Unit 6.

6 Application of Technology in Auditing

and Audit Trail

Auditing in an Automated Environment

● Increased Use of IT Systems: Businesses now rely on computer-assisted information

systems for accounting and administrative controls.
● Automation Benefits:
○ Ensures accurate data processing and reliable computation.
○ Handles high transaction volumes efficiently.
○ Speeds up business processes.
○ Enhances control effectiveness and security.
○ Reduces human errors.
○ Improves integration of business processes.

● Impact on Auditing: Traditional auditing techniques need modification to align with

automated environments.

Components of an Automated Environment

● Databases: Examples include Oracle 19C, MS-SQL Server.

● Operating Systems: Includes Windows, Unix, Linux.
● Hardware & Storage Devices: Servers, disks, tapes, network storage.
● Network Devices: Switches, routers, firewalls.
● Networks: LANs, WANs, VPNs.
● Physical & Environmental Controls:
○ IT facilities (Data centers).
○ Access control (Biometric systems, CCTVs).
○ HVAC, fire suppression systems.

● Application Software:
○ Package Software: Tally, QuickBooks.
○ Small ERPs: Tally ERP, SAP Business One, Focus ERP.
○ Enterprise ERPs: SAP ECC, Oracle EBS.

Areas of Use of Computers in Auditing

● Audit Planning & Management:

○ Preparation of audit programs.
○ Planning, scheduling, and manpower assignment.

● Validation & Review:

 ○ Checking validity, consistency, and reasonableness of entries.
○ Reviewing internal controls.
● Data Retrieval & Analysis:
○ Extracting key information for comparison.
○ Performing arithmetical computations.
○ Conducting analytical reviews (ratio analysis, trend analysis,
reasonableness tests, etc.)
● Sampling & Documentation:
○ Selecting representative samples for vouching and verification.
○ Preparing flowcharts.
○ Drafting audit reports, working papers, and other communications

Controls in an Automated Environment & Auditor’s Role

● Importance of Controls: Ensures authenticity and reliability of information in an

automated environment.
● Auditor’s Role: Evaluates controls before applying audit procedures.

Types of Controls

1. Application Controls:
○ Relate to transactions & standing data in computer-based accounting systems.
○ Auditor ascertains, records, and evaluates them to assess risk of material
misstatement.
2. Input Controls: Ensure data input is authorized, complete, accurate, and timely.
Key validation checks include:
○ Range Checks: Verify input falls within expected limits.
○ Compatibility Checks: Ensure related fields are logically aligned (e.g., sales
invoice & tax).
○ Validity Checks: Confirm the correctness of input data.
○ Exception Checks: Generate reports for unusual transactions.
○ Sequence Checks: Ensure proper order of processing, rejecting
out-of-sequence entries.
○ Control Totals: Compare pre-input totals with actual input data for
completeness.
○ Check Digit Verification: Uses algorithms to validate data accuracy.
3. Processing Controls:
○ Ensure correct and timely processing of input data.
○ Require designing and testing before live implementation.
4. Output Controls:
○ Ensure processed data is delivered only to authorized users.
○ Common controls: Batch control totals, exception reports.
○ Auditor must verify confidentiality and access control of outputs.

5. Master File Controls:

 ○ Maintain integrity of standing data in master files.
○ Require strict security measures.
○ Auditor evaluates effectiveness and adequacy of these controls.

' Auditor’s Role: The evaluation of these controls determines audit workload and scope.
Testing Methods in an Automated Environment

● Four Testing Methods:

○ Inquiry – Most efficient but must be combined with other methods.
○ Observation – Watching processes in real-time.
○ Inspection – Reviewing documents, configurations, and records.
○ Reperformance – Most effective but time-consuming.

● Factors Influencing Testing Method Selection:

○ Risk assessment & internal controls.
○ Required level of evidence.
○ Past error history.
○ Complexity of business processes.

● Common Testing Practices:

○ Walkthrough: Understand automated transaction processing via inquiry,
observation, and inspection.
○ User Transaction Observation: Monitor how users record transactions in
various scenarios.
○ Application Control Inspection:
■ Perform test checks (negative testing) to observe error messages.
■ Review technical manuals of systems & applications.

Concept of Audit Trail

● Definition:
○ A step-by-step record of transactions that allows tracing from source
documents to final accounting reports.
○ Ensures transparency, accuracy, and accountability in financial records.
● Example:
○ Sequentially numbered sales invoices are recorded in a register and filed
numerically or chronologically, enabling easy tracing.
● Audit Trail in Automated Environment:
○ Accounting software maintains a detailed log of transactions.
○ Tracks initial entry, edits (changes in name/amount), user modifications,
timestamps, and deletions.
○ Enhances control, security, and compliance in financial reporting.
Statutory Requirement for Audit Trail

● Legal Requirement:
○ As per Rule 3(1) of Companies (Accounts) Rules, 2014, amended in 2021,
effective April 1, 2022.
○ Companies must use accounting software with audit trail features.
● Mandatory Features of Audit Trail Software:
○ Records each transaction and changes (edit log).
○ Logs date and details of changes made in books of accounts.
○ Audit trail cannot be disabled.
● Audit Log Operations:
○ Automated logs track every system activity.
○ Records who made changes, when, and how.
○ Shows system response to user actions.
○ Identifies unauthorized changes and potential material misstatements.

Benefits of Audit Trail

● User Accountability:
○ Tracks user activities, ensuring responsibility for actions.
○ Prevents unauthorized alterations, viruses, and intrusions.
● Data Security:
○ Protects data from unauthorized access and fraud by internal and external
entities.
● Event Reconstruction:
○ Helps in understanding user operations, including cyberattacks.
○ Facilitates data retrieval when necessary.
● Error & System Interference Detection:
○ Identifies system failures, errors, and security threats.
○ Enables proactive response to maintain smooth operations.

Auditor’s Duty to Report on Audit Trail

● Mandatory Compliance:
○ As per Rule 11 of Companies (Audit and Auditors) Rules, 2014 (amended in
2021).
● Key Audit Reporting Requirements:
○ Verify if the company uses accounting software with an audit trail (edit log)
feature.
○ Ensure the audit trail was active throughout the year for all transactions.
○ Confirm that the audit trail has not been tampered with.
○ Check if the audit trail is preserved as per statutory record retention rules.
Unit 6.5 Audit Sampling, Audit Techniques and
Analytical Procedure (including Scrutiny of Trial
Balance and Grouping Schedules)

Concept of Audit Sampling

● Need for Sampling:

○ Large organizations have numerous transactions, making it impractical for
auditors to check every transaction.
○ Partial checking (sampling) is used to form an opinion efficiently.
● Importance of Sample Selection:
○ The success of audit sampling depends on the appropriateness of the
selected sample.
● Definition (SA-530, ICAI):
○ Audit sampling involves applying audit procedures to less than 100% of a
population.
○ Every sampling unit must have a chance of selection to ensure a reasonable
basis for conclusions.

Benefits of Audit Sampling

● Reduces Auditor’s Workload: Minimizes the number of transactions to be checked.

● Saves Time & Cost: Speeds up the audit process while reducing expenses.
● Focus on Critical Issues: Allows auditors to allocate more time to key risk areas.
● Evaluates Internal Control: Identifies weaknesses in the system, enabling corrective
actions.
● Dependable Results: Based on statistical sampling methods, ensuring reliability.

Factors to Consider for Audit Sampling

● Audit Objectives: Sampling should align with the audit's purpose.

● Nature of Population: Consider heterogeneity when selecting a sampling technique.
● Internal Control System: Strong controls allow for a smaller sample size.
● Materiality of Items: Higher materiality requires a larger sample size.
● Sampling Risk: Design the sample to keep risk within acceptable limits.
● Non-Sampling Risk: Minimize errors due to human mistakes.
● Tolerable Error: Set an acceptable error limit based on materiality.

Approaches to Sampling

A. Non-Statistical (Judgmental) Sampling

 ● Based on the auditor’s experience and judgment.
● No statistical tools used.
● Simple but subjective.

B. Statistical Sampling

1. Random Sampling: Every item has a known chance of selection.

○ Simple Random Sampling: Equal chance for all population units, suitable for
homogeneous data.
○ Stratified Sampling: Population divided into sub-groups (strata) before
selection.
2. Systematic/Interval Sampling: Selection at regular intervals (e.g., every 30th item).
3. Monetary Unit Sampling: Based on transaction value rather than count.
4. Multi-Stage Sampling: Selection at multiple levels (e.g., choosing shops first, then
selecting stock items from them).

Risk Associated with Sampling

1. Sampling Risk (Unavoidable)

● Occurs because a sample may not represent the entire population.

● Two types:
○ Compliance Procedure Risk (Test of Control): Auditor may incorrectly
conclude that controls are more/less effective than they actually are.
○ Substantive Procedure Risk (Test of Details): Auditor may incorrectly
conclude that financial statements are free from material misstatements.

2. Non-Sampling Risk (Avoidable)

● Arises from human errors like incorrect data processing or lack of expertise.
● Can be minimized or eliminated through:
○ Proper training and expertise.
○ Careful analysis of selected transactions.

Key Insight

● Sampling Risk is unavoidable but can be reduced by proper sampling methods and
larger sample sizes.
● Non-Sampling Risk is avoidable with experienced auditors and careful execution.

Stages in Audit Sampling

1. Sample Design
○ Selects an appropriate method based on audit objectives and population nature.
 2. Sample Size Determination
○ Decides the sample size to minimize sampling risk.
○ Uses statistical techniques to avoid subjectivity.
3. Sample Selection
○ Draws sample units using the chosen method.
4. Performance of Audit Procedure
○ Conducts audit tests on selected samples.
○ Replaces units if the procedure cannot be applied.
○ Forms an opinion based on results.

Audit Techniques

1. Routine Checking
○ Ensures mathematical accuracy in accounting records.
○ Detects simple errors and frauds.
○ Performed by audit clerks on primary entries, ledgers, and final accounts.
2. Test Checking
○ Examines a selected sample of transactions instead of all.
○ Based on statistical sampling techniques.
○ Saves time but involves sampling risks.
○ Not recommended for seasonal industries, legal transactions, or non-recurring
items.
3. Auditing in Depth
○ Detailed examination of selected transactions from start to finish.
○ Follows three steps:
a) Review of internal controls
b) Selection of material transactions
c) Stage-by-stage verification with documents
4. Cut-off Examination
○ Ensures correct recording of transactions at the period-end.
○ Prevents misclassification between financial years.
○ Focuses on work-in-progress, goods in transit, and outstanding items.
5. Surprise Checking
○ Conducted without prior notice to prevent concealment of fraud.
○ Increases audit efficiency.
○ Verifies material items on a non-routine basis.
6. Walk-Through Tests
○ Traces transactions through the internal control system.
○ Assesses effectiveness of internal controls.
○ Helps auditors decide on the level of reliance on internal controls.

Analytical Procedures

Concept of Analytical Procedures

 ● Traditional techniques like routine checking/test checking may fail to detect complex
errors or planned frauds.
● SA 520 defines analytical procedures as evaluating financial data through plausible
relationships among financial & non-financial data.
● Helps in identifying unusual fluctuations or inconsistencies.

Nature of Analytical Procedures (SA 520)

1. Comparison of financial data with:

○ Prior period financials.
○ Budgeted/forecasted figures.
○ Industry averages or comparable entities.
2. Relationships between:
○ Different financial data points (e.g., operating profit margin).
○ Financial & non-financial data (e.g., employee count vs. total salary expense).
3. Use of diverse analytical tools, from simple comparisons to advanced statistical
techniques.
4. Applicable on standalone, consolidated, or specific components of financial statements.

Application of Analytical Procedures (SA 520)

1. Audit Planning – Understanding client’s business & risk areas.

2. Substantive Testing – Reducing audit risk by relying on analytical tests with/without
detailed verification.
3. Investigation of Unusual Items – Examining deviations from expected values.
4. Overall Conclusion – Ensuring consistency of audit findings.

Tools & Techniques of Analytical Procedures

1. Trend Analysis – Examining fluctuations of financial items over years.

2. Testing of Reasonableness – Comparing related financial elements, e.g.:
○ Raw material consumption vs. production.
○ Wastage & scrap percentage vs. material usage.
○ Work-in-progress vs. materials issued.
3. Ratio Analysis – Evaluating financial health through ratios like:
○ Gross Profit Ratio
○ Receivable Turnover Ratio
○ Inventory Turnover Ratio
4. Sources of Information – Includes:
○ Interim financials
○ Budgets
○ Management accounts
○ Non-financial data
Concept of Trial Balance

● A statement of debit and credit balances of general ledger accounts.

● Purpose:
○ Checks arithmetical accuracy of accounting records.
○ Facilitates quick preparation of financial statements.
● Preparation:
○ Usually at the end of an accounting period (month, quarter, or year).
○ Also known as a list of General Ledger balances.

Trial Balance in Different Accounting Systems

1. Mechanized Accounting System

○ Uses account codes (Balance Sheet, Income Statement, Clearing Accounts).
○ Ensures compliance with accounting policies & regulatory disclosures.
○ Provides a structured summary for financial statement preparation.
2. Manual Accounting System
○ Tests arithmetical accuracy of records.
○ Helps in detecting clerical errors but cannot detect:
■ Errors of principle (incorrect classification of accounts).
■ Compensating errors (one error offsets another).
■ Errors of complete omission (transactions not recorded).

Additional Benefits of a Trial Balance

● Identifies unusual fluctuations (e.g., credit balance in Depreciation A/c or debit

balance in TDS Payable A/c).
● Helps in budgetary control for:
○ Incomes & expenses.
○ Element-wise working capital.
○ Capital expenditure.

Scrutiny of Trial Balance by Auditor

Purpose of Scrutinizing the Trial Balance

● Ensures arithmetical accuracy of accounts if the Trial Balance tallies.

● Helps identify areas where analytical procedures (e.g., trend analysis, variance
analysis) are required.
● Detects unusual changes in account balances by comparing with prior periods.

Key Considerations for Auditors

1. Cut-off Date Compliance

○ Trial Balance should include only transactions recorded before the declared
cut-off date.
 2. Codification Logic Adherence
○ Ensures account classification aligns with the organization’s chart of accounts.
3. Unadjusted Financial Data
○ Must be prepared strictly as per books, without any external adjustments.
4. Ledger Corrections Before Final Grouping
○ Any errors or discrepancies identified during scrutiny should be corrected before
preparing the grouping schedule.

Scrutiny of Grouping Schedule

Concept of Grouping Schedule

● Involves clustering related ledger accounts into specific groups and sub-groups before
preparing financial statements.
● Essential for compiling aggregated financial data for Income Statement, Balance
Sheet, and Notes to Accounts.

Objectives of Grouping Schedule

1. Regulatory Compliance
○ Ensures account heads are compiled per financial reporting regulations.
2. Disclosure Compliance
○ Helps in preparing Notes to Accounts by clustering related account heads as
per legal requirements.
3. Budgetary Control
○ Facilitates control at both detailed and grouped account levels, aligning with
forecasting and budgeting processes.
4. Automated Financial Analysis
○ Supports automation of financial reporting for multiple stakeholders through
computing tools or spreadsheets.

Auditor’s Role in Grouping Schedule

1. Ensuring Compliance with Regulations

○ Verifies that Grouping Schedules adhere to prescribed financial regulations.
2. Authorization of Grouping Schedule
○ Confirms that only authorized personnel have structured the Grouping
Schedules.
3. Software Customization & Controls
○ Ensures the accounting software is appropriately customized to meet reporting
needs.
4. Authorization for Changes
○ Checks that any alterations in the Grouping Schedule are duly approved by
legal or regulatory authorities.
 5. Detecting Errors & Frauds
○ Uses scrutiny & analytical audit procedures (e.g., relational analysis, trend
analysis) to identify complex errors or frauds.

