, some controls may not be instituted because they are not cost effective.
ii) Most controls are directed at transactions of usual or routine nature. Therefore transactions of unusual nature may
escape from ambit of internal control.
iii) The potential of human error remains in any system of control.
iv) Controls may not prevent frauds through collusion between two or more persons.
v) Management may override controls.
vi) Controls may not keep pace with changing circumstances.
vii) Management itself may manipulate transactions or accounting estimates.
Above inherent limitations of internal control system makes it necessary for the auditor to perform substantive procedures to
express an appropriate opinion on the financial statements. But if the "Test of Control" conducted by the auditor concludes that
internal control system is in existence, operated throughout the period and functioning effectively, the auditor may not consider
necessary to perform substantive audit procedure for that particular area. Substantive procedures though cannot be fully eliminated
and the auditor determines the area where substantive procedures should be used.
3. Give your comments on the following: (3×5=15)
a) Chitale Limited has declared dividend of 12% for FY 2069/70 in the month of Ashoj 2070. The company has booked
this as Interim Dividend in Financial Statement of 2069/70.
b) “Responsibility for properly determining the quantity and value of inventories rests with the management of the
entity”.
c) Ramu& Co. had conducted the audit of XYZ Limited for the financial years 2067/68, 2068/69 and 2069/70. CA. Raman
Saha, partner of Ramu& Co, left the firm on 1 Baishakh 2069. CA. Raman Saha has been appointed as the auditor of
XYZ limited for the year 2070/71.
Answer
a) Dividend has been declared at year end so this should be final dividend.
Further, Nepal Accounting Standards 05 on Events after the Balance Sheet Date provides that if an entity declares dividends to
holders of equity instruments after the balance sheet date, the entity shall not recognise those dividends as a liability at the balance
sheet date.
If dividends are declared after the balance sheet date but before the financial statements are authorised for issue, the dividends are
not recognised as a liability at the balance sheet date because they do not meet the criteria of a present obligation. Such dividends
are disclosed in the notes in accordance with NAS 01 Presentation of Financial Statements.
Thus, the treatment followed by Chitale limited is not in line with NAS.
b) As per NSA 200; "Objectives and General Principles Governing an Audit of Financial Statements" the responsibility for preparing
and presenting the financial statements is that of the management of the entity. Accordingly the responsibility for properly
determining the quantity and value of inventories rests with the management of theentity. Therefore, it is the responsibility of the
management of the entity to ensure that inventories included in the financial information are physically in existence and
representall owned by the entity.
The management can satisfy this responsibility by carrying out appropriate procedures such as verification of all items of inventory
at least once in every financial year. The auditor is expected to examine the adequacy of the methods and procedures of physical
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verification followed by the entity. He is also required to determine whether the procedures for identifying defective, damaged,
obsolete, excess and slow-moving items are well-designed and operate properly.
This responsibility of the management is not reduced even where the auditor attends any physical count of inventories in order to
obtain audit evidence. The entities usually maintain detailed stock records in the form of Stores/Stock ledgers showing in respect
of each major item the receipts, issues and balances. The extent of examination of these records by an auditor with reference to the
relevant basic documents (e.g., goods received notes, inspection reports, material issue notes, bin cards, etc.) depends upon the
facts and circumstances of each case. In valuation aspects, compliance with NAS 4 should also be ensured.
c) As per section 111(3) of the Companies Act, no auditor or his/her partner or ex-partner or employee or ex-employee shall be
appointed as auditor for more than three consecutive terms to perform the audit of a public company. Provided, however, that this
restriction shall not apply to any partner who ended partnership or any employee who left the service of such auditor three years
before.
In the present case, Ramu& Co has been auditor of XYZ Ltd for three consecutive years till 2069/70. Since Raman Saha is the ex-
partner of Ramu& Co and 3 years has not elapsed from the date of ending his partnership with Ramu& Co (as date of separation
being 1 Baisakh 2069), his appointment as auditor of the company for the year 2070/71 cannot be considered as lawful.

a) What are the principal contents of Terms of Audit Engagement as per NSA 210?
b) ABC Hydropower Pvt. Ltd. has purchased equipment worth of Rs. 4 million which is kept stand by for urgent usage on
need basis for repairing the heavy equipment as and when default is reported in functioning of heavy equipment. The
accountant has treated it as recurring inventory item and charged to profit and loss account at the end of each financial
year based on consumption pattern calculated on reasonable basis. Is the accounting treatment made by accountant is
correct? Comment.
c) Write down any five audit steps for the audit of Debtors.
Answer
a) The form and content of audit engagement letters may vary for each client, but they would generally include reference to:
• The objective of the audit of financial statements.

• Management's responsibility for the financial statements.
• The scope of the audit, including reference to applicable legislation, regulations or pronouncements of the Institute of
Chartered Accountants of Nepal (ICAN).
• The form of any reports or other communication of results of the engagement
• The fact that because of the test nature and other inherent limitations of an audit, together with the inherent limitations of any
accounting and internal control system, there is an unavoidable risk that even some material misstatement may remain
undiscovered.
• Unrestricted access to whatever records, documentation and other information requested in connection with the audit.
• Management's responsibility for establishing and maintaining effective internal control.
Other matters that may be included are:

• Description of the basis for fees.
• Ownership and accessibility of the auditor’s files to external parties.
• Interactions with specialists, internal auditors, and the predecessor auditor needed to conduct the audit
• Restrictions to the auditor's liability.
b) As per NAS 6- Property, Plant and Equipment, spare parts and servicing equipment are usually carried as inventory and recognized
in profit or loss as consumed. However, major spare parts and stand-by equipment qualify as property, plant and equipment when
an entity expects to use them during more than one period. Similarly, if the spare parts and servicing equipment can be used only in
connection with an item of property, plant and equipment, they are accounted for as property, plant and equipment.
In view of the above provision made in NAS 6, the equipment purchased by ABC Hydropower Pvt. Ltd. should be treated as
property, plant and equipment. Though it is servicing equipment used on repairing heavy equipment; it has to be kept stand-by and
can be used only in connection with heavy equipment and usable for more than one accounting period, it should be treated as
property, plant and equipment instead of treating it as inventory.
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c) Five audit steps for the audit of Debtors out of various possible steps are presented below:
i. Verify the opening balances with last year closing audited balances
ii. Obtain a schedule of receivables and determine whether the total agrees withthe trial balance.
iii. Obtain and consider explanations of significant variations in Debtor’s turnover ratio of current period and prior period and
anticipated debtor turnover ratio.
iv. Select a sample of debtors and obtain direct confirmation from the parties concerned.
v. Obtain an aged analysis of the debtors. Inquire about the reason for unusually large accounts, credit balances on accounts
or any other unusual balances and inquire about the collectibility of receivables.
5. Comment on the following situations/statements: (3×5=15)

a) Explain the types of threat as explained in ICAN Code of ethics.
b) "The rendering of two or more types of professional services concurrently does not by itself impair integrity, objectivity
or independence". Comment.
c) Lalu and Associates has been appointed as auditor for the year 2070/71 of ABC Bank Limited, a commercial bank in
the general meeting dated 25 Paush 2070 for remuneration of Rs. 500,000. In the course of the audit, the auditor finds
that the audit fee is too low and negotiates with the management for increase of the fees to the tune of Rs. 700,000. The
board approves the increased fee.
Answer
a) The various types of threats explained in ICAN code of ethics are as follows:
Self-interest threat – the threat that a financial or other interest willinappropriately influence the professional accountant’s
judgment orbehavior; For e.g. lowballing, hospitality or other benefits, contingent fees, loans to clients etc.
Self-review threat – the threat that a professional accountant will notappropriately evaluate the results of a previous
judgment made or serviceperformed by the professional accountant, or by another individualwithin the professional
accountant’s firm or employing organization,on which the accountant will rely when forming a judgment as part ofproviding
a current service; For e.g. valuation services along with audit service, accounting services.
Advocacy threat – the threat that a professional accountant will promotea client’s or employer’s position to the point that the
professionalaccountant’s objectivity is compromised; For e.g. the auditor Should not offer legal services to a client and
defendthem in dispute or litigation which is material to the financial statement.
Familiarity threat - the threat that due to a long or close relationshipwith a client or employer, a professional accountant will
be toosympathetic to their interests or too accepting of their work. For e.g. participation in client affairs, family and personal
relationship, audit partners leaving to join clients etc.
Intimidation threat – the threat that a professional accountant willbe deterred from acting objectively because of actual or
perceivedpressures, including attempts to exercise undue influence over theprofessional accountant. For e.g. if there is actual
or threatened litigationbetween client and assurance firm, the firmshould not continue to act
b) Section 11 of Code of Ethics of the Institute of the Chartered Accountants of Nepaldeals with "Activities Incompatible with the
Practice of Public Accountancy". Section 11 (2) stated that "the rendering of two or more types of professional services
concurrently does not by itself impair integrity, objectivity or independence".
As per Section 11 (1) a professional accountant in public practice should not concurrently engage in any business, occupation or
activity which impairs or might impair integrity, objectivity or independence, or the good reputation of the profession and therefore
would be incompatible with the rendering of professional services.
Further as per Section 11 (3) the simultaneous engagement in another business, occupation or activity unrelated to professional
services which have the effect of not allowing the professional accountant in public practice properly to conduct a professional
practice in accordance with the fundamental ethical principles of the accountancy profession should be regarded as inconsistent
with the practice of public accountancy.
c) Asper section 67 of Bank andFinancial Institutions Act, 2063, the remuneration of the auditor shall be as prescribed by the general
meeting if he or she has been appointed by the general meeting and by the board if he or she has been appointed by the board. In
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the given case Lalu and Associates has been appointed by the general meeting of ABC Bank Limited and hence his remuneration
shall be as prescribed by general meeting. So, the revision in the audit fees by the board in this case is not valid.
6. Write short notes on the following: (4×2.5=10)

a) Revaluation of Fixed Assets
b) Objectives of Audit of the Financial Statement
c) Ownership and Custody of Working Papers
d) Qualities of an Auditor
Answer
a) Revaluation of fixed assets is the process of increasing or decreasing their carrying value in case of major changes in fair market
value of the fixed asset. NAS-06, Property, Plant and Equipment requires fixed assets to be initially recorded at cost but they allow
two models for subsequent accounting for fixed assets, namely the cost model and the revaluation model. Under the Revaluation
model, the asset is carried at a revalued amount, being its fair value at the date of revaluation less subsequent depreciation and
impairment, provided that fair value can be measured reliably. Revaluations should be carried out regularly, so that the carrying
amount of an asset does not differ materially from its fair value at the balance sheet date. If an item is revalued, the entire class of
assets to which that asset belongs should be revalued. Revalued assets are depreciated in the same way as under the cost model. If a
revaluation results in an increase in value, it should be credited to other comprehensive income and accumulated in equity under
the heading "revaluation surplus" unless it represents the reversal of a revaluation decrease of the same asset previously recognised
as an expense, in which case it should be recognised in profit or loss. A decrease arising as a result of a revaluation should be
recognised as an expense to the extent that it exceeds any amount previously credited to the revaluation surplus relating to the same
asset. When a revalued asset is disposed of, any revaluation surplus may be transferred directly to retained earnings, or it may be
left in equity under the heading revaluation surplus. The transfer to retained earnings should not be made through profit or loss.
b) In conducting an audit of financial statements, the overall objectives of the auditor are:
• To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement,
whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are
prepared, in all material respects, in accordance with an applicable financial reporting framework;and
• To reporton the financial statements,and communicate as required by the NSAs,in accordance with the auditor’s findings.
Audits are not conducted with the objective of identifying fraud and errors prevalent in the company, but the audit process
normally result in identification of fraud or errors while conducting internal control evaluation and using substantive procedures.
This is because the auditing standards requires an auditor to bear in mind the possibility of the existence of frauds or errors in the
accounts under audit since they may cause the financial position to be mis-stated. So, detection of material frauds and errors as an
incidental objective of independent financial auditing flows from the main objective of determining whether or not the financial
statements give a true and fair view.
c) NSA 230, Audit Documentation contains the set of standards that deal with working papers. The standard provides that the auditor
should prepare, on a timely basis, audit documentation that provides a sufficient appropriate record of the basis for the auditor’s
report, andevidence that the audit was performed in accordance with NSAs and applicable legal and regulatory requirements.
Working papers provide evidence that an effective, efficient, and economic audit has been carried out. As such, working papers are
the property of the auditor. The auditor may, at his discretion, make portions of or extracts from his working papers available to his
client. The auditor should retain the working papers for the period specific or the period necessary to fulfill professional
responsibility relating to the assignment.
d) An auditor should adhere to the fundamental principles applicable for the auditor. The fundamental principles are integrity,
objectivity, professional competence and due care, confidentiality and professional behavior. The qualities required in and auditor
are tact, caution, firmness, good temper, integrity, discretion, industry judgment, patience, clear headedness and reliability. In
addition, he must have the shine of culture for attaining a great height. He must have the highest degree of integrity backed by
adequate independence. He must have a thorough knowledge of general principles of law which govern matters with which he is
likely to be intimate contact. He must pursue an intensive program of theoretical education in subjects like financial and
management accounting, general management, business and corporate laws, computer and information systems, taxation,
economics etc. An auditor must be honest; i.e; he must not certify what he does not believe to be true and must take reasonable
care and skill before he believes that what he certifies is true.
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7. Distinguish between: (2×5=10)

a) Auditing and Investigation
b) Batch Processing and On-Line Real Time System
Answer
a) Objects: The object of auditing is to find out whether Financial Statements givea true and fair view of business. Investigation is
undertaken to know the essential facts about a matter under inquiry. It is done with some special purpose of view.
Period: Auditing usually covers one accounting year . Investigation may cover more than one accounting year.
Legally Binding :Auditing is conducted for proprietors or is normally legally binding. Investigation is carried out on behalf of any
party interested in the matter.
Scope :Auditing is legally compulsory for companies & restricted to the financial statement. Investigation is voluntaryand carried
out on certain circumstances & may be carried out beyond the financial statement.
Time :Auditing may be conducted at the year end. Investigationmay be conducted atany time in case ofsuspicion about
anytransaction.
Report :In auditing form of report is prescribed. Ininvestigationit is not prescribed.
Appointment : In auditing appointment is made by shareholders in AGM. Ininvestigationappointment can be done by other
delegated authorities.
Qualification :Auditors qualification is prescribed by Laws. Investigators qualification has not prescribed by Laws.
Re-work :Re-audit is not generally carried out . Re-investigation may be carried out.
Perception :Audit is not carried out with doubtful mind . Investigation may be carried out with doubtful mind.
b) Data processing system in computerized environment is generally Batch Processing or On-Line Real Time (OLRT) system which
can be distinguished as under:
Batch Processing On-Line Real Time (OLRT) system

♦ Transactions are accumulated and processed in ♦ Transactions are processed as and when they occur.
group.
♦ Two types of files are maintained master file is ♦ Only master file is maintained. It keeps updating.
updated when batch processing is run.
♦ Updating does not take place as quickly as in On- ♦ Though updating takes place immediately the
Line Real time system. processing becomes complex.
♦ Not useful when instant and updated results are ♦ Useful for immediate reporting system.
required.
♦ Generally provides Audit trail. ♦ Generally, does not provide audit trail and hence
requires more attention of auditor.
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(15)
CAP-II, Audit & Assurance, Jun-14

Suggested Answer

Marks
Attempt all the questions.
1. As an auditor, give your opinions with reasons on the following cases: (45=20)
a) Satya Limited is company listed in Recognized Stock Exchange of Nepal. During
normal course of operation, a fire broke out on 15th Ashoj, 2070, in which material
worth 50 lakhs which was lying in stock since 1st Ashadh, 2070 was totally destroyed.
The financial statements of the company have not been adopted till the date of fire.
The management of the company argues that since the loss occurred in the year, 2070-
71, no provision for the loss needs to be made in the financial statements for 2069-70.
State whether argument of management is in accordance with applicable provision.
b) Dhaulagiri Ltd. is an associate of Sagarmatha Ltd. How do you ensure whether
Sagarmatha Ltd. has significance influence in Dhaulagiri Ltd. or otherwise?
c) Commission for the Investigation of Abuse of Authority (CIAA) has asked certain
information from XYZ & Co.; Chartered Accountants relating to certain client of the
audit firm for which legal proceeding is in process with CIAA. The XYZ & Co.
refused to provide such information to CIAA. Is the action of XYZ & Co. is tenable?
d) While conducting the audit of X-ray Limited, Mr. Pratap, the statutory auditor found
that the detection risk relating to certain transactions cannot be reduced to acceptable
level. As a Statutory Auditor, how would you deal in the given situation?
Answer:
a)
Event occurring after the balance sheet date: This case requires attention to NSA 560 ―Subsequent
Events‖ and NAS 5 ―Events After Balance Sheet Date‖. As per NAS 5 ―Events After Balance
Sheet Date‖, adjustments to assets and liabilities are required for events occurring after the balance
sheet date that provide additional information materially affecting the determination of the
amounts relating to conditions existing at the balance sheet date or that indicate that the
fundamental accounting assumption of going concern (i.e., the continuance of existence or
substratum of the enterprise) is not appropriate. NAS – 5 also requires disclosure of the non-
adjusting event, in the report of the approving authority.
Further, as per NSA 560 ―Subsequent Events‖, the auditor should assure that all events occurring
subsequent to the date of the financial statements and for which the applicable financial reporting
framework requires adjustment or disclosure have been adjusted or disclosed. The event took place
after the close of the accounting year and does not relate to conditions existing at the balance sheet
date. Thus, it will have no effect on items appearing at the balance sheet date because as per NAS
– 5 ―Contingencies and Events Occurring after Balance Sheet Date‖ have to be adjusted that
provide evidence of conditions existing as at the balance sheet date. However, the auditor has to
ensure that this loss will not materially affect the substratum of the enterprises as per its size,
nature and complexity of operations.
Thus, subject to satisfaction in respect of non-violation of going concern concept, the company has
correctly accounted by not providing provision. However, the auditor is required to ensure the
proper disclosure of abovementioned event.
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b)
As per Para 7 of NAS 25 , investment in associates ; if an investor holds, directly or indirectly
(e.g. through subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed
that the investor has significant influence, unless it can be clearly demonstrated that this is not the
case. Conversely, if the investor holds, directly or indirectly (e.g. through subsidiaries), less than
20 per cent of the voting power of the investee, it is presumed that the investor does not have
significant influence, unless such influence can be clearly demonstrated. A substantial or majority
ownership by another investor does not necessarily preclude an investor from having significant
influence.
Further Para 8 of NAS 25 stated that the existence of significant influence by an investor is usually
evidenced in one or more of the following ways: (a) representation on the board of directors or
equivalent governing body of the investee;(b) participation in policy-making processes, including
participation in decisions about dividends or other distributions; (c) material transactions between
the investor and the investee; (d) interchange of managerial personnel; or (e) provision of essential
technical information.
Accordingly in the light of aforesaid provision of NAS 25, for ensuring whether Sagarmatha Ltd.
have significance influence over Dhaulagiri Ltd ; first of all i have to ensure percentage of voting
power of Sagarmatha Ltd. in Dhaulagiri Ltd. or evidencing factor as mentioned in above Para ,
existence of any one evidence is deemed to have significant influence.
c)
Section 4 of the Code of Ethics of the Institute of the Chartered Accountants of Nepal deals with
"Confidentiality" applicable too Professional Accountants in Public Practice. Section 4.1 stated
that Professional accountants have an obligation to respect the confidentiality of information about
a client‘s or employer‘s affairs acquired in the course of professional services. The duty of
confidentiality continues even after the end of the relationship between the professional accountant
and the client or employer. However Section 4.7 exemplified the points which should be
considered in determining whether confidential information may be disclosed: (a) When disclosure
is authorized. When authorization to disclose is given by the client or the employer the interests of
all the parties including those third parties whose interests might be affected should be considered.
(b) When disclosure is required by law. Examples of when a professional accountant is required by
law to disclose confidential information are: (i) to produce documents or to give evidence in the
course of legal proceedings; and (ii) to disclose to the appropriate public authorities infringements
of the law which come to light. (c) When there is a professional duty or right to disclose : (i) to
comply with technical standards and ethics requirements; such disclosure is not contrary to this
section; (ii) to protect the professional interests of a professional accountant in legal proceedings ;
(iii) to comply with the quality (or peer) review of ICAN ; and (iv) to respond to an inquiry or
investigation by ICAN or regulatory body.
In view of the above provision of Code of Ethics of the Institute of the Chartered Accountants of
Nepal ; XYZ & Co. has the professional liability for disclosing the client`s information to CIAA ,
since a professional accountant is required by law to disclose confidential information are to
produce documents or to give evidence in the course of legal proceedings .
Hence the action of XYZ & Co. is not tenable, though the audit firm may consult ICAN before
providing client`s information to CIAA.
d)
The auditor should use professional judgment to assess audit risk and to design audit procedures to
ensure that it is reduced to an acceptably low level.
―Detection risk‖ is the risk that an auditor‘s substantive procedures will not detect a misstatement
that exists in an account balance or class of transactions that could be material. The higher the
assessment of inherent and control risks, the more audit evidence the auditor should obtain from
the performance of substantive procedures. When both inherent and control risks are assessed as
high, the auditor needs to consider whether substantive procedures can provide sufficient
appropriate audit evidence to reduce detection risk, and therefore audit risk, to an acceptably low
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level. The auditor should use his professional judgments to assess audit risk and to design audit
procedures to ensure that it is reduced to an acceptably low level.
If it cannot be reduced to an acceptable level, the auditor should express a qualified opinion or a
disclaimer of opinion as may be appropriate.

a) Veri Ltd. is the Public Ltd. Company. It has not appointed Company Secretary. As an
internal auditor of the Company suggest whether the company has to appoint the
Company Secretary including for the required qualification of the Company
Secretary.
b) Auditor of Elephant Ltd. was unable to confirm the existence and valuation of stock
lying at the remote project site and accepted a certificate from the management
without obtaining other audit evidence.
c) P.G. & Company is the auditors of Professional Systems Company Ltd. The
Managing Director of the Company demands copies of the working papers from the
auditors. Are the auditors bound to oblige the Managing Director?
Answer:
a) Section 185 of the company act deals with the provision for appointment of company
secretary: Section 185 (1) states that public company with the paid –up capital of ten
million rupees or more shall appoint the company secretary a Nepalese citizen who has the
qualification mentioned in Sub-section (2) . Section (2) states that a Nepalese citizen who
has worked in the related field for at least two years after obtaining the professional
certificate of company secretary issued by a native or foreign body authorized to issue the
professional certificate of company secretary pursuant to the prevailing law or who has
worked in the related field or in the field of company management for at least three years
after doing at least bachelor degree in law, management ,commerce or economics may be
appointed to the post of company secretary. Provided, however, that this provision shall not
apply to the company secretary who is incumbent at the time of commencement of this Act
for three years after the date of commencement of this Act.
In the light of above provision of company act, I have to suggest the applicability of
aforesaid provision for Veri Ltd. if its paid up capital is Rs. 10 million or more .
b) As per NSA 580 on ― Management Representation‖ in the course of audit, an auditor comes
across various matters in respect of which he is not able to obtain sufficient appropriate
audit evidence. In such a situation he may rely on the submission by the management but he
should seek corroborative audit evidence from sources inside or outside the entity and
evaluate the representation made by management.
Management representation is not a substitute for other audit evidence. The auditor should
seek and apply normal audit procedure. Mere possession of a certificate does not absolve the
auditor from his liability. He should not seek or accept certificates when subject matter is
such that it is capable of verification from internal and/or external evidences.
In the instant case, the stock site material lying with the remote project site can be easily
verified with purchase order, invoice, bill of entry, custom document, physical verification
report from independent authority, visual means for observing stock etc.
Therefore the auditor in this instant case has not used available evidences. He should not
have rested with the certificate obtained from the management and could have evaluated
other evidences. He may be held liable for negligence and professional misjudgment. But, if
the stock is not material to the financial statement because of low value, the auditor can
accept management representation as evidence if there are no reasons to question the
authenticity of representation made by the management.
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c) As per principle of Audit Documentation, the working papers are the property of the auditor,
the auditor may, at his discretion make portion of or extracts from his working papers
available to the client. In the instant case the managing director of the company has
demanded copies of the working papers from the auditor. He has no right to obtain copies of
the working papers from the auditor because they are the property of the auditor. However
the auditor may at his discretion make portions of or extracts from the working paper to the
managing director of Professional Systems Company Ltd.
Conclusion:
The auditor is not bound to oblige the managing director by supplying copies of the audit
working papers.
3. Give your comments on the following: (35=15)

th
a) Firm of Ms. KD was appointed as auditor in 10 AGM of Neupane Limited. She was removed
by Board of Directors when she was out of Nepal on personal visit.
b) Explain briefly the technique of "Internal Control Questionnaire" to facilitate the
accumulation of information necessary for proper evaluation of internal control.
c) As an auditor, how will you verify application and allotment money received on shares issued
for cash?
Answer:
a) Section 119 (1) of the Company Act, 2063 provides that no auditor appointed pursuant to
Companies Act shall be removed pending the completion of audit of accounts of any
financial year for which he/she was appointed as the auditor.
As per Sub-section (2), notwithstanding anything contained in Sub-section (1) , if any

auditor breaches the code of conduct of auditors or does any act against the interest of the
company which has appointed him/her as the auditor or commits any act contrary to the
prevailing law, such auditor may be removed through the same process whereby he/she was
appointed as auditor, by giving prior information to the ICAN, and with the approval of the
regulatory authority, if any authorized by the prevailing law for the regulation of business of
the company concerned , and failing such authority, with the approval of the Office of
Registrar.
While removing an auditor pursuant to Sub-section (2) above, the auditor shall be provided
with a reasonable opportunity to defend him/herself.
Thus, Board of Directors cannot remove if auditor has been appointed through AGM.
Further, reasonable opportunity to defend herself should be provided.
b) Internal Control Questionnaire

Internal control questionnaire is a comprehensive series of questions concerning internal
control. It is the most widely used form for collecting information about the existence,
operation and efficiency of internal control in the organisation.
In the questionnaire, questions are generally so framed that a ‗Yes‘ answer denotes
satisfactory position and a ‗No‘ answer suggests weakness. Provision is made for an
explanation or further details of ‗No‘ answers. In respect of questions not relevant to the
business, ‗Not Applicable‘ reply is given.
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The questionnaire is usually issued to the client and the client is requested to get it filled by
the concerned executives and employees. If on a perusal of the answers, inconsistencies or
apparent incongruities are noticed, the matter is further discussed by auditor‘s staff with the
client‘s employees for a clear picture. The concerned auditor then prepares a report of
deficiencies and recommendations for improvement.
An important advantage of the questionnaire approach is that oversight or omission of

significant internal control review procedures is less likely to occur with this method. With a
proper questionnaire, all internal control evaluation can be completed at one time or in
sections. The review can more easily be made on an interim basis. The questionnaire form
also provides an orderly means of disclosing control defects. It is the general practice to
review the internal control system annually and record the review in detail.
c) Verification of application and allotment money received on Shares Issued for

Cash shall be carried out as under:
On Application
Verify the amount received along with the applications for shares in the following manner:
 Check entries in the Application and Allotment Book (or Sheets) with the original
applications;
 Check entries in the Application and the Allotment Book as regards deposits of money,
received with the applications, with those in the Cash Book;
 Vouch amounts refunded to the unsuccessful applicants with copies of Letters of Regret;
 Check the totals columns in the Application and Allotment Book and confirm the journal
entry debiting Share Application Account and crediting Share Capital Account.
On Allotment
 Examine Director‘s Minutes Book to verify approval of allotments.
 Compare copies of letters of allotment with entries in the Application and Allotment
Book.
 Trace entries in the Cash book into the Application and Allotment Book for the
verification of amounts collected on allotment.
 Trace the amount collected on application as well as those on allotment from the
Application and Allotment Book into the Share Register.
 Check totals of amounts payable on allotment and verify the journal entry debiting Share
Allotment Account and crediting Share Capital Account.

a) Auditors of a commercial bank was interviewed by the inspection team of Nepal Rastra Bank
and requested the auditors to share their views on the quality of loans of the bank to assist
inspection. Will this situation affect the confidentiality clause in code of ethics?
b) Explain the limitations of Internal Control.
c) What are the factors that are to be considered while designing a confirmation request?
Answer:
a) The principle of confidentiality imposes an obligation on all professional accountants to
maintain confidentiality of information acquired as a result of professional or business
relationship unless there is legal or professional right or duty to disclose. However there are
certain circumstances when confidential information can be disclosed.
As per 4.7 of the Code of Ethics of ICAN provides the circumstances where confidential
information can be disclosed as below
a. When disclosure is authorized.

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b. When disclosure is required by law.

c. When there is a professional duty or right to disclose.
i) To comply with technical standards and ethics requirements
ii) To protect the professional interests of a professional accountant in legal
proceedings;
iii) To comply with the quality (or peer) review of ACAN, and
iv) To respond to an inquiry or investigation by ICAN or regulatory body;
In view of the above requirement of 4.7 (c) (iv) auditor can assist the regulator for
inspection.
b) An Internal Control system can provide only reasonable assurance that the management‘s
objectives in establishing the system are achieved. That is, no internal control system can
provide absolute assurance that the control objectives are achieved. This is due to the fact
that any internal control system has certain internal limitations. The limitations may arise
due to:
i. Management‘s usual requirement that the cost of an internal control does not exceed
the expected benefits to be derived.
ii. Most internal controls tend to be directed at routine transactions rather than non-
routine transactions.
iii. The potential for human error due to carelessness, distraction, mistakes of judgment
and the misunderstanding of instructions.
iv. The possibility of circumvention of internal controls through the collusion of a
member of management or an employee with parties outside or inside the entity.
v. The possibility that a person responsible for exercising an internal control could abuse
that responsibility, for example, a member of management overriding an internal
control.
vi. The possibility that procedures may become inadequate due to changes in conditions,
and compliance with procedures may deteriorate. Controls has to be cost-effective.
The inherent limitation of internal control system requires the auditor to perform substantive
procedure to be able to express an opinion.
c) As per NSA -505 ―External Confirmations‖, the design of a confirmation request may
directly affect the confirmation response rate, and the reliability and the nature of the audit
evidence obtained from responses. The following factors should be considered while
designing a confirmation request:-
 The assertions being addressed.
 Specific identified risks of material misstatement, including fraud risks.
 The layout and presentation of the confirmation request.
 Prior experience on the audit or similar engagements.
 Management‘s authorization to the confirming parties to respond to the auditor.
Confirming parties may only be willing to respond to a confirmation request containing
management‘s authorization.
 The ability of the confirming party to provide the requested information
5. Comment on the following situations/statements: (35=15)

a) Auditor of Makalu Ltd. is of the opinion that ―Nepal Standards of Auditing‖ are meant only
for references and it is not mandatory to adhere such Standards.
b) Mr. A, a practicing Chartered Accountant has been found guilty in respect of Professional
Misconduct. So, Mr. A, a Chartered Accountant in practice has been suspended from practice
XTQ
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(21)
for a period of 4 months. During the said period, though he did not undertake the audit
assignment since he had surrendered certificate of practice, he had appeared before Income
Tax authorities in his capacity as a Chartered Accountant.
c) Explain Principal Auditor in line with NSA 600. What are the factors to be considered by
auditor to act as Principal Auditor?
Answer:
a) Contention of the auditor is totally wrong and is against the fundamental assumptions and
guidelines governing Nepal Standards on Auditing.
NSA 200 "Objectives and General Principles Governing an Audit of Financial Statements"
stated that the auditor should conduct an audit in accordance with the Nepal Standards on
Auditing. These contain basic principles and essential procedures together with related
guidance in the form of explanatory and other material.
As per ICAN, while discharging their attest function, it will be the duty of the members of
the Institute to ensure that the NSAs are followed. The NSAs will apply whenever an
independent financial audit is carried out to express an opinion thereon.
The member of the Institute must follow the NSAs. The auditors must draw attention to the
material departures from NSAs in their audit report along with the reasons for such
departure. Auditors in their report has to mention that audit was conducted in accordance
with ―Nepal Standards on Auditing‖ in Nepalese context.
Hence the auditor is duty bound to follow the NSAs.
b) Undertaking Tax Representation Work:

A chartered accountant not holding certificate of practice cannot take up any other work
because it would amount to violation of the relevant provisions of the Chartered
Accountants Act, 2053. In case a member is suspended and is not holding Certificate of
Practice, he cannot in any other capacity take up any practice separable from his capacity to
practices as a member of the Institute. This is because once a member becomes a member of
the Institute; he is bound by the provisions of the Chartered Accountants Act, 2053 and its
Regulations. If he appears before the income tax authorities, he is only doing so in his
capacity as a chartered accountant and a member of the Institute. Having bound himself by
the said Act and its Regulations made there under, he cannot then set the Regulations at
naught by contending that even though he continues to be a member and has been punished
by suspension, he would be entitled to practice in some other capacity. Thus, in the instant
case, a chartered accountant would not be allowed to represent before the income tax
authorities for the period he remains suspended. Accordingly, in the present case he is guilty
of professional misconduct. However, if the Chartered Accountant is summoned by Income
Tax Authorities for any work conducted by the person before suspension of COP by ICAN,
the Chartered Accountant will be answerable to the authorities.
c)
As per NSA 600 Principal auditor means the auditor with responsibility for reporting on the
financial statements of an entity when those financial statements include financial
information of one or more components audited by another auditor.
The auditor should consider whether the auditor‘s own participation is sufficient to be able
to act as the principal auditor. For this purpose the principal auditor would consider:
(a) the materiality of the portion of the financial statements which the principal auditor
audits;
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(22)
(b) the principal auditor‘s degree of knowledge regarding the business of the components;
(c) the risk of material misstatements in the financial statements of thecomponents audited
by the other auditor; and
(d) the performance of additional procedures as set out in this NSA regarding the
components audited by the other auditor resulting in the principal auditor having
significant participation in such audit.