Unit 6.4 Audit Risk, Assessment of Audit risk,

Internal Control, Internal Check, Internal Audit -
Industry Specific, Interplay between Internal
Audit and Statutory Audit, Risk based Internal
Audit, Internal Financial Control and Internal
Control over Financial Reporting
Concept of Audit Risk

1. Definition of Audit Risk

○ Risk that an auditor provides an incorrect opinion when financial statements
contain material misstatements.
2. Possibility of Incorrect Opinion
○ Even with due diligence, auditors cannot guarantee that financial statements
are completely free from misstatements.
3. Example of Audit Risk
○ Incorrect classification of capital expenditure as revenue expenditure (e.g.,
repair cost wrongly expensed instead of capitalized).
○ Auditor fails to detect the misstatement, leading to inaccurate financial
reporting.
4. Impact of Audit Risk
○ Affects the reliability of financial statements.
○ Can lead to misleading conclusions by investors and stakeholders.

What is NOT Audit Risk?

1. False Misstatement Opinion – Incorrectly stating financials are misstated when they
are accurate.
2. Auditor’s Business Risk – Litigation, reputation damage, or publicity issues unrelated
to financial misstatements.

Types of Audit Risk

1. Risk of Material Misstatement – The risk that financial statements are materially
misstated before audit, due to error or fraud.
 ○ Overall Financial Statement Level – Misstatement affects financials as a whole.
○ Assertion Level – Misstatements in classification, calculation, or disclosure.
■ Inherent Risk (I) – Due to complex transactions or fraud (e.g., mergers,
fire damage).
■ Control Risk (C) – Due to weak internal controls (e.g., missing bank
reconciliations).
2. Detection Risk (D) – The risk that audit procedures fail to detect material misstatements
(e.g., checking invoice accuracy but not transaction occurrence).

Audit Risk Formula

Audit Risk = Inherent Risk × Control Risk × Detection Risk

Assessment of Audit Risk (SA 315)

To identify and assess the risks of material misstatement at both the financial statement and
assertion levels, auditors perform risk assessment procedures, which include:

1. Inquiries of Management & Others

○ Obtain information from management, governance, and employees at different
levels.
○ Helps understand financial reporting, unusual transactions, and strategic
changes.
2. Analytical Procedures
○ Analyze financial and non-financial data for inconsistencies or unexpected
trends.
○ Helps identify unusual transactions, relationships, or fraud risks.

3. Observation & Inspection

○ Observe operations, inspect documents, reports, and facilities.
○ Supports other audit evidence and enhances risk assessment.

Additional Factors in Assessing Audit Risk

1. Information from Prior Audits

○ Helps understand past misstatements, corrections, internal controls, and
operational changes.
○ Assists in identifying risks based on previous audit experiences.

2. Engagement Team Discussions

○ Team members share insights on financial misstatements and business risks.
○ Enhances risk assessment and audit planning through collaborative discussions.

3. Understanding the Entity & Internal Control

 ○ Industry, regulations, ownership structure, and internal controls influence risk
assessment.
○ Effective internal controls reduce but do not eliminate risks.
○ Continuous process of updating knowledge throughout the audit.

4. Dynamic Risk Assessment

○ New information may alter initial risk assessments.
○ Ineffective controls or unexpected misstatements require audit adjustments.

Internal Control: Concept & Scope

Concept of Internal Control

Internal control is a system implemented by an entity’s management and personnel to ensure:

1. Reliability of Financial Reporting – Accurate and timely financial information.

2. Effective & Efficient Operations – Orderly business conduct and asset safeguarding.
3. Compliance with Laws & Regulations – Adherence to legal and regulatory
requirements.

As per SA 265, internal control includes policies and procedures aimed at fraud prevention,
error detection, and maintaining complete and accurate accounting records.

Scope of Internal Control

Internal control includes both:

1. Administrative Control – Ensures adherence to management policies, covering

production, quality control, and pricing strategies.
2. Accounting Control – Ensures proper recording of transactions, maintaining books,
checking accuracy, and staff duty rotation.

Accounting control is further divided into:

● Internal Check – Continuous cross-verification of transactions to prevent errors.

● Internal Audit – Independent evaluation of financial and operational processes.

Basic Elements of Internal Control

1. Organizational Structure – Clearly defined roles, responsibilities, and authorization

levels.
2. Competent Personnel – Skilled employees enhance control effectiveness.
3. Division of Work – Tasks are assigned based on expertise.
4. Separation of Duties – Operations, record-keeping, and asset custody must be handled
separately.
 5. Authorization – All activities require proper approval.
6. Supervision & Review – Regular monitoring ensures system effectiveness.

Objectives of Internal Control

1. Authorization Compliance – Ensures transactions occur as per management’s

approval.
2. Accurate Recording – Transactions are systematically recorded in the correct period.
3. Fair Representation – Ensures transactions reflect actual economic events and comply
with laws.
4. Accounting Accuracy – Transactions are recorded per accounting policies and
standards.
5. Asset Protection – Prevents unauthorized use or misuse of company assets.
6. Performance Review – Identifies weaknesses and implements corrective actions.
7. Resource Optimization – Ensures efficient use of company resources.
8. Frequent Asset Verification – Regular checks to confirm the existence and accuracy of
assets.

Advantages of Internal Control

1. Efficiency & Resource Utilization – Ensures optimal use of resources, reducing

misuse.
2. Error Prevention – Detects and prevents errors, ensuring accurate records.
3. Fraud Protection – Safeguards assets from misappropriation and irregularities.
4. Employee Satisfaction – Improves productivity through clear duty segregation and
responsibility delegation.

Types of Internal Control

1. Preventive Controls – Designed to prevent errors and fraud before they occur.
○ Segregation of Duties – Splitting responsibilities for authorization, recording,
and asset handling.
○ Approvals & Authorizations – Supervisor-approved transactions ensure
compliance.
○ Security of Assets – Restricting access and periodic verification.

2. Detective Controls – Identify errors or fraud after occurrence.

○ Performance Reviews – Comparing actual vs. expected performance.
○ Reconciliations – Matching different financial data to detect discrepancies.
○ Physical Verification – Checking inventory or assets for misappropriation.

Techniques for Evaluating Internal Control System

 1. Narrative Record – Detailed description of the control system, useful for small
businesses but difficult for identifying gaps.
2. Check List – A structured set of questions to evaluate controls, usually answered as
‘Yes,’ ‘No,’ or ‘Not Applicable.’
3. Flow Chart – A visual representation of processes and controls, providing a clear
overview of operations.
4. Internal Control Questionnaire – A pre-designed set of questions to assess control
effectiveness, using Yes/No or descriptive responses.

Inherent Limitations of Internal Control

1. Breakdowns – Errors may occur due to misunderstandings, mistakes, or new

technology.
2. Judgment – Human decisions made under pressure can weaken controls.
3. Management Override – Senior personnel may bypass controls for personal gain.
4. Collusion – Employees may conspire to manipulate financial data undetected.
5. Limited Scope – More effective for routine activities, less so for complex or unique
tasks.
6. High Cost – If costs exceed benefits, the system may become impractical.

Concept of Internal Check

1. Part of Internal Control – Ensures duties are arranged so that one employee’s work is
verified by another.
2. Error & Fraud Prevention – Mistakes or frauds are automatically detected and
corrected by subsequent staff.
3. Example – In a bank, cheque processing is divided among three employees to prevent
errors.
4. ICAEW Definition – A system ensuring continuous verification of transactions as part of
routine operations.
 5. Efficient Work Allocation – Eliminates duplicate work and enhances accountability.

Objectives of Internal Check

1. Reduce Fraud & Errors – Minimizes the chances of financial and operational
irregularities.
2. Early Detection – Ensures errors and frauds are identified promptly.
3. Enhance Workforce Efficiency – Implements division of labor for better productivity.
4. Clear Responsibility Allocation – Assigns duties to hold individuals accountable.
5. Fact & Record Verification – Ensures financial and physical records are maintained
properly.
6. Moral Pressure – Encourages employees to adhere to ethical practices.
7. Ease Auditor’s Workload – Reduces dependency on external auditors.

Essential Characteristics of Internal Check System

1. Division of Work – Tasks are divided to prevent a single person from handling
everything.
2. Provision of Check – Each staff member’s work must be reviewed by another.
3. Clear Responsibility – Duties and accountability should be well-defined.
4. Use of Technology – Reduces human errors through automation.
5. Employee Rotation – Prevents manipulation by shifting responsibilities periodically.
6. Control Over Employees – Supervisors monitor areas prone to fraud.
7. Strict Supervision – Ensures compliance with internal check procedures.
8. Periodic Review – Regular evaluation for improvement and efficiency.

Here are the Advantages of the Internal Check System based on the provided image:

To the Auditor:

1. Saves Time & Cost – Reduces the need for detailed checking; allows test checking.
2. Focus on Critical Areas – Auditor can concentrate on important aspects, enhancing
audit quality.

To the Client:

1. Reduces Errors & Frauds – Continuous checking minimizes irregularities.

2. Smooth Workflow – Tasks are distributed based on employee skills, ensuring efficiency.
3. Encourages Honesty – Moral pressure ensures employees act ethically.
4. Faster Final Accounts Preparation – Timely financial reporting due to streamlined
processes.

Auditor’s Liability for Relying on Internal Check System

 1. Efficiency Gain – Internal check allows auditors to focus on critical areas like stock
valuation, asset valuation, and provisions.
2. Risk Factor – Even a strong internal check system cannot fully eliminate frauds and
errors.
3. Legal Precedent – In McBride Ltd vs. Rooke & Thomas (Canada, 1941), the court held
that auditors remain liable for undetected frauds.
4. No Liability Reduction – Relying on test checking due to internal checks does not
absolve the auditor of responsibility.

Internal Audit

● Definition & Role: Internal audit is part of an organisation’s internal control system,
initially focused on financial operations but now extends to overall operational efficiency.
● Scope of Work: It evaluates not just financial records but also purchase validity, vendor
approval, pricing reasonability, and stock inclusion.
● ICAI Definition: Internal audit is an independent management function aimed at
continuous and critical evaluation to suggest improvements and strengthen governance,
risk management, and internal controls.
● SA 610 Perspective: It involves assurance and consulting activities to enhance
governance, risk management, and internal control processes.
● Objective: A continuous assessment of operational activities to verify books of accounts
and improve the entity’s effectiveness in governance and risk management.

Scope and Objectives of Internal Audit

● Varies by Entity: Depends on size, structure, and management needs.

● Key Functions:
○ Internal Control Monitoring – Reviews controls and suggests improvements.
○ Financial & Operational Review – Assesses accuracy and classification of
data.
○ Operational Efficiency Check – Evaluates cost-effectiveness of activities.
○ Compliance Check – Ensures adherence to laws, regulations, and policies.
○ Risk Management – Identifies and improves risk controls.
○ Governance Assessment – Evaluates ethics, values, and communication
effectiveness.

Advantages of Internal Audit

● Supports Management – Ensures effective execution of plans and policies.

● Detects Errors & Frauds – Identifies financial misstatements and irregularities.
● Prevents Errors & Frauds – Continuous evaluation minimizes risks.
● Reduces Wastage – Identifies weaknesses and improves resource utilization.
● Safeguards Assets – Ensures asset protection through proper controls.
 ● Improves Efficiency – Enhances internal controls, boosting overall performance.

Internal Audit in India

● Legal Requirement: Governed by Section 138 of the Companies Act, 2013 and Rule
13 of Companies (Accounts) Rules, 2014.
● Mandatory Appointment: Internal auditors must be a CA, CMA, or other
professionals as decided by the Board.
● Applicability:
○ Listed Companies – Mandatory internal audit.
○ Unlisted Public Companies (if any of the following conditions met):
■ Paid-up share capital ≥ ₹50 crore (preceding FY).
■ Turnover ≥ ₹200 crore (preceding FY).
■ Outstanding loans/borrowings ≥ ₹100 crore (at any time in preceding FY).
■ Outstanding deposits ≥ ₹25 crore (at any time in preceding FY).

○ Private Companies (if any of the following conditions met):

■ Turnover ≥ ₹200 crore (preceding FY).
■ Outstanding loans/borrowings ≥ ₹100 crore (at any time in preceding FY).

● Execution: Internal auditors can be employees, and the Audit Committee or Board
decides the scope, periodicity, and methodology in consultation with the internal
auditor.

Interplay Between Internal and Statutory Audit – External Auditor’s

Reliance on Internal Auditor

● SA 610 Guidelines: External auditors may rely on internal audit work after evaluation.
● Key Factors for Reliance:
○ Whether internal audit is done by an in-house team or an external agency.
○ Scope, management response, and internal audit report.
○ Internal auditor’s experience, qualification, and technical compliance.
○ Authority and accountability of the internal auditor.
○ Professional care taken by the internal auditor.

● Process of Reliance:
○ External auditor discusses plans with the internal auditor.
○ Reviews internal audit reports and evaluates procedures.
○ Conducts independent audit procedures to verify adequacy.
○ Notifies management and obtains written agreements for cooperation and
confidentiality.
○ Documents the basis for reliance.

● Liability of External Auditor:

○ Even if relying on internal audit, the external auditor remains fully responsible
for audit opinions.
○ Cannot escape liability for undetected material misstatements in financial
statements.
Concept of Risk-Based Internal Audit (RBIA)

● Definition: RBIA links internal auditing with an organization’s risk management

framework, ensuring risks are managed within the company’s risk appetite.
● Difference from Traditional Audit:
○ Traditional Internal Audit → Focuses on routine control assurance.
○ RBIA → Provides assurance on risk management effectiveness along with
control assurance.
● Key Objectives of RBIA:
○ Ensure management identifies, assesses, and responds to risks effectively.
○ Verify that risk responses are appropriate and within the risk appetite.
○ Confirm that actions are taken to correct excessive residual risks.
○ Ensure continuous monitoring of risk management effectiveness.
○ Validate proper classification and reporting of risks.
● Assurance Provided to the Board:
○ Effectiveness of risk management processes.
○ Management of key risks, including effectiveness of controls.
○ Accuracy and completeness of risk reporting and classification.

Advantages of Risk-Based Internal Audit (RBIA)

1. Consistency: Ensures a structured risk management approach, enabling quick

adaptability.
 2. Transparency: Improves risk identification and control implementation for better
decision-making.
3. Specificity: Prioritizes risks, optimizes resource allocation, and addresses overlooked
threats.

IFC vs. IFC-FR

1. IFC-FR (Internal Financial Control over Financial Reporting):

○ Focuses on financial reporting controls (Balance Sheet, P&L).
○ Covers risks impacting financial statements.
○ Ensures statements are free from material misstatements.
2. IFC (Internal Financial Control):
○ Broader scope, includes IFC-FR plus operational and anti-fraud controls.
○ Ensures business efficiency, asset protection, and policy compliance.

Key Difference: IFC-FR is for financial statement reliability, while IFC ensures overall business
control and management.
Unit 6.3 Audit Engagement, Program,
Documentations, Evidence, Notebook
Audit Engagement

1. Statutory Audit: Appointment, duties, and responsibilities governed by law.

2. Other Audits: Terms decided by agreement between auditor and client.
3. Importance of Agreement:
○ Defines scope and responsibilities.
○ Prevents misunderstandings and disputes.
4. SA-210 (Audit Engagement Terms):
○ Auditor and client must agree on terms before starting the audit.
○ Terms should be documented in an engagement letter or written agreement.
○ If law defines terms in detail, a separate agreement may not be needed.

Contents of Audit Engagement Letter (SA-210)

1. Objective & Scope – Defines audit purpose and extent.

2. Management Responsibility – Clarifies management’s role.
3. Inherent Limitations – Audit may not detect all fraud/errors.
4. Use of Internal Auditor – Specifies reliance on internal audit.
5. Management Confirmation – Requirement for written confirmations.
6. Auditor’s Liability – Defines scope and limits.
7. Audit Fees – Basis of computation.
8. Billing Arrangement – Terms for invoicing/payment.
9. Report & Communication – Type and mode of reporting.
10. Report Validity – Defines audit opinion timeframe.
11. Submission Limits – Restrictions on sharing reports externally.

Audit Programme (SA 300)

1. Definition – A detailed, written plan for audit procedures and time estimates.
2. Purpose – Guides audit execution, ensures completeness, avoids omissions.
3. SA 300 Compliance – Requires a documented audit programme.
4. Timing Flexibility – Some procedures are flexible, others (e.g., stock verification) are
fixed.
5. Review & Modification – Past audit programmes can be adapted.
6. Types:
○ General Programme – Common to all audits (e.g., books verification).
○ Special Programme – Tailored for specific entities (e.g., company vs.
partnership audit).
Advantages of Audit Programme

1. Checklist – Ensures all audit procedures are covered.

2. Task Allocation – Work is properly assigned to assistants.
3. Progress Tracking – Auditor can monitor work status.
4. Accountability – Clarifies individual responsibilities.
5. Uniformity – Standardized process across audits.
6. Future Planning – Helps in planning next year’s audit.
7. Legal Evidence – Supports auditor in case of legal scrutiny.
8. Team Selection & Delegation – Aids in assigning roles effectively.
9. Defends Auditor – Proves due diligence and reasonable care.

Disadvantages of Audit Programme

1. Mechanical Process – Reduces auditor's initiative and interest.

2. Unnecessary for Small Firms – May not add value to smaller audits.
3. Staff Defense – Inefficient employees may use it as an excuse.
4. Lack of Flexibility – Not adaptable to all business types.

Audit Documentation (Audit Working Papers)

1. Definition – Records of audit procedures, evidence, and conclusions.

2. Purpose – Supports audit opinion and compliance with standards.
3. As per SA-230 – Audit documentation must record procedures, evidence, and
conclusions.
4. Forms – Can be maintained in physical or electronic format.

Purpose of Audit Working Papers

1. Evidence – Supports audit conclusions.

2. Compliance – Ensures adherence to Standards of Audit (SAs) and regulations.
3. Planning & Execution – Helps in audit planning and performance.
4. Supervision – Aids in directing and reviewing audit work (SA-220).
5. Accountability – Ensures responsibility for work done.
6. Future Reference – Retains important records for future audits.
7. Quality Control – Facilitates internal quality reviews (SQC 1).
8. Regulatory Inspections – Supports external regulatory inspections.

Contents of Audit Working Papers

1. Timely Preparation – Prepare during audit, not afterward.

2. Clarity for Review – Should allow an independent auditor to understand:
○ Audit procedures, results, and evidence.
 ○ Significant matters and professional judgments.

3. Audit Procedure Records – Document:

○ Items tested, who performed/reviewed, and dates.
4. Significant Discussions – Record key discussions with management/governance.
5. Handling Contradictions – Document resolutions of inconsistencies in conclusions.
6. Exceptions in SA Compliance – Justify departures and alternative procedures used.

Types of Working Paper Files

Ownership & Custody of Audit Working Papers

1. Auditor’s Property – Audit working papers belong to the auditor.

2. Confidentiality & Safety – Must be securely retained to meet professional/legal
requirements.
3. Regulatory Access – May need to be shared with authorities if required by law.
4. Legal Precedent – Chantery Martin & Co. case affirmed auditor’s right to retain working
papers.
5. Retention Period – As per ICAI (SQC 1), members must retain working papers for 7
years to avoid professional misconduct.

Audit Evidence

1. Definition – Facts and reasons used by the auditor to evaluate management’s

assertions.
2. Standard Reference – Defined under SA-500, ‘Audit Evidence’.
3. Purpose – Forms the basis for the auditor’s opinion on financial statements.
4. Sources – Includes accounting records and other relevant information.
5. Nature – Must be sufficient, reliable, and appropriate to support audit conclusions.
Need for Audit Evidence

1. Ensures Reliability – Provides an objective basis for forming an opinion on financial

statements.
2. Prevents Misstatements – Helps detect frauds and material errors.
3. Avoids Professional Negligence – Reduces auditor’s liability by ensuring due
diligence.
4. Reduces Audit Risk – As per SA-200, sufficient and appropriate evidence minimizes
audit risk.
5. Quality & Quantity – Sufficiency (amount) and appropriateness (relevance &
reliability) determine the effectiveness of audit evidence.

Auditor’s Judgment in Obtaining Audit Evidence

1. Sufficiency & Appropriateness – Ensures reasonable conclusions.

2. Nature of the Item – Determines relevance and risk level.
3. Internal Controls – Strong controls reduce need for extensive evidence.
4. Business Nature & Size – Larger/more complex businesses require more evidence.
5. Unusual Management Influence – External pressures may impact financial reporting.
6. Financial Position – Weak finances may indicate higher risk of misstatements.
7. Materiality – Critical areas need deeper verification.
8. Past Audit Experience – Previous findings influence current procedures.
9. Fraud/Error Detection – Adjusts audit focus based on prior discoveries.
10. Type of Information Available – Determines reliability of evidence.
11. Accounting Ratios & Trends – Identifies inconsistencies and anomalies.

Types of Audit Evidence

1. Internal Evidence – Obtained within the organization.

○ Examples: Sales invoices, cash memos, goods received notes, credit & debit
notes.
2. External Evidence – Obtained from outside sources.
○ Examples: Quotations, confirmations from debtors & creditors.

Relevance & Reliability of Audit Evidence

1. Relevance – Logical connection with audit procedure and direction of testing.

2. Reliability – Depends on the source (internal/external) and nature (visual, documentary,
oral).
General Reliability Factors:

● External evidence (e.g., third-party confirmation) is more reliable than internal evidence.
● Internal evidence is more reliable if internal controls are strong.
● Documentary & written evidence is more reliable than oral representations.
● Auditor-obtained evidence is more reliable than entity-provided evidence.

Methods to Obtain Audit Evidence

1. Inspection – Examining records, documents, or tangible assets. Reliability depends on

source and internal controls.
2. Observation – Witnessing a process or procedure being performed by others.
3. Inquiry & Confirmation – Seeking information from knowledgeable persons;
confirmation verifies recorded information.
4. Computation – Checking arithmetic accuracy or performing independent calculations.
5. Analytical Review – Studying significant ratios, trends, and investigating unusual
fluctuations.

Audit Procedure to Obtain Audit Evidence

As per SA-315 and SA-330, auditors obtain audit evidence through:

1. Risk Assessment Procedures – Understanding the entity, its environment, and internal
controls to assess risks of material misstatements.
2. Further Audit Procedures, which include:
a. Tests of Control (Compliance Procedures) – Assess operational effectiveness of
internal controls.
b. Substantive Procedures – Tests of details and analytical procedures to verify
account balances and transactions.

Tests of Control (Compliance Procedures)

● Observing control procedures being performed.

● Inspecting documentation as evidence of control execution.
● Using CAATs (Computer-Assisted Audit Techniques) in computerized systems.

Substantive Procedures

● Tests of Details – Directly verifying transactions and balances.

○ Example: Physical verification of inventory to confirm existence.
● Analytical Procedures – Studying trends, ratios, and investigating anomalies.
○ Example: Comparing revenue trends over years to identify inconsistencies.
Audit Note Book

● Definition: A record maintained during an audit to note issues, misstatements, frauds,

and matters needing clarification.
● Purpose: Ensures important concerns are addressed and assists in discussions with
management.
● Maintained separately for each client.

Contents of Audit Note Book

1. Business Details – Name of the enterprise, organization structure.

2. Legal Documents – Key provisions of MOA & AOA.
3. Previous Auditor – Communication records, if applicable.
4. Management Inputs – Representations, instructions.
5. Books of Accounts – List of records maintained.
6. Accounting & Controls – Methods followed, internal control systems, applicable laws.
7. Key Personnel – Important managerial staff.
8. Errors & Frauds – Discovered issues requiring action.
9. Clarifications Needed – Matters requiring explanation.
10. Audit Report Highlights – Special points for attention.

Unit 6.2 Brief Introduction to Auditing Standards

Concept of Standards on Auditing

● Definition: Guidelines for auditors to conduct audits effectively.

● Formulated By: Professional accounting bodies.
● Input From: Industry, academia, regulators, and stakeholders.
● Purpose: Ensure audit quality, consistency, and reliability.
● Scope: Covers principles, techniques, and best practices.

Purpose of Standards on Auditing

a. Provide a reference for audit procedures.

b. Reduce audit risk significantly.
c. Protect auditors from negligence allegations.
d. Enhance audit quality and public trust.
International Auditing and Assurance Standards Board (IAASB)

● Established: 1977 by IFAC to harmonize the accountancy profession globally.

● Function: Independent standard-setting body under IFAC.
● Objective:
○ Develop and issue high-quality auditing standards.
○ Promote convergence of international and national standards.
○ Enhance audit uniformity and quality worldwide.
○ Strengthen public confidence in the audit profession.

Auditing and Assurance Standards Board (AASB)

● Established by ICAI: Originated as the Auditing Practices Committee (APC) in 1982,

converted to AASB in 2002.
● Purpose: Ensures global alignment of Indian auditing standards with IAASB (IFAC).
● Composition: Includes ICAI council members, SEBI, RBI, IRDA, IIMs, and industry
representatives.

Objectives and Functions of AASB

1. Review & Identify: Assess global auditing trends and determine areas for new
standards.
2. Formulate Standards: Develop Engagement Standards, Quality Control Standards, and
Statements on Auditing.
3. Revise Standards: Update existing standards as per evolving audit practices.
4. Develop Guidance Notes: Provide guidance on industry-specific or general auditing
issues.
5. Update Guidance Notes: Review and revise as per changing circumstances.
6. Issue Clarifications: Provide explanations on issues arising from standards.
7. Publish Resources: Release Technical Guides, Practice Manuals, and studies for
professional guidance.

Structure of Pronouncements Issued by AASB

AASB pronouncements fall into two broad categories:

A. Engagement Standards (for different types of professional engagements)

1. Standards on Auditing (SAs): For auditing historical financial information.

2. Standards on Review Engagements (SREs): For reviewing historical financial
information.
3. Standards on Assurance Engagements (SAEs): For assurance engagements other
than audits and reviews.
4. Standards on Related Services (SRSs): For agreed-upon procedures, compilations,
and related services.
B. Standards on Quality Control (SQCs)

● Applicable to all services under Engagement Standards to ensure quality compliance.

Additional Pronouncements Issued by AASB

1. Statements on Auditing: Mandatory guidelines for professional accountants on critical

matters.
2. General Clarifications: Mandatory clarifications on issues arising from Standards.
3. Guidance Notes: Assist in implementing Engagement Standards and Quality Control
Standards, including industry-specific or general audit issues.
Procedure for Issuing Standards on Auditing (SAs)

1. Identifying Areas & Prioritization: AASB identifies the need and priority for new
auditing standards.
2. Formation of Study Groups: Task forces with ICAI members draft initial standards.
3. Exposure Draft: AASB issues a draft for public and ICAI member feedback.
4. Finalization by AASB: Comments are reviewed, and the draft is finalized.
5. Approval by ICAI Council: The Council reviews, modifies, and approves the standard
before issuance.
6. Consideration of ISAs & Local Context: International Standards, laws, and Indian
business practices are taken into account.
Unit 6.1 Nature, Scope, Objectives and
Significance of Auditing
Evolution of Auditing

1. Ancient Period (3600-3200 B.C.):

○ Audit practices existed in Egypt, Greece, and Rome for government accounts.
2. Medieval Period:
○ 12th Century: Auditing of the Corporation of the City of London.
○ 14th Century: Shakespeare’s reference to auditors in Timor of Athens suggests
established auditing practices.
○ 1314: England officially appoints auditors for public accounts.
○ 1494: Luca Pacioli introduces Double Entry Bookkeeping.
3. Industrial Revolution & 19th Century:
○ Large-scale businesses emerge, requiring independent verification of
transactions.
○ 1866: England’s Exchequer and Audit Department established.
○ 1870: The Institute of Accountants in England formed; became ICAEW in 1880.
4. Auditing in India:
○ Existed in Maurya, Gupta, and Mughal eras.
○ 1857: Joint Stock Companies Act introduces optional annual audits.
○ 1913: Companies Act makes audits mandatory.
○ 1956: Companies Act ensures only qualified professionals conduct audits.
○ 1965: Introduction of Cost Audit.
○ 1984: Tax Audit introduced under Income Tax Act, 1961.
○ 1995-97: Valuation and CENVAT audits under Central Excise Act.
○ 2013: Companies Act, 1956 replaced by Companies Act, 2013.
5. Modern Developments:
○ Globalization, liberalization, and privatization impact auditing.
○ Advanced technology and economic changes improve auditing techniques,
standards, and professional ethics.

Concept and Definitions of Auditing

Auditing has evolved significantly over time, shifting from a narrow focus on financial verification
to a broader role in assessing overall organizational performance.

A. Narrow Perspective

● Origin: The word audit is derived from the Latin audire, meaning "to hear," as auditors
originally listened to explanations about financial statements.
● Definition by Experts:
 ○ Taylor & Perry: Audit is an investigation of financial statements to form a report
based on examined evidence.
○ F.R.M De Paula: Audit is the examination of financial statements to ensure they
fairly represent a company’s financial position.
○ Prof. Montgomery: Auditing is a systematic review of records to verify financial
operations.
○ M.L. Shandilya: Auditing involves inspecting, verifying, and scrutinizing accounts
to determine financial accuracy.
○ Spicer & Pegler: An audit ensures that the Balance Sheet and Profit & Loss
Account give a true and fair view of financial performance.

Key Focus:

● Limited to checking financial records.

● Ensures accuracy and reliability of financial statements.

B. Broader Perspective

● Modern Concept: Auditing now evaluates financial and non-financial aspects of an

organization.
● Definitions:
○ ICAI General Guidelines on Internal Auditing: Audit is a systematic and
independent examination of data, records, and operations to assess accuracy
and performance.
○ SA 200 (Basic Principles Governing an Audit): Audit is an independent
examination of financial information for expressing an opinion, regardless of an
entity's size or nature.

Key Focus:

● Evaluates overall efficiency and effectiveness.

● Includes financial and operational assessments.
● Aims for transparency, accountability, and better decision-making.

Essential Features of Auditing

1. Verification & Evaluation – Assesses reliability of documents, vouchers, and

explanations.
2. Analytical & Investigative – Critically reviews accounting systems and internal controls.
3. Covers All Information – Includes both financial and non-financial data.
4. Standardized Approach – Follows set auditing and accounting standards.
5. Independent & Qualified Auditor – Requires professional competence and objectivity.

6. Ensures Reliability – Confirms accuracy and fairness of financial statements.

Nature of Auditing

1. Verification of Financial Statements – Ensures financial reports align with reporting

frameworks.
2. Examination of Accounting Data – Assesses accuracy and reliability through evidence
evaluation.
3. Use of Internal & External Evidence – Reviews records, vouchers, confirmations, and
expert opinions.
4. Expanded Scope – Includes compliance, cost records, operational, and performance
audits.
5. Systematic & Independent – Involves unbiased examination and professional
judgment.
6. Analytical & Investigative – Goes beyond mechanical verification to logical evaluation.
Scope of Auditing

1. Initially Limited – The scope was narrow in ancient times but has expanded
significantly.
2. Determining Factors – Governed by engagement terms, legislation, and ICAI
pronouncements.
3. Comprehensive Examination – The auditor must review all relevant aspects, even if
not explicitly mentioned.
4. Legal Compliance – Engagement terms cannot restrict audit scope when legislation or
ICAI guidelines require broader coverage.

Scope of Audit as per SA-200

1. Assessment of Information – Evaluates reliability and sufficiency of accounting records

using:
○ Compliance Procedures (review of accounting systems & internal controls).
○ Substantive Procedures (testing accuracy, authenticity & completeness of
records).
 2. Financial Statement Disclosure – Ensures adherence to GAAP, Accounting Standards,
and Companies Act.
3. Judgment & Materiality – Focuses on significant transactions affecting the
organization’s financial position.

Basic Principles of Audit (SA 200)

1. Integrity & Independence – Auditor must be honest, unbiased, and free from influence.
2. Confidentiality – Client information must remain private unless legally required.
3. Competence – Audit should be conducted by skilled professionals.
4. Supervision – Auditor is responsible for reviewing delegated work.
5. Documentation – Maintain proper working papers as audit evidence.
6. Planning – Understand the client’s business to design audit procedures.
7. Audit Evidence – Obtain sufficient and appropriate evidence.
8. Internal Controls – Assess accounting systems and controls.
9. Reporting – Issue an appropriate audit report based on findings.