a) Professional skepticism
b) Use of positive confirmations
c) Use of flow chart in evaluation of internal control
d) Cut off arrangements
Answer:
a) It is a requirement of NSA 200 that, when planning and performing an audit, the auditor
should adopt an attitude of professional skepticism. Professional skepticism is defined by
NSA 200 as an attitude that includes a questioning mind, being alert to conditions which
may indicate possible misstatement due to error or fraud, and a critical assessment of audit
evidence.
This does not mean that the auditors should disbelieve everything they are told, but they
should view what they are told with a skeptical attitude, and consider whether it appears
reasonable and whether it conflicts with any other evidence. In other words, they must not
simply believe everything management tells them.
b) A positive external confirmation request asks the respondent to reply to the auditor in all
cases either by indicating the respondent‘s agreement with the given information, or by
asking the respondent to fill in information. A response to a positive confirmation request is
ordinarily expected to provide reliable audit evidence. There is a risk; however, that a
respondent may reply to the confirmation request without verifying that the information is
correct. The auditor is not ordinarily able to detect whether this has occurred. The auditor
may reduce this risk, however, by using positive confirmation requests that do not state the
amount (or other information) on the confirmation request, but ask the respondent to fill in
the amount or furnish other information. On the other hand, use of this type of ―blank‖
confirmation request may result in lower response rates because additional effort is required
of the respondents.
b) Use of Flow Charts in evaluation of internal control: It is a graphic presentation of each part
of the company‘s system of internal control. A flow chart is considered to be the most
concise way of recording the auditor‘s review of the system. It minimizes the amount of
narrative explanation and thereby achieves a consideration or presentation not possible in
any other form. It gives bird‘s eye view of the system and the flow of transactions and
integration and in documentation, can be easily spotted and improvements can be suggested.
It is also necessary for the auditor to study the significant features of the business carried on
by the concern; the nature of its activities and various channels of goods and materials as
well as cash, both inward and outward; and also a comprehensive study of the entire process
of manufacturing, trading and administration. This will help him to understand and evaluate
the internal controls in the correct perspective.
d) Cut-off arrangements: Accounting is a continuous process because the business never comes
XTQ
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(23)
to halt. It is, therefore, necessary that transactions of one period would be separated from
those in the ensuing period so that the results of the working of each period can be correctly
ascertained. The arrangement that is made for this purpose is technically known as ―cut-off
arrangement‖. It essentially forms part of the internal control system of the organization.
Accounts, other than sales, purchase and stock are not usually affected by the continuity of
the business and therefore, this arrangement is generally applied only to sales, purchase and
stock. The auditor satisfies by examination and test-checks that the cut-off procedures are
adequately followed and ensure that:
 Goods purchased, property in which passed on to the client, have in fact been included
in the inventories and that the liability has been provided for in case of credit purchase.
 Goods sold have been excluded from the inventories and credit has been taken for the
sales. If the value of sales is to be received, the concerned party has been debited.
The auditor may examine a sample of documents, evidencing the movement of stock into
and out of stores, including documents pertaining to period shortly before and after the cut-
off date and check whether stocks represented by those documents were included or
excluded as appropriate during stock taking for perfect and correct presentation in the

a) Compliance Procedure and Substantial Procedures
b) Internal Control Questionnaire and Internal Control Evaluation
Answer:
a) Auditor should obtain sufficient and appropriate audit evidences and test them
before framing an opinion about the assertions the financial statements reveal. For
this, the auditor checks evidences through
 Compliance procedure and
 Substantial procedure.
Compliance procedures are tests designed to obtain reasonable assurance that those internal
control on which audit reliance is to be placed are in effect. It seeks to test that
 there exists internal control,
 the existing internal control is effective and
 the internal control is working without break or lacunae during the period under review.
When internal control is found to be to an acceptable level, the accounting entries generated in
such a system is more reliable than in one where the control is weak.
Mere satisfaction about the existence of internal control may not be sufficient for auditors to
express opinion about the assertions the financial data in the form of balances and transactions.
These i.e. transactions and balances need to be tested. This is done by audit procedure called
substantive checking. Substantive procedures are designed to obtain audit evidence as to the
completeness, accuracy and validity of the data produced by the accounting system.
The substantive procedures involve

 checking of transactions and balances and
 analytical review.
The checking of transaction and balances involves vouching of sales, purchases, payments,
receipts and scrutiny of ledgers. The analytical procedure involves critically examining the
accounts in an overall manner and it may entail computation of ratios, trend analysis so as to
dwell in length for examination of unusual or unexplained deviations.
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(24)
b) Internal Control Questionnaire (ICQ) and Internal Control Evaluation (ICE) : The internal
control questionnaires show the area where weakness occur or likely to occur. They do not
give any idea of the importance of those weaknesses. The Internal Control Evaluation brings
to light importance of those weakness disclosed by ICQ. Main points of distinctions are:
(i) ICQ incorporates a large number of detailed questions but does not attempt
to distinguish their relation in materiality. ICE isolates the main control
objectives within the area of review.
(ii) Weaknesses are highlighted by answer ―Yes‖ on ICE compared with ‗No‘ on
ICQ.
(iii) Answer ‗no‘ in ICQ indicates a weakness real or potential, but its significance
is not revealed. Whereas ICE requires audit personnel to state whether, an apparent
weakness may prove to be material in relation to the accounts as a whole.
(iv) The ‗Control Checklist‘ in ICE is more than a summary of key control
factors, and is no substitute for ICQ.
XTQ
1718
CAP-II, Audit & Assurance, Dec 2013
Suggested Answer

Marks
a) M/s Merita Impex is engaged in the business of manufacturing and trading of

musical instruments. A sum of Rs. 5 lakhs, received from an insurance company
as an insurance claim for loss of goods in transit costing Rs. 4 lakhs, is credited to
the purchase account.
b) Alpha Limited purchased a high value plant from Beta Limited in exchange of
10,000 units of its finished products. The plant was in use in Beta Limited for last
3 years and expert expects that its useful life could be further 17 years (i.e. 20
years in total). Alpha limited sells its finished products in the market at Rs 1,000
per unit whereas there is no specific market for the used plant but the expert
valuation of the used plant indicates the value of the plant as Rs. 1.2 crores.
Hence, Alpha Limited has recorded the cost price of the plant at Rs. 1.2 crores.
c) Normal waste of material in production process is 2 % of input. 10,000 kg. of
input was made in process with resultant wastage of 500 kg. Cost per kg of input
is Rs. 100. The entire quantity of waste is in stock at the year end. As an auditor
how do you ensure the proper valuation of inventory?
d) Z Ltd. paid Rs. 100,000 income tax for disposal of capital assets during fiscal year
2069/070 and showed as deduction from cash flow from operating activities. Is
this treatment in compliance with NAS 03? Suggest correct treatment in cash flow
statement.
Answer:
a) All items of income and expense which are recognised in a period should be included in
the determination of net profit or loss for the period. The claim for loss of goods in transit
is arising out of ordinary activities of the impex as a part of its normal course of business.
However, the cost of goods lost in transit is only Rs.4,00,000 while the insurance money
received is Rs.5,00,000. Purchases Account need not be credited since it would distort the
purchases done during the year and as also the gross profit. Therefore, entire amount of 5
lakhs needs to be taken to profit and loss account under an appropriate head. This is an
income arising from an ordinary activity of the enterprise but having regard to amount
involved and exceptional nature, a separate disclosure be made in the profit and loss
account. Such disclosure would enable the users to understand the performance of an
enterprise for the period.
As per NAS 18 Revenue is the gross inflow of economic benefits during the period
arising in the course of the ordinary activities of an entity when those inflows result in
increases in equity, other than increases relating to contributions from equity participants.
In a given case it has been shown after deducting in the purchase which is not as per this
standard and it should be disclosed in gross as per this NAS.
IOJ P.T.O.
1800
(2)
b) The fair value of the asset given up by Alpha Limited is Rs 10,000,000 (i.e. 10,000 units
* Rs 1,000). As per NAS 6 on property plant and equipment, if an entity is able to
determine reliably the fair value of either the asset received or the asset given up, then the
fair value of the asset given up is used to measure the cost of the asset received unless the
fair value of the asset received is more clearly evident. In the present case, the fair value
of the used plan is not clearly evident because there is no specific market for the used
plant.
Hence the plant should be recorded at the fair value of finished stock of Alpha Limited
given up to purchase the used plant; i.e. Rs 1 crore. So, the accounting treatment on
measurement of cost of used plant purchased from Beta Limited by Alpha Limited is not
in accordance with the requirement of NAS.
c) As per Para 16 of NAS-2, abnormal amounts of waste materials, labour or other

production costs, storage costs, unless those costs are necessary in the productin process
before a further production stage; administrative overheads that do not contribute to
bringing inventories to their present location and condition; and selling costs are excluded
from cost of inventories and such costs are recognized as expenses in the period in which
they are incurred.
In this case, normal waste is 200 kg and abnormal waste is 300 kg. The cost of 200 kg
will be included in determining the cost of inventories (Finished Products) at the year
end. The cost of abnormal waste amounting to Rs. 30,000 (300 kg *Rs. 100) will be
charged in the profit and loss statement.
d) As per Para 33 of NAS-3, cash flows arising from taxes on income shall be separately
disclosed and shall be classified as cash flows from operating activities unless they can be
specifically identified with financing and investing activities.
Further Para 34 added that taxes paid are usually classified as cash flows from operating
activities. However, when it is practicable to identify the tax cash flow with an individual
transaction that gives rise to cash flows that are classified as investing or financing
activities, the tax cash flow is classified as an investing or financing activity as
appropriate.
In view of the above provision in NAS -03, the treatment for income tax (capital gain tax)
on disposal of capital asset is not in compliance with NAS 03, accordingly it should be
shown under cash flow from investing activities.

a) Explain different methods of obtaining audit evidence. 7
b) What is audit risk? Explain three components of audit risk and also define their
relationship. 8
Answer:
a) Different methods of obtaining audit evidence are described below:
i) Inspection of Records or Documents: Inspection consists of examining records or
documents, whether internal or external, in paper form, electronic form, or other media.
Inspection of records and documents provides audit evidence of varying degrees of
reliability, depending on their nature and source and, in the case of internal records and
documents, on the effectiveness of the controls over their production. An example of
inspection used as a test of controls is inspection of records or documents for evidence of
authorization.
ii) Inspection of Tangible Assets: Inspection of tangible assets consists of physical
examination of the assets. Inspection of tangible assets may provide reliable audit
evidence with respect to their existence, but not necessarily about the entity‟s rights and
IOJ
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(3)
obligations or the valuation of the assets. Inspection of individual inventory items
ordinarily accompanies the observation of inventory counting.
iii) Observation: Observation consists of looking at a process or procedure being
performed by others. Examples include observation of the counting of inventories by the
entity‟s personnel and observation of the performance of control activities. Observation
provides audit evidence about the performance of a process or procedure, but is limited to
the point in time at which the observation takes place and by the fact that the act of being
observed may affect how the process or procedure is performed.
iv) Inquiry: Inquiry consists of seeking information of knowledgeable persons, both
financial and non-financial, throughout the entity or outside the entity. Inquiry is an audit
procedure that is used extensively throughout the audit and often is complementary to
performing other audit procedures. Inquiries may range from formal written inquiries to
informal oral inquiries. Evaluating responses to inquiries is an integral part of the inquiry
process.
v) Confirmation: Confirmation, which is a specific type of inquiry, is the process of
obtaining a representation of information or of an existing condition directly from a third
party. For example, the auditor may seek direct confirmation of receivables by
communication with debtors. Confirmations are frequently used in relation to account
balances and their components, but need not be restricted to these items. For example, the
auditor may request confirmation of the terms of agreements or transactions an entity has
with third parties; the confirmation request is designed to ask if any modifications have
been made to the agreement and, if so, what the relevant details are.
vi) Recalculation: Recalculation consists of checking the mathematical accuracy of
documents or records. Recalculation can be performed through the use of information
technology, for example, by obtaining an electronic file from the entity and using CAATs
to check the accuracy of the summarization of the file.
vii) Re-performance: Re-performance is the auditor‟s independent execution of
procedures or controls that were originally performed as part of the entity‟s internal
control, either manually or through the use of CAATs.
viii) Analytical Procedures: Analytical procedures consist of evaluations of financial
information made by a study of plausible relationships among both financial and non-
financial data. Analytical procedures also encompass the investigation of identified
fluctuations and relationships that are inconsistent with other relevant information or
deviate significantly from predicted amounts.
b) Audit Risk (AR): Audit risk is the risk that the auditor gives an inappropriate audit
opinion when the financial statements are materially misstated. In other words, it is a
function of the risk of material misstatement of the financial statements (or simply, the
“risk of material misstatement”) (i.e., the risk that the financial statements are materially
misstated prior to audit) and the risk that the auditor will not detect such misstatement
(“detection risk”).
Three components of audit Risk:

Inherent Risk (IR): “Inherent risk” is the susceptibility of an assertion to a misstatement
that could be material, either individually or when aggregated with other misstatements,
assuming that there are no related controls.
Control Risk (CR): “Control risk” is the risk that a misstatement that could occur in an
assertion and that could be material, either individually or when aggregated with other
misstatements, will not be prevented, or detected and corrected, on a timely basis by the
entity‟s internal control. That risk is a function of the effectiveness of the design and
operation of internal control in achieving the entity‟s objectives relevant to preparation of
the entity‟s financial statements. Some control risk will always exist because of the
inherent limitations of internal control.
IOJ
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(4)
Detection Risk (DR): “Detection risk” is the risk that the auditor will not detect a
misstatement that exists in an assertion that could be material, either individually or when
aggregated with other misstatements. Detection risk is a function of the effectiveness of
an audit procedure and of its application by the auditor. Detection risk cannot be reduced
to zero because the auditor usually does not examine all of a class of transactions,
account balance, or disclosure and because of other factors. Such other factors include the
possibility that an auditor might select an inappropriate audit procedure, misapply an
appropriate audit procedure, or misinterpret the audit results. These other factors
ordinarily can be addressed through adequate planning, proper assignment of personnel to
the engagement team, the application of professional skepticism, and supervision and
review of the audit work performed.
Relationship of Audit Risk with its components:
The relationship is expressed by the following Equation:
AR=IR*CR*DR
From the definition of various components of audit risk stated above, it is clear that IR
and CR cannot be reduced by the auditor. In other words the auditor has control over DR
only. So, to keep the audit risk at acceptable level based on above equation, if the product
of IR and CR is high, the auditor should reduce DR.

a) An audit firm was requested to perform the audit of a trading company for the
year 2068/69 where all records relating to sales transactions were seized by Inland
Revenue Department for investigation. The company requested the auditor to
accept the appointment saying that audit report with qualification on sales is
acceptable.
b) Cash book of an entity showed huge debit balances throughout the year.
c) The auditor of G-Mall had completed the audit of the financial statements for the
year 2069/70. The date of the audit report was 8 Kartik 2070 whereas financial
statements were approved by the management of the company on 10 Kartik 2070.
Answer:
a) In a given case the client is imposing the scope of audit. As per NSA 01, the term scope
of an audit refers to the audit procedures deemed necessary in the circumstances to achieve
the objective of the audit. The procedures required to conduct an audit in accordance with
NSA should be determined by the auditor having regard to the requirements of NSA,
relevant professional bodies, legislation, regulations and, where appropriate, the terms of
the audit engagement and reporting requirements.
An audit in accordance with NSA is designed to provide reasonable assurance that the
financial statements taken as a whole are free from material misstatement. Reasonable
assurance is a concept relating to the accumulation of the audit evidence necessary for the
auditor to conclude that there are no material misstatements in the financial statements
taken as a whole. Reasonable assurance relates to the whole audit process. 12. However,
there are inherent limitations in an audit that affect the auditor's ability to detect material
misstatements. These limitations result from factors such as:
a) The use of testing
b) The inherent limitations of any accounting and internal control system (e.g. the
possibility of collusion)
c) The fact that most audit evidence is persuasive rather than conclusive
Also the work undertaken by the auditor to form an opinion is permeated by judgment, in
particular regarding the gathering of audit evidence, e.g. in deciding the nature, timing and
extent of audit procedures; and the drawing of conclusion based on audit evidence
gathered, e.g. assessing the reasonableness of the estimates made by management in
preparing the financial statements.
IOJ
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(5)
Other limitations may affect the persuasiveness of evidence available to draw conclusions on
particular financial statement assertions (e.g. transactions between related parties). In these
cases certain NSA(s) identify specified procedures which will, because of the nature of the
particular assertions provide sufficient appropriate audit evidence in the absence of unusual
circumstances which increase the risk of material misstatement beyond that which would
ordinarily be expected; or any indication that a material misstatement has occurred.
In the given situation the client is imposing a limitation on the scope of audit. Since all
the records relating to sales are not available for audit, the auditor is not in the position to
perform alternate audit procedures for audit of sales. Further, sales is the most important
item of profit or loss account (being a trading company) and hence without auditing sales
an opinion on profit or loss account cannot be provided. That is the auditor has no option
but to provide disclaimer of opinion. Since this situation is known to auditor before
acceptance of engagement, it is advisable not to accept such limited scope engagement
unless required by statute.
b) Cash balance is maintained to meet the day to day operational needs of the
organization. So, the auditor has to perform audit procedures particularly having
regard to the fact that maintaining such huge balance is highly prone to
misappropriation and other forms of fraud. Accordingly since the entity is
maintaining consistently huge cash balance which is not required for its
operational needs, the auditor should carry out the surprise verification of cash
more frequently to ascertain whether the actual cash in hand agrees with the
balance as per cash book. If the actual cash balance is not in agreement with the
book balance, he should seek explanations from senior official of the entity. In
case any material difference is not satisfactorily explained, the auditor should
state this fact appropriately in his audit report. In any case, he should satisfy
himself regarding the necessity for such huge cash balance having regard to the
normal working requirements of the entity. The entity may also be advised to
deposit the whole or major part of the cash balance in the bank at reasonable
interval.
Material cash on hand if found during the audit in relation to the financial
statements taken as a whole, or if there are significant negotiable securities in the
custody of the client, consider performing the following additional procedures:
- Count the cash fund or observe and list the securities in the presence of a client
representative.
- Tie amount counted to general ledger balances.
- In most of small businesses, cash on hand is immaterial and should not be
counted, unless it is at the clients' request.
c) NSA 8 Para 25 has defined the date of report. As per this para t he auditor should date the
report as of the completion date of the audit. This informs the reader that the auditor has
considered the effect on the financial statements and on the report of events and transactions
of which the auditor became aware and that occurred up to that date. Since the auditor's
responsibility is to report on the financial statements as prepared and presented by
management, the auditor should not date the report earlier than the date on which the
financial statements are signed or approved by management.
The auditor should date the report on the financial statements no earlier than the date on
which the auditor has obtained sufficient appropriate audit evidence on which to base the
opinion on the financial statements. Sufficient appropriate audit evidence should include
evidence that the entity‟s complete set of financial statements has been prepared and that
those with the recognized authority have asserted that they have taken responsibility for
them. Since the management has approved the complete set of the financial statements on
10 Kartick 2070, it cannot be considered that the management has taken the responsibility
IOJ
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(6)
of the financial statements before 10 Kartick 2070. So, the auditor should not have dated
his report before 10 kartick 2070.

a) What are the elements that an auditor has to be considered while evaluating the
design of the entity‟s control environment?
b) State the reporting responsibilities of an auditor in the context of non-compliance
of laws and regulations in an audit of financial statements.
c) Mention briefly the conditions or events, which increase the risk of fraud or error
leading to material misstatement in financial statements.
Answer:
a) As per NSA 315 Section 67 the auditor should obtain an understanding of the control
environment. The control environment includes the governance and management
functions and the attitudes, awareness, and actions of those charged with governance and
management concerning the entity‟s internal control and its importance in the entity. The
control environment sets the tone of an organization, influencing the control
consciousness of its people. It is the foundation for effective internal control, providing
discipline and structure.
Section 68 has defined the primary responsibility for the prevention and detection of
fraud and error rests with both those charged with governance and the management of an
entity. In evaluating the design of the control environment and determining whether it has
been implemented, the auditor understands how management, with the oversight of those
charged with governance, has created and maintained a culture of honesty and ethical
behavior, and established appropriate controls to prevent and detect fraud and error
within the entity.
In evaluating the design of the entity‟s control environment, the auditor considers the
following elements and how they have been incorporated into the entity‟s processes:
i. Communication and enforcement of integrity and ethical values – essential elements

which influence the effectiveness of the design, administration and monitoring of
controls.
ii. Commitment to competence – management‟s consideration of the competence levels
for particular jobs and how those levels translate into requisite skills and knowledge.
iii. Participation by those charged with governance – independence from management,
their experience and stature, the extent of their involvement and scrutiny of
activities, the information they receive, the degree to which difficult questions are
raised and pursued with management and their interaction with internal and external
auditors.
iv. Management‟s philosophy and operating style – management‟s approach to taking
and managing business risks, and management‟s attitudes and actions toward
financial reporting, information processing and accounting functions and personnel.
v. Organizational structure – the framework within which an entity‟s activities for
achieving its objectives are planned, executed, controlled and reviewed.
vi. Assignment of authority and responsibility – how authority and responsibility
for operating activities are assigned and how reporting relationships and
authorization hierarchies are established.
vii. Human resource policies and practices – recruitment, orientation, training,
evaluating, counseling, promoting, compensating and remedial actions.
b) NSA 15 Para 14 has defined the reporting responsibilities of an auditor in the context of
non-compliance of laws and regulations in an audit of financial statements.
IOJ
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(7)
The auditor should as soon as practicable, either communicate with the audit committee,
the Board of Directors and senior management or obtain evidence that they are
appropriately informed regarding non-compliance that comes to the auditors attention.
If in the auditor‟s Judgment, the non compliance is believed to be intentional and/ or

material, the auditor should communicate the findings without delay.
If the auditor suspects that members of senior management, including members of the
Board of Directors, are involved in non-compliance, the auditor should communicate the
matter to the next higher level of authority at the entity, such as, the audit committee or
Board of Directors, to the users of the auditors‟ report or financial statements.
If the auditor concludes that the non-compliance has a material effect on the financial
statements and has not been properly reflected in the financial statements the auditor
should express a qualified or an adverse opinion.
If the auditor is precluded by the entity from obtaining sufficient and appropriate audit
evidence to evaluate whether non-compliance is, or is likely to have occurred that have or
may have material impact on the financial statements, the auditor should express a
qualified opinion or a disclaimer of opinion on the financial statements on the basis of a
limitation on the scope of the audit.
If the auditor is unable to determine whether non compliance has occurred because of
limitations imposed by the circumstances rather then by the entity, the auditor should
consider the effect on the auditor‟s report.
The auditor‟s duty of confidentiality would ordinarily preclude reporting non compliance
to a third party. However, in certain circumstances, that duty of confidentiality is
overridden by statement, law or by courts of laws.
c) NSA 5 has defined the risk of fraud and error in the entity. In planning and performing
his examination, the auditor should take into consideration the risk of material
misstatements of the financial information caused by fraud or error. Weaknesses in the
design of the internal control system and non-compliance with identified control
procedures amongst other conditions or events which increase the risk of fraud or errors
are:
i. Weaknesses in the design of the internal control system and non-compliance with
the laid down control procedures.
ii. Doubts about the integrity or competence of the management.
iii. Unusual pressures within the entity
iv. Unusual transactions
v. Problem in obtaining sufficient and appropriate audit evidence.
5. Comment on the following situations/statements: (35=15)

a) Ram, a Chartered Accountant prepared a project report for one of his clients to
obtain bank finance (long-term) of Rs. 50 lakhs from a commercial bank.
Consequent to the sanction of the loan by the bank, Ram charged 2% fee on the
figures of loan sanctioned.
b) Goma Limited, a leading trading business in electronic goods, has appointed CA.
Ranaji Ojha a statutory auditor with Rs. 1.5 lakhs audit fees. Besides, the
company has offered 5 latest model iphones costing of Rs. 1.5 lakhs to his family
members as gift.
c) While submitting the financial proposal on consultancy works of Emiliya Gypsum
Limited, PZT Associates, a CA. firm has calculated the cost as follows:
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FCA Rs. 5,000 Per day/person
ACA Rs. 2,500 Per day/person
RA Rs. 2,000 Per day/person
Assistants Rs. 1,000 Per day/person
Answer:
a) Section 10 of Code of Conduct has defined the way how the practicing professional
accountants charge fee on their works.
10.2 Professional fees should be a fair reflection of the value of the professional services
performed for the client, taking into account:
(a) The skill and knowledge required for the type of professional services involved.
(b) The level of training and experience of the persons necessarily engaged in performing
the professional services.
(c) The time necessarily occupied by each person engaged in performing the professional
services.
(d) The degree of responsibility that performing those services entails.
10.3 Professional fees should normally be computed on the basis of appropriate rates per
hour or per day for the time of each person engaged in performing professional services.
These rates should be based on the fundamental premise that the organization and
conduct of the professional accountant in public practice and the services provided to
clients are well planned, controlled and managed. They should take into account the
factors set out in paragraph 10.2 and are influenced by the legal, social and economic
conditions of each country. It is for each professional accountant in public practice to
determine the appropriate rates.
10.4 A professional accountant in public practice should not make a representation that
specific professional services in current or future periods will be performed for either a
stated fee, estimated fee, or fee range if it is likely at the time of the representation that
such fees will be substantially increased and the prospective client is not advised of that
likelihood.
10.5 When performing professional services for a client it may be necessary or expedient
to charge a pre-arranged fee, in which event the professional accountant in public practice
should estimate a fee taking into account the matters referred to in paragraphs 10.2
through 10.4.
Section 34(10) of Nepal Chartered Accountants Act, 1997 states that “Members holding
Certificate of Practice shall not base their remuneration as a percentage on the profit or on
any other uncertain results”.
Entering into a contingent fee arrangement relating to an assurance engagement is an

example of self interest threat. In the present case, audit fee is contingent upon the profit
after tax of the client. So, this is the situation of self interest threat to the auditor and
hence it is advisable for the auditor not to accept the engagement under such fee
arrangement.
b) A professional accountant should not accept any gifts or goods from the client which
threat the independence. Code of Conduct Section 8.6 and 8.9 attracts to the professional
accountant to accept the gift and goods. Section 8.6 says personal and family
relationships can affect independence. There is a particular need to ensure that an
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independent approach to any assignment is not endangered as a consequence of any
personal or family relationship.
It is recognized that it would be impracticable to attempt to prescribe in detail in ethical
requirements the permissible extent of a personal relationship between a professional
accountant in public practice and a client, or those occupying responsible executive
positions (e.g., director, chief executive, financial officer or another employee in a similar
position) with a client.
Section 8.10 of the Code of Conduct has defined not to accept any goods and services
from the client. Acceptance of goods and services from a client may be a threat to
independence. Acceptance of undue hospitality poses a similar threat. Goods and services
should not be accepted by professional accountants in public practice, their spouses or
dependent children except on business terms no more favorable than those generally
available to others. Hospitality and gifts on a scale which is not commensurate with the
normal courtesies of social life should not be accepted.
In a given case offering of 5 mobile sets of significant value to the auditor by Goma
Limited seems to have the intent of influencing the decision making of the auditor. Hence
this is the situation of self interest threat, familiarity threat and intimidation threat. In this
situation the auditor should evaluate the significance of the threats and apply safeguards
to eliminate threats or reduce them to an acceptable level. If the threat cannot be
eliminated or reduced to an acceptable level, the gifts shall not be accepted by the
auditor.
c) Nepal Chartered Accountant Act, 2053, Nepal Chartered Accountants Rules, 2061 and
the Code of Conduct of the Institute have given authority to make certain standards on
the charging of fees by its members. Applying the power as provided in the above
statutes, the Council has decided and fixed certain fundamental principles on minimum
fees, consultancy services fee and fee on certification work. As per the clause 2 of the
decision, the Council has fixed the minimum consultancy charges as follows:
FCA member Rs. 6000/- per working days
CA member Rs. 4000/- per working days
RA member Rs. 2000/- per working days
Other/assistants Rs. 1500/- per working days
In a given case, the fee as quoted by the CA firm is not complying with the decision as
made by the Council except RA member charge which is as per the decision of the
Council.

a) Guiding factors of materiality concept
b) Adverse opinion
c) Going concern
d) A qualifying insurance policy
Answer:
a) Guiding Factors of Materiality Concept
NSA 320 “Audit Materiality”, establishes standards on the concept of materiality and the
relationship with audit risk while conducting an audit. Guiding factors for determining
the materiality are:
i. Item of materiality may be determined individually or in aggregate.
ii. The materiality depends on the regulatory or legal considerations.
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iii. Materiality is not often reckoned with respect to quantitative details above. It has
qualitative dimensions as well.
b) Adverse Opinion
An adverse opinion should be expressed by the auditor when the effect of a disagreement
is so material and pervasive to the financial statements that the auditor concludes that a
qualification of the report is not adequate to disclose the misleading or incomplete nature
of the financial statements. Whenever the auditor expresses an opinion that is other than
unqualified, a clear description of all the substantive reasons should be included in the
report and, unless impracticable, a quantification of the possible effect(s) on the financial
statements. Ordinarily, this information would be set out in a separate paragraph
preceding the opinion or disclaimer of opinion on the financial statements and may
include a reference to a more extensive discussion, if any, in a note to the financial
statements.
c) Going Concern
The going concern assumption is a fundamental principle in the preparation of financial
statements. Under the going concern assumption, an entity is ordinarily viewed as
continuing in business for the foreseeable future with neither the intention nor the
necessity of liquidation, ceasing trading or seeking protection from creditors pursuant to
laws or regulations. Accordingly, assets and liabilities are recorded on the basis that the
entity will be able to realise its assets and discharge its liabilities in the normal course of
business.
d) A qualifying insurance policy is an insurance policy issued by an insurer that is not a
related party (as defined in NAS 16 Related Party Disclosures) of the reporting entity, if
the proceeds of the policy:
a. can be used only to pay or fund employee benefits under a defined benefit plan; and
b. are not available to the reporting entity‟s own creditors (even in bankruptcy) and
cannot be paid to the reporting entity, unless either:
i. the proceeds represent surplus assets that are not needed for the policy to meet
all the related employee benefit obligations; or
ii. the proceeds are returned to the reporting entity to reimburse it for employee
benefits already paid.

a) Audit plan and audit program
b) Audit report and certificate
Answer:
a) Audit Plan and Audit Program
The Distinction between Audit Plan and Audit Program are outlined as follows:
Audit plan is the developing a general strategy and a detailed approach for the expected
nature, timing and extent of the audit. The auditor plans to perform the audit in efficient
and timely manner where as audit program is the step and guidance and works as a tool
for performing/implementing audit at the execution level. The distinctions of those two
are:
i. Audit plan is prepared before preparing audit program.
ii. Audit plan is border scope than audit program.
iii. Audit plan assists acquiring knowledge of clients business and concentrating on
risk areas which will help for preparing effective audit program.
iv. Audit plan generally prepares by senior auditors and program may be prepared by
juniors based on plan and duly approved by seniors.
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b) Audit Report and Certificate
i. The term „report‟ is used where an expression of opinion is involved. The term
„certificate‟ is preferable where the auditor comments on or verifies facts
ii. The Auditor Report is based on facts, estimates and assumptions whereas Auditor's
Certificate is based on actual facts
iii. Auditor Report is not a guarantee of the absolute correctness & accuracy of
the books of accounts. But the auditor certificate serves as a guarantee of the
absolute correctness & accuracy of the books of accounts
iv. If the Auditor Report is later on found to be wrong, he cannot be held responsible
since he has given merely his opinion on the state of affairs of the company. But if
the duly signed certificate is found as wrong, he will be held responsible
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1810
F-Suggested Answer
Audit & Assurance
CAP II, June 2013

Marks
a) During the course of audit of a limited company, the auditor detected that the
managing director had committed a fraud involving a loss to the company. And
the managing director has also fully compensated the loss as committed by him
to the company immediately after the detection of fraud.
b) On the basis of approval accounting policy, Bee Limited has revalued its
property and charged Rs. 5 crores revaluation loss in profit and loss account in
2067/68 whereas transferred Rs. 10 crores the revaluation gain to revaluation
reserve in 2068/69.
c) A company wants to adjust the bank balance on the balance sheet date by
reversing the entry for a cheque issued in the normal course of business and
cancelled after the year end but before the finalization of accounts. The cheque
was returned on the ground that the signature differs.
d) Richak & Associates, a chartered accountant firm, was appointed as an auditor
of a company on 15 Aswin 2069 for the year 2068/69 where Ram Lal, one of
the partners of the audit firm, was holding 5% shares of the company since
2065. But Ram Lal sold all his shares of the company on 30 Aswin 2069. It was
further noted that the audit report was signed by another partner of the firm on
15 Falgun 2069 only.
Answer:
a) The detection of a fraud committed by the Managing Director involving a loss to the
company is a serious matter irrespective of the fact that the Managing Director has fully
compensated the company before the end of the fiscal year. In this context, NSA-240 on
“the Auditor responsibility to consider fraud and error in an audit of financial statements”
enumerates responsibilities of the auditor in case fraud and error to exist while
conducting the audit. It requires, first of all that auditor should consider the implications
of the circumstances on the true and fair view which the financial statements ought to
convey and secondly, where the significant fraud has occurred, that auditor should
consider the necessary for a disclosure of fraud in the financial statements and if adequate
disclosure is not made, the necessity for a suitable disclosure in his report.
NSA 240 further defined the duties of the auditor to communicate these matters to the
appropriate level of management on a timely basis, and consider the need to report such
matters to those charged with governance in such case.
When the auditor has obtained evidence that fraud exists or may exist, it is important that the
matter be brought to the attention of an appropriate level of management. This is so even if
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1893
(2)
the matter might be considered inconsequential (for example, a minor defalcation by an
employee at a low level in the entity‟s organization). The determination of which level of
management is the appropriate one is also affected in these circumstances by the likelihood
of collusion or the involvement of a member of management. If the auditor has determined
that the misstatement is, or may be, the result of fraud, and either has determined that the
effect could be material to the financial statements or has been unable to evaluate whether the
effect is material, the auditor: (a) discusses the matter and the approach to further
investigation with an appropriate level of management that is at least one level above those
involved, and with management at the highest level; and (b) if appropriate, suggests that
management consult with legal counsel.
b) NAS 6 paras 39, 40 and 41 are related with the treatment of revaluation of fixed assets. As per
this para, if an asset‟s carrying amount is increased as a result of a revaluation, the increase shall
be credited directly to equity under the heading of revaluation surplus. However, it reverses a
revaluation decrease of the same asset previously recognized in profit or loss.
If an asset‟s carrying amount is decreased as a result of a revaluation, the decrease shall be

recognized in profit or loss. However, the decrease shall be debited directly to equity under
heading of revaluation surplus to the extent of any credit balance existing in the revaluation
surplus in respect of that asset.
The revaluation surplus included in equity in respect of an item of property, plant and equipment
may be transferred directly to retained earnings when the asset is derecognized. This may involve
transferring the whole of the surplus when the asset is retired or disposed of. However, some of
the surplus may be transferred as the asset is used by an entity. In such a case, the amount of the
surplus transferred would be the difference between depreciation based on the revalued carrying
amount of the asset and depreciation based on the asset‟s original cost. Transfers from revaluation
surplus to retained earnings are not made through profit or loss.
Hence in a given case, the revaluation profit of Rs 5 crores is to be credited to profit or

loss account of the year 2068/69, the amount equivalent to revaluation loss which was
charged to profit or loss account in earlier years and Rs 5 crores is to be credited to equity
directly (i.e. revaluation reserve). So, the accounting treatment on revaluation of property,
plant and equipment provided by the company for the year 2068/69 is not in accordance
with the requirement of NAS.
c) According to the NAS-05 “Events After the Balance Sheet Date”, assets and liabilities
should be adjusted for significant events occurring after the balance sheet date that
provide additional evidence to assess estimation of amounts relating to conditions
existing at the balance sheet date. Since the phenomenon of difference in signature
existed on the balance sheet due (though known afterwards); the reversal of the entry
can be made as on the balance sheet date if the amount is material.
d) A person or a firm in which such person has substantial shareholding of the company or a
shareholder holding one percent or more of the paid up capital of the company or his/her
close relative is not qualified for appointment as an auditor as per section 112(1) of the
Companies Act. So, in the present case since Ram Lal, a partner of Richak & Associates,
holds 5% shares of the company, Richak & Associates is disqualified from appointment
as an auditor as on 15 Asoj 2069. But Ram Lal disposes all his shares after appointment
of his firm as an auditor and audit report is signed after his disposal of shares. Despite
this fact as per section 112(4) of the Companies Act since the appointment of auditor is in
contravention of the provisions of the Companies Act, the audit cannot be considered as
valid.
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1894
(3)
a) As an auditor of a small business, how can you assure the internal control
system of that company? 8
b) How would you safeguard your client against the payment for fictitious
purchases? 7
Answer:
a) Internal control is a set of internally generated policies and procedures adopted by the
management of an enterprise which is pre requisitive for an organization‟s efficient and
effective performance. It is thus a primary responsibility of every management to create
and maintained adequate system of internal control appropriate to the size and nature of
the business entity.
The system of internal control as the process designed, implemented and maintained by
those charged with governance, management and other personnel to provide reasonable
assurance about the achievement of an entity‟s objectives with regard to reliability of
financial reporting, effectiveness & efficiency of operations, safeguarding of assets and
compliance with applicable laws & regulations.
The auditor needs to obtain the same degree of assurance in order to given an unqualified
opinion on the financial statements of both small & large entities. However many
controls which would be relevant to large entities are not practical in small business. For
example, in a small business, accounting procedure may be performed by a few persons.
Small business is characterized by the lower number of employees, minimum investment
of capital, small capacity of production, difficulty to segregate the owner and the
management and there is less use of technology. It means the business is producing the
product (if it is a manufacturing industry) manually using very less mechanical tools and
traditional tools.
Like, another characteristic is the simplicity and local products designed to cover up the
local environment. It is highly labour intensive and less machine oriented in nature. Also
the business is dependent with the skill labour instead of installing high value of machine.
Those persons may have both operating and custodial responsibilities and segregation of
function may be missing or severely limited.
Inadequate segregation of duties, may in some cases, is offset by supervisory controls

exercised by the owner. The supervisory function by the owner becomes possible because
of the fact that he has direct personal knowledge of the business and involvement in the
business transactions.
In circumstances where segregation of duties is limited and the evidence of supervisory
controls is lacking the evidence necessary to support the auditors opinion on the financial
information may have to be obtained largely through substantive procedure.
b) The auditor has to be very cautious while verifying the purchases that no payments have
been made for the fictitious purchases. For this purpose, he may have to take the
following actions:
i) He should examine first the internal control system in connection with purchases and
satisfy himself with regard to its effectiveness.
ii) He should ensure that before passing the invoices for payment, they are checked with
the original order, with goods received book and the stock records.
iii) He should inspect the invoices and see that the authorities responsible for passing them
for payment have duly checked them and initialed.
iv) He should test check the invoices to see that dates given in the invoices are for the
period concerned and they have been addressed in the name of the client.
RCP
1895
(4)
v) He should also compare a number of invoices with the records in the goods received
book and stock records.
vi) He can make physical verification of the goods purchased, if a part of it is still in the
stock.
vii) He should also compare the supplier‟s statement with the supplier‟s account.
viii) Postings in the various suppliers‟ accounts should also be checked and compared with
the statement received from them.