Objectives of Auditing (SA 200)

1. Reasonable Assurance – Ensure financial statements are free from material

misstatements (fraud or error) and comply with financial reporting standards.
2. Reporting – Express an opinion on financial statements and communicate findings as
per auditing standards.

Primary and Secondary Objectives of Auditing

1. Primary Objective – Ensure financial statements provide a true & fair view of the
financial position and performance of a business, as required under Section 143 of the
Companies Act, 2013.
2. Secondary Objective – Detect frauds and errors in financial records and report
material misstatements if found.

Social Objectives of Auditing

While fulfilling its primary and secondary objectives, an audit also serves certain social
objectives, such as:

1. Protecting shareholders' interests

2. Preventing tax evasion
3. Safeguarding against capital erosion
4. Ensuring fair returns for investors
5. Maintaining reasonable prices for customers
6. Ensuring fair compensation for workers
7. Complying with corporate social responsibility (CSR) policies
Significance of Auditing

Legal Perspective:

● Accepted by tax and sales authorities.

● Facilitates loan approvals and insurance claims.
● Aids in bankruptcy and insolvency cases.

Internal Control Perspective:

● Detects frauds and errors early.

● Ensures employee accountability.
● Provides management insights.
● Maintains consistency in financial records.

External Perspective:

● Simplifies account settlements and business valuation.

● Helps assess future business trends.

Advantages of Audit

1. Protects stakeholders' interests.

2. Acts as a deterrent against fraud and errors.
3. Ensures employees maintain accurate records.
4. Enhances reliability for government authorities (e.g., tax audits).
5. Identifies wastages and losses, enabling corrective actions.
6. Aids in corporate restructuring and valuations.
7. Required by banks, financial institutions, and government for financial assistance.
8. Helps in smooth settlement of partner accounts, preventing disputes.

Inherent Limitations of an Audit

1. Detection Limitations: Audit does not guarantee the identification of all material
misstatements due to:
○ Test-based approach.

○ Persuasive rather than conclusive audit evidence.

○ Internal control limitations, such as management override.
2. Professional Scepticism: Auditors must remain alert to risks of fraud or errors,
questioning unusual transactions and assessing the reliability of management’s
representations.
3. Materiality Considerations: Auditors judge materiality based on financial impact,
relevance, and economic influence, which may vary based on circumstances.
Classification of Auditing

I. Organisational Structure-wise Classification

A. Statutory Audit

A Statutory Audit is conducted as per legal requirements. Laws define its scope, reporting
format, and appointment process. It is mandatory for companies, government bodies, banks,
and insurance firms.

● Governing Laws:
○ Companies Act, 2013 (for companies).
○ Comptroller and Auditor General (CAG) guidelines (for government audits).
○ IRDAI/RBI regulations (for insurance & banks).

● Appointment of Auditor:
○ By shareholders in a General Meeting.
○ By the Central Government if shareholders fail to appoint one.
○ Must be a Chartered Accountant with a valid Certificate of Practice (COP).

Advantages of Statutory Audit:

● Ensures financial statements are true, fair, and reliable.

● Assists in tax assessments and compliance.
● Facilitates mergers, acquisitions, and settlement of partner accounts.
● Strengthens internal control systems and checks mismanagement.
● Enhances trust for banks, investors, and creditors.
● Helps in securing financial assistance and government grants.
● Ensures proper profit distribution and legal compliance.

B. Non-Statutory Audit

A Non-Statutory Audit is conducted voluntarily, not mandated by law. It is undertaken for

reliability and internal control improvements.

Advantages for Sole Proprietors:

● Strengthens internal controls.

● Enhances credibility of financial statements.
● Facilitates easier tax assessments and loan approvals.
● Provides moral checks on employees.

Advantages for Partnership Firms & Others:

● Helps settle accounts among partners fairly.

● Protects interests of inactive partners.
 ● Aids in goodwill valuation during partner admission/retirement.
● Enhances credibility for securing loans and resolving disputes.

Even entities not legally required to conduct an audit often do so voluntarily to reap these
benefits.

II. Objective-wise Classification of Audit

A. Internal Audit

As defined by The Institute of Chartered Accountants of India (ICAI), Internal Audit is an

independent management function that continuously assesses an entity’s operations. Its
primary aim is to enhance governance, risk management, and internal controls.

Key Features of Internal Audit:

● Provides transparency in financial reporting.

● Identifies irregularities and non-compliances early, unlike Statutory Audit, which reviews
past transactions.
● Strengthens internal control mechanisms and risk management strategies.
● Evaluates policies and procedures beyond financial matters.

B. Independent Financial Audit

An Independent Financial Audit is conducted by a qualified auditor to assess the
truthfulness and fairness of an entity’s financial statements. It may be conducted voluntarily or
as required by law for certain entities.

Key Aspects:

● Applies to sole proprietorships, partnerships, non-profits, and corporations.

● Ensures financial statements are free from misstatements.
● Enhances credibility and aids in regulatory compliance.

III. Periodicity-wise Classification of Audit

A. Periodical or Final Audit

Final Audit is conducted at the end of the accounting year after the books of accounts have
been closed. It ensures minimal disruption to the client’s business operations and is
completed in one session due to its continuous nature.

Advantages of Final Audit:

● Cost-effective as it requires one-time execution.

● Non-disruptive to ongoing accounting functions.
● Planned approach enhances audit efficiency.
● Less risk of tampering since books are already closed.

Limitations of Final Audit:

● Errors and frauds are detected only at the end of the year, making it difficult to fix
responsibility.
● Delays in financial reporting and presentation of financial statements.
● Sample testing approach reduces the chances of detecting all frauds.

B. Interim Audit

Interim Audit is conducted between two annual audits for a specific period (e.g., quarterly or
half-yearly). It is commonly used for interim financial reporting and purposes like dividend
declaration or business valuation.

Uses of Interim Audit:

● Helps in ascertaining interim profit/loss and declaring interim dividends.

● Assists in partnership changes (admission, retirement, or death of a partner).
● Supports valuation of goodwill and net worth in business acquisitions.
● Aids in fraud investigation when irregularities are suspected.
● Helps in obtaining loans from financial institutions.

Limitations:
 ● Figures audited during interim audits may be altered later.
● Lacks legal status as it is not the final audit.

C. Continuous Audit

According to the Institute of Internal Auditors, USA, continuous auditing is an automated

method used to assess control and risk frequently. Instead of periodic reviews, it involves
ongoing testing of 100% of transactions throughout the year.

Basic Features of Continuous Audit:

● Conducted throughout the year at regular or irregular intervals.

● Uses technology for automated monitoring.
● Involves surprise visits by auditors.
Provides real-time detection of errors and frauds.

When Continuous Audit is Necessary:

● Internal controls are weak and require close monitoring.

● Large volume of transactions is handled regularly.
● Management requires frequent audit reports for better decision-making.

Advantages of Continuous Audit:

● Early detection of frauds and errors, preventing major losses.

● Quick rectification of mistakes.
● Ongoing guidance from auditors improves financial management.
● Timely finalization of accounts at year-end.
● Acts as a moral check on employees, improving efficiency.
● Enhances statutory audit effectiveness by reducing routine work.

Demerits of Continuous Audit:

● Alteration of records after audit checks.

● Frequent visits may inconvenience staff.
● Clash of duties between auditors and internal staff.
● More expensive due to increased audit hours.
● Repetitive work may make auditing mechanical.

D. Limited Review

● Purpose: Quarterly and year-to-date financial review as per SEBI regulations.

● Scope: Less detailed than a full audit; does not follow GAAS.
● Timeframe: Financial results must be submitted within 45 days of each quarter (except
the last one).
● Process: Limited examination of books without full access to all supporting documents.
 ● Assurance: Provides limited assurance instead of a comprehensive audit opinion.
● Importance: Ensures regulatory compliance and timely financial disclosures to stock
exchanges.

IV. Scope-wise Classification of Audit

1. Complete Audit – Covers all business aspects; rarely practical due to vast scope.
2. Partial Audit – Limited to specific areas; scope defined in engagement terms.
3. Detailed Audit – Examines transactions from recording to final financial impact.

V. Subject Matter-wise Classification of Audit – Concise Pointers

1. Cost Audit – Reviews cost records and ensures accurate cost reporting.
2. Management Audit – Evaluates management efficiency, planning, and control.
3. Operational Audit – Assesses efficiency and effectiveness of business operations.
4. Tax Audit – Verifies tax compliance and accuracy of taxable income.
5. Social Audit – Examines corporate social responsibility and societal impact.
6. Propriety Audit – Ensures financial discipline and adherence to rules.
7. Forensic Audit – Investigates financial fraud and irregularities.
8. Performance Audit – Reviews government programs for efficiency and accountability.
9. Secretarial Audit – Checks compliance with corporate laws and regulations.
10. Human Resource Audit – Evaluates HR policies, compliance, and efficiency.
11. Information Systems Audit – Assesses IT systems for security, efficiency, and data
integrity.
12. Environmental Audit – Reviews compliance with environmental laws and sustainability
practices.
Unit 7.7 National Financial Reporting Authority
(NFRA)
Background

Governance & Quality Control: Accounting and auditing quality are crucial for governance.
NACAS Establishment: The Central Government set up the National Advisory Committee on
Accounting Standards (NACAS) under Section 210A of the Companies Act, 1956.
Purpose of NACAS: To advise on accounting standards and auditing procedures.
Replacement by NFRA: NACAS was replaced by the National Financial Reporting Authority
(NFRA) under the Companies Act, 2013.
Role of NFRA: NFRA is a quasi-judicial body overseeing accounting and auditing matters.

Constitution of NFRA: The National Financial Reporting Authority (NFRA) was established on
1st October 2018 by the Government of India under Section 132(1) of the Companies Act, 2013.

Composition of NFRA:

● Chairman: An eminent individual with expertise in accounting, auditing, finance, or law.

● Members: Up to 15 members can be part of the NFRA.

NFRA Structure: The NFRA is made up of the following committees:

○ Accounting Standards Committee

○ Auditing Standards Committee
○ Enforcement Committee

NFRA Duties (Section 132(2) of Companies Act, 2013):

1. Recommend Standards: Recommend accounting and auditing policies for company

approval by the Central Government.
2. Monitor & Enforce Compliance: Monitor and ensure adherence to accounting and
auditing standards.
3. Oversee Quality: Oversee the quality of services ensuring compliance with standards
and suggest improvements.
4. Other Functions: Perform any additional functions necessary to support these duties.

Public Interest Protection (NFRA Rules, 2018):

● Protect public, investor, creditor interests by establishing high-quality accounting and

auditing standards.
● Ensure effective oversight of accounting and auditing functions performed by companies
and auditors.
NFRA’s Role in Auditing

A. Recommending Auditing Standards

● NFRA recommends auditing policies and standards for adoption by companies, with
approval from the Central Government.
● It receives recommendations from the Institute of Chartered Accountants of India (ICAI)
on new or amended auditing standards.
● NFRA may seek additional information from ICAI and will consider all recommendations
before making final recommendations.

B. Monitoring & Enforcing Compliance with Auditing Standards

● Monitoring & Review: NFRA reviews audit documents, evaluates auditors' quality
control systems, and tests audit procedures as necessary.
● Governance Reporting: Auditors may be required to report on governance practices to
promote audit quality and reduce risks.
● Additional Information: NFRA can request additional information or require auditors'
personal presence for clarifications.
● Expert Involvement: Monitoring and enforcement are performed by officers with
relevant audit industry experience.
● Public Disclosure: NFRA may publish findings of non-compliance on its website unless
public interest requires otherwise.
● Confidentiality: Proprietary or confidential information will not be published unless
necessary for public interest.

C. Power to Investigate

● NFRA has the power to investigate professional or misconduct matters, either under
Section 132(4) or based on its own oversight activities.
● Suo-Motu Investigations: NFRA can initiate investigations into misconduct after
recording written reasons.
● Fraud Reporting: If evidence suggests fraud involving over ₹1 crore, NFRA must report
to the Central Government.
● Exclusivity of Investigation: NFRA exclusively initiates actions for professional
misconduct against auditors of companies under its purview.
● Other Misconduct Cases: ICAI continues proceedings for auditors of other companies
under the Chartered Accountants Act, 1949.
Unit 7.6 Report on Internal Financial Control over
Financial Reporting
Internal Financial Control promotes risk management and governance to reduce instances of
fraud within an organization.

Defined in Section 134(5)(e), it refers to policies and procedures that ensure:

● Efficient conduct of business operations.

● Adherence to company policies.
● Safeguarding assets.
● Prevention and detection of frauds and errors.
● Accuracy and completeness of accounting records.
● Timely preparation of reliable financial information.

Importance of Internal Financial Control:

● Reduces the auditor's burden.

● Provides reasonable assurance about the accuracy of accounts and results.

Section 143(3)(i) of the Companies Act, 2013: The auditor's report must state whether the
company has adequate Internal Financial Control (IFC) in place and evaluate the effectiveness
of such controls.
Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014: Requires the Board of Directors’
report for all companies to include details about the adequacy of internal financial controls with
reference to the financial statements.
Section 143(3)(i) of Companies Act, 2013: Requires auditors to report on the adequacy and
effectiveness of Internal Financial Controls (IFC) in place.
Rule 10A of Companies (Audit & Auditors) Rules, 2014:

● For financial years starting on or after 1st April 2015, auditors must report on the
existence and effectiveness of IFC.
● Auditors may voluntarily report on IFC for the financial year ending on or before 31st
March 2015.

Auditor’s Objective: To express an opinion on the effectiveness of the company’s internal

financial controls over financial reporting.
Global Reporting Standards: Auditor’s report on internal controls is combined with the report
on financial statements and relates only to internal financial controls over financial reporting.

Internal Financial Controls over Financial Reporting: Includes policies and procedures to:

● Ensure accurate records of transactions and asset dispositions.

 ● Record transactions to allow preparation of financial statements in accordance with
accounting principles.
● Prevent or detect unauthorized use or disposal of assets that could impact financial
statements.

Audit Process: Involves planning, testing control design and effectiveness, and reporting on
IFC over financial reporting.
Consolidated Financial Statements: Reporting applies to IFC-FR for respective components
included in consolidated financial statements if they are companies under the 2013 Act.
Exclusion of Interim Reports: Reporting on IFC does not apply to interim financial statements
unless required by law or regulation.
Unit 7.5 Audit Report, Report vs. Certificate,
Reporting Requirements under Companies Act,
Contents of the Reports and Modifications in the
Report (with Coverage of CARO)

Audit Report:

● Definition: An audit report is a written communication from the auditor to the appointing
authority, expressing their opinion on whether the financial performance and position of
the organization exhibit a true and fair view.
● Purpose: The primary purpose of the audit report is to communicate the auditor's
opinion on the financial statements after conducting an audit.
● Lancaster's Definition: According to Lancaster, a report is a statement of facts that is
clear and concise, intended to provide information to those who do not already have full
knowledge of the subject matter.
● Audit Report as the Final Step: Preparing the audit report is the last step in the audit
process, where the auditor finalizes and communicates their findings and opinion on the
financial statements.

Audit Certificate:

● Definition: An audit certificate is a written confirmation by the auditor asserting the

accuracy of the facts stated within it, without involving any estimate or opinion.
● Purpose: When an auditor certifies a statement, it means that the contents are
measurable, and the auditor has verified the accuracy of the data provided.
● Dicksee's Definition: According to Dicksee, a certificate "makes certain" the facts, and
it is limited to facts that can be absolutely verified.
● Key Difference from Audit Report: Unlike an audit report, which expresses an opinion,
an audit certificate verifies factual accuracy with no room for estimation or subjective
judgment.

Good Audit Report:

1. Simplicity: The report should be easy to understand, written in simple language, and
self-explanatory.
2. Clarity: The auditor should clearly mention the purpose of the audit, sources of
information, findings, and their overall opinion in an unambiguous manner.

3. Brevity: The report should be concise and specific, including all relevant information
while avoiding unnecessary details.
 4. Firmness: The report should assert whether the financial statements represent a true
and fair view of the business’s performance and financial status.
5. Objectivity: The report should be based on objective evidence, minimizing bias and
relying on verifiable data.
6. Disclosure: The report should disclose all relevant facts truthfully, based on the
materiality of the concerned items.
7. Impartiality: The report should be unbiased, with impartial and objective
recommendations.
8. Information-based: Only relevant and accurate information should be included in the
audit report.
9. Timeliness: The report should be prepared and presented within the stipulated time
frame to assist in timely decision-making.

Requirements as per the Companies Act, 2013:

1. Section 143(2): Auditor must report if financial statements reflect a true and fair view of
the company's financial position.
2. Section 143(3): Auditor must confirm that:

○ Necessary information was obtained from management.

○ Proper books of account were maintained.
○ Financial statements comply with accounting standards.
○ Any qualifications or adverse remarks.
○ Adequate internal controls are in place.

3. Section 143(4): If any negative answers are given, the auditor must explain the reasons.
4. Section 143(5): In government companies, auditors must report any directions issued by
the Comptroller and Auditor General (CAG).
5. Section 143(12): Auditor must report any fraud discovered during the audit to the
Central Government.
6. Companies (Auditor’s Report) Order: Auditor’s report must include prescribed
matters.
7. Rule 11 of Companies (Audit and Auditors) Rules 2014: The report must include
views on:
○ Pending litigations.
○ Provisions for foreseeable losses on long-term contracts.
○ Delays in transferring funds to the Investor Education and Protection Fund.
○ Loans and investments made to or from intermediaries.
○ Compliance with Section 123 regarding dividends.
○ Use of accounting software with audit trail for financial records (from April 2022).

Basic Elements/ Contents of Audit Report as per Standards on Auditing

The basic elements/contents of an audit report as per SA-700 (Revised) are as follows:
1. Title: The report must have an appropriate title, such as "Independent Auditor’s Report,"
to differentiate it from other reports.
2. Addressee: The report should be addressed according to the terms of engagement,
typically to the appointing authority, such as the members of a public limited company.
3. Auditor’s Opinion:
○ The first section should state the auditor's opinion, specifying the name of the
client, the audited financial statements, significant accounting policies,
explanatory information, and the date and period of the financial statements
audited.
4. Basis for Opinion:
○ This section explains the basis for the auditor's opinion. It includes statements
on:
■ Compliance with applicable standards on auditing.
■ A reference to the section that describes the auditor’s responsibilities.
■ The auditor’s independence.
■ The sufficiency and appropriateness of audit evidence.

5. Report on Going Concern Assumption:

○ If applicable, the auditor must report on the going concern assumption under SA
570 (Revised).

6. Key Audit Matters:

○ For audits of complete sets of general-purpose financial statements of listed
entities, the auditor needs to communicate key audit matters (matters of most
significance in the audit, like valuation of goodwill, financial instruments, etc.), as
per SA 701. Legal or regulatory requirements may also mandate communication
of key audit matters for other entities.

7. Responsibilities for the Financial Statements:

○ This section explains that the management is responsible for the preparation of
financial statements and the maintenance of internal controls. The auditor
references SA 200 and SA 210, which require management to ensure the
financial statements are free from material misstatement and assess the entity's
ability to continue as a going concern.

8. Auditor’s Responsibilities for the Audit of the Financial Statements:

○ The auditor’s responsibilities include:
■ Obtaining reasonable assurance that the financial statements are free
from material misstatement.
■ Exercising professional judgment and maintaining professional skepticism
throughout the audit.
■ Assessing the risk of material misstatements and understanding internal
control systems.
 ■ Evaluating the appropriateness of accounting practices and
management’s use of the going concern assumption.

9. Other Reporting Responsibilities:

○ If applicable, other legal and regulatory requirements must be reported under a
separate heading titled “Report on Other Legal and Regulatory Requirements."

10. Signature of the Auditor:

○ The report should be signed by the auditor (engagement partner) in their
personal name. If the audit firm is appointed, the report is signed in the auditor’s
personal name and the name of the firm. The auditor’s membership number and
the firm’s registration number (where applicable) must be included.

11. Place of Signature:

○ The report must specify the location (usually the city) where the auditor’s report is
signed.

12. Date of the Auditor’s Report:

○ The date on which the auditor signs the report is the date of the audit report.

Contents of Audit Report as per Companies (Auditor’s Report) Order 2020

The Companies (Auditor’s Report) Order 2020 (CARO 2020), notified by the Ministry of
Corporate Affairs on 25th February 2020, applies to statutory audits of certain companies for
financial years beginning on or after 1st April 2021, i.e., for the 2020-21 financial year. The
key provisions of CARO 2020 are as follows:

A. Notification

● CARO 2020 replaces CARO 2016.

● It specifies the matters that must be included in the auditor's report for each company
subject to the order, as per Section 143 of the Companies Act, 2013.

B. Eligible Companies

CARO 2020 applies to all companies, including foreign companies as per the definition under
Section 2(42) of the Companies Act, except for the following types of companies:

1. Banking Companies: As defined under Section 5(c) of the Banking Regulation Act,
1949.
2. Insurance Companies: As defined under the Insurance Act, 1938.
3. Section 8 Companies: Companies licensed under Section 8 of the Companies Act,
which are formed for promoting commerce, art, science, religion, sports, charity, or any
other similar objectives.
 4. One Person Companies (OPC): As defined under Section 2(62) of the Companies Act.
5. Small Companies: As defined under Section 2(85) of the Companies Act.
6. Private Limited Companies (that are neither subsidiaries nor holding companies of a
public company) with:
○ A paid-up capital and reserves and surplus not exceeding one crore rupees
at the balance sheet date.
○ Total borrowings not exceeding one crore rupees from any bank or financial
institution at any point during the financial year.
○ Total revenue (including from discontinued operations) not exceeding ten crore
rupees during the financial year as per the financial statements.

Contents of CARO

Non-current Assets [Clause 3(i)]:

● Records and verification of assets: The auditor checks if the company maintains
proper records of assets, including details and locations of property, plant, equipment,
and intangible assets. This also includes verifying the physical existence of assets at
reasonable intervals.
● Title deeds: The auditor verifies whether title deeds for immovable properties are held in
the company's name.
● Revaluation of assets: The auditor ensures that any revaluation of assets is based on a
valuation by a registered valuer and checks for any material changes in the carrying
value.
● Benami properties: The auditor must report whether the company is holding any
benami properties, as defined under the Benami Transactions (Prohibition) Act, 1988.

Inventory [Clause 3(ii)]:

● Physical verification: The auditor checks whether inventory has been physically
verified at reasonable intervals and whether the verification procedure is adequate.
● Discrepancies: Any discrepancies in inventory of 10% or more should be reported,
including how the company addresses these discrepancies.

Investment, Providing Guarantee/security, Granting Loan or Advances

[Clause 3(iii)]:

● Investments and loans: The auditor verifies if the company has made investments,
provided loans, or guarantees. The terms and conditions are assessed to ensure they
are not prejudicial to the company’s interests.
● Repayment schedule: For loans, the auditor ensures there is a clear schedule for
repayment of principal and interest.
Loan to Director and Investment by the Company [Clause 3(iv)]:

● The auditor checks compliance with provisions under Sections 185 and 186 of the
Companies Act, particularly regarding loans and investments made by the company to
directors and related parties.

Acceptance of Deposits [Clause 3(v)]:

● Compliance with RBI directives: If the company accepts deposits, the auditor checks
whether the company is complying with the RBI directives and applicable provisions
under the Companies Act.

Statutory Dues [Clause 3(vii)]:

● Payment of statutory dues: The auditor ensures that the company regularly deposits
statutory dues like provident fund, income tax, sales tax, etc. They must also report any
outstanding dues for over six months.
● Pending disputes: The auditor must disclose any pending disputes related to taxes or
other statutory dues and the forum where the disputes are pending.

Disclosure of Unrecorded Income [Clause 3(viii)]:

● The auditor assesses whether any income not recorded in the company’s books has
been disclosed during tax assessments, and whether such income has been properly
recorded.

Repayment of Loan [Clause 3(ix)]:

● Loan repayment default: The auditor reports any defaults in loan repayments or
interest payments.
● Use of funds: The auditor checks whether funds raised through loans were applied for
the intended purpose.

Related Party Transaction [Clause 3(xiii)]:

● The auditor ensures that transactions with related parties comply with Sections 177 and
188 of the Companies Act, and that these transactions are properly disclosed in the
financial statements.

Reporting of Fraud [Clause 3(xi)]:

● Fraud reporting: The auditor reports any fraud committed by or against the company
during the year, including the nature and amount involved.
 ● Whistleblower complaints: The auditor considers whistleblower complaints, if any, and
reports on the nature and outcome.

Different Types of Opinions in Audit Reports

The opinions expressed in audit reports issued by statutory auditors can broadly be categorized
into two types: (A) Unmodified Opinion and (B) Modified Opinion.

A. Unmodified Opinion:

● An audit report with an unmodified opinion is also known as a 'Clean Report' or

'Unqualified Report'.
● The auditor expresses this opinion when they are satisfied that the financial statements
present a true and fair view of the company's financial position and performance during
the audit period.
● The auditor issues an unmodified opinion when the following criteria are met:
1. Consistency: The financial statements have been prepared using Generally
Accepted Accounting Principles (GAAP), consistently applied.
2. Compliance: The financial statements comply with relevant statutory regulations
and requirements.
3. Adequate Disclosure: There are adequate disclosures of all material matters
relevant to the proper presentation of the financial information, subject to
statutory requirements.
4. Changes in Accounting Principles: Any changes in accounting principles or
methods and their effects have been properly determined and disclosed.

B. Modified Opinion:

A modified opinion is expressed when the auditor concludes that there is a need for
modification in the audit report, which can happen in two circumstances as per SA 700
(Revised):

1. Material Misstatement: The auditor concludes that the financial statements, as a whole,
are not free from material misstatements.
2. Inability to Obtain Sufficient Evidence: The auditor is unable to obtain sufficient
appropriate audit evidence to conclude that the financial statements are free from
material misstatements.

There are three types of modified opinions:

1. Qualified Opinion:

A qualified opinion is expressed when:

 ● The auditor concludes that misstatements, either individually or in aggregate, are
material but not pervasive (i.e., not highly significant).
● The auditor is unable to obtain sufficient appropriate audit evidence but concludes that
the possible effects of undetected misstatements could be material but not pervasive.
● Pervasive refers to the effect of misstatements that are not confined to specific
elements, accounts, or items, and could represent a substantial proportion of the
financial statements or are fundamental to users' understanding.
● Some situations where a qualified opinion is appropriate:
○ Non-adherence to AS-2: Regarding inventory valuation at the lower of cost and
net realizable value.
○ Prevented by management: The auditor was prevented from observing the
counting of physical inventory, which is material to the financial statements.

2. Adverse Opinion:

An adverse opinion is expressed when:

● The auditor concludes that misstatements, either individually or in aggregate, are both
material and pervasive to the financial statements.
● Some situations when an adverse opinion might be issued:
○ Going concern: Financial statements were prepared on a going concern basis
even though the company planned to cease operations within six months.
○ Inadequate provision: There was inadequate provision for doubtful debts.

3. Disclaimer of Opinion:

A disclaimer of opinion is issued when:

● The auditor is unable to obtain sufficient appropriate audit evidence to base their opinion.
● The auditor concludes that the possible effects of undetected misstatements could be
both material and pervasive.
● In rare circumstances, the auditor may disclaim an opinion if the uncertainties involved
are so numerous that their cumulative effect cannot be reasonably determined.
● Some situations where a disclaimer of opinion is appropriate:
○ Management interference: The auditor was prevented from observing the
physical inventory count and performing other procedures like obtaining external
confirmations for debtors, creditors, and bank balances.
○ Non-receipt of branch reports: The auditor did not receive branch audit reports
from a significant number of branches.

Deciding on Appropriate Modified Opinion (As per SA 705)

The decision on whether to issue a modified opinion and, if so, which type, depends on two
key factors:
 1. The nature of the matter that gives rise to the modification.
2. The auditor’s judgment about the pervasiveness of the effects on the financial
statements.

The following table explains how the auditor should decide on an appropriate modified opinion
based on these two factors.

Audit Report with ‘Emphasis of Matter’ and ‘Other Matter’ Paragraphs

A. ‘Emphasis of Matter’ Paragraph (SA 706)

As per SA 706 (Revised), the Emphasis of Matter paragraph is used by the auditor when,
after forming an opinion on the financial statements, there is a matter that, although
appropriately presented or disclosed in the financial statements, is so significant that it is
fundamental for users' understanding of the financial statements.

Conditions for Emphasis of Matter Paragraph:

1. The auditor does not modify the opinion on the financial statements in accordance
with SA 705 as a result of the matter.
2. The matter has not been determined to be a key audit matter under SA 701 that
needs to be communicated in the auditor’s report.

How to Include Emphasis of Matter Paragraph:

● The paragraph should be included in a separate section of the auditor’s report with a
heading that includes the term ‘Emphasis of Matter’.
● It should clearly reference the matter being emphasized and where relevant
disclosures can be found in the financial statements.
● It should state that the auditor’s opinion is not modified in respect of the emphasized
matter.

Examples of Circumstances for Including Emphasis of Matter Paragraph:

1. Uncertainty regarding the outcome of exceptional litigation or regulatory action.

2. Significant subsequent events occurring between the date of the financial statements
and the date of the auditor’s report.
 3. Early application of a new accounting standard that has a material effect on the
financial statements.
4. A major catastrophe that has had, or continues to have, a significant effect on the
entity’s financial position.

B. ‘Other Matter’ Paragraph (SA 706)

The Other Matter paragraph is included by the auditor when they believe it is necessary to
communicate a matter that is not presented or disclosed in the financial statements but is
relevant to users’ understanding of the audit, the auditor’s responsibilities, or the auditor’s
report.

Conditions for Other Matter Paragraph:

1. The matter is not prohibited by law or regulation.

2. The matter has not been determined to be a key audit matter under SA 701 that
needs to be communicated in the auditor’s report.

How to Include Other Matter Paragraph:

● The paragraph should be included in a separate section with the heading ‘Other
Matter’ or another appropriate heading.

Circumstances in Which an Other Matter Paragraph May Be Necessary:

1. When relevant to users’ understanding of the audit, such as when specific details
about the audit process need to be explained.
2. When relevant to users’ understanding of the auditor’s responsibilities or the
auditor’s report, such as when there are specific legal or regulatory responsibilities to
highlight.
3. When reporting on multiple sets of financial statements that require clarification or
distinction in the report.
4. When there is a restriction on the distribution or use of the auditor’s report, such as
if the report cannot be shared with third parties outside of a specified group.
Unit 7.4 Audit of Various Items of Financial
Statements (with Special Emphasis on Audit of
Inventory and PPE)

Audit of Financial Statement Items - Concept

● Guidance: Financial statements in India are prepared in accordance with:

○ Accounting standards by the Institute of Chartered Accountants of India.

○ Indian GAAP (Generally Accepted Accounting Principles).
○ Companies Act, 2013, through Schedule III for format.

● Audit Process: Involves examining:

○ The company’s financial statements.

○ Related disclosures in the Note to Accounts section.
○ Focuses on various items recorded in the financial statements.

Vouching and Verification

● Vouching:

○ Examines accuracy, authority, and authenticity of transactions in the books using

vouchers.
○ Ensures:

■ All transactions are recorded, with nothing left out.

■ Transactions are supported by documentary evidence.
■ No fraudulent transactions are recorded.
■ Transactions belong to the correct accounting year (accrual basis).
■ Necessary vouchers are with the client.
■ Transactions are properly authorized.
■ Transactions are recorded at the correct value and calculated accurately.
■ Transactions are relevant to the organization.
■ Proper accounting entries are made.