a) The chief executive officer of a client company has returned your draft
representation letter stating that the directors fail to see why such a letter is
necessary and declaiming to issue the letter.
b) The management of Shri Ram Pvt. Ltd. argued that auditor has not carried out the
work properly citing reason that certain fraud and error were revealed after
issuing audit report, whereas audit report was silent on such fraud & error.
c) Mr. Raj, a fellow member of the Institute of Chartered Accountants of Nepal,
working as manager of Rahul & Associates, a chartered accountant firm, signed
the audit report of Om Ltd. on behalf of Rahul & Associates.
Answer:
a) NSA 580 has defined the management representations while conducting the audit. The
auditor should obtain written representations from management on matters material to the
financial statements when other sufficient appropriate audit evidence cannot reasonably be
expected to exist. The possibility of misunderstandings between the auditor and management
is reduced when oral representations are confirmed by management in writing. Matters which
might be included in a letter from management or in a confirmatory letter to management are
contained in the example of a management representation letter in the Appendix to this NSA.
8. Written representations requested from management may be limited to matters that are
considered either individually or collectively material to the financial statements. Regarding
certain items it may be necessary to inform management of the auditor‟s understanding of
materiality.
If management refuses to provide a representation that the auditor considers necessary, this
constitutes a scope limitation and the auditor should express a qualified opinion or a
disclaimer of opinion. In such circumstances, the auditor would evaluate any reliance placed
on other representations made by management during the course of the audit and consider if
the other implications of the refusal may have any additional effect on the auditor‟s report.
b) Nepal Standards on Auditing (NSA) 240 on „The Auditor's Responsibility to Consider

Fraud and Error in an Audit of Financial Statements‟ deals the matter on auditor
responsibility. NSA 01 has defined the objective of an audit of financial statements and
as per this standard, the auditor should express an opinion whether the financial
statements are prepared, in all material respects, in accordance with an identified
financial reporting framework or relevant practices. An audit conducted in accordance
with NSAs or relevant practices is designed to provide reasonable assurance that the
financial statements taken as a whole are free from material misstatement, whether
caused by fraud or error. The fact that an audit is carried out may act as a deterrent, but
the auditor is not and cannot be held responsible for detection of fraud and error.
The management connotation on charge to auditor will be tenable only if the auditor fails
to carry out his duty under following parameters:
i) Using professional skepticism for understanding the risk of material misstatements

resulting from the errors and frauds in financial statements.
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1896
(5)
ii) Audit preliminaries for gaining knowledge about any susceptibility of misstatements
arising from fraud; Audit planning with audit team, audit enquiry of management;
discussion with charge of corporate governance; identification of fraud risk
factors etc.
iii) Audit Response when fraud risk factors are identified to be present-Considering
modifying substantive procedures to reduce detection risk.
iv) Circumstances indicative of presence of misstatement resulting from fraud,
identification of misstatement.
v) Determining the effect of misstatement in financial statements, tagging it with fraud,
documentation, communication and reporting.
vi) Awareness of auditor‟s responsibility in addition with the responsibility of that charge
of governance.
c) Signature on Audit Report: Section 116 of the Companies Act, 2063 requires that only a
person appointed as the auditor of the company or where a firm is so appointed, the
member who has been authorized by a decision of the partners of such institution, may
sign the auditor‟s report or sign or authenticate any other document of the company
required by law to be signed or authenticated by the auditor. Therefore, Mr. Raj, a fellow
member of the Institute and a manager of M/s Ram & Associates., Chartered
Accountants, cannot sign on behalf of the firm in view of the specific requirements of the
Companies Act, 2063.

a) Under what circumstances an independent auditor can issue comfort letter to
his/her client?
b) District Education Office has appointed you as an auditor for some community
schools of Humla District. What special points do you consider while doing
audit of such schools? Explain.
c) Write down ten areas where different accounting policies are applied on
accounting the financial transactions based on the nature of entities.
Answer:
a) A letter from independent auditor including in a preliminary prospectus stating that,
while a full audit has not undertaken, the auditor has done a review sufficient to assure
that financial statement information in the preliminary prospectus is correctly prepared to
the best of the auditor knowledge. The auditor in effort states that, had a full audit been
done, they are comfortable that the audited financial statements would not be materially
different from the ones presented in the preliminary prospectus.
Before or during a new issue, a statement by an auditor stating that, while a full audit has
not been done, a review of the issue's prospectus has revealed nothing inaccurate or
misleading. The comfort letter also states that the auditor is confident that a full audit
would not uncover anything unusual that would negatively affect the issue.
In other word, a letter is given to organizations or persons of interest by external auditors
regarding statutory audits, statements and reports used in a prospectus. The comfort letter
will be attached to the preliminary statements as assurance that it will not be materially
different from the final version.
b) Audit of Education Institutions i.e. Community Schools of Humla District:
The special steps involved in their audit are the following:
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1897
(6)
 Examine the Education Act and Education Rules in these cases as these are the
Community Schools which are under the control of the District Education Office and
note all the provisions affecting accounts. .
 Read through the minutes of the meeting of the School Management Committee, noting
resolutions affecting account to see that these have been duly complied with, specially the
decisions as regards the operation of bank account and sanctioning of expenditure.
 Check names entered in the Students Fee Register for each month or term, with the
respective Class Registers, showing names of student on rolls and test amount of fees and
extra charged; and verify that there operates a system of internal check which ensures that
demands against the student are properly raised.
 Check fees received by comparing counterfoils or receipts granted with entries in the
Cash Book and tracing the collections in the Fee Register to confirm that the revenue
from this source has been duly accounted for.
 Total up the various columns of the Fees Register for each month or term to ascertain that
fees paid in advance have been carried forward and that the arrears that are irrecoverable
have been written off under the sanction of an appropriate authority.
 Check admissions fees with admissions slips signed by the head of the institution and
confirm that the amount has been credited to a Capital Fund, unless the School
Management Committee has taken a decision to the contrary.
 See the free studentship and concessions have been granted by a person authorized to do
so, having regard to the Rules prepared by the Management Committee.
 Confirm that fines for late payment or absence, etc. have been either collected or remitted
under proper authority.
 Confirm that hostel dues were recovered before student's accounts were closed and their
deposits of caution money refunded.
 Verify rental income from landed property with the rent rolls, etc.
 Verify any government or local authority grant with the memo of grant. If any expense
has been disallowed for purposes for grant, ascertain the reasons thereof.
 Report any old heavy arrears on account of fees, dormitory rents, etc. to the Management
Committee.
 Confirm that caution moneys and other deposits paid by students on admission, have
been shown as liability in the balance sheet and not transferred to revenue, unless they are
not refundable.
 See that the investments representing endowment funds for prizes are kept separate and
any income in excess of the prizes has been accumulated and inappropriate securities.
 Check the distribution of scholarship to the students and ensure the same with the receipts
of the students.
 Check the distribution sheet of textbooks, payroll of the PCF teachers with the number of
students.
c) Various Nepal Accounting Standards (NAS) are issued by the Accounting Standard
Board of Nepal which are mandatory in nature and few are recommendatory as well. For
prudent accounting practices; application of NAS should be made on accounting of
financial transactions. Some areas where accounting policies suggested by NAS are:
i) Method of depreciation, depletion and amortization-Straight Line Method, Written

Down Value method.
ii) Accounting Concept: Historical cost convention is to be defined.
iii) Fluctuation of foreign currency and its treatment should be defined.
iv) Valuation of inventories – FIFO, LIFO, weighted average etc.
v) Treatment of goodwill – write off, retain.
vi) Valuation of investment –at cost, market or net realizable value etc.
vii) Treatment of retirement benefits-Actuarial, funded through trust, insurance policy etc.
viii) Recognition of Revenue either on mercantile or accrual basis is defined.
ix) Revaluation of fixed assets and writeoff of fixed assets having certain value say Rs.
1,000 or less.
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1898
(7)
x) Treatment of contingent liabilities.
5. Comment on the following situations/statements. (35=15)

a) Siddhi & Co., a chartered accountant firm is appointed a fund manager of an
INGO situated in Nepal. The INGO has then transferred money in the current
account of Siddhi & Co. for the operation of project activities. Opine on the act
of Siddhi & Co. for:
i) transferring certain money to saving bank account and
ii) charging/ drawing fee due from the client.
b) RB Associates, a firm of chartered accountants has two partners, R and B. The
firm is already holding audit of 130 companies including audit of 90 NGOs. The
firm is offered the audit of Labour Welfare Association.
c) CA. Khari Adhikari heads the internal audit department of Tee limited. The
external audit firm decided to rely on the internal auditor‟s work relevant for
external audit because of the professional competency of the chief of internal
audit of Tee Limited. Later it was found that the external auditor had conducted
audit procedures himself instead of relying on internal auditor‟s work; however
claimed that he should not be made responsible for inappropriate audit opinion
because he had relied on the work of qualified internal auditor.
Answer:
a) Section 12 of the Code of Ethics of the Institute of the Chartered Accountants of Nepal
permits keeping client‟s money for using on legal activities on behalf of client and which
is also permitted by the ToR and the agreement with the client.
i) The act of transferring client‟s money in saving bank account for reasonable
time is valid only when it seems likely that the client‟s monies remain on
current account for a significant period of time and Siddhi & Co. have taken
prior concurrence of the client.
ii) Siddhi & Co., can charge/draw fees due from a client‟s monies provided that
client, after being notified of the amount of such fees, has agreed to such
withdrawal.
b) As per the notification issued by the ICAN :
i) In case of partnership firms of auditor, the ceiling on audit is hundred entities per
partner of the firm.
ii) The maximum number of audits of the public company registered under Company Act
is 15 and number of audits of other entities is 85 per partner.
iii) The firm can taken maximum of two hundred audits (100 × 2), but the number of
Audits of NGOs should not exceed 90. There are two partners – R and B.
iv) The firm is holding 90 audits of NGOs at present.
v) The firm can, therefore, accept audit of Labour Welfare Association assuming that
Labour Welfare Association is registered under the Association Registration Act, 2034.
c) The role of internal auditing is determined by management, and its objectives differ from
those of the external auditor who is appointed to report independently on the financial
statements. The internal audit function‟s objectives vary according to management‟s
requirements. The external auditor‟s primary concern is whether the financial statements are
free from material misstatements. Nevertheless some of the means of achieving their
respective objectives are often similar and thus certain aspects of internal auditing may be
useful in determining the nature, timing and extent of external audit procedures. Internal
auditing is part of the entity. Irrespective of the degree of autonomy and objectivity of
RCP
1899
(8)
internal auditing, it cannot achieve the same degree of independence as required of the
external auditor when expressing an opinion on the financial statements. The external auditor
has sole responsibility for the audit opinion expressed, and that responsibility is not reduced
by any use made of internal auditing. All judgments relating to the audit of the financial
statements are those of the external auditor.
The external auditor has sole responsibility for the audit opinion expressed, and that
responsibility is not reduced by any use made of internal auditing. All judgments relating
to the audit of the financial statements are those of the external auditor. Hence the
external audit firm in the given situation cannot be relieved of its duty to express opinion
on the financial statements by relying on the work of internal auditor.

a) Detection risk
b) Audit strategy
c) Features of government audit
d) Tolerable error
Answer:
a) Detection risk: Detection risk is the risk that the auditor will not detect a misstatement
that exists in an assertion that could be material, either individually or when aggregated
with other misstatements. Detection risk is a function of the effectiveness of an audit
procedure and of its application by the auditor. Detection risk cannot be reduced to zero
because the auditor usually does not examine all of a class of transactions, account
balance, or disclosure and because of other factors. Such other factors include the
possibility that an auditor might select an inappropriate audit procedure, misapply an
appropriate audit procedure, or misinterpret the audit results. These other factors
ordinarily can be addressed through adequate planning, proper assignment of personnel to
the engagement team, the application of professional skepticism, and supervision and
review of the audit work performed.
b) Audit Strategy
Audit planning is the process of gathering information and design audit strategies. The
main output of audit planning is a tailored audit approach supported by appropriate
administrative arrangements.
Audit strategy is concerned with designing optimized audit approaches that seeks to
achieve the necessary audit assurance at the lowest cost within the constraints of the
information available. Audit procedures should be relevant to the important assertions,
and as cost effective as possible to perform.
Audit strategy generally involves the following steps:

i) Obtaining knowledge of clients business,
ii) Performing analytical procedures at initial stage,
iii) Evaluating inherent risks,
iv) Evaluating internal control system for strategy purpose and
v) Formulating the strategy.
The auditor should also develop the strategy by considering the results of gathering or
updating information about the client, and making preliminary judgment about
materiality, inherent risk and control effectiveness.
RCP
1900
(9)
The initial assessment of the quality and complexity of the client‟s system will affect the
amount of the information the auditor needs to gather. Sometimes, on a new engagement,
the appropriate strategy may be oblivious from a limited amount of investigation work.
c) Features of Government Audit

Citizen of the country are more concern on issues concerning public accountability, including the
misuse of public funds, evaluation of the effectiveness and outcomes of government programs,
information disclosure based on the “right-to-know,” and requests for disclosure of government
financial data through financial statements. To meet these challenges, each government has one
Supreme Audit Institution that is responsible for the public auditing whereas Financial
Comptroller General is responsible to maintain public accounting.
Supreme Audit Institution in Nepal is called the office of the Auditor General (OAGN) who
conduct public audit of the government budget and expenditure. Regarding the aim of auditing,
public audits are carried out as comprehensive audits that include financial auditing and
performance auditing or value-for-money (VFM) auditing.
The aim of audit of government auditing has some audit areas that are completely different from
those concerning the auditing of corporate accounts. In government auditing, the scope of
financial auditing includes audit areas other than the audit of accounts, and performance auditing
includes the evaluation of economy, efficiency, and effectiveness. OAGN also performs the audit
of regularity and propriety.
Government auditing was initially conducted as compliance audits, which means accurate
account auditing or financial auditing. Subsequently, government organizations were required to
provide effective public services by efficient management in the performance of their trusteeship
obligations, which in turn necessitated performance auditing.
As a feature of performance auditing, the Auditing Standards of the International Organization of

Supreme Audit Institutions (INTOSAI) point out that “performance audits should not concentrate
solely on criticism of the past but should be constructive.
d) Tolerable error: Tolerable error is the maximum error that that the auditor would be
willing to accept and still concludes that the result from the sample has achieved the audit
objective. Tolerable error is considered during the planning stage and for substantive
procedures related to the auditor judgment about materiality. The smaller the tolerable
error, the greater the sample size will need‟s be.
In test of control, the tolerable error is the maximum rate of deviation from a prescribed
control by control procedure that at the auditor would be willing to accept, based on the
preliminary assessment of control risk. In substantive procedure, tolerable error is the
maximum monetary error in an account balance or a class of transactions that the auditor
would be willing accept, so that when the result of all audit procedure are reasonable
assurance, that the financial statement are not materially mis-stated.
7. Distinguish between : (25=10)

a) Computerized and manual accounting system
b) Test checking and routine checking
Answer:
a) Distinction between computerized and Manual Accounting System:
i) Faster and efficient in processing of information in computerized system and no such
faster and efficient in processing of information in manual system
ii) Automatic generation of accounting documents like invoices, cheques and statement of
account which manual system cannot produce.
RCP
1901
(10)
iii) With the larger reductions in the cost of hardware and software and availability of user-
friendly accounting software package, it is relatively cheaper like maintaining a manual
accounting system;
iv) More timely information can be produced than manual system
v) No more manual processing of the data- all automatically posted to the various
ledgers/accounts and many types of useful reports can be automatically generated for
management to make decisions where as such reports cannot generated on manual system
vi) Power failure, computer viruses and hackers are the inherent problems of using
computerized systems, such risk not remain in manual system
vii) Once data been input into the system, automatically the output are obtained hence the
data being input needs to be validated for accuracy and completeness, we should not
forget concept of GIGO (Garbage In(Input) Garbage out ( Output) where validation in
manual system can be checked on inception
viii) Accounting system not properly set up to meet the requirement of the business due to
badly programmed or inappropriate software or hardware or personnel problems can
caused more havoc , where manual system does not have such problem.
ix) Danger of computer fraud if proper level of control and security whether internal and
external are not properly been instituted, where manual system does not have such
problem.
b) Test checking and routine checking can be distinguished on the basis of following points:
i) Concept: Test checking involves selecting a few transactions on the basis of auditor‟s
judgment and examining them. But routine checking involves checking of books and
records.
ii) Object: The main object of test checking is to form an opinion on the financial statements
on the basis of examination of selected sample. While the main object of routine
checking is ensuring arithmetical accuracy of the entries in the original books and ledgers
and posting to correct ledgers accounts.
iii) Relationship: Routine checks may be performed on the basis of test checking.
RCP
1902
The Institute of Chartered Accountants of Nepal
Suggested Answers of Audit and Assurance
CAP II Examination- December 2012
a) Your client has computed the deferred tax assets or liabilities on: i. Fixed assets as per financial base Rs.
500,000, as per tax base Rs. 600,000; ii. Other assets as per financial base 300,000 as per tax base Rs. 200,000 and other
liabilities as per financial base Rs. 100,000 as per tax base Rs. 50,000. Consider applicable tax rate 5% and opening
balance of deferred tax asset is Rs.5,000As a Auditor how would be check the accounting treatment made on deferred
tax by your client (show your computation as well)?
b) Puran (A practicing Chartered Accountant) has been appointed as statutory auditor of ABC Development Bank
Limited for the fiscal year 2068/69. Puran has been holding certain paid up share capital of the bank since the year 2060.
Is the appointment of Puran is valid?
c) New auditor of XYZ Limited signed the financial statements for the year 2068/69 without considering the
previous year auditor's report and financial figures.
d) The Balance sheet of ABC Ltd. includes inventory amounting to Rs. 3 crores out of total assets of 20 crores. The
inventories were valued at cost. The market price of the inventories was Rs. 2.5 crores. The company has disclosed this
fact in the notes to accounts.
Answer:
a) Nepal Accounting Standard 9 (NAS) defined on deferred tax assets and liabilities. The NAS suggested for
computing deferred tax assets or liabilities on temporary differences on tax base and financial base and booking
corresponding income or expenses. The computation of deferred tax has been as follows:
Particulars Financial Tax Base (B) Deferred (Assets) Applicable Deferred Tax (Assets)
Base (A) /Liabilities C= (A-B) /Liabilities @ 5% D= C*5%
1.Fixed Assets 500,000 600,000 (100,000) Yes (5,000)
2.Other Assets 300,000 200,000 100,000 Yes 5,000
3. Liabilities 100,000 50,000 (50,000) Yes (2,500)
Net Asset (2,500)
Previous year Asset Balance (5,000)
Decrease in Asset (Charged to 900,000 850,000 (50,000) (2,500)
PL)
Accordingly closing balance of deferred tax should be Rs. 2,500 and deferred tax asset should be credited by Rs. 2,500
by charging corresponding amount to profit & loss account as deferred tax expenses.
b) Section 112 of the Companies Act, 2063 stated the disqualifications of auditor: As per Act None of the certain persons
or the firms or companies in which such persons are partners shall be qualified for appointment as auditor and shall,
despite appointment as auditor, continue to hold office.
Provision regarding appointing shareholder as auditor as per Companies Act stated that: persons or the firms or
companies who is substantial shareholder of the company or a shareholder holding one percent or more of the paid up
capital of the company or his close relative cannot be appointed as auditor.
In the instance case the % of holding paid up capital is not mentioned, if the Puran himself or firm or company he is
partner or shareholder or his close relative do not hold one percent or more than one percent of the paid up capital of
ABC Development Bank Limited only than Puran is qualified to be appointed as auditor.
c) NSA 24 Para 9 has defined the treatment of the previous figures and auditors' report. As per the Para 9, the auditor
should obtain sufficient appropriate audit evidence that the corresponding figures meet the requirement of the relevant
financial reporting framework. The extent of audit procedures performed on the corresponding figures is significantly
less than for the audit of the current period figures and is ordinarily limited to ensuring that the corresponding figures
have been correctly reported and are appropriately classified. This involves the auditor assessing whether:
i) accounting policies used for the corresponding figures are consistent with those of the current period or whether
appropriate adjustments and/or disclosures have been made; and
ii) corresponding figures agree with the amounts and other disclosures presented in the prior period or whether
appropriate adjustments and/or disclosures have been made.
1978
Suggested Answers – Audit and Assurance
CAP II Examination – December 2012
In Para 10 when the financial statements of the prior period have been audited by another auditor, the incoming auditor
assesses whether the corresponding figures meet the conditions specified in paragraph 9 above and also follows the
guidance in NSA 21, “Initial Engagements-Opening Balances.”
In Para 11 when the financial statements of the prior period were not audited, the incoming auditor nonetheless assesses
whether the corresponding figures meet the conditions specified in paragraph 9 above and also follows the guidance in
NSA 21.
In Para 12 if the auditor becomes aware of a possible material misstatement in the corresponding figures when
performing the current period audit, the auditor performs such additional procedures as are appropriate in the
circumstances.
When the comparatives are presented as corresponding figures, the auditor should issue an auditor‟s report in which the
comparatives are not specifically identified because the audit opinion is on the current period financial statements as a
whole, including the corresponding figures.
When the auditor‟s report on the prior period, as previously issued, included a qualified opinion, disclaimer of opinion,
or adverse opinion and the matter which gave rise to the modification is: (a) unresolved, and results in a modification of
the auditor‟s report regarding the current period figures, the auditor‟s report should also be modified regarding the
corresponding figures; or (b) unresolved, but does not result in a modification of the auditor‟s report regarding the
current period figures, the auditor‟s report should be modified regarding the corresponding figures.
d) As per Nepal Accounting Standard 4, Inventories should be measured at lower of cost or net realizable value. In the
present case the cost price of the inventories is 3 crores and net realizable value is 2.5 crores and hence the inventories
should be presented at 2.5 crores in the balance sheet. However, the company has presented the inventories at 3 crores
and disclosed in the notes to accounts that the inventories have been presented at cost although its net realizable value is
lower than the cost. Mere disclosure of this fact in the notes however does not result into compliance with the accounting
standard. Hence as an auditor I will qualify my audit report because inventory in the present case represents material
item of the assets of the company and it has been materially misstated in the balance sheet.

a) You have taken up the assignment for Due Diligence Review of the financial statement as of 31 Asadh 2069 of Das
Dhunga Bank Ltd for facilitating the merger process with Lucky Finance Co. Ltd. Write down any seven points you have
to pay due consideration on carrying out the review on assets side (covering each asset category) of the financial
statement. 7
b) As a quality control manager of the audit engagement team of D Limited, how can you ensure that your team has
performed the audit works as per the standard maintained by your audit firm along with the other mandatory compliance
of various national and international standards in auditing and accounting? Points out the review procedures to ensure the
quality of the audit work? 8
Answer:
a) Upon taking up the assignment for due diligence review of the Das Dhunga Bank Ltd; i have to pay due
following due consideration on review assets side of the financial statement:
i. Loan & Advances: The due consideration to be paid on loan and advances is whether the adequate loan loss
provision has been made in line with Nepal Rastra Banks Directive applicable to the bank.
ii. Investment: The due consideration to be paid on investment is that whether the investment has been made in
line with Nepal Rastra Banks Directive in eligible portfolio. If investment is doubtful of recovery to see whether
necessary provision has been set aside or otherwise. Further in applicable cases have to see whether required
reserves/funds against the investment been set aside.
iii. Fixed Assets: The due consideration to be paid on fixed assets is that whether all the fixed assets appearing in
financial statement legally owned by the entity, physically available and are in working condition. The major fixed assets
should be revalued with the help of expert for the purposes of DDA.
iv. Advance Tax: The due consideration to be paid on Advance Tax is to see whether the amount shown as
advance tax are really an existed asset representing the cash deposits made and advance tax made by parties and are not
time barred for claiming for assessment of tax purposes.
v. Non-Banking Assets (NBA): To see whether the NBA are on the possession and ownership of the bank. See
whether disposal (sales) process of NBA has not been suffered any hindrances like NBA is insufficient for covering
dues recoverable, NBA is subject to lien of others , NBA is under legal cases. Further should be ensured that NBA is
adequately provisioned as per NRB Directives.
vi. Advances: To see the recoverability of advances. If advances are doubtful of recoverability, ensure that
whether adequate provision against possible loss has been made.
vii. Deposits : To see the existence of various deposits . If deposits are doubtful of refund and are not backed
up with sufficient documents, ensure that whether adequate provision against possible loss has been made.
b) The quality control manager inform the responsibilities of the engagement team and also give some of the things to
be ensured before starting the works as follows;
 understanding the nature of the entity's business
 Possible risk related issues
 Problems that may arise; and
2 of 62 1979
 The detailed approach to the performance of the engagement.

The engagement team's responsibilities includes maintaining an objective state of mind and an appropriate level of
professional skepticism, and performing the work delegated to them in accordance with the ethical principle of due care.
The quality control manager before review the files, will supervise the engagement team and do the following works:
 Tracking the progress of the audit engagement;
 Considering the capabilities and competence of individual members of the engagement team, whether they have
sufficient time to carry out their work, whether they understand their instructions, and whether the work is being carried
out in accordance with the planned approach to the audit engagement.
 Addressing significant issues arising during the audit engagement, considering their significance and modifying the
planned approach appropriately.
 Identifying matters for consultation or consideration by more experienced engagement team member during the
audit engagement.
The quality control manager will review the work performed by their team members and consider the following while
reviewing the works and working papers:
 The work has been performed in accordance with professional standards and regulatory and legal requirements;
 Significant matters have been raised for further consideration;
 Appropriate consultations have taken place and the resulting conclusions have been documented and implemented.
 There is a need to revise the nature, timing and extent of work performed;
 The work performed supports the conclusions reached and is appropriately documents;
 The evidence obtained is sufficient and appropriate to support the auditor's report;
 The objectives of the engagement procedures have been achieved.
The engagement partner conducts timely reviews at appropriate stages during the engagement. This allows significant
matters to be resolved on a timely basis to the engagement partner‟s satisfaction before the auditor‟s report is issued. The
reviews cover critical areas of judgment, especially those relating to difficult or contentious matters identified during the
course of the engagement, significant risks, and other areas the engagement partner considers important. The engagement
partner need not review all audit documentation. However, the partner documents the extent and timing of the reviews.
Issues arising from the reviews are resolved to the satisfaction of the engagement partner.
3. Giv
e your comments on the following: (35=15)
a) Sahara Garment Private Limited is one of the leading garments industries in Nepal. The company has exported
50,000 readymade shirts to Turkey for equivalent NPR 10 millions and booked NPR 10 millions as income in their
account, however, the government of Turkey for the time being has suspended the equivalent NPR 5 millions amount to
be remitted to Sahara Garment P Ltd on the ground that the quota system as determined by the government of Turkey is
below than the goods as supplied by Sahara Garment from Nepal
b) Mr. Lakhan, Statutory Auditor of Radha Krishna Pvt. Ltd wants to verify cash on hand as on 31st Asadh, 2069. The
Management informs Mr. Lakhan that it is not possible to cooperate, as cashier has been out of station. Advise Mr.
Lakhan on how to deal with the situation.
c) A proprietary audit firm of Chartered Accountant has accepted the engagement to audit the accounts of a private
school with annual turnover of Rs 10 lakhs at the audit fee of Rs 8,500. The firm anticipates that the audit will consume
estimated time of 2 man days of the Chartered Accountant.
Answer:
a) NAS 07 Nepal accounting standards on revenue Para 18 has clearly defined the case of remit suspense. As per this
Para revenue is recognized only when it is probable that the economic benefits associated with the transaction will flow
to the entity. In some cases, this may not be probable until the consideration is received or until an uncertainty is
removed. For example, it may be uncertain that a foreign governmental authority will grant permission to remit the
consideration from a sale in a foreign country. When the permission is granted, the uncertainty is removed and revenue is
recognized. However, when an uncertainty arises about collectability of an amount already included in revenue, the
uncollectable amount or the amount in respect of which recovery has ceased to be probable is recognized as an expense,
rather than as an adjustment of the amount of revenue originally recognized.
Sahara Garment P Ltd has to adjust the balance suspended amount from the revenue which was recognized previously.
Otherwise the auditor should make qualification on the revenue reorganization.
b) The scope of audit may be limited for varied reasons, (i) the entity may impose restriction on scope of audit, (ii) the
limitation may be imposed by circumstances. When the audit is carried out under and as per statute, the auditor should
not accept the assignment when his duties are curtailed by agreement, unless required by any Law.

3 of 62 1980
When audit is carried out in accordance with the entity‟s terms voluntarily, the auditor may indicate his scope in his
audit report.
Sometimes, the circumstances may impose restrictions on audit scope. For example, if the auditor is appointed after the
year end, he may not be able to participate in inventory checking. Or sometimes, the records required may not be
available so that the auditor may not be able to check details in the manner he liked. Such limitations in scope may
warrant an auditor to express disclaimer of opinion or qualified opinion in his audit report depending upon the
circumstances.
The non co-operation of Radha Krishna Pvt. Limited will amount to limitation on scope of auditors.
c) As per directive issued by the council, a CA member holding COP shall charge the audit fee to his audit client and
the fee shall not be less than Rs 10,000. If the audit client is a financial institution regulated by Nepal Rastra Bank or
insurance company regulated by the Insurance Board, the audit fee shall not be less than Rs 40,000. However, above
minimum fee does not apply where the audit client is a Government Primary School/Community School with annual
turnover of less than Rs 5 lakhs and where the audit client is an organization with annual turnover of less than Rs 2
lakhs. In the present case the CA member has charged the audit fee of Rs 8,500 to a private school with annual turnover
of Rs 10 lakhs which is not covered by the exception for charging lower fee and hence the auditor should have charged at
least Rs 10,000 as audit fee. Hence the member seems to have not followed the directive of the council and accordingly
may be subject to disciplinary action.
a) How will you verify the retirement gratuity to employees?

b) An audit is not a guarantee that the financial statements are free from material misstatement, because absolute
assurance is not attainable. What are the factors which hinders the auditor to provide absolute assurance?
c) As statutory Auditor of XYZ Pvt. Ltd. you requested your client for sending letter for balance confirmations from
certain debtors, the client argue that since the said balances with debtors are under dispute and the matter is pending in
the court it is not necessary to ask balance confirmation.
Answer:
a) Verification of retirement gratuity
 Examine the basis on which payable to employees is worked out. The liability for gratuity may either be worked on
actuarial rules or agreement or the presumption that all employees retire on the balance sheet date.
 Verify computation of liability of gratuity on the aggregate basis.
 Check the amount of gratuity paid to employees who retired during the year with reference to number of years of
services rendered by them.
 See that the annual premium has been charged to profit and loss account in cash the concern has taken a policy from
the insurance companies.
 Ensure that the basis of computing gratuity is valid.
 Ensure that the accounting treatment is in accordance with NSA 24 Accounting and Reporting by Retirement
Benefits Plans'.
b) Factors hindering the auditor to provide absolute assurance: Auditor provides reasonable assurance on the
financial statements and is not in the position to provide absolute assurance due to the following factors:
i) Use of testing/sampling rather than 100% checking,
ii) The inherent limitations of internal control (for example, the possibility of management override or collusion),
iii) The fact that most audit evidence is persuasive rather than conclusive and
iv) The work undertaken by the auditor to form an audit opinion is permeated by judgment, in particular
regarding: (a) The gathering of audit evidence, for example, in deciding the nature, timing and extent of audit
procedures; and (b) The drawing of conclusions based on the audit evidence gathered, for example, assessing the
reasonableness of the estimates made by management in preparing the financial statements.
c) NSA 505, “External Confirmations”, establishes standards on the debtor‟s use of external confirmation as a means
of obtaining audit evidence. It requires that the auditor should employ external confirmation procedures in consultation
with the management. The auditor may come across certain situations in which the management may request him not to
seek external confirmation from certain parties because of dispute with the debtors, etc. The management, for example,
might make such a request on the grounds that due to a dispute with the particular debtor, the request for confirmation
might aggravate the sensitive negotiations between the entity and the debtor. In such cases, when an auditor agrees to
management‟s request not to seek external confirmation regarding a particular debtor, the auditor should consider
validity of grounds for such a request and assess management‟s integrity and obtain evidence to support the same. The
auditor should also ask the management to submit its request in a written form, dealing therein the reasons for such a
request. The auditor agrees to management‟s request not to seek external confirmation regarding a particular matter, the
auditor should document the reasons for accepting to the management‟s request and should apply alternative procedures
to obtain sufficient appropriate evidence regarding that matter. While considering the validity of request, in case the
auditor reaches at a conclusion that the same was not valid, he may appropriately modify the report.