● Verification:

○ Substantiates assets and liabilities recorded by physical inspection and

examining legal/official documents.
 ○ Involves:
■ Examination of existence, ownership, and possession of assets/liabilities.
■ Checking for charges against assets.
■ Verifying the accounting of assets/liabilities.
■ Ensuring correct valuation of assets/liabilities.
■ Ensuring adequate disclosures as required by regulations.

● Application in Audit: Both vouching and verification are used to examine financial
statement items.

Role of Management Assertions in Designing the Audit Procedure

● Definition of Assertions: In auditing, assertions are implicit or explicit claims made by

management about the financial statements, regarding various elements such as
completeness, existence, and valuation.
● Key Assertions by Management:
○ Completeness: All transactions and balances that should be included are
recorded.
○ Cut-off: Transactions are recorded in the correct accounting period.
○ Existence/Occurrence: Assets, liabilities, and transactions exist and have
occurred.
○ Valuation/Measurement: Assets and liabilities are accurately valued and
measured.
○ Rights and Obligations: The company holds rights to its assets and obligations
for its liabilities.
○ Presentation and Disclosure: Financial statements are presented and
disclosed in accordance with applicable standards.
● Role of Auditor: The auditor designs audit procedures to verify the truthfulness and
fairness of the financial statements, ensuring that the assertions made by management
are accurate.
Audit of Income Statement Items - Revenue from Operation

● Definition: Revenue from operation includes sales of goods, services, and other
operating revenues (e.g., discount received, bad debt recovery). For finance companies,
it includes interest income and income from other financial services.

Audit Procedures for Revenue from Operations

1. Occurrence:
○ Ensure all revenue transactions are genuine and not duplicated.
○ Test-check invoices with accounting entries and review sales invoice sequences.
○ Confirm transactions with customers to verify authenticity.
○ Verify that no fake sales have been recorded.
○ Ensure service revenue is recognized as per the company’s policy.

2. Cut-off:
○ Ensure that only revenue from sales and services performed within the year is
included.

3. Completeness:
○ Verify that all sales during the year have been included.
 ○ Apply cut-off procedures to ensure proper revenue recognition at year-end.

4. Measurement:
○ Ensure revenues are measured accurately according to applicable accounting
standards.
○ Check trade discounts and ensure no separate entries for them.
○ Verify that sales taxes, insurance, etc., are recorded separately from revenue.

5. Presentation and Disclosures:

○ Ensure proper disclosures for revenue from operations:
■ By class of goods for non-finance companies.
■ Revenue from sale of products, services, and other operating revenues,
less excise duty.
■ For finance companies, disclose revenue from interest and other financial
services.
○ Disclose discounts beyond usual trade discounts and related party transactions.
○ For service companies, disclose gross income from services rendered under
broad categories.

Audit of Income Statement Items - Other Income

● Definition: Other income includes interest income (for companies other than finance
companies), dividend income, net gain on the sale of investments, and other
non-operating income such as royalties and lease rentals.

Audit Procedures for Other Income

1. Occurrence:
○ Obtain a list of new fixed deposits, including rate, tenure, and date of investment.
○ Obtain confirmation of interest income from the bank and a copy of Form 26AS to
confirm interest income and related TDS.
○ Investigate the investment ledger for new investments (corporate bonds,
debentures, shares) and check the interest/dividend income generated.
○ Trace a sample of dividend/interest received from the cash book through
warrants to investment certificates and their deposit into the bank.
○ Verify net gain/loss on sale of investments using relevant documents such as
DEMAT and trading account details.

2. Cut-off:
○ Ensure interest income does not include unearned interest and includes only
accrued interest on investments.

3. Completeness:
○ Verify all interest and dividend received have been recorded appropriately.
 4. Measurement:
○ Check the accuracy of interest calculations for new and existing fixed deposits.
○ Ensure dividend income received is accurate.
○ For interest/dividend received after TDS deduction, ensure the amounts are
recorded at gross.
○ Ensure proper adjustment of pre-acquisition dividends/interest with the cost of
investment.

5. Presentation and Disclosure:

○ Ensure proper disclosure as per Schedule III (Part 2):
■ Interest Income (for non-finance companies).
■ Dividend Income.
■ Net gain/loss on sale of investments.
■ Other non-operating income (net of attributable expenses).

Audit of Income Statement Items - Purchases

● Definition: Purchases include the cost of raw materials in a manufacturing organization

and the cost of merchandise in a trading organization. The auditor ensures the accuracy
of reported purchase amounts and accounts payable.

Audit Procedures for Purchases

1. Occurrence:
○ Ensure that only genuine purchases have been recorded in the books of
accounts. This can be done by examining purchase orders, goods received
notes, and purchase invoices.
○ Photocopies of purchase invoices should not be allowed; purchase invoices must
be in the name of the entity.
○ Check whether all purchases are approved by the relevant authority, particularly
for purchases from related parties.
2. Cut-off:
○ Ensure that only purchases made during the year are recognized as expenses in
the current period.

3. Completeness:
○ Apply the cut-off procedure to ensure that purchases are recorded in the current
accounting period.
○ Ensure that the purchase invoice is booked only after the transfer of risk and
reward related to ownership, considering delivery terms like F.O.B and C.I.F.
○ Carefully check return transactions based on relevant documents.
○ Ensure the correct accounting of goods-in-transit.

4. Measurement:
 ○ Ensure the correct calculation of purchase transaction values, considering any
trade discounts applied.
○ Verify information regarding input tax credit and ensure appropriate adjustments
are made in this regard.

5. Presentation and Disclosure:

○ Ensure proper disclosure as per Schedule III (Part 1):
■ Manufacturing Companies: Disclosure of raw materials and goods
purchased under broad heads.
■ Trading Companies: Disclosure of purchases of goods traded under
broad heads.
■ Transactions with related parties must be separately disclosed.

Audit of Income Statement Items - Employee Benefit Expenses

● Definition: Employee benefit expenses encompass all amounts payable by the

organization to its employees, including wages and salaries, perquisites,
post-employment benefits (gratuity, superannuation, leave encashment, provident fund,
ESI contributions), and welfare expenses. These expenses often represent a significant
portion of total costs, and auditors must ensure their proper recording and compliance.

Audit Procedures for Employee Benefit Expenses

1. Occurrence:
○ Ensure all employee benefit expenses are genuine and appropriately recorded.
○ Obtain a complete list of employees, including data on new hires, their
appointment dates, and remuneration terms and conditions.
○ For a sample of new employees, conduct a thorough examination of their
appointment and remuneration as per the terms.
○ Review the list of employees who resigned or were terminated during the year to
ensure their payments were properly calculated and settled.
○ Obtain and examine the payroll register to assess the reasonableness of
remuneration and investigate any irregularities.
○ Verify that all adjustments such as outstanding salary, PF contributions, TDS
deposits, and ESI premiums have been recorded accurately.

2. Cut-off:
○ Ensure that only employee benefit expenses relating to the current year have
been recognized.

3. Completeness:
○ Verify that all employee benefit expenses have been properly recorded in the
books of accounts.
 ○Ensure that any amounts deducted from salaries (e.g., employee contributions)
have been duly deposited and if not, shown as current liabilities.
4. Measurement:
○ Check that the total remuneration amount is correctly calculated, possibly by
conducting a test on a sample.
○ Ensure that statutory deductions, such as taxes and post-employment benefits,
have been determined according to the adopted policy.

5. Presentation and Disclosure:

○ Ensure compliance with Schedule III (Part 1) disclosure requirements,
specifically:
■ Employee benefits expense should be separately disclosed as:
■ Salaries and wages
■ Contributions to provident and other funds
■ Expenses related to Employee Stock Option Schemes (ESOP)
and Employee Stock Purchase Plans (ESPP)
■ Staff welfare expenses

Audit of Income Statement Items - Depreciation and Amortisation

● Definition: Depreciation is the allocation of the cost of a tangible asset over its useful
life, while amortisation refers to the similar process for intangible assets. These charges
are significant to a company’s overall expenditure and have a direct impact on
profitability, making their audit crucial to ensure accuracy and appropriateness.

Audit Procedures for Depreciation and Amortisation

1. Occurrence:
○ Obtain the fixed asset register and identify items of assets that were acquired,
sold, or discarded during the year. This will help determine which assets are
eligible for depreciation and amortisation.
○ Select a sample of assets based on materiality considerations and verify the
rates and amounts of depreciation and amortisation calculated.

2. Cut-off:
○ Ensure that depreciation is charged on assets from the date they are put to use,
not from the purchase date.
○ If the company uses a time-based depreciation policy, ensure that depreciation is
calculated from the date the asset is put to use until the year-end for assets
acquired during the year, and for assets sold, depreciation should be calculated
from the beginning of the year up to the date of sale.

3. Completeness:
 ○ Ensure that depreciation and amortisation have been charged on all eligible
tangible and intangible assets, and verify that no fake assets have been
considered for depreciation.
○ Ensure that the depreciation and amortisation amounts have been appropriately
accounted for in the primary books and posted to the correct accounts.
○ Verify that depreciation on revalued amounts has been properly accounted for
from the revaluation reserve.
○ Ensure that any retrospective change in the method of depreciation has been
appropriately reflected in the Income Statement.

4. Measurement:
○ Ensure that the rate of depreciation is consistent with the rates suggested in
Schedule II, and that depreciation and amortisation amounts have been
calculated accurately based on the rates and time involved.
○ Ensure that the rates used for depreciation conform to the effective life of the
assets.
○ Verify that the residual value of assets has been properly determined.
○ Check that in case of changes in the estimated useful life or impairment,
depreciation is recalculated appropriately.

5. Presentation and Disclosure:

○ Ensure the following disclosures are made in accordance with Schedule III (Part
1):
■ Accounting policy for depreciation and amortisation.
■ Useful life of assets as per Schedule II.
■ Residual value and the method of depreciation.

Audit of Finance Cost

Finance cost primarily comprises interest expenses on structured debt instruments, such as
debentures, and traditional finance sources like bank loans (secured or unsecured). To conduct
an audit of finance costs, the auditor needs to review the schedule of loans and information
regarding debt instruments, interest rates, and loan tenures. This helps determine the interest
cost for the relevant period.

Audit Procedures for Finance Cost

1. Occurrence:
○ Ensure that interest has been provided for all eligible debt instruments and loans.
○ Verify the amount of interest payment using bank statements and cross-check it
with accounting entries in the cash book and general ledger.

○ Confirm that interest was paid and provided only on loans that were outstanding
either for part of the year or for the entire year.
 2. Cut-off:
○ Ensure that interest has been provided only for the period during which the loan
was outstanding in the current year.
3. Completeness:
○ Verify that interest due but not yet paid has been considered as accrued interest
and appropriately accounted for and shown in the financial statement.
4. Measurement:
○ Verify the calculation of interest payable based on the rate, loan amount
outstanding, and the duration for which the loan was outstanding during the year.
○ Pay extra attention to loans repaid during the year and debentures redeemed
during the year to ensure that the interest calculation is accurate.
5. Presentation and Disclosure:
○ Ensure compliance with disclosure requirements as per Schedule III (Part 1) and
relevant Accounting Standards (or Ind AS) for finance costs.

Audit of Other Expenses

Other expenses include power and fuel, rent, repairs, insurance, traveling, and miscellaneous
costs. The auditor must ensure these are valid, appropriately classified, and authorized.

Audit Procedures:

1. Occurrence
○ Verify that all expenses are legitimate with supporting documents.
○ For rent, power, fuel, and insurance, check schedules and agreements for
completeness and correctness.
○ For legal and professional expenses, confirm authenticity through summaries and
verify monthly costs.
2. Cut-off:
○ Ensure expenses apply only to the current year, especially for advances like rent
and insurance.
3. Completeness:
○ Confirm that transactions are authenticated, classified correctly, and properly
recorded, including adjustments for outstanding or prepaid expenses.
4. Measurement:
○ Verify the calculation of monthly expenses, adjustments, and ensure
reasonableness through past data or analytical procedures.
5. Presentation and Disclosure:
○ Ensure compliance with disclosure requirements as per Schedule III, especially
regarding correct classification of expenses.

Audit of Balance Sheet Items

Property, Plant, and Equipment

PPE includes assets like land, buildings, plant, and vehicles, held for use in business
operations. The audit process follows the Guidance Note and relevant Accounting Standards
(AS 10 or Ind AS 16).

Audit Procedures:

1. Existence:
○ Conduct physical verification and compare with asset register.
○ Investigate discrepancies and ensure non-working assets are deleted.

2. Rights and Obligations:

○ Verify that PPE additions are approved, follow internal procedures, and are in the
company's name.
○ For land/buildings, check title deeds and confirm any charge with lenders if
applicable.
○ Verify deletions have appropriate authorization and rationale.
3. Cut-off:
○ Ensure assets and depreciation are properly accounted for as of the reporting
date.
4. Completeness:
○ Verify the PPE schedule, reconcile opening and closing balances, and ensure
accuracy.
5. Valuation:
○ Ensure assets are valued at cost less depreciation and impairment.
○ Confirm depreciation is calculated correctly as per Schedule II of the Companies
Act 2013.
○ Verify impairment assessments and accounting treatments.
6. Presentation and Disclosure:
○ Ensure proper disclosure under ‘Non-current Assets’ as per Schedule III of the
Companies Act 2013, including in the 'Notes to Accounts'.

Patent and Copyright

● Patent: An exclusive right granted to the inventor to make, use, and sell an invention.
● Copyright: An exclusive right granted to the creator of a work (literary, music, art) to
publish or republish it.

Audit Procedures:

1. Existence:
○ Obtain a schedule of patents and copyrights.
○ Physically verify registration documents and confirm active use.
2. Rights and Obligations:
 ○ Verify ownership through the certificate of patent and contract papers for
copyrights.
○ Check agreements for purchased patents and copyrights.
○ Ensure renewal receipts and fees are correctly handled.
3. Cut-off:
○ Confirm assets are properly accounted for as of the reporting date, with
amortization pertaining only to the current period.
4. Completeness:
○ Verify all patents and copyrights are properly listed in the register, and ensure
additions and deletions are recorded.
○ Check the accuracy of asset movement in the register.
5. Valuation:
○ Ensure patents and copyrights are recorded at cost less amortization.
○ For purchased patents and copyrights, include registration and acquisition costs.
○ In-house developed patents should have all related development costs
capitalized.
○ Write off the cost over the patent’s legal or useful life, whichever is shorter.
6. Presentation and Disclosure:
○ Ensure patents and copyrights are disclosed under ‘Non-current Assets’ as per
Schedule III of the Companies Act 2013.
○ Ensure all relevant details are disclosed in the ‘Notes to Accounts’ section.

Investments

Investments are assets held by an enterprise to earn income or capital appreciation. These can
include government securities, shares, debentures, and mutual funds. They are classified as
either Non-current investments or Current investments as per Schedule III of the Companies
Act, 2013.

Audit Procedures:

1. Existence:
○ Obtain a detailed schedule of all investments with relevant details (name, nature,
purchase price, etc.).
○ Cross-check the aggregate figure of investments with the balance sheet.
○ Physically verify investment certificates or demat statements to confirm
ownership as of the reporting date.
○ For investments not yet received, verify purchases through allotment advice,
broker’s notes, etc.
○ If investments are not in the entity’s custody, obtain a certificate from the relevant
authority.
2. Rights and Obligations:
○ Verify the company's power to invest by reviewing its Memorandum and Articles.
○ Verify the company's rights regarding dividends and interest, ensuring that all
interest has been duly received and recorded.
 ○ Ensure outstanding interest is recalculated and accurately reflected in the
accounts.
3. Cut-off:
○ Ensure the balance sheet includes all investments owned by the company as of
the reporting date.
4. Completeness:
○ Confirm the schedule of investments is exhaustive and includes all investments.
○ Ensure all movements in the investment ledger are properly recorded.
5. Valuation:
○ Ensure that all costs related to the purchase of investments have been
capitalized correctly.
○ Check that bonus shares are recorded in the investment ledger without assigning
a cost to them.
○ Verify that pre-acquisition dividends are credited to the investment account, not
the profit and loss statement.
○ Ensure the valuation of investments aligns with relevant accounting standards.
6. Presentation and Disclosure:
○ Verify that investments are disclosed under ‘Non-current Assets’ and ‘Current
Assets’ within the subhead ‘Financial Assets’ in the balance sheet as per
Schedule III of the Companies Act, 2013.
○ Ensure that all relevant details are disclosed in the ‘Notes to Accounts’ section.