4 of 62 1981
a) Though the audit for the year 2068/69 was completed, but not signed the financial statements of X Limited by the
board of directors. In the mean time, the board has decided to stop the operation of Z Limited, one of the major
subsidiary companies of X Limited with effect from Marg 1, 2069.
b) What is the responsibility of the professional accountant " When he knows a material error or omission in a tax
return of a prior year (with which the professional accountant may or may not have been associated), or of the failure to
file a required tax return?
c) Ramesh Sharma was Chief Finance Officer of A Ltd for the period 1 Srawan 2064 to 15 Ashad, 2069. He joined
XYZ Chartered Accountant firm from 1 Srawan 2069 as Senior Audit Manager. A Ltd. has approached the firm on 15
Shrawan 2069 for the audit of accounts for the year 2068/69 with Ramesh Sharma as Engagement Manager of the audit
team. Please provide your opinion on what the audit firm should do?
Answer:
a) NAS 05 section 21 has defined the non – adjusting events after the balance sheet date, but it should be disclosed in
the balance sheet. The sections this events as follows:
If non-adjusting events after the balance sheet date are material, nondisclosure could influence the economic decisions of
users taken on the basis of the financial statements. Accordingly, an entity shall disclose the for each material category of
non-adjusting event after the balance sheet date:
(a) the nature of the event; and
(b) an estimate of its financial effect, or a statement that such an estimate cannot be made.
Section 22 has defined the examples of non adjusting events after the balance sheet date are as follows:
(a) a major business combination after the balance sheet date (NAS 21 Business Combinations requires specific
disclosures in such cases) or disposing of a major subsidiary;
(b) announcing a plan to discontinue an operation;
(c) major purchases of assets, classification of assets as held for sale, other disposal of assets, or expropriation of major
assets by government;
(d) the destruction of a major production plant by a fire after the balance sheet date;
(e) announcing, or commencing the implementation of, a major restructuring;
(f) major ordinary share transactions and potential ordinary share transactions after the balance sheet date (NAS 26
Earnings Per Share requires an entity to disclose a description of such transactions, other than when such transactions
involve capitalization or bonus issues, share splits or reverse share splits all of which are required to be adjusted under
NAS 26);
(g) abnormally large changes after the balance sheet date in asset prices or foreign exchange rates;
(h) changes in tax rates or tax laws enacted or announced after the balance sheet date that have a significant effect on
current and deferred tax assets and liabilities (see NAS 09 Income Taxes);
(i) entering into significant commitments or contingent liabilities, for example, by issuing significant guarantees; and
(j) commencing major litigation arising solely out of events that occurred after the balance sheet date.
In the financial statements of X Limited, a proper disclosure is required regarding the closure of the subsidiary company
Z Limited and its effects though the financial figures will not be changed in the balance sheet.
b) As per Section 5.8 of the Code of Ethics of the institute of the chartered accountants of Nepal in such case
professional accountant is responsible for:
i. Promptly advise the client or employer of the error or omission and recommend that disclosure be made to the
revenue authorities. The professional accountant is not obligated to inform the revenue authorities.
ii. If the client or the employer does not correct the error the professional accountant:
(a) should inform the client or the employer that it is not possible to act for them in connection with the return or other
related information submitted to the authorities; and
(b) should consider whether continued association with the client or employer in any capacity is consistent with
professional responsibilities.
iii. If the professional accountant concludes that a professional relationship with the client or employer can be
continued, all reasonable steps should be taken to ensure that the error is not repeated in subsequent tax returns.
c) Ramesh Sharma was the Chief Finance Officer of A Ltd. for almost entire year 2068/69. He has left A Ltd just a
month before the audit firm was approached by A Ltd for audit of 2068/69 and proposes his name to be engaged as
engagement manager in the audit team. This situation may result into self-interest, self review and familiarity threat to
the firm. Hence the firm should request A Ltd. that the firm cannot assign Ramesh as an audit team member. If A Ltd
does not accept the audit team without Ramesh as senior member in the audit team from the firm, the audit firm should
not accept this engagement.
5 of 62 1982

a) Legal liabilities of auditor
b) Internal Audit
c) Engagement Letter
d) "During payments vouching, the auditor does not merely check proof that money has been paid away".
Answer:
a) Legal Liabilities of auditor:
Auditors must always perform their work complying the basic principles of audit, which are, integrity, objectivity,
independence, confidentiality, professional competency, due care and technical standards.
If the same is not complied with, then they can be held liable on account of:
i) Non compliance with Nepal Standards on Auditing; and
ii) Failure to protect the interest of stakeholders relying upon the audited financial statements;
Accordingly, the auditors‟ liability falls under three categories:

i) To their clients (company itself);
ii) To third parties in case of negligence; and
iii) Civil and criminal liabilities.
b) Internal Audit: Internal audit is an independent, objective assurance and consulting activity designed to add value
and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic,
disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.
c) Engagement Letter: It is letter issued by the auditor to the auditee which includes written terms of engagement.
This letter basically sets out the responsibilities of the auditor and the auditee and includes other information such as
audit fee and its payment terms, out of pocket expenses etc. This letter helps to resolve the confusion which may arise
during or subsequent to audit.
d) Vouching is a substantive audit procedure which aims at verifying the genuineness and validity of a transaction
contained in the accounting records. It involves examination of documentary evidence to support the genuineness of
transaction.
Thus the object of vouching the payments of a business is not merely to ascertain that money has been paid away; but the
auditor aims to obtain reasonable assurance in respect of following assertions in regard to transactions recorded in the
books of account that :
i) a transaction is recorded in the proper account and revenue or expense is properly allocated to the accounting period;
ii) a transaction pertains to entity and took place during the relevant period;
iii) all transactions which have actually occurred have been recorded;
iv) all transactions were properly authorized; and
v) transactions have been classified and disclosed in accordance with recognizedaccounting policies and practices.
Thus, it is through vouching that the auditor comes to know the genuineness of transactions recorded in the client‟s
books of account wherefrom the financial statements are drawn up.
Thus, the auditor‟s basic duty is to examine the accounts, not merely to see its arithmetical accuracy but also to see its
substantial accuracy and then to make a report thereon.
7. Distinguish between (25=10)

a) Statutory & System Audit
b) Peer review, hot review and cold review
Answer:
a) The major differences between statutory and system auditing can be described as follows:
(i) Purpose: The statutory auditing is basically concerned with the opinion that whether the historical information
recorded is correct or not, whereas the system auditing emphasizes on effectiveness and efficiency of operations for
future performance.
(ii) Area: Statutory audits are restricted to the matters directly affecting the appropriateness of the presented financial
statements whereas the system audit covers all the activities that are related to efficiency and effectiveness of operations
directed towards accomplishment of objectives of organization.
(iii) Reporting: The statutory audit report is sent to all stock holders, bankers and other persons having interest in the
organization. However, the system audit report is primarily for the management.
(iv) End task: The statutory audit has reporting the findings to the persons getting the repost as its end objectives,
however, the system audit is not limited to the reporting only, but includes suggestions for improvements also.
(v) Auditor: In Statutory Audit generally opinion on the financial statement has to be expressed by COP holder of
ICAN, though system audit could be done in-house or by outsourcing where it is not necessary for carrying out by COP
holder.
b) Peer Review
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This is a critical independent review of one public accounting firm practices by another public accounting firm. It is a
review of the firm‟s accounting and auditing practices. It is intended that the review be done by practitioners upon fellow
practitioners.
Such an external review offers a more objective evaluation of the quality of performance than could be done by self
review.
Peer review study the adequacy of the firms established quality control policies and tests to determine the extent of the
firms compliance to these policies.
Suggestions for improvement to the system are outlined in a letter of comments issued by peer reviewers to the reviewed
firm. If a firm fails to take appropriate corrective action, various actions may be imposed e.g. suspension from
membership.
In carrying out the review it is limited to:-
 • Professional aspects of the practice.
 • The overall total quality control policies.
 • Professional aspect of the firms accounting and auditing practices like maintenance of working papers and work
products such as report to the financial statements.
Hot Review
Is an independent review of an audit by a suitably qualified firm of auditors before the issue of the audit report? The
review includes evaluation of the engagement, working papers, reports and the firm compliance with established quality
control policies and professional standards.
Hot review helps the reviewed firm to make necessary changes on their report or have confidence that what they are
reporting was well conducted and no liability can result from their report.
Hot reviewers assess how the firm accepted their engagement i.e. whether they followed professional ethics and whether
they were qualified to act as auditors for the entity. Secondly they review the firms audit plans and audit programs to
consider how duties were assigned delegated and directed. They address the critical areas by evaluating the working
papers and how the audit evidence was gathered i.e. audit tests and procedures were well performed according to the
established standards.
Finally the reviewers will evaluate the report and make conclusion in writing as to whether all the matters raised have
been satisfactorily satisfied/resolved by the firm. They will also recommend whether further tests are necessary to come
up with comprehensive reports.
Cold Review
It is the involvement of an independent accounting firm or a partner to provide assurance that all the firms‟ in house
quality control policies have been complied with as well as provide a second opinion that the audit was performed in
accordance with generally accepted audit standards.
Cold review is an objective examination of an audit assignment after its completion referred to as post audit review.
Cold review assess the policies and procedures the firm used to conduct its audit. This involves audit planning and
ascertaining that the audit team followed the audit plans together with audit programs. It also ascertains that work was
well documented through working papers and judgment or conclusion made.
Cold review report to staff adherence to ISAS and review work done by each staff and see that it is according to the
policies of the firm.

7 of 62 1984
CAP-II, Audit & Assurance, June 2012
Suggested Answer

Marks
a) A firm of a father and a son is receiving Rs. 2 lakhs towards job work done for
XYZ Ltd. during the year ended on 32.03.2068. The total job work charges paid by
XYZ Ltd. during the year are over Rs. 50 lakhs. The father is a Managing Director
of XYZ Ltd. having substantial holding. The Managing Director told the auditor
that since he is not involved in the activities of the firm and since the amount paid
to it is insignificant; there is no need to disclose the transaction. He further
contended that such a payment made in the last year was not disclosed. Is
Managing Director right in his approach?
b) Shree Ltd. has 2 divisions X and Y. The finished products of division X are
transferred to division Y where further processing is carried out before sale to
customers. To achieve transparency and accountability between the divisions,
division X raises an invoice on division Y at cost plus normal margins. At the year
end the unrealized profits on inter-division stocks are eliminated. However, the
transfers are recorded at the invoice value as sales and purchases in the respective
divisions for the purpose of preparing the Profit & Loss Account. Suitable
disclosures, for this are given in the ‗Notes to Accounts‘.
c) Surya, a Chartered Accountant was engaged by Terai Company Pvt. Ltd. for
auditing their accounts. He sent his letter of engagement to the Board of Directors,
which was accepted by the company. In the course of audit of the company, the
auditor was unable to obtain appropriate sufficient audit evidence regarding
inventories. The client requested for a change in the terms of engagement.
d) During the course of audit of M/s Grow Company Limited, you, as an auditor
found huge difference between the control accounts and subsidiary records. The
chief finance controller informed that this is common due to huge volume of
business conducted by the company during the year. How would you deal in this
situation?
Answer:
a)
Nepal Accounting Standard 16 and IAS 24,―Related Party Disclosures‖ applies to the facts of the case.
IAS 24 requires disclosure of party relationship and transactions between a reporting enterprise and its
related parties. The parties are considered to be related if at any time during the reporting period, one
party has the ability to control the other party or exercise significant influence over the other party in
making decisions. As per the explanation given in IAS 24, significant influence is said to exist in case
the investing party has 20% or more voting power in the enterprise. In the instant case, the managing
director of XYZ Ltd. is a partner in the firm with his son, which has been paid Rs. 2 lakhs as job work
charges. The managing director is having a substantial holding in the firm. The case is covered by NAS
16. The approach of the managing director is not tenable under the law and accordingly all disclosure
requirements have to be complied. Since there is related party transaction the contention of managing
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Director is not correct and the auditor should advise him to make proper disclosure as required by NAS
and if the management refuses, the auditor shall express a qualified report.
b)
As per the definition of the term ―Revenue‖ in NAS 07, revenue is the gross inflow of cash,
receivables or other consideration arising in the course of the ordinary activities of an enterprise
from the sale of goods, from the rendering of services, and from the use by others of enterprise
resources yielding interest, royalties and dividends. Revenue is measured by the charges made
to customers or clients for goods supplied and services rendered to them and by the charges and
rewards arising from the use of resources by them.
The definition clearly implies that the transfers within the enterprise cannot be considered as
fulfilling the definition of the term ―revenue‖. Thus, the recognition of inter-divisional transfers
as sales is an inappropriate accounting treatment and is inconsistent with NAS 07. Further, in
case of inter-divisional transfers, risks and rewards remain within the enterprise and also there is
no consideration from the point of view of the enterprise as a whole. Thus, the recognition
criteria for revenue recognition are also not fulfilled in respect of inter-divisional transfers. In
the instant case, therefore, Shree Ltd cannot recognize inter-division transfers from X to Y as
sales and the same will have to be eliminated during finalization. If management do not agree to
do so, the auditor shall qualify his report.
c)
Nepal Standard on Auditing (NSA-210) stated about the ―Terms of Audit Engagements‖.
Auditor should consider following matters:
i. An auditor who is required to change the engagement which requires lower level of
assurance before the completion of engagement should consider the appropriateness of
doing so.
ii. But when the terms of engagement are changed, both the auditor and the clientshould
agree on the new terms.
iii. However, the auditor should not agree to a change in terms where there is no
reasonable justification for doing so.
In the instant case, the auditor was unable to obtain sufficient evidence regardinginventories.
The client requested him for a change in the terms of the agreement to avoid qualified/adverse
opinion. Hence there is no reasonable justification for change in the terms of engagement.
Thus the auditor should not agree for change in the terms of engagement letter.
d)
The finding of huge difference between the control accounts and subsidiary records of M/s Grow
Company Limited indicates that there may be material misstatements requiring detailed
examination of the books and records so as to ascertain the reason for the difference. The
contention of the chief financial controller cannot be acceptable simply because the company has
conducted huge volume of business during the year. Such finding indicates recording of business
transactions is not being done properly or the accounting system in the company fails to capture
all transactions in time. The auditor would rather check whether it is a recurring phenomenon or
not. He would also verify why such reconciliation could not be done at a subsequent date.
Considering all these facts, it may indicate the possibility of some kind of material misstatements
in the financial statements. As per NSA 240, ―The Auditor‘s Responsibility to Consider Fraud
and Error in an audit of Financial Statements‖ the auditor should perform procedures to
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determine whether the financial statements are materially misstated when the auditor encounters
the situation that there is material misstatement in the financial statements. The auditor is
required to report appropriately if he came across any material information involving fraud or
gross irregularity.

a) While compiling the financial statements of a concern, you observed that the input
information supplied by the concern is incomplete, incorrect and few of the
Accounting Standards have not been followed. Describe, in brief, the procedure
you will follow in the given circumstances. 8
b) Describe the policies to be considered by an auditor regarding quality control as
prescribed in quality control standard. 7
Answer:
a)
According to AAS 31(SA 4410) ―Engagements to Compile Financial Information‖, an
accountant would normally have to rely upon the management for information to compile the
financial statements in a compilation engagement. If in the course of compilation of financial
statements, it is observed that the information supplied by the entity is incorrect, incomplete or
otherwise unsatisfactory, the accountant should perform following procedures:
(i) Make any enquiries of management to assess the reliability and completeness of the
information provided;
(ii) Assess internal controls prevailing in the entity; and
(iii) Verify any matters or explanations.
The accountant may also request the management to provide additional information. This may
be asked in the form of management representation letter. If the management refuses to provide
additional information, the accountant should withdraw from the engagement, informing the
entity of the reasons for such withdrawal.
If one or more accounting standards are not complied with, the same should be brought to the
notice of the management and if the same is not rectified by the management, the accountant
should include the same in notes to the accounts and the compilation report to the management.
b) The policies to be considered by an auditor regarding quality control as prescribed in quality control
standard (NSQC) are given below:
- Professional requirements as mentioned in Code of Ethics,
Personnel in the firm are to adhere to the principles of independence, integrity, objectivity,
confidentiality and personal behaviours.
- Skills and competence,
Staffing should be arranged to maintain the technical and professional competence
required to enable them to fulfil their responsibilities with due care.
- Assignment,
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Audit work to be assigned to personnel who have the degree of technical training and
proficiency required in the circumstances.
- Delegation,
There is to sufficient direction, supervision and review of work at all levels to provide
reasonable assurance that the work performed meets appropriate standards of quality.
- Consultation,
Whenever necessary, consultation within or outside the firm is to occur with those who
have appropriate expertise.
- Acceptance and Retention of Clients,
An evaluation of prospective clients and review, on an ongoing basis, of existing clients is
to be conducted. In making a decision to accept or retain a client, the firm's independence
and ability to serve the client properly are to be considered.
- Monitoring,
The continued adequacy and operational effectiveness of quality control policies and
procedures is to be monitored.

a) Howard Ltd., as part of overall cost cutting measure announced voluntary
retirement scheme (VRS) to its employees, to reduce the employee strength.
During the year ended 32.03.2068 the company paid a compensation of Rs.10
million to those who availed the scheme. The chief accountant has reflected this
payment as part of regular salaries and wages paid by the company.
b) Reena Ltd. received Rs. 50 lakhs as grant from the Nepal Government towards the
part cost of a specific machinery. The company credited the above sum of Rs. 50
lakhs as income in its profit & loss account for the year.
c) Himalayan Co. Ltd. reappointed Ram and Ramita as their joint auditors in the
Annual General Meeting. The AGM authorized the Board for fill up the vacancy
on their own in the event of both or either of auditors declined to accept the
assignment. The Board passed a resolution to appoint Prabhat if any of the auditors
declined to accept the assignment. Later on Ramita declined to accept the
assignment and Board of Directors appointed Prabhat in place of Ramita as per its
resolution.
Answer
a)
NAS 1, ―Presentation of Financial Statements‖ clearly states that when the items of income
and expenses are material, their nature and amount shall be disclosed separately. Such a
disclosure shall assist in understanding the financial performance achieved and in assessing
future results. In the instant case the payment made to the employees on account of VRS as
an overall cost cutting measure would fall under the domain of material item. Accordingly it
is eligible to be shown separately in the income statement of Howard Ltd., so that the effect
of it on the operating results of the Company during the previous year can be perceived.
Therefore, clubbing of Rs. 10 million with the regular salaries and wages of the company by
the Chief Accountant is not appropriate.
b) NAS 10: Accounting for government grants recognized two methods of presentation of
grants related to specific fixed assets in financial statements as acceptable alternatives:
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(i) Under first alternative, the grant is shown in the Balance Sheet as a deduction from the
gross value of a machinery. The grant is recognized in P& L A/c over the useful life of a
depreciable asset by way of a reduced depreciation charges.
(ii) Under second alternative, it can be treated as deferred income which should be
recognized in P & L A/c over useful life of asset in proportion in which depreciation on
machinery will be charged. The deferred income pending its apportionment to P & L A/c
should be disclosed in Balance Sheet with a suitable description e.g. Deferred Government
Grants.
In the given case, Reena Ltd. received Rs.50 lakhs as grant towards part cost of specific
machinery. The company has credited the said sum as income in its Profit and Loss account
which is incorrect as per the above provisions.
c)
In the present case Ramita is one of the joint auditors who was appointed in Annual General
Meeting, but declined to accept the appointment. The Board of Directors as per their
resolution, appointed Prabhat as a joint auditor in her place. In this case, the vacancy created
by Ramita is neither caused by resignation of Ramita nor is it a casual vacancy because
Ramita‘s appointment had not become effective. Hence, appointment of Prabhat as joint
auditor by the Board is not valid. Prabhat can only be appointed as joint auditor by
shareholders in the General Meeting.

a) "The auditors should communicate audit matters of governance interest arising
from the audit of financial statements with those charged with the governance of
an entity". Briefly state the five major matters to be included in such
Communication.
b) Discuss ―Audit through the computer‖.
c) Treatment of foreign currency monetary items on balance sheet date.
Answer:
a) NSA 260 deals with communications of audit matters with those charged with governance.
The following are the audit matters of governance interest which are to be communicated.
(i) The general approach and overall scope of audit including expected limitations.
(ii) The selection of or change in significant accounting policies and practices that have
a material effect on the entity‘s financial statements.
(iii) The potential effect on the financial statements of any significant risks and exposures.
(iv) Adjustment to financial statements arising out of audit which have a significant effecton
the financial statement.
(v) Material uncertainties that may cast significant doubt on the entity‘s ability to continue
as a going concern.
(vi) Disagreement with management on matters which could have significant impact to the
financial statements and to audit report.
(vii) Expected modifications to the audit report.
(viii) Others matters like material weakness in internal control measures, questions on
management integrity and fraud involving management.
(ix) Other matters agreed in terms of audit engagement.
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b)
Computerization of accounts does not affect the basic objectives of auditing. However, the
auditor would need to modify his audit procedures, approach and technical capabilities so as
to be able to form an opinion on the accounts processed in a computerized environment.
Audit through the Computer is the audit, with the help of computer technology in the audit
of accounts processed in a computerized environment.Audit through the computer
requires that the auditor submits data to the computer for processing. The results are then
analyzed for the processing reliability and accuracy of the computer program. Technical
and other developments that necessitated this approach include the following;
i. On line data entry
ii. Elimination or reduction of print outs
iii. Real time files up dating
The auditor can use the computer to test:

i. The logic and controls existing within the system, and
ii. The records produced by the system
Depending upon the complexity of the application system being audited, the approach may
be fairly simple or require extensive technical competence on the part of the auditor.
There are several circumstances where auditing through the computer must be used:
a. The application system processes large volumes of input and produces large
volumes of output that make extensive direct examination of the validity of input
and output difficult.
b. Significant parts of the internal control system are embodied in the computer
system. For example, in on line banking system a computer programme may
batch transactions for individual tellers to provide control totals for reconciliation
at the end of the day‘s processing.
c. The logic of the system is complex and there are large portions that facilitate use
of the system for efficient processing.
d. There are substantial gaps in the visible audit trail.
The primary advantage of this approach is that the auditor has increased power to effectively
test the computer system. The range and capability of tests that can be performed increases
and the auditor acquires greater confidence that data processing is correct. By examining the
system‘s processing, the auditor also can assess the system‘s ability to cope with
environment change.
The primary disadvantages of the approach are generally high costs and the need for
extensive technical expertise when systems are complex. However, these disadvantages are
really not that important if auditing through the computer is the only viable method of
carrying out the audit.
Auditing through computer may be conducted through test data, computer programme, etc.
c)
Foreign Currency Monetary Items and its Treatment on Balance Sheet date: As per NAS- 11
on ―Accounting for the Effects of Changes in Foreign Exchange Rates‖ monetary items are
money held and assets and liabilities to be received or paid in fixed or determinable amounts
of money, e.g., cash, receivable, payables, etc. Regarding foreign currency transactions,
NAS 11 requires that while reporting effects of changes in exchange rates subsequent to
initial recognition, at each balance sheet date, monetary items denominated in a foreign
currency, (e.g., foreign currency notes, balances in bank accounts denominated in a foreign
currency, and receivables, payables and loans denominated in a foreign currency) should be
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reported using the closing rate prevailing on balance sheet date. However in certain
circumstances the closing rate may not reflect, with reasonable accuracy, the amount in
reporting currency that is likely to be realized from or required to be disbursed to because
the rate is unrealistic. In such circumstances, the relevant monetary item should be reported
in the reporting currency at the amount which is likely to be realized from or required to be
disbursed to at the balance sheet date.

a) On final audit of Hattiban Limited, the physical verification of fixed assets was
conducted. However the auditor was not able to confirm the existence of valuable
items and costly equipments. Though, the auditor received a certificate from the
management to prove its existence and value and accepted the same blindly
without applying any further procedures.
b) A firm or a member of the audit team accepts gifts or hospitality of which the
value is not trivial and inconsequential. (Give your answer on the basis of the
Provision of IFAC Code of Ethics adopted by ICAN.)
c) ABC Commercial Bank provided loan to an audit team member under terms and
conditions other than normal. (Give your answer on the basis of the Provision of
IFAC Code of Ethics adopted by ICAN.)
Answer:
a) The physical verification of fixed assets is the primary responsibility of the management.
The auditor, however, is required to examine the verification programme. Further, he must
satisfy himself about the existence, ownership, procession and valuation of fixed assets. It
appears from the facts of the case that the auditor has not been able to verify either existence or
valuation of significant fixed assets despite conducting physical verification audit procedure
himself. Ultimately, he accepted the certificate from the management without performing
further procedures. As per NSA 580, ―Written Representations‖, representation by management
cannot be a substitute for other audit evidence that the auditor could reasonably expect to be
available. Thus, a representation by management as to the existence of valuables and machinery
is no substitute for adopting normal audit procedures regarding verification of valuable and
important machinery. If the auditor is unable to obtain sufficient appropriate audit evidence that
he believes will be available, this will constitute a limitation on the scope of his examination
even if he has obtained a representation from management on the matter.
b) There will be self-interest and familiarity threat to compliance with the fundamental principles
which the auditors are required to comply. The threat would be so significant that no safeguards
could reduce it to an acceptable level. The firm or the member of the audit team shall not accept
such gifts or hospitality.
c) There will be self-interest threat and the significance of the threat would be so significant that
no safeguard could reduce it to an acceptable level. So such loan shall not be accepted.
6. Write short notes on the following (Any Four): (42.5=10)

a) Contingent assets
b) Disclaimer of opinion
c) Three important characteristics of an effective system of computer audit
programme
d) Analytical procedures in planning an audit
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e) Familiarity threat
Answer:
a) The contingent assets are those which may arise on the happening of an uncertain event. As a
general practice, contingent assets are not recorded in the balance sheet because that would imply taking
credit for revenue which has not accrued. But it is logical as the contingent liabilities are shown in the
balance sheet the contingent assets should also be shown. The Companies Act does not require disclosure
of contingent assets in the balance sheet. However, if contingent asset have a significant value, it may be
advisable to disclose such assets in a note to the balance sheet.
As regards valuation of contingent assets, it may be noted that ordinarily no valuation would be required.
However, if such assets were disclosed by way of a note, a proper valuation based on the related contract
would be made. Where full realization of such assets is doubtful even on the face of contingency
occurring, it would be safer to value the assets on a realisable basis.
b)
Depending upon the circumstances, an auditor expresses an opinion on the financial statement.
A disclaimer of opinion should be expressed when the possible effect of a limitation on scope is
so material and pervasive that the auditor has not been able to obtain sufficient appropriate audit
evidence and accordingly is unable to express an opinion on the financial statements.
c)
Important characteristics of an effective system of computer audit program:
(i) Should be simple to use and eliminate the need to remember countless details normally
required in writing or revising computer programs.
(ii) Should be easily understandable even by those with little computer expertise and easyto
use.
(iii) Should be capable of being used with different configuration of computers.
(iv)The package has to include adequate support at the time of installation, provideadequate
training to the staff and to provide documentation. There should be a provision for
future revision of the program.
(v) The package should have statistical sampling capability.
(vi) The system has to be acceptable to all users in terms of easy execution and compatible
with the existing system.
(vii) The program has to be capable of processing different types of applications.
(viii) The program should have strong report writing function including the ability to
preparemultiple reports in a single program run and to generate flexible output report
formats.
d)
In the planning stage, analytical procedures assist the auditor in understanding the client‘s
business and in identifying areas of potential risk by indicating aspects of and developments
in the entity‘s business of which he was previously unaware. This information will assist the
auditor in determining the nature, timing and extent of his other audit procedures.
Analytical procedures in planning the audit use both financial data and non-financial
information, such as number of employees, the square feet of selling space, volume of goods
produced and similar information.
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e) Familiarity threat:
The circumstances in which professional accountants operate may create specific threats to
compliance with the fundamental principles which the auditors are required to comply.
Threats may be created by a broad range of relationship and circumstances. One of such
threat may be Familiarity threat. It is a threat that due to a long or close relationship with a
client or employer, a professional accountant will be too sympathetic to their interests or too
accepting of their work. Some of the circumstances that create familiarity threat include:
 A member of the audit team having a close or immediate family member who is a
director or officer of the client,
 Senior personal having a long association with the audit client etc.
7. Distinguish between (Any Two): (25=10)

a) Internal check and Internal control
b) Test checking and statistical sampling
c) Evidence Vs. validity of transaction
Answer:
a)Internal check is a check on day-to-day transactions which operate continuously as part of the
routine system whereby the work of one person is proved independently or is complementary
to the work of another, the object being the prevention or early detection of errors or fraud.
Internal check is a part of the overall internal control system and operates as built-in device
as far as the staff organization and job allocation aspects of the control system are concerned.
The internal control is a plan of an organization and all the methods and procedures adopted
by the management of an entity to assist in achieving management's objective of ensuring, as
far as practicable, the orderly and efficient conduct of its business, including adherence to
management policies, the safeguarding of assets, prevention and detection of fraud and error,
the accuracy and completeness of the accounting records and the timely preparation of
reliable financial information.
b)
During audit, entries, involving large amounts or relating to material accounts are seen
exhaustively and they are picked up for verification at random from the remainder according
to certain plan is known as test checking. The only quality that this technique can claim lies
in its keenness to cover larger amounts and material accounts. Even if errors, frauds etc.
remain undetected in the part not checked, they are not likely to be too big as to upset the
truth and fairness of the financial statement.
On the other hand, Statistical sampling is a method of audit testing which is more scientific
based entirely on the auditors own judgment because it involves use of mathematical laws of
probability in determining the appropriate sample size in varying circumstances. Statistical
sampling has reasonably wide application where a population to be tested consists of a large
number of similar items and more in the case of transactions involving compliance testing,
debtors confirmation, payroll checking, vouching of invoices and petty cash vouchers.
C) Entries in the books are usually made on the basis of some kind of documentary evidence. It
generally exists in a variety of forms e.g. payees receipts, suppliers invoices, statements of
account of parties, minutes of Board of Directors or shareholders, contract documents etc.
These all form documentary evidence for transactions. On the other hand, it is also the
function of audit to establish that payments have been made validly to the person who is
shown to be recipients e.g. salary is paid to partners according to provision contained in the
partnership deed, director's fee is paid according to the minute of shareholders meeting,
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suppliers are paid according to their invoices etc. It is termed as the validation of the
transactions.
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CAP-II, Audit & Assurance, Dec 2011

Suggested Answer

Marks
1. G
ive your opinions with reasons on the following cases: (45=20)
a) Audit of the Sagarmatha Byapar Co. Pvt. Ltd. is in final stage and the audit
report is being drafted. Management of the company, including Chief
Executive Officer, is of the view that auditors are primarily responsible for
preparation and fair presentation of financial statements. Management of the
company is of the view that they are free to prepare accounts in their own way
and it is the duty of the auditor to satisfy about financial statements to
government and other regulatory agencies.
b) Grand Industries Ltd. is engaged in manufacturing and supply of gear boxes to
Suzaki Vehicles Ltd. As per terms of supply, full price of the goods are not
released by Suzaki Vehicles Ltd. but 15% thereof is retained and paid after
one year, if there is satisfactory performance of the parts supplied. Grand
Industries Ltd. accounts for only 85% of the invoice value as sale at the time
of supply and balance 15% is accounted as sale in the year of receipt of
payment.
c) During the audit period, the liaison officer deputed by the client Lumbini
Insurance Company constantly asks you to participate in lunch arranged
outside office premises. He has also informed you that there is a program of
welcome and farewell dinner too. Liaison officer has also informed you that
you need not worry about time schedule, as there would be someone available
among client's staff to bailout if needed. Daily newspapers and magazines are
made available in plenty in the audit room. Other staff of the client are also
having regular visit in the working area.
d) The Company`s plant & machinery was Rs. 200 million as on 1st Shrawan
2067. It provided depreciation at 15% per annum under WDV method.
However it noticed that about Rs. 20 million worth of imported asset, which is
component of above plant & machinery acquired on 1st Shrawan 2067, would
be obsolete in 2 years. Company wants to write off this asset over 2 years. Can
Company do so? Give Comments.
Answer No. 1
a) Paragraph 15 of Nepal Standard on Auditing (NSA 200) mentions that while the
auditor is responsible for forming and expressing an opinion on the financial statements,
the responsibility for preparing and presenting the financial statements is that of the
management of the entity. The audit of the financial statements does not relieve
management of its responsibility. Management rather than the auditor is responsible for
the preparation and fair presentation of financial statements. This responsibility
includes designing, implementing and maintaining internal control relevant to the
preparation and fair presentation of financial statements that are free from material
misstatements, whether due to fraud or error, selecting and applying appropriate
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accounting policies, and making accounting estimates that are reasonable in the
circumstances. Thus, the contention of the management is not correct.
b) According to NAS-7 on Revenue, revenue recognition from sale of goods should be
recognized when the seller has transferred to the buyer, the property or the goods for a
price or when the seller has transferred all significant risk and rewards and the seller
has no effective control over goods and no significant uncertainty exists regarding the
amount of consideration and its collectability. In the given case the goods as well as
the risk and ownership has been transferred by Grand Industries Ltd., to Suzaki
Vehicles Ltd., on the basis of invoice and delivery of material. In the instant case,
therefore, Grand Industries Ltd. should recognize sale at full 100% of the invoice
value in spite of the fact that 15% payment will be released after one year. However,
depending upon the past experience regarding collectability of 15% amount, they can
make a provision for the amount that is not likely to be realized. Hence, the treatment
given by the company is not correct and if they do not correct it, the auditor should
qualify his report.
c) Section 260 of Code of Ethics for the members of the Institute of Chartered
Accountants of Nepal -2060 prescribed the ICAN states about the gift and hospitality
to the auditors by the client.
The existence and significance of any threat will depend on the nature, value, and
intent of the offer. Where gifts or hospitality are offered that a reasonable and
informed third party, weighing all the specific facts and circumstances, would
consider trivial and inconsequential, a professional accountant in public practice may
conclude that the offer is made in the normal course of business without the specific
intent to influence decision making or to obtain information. In such cases, the
professional accountant in public practice may generally conclude that any threat to
compliance with the fundamental principles is at an acceptable level.
The objectives of the accountancy profession are to work to the highest standards of
professionalism, to attain the highest levels of performance and generally to meet the
public interest requirement set out above. These objectives require four basic needs to
be met. They are credibility, professionalism, quality of services and confidence. An
auditor is expected to maintain the highest degree of integrity, professionalism and
independence. He represents the trust and faith of the whole professional body. There
could be various obstacle and impediments while conducting his professional duty.
However, he should remain intact and vigilant towards achieving his professional
goal.
Provision of lunch is governed by conditions laid in engagement letter and

appointment letter. If the contract states provision of lunch, it should not be construed
as accepting any undue advantage whether arranged inside or outside. However,
attendance in farewell party is not concerned with the auditor. Thus, the auditor needs
to avoid such attendance. Receiving Newspapers as courtesy from the client and the
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regular visits by the staff of the client in the working place is not the problem but it
must be seen that there would be no compromise in the professional ethics and
standards.
d) As per Nepal Accounting Standard 6 (Property, Plant and Equipment), where the
addition or extension retains a separate identity and is capable being used after the
existing asset is disposed off, depreciation should be provided independently on the
basis of an estimate of its own useful life. As it appears that imported assets of Rs. 20
million, which is component of plant and machinery, is having independent useful
life. Therefore, the company`s policy to write off over two years is correct.
2. A
nswer the following:
a) You are appointed as manager of quality control section in one of the leading
audit firm of Nepal, the senior partner of the firm instructs you to draft
objectives statement for quality control policies & procedures. 8
b) List out the analytical procedures that you would adopt in audit of Revenue of
an entity. What are the factors that determine the extent of reliance on such
analytical procedures? 7
Answer No. 2
a) As per Nepal Standards on Quality Control(NSQC) 1, it is necessary for quality control
for firm`s that perform audits and review of historical financial information and other,
accordingly, the relevance of quality control The relevance of quality control issue in
auditing services is equal importance like in other services. If quality control could not
be done in auditing work, quality services could not be provided to client which may
result negative consequences both for auditor and client including in overall all
economy. Hence, every auditor should carry out the audit work based on formal quality
control policy & procedures. The objective statement of quality control policies &
procedures would be:
i. Professional Requirements
personnel in the firm should adhere to the principles of independence,
integrity, objectivity, confidentiality and professional behavioral number
of procedures may be framed to achieve this objective .for example, a
firm may require all its personnel to make a written statement every year
as to whether they hold any shares or any other interest in the enterprises
being audited by the firm.
ii. Skills and Competence
the audit skills firm should be staffed by personnel who have attained
and maintain the technical standards and professional required to enable
them to fulfill their responsibilities with due care .for example, a firm
can achieve this objective through proper recruitment procedures,
periodic staff and a system whereby latest information relating to current
development in professional standards, law, etc is regularly
communicated to audit staff.
iii. Assignment
Audit work should be assigned to such personnel as have the degree of
technical training and proficiency required in the circumstances.
iv. Delegation
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There should be sufficient direction, supervision and review of work at

all levels to provide reasonable assurance that the work performed meets
appropriate quality standards. For example, a firm may establish
guidelines relating to the form and content of working papers; use of
standardized forms, etc .similarly, the audit plans may identify the
staffing requirements and timing of various phases of audit to facilitate
delegation of audit now.
v. Consultation
Where ever necessary, persons having appropriate expertise, within or
outside the firm, should be consulted.
vi. Acceptance and Retention of Clients
Before accepting an audit, the firm should evaluate its independence and
ability to serve the prospective client properly. A similar review should
be made, on-going basis, of association with the existing clients.
vii. Monitoring
The continued adequacy and operational effectiveness of the quality
control policies and procedures should be maintained.
b) Analytical procedures are one of many audit processes which help an auditor
understand the client's business and changes in the business, and to identify potential
risk areas to plan other audit procedures. It includes comparison of financial
information, relating financial and non financial information and consideration of
practicable relationship of data.
The analytical procedures that will be adopted in obtaining audit evidence regarding the
various assertions relating to revenue are as follows:
i. Comparison of Gross-profit ratio to sales for the current year with the
corresponding figures of the previous years.
ii. Comparison of ratio of sales returns to sales for the current year with the
corresponding figures for previous years.
iii. Comparison of trade discount to sales for the current year with previous year.
iv. Review of Reconciliation of Excise/VAT booked during the year with
Excise/VAT returns submitted with the total sales booked.
v. Comparison of dividend/interest/royalty for the current year with the
corresponding figures for previous years.
vi. Comparison of ratio of income on investments to average investment for the
current year with corresponding figures for the previous year.
The factors that affect the extent of reliance on analytical procedures are as follows:
i. Materiality: When items are material, the auditor doesn‟t solely rely on the
analytical procedures in forming conclusions but will carry other substantive
procedures also.
ii. Other procedures: When other procedures are also directed towards the same
objective, it might confirm or dispel the questions raised from the application of
analytical procedures.
iii.Weak controls: When internal controls are weak, greater reliance is placed on tests
of balances and tests of details of transactions rather than on analytical procedures.
iv. Accuracy: The accuracy with which expected results of analytical procedures can be
predicted. For example greater reliance is place on gross profit ratio compared to
previous year than in comparing discretionary expenses such as donation.
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3. G
ive your comments on the following: (35=15)
a) Mr. Alex Pitt, partner of M/s Pitt Marwick & Associates, a Chartered
Accountant firm was appointed as an auditor of Cosmopolitan Commercial
Bank Ltd. One of the shareholders of the bank lodged a complain against the
auditor for not assuming the responsibilities to consider laws and regulations
with regards to lending to a business house in an audit of financial statements
of the bank. You are asked to identify the auditors' responsibilities to consider
laws and regulations in an audit of financial statements of bank with regards to
complaint lodged against the auditor?
b) On being appointed, the auditor of a company for the first time you find that
the cashier also handles the books of account and the cash receipt are not
being banked intact but parts of these are being utilized for cash payments.
What are the risks involved? What could be your recommendations to mitigate
the risks envisaged?
c) Xylocain Communications Company is one of the leading companies dealing
with various telecommunication services, wireless networking and internet
related services. It receives huge collection of cash daily from its customer on
various accounts. Everything looked well, until one day it was noticed that
large amount was missing in the bank account. In fact that said amount was
not credited in the bank account at all and it was missing since last few years.
When the case was revealed, probably it was too late to recover the money.
Considering the above case, what are the likely documents you would like to
examine as an auditor of the company?
Answer No. 3
a) In accordance with NSA 200: “Objective and General Principles Governing an Audit of
Financial Statements,” the auditor should plan and perform the audit with an attitude of
professional skepticism recognizing that the audit may reveal conditions or events that
would lead to questioning whether an entity is complying with laws and regulations. In
accordance with specific statutory requirements, the auditor may be specifically
required to report as part of the audit of the financial statements whether the entity
complies with certain provisions of laws or regulations. In these circumstances, the
auditor would plan to test for compliance with these provisions of the laws and
regulations.
Further, the auditor should obtain sufficient appropriate audit evidence about
compliance with those laws and regulations generally recognized by the auditor to have
an effect on the determination of material amounts and disclosures in financial
statements. The auditor should have a sufficient understanding of these laws and
regulations in order to consider them when auditing the assertions related to the
determination of the amounts to be recorded and the disclosures to be made. Section
115(3) (e) of the Nepal Company Act, 2063 specially states that the auditor should
report any non compliance of prevailing laws. Further, Banks and financial Institutions
Act 2063 also requires report of auditors on certain matters. Thus, Here, in given
situation, the auditor should plan his audit and report for lending to a business house in
accordance with the prevailing banking rules and regulations. He should have sufficient
knowledge of statutory provisions of lending and its reporting in prescribed format.
b) Since the cashier handles books of accounts and cash is not deposited intact in the bank
account the internal control system of the company is found very weak. There are the
risks of cash being misappropriated. Examples could be:
 failure to record purchases properly in order to misappropriate cash.
 misappropriation cash from a machine or whilst cash is in transit.
 acceptance or solicitation of money or a benefit to provide cash to a third party.
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 acceptance or solicitation of money or a benefit to provide goods or services to a

third party without taking a cash payment from that party.
This may create significant risk to the company that may erupt from the weak internal
control system. Recommendations to company for the enhancement of the internal
control system of the company are as follows:
a. The cashier should not have access to the books of accounts. The books of account
should be handled by the accountants who should not be directly involved with the
cash transaction.
b. All the cash collections should be deposited to the bank.
c. Cash payments should be made through the Bank.
d. Petty expenses should be managed through the Petty cash book, for which purpose
the petty cash, imprest should be provided to the petty cashier through the bank.
c) Considering the case presented the auditor of Xylocain Communications Company

should check all the books of accounts and documents related with the cash and bank
transactions. Hence, the likely documents the auditor should examine in the
circumstances presented are mentioned hereunder:
i) Separ
ate Cash receipt register for different services like tele-communication, wireless
networking and internet related services
ii) Prenumbered Receipt pad for collecting cash.
iii) Security arrangement in the counter area.
iv) Procedures followed to deposit the amount in the bank
v) Special arrangements with bank for transferring funds, if any
vi) Bank reconciliation statement
vii) Duty rotation of the personnel, directly handling cash collection
viii) Reporting arrangement to central office
ix) Fidelity Insurance etc
x) Bank deposit slips
4. A
nswer the following: (35=15)
a) What is the relationship between materiality and audit risk and how audit risk
can be reduced to an acceptable level?
b) What are the points to be considered while using the work of an expert?
c) What are the steps followed while conducting audit of incomplete records?
Answer No. 4
a)
The auditor is concerned with expressing opinion on true and fairness of the the
financial statements. Similarly, as per NSA-240 Nepal Standards on Auditing the
auditors' responsibility to consider fraud and error in an audit of financial statements. Audit
Risk is the risk that the auditor gives an inappropriate audit opinion when the financial
statements are materially misstated or the frauds and errors are not reported. Due to nature
of audit evidence and the characteristics of fraud, the auditor is not able to obtain absolute
assurance of detecting misstatements and frauds. Thus, the auditor gives only reasonable
assurance that material misstatements are detected.
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The concept of materiality recognizes that some matters, either individually or in the
aggregate, are important for fair presentation of financial statements in conformity with
generally accepted accounting principles, while other matters are not important. As per
NSA-320 on Audit Materiality the auditor should consider materiality and its relationship
with audit risk when conducting an audit. "Materiality" is defined in the Nepal Accounting
Standards Board's "Framework for the Preparation and Presentation of Financial
Statements" in the following terms: "Information is material if its omission or misstatement
could influence the economic decisions of users taken on the basis of the financial
statements. Materiality depends on the size of the item or error judged in the particular
circumstances of its omission or misstatement. Thus, materiality provides a threshold or
cut-off point rather than being a primary qualitative characteristic which information must
have if it is to be useful."
According to NSA-320 on Audit materiality, there is an inverse relationship between

materiality and degree of audit risk. Higher the materiality level, lower the audit risk
and vice-versa. The risk that a particular account balance or class of transaction would
be mis-stated by an extremely large amount might be very low. But the risk that it could
be mis-stated by an extremely small amount might be very high. The auditor considers
this inverse relationship when he determines the nature, timing and extent of his audit
procedures. If after planning for specific audit procedures, he concludes that acceptable
materiality level is lower, audit risk is increased. The auditor should try to reduce the
audit risk to an acceptable level by:-
i. Reducing the assessed degree of control risk by carrying out extended or
additional test of control, or
ii. Reducing detection risk by modifying the nature, timing and extent of his
substantive procedures.
b) NSA 620 Nepal Standards on Auditing using the work of an expert prescribes that when
using the work performed by an expert, the auditor should obtain sufficient appropriate audit
evidence that such work is adequate for the purposes of the audit. During the audit, the auditor
may seek to obtain, in conjunction with the client or independently, audit evidence in the
form of reports, opinions, valuations, and statements of an expert. Examples are:
a. Valuations of certain types of assets, for example, land and buildings, plant and
machinery, works of art, and precious stones.
b. Determination of quantities or physical condition of assets, for example,
minerals stored in stockpiles, mineral and petroleum reserves, and remaining
useful life of plant and machinery.
c. Determination of amounts using specialized techniques or methods, for
example, an actuarial valuation.
d. The measurement of work completed and to be completed on contracts in
progress for the purpose of revenue recognition.
e. Legal opinions concerning interpretations of agreements, statutes, regulations,
notifications circulars, etc.
When determining whether to use the work of an expert or not, the auditor should
consider:
a) The materiality of the item being examined in relation to the financial
information as a whole.
b) the nature and complexity of the item including the risk of error therein,
and
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c) the other audit evidence available with respect to the item.

When the auditor plans to use the expert‟s work as audit evidence, he should satisfy
himself as to the expert‟s skills and competence by considering the expert‟s
professional certification, license or membership in an appropriate professional body
and experience and reputation in the field in which the auditor is seeking evidence.
However, when the auditor uses the work of an expert employed by him, he will not
need to inquire into his skills and competence.
The auditor should also consider the objectivity of the expert. The risk that an expert‟s
objectivity will be impaired increases when the expert is employed by the client, or
related in some other manner to the client.
Accordingly, in these circumstances, the auditor should (after taking into account the
factors stated above) consider performing more extensive procedures than would
otherwise have been planned, or lie might consider engaging another expert.
c) Incomplete records emanate risk of misstatement of financial statement due to omission

and wrong recording of transactions. Therefore, the auditor should be careful in this
regard. Steps that are followed in audit of incomplete records are as below:
a) Ascertain the exact status of accounting records available including memoranda
records.
b) Ensure that the management compiles / reconstructs accounting records to the
extent practicable.
c) Perform compliance procedure to assess whether any control system is in
operation.
d) Vouch transactions recorded in books of account with reference to appropriate
audit evidence. Check posting, casting etc.
e) Examine the system in operation in respect of custody managed cash memos,
receipts, check books etc.
f) Verify fixed assets by observing physical verification.
g) Conduct surprise checks to verify cash in hand, inventory etc.
h) Apply analytical review procedures in depth and notice deviations to investigate
in detail.
i) Formulate an appropriate audit opinion based on above findings.
5. A
a) Mr. Saroj Khandelwal, a professional accountant and member of ICAN
performs his auditing services in a country other than Nepal also. He
published his advertisement in one of the country other than Nepal explaining
about his competency and skill to perform auditing, management and
consultancy services at very reasonable fee. He argued that it was permitted
by the local ethical requirement of that country. How would you analyze this
issue if you were a member of disciplinary committee of ICAN and the issue
had been lodged before the committee?
b) Mr. Shushil Maharjan, a Chartered Accountant published a book and gave his
personal details as the author. These details also mentioned his professional
experience and his present association as partner with M/s Daniel Brisk, a
Swedish firm of Chartered Accountant Firm. What will be your opinion in this
respect?
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c) Mr. Shanti Das a Chartered Accountant audited a religious institution

established for purely promoting social values without charging any audit fee.
Give your comment.
Answer No. 5
a) The issue mentioned in the question above should be analyzed as per section 6 of the
Code of Ethics issued by the ICAN to its members which states that a professional
accountant qualifying in Nepal may reside in another country or may be temporarily
visiting that country to perform professional services. In all circumstances, the
professional accountant should carry out professional services in accordance with the
relevant technical standards and ethical requirements. When a professional accountant
performs services in a country other than Nepal and differences on specific matters
exist between ethical requirements of the two countries the following provisions should
be applied:
i. When the ethical requirements of the country in which the services are
being performed are less strict than the ICAN Code of Ethics, then the
ICAN Code of Ethics should be applied.
ii. When the ethical requirements of the country in which services are
being performed are stricter than the ICAN Code of Ethics, then the
ethical requirements in the country where services are being performed
should be applied.
iii. When the ethical requirements of Nepal are mandatory for services
performed outside that country and are stricter than set out in (i) and (ii)
above, then the ethical requirements of Nepal should be applied.
Hence, in the given context, Mr Saroj Khandelwal will be held liable for disciplinary
action under the Codes of Ethics of ICAN.
b) The supplementary Directive to code of ethics issued by the Institute of Chartered

Accountants of Nepal on “Publicity and Advertisement” prescribes the provisions for
publishing book or article. It allows the members to state their name, professional
qualification and the name of their firms but restricts the members from disclosing the
services provided by them. In the given case, Mr. Shushil Maharjan. a chartered
accountant, published the book and mentioned his professional experience and his
association as a partner with M/s Daniel Brisk, a Swedish firm of chartered accountants.
Mr. Shushil Maharjan being a chartered accountant in practice has committed the
professional misconduct by mentioning that at present he is a partner in M/s Daniel
Brisk, a Swedish firm of chartered accountants.
c) The Code of Ethics issued by the Institute of Chartered Accountants of Nepal on

“Soliciting Business, Accepting New Engagement, Fees and Commission” prescribes
the provisions for providing service free of cost. Subject to non compromise in the
quality of professional services being offered, it allows the members to provide services
without charging any fee to the welfare or spiritual institutions established with an
objective of providing social services. Further, the council of The Institute of Chartered
Accountants of Nepal has waved (vide decision dated 2067/6/17) requirement of
minimum fee for the religious organizations which have annual transactions of less than
2 lacs.
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Accordingly in the given case, if the transactions of the institution does not exceed 2
lacs, it will not be termed as guilty of professional misconduct as the service was
provided to a religious institution established for purely promoting social values.
However, if the transactions of the institution exceeds 2 lacs, the auditor shall be guilty
of violating code of conduct.
6. W
rite short notes on the following (Any Two): (25=10)
a) Inherent Limitations of an Audit
b) Audit trail in a computerized accounting environment
c) Management representation
d) Control Risk
Answer No. 6
a) Inherent Limitations of an Audit
An auditor cannot obtain absolute assurance that material misstatements in the financial
statements will be detected. Owing to the inherent limitations of an audit, there is an
unavoidable risk that some material misstatements of the financial statements will not
be detected, even though the audit is properly planned and performed in accordance
with NSAs. An audit does not guarantee all material misstatements will be detected
because of such factors as the use of judgment, the use of testing, the inherent
limitations of internal control and the fact that much of the evidence available to the
auditor is persuasive rather than conclusive in nature. For these reasons, the auditor is
able to obtain only reasonable assurance that material misstatements in the financial
statements will be detected.
b) Audit Trail in a Computerized Accounting Environment:

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

either unsolicited or in response to specific enquiries. It acknowledges its responsibility
for the implementation and operation of accounting and internal control system that are
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designed to prevent and detect fraud and error. Nepal Standard on Auditing – 580,
Management Representation states that the auditor should obtain appropriate
representation from management evidencing that the management acknowledges its
responsibility for the fair presentation of the financial statements in accordance with the
relevant financial reporting framework and has approved the financial statements. The
auditor can obtain evidence of management‟s acknowledgment of such responsibility and
approval from relevant minutes of meetings of the board of directors or similar body or by
obtaining a written representation from management or a signed copy of the financial
statements. The possibility of misunderstandings between the auditor and management is
reduced when oral representations are confirmed by management in writing. However,
representations by management cannot be a substitute for other audit evidence that the
auditor could reasonably expect to be available. If the auditor is unable to obtain sufficient
appropriate audit evidence regarding a matter which has, or may have, a material effect on
the financial statements and such evidence is expected to be available; this will constitute a
limitation in the scope of the audit, even if a representation from management has been
received on the matter.
d) Control Risk
Audit risk is the risk that an auditor may give an inappropriate opinion on financial
information that is materially misstated. Audit risk is composed of three components
viz. inherent risk, control risk and detection risk. Control risk is the risk that
misstatement that could occur in an account balance or class of transactions and that
could be material, individually or when aggregated with misstatements in other
balances or classes, will not be prevented or detected on a timely basis by the system of
internal control. There will always be some control risk because of the intrinsic
limitations of any system of internal control.
For assessing control risk, the auditor should consider the adequacy of control design,
as well as test adherence to control procedures. In the absence of such assessment, the
auditor should assume that control risk is high. The auditor ordinarily assesses control
risk at a high level for some or all assertions where:
- The entity`s policies and procedures relating to an assertion are not effective or
- Evaluating the effectiveness of the entity`s policies and procedures would be
inefficient
The auditor may make a preliminary assessment of control risk at less than a high level
only when the auditor:
- Is able to identify policies and procedures of the accounting and internal control
systems relevant to specific assertions which are likely to prevent or detect material
misstatements in the financial statements ; and
- Plans to perform tests of control or support the assessment.

It may be noted that nature, timing and extent of substantive audit procedures to be
performed would depend upon the auditor`s assessment of the inter-relationship
between inherent risk, control risk and detection risk.
7. D
istinguish between the following (Any Two): (25=10)
a) Audit Planning and Audit Program
b) Management Audit and Operational Audit
c) Compliance Procedures and Substantive Procedure
d) Tagging and Tracing
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Answer No. 7
a) Audit Planning and Audit Program
As per NSA-300 on Audit Planning, the auditor should plan the audit work so that the audit
will be performed in an effective manner. The "Audit Planning" means developing a general
strategy and a detailed approach for the expected nature, timing and extent of the audit. The
auditor plans to perform the audit in an efficient and timely manner. Audit planning is one of
the basic principles of auditing. Plan should be based on knowledge of the clients business.
Audit planning is a continuous process throughout the audit engagement and covers
developing an overall plan for the expected scope and conduct of the audit and developing
an audit program showing the nature, timing and extent of audit procedures. Adequate
planning of the audit work helps to ensure that appropriate attention is devoted to important
areas of the audit, those potential problems are identified and that the work is completed
expeditiously. Planning also assists in proper assignment of work to assistants and in
coordination of work done by other auditors and experts. The extent of planning will vary
according to the size of the entity, the complexity of the audit and the auditor's experience with
the entity and knowledge of the business. Matters to be considered by the auditor in developing
the overall audit plan include knowledge of business, understanding the accounting and internal
control systems, risk and materiality, nature, timing and extent of procedures, coordination,
direction supervision and review process etc.
The same NSA-300 mentions that the auditor should develop and document an audit program
setting out the nature, timing and extent of planned audit procedures required to implement the
overall audit plan. Hence, audit program is nothing but a list of examination and
verification steps to be applied set out in such a way that the inter-relationship of one step
to another in clearly shown and designed, keeping in view the assertions discernible in the
statements of account produced for audit or on the basis of an appraisal of the accounting
records of the client. In other words, an audit program is a detail plan of applying the audit
procedures in the given circumstances with instructions for the appropriate techniques to be
adopted for accomplishing the audit objectives.
The difference between audit plan and audit program is that audit program is a part of audit
plan. While audit plans involves each step of audit from engagement to issuance of final
report audit program deals with only nature, timing and extent of audit procedures.
b) Management Audit and Operational Audit.
Management audit is an audit of the management. The management audit is, therefore,
concerned itself with the whole field of activities of the concern, from top to bottom
starting from the top, because we are primarily concerned with whether the general
management is functioning smoothly and satisfactorily. Management audit is concerned
with appraising management‟s accomplishment of organizational objectives, the
management functions of planning, organizing, directing and controlling, and the adequacy
of management‟s decisions and actions in moving towards its stated objectives.
Management audit is a complex task closely linked with the process of management. It
usually involves the following steps:
a) Identification of the objectives of the organization.
b) The overall objectives are to be split down into detailed targets and plans for
various segments.
c) The organizational structure is to be reviewed to assess whether or not it can
effectively achieve the overall objectives and detailed targets.
d) The performance of each functional area or responsibility center is to be examined
and compared with the targets and objectives.
e) On
the basis of above examination, a realistic course of action may be recommended.
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On the other hand, operational audit is an audit for the management. It is undertaken at
the instance of the management for providing it with information and appraisal of
operations and activities. Operational auditing is essentially a review and appraisal of
operations of an organization carried on by a competent independent person. Hence,
operational audit refers to a systematic independent appraisal activity within an
organization for a review of the entire departmental operations as a service to
management. Operations audit is a technique for regularly and systematically,
appraising unit or function effectiveness against corporate and industry standards by
utilizing personnel who are not specialists in the area of study with the objective of
assuring a given management that its aims are being carried out in identifying
conditions capable of being improved.
Management audit deals with various aspects of the management process whereas
operational audit is confined to various activities and operations in the functional areas.
Management audit attempts to evaluate the performance of various management
process and functions.
c) Compliance procedures and substantive procedure

Compliance procedures are those tests designed to obtain reasonable assurance that
those internal controls on which audit reliance is to be placed are in effect. In obtaining
audit evidence from compliance procedures, the auditor is concerned with assertions that
the control exists, the control is operating effectively and the control has so operated
throughout the period of intended reliance.
Whereas substantive procedures are tests designed to obtain evidences as to the
completeness, accuracy and validity of the data produced by accounting system. They
are of two types: tests of details of transactions and balances and analysis of significant
ratios and trends. As mentioned in NSA-500 Audit Evidence, when obtaining audit
evidence from substantive procedures, the auditor should consider the sufficiency and
appropriateness of audit evidence from such procedures together with any evidence from
tests of control to support financial statement assertions.
d) It is a technique better than Integrated Test Data Facility. It involves tagging the client`s
input data in such a way that relevant information is displayed at key points. It uses the
actual data, and so the question of elimination of special entries test data designed under
Integrated Test Data Facility does not arise. The hard copy, so produced is available
only to the auditor and may describe such inputs as hours worked in a pay period in
excess of 60; or sales orders processed in excess of Rs. 200,000 etc. This enables the
auditor to examine transactions at the intermediate steps in processing.
The advantage of tagging and tracing approach lies in the use of actual data and
elimination of the need for reversing journal entries. The disadvantage is that the
erroneous data will not necessarily be tagged. An effective combination approach may
be to use the ITF approach (Integrated Test Facility) for a few hypothetical transactions
and the tagging and tracing approach to follow line data through a complex system.
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Suggested Answers of Auditing and Assurance
CAP II Examination – June 2011
1. Give your opinions with reasons on the following cases: (45=20)
a) Terai Bank Limited provided a long term loan amounting to Rs. 250 Million to Relax Hotel Pvt. Limited for hotel
operation. The hotel is unable to repay installment (principal & interest) as per repayment schedule. Accordingly you are
appointed by the Bank for special review of the income of the hotel to ensure whether income procedures are duly complied
with and the amount has been fully accounted for. As a special reviewer how would you plan your review work?
b) A Donor has appointed you as an auditor for ensuring financial management capacity of the NGO before funding
made to the NGO to rely on the fund operating capability of the NGO. What would be your special focus area for such
assignment?
c) The Board of Directors meeting of M/s Dikpal Commercial Bank Limited, proposed dividend @ 50 % for the fiscal
year 2066/067. The Annual General Meeting approved the dividend @ 70% instead of the proposed dividend by the Board
of Directors. Examine the decision of the Annual General Meeting to approve dividend in excess of the proposed dividend
by the Board of Directors and whether it is commensurate with the company Act, 2063.
d) Paudel Provident Fund (PPF) is a approved retirement fund, which manages retirement benefits of employees of
group of companies relating to "Poudel Group". PPF has entered into an agreement with a commercial bank for maintenance
and operation of the retirements accounts relating to its beneficiaries. Under the agreement, PPF is required to open a
deposit account in the bank and maintain the entire fund only with the bank. During the audit of PPF, auditor finds that bank
has credited its account with excess interest by 4,32,000. All the interest income in the account is distributed on pro-rata
basis to the individual employees through accounts maintained in the bank itself.
Answer No.1
a) An efficient and effective review can only be performed if this has been thoroughly and properly planned. The planning
stage of the review should be used to establish an overall strategy for the review.
Adequate planning will ensure that appropriate attention is given to crucial areas of the review and that potential problems
are identified on a timely basis. At the planning stage the engagement partner should assign the necessary staffs who
possess the skills and ability required in order to ensure the review is carried out efficiently and in accordance with the
Nepal Standards on Auditing.
Planning Activities
At the planning stage the overall audit strategy is developed. The audit strategy sets the scope, timing and direction of the
review. At this stage the reviewer will develop the detailed review plan which will help identify problem areas and
important review areas.
Once the strategy has been established, then the reviewer is able to develop the more detailed review plan to address the
matters identified in the overall strategy.
Contents of the Plan
The review plan should document the nature, timing and extent of the procedures to be adopted which should be sufficient
and effective enough to be able to assess the risks associated with review engagements.
The detailed plan should also contain a description of the nature, timing and extent of planned further audit procedures at the
assertion level for each material class of transactions, account balances and disclosures.
Finally, the review plan should also contain details of other procedures to be adopted so that the review can be carried out
effectively.
Typical contents of the detailed plan are:
• Nature of the business and what it does
• Risk and problematic areas (both business risk and financial statement risk)
• Details of any complexities associated with the assignment
• Specific accounting and auditing standards relevant to the assignment
• Budgets
• Planned review procedures
• Details of sampling techniques
• Key personnel employed at the clients
For the purpose of this review of the income of the hotel and purpose of assignment an audit program with detailed
procedures should also be developed to conduct the review work efficiently and effectively. Audit procedures inter alia
includes amongst the following:
i. Whether rack rates has been maintained for different types of rooms (Suit/Deluxe/Superior etc), banquette rates are
formalized with recipe and other rates are formalized & approved by competent authority.
ii. Whether there are formal discount rates. If discount rate is in excess of formal rate, whether this is approved by the
competent authority.
NMG P.T.O.
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iii. Whether rate agreements has been entered with regular official & individual parties and duly signed of both parties. If
yes agreed rates have been applied or otherwise to ensure how the rate is formalized in such cases.
iv. Whether complimentary service provided to guests are within the power of approving authority.
v. Whether the billing are made on timely basis and accounted accordingly on departure of guest with evidence of
acceptance by guests. If bill is to be forwarded to customer through mail, is it forwarded on timely basis?
vi. Whether there is clear cut credit policy and credit facility provided only to eligible guest backing with deposition of
advance.
vii. Whether revenue as per income of auditor`s report, accounting system and VAT return has been matched. In case of
difference, is proper reconciliation has been made.
viii. Whether rates have been reviewed as per formal policy of hotel and approved by the competent authority.
ix. Whether record of revenue charged has been reflected in the concerned ledger folios of the guest.
x. Whether accounting system (Software/Manual) for revenue is commensurable with volume of transactions of the
hotel.
xi. Check the closing procedures of the hotel during physical presence on sample night audits.
xii. Make the surprise check on different point of sales and observed if any evidences of concealing the income (by not
issuing bill, by providing huge discounts, by undervaluing the bill etc.)
xiii. Check the recovery rate from debtors and utilization of cash.
b) For ensuring financial management capacity of the NGO my special focus area would be:
i. To ensure whether adequate internal control system for accounting administration has been existed within the
organization.
ii. To ensure the required experiences & academic qualification of accounting staff.
iii. To ensure the volume of donors fund previously operated by the NGO.
iv. To ensure the adequacy of policies etc (like accounting manual, chart of account, financial & administrative
regulation, software are in place & adequate).
v. To see the annual audit report, internal audit report & other types of audit report for ensuring serious and risky areas
if any to pay due attention.
vi. To ensure the basic accounting concept of non-accounting staff for handling the advances.
vii. To see overall account of the NGO, whether there is any diversion of project fund to institutional fund through any
unfair means.
viii. To see the composition of program cost & office running cost for ensuring whether office running cost mainly salary
is excessively high than program cost.
ix. To the composition of common cost (cost shared by different donors) in past period to ensure that whether same cost
has been borne by different donors in books of accounts.
x. To ensure whether periodical reconciliation (bank/cash/fund etc) system are in place.
xi. To ensure whether budgetary control system are in place.
xii. To ensure whether there is excessive turnover of the accounting staff.
xiii. To ensure whether proper & adequate delegation of authority has been made and properly exercised in practice.
c) The Annual General Meeting is authorized body to approve dividend under section 77 (6) of the Company Act,
2063. The proviso to the said section has however, restricted the Annual General Meeting to approve the dividend in
excess of the dividend proposed by the Board of Directors. However, the dividend at lower rate can be approved. Thus,
the decision of Annual General Meeting of Ms. Shangrila Commercial Bank Ltd. to approve dividend in excess of the
dividend proposed by the Board of Directors is void and Annual General Meeting can only approve the dividend at the
lower rate or at the rate proposed by the Board of Directors.
d) As per NSA 200 "Objective and General Principles Governing an Audit of Financial Statements", The objective
of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are
prepared, in all material respects, in accordance with an identified financial reporting framework.
Once the financial statements are misstated, auditor is required to report on the matter by quantifying its impact on the
financial statements. Therefore, auditor should look in to the matter by verifying the fact about how PPF has treated the
excess credit by the bank in its account. Even if bank cannot recover from PPF's employee, and the PPF has not given any
effect to this item in its account, auditor should ask management to disclose the fact in notes to the account of financial
statements and of require, should modify the audit report accordingly.

a) What are the auditor‟s responsibilities for detection of frauds and errors? 10
b) Briefly explain the concept of Materiality. 5
Answer No. 2
a) It has been explicitly mentioned in the NSA 240 that the primary responsibility for the prevention and detection
of fraud rests with both those charged with governance of the entity and with management. The respective responsibilities
of those charged with governance and of management may vary by entity to entity. It is important that management, with
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the oversight of those charged with governance, place a strong emphasis on fraud prevention, which may reduce
opportunities for fraud to take place, and fraud deterrence, which could persuade individuals not to commit fraud because
of the likelihood of detection and punishment. It is the responsibility of those charged with governance of the entity to
ensure, through oversight of management, that the entity establishes and maintains internal control to provide reasonable
assurance with regard to reliability of financial reporting, effectiveness and efficiency of operations and compliance with
applicable laws and regulations. This responsibility includes establishing and maintaining controls pertaining to the
entity‟s objective of preparing financial statements that give a true and fair view (or are presented fairly in all material
respects) in accordance with the applicable financial reporting framework and managing risks that may give rise to
material misstatements in those financial statements. Such controls reduce but do not eliminate the risks of misstatement.
An auditor conducting an audit in accordance with NSAs obtains reasonable assurance that the financial statements taken
as a whole are free from material misstatement, whether caused by fraud or error. An auditor cannot obtain absolute
assurance that material misstatements in the financial statements will be detected because of such factors as the use of
judgment, the use of testing, the inherent limitations of internal control and the fact that much of the audit evidence
available to the auditor is persuasive rather than conclusive in nature.
The primary objective of an auditor is to express an opinion on the financial statements. However, the auditor while
conducting the audit is required to consider the risk of material misstatements in the financial statements resulting from
fraud or error. An audit conducted in accordance with the auditing standards generally accepted in Nepal is designed to
provide reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether
caused by fraud or error. The fact that an audit is carried out may act as a deterrent, but the auditor is not and cannot be
held responsible for the prevention of fraud and error.
The auditor's opinion on the financial statements is based on the concept of obtaining reasonable assurance; hence, in
an audit, the auditor does not guarantee that material misstatements, whether from fraud or error, will be detected.
b) Materiality is an important consideration for an auditor to evaluate whether the financial statements reflect a true
and fair or not. The auditor should consider materiality and its relationship with audit risk when conducting an audit. The
Nepal Accounting Standards Board's "Framework for the Preparation and Presentation of Financial Statements" defines
Materiality in the following terms: "Information is material if its omission or misstatement could influence the economic
decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error
judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or cut-off
point rather than being a primary qualitative characteristic which information must have if it is to be useful."
In designing the audit plan, the auditor establishes an acceptable materiality level so as to detect quantitatively material
misstatements. However, both the amount (quantity) and nature (quality) of misstatements need to be considered.
Examples of qualitative misstatements would be the inadequate or improper description of an accounting policy when it is
likely that a user of the financial statements would be misled by the description, and failure to disclose the breach of
regulatory requirements when it is likely that the consequent imposition of regulatory restrictions will significantly impair
operating capability.
The auditor should consider the possibility of misstatements of relatively small amounts that, cumulatively, could have a
material effect on the financial statements. For example, an error in a month end procedure could be an indication of a
potential material misstatement if that error is repeated each month.
The auditor should also consider materiality at both the overall financial statement level and in relation to individual
account balances, classes of transactions and disclosures. Materiality may be influenced by considerations such as legal
and regulatory requirements and considerations relating to individual financial statement account balances and
relationships. This process may result in different materiality levels depending on the aspect of the financial statements
being considered.
While determining the nature, timing and extent of audit procedures; and evaluating the effect of misstatements, the
auditor should consider the materiality. When planning the audit, the auditor should consider what would make the
financial statements materially misstated. The auditor's assessment of materiality, related to specific account balances and
classes of transactions, helps the auditor decide such questions as what items to examine and whether to use sampling and
analytical procedures. This enables the auditor to select audit procedures that, in combination, can be expected to reduce
audit risk to an acceptably low level. There is an inverse relationship between materiality and the level of audit risk, that
is, the higher the materiality level, the lower the audit risk and vice versa.
The auditor in addition to exercising professional judgment should consider any legislation or regulation which may
impact that assessment while assessing materiality in the case of the public sector. In the public sector, materiality is also
based on the “context and nature” of an item and includes, for example, sensitivity as well as value. Sensitivity covers a
variety of matters such as compliance with authorities, legislative concern or public interest.