Inventories/Stock in Trade

Inventory includes raw materials, work-in-progress, finished goods, and goods in consignment
or on sale/approval. Management is responsible for verifying and valuing inventory annually,
and the auditor follows a set procedure to confirm this.

Audit Procedures:

1. Existence:
○ Verify the client’s plan for physical inventory checks and ensure proper
supervision.
○ For periodic systems, count inventory at period-end; for perpetual systems, count
at interim dates.
○ Confirm inventories with third-party locations.
2. Rights and Obligations:
○ Verify ownership through documentation (purchase invoices, orders).
○ Review consignment and collateral agreements.
○ Obtain third-party confirmations for held inventory.
3. Cut-off:
○ Ensure inventory values are correct and reflect ownership as of the reporting
date.
4. Completeness:
○ Perform analytical procedures and cut-off tests for abnormal inventory.
 ○ Reconcile physical inventory with perpetual records.
5. Valuation:
○ Confirm inventory valuation method (LIFO, FIFO, etc.).
○ Ensure raw materials, work-in-progress, and finished goods are valued at cost or
NRV.
6. Presentation and Disclosure:
○ Classify inventory under “Current Assets” in the balance sheet.
○ Disclose inventory details (classification, goods-in-transit, valuation method) in
the Notes to Accounts.

Loans

Loans include both long-term and short-term loans and advances as per the Companies Act,
2013.

Audit Procedures:

1. Existence:

○ Verify loan schedules with ledger balances.

○ Obtain written confirmations from borrowers.
○ For claims (e.g., insurance), ensure only admitted claims are shown as
loans/advances.
○ Verify statutory returns (IT, GST) match the amounts recorded in books.
2. Rights and Obligations:
○ Ensure loans are authorized by the Memorandum and Articles of Association.
○ Verify related party loans and security documentation (mortgages, etc.).
○ Ensure employee advances are being regularly deducted from salaries.
3. Cut-off:
○ Confirm loans recorded in the Balance Sheet include all outstanding loans as of
the reporting date.
4. Completeness:
○ Ensure all outstanding loans and advances are recorded.
○ Verify recovery of amounts against advances.
5. Valuation:
○ Obtain aging schedules for loans and details of loans under litigation.
○ Assess adequacy of allowances for doubtful loans.
○ Ensure bad loans are appropriately moved to provisions or written off with proper
authorization.
6. Presentation and Disclosure:
○ Loans should be classified under Non-current and Current Assets as per
Schedule III.
○ Ensure all relevant information is disclosed in the Notes to Accounts.
Trade Receivable

Trade Receivable refers to amounts due from customers for goods and services rendered in
the normal course of business, excluding advances or loans.

Audit Procedures:

1. Existence:
○ Obtain and verify debtor schedules signed by a responsible officer, ensuring they
match the ledger accounts.
○ Verify the validity, accuracy, and recoverability of trade receivable balances.
○ Review debtor aging, ensuring proper determination and credit terms.
2. Rights and Obligations:
○ Confirm that the company has valid claims on the amounts shown as trade
receivables.
○ Examine bills and notes receivable to ensure they are legally held by the
company.
3. Cut-off:
○ Ensure the receivable balance represents only the amounts outstanding on the
reporting date.
4. Completeness:
○ Confirm all debtors and receivables are included, with confirmation from debtors
if necessary.
○ Inspect relevant correspondence (e.g., court orders for insolvency,
correspondence on bad debts).
○ Perform subsequent realizations verification.
5. Valuation:
○ Recompute and compare provisions for bad and doubtful debts to assess
reasonableness.
○ Verify calculations for bill discounts, and investigate any excessive rebates or
discounts.
○ Examine bad debts written off.
6. Presentation and Disclosure:
○ Trade receivables must be sub-classified as secured/unsecured, good or
impaired.
○ Disclose allowances for bad and doubtful debts separately.
○ Specify debts due by directors, officers, or related parties.
○ Provide an aging schedule for outstanding trade receivables.

Cash and Cash Equivalents

Cash and Cash Equivalents include cash in hand, stamps, balances in current accounts,
margin money, cash credit accounts, fixed deposits, and cheques in hand. These are the most
liquid assets, requiring careful auditing.
Audit Procedures:

1. Existence:
○ Perform surprise physical verification of cash in hand.
○ Test cash book entries for accuracy, ensuring any advances are properly
documented.
○ Conduct cash sensitivity analysis to detect any unusual variations in monthly
receipts and payments.
○ Obtain and review Bank Reconciliation Statements (BRS) for all bank accounts,
ensuring they are signed and discrepancies are addressed.
○ Communicate with banks for written confirmation of balances held.
2. Rights and Obligations:
○ Ensure all deposits are in the company’s name by examining bank confirmations
and deposit certificates.
3. Cut-off:
○ Verify that cash balances reflect amounts on the reporting date.
4. Completeness:
○ Confirm 100% of bank accounts and include all cash in hand in the total balance.
5. Valuation:
○ Ensure foreign currency balances are restated at the exchange rate on the
reporting date.
6. Presentation and Disclosure:
○ Ensure disclosures comply with relevant accounting standards and Schedule III
of the Companies Act 2013.

Share Capital

Share Capital refers to the capital raised by a company through the issuance of shares to the
public or private investors. For public companies, this process involves issuing a prospectus,
making allotments, and appointing underwriters. An auditor must carefully verify all related
aspects during the audit of share capital.

Audit Procedures:

1. Existence:
○ Reconcile the opening and closing share capital balances to identify any new
issues, capitalisation, buybacks, or redemptions.
○ Ensure that any changes in share capital are within the authorised capital limit.
○ Verify that changes in share capital are properly authorised through resolutions
from the Board of Directors (BOD) and shareholders.
2. Rights and Obligations:
○ Ensure that the new issue complies with the Companies Act, 2013, SEBI
regulations, and other guidelines.
○ Verify that shares have not been issued at a discount and, if issued at a premium,
ensure proper usage of the share premium balance.
 ○ For issues like sweat equity, right shares, or bonus shares, confirm compliance
with relevant rules.
3. Cut-off:
○ Ensure that the share capital balance reflects the amount as of the reporting
date.
4. Completeness:
○ Confirm that all changes in share capital are properly recorded and reflected in
the accounting entries.
5. Valuation:
○ Verify that the total proceeds from share capital are correctly calculated,
allocated, and include any underwriter’s commission and settlement of accounts.
6. Presentation and Disclosure:
○ Ensure the following disclosures as per Part I of Schedule III of the Companies
Act 2013:
■ Number and amount of authorised, issued, and fully paid/subscribed
shares.
■ Par value per share.
■ Reconciliation of outstanding shares.
■ Rights, preferences, and restrictions attached to shares.
■ Shareholding details, including any shareholder with more than 5% of
shares.
■ Shares reserved for issue under options, contracts, or commitments.
■ Terms of any convertible securities.
■ Unpaid calls, forfeited shares, and details of the shareholding of
promoters.

Other Equity

Other Equity, as per Schedule III, Division 2 of the Companies Act, 2013, includes:

1. Share application money pending allotment

2. Equity component of compound financial instruments
3. Reserves and Surplus (Capital Reserve, Securities Premium, Retained Earnings, etc.)
4. Debt instruments through Other Comprehensive Income (OCI)
5. Equity instruments through OCI
6. Effective portion of Cash Flow Hedges
7. Revaluation Surplus
8. Foreign currency translation reserves
9. Other items of OCI
10. Money received against share warrants

While some components can be used for dividend payments, others, such as Securities
Premium and Capital Redemption Reserve, have specific restrictions on usage.

Audit Procedures:
 1. Existence:
○ Verify and reconcile opening and closing balances of reserves.
○ Ensure additions (e.g., premium from new share issues, transfers to reserves)
are genuine and properly authorized.
○ Investigate any reductions and validate the transactions.
2. Rights and Obligations:
○ Ensure compliance with relevant laws and regulations.
○ Verify that reserves are utilized only for their specified purposes.
3. Cut-off:
○ Ensure each item in Other Equity reflects the correct balance as of the reporting
date.
4. Completeness:
○ Confirm that all changes in Other Equity are recorded accurately and reflected in
the financial statements.
5. Valuation:
○ Validate calculations for additions and utilizations, such as dividend payments,
ensuring compliance with the Companies (Declaration and Payment of Dividend)
Rules, 2014.
6. Presentation and Disclosures:
○ Ensure compliance with Schedule III, Part 1:
■ Classification of reserves (Capital Redemption Reserve, Debenture
Redemption Reserve, Share Options Outstanding, etc.).
■ Retained Earnings as the balance from the Statement of Changes in
Equity.
■ Earmarked reserves must be disclosed separately.
■ Debit balance of Profit & Loss should be shown as a negative under
Retained Earnings.
■ Each Other Equity component must be disclosed with its nature and
amount.

Borrowings

Borrowings include both long-term (for business expansion, asset purchase) and short-term
(for working capital financing) loans.

Audit Procedures:

1. Existence:
○ Obtain a schedule of all borrowings (date, term, interest rate, loan amount,
pledged assets).
○ Verify loan agreements and ensure loans are recorded in the company’s name.
○ Obtain and match bank confirmations with recorded balances.
2. Rights and Obligations:
○ Review the Articles and Memorandum of Association for borrowing rules.
○ Verify Board resolutions approving the loans.
 ○ Examine loan agreements and compliance with terms.
○ Confirm asset pledging details and nature of charges (fixed/floating) to prevent
unauthorized disposal.
3. Completeness:
○ Ensure all loans are reported and no fully repaid loans remain outstanding.
○ Verify new loans in Board meeting minutes.
○ Cross-check pledged asset details and charge nature.
4. Valuation:
○ Ensure consistency in loan accounting methods.
○ Verify timely interest payments and outstanding dues.
○ For amortizing loans (installment-based), confirm classification of current
maturities.
5. Presentation and Disclosure:
○ Classify non-current and current borrowings per Schedule III of the Companies
Act, 2013.
○ Disclose current maturities of long-term loans under Current Liabilities with
footnotes.
○ Report restrictive covenants in financial statements.
○ Ensure pledged asset charges are reflected in the Balance Sheet.
○ If the security value is insufficient, classify the loan as secured only up to its
market value.

Audit Procedures for Trade Payables

A. Sundry Creditors

1. Existence
○ Verify the internal control system for creditor transactions.
○ Cross-check the trade creditors' schedule with ledger balances.
○ Obtain confirmation from selected creditors.
○ Cross-verify information from General Ledger with Creditors' Ledger Control
Account.
2. Rights and Obligations
○ Ensure compliance with contract terms and verify goods/services received.
○ Examine Goods Inward Book for confirmation.
3. Cut-off
○ Ensure the balance includes only outstanding amounts as of the reporting date.
4. Completeness
○ Confirm that no creditor is omitted from the schedule.
○ Verify year-end transactions carefully.
5. Valuation
○ Match the schedule's total with creditors' balances.
○ Check invoices, purchase records, and return transactions.
○ Verify discounts received and long-outstanding payments for fraud risks.
 6. Presentation and Disclosure
○ Ensure classification under Current Liabilities → Trade Payables in the
Balance Sheet.
○ Segregate MSME and non-MSME dues as per Schedule III of the Companies
Act, 2013.

○ Verify disclosure in Notes to Accounts.

B. Bills Payable

1. Existence
○ Verify the bills payable schedule with relevant books/accounts.
○ Ensure bills are outstanding and not expired.
○ Check recording of bill acceptance/dishonour.
2. Rights and Obligations
○ Examine bill conditions and legal compliance.
○ Verify any asset charges due to bill acceptance.
3. Cut-off
○ Ensure only outstanding bills as of the reporting date are included.
4. Completeness
○ Confirm no bills are omitted or expired bills included.
○ Obtain written confirmation from management.
5. Valuation
○ Ensure schedule totals match the bills payable account.
○ Verify dishonoured bills through correspondence, notary notifications, and bank
statements.
○ Check renewal of dishonoured bills and interest recording.
6. Presentation and Disclosure
○ Ensure classification under Current Liabilities → Trade Payables in the
Balance Sheet.
○ Segregate MSME and non-MSME dues as per Schedule III of the Companies
Act, 2013.
○ Verify disclosure in Notes to Accounts.

Audit of Special Transactions – Alteration of Share Capital (Section 61)

1. Authorization Check
○ Confirm that the alteration is permitted by the Articles of Association.
2. Approval Verification
○ Examine Board meeting minutes and ordinary resolution passed in the
general meeting.
3. Legal Compliance
○ Verify the updated Memorandum and Articles of Association reflecting the
alteration.
○ Obtain reasons for the alteration of share capital.
 4. Impact on Shareholders
○ Check for changes in voting percentages due to share consolidation or division.
5. Denomination Compliance
○ Ensure the altered share capital’s denomination is more than one rupee.
6. Accounting & Records
○ Verify that proper accounting entries have been passed.
○ Cross-check the Register of Members for necessary updates.

Audit of Special Transactions – Issue of Bonus Shares (Section 63)

1. Authorization Check
○ Confirm that the issue of bonus shares is permitted by the Articles of
Association.
2. Approval Verification
○ Verify Board meeting minutes and ordinary resolution passed in the general
meeting.
3. Eligibility & Compliance
○ Ensure that only fully paid-up bonus shares are issued to existing members.
○ Confirm that revaluation reserves are not capitalized for issuing bonus shares.
4. Financial Dues Check
○ Verify that the company has no default in:
■ Payment of interest or principal on fixed deposits/debt securities.
■ Payment of statutory dues (PF, gratuity, bonus) of employees.
5. Additional Verifications
○ Ensure partly paid-up shares (if any) are made fully paid-up before bonus
issuance.
○ Confirm that bonus shares are not issued in lieu of dividends.

Audit of Special Transactions – Splitting of Shares

1. Authorization Check
○ Confirm that the splitting of shares is permitted by the Articles of Association.
2. Approval Verification
○ Verify Board meeting minutes and ordinary resolution passed in the general
meeting.
3. Legal Documentation
○ Ensure that the alteration is properly reflected in the Memorandum & Articles of
Association.
4. Accounting & Record Maintenance
○ Verify that proper accounting entries have been recorded.
○ Check the Register of Members to confirm necessary updates.

Audit of Special Transactions – Re-issue of Forfeited Shares

 1. Authorization Check
○ Confirm that the Board of Directors has the authority under the Articles of
Association to reissue forfeited shares.
○ Verify the Board resolution approving the reissue.
2. Verification of Amounts Collected
○ Check the amounts collected from allottees and ensure proper recording of
re-allotment entries.
○ Ensure that the total amount received (including pre-forfeiture payments) is not
less than the par value of the shares.
3. Accounting Treatment
○ Verify that any surplus from reissue is correctly credited to the Capital
Reserve Account.
4. Compliance with Section 53
○ If partly paid shares are forfeited for non-payment and later reissued as fully
paid, confirm compliance with Section 53 regarding allotment at a discount.

Audit of Special Transactions – Issue of Debentures and Redemption of

Debentures

Issue of Debentures

1. Verification of Prospectus Filing

○ Ensure the prospectus has been duly filed with the registrar before the date of
allotment of debentures.
2. Check of Amount Collected
○ Verify the amount collected in the cash book with receipts issued to
applicants and cross-check with the application and allotment book.
3. Examine Debenture Trust Deed
○ Review the debenture trust deed for terms related to issue and repayment.
4. Mortgage and Charge Registration
○ If debentures are secured, verify that the charge has been properly recorded in
the register of mortgages and charges and registered with the registrar of
companies.
5. SEBI Compliance
○ Ensure compliance with SEBI guidelines for the debenture issue.
6. Debentures Issued as Consideration
○ Verify the contract for debentures issued as fully paid-up to vendors as part of
the purchase consideration.