a) You have attended physical verification of Supreme Garments Limited and noted no discrepancies between the
physical quantity and the Store Register for the year ending 15 July, 2010. The management provides a statement of value of
stocks but refuses to provide with the cost sheet and calculations regarding how the value has been arrived. The company
discloses that the value of stocks is as “certified by the management” in the Financial Statement. The management is ready
to disclose the same in the Management Representation letter.
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b) The Critical Pollution Extinction Company Limited procured a pollution controlling machine for which the
government has 50% rebate in customs duty upon the precondition that the machine should be used for at least 5 years.
During the course of audit you found that the company has credited 50% rebate provided to income for the year by
disclosing the same in the Notes to Accounts in the Financial Statement. What is your opinion as regards the accounting
treatment by the company?
c) Mr. Yadav, a Chartered Accountant in practice enters into an agreement with Mr. Puspa Adhikari, an individual
who has passed one group of CA final 2 years back. The agreement provides that Mr. Puspa Adhikari shall work in all
professional assignments of Mr. Yadav and shall receive 15 percent of fee received from such assignments as remuneration.
Explain whether the agreement is in order as per Code of Ethics or any other relevant reference? If remuneration is based on
cash flow, does it violate the provisions of the Code of Ethics?
Answer No.3
a) As per NSA-500 “Audit Evidence”, Audit evidence regarding an assertion of existence of inventory will not
compensate for failure to obtain assertion regarding valuation. The auditor should satisfy himself that the valuation of
inventories is in accordance with the Nepal Accounting Standard -02 “Inventories”. The auditor should examine the
methods of applying the basis of inventory valuation which include examination of stock sheets, costing records and
treatment of overhead expenses as a part of cost of inventories. In the given case, it will be construed as limitation on the
scope of auditors. Accordingly, the auditor will have to issue a qualified opinion.
Certification by Management of Supreme Garments Ltd. cannot be taken as conclusive evidence and it cannot relieve the
duty of auditors when there are other procedures and means of gathering audit evidence. Just because management had
owned responsibility for the correctness of its valuation of Stock/inventory, the auditor cannot shirk his responsibility.
This is negligence on his part if he relies on the management representation without assessing the corroborative available
evidences.
b) As mentioned in Para 8 of NAS 10 Accounting for Government Grants and Disclosure of Government
Assistance, a government grant is not recognized until there is reasonable assurance that the entity will comply with the
conditions attaching to it, and that the grant will be received. Receipt of a grant does not of itself provide conclusive
evidence that the conditions attaching to the grant have been or will be fulfilled. Government grants shall be recognized as
income over the periods necessary to match them with the related costs which they are intended to compensate, on a
systematic basis. They shall not be credited directly to shareholders‟ interests. It is fundamental to the income approach
that government grants be recognized as income on a systematic and rational basis over the periods necessary to match
them with the related costs. Income recognition of government grants on a receipts basis is not in accordance with the
accrual accounting assumption. Government grants related to assets, including non- monetary grants at fair value, shall be
presented in the balance sheet either by setting up the grant as deferred income or by deducting the grant in arriving at the
carrying amount of the asset. Hence the NAS has provided two acceptable alternative methods of presentation in financial
statements of grants related to assets. According to the first method, the grant amount is accounted for as deferred income
which is recognized as income on a systematic and rational basis over the useful life of the asset. Under the other
alternative method, government grant is deducted in arriving at the carrying cost of the asset and the grant is recognized as
income over the depreciable asset by way of a reduced depreciation charge.
Hence, as mentioned here above, the treatment to credit whole of the credit rebate amount in the year of purchase of the
machine by Critical Pollution Extinction Company is not appropriate since it is bound by the precondition that the
machine should be used for at least 5 years. The 50% rebate received on customs duty should be credited to income for at
least over a period of 5 years.
c) As per section 34(3) of Nepal Chartered Accountants Act, 1997, one shall not share the auditing fees or
remuneration or distribute as profit with any person other than a member of the institute and shall not pay any
commission, brokerage, etc. out of the professional fees earned to any person or member.
In the above case also, Mr. Yadav a Chartered Accountant in practice enter into agreement to share auditing fees.
Accordingly, Mr. Yadav would be held guilty of professional misconduct since he agreed to share the fees to his
employee.
Even if remuneration were based on cash flow, it would tantamount to be based on fees received on cash and accordingly
Mr. Yadav would be held guilty of professional misconduct.

a) Babarmahal Trading Ltd (BTL) is a wholesaler of Chinese goods and all accounting information is stored on BTL‟s
computer. You are the audit senior in charge of the audit of the receivables balance. Explain the audit procedures that
should be carried out on the receivables balance at BTL.
b) Proper audit is not possible without adequate knowledge of client‟s business. Explain it.
c) Define the concept of internal control and explain its inherent limitations.
Answer No.4
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a) Procedures for verification of receivable balance of BTL are prescribed below:

 Cast the receivables ledger to ensure it agrees with the total on the receivables control account.
 Compare the balance on each receivable account with its credit limit to ensure this has not been exceeded.
 Review the balances in the receivables ledger to ensure no balance exceeds total sales to that customer.
 Calculate receivables days for each month end to monitor control of receivables over the year.
 Stratify receivables balances to show all material items and select appropriate sample for testing.
 Produce an aged receivables analysis to assist with the identification of irrecoverable receivables.
 Obtaining the external confirmations as per NSA 505 and evaluating whether the results of the external confirmation
process together with the results from any other audit procedures performed, provide sufficient appropriate audit
evidence regarding the assertion being audited. In conducting this evaluation the auditor considers the guidance
provided by NSA 330 and NSA 530, “Audit Sampling and Other Selective Procedures.”
b) Obtaining an understanding of the entity and its environment is an essential aspect of performing an audit in
accordance with Nepal Standard on Auditing . In particular, that understanding establishes a frame of reference within
which the auditor plans the audit and exercises professional judgment about assessing risks of material misstatement of the
financial statements and responding to those risks throughout the audit, for example when:
 Establishing materiality and evaluating whether the judgment about materiality remains appropriate as the audit
progresses;
 Considering the appropriateness of the selection and application of accounting policies, and the adequacy of financial
statement disclosures;
 Identifying areas where special audit consideration may be necessary, for example, related party transactions, the
appropriateness of management‟s use of the going concern assumption, or considering the business purpose of
transactions;
 Developing expectations for use when performing analytical procedures;
 Designing and performing further audit procedures to reduce audit risk to an acceptably low level; and
 Evaluating the sufficiency and appropriateness of audit evidence obtained, such as the appropriateness of assumptions
and of management‟s oral and written representations.
The auditor uses professional judgment to determine the extent of the understanding required of the entity and its
environment, including its internal control. The auditor‟s primary consideration is whether the understanding that has been
obtained is sufficient to assess the risks of material misstatement of the financial statements and to design and perform
further audit procedures. The depth of the overall understanding that is required by the auditor in performing the audit is less
than that possessed by management in managing the entity.
c) The concept of internal control may be defined as the plan of organization and all the methods and procedures
adopted by the management of an entity to assist in achieving management‟s objectives of ensuring the orderly and efficient
conduct of its business, including adherence to management policies, the safeguarding of assets, prevention and detection of
fraud and error, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial
information. The system of internal control extends beyond those matters which relate directly to the functions of the
accounting system and comprises control environment and control procedures. Internal control is an essential prerequisite
for efficient and effective management of any organization. It is thus, a primary responsibility of every management to
establish and maintain an adequate system of internal control appropriate to the size and nature of the business of the entity.
An internal control system can provide only reasonable, not absolute, assurance that the management‟s objectives in
establishing the system are achieved. This is because there are some inherent limitations of internal control. These
limitations are mentioned hereunder:
 Controls have to be cost effective. Hence, some control mechanisms may not have been implemented merely because
they are not cost-effective.
 Most control tools are directed at transactions of a usual nature. Therefore, transactions of unusual nature might have
been escaped from such controls.
 The human error potentiality prevails everywhere, even in the control systems.
 Any system of control has its limitations in preventing frauds through collusion between two or more persons.
 Controls may not change with the pace of changes in conditions.
 Management itself may manipulate transactions or accounting estimates.
 A member of management may himself override the control system.
a) Nepal Standards on Auditing relating to "Management Representation" provides guidance on the use of management
representation as audit evidence. Enumerate five items that could be included in a management representation letter.
b) Briefly explain five methods of sampling.
c) What are the principal contents of audit engagement letter?
Answer No. 5
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a) Following matters form part of the management representation letter as per NSA 580 „Management
Representations‟:
 It is management's responsibility for the fair presentation of the financial statements in accordance with Nepal
Accounting Standards or relevant practices.
 No irregularities involving management or employees that could have a material effect on the financial statements
 All books of account and supporting documentation have been made available to the auditors
 Information and disclosures with reference to related parties is complete
 Financial statements are free from material misstatements including omissions
 No non-compliance with any statute or regulatory authority requirements.
 No plans that will materially alter the carrying value or classification of assets or liabilities in the financial statements
 No events, unless already disclosed, after the end of the reporting period that needs disclosure in the financial
statements.
b) Methods of sampling is presented below:

Haphazard Sampling
Haphazard sampling is a technique adopted by the auditor where the sample does not follow a structured technique.
Haphazard sampling is not appropriate when using statistical sampling and the auditor should always ensure that haphazard
sampling is not „doctored‟ in such a way that it deliberately avoids sampling items which, for example, are difficult to
locate. All items in the population should stand a chance of being sampled.
Stratified Sampling
This is a technique where the auditor will split items in a sample into their various strata‟s. For example, in a payroll sample
the auditor might split the sample between full-time males, full-time females, part-time males and part-time females and
work out the percentage of the strata in the population (the population being the total amount that makes up a figure). For
example if 30% of the population are full-time males, 40% full-time females, 20% part-time males and 10% part-time
females, then the sample will consist of 30% full-time males, 40% full-time females etc.
Systematic Sampling
Often referred to as „interval‟ sampling this is where the auditor will take the number of sampling units in the population
and divide this into the sample size to give a sampling interval. For example in a sales invoice sample where the sampling
interval is 20, then the auditor will determine a starting point for sampling and sample every 20th sales invoice thereafter.
Block Sampling
Block sampling is a technique where the auditor applies procedures to such items that all occur in the same block of time or
sequence. For example testing amounts received from customers in the month of September. Alternatively, a „block‟ of
remittance advices received in September would be tested in their entirety. It is to be noted that block sampling should be
used with caution because valid references cannot be made beyond the period or block examined. Where the auditor does
use block sampling, then many blocks should be selected to help minimise sampling risk.
Judgement
Auditors can use their judgement in selecting items for sampling. There are three basic issues which determine which items
are selected:
 The value of items
 The relative risk (items prone to error should be given special attention)
 The representativeness (the sample should be representative of the population)
c) The form and content of audit engagement letters may vary for each client, but they would generally include
reference to:
 The objective of the audit of financial statements;
 Management‟s responsibility for the financial statements;
 The scope of the audit, including reference to applicable legislation, regulations, or pronouncements of professional
bodies to which the auditor adheres;
 The form of any reports or other communication of results of the engagement;
 The fact that because of the test nature and other inherent limitations of an audit, together with the inherent limitations
of internal control, there is an unavoidable risk that even some material misstatement may remain undiscovered; and
 Unrestricted access to whatever records, documentation and other information requested in connection with the audit.
 Management‟s responsibility for establishing and maintaining effective internal control.

6. Write short notes on the following: (25=10)
a) Disadvantages of the use of an audit program.
b) Flow Chart
Answer No. 6
a) The possible disadvantages of the use of an audit program are:
i. The work may become mechanical and particular parts of the programme may be carried out without any
understanding of the object of such parts in the whole audit scheme.
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ii. The programme often tends to become rigid and inflexible following set grooves; the business may change in its
operation of conduct, but the old programme may still be carried on. Changes in staff or internal control may render
precaution necessary at points different from those originally decided upon.
iii. Inefficient assistants may take shelter behind the programme i.e. defend deficiencies in their work on the ground that no
instruction in the matter is contained therein.
iv. A hard & fast audit program may kill the initiative of efficient and enterprising assistants.
v. Preparation of audit program without preliminary depth assessment of clients business and without considering scope of
work to be carried out by auditor will not provide objectivity of the audit work.
c) Flow Chart is a graphical presentation of all the processes within an organization. It gives bird`s eye view of the system
and the flow of transactions that is of particular interest for the auditors. It facilitates the auditors in accumulation of the
information necessary for the proper review and evaluation of internal controls implemented within an organization. It
is considered to be the most concise way of recording the auditor`s review of the system. It minimizes the amount of
narrative explanation and thereby achieves a consideration or presentation not possible in any other form.
7. Justify with reason, whether following statement is true or false. (25=10)

a) Reducing assurance engagement risk to zero is very rare.
b) Balance confirmation from debtors/creditors can only be obtained at the end of the financial year.
Answer No. 7
a) The statement is true. Reducing assurance engagement risk to zero is very rare because of the following reasons:
 The use of selective testing;
 The inherent limitations of internal control;
 The fact that much of the evidence available to practitioner is persuasive rather than conclusive; and
 The use of judgment in gathering and evaluating evidence and framing conclusions based on that evidence.
b) The statement is false. Direct confirmation of balances from debtors/creditors in respect of balances standing in
their accounts at end of the financial year end is perhaps the best method of ascertaining whether the balances are genuine
accurately stated and undisputed where internal control system is relatively weak. The conformation date, methods of
obtaining confirmation etc. are to be determined by the auditor. Debtors/creditors may be requested to confirm balance
either as at the date of balance sheet or any other selected date which reasonably close to the date of balance sheet. The
date should be settled by the auditor in consultation with the entity. Therefore, it is not necessary that balances of
debtors/creditors should be obtained and verified at the end of financial year.
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Marks
1. G
ive your opinions with reason on the following cases: (45=20)
a) An auditor of New Nepal Ltd. audited and signed the accompanying financial statement
of the company as of July 15, 2010 (Corresponding to 31st Ashad, 2067). Date of the
signature of the audit report was August 16, 2010.
b) Shareholder of ABC Ltd. appointed Goddar & Co. as statutory auditor for last financial
year. During the audit, auditor found that previous auditor had issued qualified audit
report in respect of assets which was overstated by Rs.15 Million and a director‘s capital
account was credited by that amount. After series of discussion, current auditor reached
in to conclusion that he was appointed for the current financial year and he is not
responsible for the misstatement in previous year which is already reported by previous
auditor.
c) STU Bank Ltd. appointed you as due diligence auditor to find reason of loss in
international Wool Ltd. The company imports woolen threads and manufactures and
exports woolen sweaters to Wall Mart. Profit margin in such business after input vat
refund is 26%. International Wool Ltd. imported woolen raw materials of Rs. 200 million
and sales was 220 million in F/Y 2009/10. Cost of raw materials is inclusive of all
material input. Opening and closing stock remained the same for the year. How would
you plan your audit work and what area would you focus?
d) XYZ Hotels Ltd. has incurred loss and one of its illiterate director wants your assistance
to find out exactly what happened in the company. He suspects that the company has paid
excessive interest on its borrowing. He has found average of 12 month end borrowing
balance was Rs. 120 million and prevailing interest rate was 10% for the year. Interest
paid for 12 month was Rs. 12 million. Suggest to the director on this matter how he can
verify this matter.
Answer No.1
a)
Audit of financial statement is normally carried out for a full financial year. Financial
year as per the prevelling law is first of Shrawan to the end of Ashad month as per Nepali
calendar. Date of the audit report should be after the date of financial year end and after
completation of audit functions. However, in above mentioned case, date of financial
statements is July 15,2010,which is 1 day short of actual financial year end i.e. July
16,2010( corresponding to 32 ashad 2067).This may happen in following situations:
a) An assurance assignment was for audit of financial statements of that date.
b) Company ended its operation from that date.
c) Company is merged to another company from that date.
d) Company went in to liquidation from that date.
e) Auditor signed wrong dated financial statement.
Therefore the auditor should check out the relevant date of financial statements under
audit before signing the report.
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CAP II Examination – December2010
b) As per NSA 510 Initial Engagements- Opening Balances, for initial audit engagements,
the auditor should obtain sufficient appropriate audit evidence that (a)the opening balance
do not contain misstatements that materially affect the current period‘s financial
statements; (b) the prior period‘s closing balances have been correctly brought forward to
the current period or, when appropriate, have been restated. If the effect of the
misstatement is not properly accounted for and adequately disclosed, the auditor should
express a qualified opinion or an adverse opinion, as appropriate. Since the misstatement
is carried forward during the current year, it has affected current year position as well and
accordingly the, auditor‘s contention is not valid. Goddar &Co. should qualify his report
quantifying the misstatements unless management is ready to correct the statements.
c) Based on the information furnished, audit plan of international wool Ltd. is to obtain or
update the knowledge of the business including consideration of the entity‘s organization,
accounting systems, operating charecteristics and the nature of its assets, liabilities,
revenues and expenses. After initial assessment and knowledge about the nature of
business, areas for special attention can be identified. In this case following areas need
special attention:
1) Whether proper accounting policy is adopted or not.
2) Whether VAT input/VAT refund is excluded from the cost or not
3) Whether process loss is normal and comparable to the industry or not.
4) Whether pilferage and theft of raw material is properly controlled or not.
5) Whether raw material cost and sales value was properly accounted or not.
6) Whether other items of revenue or expenses pertaining to business are properly
recorded in the book of accounts or not.
d) Average interest cost on the average borrowing by XYZ Hotels Ltd. is matching with
prevailing interest rate. However, detailed verification of borrowing and interest expenses
booked need to be carried out as following:
1) Examine the date, rate and amount of borrowing with reference to borrowing
documents.
2) Verify booking date of the balances in individual accounts and total of borrowing
balance.
3) Examine whether there is a procedure for obtaining confirmation of balance
periodically.
4) Check calculations of interest and examine whether interest expenses has been
accurately provided for with reference to the duration of borrowing.
5) Trace the amount of borrowing in to bank account and interest and loan repayment
from bank account.
6) Examine whether borrowing is properly authorized and whether internal control
procedures have been followed.
7) Examine that other items of liability is not booked as borrowing.
2. A
a) What are the basic elements of an assurance engagement? 7

b) An statutory auditor of a commercial Bank is requested to report about frauds. The
management suspects that in two loan files there could be fraud. The auditor has already
found a case of misuse of authority relating to a loan amount of Rs. 2500000 resulting
into loss to the Bank to the extent of that amount. However, the auditor was unable to
find fraud in any other loan transactions. Suggest the auditor about his course of action. 8
Answer No.2
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a)
i) Three party relationship: Assurance engagements involve three separate parties: a
practitioner, a responsible party and intended users.
ii) An appropriate subject matter: Subject matter information may be the reorganization,
measurement, presentation and disclosers represented in financial statements, key
indicators, special documents, assertion about effectiveness or statement of compliance
depending on the nature of assurance engagements.
iii) Suitable criteria: Criteria can be formal or informal depending up on the nature of
assurance engagement. It may be Nepal Standards on Auditing or an established internal
control framework or individual control objectives specifically designed for the
engagement or applicable law, regulation or contract.
iv) Sufficient appropriate evidence: The practitioner plans and performs an assurance
engagement with an attitude of professional skepticism to obtain sufficient appropriate
evidence about whether the subject matter information is free of material misstatement.
The practitioner considers materiality, assurance engagement risk, and the quantity and
quality of available evidence when planning and performing the engagement.
v) Assurance report: The practitioner provides a written report containing a conclusion that
conveys the assurance obtained about the subject matter information.
b) The primary responsibly for the prevention and detection of fraud and error rests with
both those charged with the governance and the management of an entity. The auditor
should obtain evidence that management acknowledges its responsibility for the fair
presentation of the financial statements in accordance with the relevant financial
reporting framework, and has approved the financial statements.
Objective of an audit of financial statements is to enable an auditor to express an opinion
on such financial statements and not the detection and prevention of fraud and error.
Audit involves exercise of judgement. Also, the nature of the audit evidence enables the
auditor to draw only reasonable conclusions therefrom. Because of the inherent
limitation of an audit, there is an unavoidable risk that some material misstatements may
remain undiscovered. While in many situations, the discovery is not the main objective of
audit nor is the auditor‘s program of work specifically designed for such discovery. The
audit cannot, therefore be relied upon to ensure the discovery of all frauds or errors but
where the auditor has such indication, he should extend his procedures to confirm or
dispel his suspicions.
3. G
a) Kathmandu Boarding School was established in year 2010. It recently constructed

swimming pool of 2020 meter size behind its main building. Due to Vastusastra
problem, the swimming pool was reconstructed toward 5 meter west side of the building.
Relocation of the pool incurred additional cost of 20%. Suggest, how this cost be booked
in account.
b) Management of MNO production House argues that the auditor should accept the figure
of stock verification conducted by internal audit. The management is willing to certify
this figure. The engagement partner, however, insists that stock verification should be
carried out again by management in presence of his assistants on 25% of locations.
c) PR Sharma & Co. appointed you as an assistant auditor for audit of a business
organization. You were asked to prepare internal control questionnaire for audit of
payments of the organization.
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Answer No 3
a) According to NAS 6 Property, Plant and Equipment, the expenditure for relocation of
swimming pool should be capitalized. However, the carrying amount of those parts that
are replaced should be derecognized in accordance with the de-recognition provisions.
b) The auditor should obtain sufficient and appropriate audit evidence from compliance and
substantive procedures to form his opinion. Accordingly, the auditor can demand the
physical verification be done in the presence of his assistants to obtain a level assurance
of the inventory system in place. However, auditor should also consider the reliance that
may be placed in the report of internal audit in accordance with NSA 610 considering the
work of Internal Auditing. Where such reliance may be placed in the work of an internal
audit, the physical verification is not necessary.
c) Internal control questionnaire for audit of payment is as given below:
1) Are the duties related to payment segregated and rotated periodically?

2) Are the financial powers properly laid down and reasonable?
3) Have the financial powers of various authorities been intimated to various
departments?
4) Whether proper and adequate documents are maintained for each payment?
5) Is the arithmetical accuracy, price, quality, timing and other terms and conditions ( of
the contract) is ensured before approving a payment?
6) Are payments made through account payee cheques except in exceptional cases?
7) Are bills marked as ‗paid‘ once the payment has been made? Are there adequate
controls to ensure that payment is not made twice against the same bill?
8) Is the person/party, to whom payment is made, properly identified?
9) Is issue of cheque properly controlled? Are all cheques pre numbred? Is each cheque
duly accounted for?
10) Is there a system of sending monthly statement of accounts to suppliers and other
parties?
11) Are there adequate controls for safe custody of cheque books?
4. A
a) Ramila & Associates is a proprietorship firm of chartered accountant. Ramila, the

proprietor of the firm, was the board member of Lalima Bank Ltd till 32 Asadh, 2067.
During the AGM of Bank for the financial year 2066/67, she has been appointed as
statutory auditor for the financial year 2067/68. Should she accept the said appointment?
b) What is accounting estimates? Provide eight examples of accounting estimates.

c) What is the importance of working papers to the auditor? List out the documents to be
kept in permanent audit files.
Answer No.4
a) As per section 8.4 of Code of Ethics issued by ICAN, ―when professional accountants in
public practice are or were, within the period under current review or immediately
preceding an assignment: a) a member of the board, an officer or employee of a
company; or b) a partner of or in the employment of, a member of the board or an officer
or employee of a company. They would be regarded as having an interest which could
detract from independence when reporting on that company‖.
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Accordingly as per above Para, CA Ramila was board member of the bank immediately
preceding an assignment and the period is not less two years, hence she should not accept
this assignment as statutory auditor for the financial year 2067/68.
b) Accounting estimate means an approximation of the amount of an item in the absence of

a precise means of measurement. On this ICAN has issued NSA 540. The examples are:
i. Allowances to reduce inventory and accounts receivable to their estimated
realizable value.
ii. Provisions to allocate the cost of fixed assets over their estimated useful life.
iii. Accrued Revenue.
iv. Provision for taxation.
v. Provision for a loss from lawsuit.
vi. Insurer`s liability for outstanding claim.
vii. Losses on construction contracts in progress.
viii. Amortization of certain items like goodwill and deferred revenue expenditure.
c) Working papers are the property of the auditor. In view of the importance of working
papers to the auditor, ICAN has issued NSA 230/Documentation. The importance of
working papers are: i.) to assist in the planning and performance of the audit, ii.) to assist
in the supervision and review of the audit work and iii.) to provide evidence of the audit
work performed to support the auditor`s opinion.
Working paper files are generally divided in to two types as per nature of documents;
namely permanent working paper files (permanent audit files) and current working paper
files (current audit files). The contents of permanent audit files are:
i. information concerning the legal and organizational structure of the client. In the
case of a company, this includes the Memorandum and Articles of Association. In
case of a statutory corporation, this includes the Act and Regulations, under which
the corporation functions,
ii. extracts or copies of important legal documents, agreements and minutes relevant
to the audit,
iii. a record of the study and evaluation of the internal controls related to the
accounting system. This might be in the form of narrative descriptions,
questionnaires or flow charts, or some combination thereof,
iv. copies of audited financial statements of previous years,
v. analysis of significant ratios and trends,
vi. copies of management letters issued by the auditor, if any,
vii. record of communication with the retiring auditor, if any before acceptance of the
appointment as auditor,
viii. notes regarding significant accounting policies and
ix. significant audit observations of earlier years.
5. A
a) Define the concept of internal control and explain its inherent limitations.
b) List out the circumstances, where auditing is done through the computer.
c) Briefly explain the concept of Materiality.
Answer No.5
(a) The concept of internal control may be defined as the plan of organization and all the
methods and procedures adopted by the management of an entity to assist in achieving
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management‘s objectives of ensuring the orderly and efficient conduct of its business,
including adherence to management policies, the safeguarding of assets, prevention and
detection of fraud and error, the accuracy and completeness of the accounting records,
and the timely preparation of reliable financial information. The system of internal
control extends beyond those matters which relate directly to the functions of the
accounting system and comprises control environment and control procedures. Internal
control is an essential prerequisite for efficient and effective management of any
organization. It is thus, a primary responsibility of every management to establish and
maintain an adequate system of internal control appropriate to the size and nature of the
business of the entity.
An internal control system can provide only reasonable, not absolute, assurance that the
management‘s objectives in establishing the system are achieved. This is because there
are some inherent limitations of internal control. These limitations are mentioned
hereunder:
(a) Controls have to be cost effective. Hence, some control mechanisms may not have
been implemented merely because they are not cost-effective.
(b) Most control tools are directed at transactions of a usual nature. Therefore,
transactions of unusual nature might have been escaped from such controls.
(c) The human error potentiality prevails everywhere, even in the control systems.
(d) Any system of control has its limitations in preventing frauds through collusion
between two or more persons.
(e) Controls may not change with the pace of changes in conditions.
(f) Management itself may manipulate transactions or accounting estimates.
(g) A member of management may himself override the control system.
b) The auditor can use the computer to test the logic and controls prevalent within the system
and the records generated by the system. Depending upon the complexity of the
application system being audited, the approach may be different. It may be fairly simple or
may require extensive technical competence on the part of the auditor. Circumstances that
may cause to conduct audit through the computer are as follows:
(a) The application system processes large volume of input and produces large volumes
of output that make extensive direct examination of the validity of input and output
difficult.
(b) Significant parts of the internal control system are embodied in the computer system.
(c) The logic of the system is complex and there are large portions that facilitate use of
the system or efficient processing.
(d) Because of cost-benefit considerations, there are substantial gaps in the visible audit
trail.
c) Materiality is an important consideration for an auditor to evaluate whether the financial

statements reflect a true and fair view or not. The auditor should consider materiality and its
relationship with audit risk when conducting an audit. The Nepal Accounting Standards Board's
"Framework for the Preparation and Presentation of Financial Statements" defines Materiality in
the following terms: "Information is material if its omission or misstatement could influence the
economic decisions of users taken on the basis of the financial statements. Materiality depends
on the size of the item or error judged in the particular circumstances of its omission or
misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary
qualitative characteristic which information must have if it is to be useful."
In designing the audit plan, the auditor establishes an acceptable materiality level so as to detect
quantitatively material misstatements. However, both the amount (quantity) and nature (quality)
of misstatements need to be considered. Examples of qualitative misstatements would be the
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inadequate or improper description of an accounting policy when it is likely that a user of the
financial statements would be misled by the description, and failure to disclose the breach of
regulatory requirements when it is likely that the consequent imposition of regulatory restrictions
will significantly impair operating capability.
The auditor should consider the possibility of misstatements of relatively small amounts that,
cumulatively, could have a material effect on the financial statements. For example, an error in a
month end procedure could be an indication of a potential material misstatement if that error is
repeated each month.
The auditor should also consider materiality at both the overall financial statement level and in
relation to individual account balances, classes of transactions and disclosures. Materiality may
be influenced by considerations such as legal and regulatory requirements and considerations
relating to individual financial statement account balances and relationships. This process may
result in different materiality levels depending on the aspect of the financial statements being
considered.
While determining the nature, timing and extent of audit procedures; and evaluating the effect of
misstatements, the auditor should consider the materiality. When planning the audit, the auditor
should consider what would make the financial statements materially misstated. The auditor's
assessment of materiality, related to specific account balances and classes of transactions, helps
the auditor decide such questions as what items to examine and whether to use sampling and
analytical procedures. This enables the auditor to select audit procedures that, in combination,
can be expected to reduce audit risk to an acceptably low level. There is an inverse relationship
between materiality and the level of audit risk, that is, the higher the materiality level, the lower
the audit risk and vice versa.
The auditor in addition to exercising professional judgment should consider any legislation or
regulation which may impact that assessment while assessing materiality in the case of the public
sector. In the public sector, materiality is also based on the ―context and nature‖ of an item and
includes, for example, sensitivity as well as value. Sensitivity covers a variety of matters such as
compliance with authorities, legislative concern or public interest.
6. W
rite short notes on the following (Any Two): (25=10)
a) Permanent Audit File.

b) Impairment of assets.
c) Cut off Procedure.
d) Performance Audit.
Answer No.6
(a) In a recurring audit, the file of working papers that are relevant to more than one audit
engagement or core documents are often kept separately in a file known as permanent
audit file. Permanent audit file is updated regularly with information of continuing
importance to succeeding audit. As per NSA 230-Audit Documentation a permanent
audit file normally includes:
i. Information concerning the legal and organizational structure of the client. In the
case of a company, this includes the memorandum and articles of association. In
the case of a statutory corporation, this includes the Act and Regulations under
which the corporation operates.
ii. Extracts or copies of important legal documents, agreements and minutes relevant
to the audit.

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iii. A record of the study and evaluation of the internal controls related to the
accounting system.
iv. Copies of audited financial statements of previous years.
v. Analysis of significant ratios and trends.
vi. Copies of management letters issued by the auditor if any.
vii. Record of communication with the retiring auditor, if any before acceptance of
the appointment as a auditor and
viii. Notes regarding significant accounting policies.
b) A
n asset is impaired when the carrying amount of the asset exceeds its recoverable amount.
The difference between the carrying amount of an asset and recoverable amount is
termed as impairment loss. Besides charging annual depreciation on assets by the reason
of normal wear and tear, afflux ion of time and obsolescence to reinstate the correct value
of the assets considering the future cash flows that the asset can generate, impairment
loss needs to be provided. Some indications that an asset might have been impaired are
mentioned as follows:
(a) S
ignificant changes with an adverse effect on the entity have taken place during the
period, or will take place in the near future, in the technological, market,
economic or legal environment in which the entity operates or in the market to
which an asset is dedicated.
(b) T
he carrying amount of the net assets of the entity is more than its market
capitalization.
(c) E
vidence is available of obsolescence or physical damage of an asset.
(d)
Evidence is available from internal reporting that indicates that the economic
performance of an asset is, or will be, worse than expected.
If any of the above indications is present, an entity is required to make a formal estimate
of recoverable amount and impairment loss need to be provided.
c) It refers to the procedure adopted by the management to ensure that transactions of one
period are separated from those at the commencement of the next accounting period. The
cut off r is very significant so as to ensure that revenue and expenditures of one year do
not get recorded in the following year since it will distort the true and fair view of the
accounts. These procedures are applied to ensure that:
(a) The proper procedure has been followed for adjusting the inventory to take into
account movements to and from inventory, which have taken place between the
stock taking date and balance sheet date where stock has been taken on a date
other than the balance sheet date.
(b) Goods sold have been excluded from the inventories and credit has been taken for
the sales in the case of credit sales.
(c) Goods purchased have been in the inventories and that the liabilities have been
provided for in case of credit purchase.
d) Performance audit refers to the evaluation of the economy, efficiency and effectiveness
of selected activities of the client. In this situation, economy is concerned with
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minimizing the cost of resources acquired or used, having regard to appropriate quality.
Efficiency refers to the relationship between the output of goods/ services or other results
and the resources used to produce them. Here, the auditor examines how far maximum
output is attained for a given input.
Similarly, effectiveness refers to the relationship between the intended results and the
actual results of the activity. Thus, the auditor examines how successfully the outputs in
the form of goods/ services or other results achieve policy objectives, operational goals
and other expected effects.
In practice, therefore, while carrying out the performance audit, the auditor looks at these
different aspects together particularly when considering the closely linked aspects of
economy and efficiency.
7. J
ustify with reason, whether following statement is true or false. (25=10)
a) G
enerally, purpose of misstatement in a financial statement of a medium sized sole
proprietorship business in Nepal is to benefit proprietor himself.
b) Audit plan is substitute for audit program.
Answer No.7
a) True: Typical medium sized business in Nepal, tend to mispresents their financial
statements to benefit their proprietor by way of lowering or reducing tax liability by
understanding income or over standing the expenses. Typical medium sized business-
man tends to lower payment of tax or do not want to pay any tax. Some time such
business man may mistake his financial statements to justify his loan application to a
bank and financial institutions. In other situations such financial statements may be
misstated to mislead the various stakeholders or users of such financial statements so that
benefits is derived by proprietor of such business.
b) The statement is false: Audit plan is initial step of audit. Whereas, audit program is
setting up of procedures that are needed to implement the audit plan. Overall audit plan is
for expected scope ans conduct of audit. On the other hand audit program shows nature,
time and extend of audit procedures.
In planning an audit, auditor should consider facteo such as complexity of the audit, the
environment in which the clint operates, his previous experience with the clint and
knowledge of clint‘s business. The audit program serves as a set of instructions to the
assistants involved in the audit and a means to control the proper execution of the work.
Therefore, audit program supplement the audit plat for execution and it does not stand out
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CAP II Examination June 2010
1. G
ive your opinions with reason on the following cases: (45=20)
a) M/s Joshi & Joshi is a practicing Chartered Accountants firm. One of the senior partners of the
firm is also associated with import/export trade and he is the sole proprietor of that business.
Mr. Joshi has also taken huge amount of loan from various banks and he is found visiting more
to government offices than in his own firm or to his clients. Comment on given case with
reference to ‗Code of Ethics‘.
b) Metro Developers Pvt. Ltd is Bharatpur based Real Estate Company. It has invested heavily on
the apartments and commercial complexes on and around Narayangarh. Recently, audit of the
transaction for rental receipts was hastily completed by taking monthly average figure and
multiplying it by 12. You are required to suggest appropriate way of conducting of audit for the
above said transaction of rental receipts.
c) Association for Backward Communities (ABC) is one of the NGOs working in the Midwest
part of the country. There seems to be confusion regarding total receipt of the NGO as what
could be the probable revenue sources and how they should be vouched. The chief of the NGO
is mostly on the foreign tour and the accountant of the NGO simply says ‗boss knows
everything and he is just clerk‘. What documents you will insist to check to deal with the
situation?
d) Torstar‘s Heaven is star level hotel situated at Nagarkot. During the initial discussion it is
noticed that the hotel management is aware of pilferage issues, however due attention is not
paid to address the situation. You are required to express your statement underlying the
importance of internal control on the pilferage issues and the probable consequences of it, if
not addressed properly.
Answers:
1.a.) A professional accountant in public practice should not concurrently engage in any business,
occupation or activity which impairs or might impair integrity, objectivity or independence, or the
good reputation of the profession and therefore would be incompatible with the rendering of
professional services. The simultaneous engagement in other business, occupation or activity
unrelated to professional services, which have the effect of not allowing the professional
accountant in public practice properly to conduct a professional practice in accordance with the
fundamental ethical principles of the accountancy profession should be regarded as inconsistent
with the practice of public accountancy.
b.) To vouch for rental receipts, various documents need to be seen. To start with, copies of bills
issued to tenants should be test checked by reference to copies of tenancy agreements and bills of
charges paid by the landlord on behalf of the tenants e.g., house tax, water tax etc. The amounts
collected from tenants on account of rent should be checked by reference to receipts issued by
them. The entries in the Rental Register in respect of rents accrued afterwards should be verified.
The register should also be scrutinized for finding out the rent amount, which have not been
recovered and are considered bad or irrecoverable, for deciding whether these should be written off
or provision against the same should be made.
c.) The receipt of income of NGO may be checked on the following lines:
i) Contribution and grants for projects and programmes: Check agreements with donors
and grants letters to ensure that funds received have been accounted for. Check that all
2405
foreign contributions receipts are deposited into bank accounts and proper disclosure is
made.
ii) Receipts from fund raising programmes: Verify in detail the internal control system and
ascertain who are the persons responsible for collection of funds and mode of receipt.
iii) Interest and dividends: Check the interest and dividends received and receivable with
investments held during the year.
iv) Miscellaneous receipts: Check sale of scrap, rental receipts etc, if any.
d.) Pilfering is one of the greatest problems in any hotel and the importance of internal control
cannot be over stressed. It is the responsibility of the management to introduce controls, which will
minimize the leakage as far as possible. If the internal control in the hotel is weak, then a very
serious problem exists for the auditor. Preparing accounts at regular interval for each of the cost/
revenue centers and investigating the deviation if any could be helpful in this regard. If necessary,
scope of audit tests will have to be increased and in the event of material margin discrepancy
being unexplained, the auditor may consider qualifying his report.
2. A
a) T
he auditor may encounter circumstances that, individually or in combination, indicate the
possibility that the financial statements may contain a material misstatement resulting from
fraud or error. List down some of those (at least 8) circumstances that indicate a possible
misstatement. 8
b) S
o far as the auditor is concerned, the examination and evaluation of the internal control system
is an indispensable part of the overall audit programme. What are the key areas that auditor
will enable to know after reviewing internal controls. 7
Answers:
2.a.)
Some of the circumstances that, individually or in combination, indicate the possibility that the
financial statements may contain the material misstatement:
i) Unrealistic time deadlines for audit completion imposed by management.
ii) Reluctance by management to engage in frank communication with appropriate third
parties, such as regulators or bankers.
iii) Limitation of audit scope imposed by management.
iv) Identification of important matters not previously disclosed by management.
v) Significant difficult-to-audit figures in the accounts.
vi) Aggressive application of accounting principles.
vii) Conflicting or unsatisfactory evidence provided by management or employees.
viii) Unusual documentary evidence such as handwritten alterations to documentations
ix) Information provided unwillingly or after unreasonable delay.
x) Seriously incomplete or inadequate accounting records.
b.) The review of internal controls will enable the auditor to know:
i) Whether errors and frauds are likely to be located in the ordinary course of operations
of the business.
ii) Whether an adequate internal control system is in use and operating as planned by the
management.
iii) Whether an effective internal auditing department is operating.
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iv) Whether the controls adequately safeguards the assets.

v) How far and the how adequately the management is discharging its function in so far as
correct recording of transactions is concerned.
vi) How reliable the reports, records and the certificates to the management can be.
vii) The extent and the depth of the examination that he needs to carry out in the different
areas of auditing.
viii) What would be appropriate audit technique and audit procedure in the given
circumstances.
ix) What are the areas where control is weak and where it is excessive.
x) Whether some worthwhile suggestions can be given to improve the control system.
3. G
a) G
iant Ltd. is newly established cement industry and yet to start commercial production. Various
payments, large and small, are being regularly made. You are required to prepare internal
control questionnaire regarding ‗procedure for authorization‘ for payments.
b) During the course of audit, M/s Guess and Guess Associates, an audit firm, has checked 20
percent of the postings from Cashbook to General Ledger. Some serious questions could be
raised about the representative nature of the sample and about the validity of sample results.
What could those serious concerns be?
c) Forward Looking Co Ltd is dealing with various transactions that could be well termed as
contingent liability. As an auditor, suggest some of the procedures for verifying contingent
liabilities?
Answers:
3.a)
The internal control questionnaire for ‗procedure for authorization‘ may be drawn as below:
i) Does the enterprise have a formal document showing the various authorities, which can
sanction payments along with the nature of the relevant payments and the limit on sanctioning
powers?
ii) Does the system provide for authorization for certain payments by the top
management or the governing body?
iii) Are the financial powers of various sanctioning/disbursing authorities reasonable?
iv) Have the financial powers of various authorities been intimated to various
departments of the enterprise?
v) Is there a system of post facto authorization of payments in exceptional cases where
prior sanction could not be obtained?
b. Some of the serious concerns about the representative nature of the sample and about the
validity of sample results could be:
i) Why select, say 20 percent of the posting? Why can it not be 15 or 25 percent? Why check
only 2 months?
ii) Can we just state the percentage size of the sample without reference to the total number of
transactions? Are we taking the same amount of risk if we check 2 out of a total of 10
transactions or 200 out of 2000 transactions?
iii) How can we draw conclusions about the transactions of the whole year by merely checking the
transactions of a few specified months, especially as the level of activity may vary from month
to month?
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iv) By not stating the manner in which the 20 percent of the transactions have to be selected,
would not the audit assistants consciously or unconsciously select only those transactions,
which are simpler and easier to audit?
c.
The auditor may carryout the following procedures for verifying the contingent liabilities:
i) Review the minutes of the meetings of board of directors/ committees.
ii) Review the relevant contracts, agreements and arrangements.
iii) Review the list of pending legal cases, correspondence relating to taxes, duties etc.
iv) Review the records maintained by the entity regarding contingent liabilities.
v) Make enquiries of and hold discussion with the entity‘s management.
vi) Obtain representations from the management.
4. A
a) W
hat are the assertions with which an auditor is concerned with while obtaining audit evidence
from substantive procedures?
b) Mention briefly the conditions or events, which increase the risk of fraud or error leading to
material misstatement in Financial Statements.
c) What is agreed upon procedures?
Answers:
(a) An auditor is concerned with following assertions:-
(i) Existence: That an asset or liability exists at a given date.
(ii) Rights and obligations: That an asset is a right of the concern and a liability is an obligation at
a given date.
(iii)Occurrence: That a transaction or event which took place pertains to the entity during the
relevant period.
(iv) Completeness: That there are no unrecorded assets, liabilities or transaction.
(v) Valuation:That an asset or liability is recorded at an appropriate carrying value.
(vi) Measurement: That a transaction is recorded in the proper amount and revenue or expense is
allocated to the proper period.
(vii)Presentation and disclosure: That an item is disclosed classified and described in accordance
with recognised accounting policies and practices and relevant statutory requirements.
(b) In planning and performing his examination, the auditor should take into consideration the
risk of material misstatements of the financial information caused by fraud or error.
Weaknesses in the design of the internal control system and non-compliance with
identified control procedures amongst other conditions or events which increase the risk of
fraud or error are:
(i) Weaknesses in the design of internal control system and non-compliance with the laid
down control procedures, e.g., a single person is responsible for the receipt of all d ak and
marking it to the relevant sections or two persons are responsible for receipt of dak but the
same is not followed in actual practice, etc.
(ii) Doubts about the integrity or competence of the management, e.g., domination by one
person, high turnover rate of employees, frequent change of legal counsels or auditors,
significant and prolonged understaffing of the accounts department, etc.
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(iii)Unusual pressures within the entity, for example, industry is doing well but the company is
not performing all right, heavy dependence on a single line of product, inadequate working
capital, entity needs raising share prices to support the market price in the wake of public
offer, etc.
(iv)Unusual transactions such as transactions with related parties, excessive payment for
certain services to lawyers, etc.
(v) Problems in obtaining sufficient and appropriate audit evidence, e.g., inadequate
documentation, significant differences between the figures as per the accounting records
and confirmation received from third parties, etc.
(c)
According to the NSA 4400, ―Engagement Agreed upon Procedures Regarding Financial
Information‖ the objective of an agreed-upon procedures engagement is for the auditor to carry out
procedures of an audit nature to which the auditor and the entity and any appropriate third parties
have agreed and to report on factual findings.
As the auditor simply provides a report of the factual findings of agreed-upon procedures, no
assurance is expressed by him in his report. Instead, users of the report assess for themselves the
procedures and the findings reported by the auditor and draw their own conclusions from the work
done by the auditor.
The report is restricted to those parties that have agreed to the procedures to be performed since
others, unaware of the reasons for the procedures, may misinterpret the results. However, it is
possible in certain circumstances that the report of the engagement may not be restricted only to
those parties that have agreed to the procedures to be performed, but made available to a wider
range of entities or individuals, e.g., in case of Government organisations.
The auditor should conduct an agreed-upon procedure engagement in accordance with this NSA
and the terms of the engagement. The auditor should ensure with representatives of the entity and,
ordinarily, other specified parties who will receive copies of the report of factual findings, that
there is a clear understanding regarding the agreed procedures and the conditions of the agreement.
Matters to be agreed include the following:

- Nature of the engagement including the fact that the procedures performed will not constitute
an audit or a review and that accordingly no assurance will be expressed.
- Stated purpose for the engagement.
- Identification of the financial information to which the agreed-upon procedures will be applied.
- Nature, timing and extent of the specific procedures to be applied.
- Limitations on distribution of the report of factual findings. When such limitation would be in
conflict with the legal requirements, if any, the auditor would not accept the engagement.
In certain circumstances, for example, when the procedures have been agreed to between the
regulator, industry representatives and representatives of the accounting profession, the auditor
may not be able to discuss the procedures with all the parties who will receive the report. In such
cases, the auditor may consider, for example, discussing the procedures to be applied with
appropriate representatives of the parties involved, reviewing relevant correspondence from such
parties.
Matters that would be included in the engagement letter include:

- A listing of the procedures to be performed as agreed-upon between the parties.
- A statement that the distribution of the report of factual findings would be restricted to the
specified parties who have agreed to the procedures to be performed.

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5. C
omment on the following: (35=15)
a) W
hat is clean audit report? Explain how it is different from qualified report?
b) H
ow the work of an expert should be evaluated before accepting the same as Audit
evidence?
c) C
are Limited purchased machinery on 1.4.2065 from a foreign country at a price of $ 200
thousands upon terms of credit that the price should be settled within six months from the date
of purchase. The company capitalised the asset and created liability for the capital goods
converting the foreign currency liability to Nepalese Rupees at a rate of exchange prevailing as
on 1.4.2065. When the company settled the liability on 30 Poush 2065, it had to incur an
additional amount of Rs. 5,00,000 due to change in foreign exchange rate on the date of
settlement. It added this additional amount of exchange variation in the capital cost of the asset
and charged depreciation upon the enhanced amount of asset value from 1 Magh 2065. Give
your opinion.
Answers:
a) A clean audit report is a report issued by an auditor in case he does not have any reservation in
respect of matters contained in the financial statements. In such a case, the audit report may
state that the financial statements give a true and fair view of the state of affairs and of profit
and loss account during the period. A clean report may be without any modifications or with
modifications which are just for matter of emphasis. Under the following circumstances an
auditor is justified in issuing a clean report:
(i) the financial information has been prepared using acceptable accounting policies, which have
been consistently applied;
(ii) the financial information complies with relevant regulations and statutory requirements; and
(iii) there is adequate disclosure of all material matters relevant to the proper presentation of the
financial information, subject to statutory requirements, where applicable.
Qualified audit report, on the other hand, is one when auditor does not give a clean chit about the
truthfulness and fairness of the financial statements but makes certain reservations. A qualified
report is a modified report as to the auditor‘s opinion. A qualified report is issued when there is
limitation on the scope of audit or disagreement with management, regarding the acceptability of
accounting policies selected or the method of application or the adequacy of financial statement
disclosure.
The auditor uses the word to indicate his qualification or reservation by placing the word ―subject
to‖ or ―except to‖. The qualifications should indicate impact on profits and account balances and
should be specific, clear and self explanatory. The auditor should also give reasons for
qualification. In case of companies, there is also a legal requirement of the CompanyAct which
provides that where the auditor answers any of the statutory affirmations in negative or with
qualification, his report shall state the reasons for such answer.
Thus, it is clear from the above that in case of a clean report, the auditor has no reservation in
respect of various matters contained in the financial statements but a qualified report may involve
certain matters involving difference of opinion between the auditor and the management.
b) Using the work of an expert: As per the NSA 620, when the auditor intends to use the work
of an expert he should evaluate the following before accepting the same as audit evidence:
(i) Professional qualification of the expert;
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(ii) Experience and reputation of expert in related field;

(iii)Independence and objectivity of the expert;
(iv) The objectives and scope of the expert‘s work;
(v) Expert‘s relationship with the client, if any;
(vi) The source data used;
(vii)Assumptions and method used;
(viii) The results of the expert‘s work in the light of auditor‘s overall knowledge of the business
and of the result of his audit procedures.
c) Effects of Changes in Foreign Exchange rates: According to NAS 11-Para 24, the foreign
currency transactions should be initially recognized at the exchange rate prevailing on the date
of transaction. Accordingly, the asset and liability should be accounted at exchange rate
prevailing on the date of purchase. The monetary items should be reported at the exchange rate
prevailing on the close of the accounting period. The liability for capital goods purchased is a
monetary item.
If during the accounting period, if a monetary liability is settled at a rate different from the rate
at which it was initially recognized the exchange difference should be charged to P&L account
in the year of settlement.
According to NAS 11, hence, it is necessary to write off Rs, 500 thousands being exchange
differences at the date of settlement. It cannot be added to the cost of the capital. Hence, the
company is wrong in capitalizing foreign exchange differences between the amounts of initial
recognition and settlement and computing depreciation on the wrongly capitalized portion of
the asset. This needs correction by the company. Else, the auditor may qualify his report upon
relevant considerations.
6. W
rite short notes on the following (ANY TWO): (25=10)
a) Change in Accounting Policies

b) Management representation as an audit evidence
c) External Confirmation Process to obtain audit evidence at the assertion level
Answers:
a) Change in accounting policies:
- The consistency is also an accounting assumption. Therefore the accounting policies should
consistently be applied and followed from years to years.
- Change in accounting policy is permitted only if such change is to bring accounts in line with
accounting standards, provisions of law or for better presentation of financial statements.
- When change in accounting policies or method is effected, the fact of such change and its
impact on accounts must be disclosed.
- If change is made in the accounting policies which has no material effect on the financial
statements for the current period but which is reasonably expected to have a material effect in
later periods, the fact of such change should be appropriately disclosed in the period in which
the change is adopted.
b) The management representation as an audit evidence:

- During the course of an audit, management makes many representations to the auditor, either
unsolicited or in response to some specific enquiries.
- The auditor also should obtain representation from management, where considered appropriate
and necessary.

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- The management representation is taken to corroborate audit evidence, but representations by

management can not be a substitute for other audit evidences that the auditor could reasonably
expect to be reasonably available.
- In certain cases, where knowledge of facts is confined to management, a representation by
management may be the only audit evidence, which can reasonably be expected to be
available.
- If a management representation is contradicted by an available other audit evidence, the auditor
should examine the circumstances and, when necessary, reconsider the reliability of other
representations made by management.
c) External Confirmation Process:

Para 30 of NSA 505: When confirming confirmation procedures, the auditor should maintain
control over the process of selecting those to whom a request will be sent, the preparation and
sending of confirmation requests and the responses to those requests. Control is maintained
over communications between the intended recipients and the auditor to minimise the
possibility that the results of the confirmation process will be biased because of the
interception and alteration of confirmation requests or responses. The auditor ensures that it is
the auditor who sends out the confirmation requests, that the requests are properly addressed,
and that it is requested that all replies are sent directly to the auditor. The auditor considers
whether replies have come from the purported senders.
7. H
ow will you vouch and verify the followings (ANY TWO): (25=10)
a) Provision for income tax
b) Bank Borrowings
c) Premium paid for insurance of a Motor car.
Answers:
a) Provision for income tax
(i) Obtain the computation of income prepared by the auditee and verify whether it is as per the
Income-tax Act, 1961 and Rules made there under.
(ii) Review adjustments, expenses, disallowed special rebates, etc. with particular reference to the
last available completed assessment.
(iii) Examine relevant records and documents pertaining to advance tax, self assessment tax and
other demands.
(iv) Compute tax payable as per the latest applicable rates in the Finance Act.
(v) Ensure that overall provisions on the date of the balance sheet is adequate having regard to
current year provision, advance tax paid, assessment orders, etc.
b) Bank Borrowings
Borrowings from the banks may be either in the form of overdraft limit or fixed loans.
In each case, borrowings should be verified as follows:
1. Reconcile the balances in the overdraft or loan account with that shown in the pass books and
confirm the last mentioned balance by obtaining balance confirmation certificate from the
bank.
2. Obtain certificate from the bank showing particulars of securities deposited with the bank as
security for the loans or of the charge created on an asset / assets of the concern and confirm
the same has been correctly disclosed and duly registered with the Registrar of Companies and
recorded in the Register of Charges.

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3. Verify the authority under which the loan or overdraft has been raised. In case of the company,
only the Board of Directors is authorised to raise a loan or borrow from a bank.
4. In case of company, confirm restraint of Company Act regarding the maximum amount of loan
that the company can raise has not been contravened.
5. Ascertain the purpose for which the loan has been raised and the manner in which it has been
utilized and that this has not prejudicially affected the concern.
c) Premium paid on Insurance of a Motor Car

(i) Check insurance cover note issued by Insurance Company. Verify car no., period of Insurance
etc.
(ii) See that ―No claim Bonus‖ is given, where entitled, by the Insurance Company.
(iii) Ensure that proper adjustment is made for pre-paid insurance premium.

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Suggested Answers/CAP-II/December/2009/Group-I
Audit & Assurance

1. Give your opinions with reason on the following cases: (54=20)
a) An audit report states “subject to all the notes on the accounts, we report that the balance sheet
and the profit and loss account give a true and fair view……”
b) A sum of Rs.10,00,000 is received from an Insurance company in respect of a claim for loss of
goods in transit costing Rs.8,00,000. The amount is credited to the Purchases Account.
c) An auditor of a limited company did not verify the investment and he inserted a note in the
balance sheet "Investment not verified". The shareholders approved and adopted the accounts
at the annual general meeting. Subsequently, it transpired that investments were
misappropriated and the company suffered a loss.
d) BMG Ltd. is a manufacturing company produces durable consumer goods with an annual
turnover of Rs. 100 crores. The company receives orders from its commission agents all over the
country, but goods are dispatched directly to the customers. The documents including transport
bills are sent through the bank for collection. At the end of the 6th year, it is found that
documents covering the dispatch of goods worth Rs. 10 crores were still lying with the banks not
cleared by the customers even though the normal collection period of 15 days from the date of
dispatch has expired. Should revenue be recognised in the above case?
e) In view of the qualified report of the statutory auditor, the Board of Directors has decided to
amend the accounts and resubmit the same to the statutory auditor for report before the
accounts are placed for adoption at the annual general meeting.
Answer:
a) The report is not proper. It is not clear whether the auditor is really making a
qualification. Many of the notes on the accounts of explanatory nature can not in any
case be a subject matter of the auditor’s qualification. The auditor should have made
the qualification with reference to specific notes about which he has reservations, and
should have also quantified the effect of the qualifications.
b) All items of income and expense which are recognized in a period should be included in
the determination of net profit or loss for the period. The claim for loss of goods in
transit is arising out of ordinary activities of the enterprise as a part of its normal course
of business. However, the cost of goods lost in transit is only Rs.8,00,000 while the
insurance money received is Rs.10,00,000. Purchases Account need not be credited
since it would distort the purchases done during the year and as also the gross profit.
Therefore, entire amount of Rs.10 lacs needs to be taken to profit and loss account
under an appropriate head. This is an income arising from an ordinary activity of the
enterprise but having regard to amount involved and exceptional nature, a separate
disclosure is to be made in the profit and loss account. Such disclosure would enable
the users to understand the performance of an enterprise for the period.
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c) In case of audit of a limited company, an auditor has to comply with the statutory duties
as prescribed under Companies Act. Verification of investments is an important function
of an auditor since, it is an important asset shown in the balance sheet. The auditor
cannot be expected to give a report on the truth and fairness of the financial
statements of the company without verifying its investment. If he specifically mentions
in his audit report, the fact that, he did not verify the investments, he would not be
relieved from his statutory duties. Such statutory duties can never be curbed, though
they may be extended.
d) According to NAS - 07 on Revenue, revenue from the sale of goods shall be recognized
when
 the seller of goods has transferred to the buyer the significant risks and rewards of
ownership of the goods;
 the seller retains neither continuing managerial involvement to the degree usually
associated with ownership nor effective control over the goods sold;
 the amount of revenue can be measured reliably.
 It is probable that the economic benefits associated with the transaction will flow to the
entity; and
 The costs incurred or to be incurred in respect of the transaction can be measured reliably.
Since the transport bills were sent through the bank for collection, it may be said that the seller
entity has retained effective control over the ownership of goods. Further since the documents
were not cleared by the customer even after the expiry of the normal period of collection, there
is an uncertainty in the realization of sale proceeds. Apparently, the amount also appears to be
quite material being 10% of total turnover. Hence, revenue should not be recognised in this
case.
e) The Board of Directors is competent to amend the accounts and re -submit the same to
the statutory auditor for his report before the accounts are placed at the annual general
meeting. The auditor should examine the accounts again after amendment to satisfy
about the appropriateness or otherwise of the amendments. He should in particular see
that the points covered by his qualifications have been properly rectified. The report
that may be issued by the statutory auditor on such amended accounts will be in
substitution of the report issued on accounts before amendment. In other words, a
fresh audit report has to be issued on the amended accounts and all copies of the first
report and originally prepared accounts have to be withdrawn. In case it is not possible
to withdraw all copies of the orig inal accounts and the original report of the auditor, an
adequate disclosure of the fact of the revision of accounts approved by the Board and
reported on by the auditor should be made in the amended accounts. In case the
auditor is satisfied about such disclosure, he may not refer to this matter in his report.
However, in case he feels that the disclosure is not adequately comprehensive or no
disclosure has been made in the amended accounts, it will be the duty of the auditor to
refer to the fact in his revised report.
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a) What are the assertions with which an auditor is concerned with while obtaining audit evidence
from substantive procedures?
b) Mention briefly the conditions or events, which increase the risk of fraud or error leading to
material misstatement in financial statements.
c) Explain the advantages of "Audit Working Papers".
Answer:
a) An auditor is concerned with following assertions:-
i) Existence: That an asset or liability exists at a given date.
ii) Rights and obligations: That an asset is a right of the concern and a liability is an
obligation at a given date.
iii) Occurrence: That a transaction or event which took place pertains to the entity
during the relevant period.
iv) Completeness: That there are no unrecorded assets, liabilities or transaction.
v) Valuation: That an asset or liability is recorded at an appropriate carrying value.
vi) Measurement: That a transaction is recorded in the proper amount and revenue or
expense is allocated to the proper period.
vii) Presentation and disclosure: That an item is disclosed classified and described in
accordance with recognised accounting policies and practices and relevant statutory
requirements.
b) In planning and performing his examination, the auditor should take into consideration
the risk of material misstatements of the financial information caused by fraud or error.
Weaknesses in the design of the internal control system and non-compliance with
identified control procedures amongst other conditions or events which increase the risk
of fraud or error are:
i) Weaknesses in the design of internal control system and non-compliance with the laid
down control procedures, e.g., a single person is responsible for the receipt of all
information and marking it to the relevant sections or two persons are responsible for
receipt of information but the same is not followed in actual practice, etc.
ii) Doubts about the integrity or competence of the management, e.g., domination by one
person, high turnover rate of employees, frequent change of legal counsels or auditors,
significant and prolonged understaffing of the accounts department, etc.
iii) Unusual pressures within the entity, for example, industry is doing well but the company
is not performing all right, heavy dependence on a single line of product, inadequate
working capital, entity needs raising share prices to support the market price in the wake
of public offer, etc.
iv) Unusual transactions such as transactions with related parties, excessive payment for
certain services to lawyers, etc.
v) Problems in obtaining sufficient and appropriate audit evidence, e.g., inadequate
documentation, significant differences between the figures as per the accounting
records and confirmation received from third parties, etc.
c) Audit working papers constitute the basic records for the auditor in respect of the audit
carried out by him. They constitute the link between the auditor's report and clients'
record.
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These include retention of permanent record in the nature of a document to show the
actual audit work executed the nature of the work, the extent of the work and important
points, facts, dates and decisions having bearing on the audit of the accounts audited.
The working papers, if properly maintained, can be used as defense in case of need. The
audit working papers are found very useful in the following aspects as they:
i) aid in the planning and performance of the audit;
ii) aid in the supervision and review of the audit work;
iii) provide evidence of the audit work performed to support the auditor's opinion; and
iv) act as an evidence in the Court of law when a charge of negligence is brought against
the auditor.
a) In a medium size trading organisation the accountant was given additional responsibility of
making recoveries from the debtors. On one occasion, when an insurance claim of Rs. 25,000
was received, he credited the same to the account of a debtor and misappropriated the cash
which he had recovered from the said debtor. Pinpoint weaknesses in the internal control system
which led to this situation.
b) Gear Ltd. is engaged in manufacturing and supply of gear boxes to Kathmandu Automobile Ltd.
As per terms of supply, full price of the goods are not released by Kathmandu Automobile Ltd.
but 10% thereof is retained and paid after one year, if there is satisfactory performance of the
parts supplied. Gear Ltd. accounts for only 90% of the invoice value as sale at the time of supply
and balance 10% is accounted as sale in the year of receipt of payment.
c) Inventories of a car manufacturing company include the value of items required for the
manufacture of a model which was removed from the production line five years back, at cost
price.
Answer:
a) Following two essential features of internal control are relevant here :
i) Breaking the chain of the work in a manner so that no single person can handle a
transaction from the beginning to the end and
ii) Segregation of accounting and custodial functions.
Weakness in internal control system in the instant case:
 The accountant is receiving cash and also passing the entries in the books. The
accountant should not have been allowed to effect recoveries.
 It also appears that system for issuing receipts for amount received - whether
cash or cheque is also lacking.
 In a small and to some extent medium size organization, the supervision of the
owner offsets the deficiencies in internal control system. But i n this case, it
appears, that supervision and personal control is also lacking.
Thus, in the given case, the main weakness of the system is that it is ignoring the
basic requirements of a good internal control system.
b) According to NAS 7 on Revenue, revenue from sale of goods should be recognized when
the seller has transferred to the buyer, the property in the goods for a price or when the
seller has transferred all significant risk and rewards and the seller repairs no effective
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control over goods and no significant uncertainty exists regarding the amount of
consideration and its collectability.
In the given case the goods as well as the risk and ownership has been transferred by Gear
Ltd., to Kathmandu Automobile Ltd., on the basis of invoice and delivery of material.
In the instant case, therefore, Gear Ltd., should recognize sale at full 100% of the invoice
value in spite of the fact that 10% payment will be released after one year. However,
depending upon the past experience regarding collectability of 10% amount, they can make
a provision for the amount that is not likely to be realized.
Hence, the treatment given by the company is not correct and if they do not correct it, the
auditor should qualify his report.
c) Inventory valuation: NAS 4 on “Inventories” provides that the cost of inventories may
not be recoverable if those inventories are damaged, have become wholly or partially
obsolete, or if their selling prices have declined.
Accordingly, the auditor should examine whether appropriate allowance has been made
for the defective, damaged, obsolete and slow-moving inventories in determining the
net realizable value.
In this case, items required for the manufacture of a model which has been withdrawn
from the production line five years ago are included in the stock at cost price resulting
in overstatement of inventory and profit. As it appears from the facts given that the
net realizable value of these items is likely to much lower than the cost at which these
are being shown in the books of account.
Accordingly, it becomes necessary to write down the inventory to ‘net realizable value’
if the items of inventories become wholly or partially obsolete. Under the
circumstance, the auditor should qualify the report appropriately.

a) What is an "Audit Evidence"?
b) "Physical presence of the auditor at the time of year end verification of stocks is though not
always possible, it is recommended that he should at least be present as an observer." Signify the
importance of this statement and list out the important aspects which the auditor should look
into to ensure an effective physical verification programme.
c) Indicate briefly the purposes for which analytical procedures are applied by the Auditor.
Answer:
a) Audit Evidence: Audit evidence refers to any information, verbal or written, obtained by
the auditor on which he bases his opinion on financial statements.
The audit evidence may be of varied nature and can assume various forms. For example,
a signature on the voucher of a designated official, the payee’s receipt, etc. Even the
information obtained by the auditor by discussing with the officials of the compan y also
constitutes audit evidence.
Generally audit evidence depending on its source may be classified as internal evidence
or external evidence. Internal evidence is one that has been created within the client’s
organization and without its ever going to outside party. Examples are duplicate sales
invoices, employee’s time reports, etc. External evidence on the other hand is the
evidence that originates outside the client’s organization; for example, purchase invoice,
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bank statement, debit notes and credit notes coming from parties, quotations,
confirmations, etc.
Sometimes in certain transactions, external evidence is obtained, directly by the auditor,
e.g., certificates as regards bank balance, confirmation of balances of debtors and
creditors, etc.
The auditor also obtains evidence by performing various analytical procedures. The
auditor should evaluate whether he has obtained sufficient appropriate audit evidence
before he draws his conclusions there from.
The reliability of audit evidence depends on its source – internal or external, and on its
nature-visual, documentary or oral. The auditor may gain increased assurance when
audit evidence obtained from different sources or of different nature is consistent. In
these circumstances, he may obtain a cumulative degree of assurance higher than that
which he attaches to the individual items of evidence by themselves.
Conversely, when audit evidence obtained from one source is inconsistent with that
obtained from another, further procedures may have to be performed to resolve the
inconsistency. Audit evidence should, in totality enable the auditor to form an opinion
on the financial information.
b) Physical verification of inventories is the responsibility of the management of the entity.

However, where the inventories are material and the auditor is placing reliance upon the
physical count by the management, it may be appropriate for the auditor to attend the
stock-taking. The extent of auditor's attendance at stock-taking would depend upon his
assessment of the efficacy of relevant internal control procedures, and the results of his
examination of the stock records maintained by the entity and of the analytical review
procedures. The procedures concerning the auditor's attendance at stock -taking depend
upon the method of stock-taking followed by the entity. There are two principal
methods of stock-taking: periodic stock-taking and continuous stock-taking. Under the
first method, physical verification of inventories is carried out at a single point of time,
usually at the year end. Under the second method, physical verification is carried out
throughout the year, with different items of inventory being physically verified at
different points of time. However, the verification programme is normally so designe d
that each material item is physically verified at least once in a year and more often in
appropriate cases. The continuous stock-taking method is effective when a perpetual
inventory system of record-keeping is also in existence. Some entities use continuous
stock-taking methods for certain stocks and carry out a full count of other stocks at a
selected date. The auditor is expected to examine the adequacy of the methods and
procedures of physical verification followed by the entity.
Before commencement of the verification, the management should issue appropriate

instructions to stock-taking personnel. Such instructions should cover all phases of physical
verification and preferably be in writing. It would be useful if the instructions are formulated by
the entity in consultation with the auditor. The auditor should examine these instructions to
assess their efficacy. Where the auditor is present at the time of stock-taking, he should observe
the procedure of physical verification adopted by the stock-taking personnel to ensure that the
instructions issued in this behalf are being actually followed. The auditor should also perform
test-counts to satisfy himself about the effectiveness of the procedures.
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c) Analytical procedures are used for the following purposes:
i) to assist the auditor in planning the nature, timing and extent of other audit procedures;
ii) as substantive procedures when theirs use can be more effective or efficient than tests of
details in reducing detection risk for specific financial statement assertions, and
iii) as an overall review of the financial statements in the final review stage of the audit.
Thus, analytical procedures may be used extensively while conducting an audit to establish
authenticity of information contained in the financial statements. In some cases, analytical
procedures can be more effective than tests of details in reducing detection risk for specific
financial statement assertions. This is particularly true in case volume of information is
homogeneous and quite large. For instance, in case of salaries and wages the volume is generally
quite large and only internal evidence is available. In such a case, performing analytical
procedures would provide substantive audit evidence and reduce the extent of vouching to a
large extent.
5. Comment on the following: (35=15)
a) Mr. A, a Chartered Accountant gave 50% of the audit fees received by him to the person, who
was not a Chartered Accountant, under the classification of office allowance and such an
arrangement continued for a number of years.
b) Mr. Baidya, who is a practicing Chartered Accountant, accepted his appointment as an auditor at
a lower fee than the audit fee charged by the previous auditor. Some of the practicing
accountants claimed that Mr. Baidya had obtained the audit by undercutting.
c) There is an affirmative relationship between materiality and the level of audit risk.
Answer:
a) Mr. A, Chartered Accountant had shared his profits with a non CA and, therefore, is guilty of
professional misconduct under section 34(2) of ICAN Act. It is not the nomenclature to a
transaction that is material but it is the substance of the transaction, which has to be looked
into.
b) As per Section 10.2 of Code of Ethics issued by ICAN, a professional accountant in public practice
should charge fees taking into account:
i) The skill and knowledge required for the type of services involved
ii) The level of training and experience necessary for the person necessarily engaged in
performing the services
iii) The time necessarily occupied by each person engaged in performing the services
iv) The degree of responsibility that performing those service entails.
As per Section 10.4 of Code of Ethics issued by ICAN, a professional accountant in public practice
should not make a representation that specific professional services in current or future periods
will be performed for either a stated fee, estimated fee or fee range if it is likely at the time of
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the representation that such fees will be substantially increased and the prospective client is not
advised of that likelihood.
As per Section 10.6 of Code of Ethics issued by ICAN, it is not improper for a professional accountant
in public practice to charge a client a lower fee than has previously been charged to similar services,
provided the fee has been calculated in accordance with Section 10.2 and 10.4 of Code of Ethics
issued by ICAN. In the given case, it would not amount to the undercutting if the fees are based on
the quantum of work, incidental and pocket expenses and other terms of appointment and hence
the claim of the other accountants may not be held tenable.
c) No. As per para 10 of NAS 320 (Audit Materiality) , There is an inverse relationship between
materiality and the level of audit risk, that is, the higher the materiality level, the lower the audit
risk and vice versa. The auditor takes the inverse relationship between materiality and audit risk
into account when determining the nature, timing and extent of audit procedures. For example,
if, after planning for specific audit procedures, the auditor determines that the acceptable
materiality level is lower, audit risk is increased. The auditor would compensate for this by
either:
i) Reducing the assessed risk of material misstatement, where this is possible, and
supporting the reduced level by carrying out extended or additional tests of control; or
ii) Reducing detection risk by modifying the nature, timing and extent of planned
substantive procedures.
6. Write short notes on the following (Any TWO): (25=10)

a) Surprise Checks
b) Modified Auditor's Report
c) Flow Chart
Answer:
a) Surprise checks are mainly intended to ascertain whether the system of internal control is
operating effectively and whether the accounting and other records are prepared concurrently
and kept up-to-date. It has often been found that manipulations and frauds are facilitated under
a system of book-keeping which does not give proper emphasis to the need to keep the books
up-to-date. Errors in book-keeping are often indicative of weaknesses in internal control which
may be taken advantage of in order to perpetrate frauds or manipulations.
The element of surprise in an audit can be both with regard to the time of the audit, that is the
selection of the date at which the auditor visits the clients' office to carry out the audit and the
selection of the items which are subjected to audit.
Surprise checks are a useful method of determining whether or not such errors exist and where
they exist, of bringing the matter promptly to the attention of the management so that
corrective action is taken immediately. Consequently, surprise visits by the auditor can exercise
a good moral check on the client's staff.
b) An Auditor's report is considered to be modified if either an emphasis of matter paragraph(s)

added to the report or if the opinion is other than unqualified. It includes matters that do not
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affect the auditor's opinion by emphasis of matter or matters that do affect the auditor's opinion
by issuing qualified opinion, disclaimer of opinion or adverse opinion.
Uniformity in the form and content of each type of modified report will enhance the user's
understanding of such reports.
In certain circumstance, an auditor's report may be modified by adding an emphasis of matter

paragraph to highlight a matter affecting the financial statements which is included in a note to
the financial statements that more extensively discusses the matter. The addition of such an
emphasis of matter paragraph does not affect the auditor's opinion. The paragraph would
preferably be included preceding the opinion paragraph and would ordinarily refer to the fact
that the auditor's opinion is not qualified in this respect.
An auditor may not be able to express an unqualified opinion when either of the following
circumstances exists and, in the auditor's judgment, the effect of the matter is or may be
material to the financial statements:
 there is a limitation on the scope of the auditor's work; or

 there is a disagreement with management regarding the acceptability of the accounting
policies selected, the method of their application or the adequacy of financial statement
disclosures.
The circumstances described in (a) could lead to a qualified opinion or a disclaimer of opinion.
The circumstances described in (b) could lead to a qualified opinion or an adverse opinion.
c) It is a graphic presentation of each part of the company's system of internal control. A flow chart
is considered to be the most concise way of recording the auditor's review of the system. It
minimizes the amount of narrative explanation and thereby achieves a consideration or
presentation not possible in any other form. It gives bird's eye view of the system and the flow
of transactions and integration and in documentation, flaws in the system can be easily spotted
and improvements can be suggested.
It is also necessary for the auditor to study the significant features of the business carried on by
the concern; the nature of its activities and various channels of goods and materials as well as
cash, both inward and outward; and also a comprehensive study of the entire process of
manufacturing, trading and administration. The flow chart facilitates auditor to understand and
evaluate the internal controls in the correct perspective.
7. Explain the difference between (Any TWO): (2 5=10)

a) Clean Audit Report and Qualified Audit Report.
b) Continuous and Final Audit
c) Internal Control and Internal Check
Answer:
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a) Clean Audit Report and Qualified Audit Report: A clean report which is otherwise known as
unconditional opinion is issued by the auditor when he does not have any reservation with
regard to the matters contained in the financial statements. In such a case, the audit report
may state that the financial statements give a true and fair view of the state of affairs and
profit and loss account for the period. Under the following circumstances an auditor is
justified in issuing a clean report:
i) the financial information has been prepared using acceptable ac counting policies,
which have been consistently applied;
ii) the financial information complies with relevant regulations and statutory
requirements; and
iii) there is adequate disclosure of all material matters relevant to the proper
presentation of the financial information, subject to statutory requirements,
where applicable.
Qualified audit report, on the other hand, is one which does not give a clear cut about the
truth and fairness of the financial statements but makes certain reservations.
The gravity of such reservations will vary depending upon the circumstances. In majority of
cases, items which are the subject matter of qualification are not so material as to affect the
truth and fairness of the whole accounts but merely creates uncertainty about a particular
item. In such cases, it is possible for the auditors to report that in their opinion but subject
to specific qualifications mentioned, the accounts present a true and fair view.
Thus, an auditor may give his particular objection or reservation in the audit report and
state "subject to the above, we report that balance sheet shows a true and fair view……..".
The auditor must clearly express the nature of qualification in the report. The auditor
should also give reasons for qualification and all qualifications should be contained in the
auditor's report.
The words "subject to" are essential to state any qualification. It is also necessary that the
auditors should quantify, wherever possible the effect of these qualifications on the
financial statements in clear and unambiguous manner if the same is material and state
aggregate impact of qualifications.
Thus, it is clear from the above that in case of a clean report, the auditor has no reservation
in respect of various matters contained in the financial statements but a qualified report
may involve certain matters involving difference of opinion between the auditor and the
management.
b) Final Audit is commonly understood to be an audit which does not begin until the books
have closed at the end of the accounting period and thereafter is carried on continuously
until completed. Whether an audit ought to be conducted continuously after the close of the
financial year should be decided on a consideration of the size of the business and the
extent of detailed checking required.
Continuous Audit is one in which the auditor's staff is engaged continuously in checking the
accounts of the client the whole year round or when for this purpose the staff attends at
intervals, fixed or otherwise, during the currency of the financial period. Strictly speaking, when
auditor's staff attends the audit work at fixed intervals it may be strictly called interim audit. This
is when an audit is conducted up to a particular date within the accounting period. The auditor
may attend to audit the figures for a month or for a quarter, as the work may require. It would
differ distinctly from the final audit in the extent of the work carried out; verification of assets,
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for example would be left until the final audit. In case of a continuous audit, the work is
conducted throughout the course of the financial year but is not taken to a specific accounting
period, as is an interim audit. It might be that during the course of the continuous work interim
figures are being audited, but the significant factor here is that the auditor will be engaged
continuously on the audit throughout the financial period. Staff may be in residence throughout
the period or may come and go at irregular intervals, but most of the time, the audit staff is
present at the location. Thus, in case of continuous audit, the audit staff is present at the client's
premises almost during the entire accounting period.
c) Internal Control comprises whole system of controls, financial or otherwise establish ed by

the management for the conduct of business. It includes internal check and internal audit
besides other controls. But internal check refers to a system of allocating duties among the
staff in such a manner that every person records a different aspect of a transaction. It is
narrower in scope.
A system of internal control strives to achieve objectives such as adherence to policies and
procedures laid down by management, safeguarding of assets, prevention and detection of
frauds and errors, accuracy and completeness of records and timely preparation of reliable
financial information. On the other hand, internal check is designed to prevent frauds and errors
and fixing responsibility and safeguarding the assets. It is a part of Internal Control system.
Internal Control system is reviewed occasionally by the management in the light of changes
within the organization, in the economic environment and suggestions of external and internal
auditor. But Internal Check once introduced in the organization is generally stable for a certain
period and, hence, less flexible as compared to the internal control system.
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All questions are compulsory.
Question No. 1
Comment and give your views as auditor with reasons on each of the
following case: (4×4=16)
a) The management tells you that the work in process is not valued
since it is difficult to ascertain the same in view of the multiple
processes involved and in any case the value of opening and closing
work in process would be more or less the same.
Answer
According to NAS-4 on "Inventories", it includes among others
those assets which are in the process of production for sale in the
ordinary course of business apart from finished goods and those
materials or supplies to be consumed in the production process or in
the rendering of services. It is, thus, necessary for a company to
ensure that each and every component of inventory is valued
properly. The argument advanced by the company that it is difficult
to ascertain the same in view of the multiple processes involved is
not acceptable. In general, the audit procedures regarding work-in-
process are similar to those used for raw materials and finished
goods. The auditor has to carefully assess the stage of completion of
the work-in-process for assessing the appropriateness of its
valuation.
The argument that the opening and closing work-in-process would

be more or less the same is also not justified because the omission of
those would lead to distortion of true and fair view. Further, costs
incurred for raw materials and the overheads would normally
different and would give rise to different value of opening and
closing stock. In view of the above, the auditor shall have to qualify
the Assurance Report in case work-in-process is not valued and
shown in the financial statements.
b) Mr. Bhandari & Associates, Chartered Accountants was appointed as

an auditor of the company. Subsequently, Mr. Sharma & Associates,
Chartered Accountants was offered appointment as an auditor of the
company replacing Mr. Bhandari & Associates, Chartered
Accountants. Mr. Sharma & Associates, Chartered Accountants for
whom this is an initial audit engagement accepts the appointment
and starts the audit without communicating with anyone.
2608
Suggested Answers of Accounting
Answer
Mr. Sharma & Associates has started the audit in violation with NSA
300 "Planning the Audit". According to NSA 300 "Planning an
Audit", the auditor should communicate with previous auditor where
there has been a change of auditors, in relevance to ethical
requirements.
And again since it is initial audit, the auditor may need to expand the
planning activities because the auditor does not ordinarily have
previous experience with the entity that is considered when planning
recurring engagements. The auditor should consider the following in
developing overall audit strategy and plan.
 Unless prohibited by the law, arrangement to be made with
previous auditor to review the previous auditor's working papers;
 Any major issues discussed with management in connection with
the initial selection as auditors.
 Other procedures required by the firm's system of quality control
for initial audit engagements
c) The entire liability for interest on deferred payment terms is treated

as part of capital cost of the asset as such liability was incurred at the
time of acquisition of the asset itself.
Answer
According to NAS - 8 on "Borrowing Costs", under allowed
alternative treatment, borrowing costs that are directly attributable to
the acquisition, construction or production of a qualifying asset shall
be capitalised as part of the costs of that asset. The interest on
deferred payment terms are borrowing costs directly attributable to
the acquisition of the asset and can be treated as part of the capital
cost. However, under NAS - 8, the capitalisation of borrowing cost
shall cease when substantially all the activities necessary to prepare
the qualifying asset for its intended use are complete. Hence, the
interest on deferred payment related to the period after the assets are
ready to put to use shall not be capitalised.
d) Fire Ltd. purchased equipment for its power plant from Urja Ltd.
during the year 2006-07 at a cost of NRs.100 lacs. Out of this they
paid only 90% and balance 10% was to be paid after one year on
satisfactory performance of the equipment. During the Financial year
2007-08, Urja Ltd. waived off the balance 10% amount which was
credited to Profit and Loss account by Fire Ltd. as discount received.
Answer
According to NAS-6 on Property, Plant and Equipment, the cost of
an asset may undergo changes subsequent to its acquisition on

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account of exchange fluctuation, price adjustment, change in duty

or similar factors. Such change in price /cost needs to be adjusted
with the cost of the asset.
In the give case, Fire Ltd., initially accounted for 100% amount i.e.,
NRs.100 lacs as cost of property plant and equipment although they
paid only NRs.90 lacs and kept NRs.10 lacs as payable to the credit
of Urja Ltd. Now since the supplier has waived off the balance
amount of NRs.10 lacs, this should be treated as change in price and
needs to be adjusted with the cost of asset.
Therefore, the treatment given by Fire Ltd., in crediting NRs.10.
Lacs as discount to Profit & Loss Account is completely wrong and
needs to be corrected. It will have effect on depreciation also and
needs adjustment.
The auditor should report the matter if suitable changes are not made
in the accounts
Question No. 2
What are the special steps involved in conducting the audit of an
Educational Institution? 14
Answer
The special steps involved in the audit of an educational institution are
the following:
a) Examine the Trust Deed or Regulations in the case of school or
college and note all the provisions affecting accounts. In the case of
a university, refer to the Act of Legislature and the Regulations
framed there under.
b) Read through the minutes of the meetings of the Managing
Committee or Governing Body, noting resolutions affecting accounts
to see that these have been duly complied with, specially the
decisions as regards the operation of bank accounts and sanctioning
of expenditure.
c) Check names entered in the Students‘ Fee Register for each month or
term, with the respective class registers, showing names of students
on rolls and test amount of fees charged; and verify that there
operates a system of internal check which ensures that demands
against the students are properly raised.
d) Check fees received by comparing counterfoils of receipts granted
with entries in the cash book and tracing the collections in the Fee
Register to confirm that the revenue from this source has been duly
accounted for.
e) Total up the various columns of the Fees Register for each month or
term to ascertain that fees paid in advance have been carried forward
and the arrears that are irrecoverable have been written off under the
sanction of an appropriate authority.

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f) Check admission fees with admission slips signed by the head of the
institution and confirm that the amount had been credited to a
Capital Fund, unless the Managing Committee has taken a decision
to the contrary.
g) See that free studentship and concessions have been granted by a
person authorized to do so, having regard to the prescribed Rules.
h) Confirm that fines for late payment or absence, etc., have either been
collected or remitted under proper authority.
i) Confirm that hostel dues were recovered before students‘ accounts
were closed and their deposits of caution money refunded.
j) Verify rental income from landed property with the rent rolls, etc.
k) Vouch income from endowments and legacies, as well as interest
and dividends from investment; also inspect the securities in respect
of investments held.
l) Verify any Government or local authority grant with the relevant
papers of grant. If any expense has been disallowed for purposes of
grant, ascertain the reasons and compliance thereof.
m) Report any old heavy arrears on account of fees, dormitory rents, etc,
to the Managing Committee.
n) Confirm that caution money and other deposits paid by students on
admission have been shown as liability in the balance sheet and not
transferred to revenue.
o) See that the investments representing endowment funds for prizes
are kept separate and any income in excess of the prizes has been
accumulated and invested along with the corpus.
p) Verify that the Provident Fund money of the staff has been invested
in appropriate securities.
q) Vouch donations, if any, with the list published with the annual
report. If some donations were meant for any specific purpose, see
that the money was utilised for the purpose.
r) Vouch all capital expenditure in the usual way and verify the same
with the sanction for the Committee as contained in the minute book.
s) Vouch in the usual manner all establishment expenses and enquire
into any unduly heavy expenditure under any head.
t) See that increase in the salaries of the staff have been sanctioned and
minuted by the Committee.
u) Ascertain that the system ordering inspection on receipt and issue of
provisions, foodstuffs, clothing and other equipment is efficient and
all bills are duly authorized and passed before payment.
v) Verify the inventories of furniture, stationery, clothing, provision
and all equipment, etc. These should be checked by reference to
Stock Register and values applied to various items should be test
checked.
w) Confirm that the refund of taxes deducted from the income from
investment (interest on securities, etc.) has been claimed and

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recovered since the institutions are generally exempted from the

payment of income-tax.
x) Verify the annual statements of accounts and while doing so see that
separate statements of account have been prepared as regards Poor
Boys Fund, Games Fund, Hostel and Provident Fund of Staff, etc.
Question No. 3 'a'

Briefly discuss the basis of disclosure of accounting policies according
to NAS-1 on ―Presentation of Financial Statements". 4
Answer
According to NAS-1, an entity shall disclose in the summary of
significant policies:
 measurement basis used for preparing the financial statements;
 the other accounting policy used that are relevant to an
understanding of the financial statements.
In addition to the specific accounting policies used in the financial
statements, it is important for the users to be aware of the measurement
basis used (historical cost, current cost, realizable value, fair value or
present value) because they form the basis on which the financial
statements are prepared. When more than one measurement basis is used
in the financial statements, for an example, when certain non-current
assets are revalued, it is sufficient to provide an indication of the
categories of assets and liabilities to which each measurement basis is
applied.
In deciding whether a particular policy shall be disclosed, management

considers whether disclosure would assist users in understanding the
way in which transactions and events are reflected in the reported
financial performance and financial position. The accounting policies
that an entity might consider presenting include revenue recognition,
recognition and depreciation/ amortization of tangible and intangible
assets, capitalization of borrowing costs and other expenditure, financial
instruments and investments, leases, research and development costs,
inventories, taxes, provisions, employee benefit costs, foreign currency
transaction, definition of cash and cash equivalent and government
grants.
Question No. 3 'b'

What does qualified opinion mean? What are the situations in which
the auditor should qualify the assurance report? 4
Answer
A qualified opinion is issued when the auditor concludes that he
cannot issue an unqualified opinion but that the effect of any
disagreement, uncertainty or limitations on scope is not so material as

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to require an adverse or a disclaimer of an opinion. It is given in

respect of a part of the information reflected in the financial statements
and that the auditor is not in agreement with that part. Moreover, the
part with reference to which he is not in agreement does not materially
affect the view portrayed by the financial statements. Thus, the need
for a qualified opinion arises where the auditor is satisfied with the
truth and fairness of the financial statements; yet because of certain
transactions he is not fully satisfied so as to issue a clean or
unqualified report.
The auditor should qualify their Assurance Reports in case -
 accounting policies have not been properly disclosed, or

 accounts have not been prepared on accrual basis
 the fundamental accounting assumption of going concern has not
been followed and this fact has not been disclosed in the financial
statements, or
 proper disclosures regarding changes in the accounting polices have
not been made.
Question No. 3 'c'

What are the general considerations in framing a system of internal
check? 7
Answer
The following are the general considerations in framing a system of internal check:
 No single person should have an independent control over any
important aspect of the business. All dealings and acts of every
employee should, in the ordinary course, come under the review of
another.
 The duties of members of the staff should be changed from time to
time without any previous notice so that the same officer or
subordinate does not, without a break, perform the same function for
a considerable length of time.
 Every member of the staff should be encouraged to go on leave at
least once in a year. Experience has shown that frauds successfully
concealed by employees are often unearthed when they are on leave.
 Persons having physical custody of assets must not be permitted to
have access to the books of account.
 There should exist an accounting control in respect of each important
class of assets; in addition, these should be periodically inspected so
as to establish their physical condition.
 To prevent loss or misappropriation of cash, mechanical devices,
such as the automatic cash register, should be employed.
 A majority of business concerns now-a-days work according to some
kind of budgetary control. It enables them to review from time to

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time the progress of their trading activities. Such business houses

should have a separate staff for the collection of statistical figures
which later on should be checked with corresponding figures from
the financial books. If wide discrepancies are observed, these should
be reconciled.
 For stock-taking, at the close of the year, trading activities should, if
possible, be suspended. The task of stock-taking, and evaluation
should be done by staff belonging to several sections of the
organisation. It may prove dangerous to depend exclusively on the
stock section staff for these tasks, since they may be tempted to
under or over-state the stock.
 The financial and administrative powers should be distributed very
judiciously among different officers and the manner in which these
are actually exercised should be reviewed periodically.
 Procedures should be laid down for periodical verification and
testing of different sections of accounting records to ensure that they
are accurate.
Accounting procedures should be reviewed periodically, for,
even well-designed and carefully installed procedures, in course
of time, cease to be effective.
Question No. 4
How will you vouch and/or verify the following? (5×3=15)
a) Personal expenses of directors met by the company
Answer
The personal expenses of the director are the facilities of his
accommodation, transportation, communication, entertainment etc.
Such expenses that are of personal nature should be verified as per
below:
 Check the articles of association, service contract, minutes of
general meeting, etc., to ensure that the payment complies with
the provision stated therein.
 Enquire to ensure that personal expenses are not camouflaged in
any other revenue items as contemplated under the Companies
Act.
 Ascertain compliance with disclosure and limitation prescribed
by the Companies Act.
 Check documentary evidences in support of the expenses
reimbursed.
 Ensure the compliance with the provisions set forth by the
Income Tax Act 2058 to incorporate such payments in his/her
income from employment and withhold the tax.
b) Preliminary expenses

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Answer
It is the expenditure incurred incidental to the creation, formation
and floating of a company. It consists of stamp duties, registration
fees, legal costs, consultant's fees, expenses of printing of
memorandum and articles, etc. The following should be checked:
 Check Board‘s minute book containing the resolution approving
the expenses claimed by promoters as having been spent in
formation of the company.
 Examine supporting papers and vouchers, contracts, agreements,
etc. to support the promoters‘ claims. Also check bills and
receipts issued by the printer of the memorandum and articles of
association, share certificates, etc.
 Check receipt for the registration fee paid for registration of the
company.
 Verify rates of stamp required to be affixed on the memorandum
and articles of association.
 Ascertain Boards‘ minute book for the decision to write off the
preliminary expenses over a period. The quantum thereof which
has not yet been written off for these expenses should be carried
forward in the balance sheet under the head miscellaneous
expenditure (to the extent not written off or adjusted) over a
period of years.
 Check that no expenses other than those constituting preliminary
expenses are booked under this head, e.g. underwriting
commission and brokerage paid.
 Ensure that the whole expenses are charged to the income
statement because of not being eligible for recognition as
Intangible Assets under NAS 27.
c) Patents
Answer
Patents are normally treated as intangible assets subject to
recognition criteria under NAS 27. The same shall be verified as
per below:
 Obtain the schedule containing particulars of the patents owned
by the client as on the balance sheet date. The particulars should
contain the dates of registration of the patents with the related
authorities and the dates in respect of the last renewal.
 See that the total of the values of the patent rights shown in each
list agree with the values shown in the respective ledger
accounts.
 Examine the cost of patent rights. In case of outright purchase of
patent rights, the purchase consideration, legal fees and
registration charges should be included in cost. When they are

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developed within the organization, all costs incurred on their

development including legal and registration expenses for
registration of the patent should constitute the cost. Capitalized
value should be amortized over the life of the patent.
 See that the renewal fees in respect of the patent rights have been
paid and the same has been treated as a revenue charge.
 Examine the valuation of the patent rights. It should be seen that
the patent rights have been valued at cost less depreciation
attributable to the expired legal life of the patent rights.
However, if it is found that the patent rights have already lost
substantial part of their commercial value, it would be proper to
value it at their residual commercial value, when it is less than
the book value for their unexpired legal life. In case the product
covered by the patent rights does not have any sale value then
patents should be shown at nil valuation notwithstanding any
residual life. Reference to compliance with the provisions of
NAS 27 Intangible Assets should be verified.
d) Advances given to suppliers
Answer
The amount paid in advance for the supplies of goods or services is
termed as advances to supplier. The same shall be verified as per
below:
 Obtain a schedule of advances given to the suppliers and enquire
the management regarding the purpose of such advances.
 Conduct an aging analysis of the advances to confirm the
balances are regular and moving.
 Where the balances are outstanding since long, ensure that the
management has initiated reasonable steps for its recovery or
settlement.
 Where the balances are doubtful of recovery ensure adequate
provision for loss is set apart in the accounts.
 Where the balances are confirmed of being bad, ensure that the
same are written off from the accounts.
 Cases were noted where advances were shown as deposits in
balance sheet. Hence, ensure booking of advances in proper
accounting heads.
 Carry out external confirmation as per the need to further assure
that the balances stated in the accounts are correct.
e) Forfeiture of Shares
Answer
The shares are forfeited where the applicant fails to pay the sum
called on the allotment. The same shall be verified as per below:

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 ascertain that the Articles authorise the Board of Directors to

forfeit shares and that the power has been exercised by the Board
in the best interest of the company;
 verify the amount of call or instalment of calls which was
outstanding in respect of each of the share forfeited.,
 ascertain that the procedure in the Articles has been followed
viz., the notice given to the defaulting shareholders warning them
that in the event of non-payment, by a specified date, of the
amount of call already made on the shares standing in their
names, together with interest, if any, the shares shall be forfeited,
see that the proper resolutions of Directors, first as regards
issuance of notice and afterwards in respect of forfeiture of
shares; and
 verify the entries recorded in the books of account consequent
upon forfeiture of shares to confirm that the premium, if any,
received on the issue of shares has not been transferred to the
Forfeited Shares Account.
Question No. 5 'a'

Mr. A, a practicing chartered accountant receives commission from
Mr. X, another practicing chartered accountant NRs. 50,000 being
50% of the audit fee for the referral of statutory audit of Xerox
Company Limited, a listed company. State your views. 5
Answer
According to Section 10 of Code of Ethics, 2060 issued by Institute of
Chartered Accountants of Nepal, the payment or receipt of
commission by a professional accountant in public practice could
impair objectivity and independence. A professional accountant in
public practice should not therefore pay a commission to obtain a
client nor should a commission be accepted for referral of a client to a
third party. The payment and receipt of commission are permitted only
for such engagements for which independence is not required and the
professional account in practice should nonetheless disclose the facts
to the client. In the above case since the above assignment requires
independence, Mr. A and Mr. X both are not complying with the
ethical requirements under Code of Ethics issued by ICAN. The
disciplinary action can be taken by the Council on fulfilling the
petition requirements and after recommendation of Disciplinary
Committee.
Question No. 5 'b'

Mr. Nimesh, a partner of TMS & Associates, a practicing Chartered
Accountant in its business letter head prints its previous association as
member Secretary to one of the reputed political party of the country.
State your views. 5

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Answer
According to preface directives issued by ICAN related to Section 7 and
14 of the Code of Ethics of ICAN, 2060, a professional accountant in
practice, should not print or write its positions not related to the
accounting profession in the name plate, identity card, visiting card,
business card and business stationeries used for the purpose of its
profession. Hence, Mr. Nimesh has violated ethical requirements under
Code of Ethics issued by ICAN and hence attracts the disciplinary
actions by Council under the recommendation of Disciplinary
Committee.
Question No. 6 'a'

Write short notes on the following: (3×5=15)
a) Analytical review
Answer
AAS 5 on Audit Evidence defines analytical review as those tests of
details which consists of studying significant ratios and trends and
investigating unusual fluctuation and items. Thus, analytical reviews
are substantive audit procedure with the help of which auditor can
perform tests of details in more efficient and effective manner.
Therefore, analytical reviews are nothing best analytical review
procedures which have been considered at length in AAS-14 on
―Analytical Procedures‖. According to AAS-14, analytical procedures
include the consideration of comparisons of the entity‘s financial
information with, for example, comparable information for prior
periods or anticipated results of the entity, such as budgets or
forecasts. Consideration of relationships among elements of financial
information that would be expected to conform to a predictable pattern
based on the entity‘s experience, such as gross margin percentages,
between financial information and relevant non-financial information,
such as payroll costs to number of employees also constitute analytical
review procedures.
Analytical review procedures are used for the following purposes:
 to assist the auditor in planning the nature, timing and extent of other
audit procedures;
 as substantive procedures when their use can be more effective or
efficient than tests of details in reducing detection risk for specific
financial statement assertions; and
 as an overall review of the financial statements in the final review
stage of the audit.

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The extent of reliance that the auditor places on the results of analytical
review procedures depends on materiality of the items involved,
assessment of inherent and control risks, etc.
b) Audit trail in a computerized accounting environment
Answer
Audit trail or audit log is a chronological sequence of audit records,
each of which contains evidence directly pertaining to and resulting
from the execution of a business process or system function. In simple
accounting words, it refers to documentation of detailed transactions
supporting summary ledger entries. This documentation may be on
paper or electronic records.
An audit trail refers to a situation where it is possible to relate ‗one-to-
one‘ basis, the original input along with the final output. The work of
an auditor would be hardly affected if ―Audit Trail‖ is maintained i.e.
if it were still possible to relate, on a ‗one-to-one‘ basis, the original
input with the final output. A simplified representation of the
documentation in a manually created audit trail. The particular credit
notes may be located by the auditor at any time he may wish to
examine them, even months after the balance sheet date. He also has
the means, should he so wish, of directly verifying the accuracy of the
totals and sub-totals that feature in the control listing, by reference to
individual credit notes. He can, of course, check all detailed
calculations, casts and postings in the accounting records, at any time.
In first and early second-generation computer systems, such a
complete and trail was generally available, no doubt, to management‘s
own healthy skepticism of what the new machine could be relied upon
to achieve – an attitude obviously shared by the auditor. In such a
system
 The output itself is as complete and as detailed as in any manual
system.
 The trail, from beginning to end, is complete, so that all documents
may be identified by located for purposes of vouching, totaling and
cross-referencing.
Any form of audit checking is possible, including depth testing in either

direction. In case audit trail is missing, the auditor employs Computer
Assisted Techniques (CAATs) to ensure the validity of accounting data.
c) Process of judgment formation by Auditor
Answer
After the audit, the opinion that the auditor expresses is the result of
exercise of judgment on facts, evidence and circumstances which he

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comes across in the course of audit. The judgment is formed on the

following basis:-
 Identification of the assertions to be examined.
 Evaluation of the assertion as to relative importance.
 Collection of the information or evidence about the assertions to
enable him to give an informed opinion.
 Evaluation of evidence as valid or invalid, pertinent or not
pertinent, sufficient or insufficient.
 Formulation of judgment as to the fairness of the assertions
under consideration.

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Question No. 7
Distinguish between following: (3×5=15)
a) Permanent Audit File and Current Audit File

Answer
In a recurring audit, the working papers have to be retained for future
reference as well. In such cases they are classified as permanent audit
file and current audit file.
Permanent audit file is updated regularly with information of

continuing importance to succeeding audit whereas working paper
which contain information relating primarily to the audit of single
period is kept in current audit file.
A permanent audit file normally includes:
 Information concerning the legal and organizational structure of the
entity. In the case of a company, this includes the Memorandum and
Articles of Association. In the case of a statutory corporation, this
includes the Act and Regulations under which the corporation
functions.
 Extracts or copies of important legal documents, agreements and
minutes relevant to the audit.
 A record of the study and the evaluation of the internal controls
related to the accounting system.
 Copies of audited financial statements for previous years.
 Analysis of significant ratios and trends.
The current file normally includes:

 Correspondence relating to acceptance of annual reappointment.
 Extracts of important matters in the minutes of Board Meeting and
General Meetings as relevant to audit.
 Evidence of the planning process of the audit and audit programme.
 Analysis of transactions and balances.
 A record of nature, timing and extent of auditing procedures
performed, and the results of such procedures.
b) Control Risk and Detection Risk

Answer
Control risk is the risk that misstatement that could occur in an account
balance or class of transactions and that could be material, individually
or when aggregated with mis-statements in other balances or classes,
will not be prevented or detected on a timely basis by the system of
internal control There will always be some control risk because of the
intrinsic limitation of any system of internal control To assess control
risk, the auditor should consider the adequacy of control design, as

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well as test adherence to control procedures. In the absence of such an

assessment, the auditor should assume that control risk is high.
Detection risk is the risk that an auditor's procedures will not detect a
misstatement that exists in an account balance or class of transactions
that could be material, individually or when aggregated with
misstatements in other balances or classes. The level of detection risk
relates directly to the auditor's procedures. Some detection risk would
always be present even if an auditor were to examine 100 percent of
the account balance or class of transaction because, for example, the
auditor may select an inappropriate audit procedure, misapply an
appropriate audit procedure or misinterpret the audit results.
c) Audit Technique and Audit Procedure

Answer
For collection and accumulation of audit evidence, certain methods
and means are available and these are known as audit techniques. The
two terms, techniques and producers are often used interchangeably; in
fact, however, a distinction does exist. Procedure may comprise a
number of techniques and represents the broad frame of the manner of
handling the audit work; techniques stand for the methods employed
for carrying out the procedure. Vouching is a substantive audit
procedure which involves audit techniques like casting, cross-casting,
checking of posting etc. verification of assets and liabilities is a
substantive audit procedures which involves application of audit
techniques like physical examination, confirmation from third parties
etc.

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Suggested Answers December 2022 Examination (CAP II - Group I)

Paper 2: Audit and Assurance

S.N. Particulars Amount (Rs.)

2. Give your comments on the following cases: (45=20)

3. Answer the following: (35=15)

4. Answer/Comment on the following: (35=15)

5. Answer/Comment on the following: (25=10)

7. Distinguish between: (25=10)

7 b) Accounting policies and accounting estimate

adopted by an entity for available at the time of

d) Stratification and Value-Weighted Selection: In considering the characteristics of the population

3. Answer the following: (35=15)

4. Answer/Comment on the following: (35=15)

b) Audit of corporate bodies substantially owned by the government:

6. Write short notes on the following: (42.5=10)

7. Distinguish between: (25=10)

2. Give your comments on the following cases: (45=20)

3. Answer the following: (35=15)

b) Briefly discuss about the limitations of Internal Controls.

4. Answer/Comment on the following: (35=15)

b) A partner of a firm of Chartered Accountants during a T.V. interview handed over

5. Answer/Comment on the following: (25=10)

6. Write short notes on the following: (42.5=10)

7. Distinguish between: (25=10)

 the nature of the event; and

Attempt all questions.

2. Give your comments on the following cases: (45=20 marks)

Paper 2: Audit and Assurance

© The Institute of Chartered Accountants of Nepal 21

© The Institute of Chartered Accountants of Nepal 22

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examination even if he has obtained a representation from management on the matter.

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© The Institute of Chartered Accountants of Nepal 26

4. As per section 10 (4), the remuneration to be paid by the concerned organization to

© The Institute of Chartered Accountants of Nepal 28

© The Institute of Chartered Accountants of Nepal 29

7. Distinguish between: (2×5=10 marks)

Description Auditing is the independent Investigation means an inquiry, or

Owners Audit is conducted on behalf of Investigation may be conducted

Process Routine process Investigation is not a regular

Scope It includes only an examination of It covers an examination of the

Employees Does not examine personally May examine personally

Sequence Usually conducted before Usually conducted after the audit of

Person Audit is to be conducted by a Investigation may be take on even

Legal Audit is mandatory under law There is no such legal obligations

© The Institute of Chartered Accountants of Nepal 30

• Test of controls and

procedure called substantive procedure. Substantive procedures are designed to obtain

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© The Institute of Chartered Accountants of Nepal 2

c) As per NAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors”

© The Institute of Chartered Accountants of Nepal 3

2. Give your comments on the following cases: (45=20)

b) Mr. Kumar, a practicing Chartered Accountant was ordered to surrender his

© The Institute of Chartered Accountants of Nepal 4

© The Institute of Chartered Accountants of Nepal 5

3. Answer the following: (35=15)

Following points should be considered for reporting identified non-compliance to audit

© The Institute of Chartered Accountants of Nepal 6

 If in Mr. Basnet‟s judgment, the non-compliance is believed to be intentional and

c) Written Representation: The management is responsible for the preparation and

© The Institute of Chartered Accountants of Nepal 7

Extent of Reliance: Written representations are necessary information that auditor