Redemption of Debentures

1. Examine Debenture Trust Deed

○ Inspect the debenture trust deed for terms and conditions regarding
redemption.
2. Check Directors' Minute Book
 ○ Ensure the Director’s minute book authorizes the redemption of debentures.
3. Vouch Redemption
○ Vouch the redemption using debenture bonds cancelled and the cash book.
4. Accounting Treatment
○ Thoroughly examine the accounting treatment of debenture redemption.

A. Sources of Dividend (Section 123(1))

● Dividend Declaration: A company can declare dividends only out of:

○ Profits of the current financial year after providing for depreciation.
○ Undistributed profits from previous years after depreciation.
○ Government-provided funds for dividend payments.

B. Transfer to Reserves

● Before declaring dividends, a company may transfer a portion of its profits to reserves as
per its discretion.

C. Payment of Dividend from Accumulated Profits

● If a company does not have sufficient profits in the current year, it may declare dividends
from accumulated profits of previous years, but it must follow specific rules:
1. Dividend rate should not exceed the average rate of the last 3 years.
2. Total amount drawn should not exceed one-tenth of paid-up capital and free
reserves.
3. The amount drawn should be used to cover current year's losses before
declaring dividend.
4. Remaining reserves should not fall below 15% of paid-up capital.

D. Interim Dividend

● The Board of Directors can declare interim dividends during the financial year from the
surplus profit.
● If there are losses in the current financial year, the dividend declared cannot exceed the
average of the last 3 years' dividends.

E. Procedure for Dividend Payment (Section 123(4) & 123(5))

● Dividend must be deposited in a separate account within 5 days of declaration.

● Dividends can be paid only to registered shareholders or their designated banker.
● Payment can be made in cash, cheque, warrant, or any electronic mode.
F. Restriction on Dividend Declaration

● A company failing to comply with provisions under sections 73 and 74 (related to

borrowing and repayments) cannot declare dividends on equity shares.

G. Unpaid Dividend (Section 124)

● Unpaid or Unclaimed Dividends: If dividends are not claimed within 30 days, they must
be transferred to a "Unpaid Dividend Account" in a scheduled bank within 7 days.
● Transfer to IEPF: If unpaid dividends remain unclaimed for 7 years, they must be
transferred to the Investor Education and Protection Fund (IEPF).
● Interest on Default: Failure to transfer unpaid dividends to the Unpaid Dividend Account
results in interest at 12% per annum, benefiting shareholders.

Penalties for Non-Compliance

● The company may face a penalty of ₹1 lakh, with a further ₹500 per day of continuing
non-compliance (maximum ₹10 lakh).
● Officers in default can be fined ₹25,000, with a further ₹100 per day of continuing default
(maximum ₹2 lakh).

H. Punishment for Failure to Distribute Dividends [Section 127]

Once a dividend is declared, the company must pay the dividend or at least post the dividend
warrant to every shareholder entitled to the payment within 30 days from the declaration date.

If the company fails to do so, every director who is knowingly a party to the default will be
punishable with:

● Imprisonment: Up to 2 years
● Fine: Not less than ₹1,000 for each day the default continues

In addition, the company will be liable to pay simple interest at a rate of 18% per annum for the
period during which the default continues.

However, no offense under this section will be considered committed under the following
circumstances:

1. If the failure to pay the dividend was due to any law preventing it.
2. If the shareholder provided directions that the company could not comply with, and the
company communicated this to the shareholder.
3. If there is a dispute regarding the right to receive the dividend.
4. If the dividend was lawfully adjusted by the company against any sum due to it from the
shareholder.
 5. If there is any other reason for the failure to pay or post the warrant within the prescribed
period, and the failure was not due to a default by the company.

Audit Procedure for Final Dividend

1. Examine Articles of Association: The auditor should check the company’s Articles of
Association to understand if there are any differential rights of shareholders regarding
dividends.
2. Review Board and Shareholder Meeting Minutes: The auditor must review the
minutes of the directors' and shareholders’ meetings to ensure the dividend was properly
recommended and passed by the shareholders’ resolution.
3. Verify Dividend Calculation: The auditor should verify that the amount of dividend paid
was calculated correctly.
4. Compliance Check: Ensure that the provisions of the Companies Act, 2013 and the
Companies (Declaration and Payment of Dividend) Rules, 2014 have been complied
with.
5. Bank Account Verification: Using the bank statements, the auditor must verify that the
total dividend amount was transferred to a separate bank account in a scheduled bank
within 5 days from the declaration date and that dividends were paid only from that
account.
6. Payment to Rightful Owners: The auditor must verify that the dividend has been paid
to the rightful owner. This involves checking the Dividend Register and bank statements.
Additionally, the auditor should reconcile the amount of outstanding dividend warrants
with the Dividend Register and the balance in the bank account.
7. Efforts to Distribute Dividend on Time: The auditor must assess whether the
management made sufficient efforts to distribute the dividend within 30 days of
declaration. They should investigate any cases where the dividend could not be paid
within this period.
○ If irregularities are identified, the auditor should inquire with the management
and, if unsatisfied, report these issues to the shareholders.

Audit Procedure for Interim Dividend

1. Examine Articles of Association: The auditor should review the Articles of Association
to confirm whether the payment of interim dividends is permitted.
2. Review Board Meeting Minutes: The auditor must examine the minutes of the
directors' meetings to ensure that a resolution for the interim dividend payment was
passed.
3. Justification for Interim Dividend: The auditor should critically appraise the justification
for paying the interim dividend based on interim accounts.
4. Bank Account Verification: The amount of interim dividend should be deposited in a
scheduled bank in a separate account within 5 days of the declaration of the dividend.
5. Payment to Rightful Owners: The auditor should verify the Dividend Register and bank
statements to ensure the dividend was paid to the rightful owner. They should reconcile
 the outstanding dividend warrants with the Dividend Register and the bank account
balance.

Audit Procedure for Unpaid Dividend

1. Collect Details of Unpaid Dividend: The auditor must collect a statement or list
detailing unpaid dividends, including shareholder names, amounts payable, warrant
numbers, and reasons for non-payment.
2. Investigate Company’s Fault: The auditor should conduct an enquiry to determine if
there was any fault on the company’s part and what action was taken.
3. Verify Supporting Documents: The auditor should verify the statement provided by
management with supporting documents such as the Dividend Register, returned
warrants, and bank statements. The accuracy of the dividend calculation should be
confirmed.
4. Transfer to Unpaid Dividend Account: The auditor should verify whether the unpaid
dividend has been transferred to a separate Unpaid Dividend Account within 7 days
after the 30-day payment period expires.
5. Verify Interest and Penalty: If there is any fault on the company’s part, the auditor
should verify whether interest and penalty have been deposited.
6. Check Publication of Unpaid Dividend Details: The auditor should verify whether the
company has published the details of unpaid dividends on its website and on other
government-approved websites.
7. Payment of Previously Unpaid Dividend: The auditor should verify that previously
unpaid dividends have been paid to the rightful owners.
8. Transfer to IEPF: If the dividend remains unpaid for more than 7 years, the auditor must
verify whether the dividend, along with accrued interest, has been transferred to the
Investor Education and Protection Fund (IEPF).
9. Transfer of Shares to IEPF: The auditor should also check that any shares with unpaid
dividends transferred to IEPF have also been transferred to the fund.
Unit 7.3 Secretarial Audit
Secretarial Audit: Applicability and Conduct

(a) The Companies Act, 2013:

● Applicable to:
1. Listed companies
2. Public companies with a paid-up capital of ₹50 crore or more
3. Public companies with a turnover of ₹250 crore or more
4. Companies with loans/borrowings of ₹100 crore or more
● Requirements: Secretarial Audit Report (Form MR-3) must be annexed with the Board’s
Report.
● Penalty: ₹2 lakh penalty for non-compliance by the company, officers, or the company
secretary in practice.

(b) SEBI Regulations:

● Applicable to: Listed entities and material unlisted subsidiaries in India.

● Requirements: Annex a secretarial audit report with the annual report and submit a
secretarial compliance report to stock exchanges within 60 days of the financial
year-end.
● Amendment: SEBI (LODR) Regulations were amended in May 2021.

Secretarial Audit Report

Format: The Secretarial Audit Report must be in Form MR-3 as per Section 204 and Rule 9 of
the Companies Act, 2013.

Board's Responsibility: The Board must explain any qualifications or observations in the
report.

SEBI Compliance: Listed entities and material unlisted subsidiaries must annex the report to
their annual report and submit a Secretarial Compliance Report to stock exchanges within 60
days of the financial year-end.

SEBI Circular: Formats for the Secretarial Audit and Compliance Reports were notified by SEBI
on February 8, 2019, effective from the FY ending March 31, 2019.
Unit 7.2 Cost Audit
Concept and Definition of Cost Audit

1. Definition: Independent examination of cost data to verify accuracy and compliance with
cost accounting principles.
2. Verification: Ensures accuracy of cost accounts, reports, statements, and costing
techniques.
3. Examination: Checks adherence to cost accounting procedures and objectives.
4. Objective: To authenticate results related to cost ascertainment and regulatory
compliance.
5. According to ICMA England: Verifies cost accounts and adherence to the cost
accounting plan.
6. According to ICMA India: Independent review of cost and related information for
products, irrespective of entity size or legal form, to express an opinion.

Importance of Cost Audit:

1. Decision Support: Provides authentic data for pricing policy, product mix, outsourcing,
and product discontinuation.
2. Identifies Inefficiencies: Helps in identifying inefficiencies and improving productivity.
3. Resource Optimization: Ensures optimum utilization of limited resources, benefiting
customers.
4. Cost Control Evaluation: Appraises the effectiveness of cost control mechanisms
within the organization.
5. Basis for Standard Cost: Audited cost data helps in determining standard cost data.
6. Government Decisions: Audited data on cost structures influences government
decisions on tariff protection.

Regulatory Framework of Cost Audit in India:

1. Section 148(1) of the Companies Act, 2013 authorizes the Central Government to
mandate the maintenance of cost records for certain companies.
2. Section 148(2) empowers the government to make the audit of cost records mandatory
for those companies.
3. Companies (Cost Records and Audit) Rules, 2014 were issued by the Ministry of
Corporate Affairs on 30.06.2014, and amended in December 2014.
4. The rules have been amended multiple times, with the latest amendments occurring in
2019.

Important Provisions of Companies Act 2013 & Cost Records Rules (2014):

1. Application of Cost Records [Rule 3]:

 ○ All companies, whether in regulated or non-regulated sectors, engaged in the
production of goods or providing services, with a turnover of ₹35 crore or more in
the previous financial year, must maintain cost records.
○ Foreign companies are also included under this rule.
○ Excludes micro and small enterprises as per the turnover criteria of the Micro,
Small, and Medium Enterprises Development Act, 2006.

Applicability for Cost Audit [Rule 4]:

1. For Companies under Item (A) of Rule 3:

○ Companies with an annual turnover of ₹50 crore or more, and individual
product/service turnover of ₹25 crore or more, must conduct a cost audit.

2. For Companies under Item (B) of Rule 3:

○ Companies with an annual turnover of ₹100 crore or more, and individual
product/service turnover of ₹35 crore or more, must conduct a cost audit.

3. Exceptions:
○ Companies whose revenue from exports exceeds 75% of total revenue, or those
operating in special economic zones, or engaged in electricity generation for
captive consumption, are exempt from cost audit.

4. Additional Audit Requirement:

○ Cost audit under this rule is in addition to the regular audit under Section 143 of
the Companies Act, 2013.

Maintenance of Records [Rule 5]:

1. Requirement for Cost Records:

○ Companies, including all units and branches, must maintain cost records in Form
CRA-1 for each financial year starting on or after April 1, 2014.
○ For non-regulated sectors (as specified in Rule 3), the requirement applies
starting from April 1, 2015.

2. Regular Maintenance:
○ Cost records must be maintained regularly to facilitate the calculation of per unit
production cost, cost of operations, sales cost, and margins for each
product/activity on a monthly, quarterly, half-yearly, or annual basis.

3. Purpose of Cost Records:

○ Records should help control operations and costs for optimum resource
utilization and provide necessary data for compliance with these rules.

Appointment of Cost Auditor [Rule 6]:

 1. Appointment of Cost Auditor:
○ Companies must appoint a cost auditor within 180 days from the start of each
financial year.
○ Written consent and a certificate from the cost auditor confirming eligibility and
compliance with the relevant laws must be obtained before the appointment.

2. Certificate from Cost Auditor:

○ The cost auditor must submit a certificate confirming eligibility, disqualification
status, compliance with the Companies Act, and other applicable criteria.

3. Filing with Central Government:

○ Companies must inform the appointed cost auditor and file a notice of the
appointment with the Central Government within 30 days of the board meeting or
within 180 days of the financial year’s start, using Form CRA-2.

4. Tenure of Cost Auditor:

○ The cost auditor remains in office until 180 days after the financial year closes or
until the cost audit report is submitted. The cost auditor can be removed through
a board resolution, with reasons provided.

5. Casual Vacancy:
○ Any casual vacancy in the cost auditor position must be filled within 30 days, and
the company must notify the Central Government using Form CRA-2.

6. Approval of Cost Statements:

○ The cost statements must be approved by the Board of Directors before being
submitted to the cost auditor for the report.

7. Audit Committee Role:

○ For companies required to form an audit committee, the Board shall appoint a
cost auditor on the recommendation of the committee.

5. Disqualification of Cost Auditor:

● Disqualification: Persons disqualified under Section 141(3) of the Companies Act

cannot be appointed as cost auditors.
● Restriction: A company’s appointed auditor under Section 139 cannot act as the
company's cost auditor.

6. Remuneration of Cost Auditor:

● Remuneration Determination: The Board, based on the Audit Committee's

recommendation (if any), decides the remuneration of the cost auditor. The remuneration
must be ratified by shareholders.
 ● In Absence of Audit Committee: If no audit committee is required, the Board appoints
a cost auditor, and the remuneration must still be ratified by shareholders.

7. Rights and Duties of Cost Auditor:

● Equal Rights and Duties: The rights, duties, and obligations applicable to company
auditors also apply to the cost auditor.
● Company’s Duty: It is the company’s responsibility to provide all necessary assistance
and facilities to the cost auditor for auditing the cost records.

8. Submission of Cost Audit Report:

● Form CRA-3: Cost auditor submits the audit report, including any reservations,
qualifications, or suggestions.
● To the Board: Report must be sent to the Board of Directors within 180 days from the
end of the financial year.
● To the Government: Company must file the report with the Central Government in Form
CRA-4 within 30 days of receiving the report, along with explanations for any
qualifications.
● Extended Filing: Companies with an extended AGM deadline can file CRA-4 within the
extended period for financial statements.
● Further Information: Central Government may request additional details, which the
company must provide within the specified time.

9. Forms Relevant to Cost Records and Cost Audit:

● CRA-1: For maintaining cost records.

● CRA-2: For informing the Central Government about the appointment of a cost auditor.
● CRA-3: For submitting the cost audit report.
● CRA-4: For filing the cost audit report with the Central Government.

10. Penal Provisions in Case of Default:

● Company's Default: Fine between ₹25,000 and ₹5,00,000; officers in default may face
imprisonment up to 1 year or a fine between ₹10,000 and ₹1,00,000.
● Cost Auditor's Default: Penalties as per Section 147(2) to (4).

11. Reporting Requirements of Cost Audit (CRA-3):

1. Information/Explanations: Confirm if all necessary information for the audit was

obtained.
2. Cost Records: Verify if proper cost records are maintained as per Rule 5.
3. Branch Returns: Ensure returns from unvisited branches are received.
4. Compliance: Check if books and records comply with the Companies Act, 2013.
5. Internal Audit: Assess adequacy of internal audit for cost records.
6. Fair View: Confirm if the annexed statements give a true and fair view of costs, sales,
and margins.
7. Cost Statements: Ensure unit-wise/product-wise cost statements are audited and
maintained.
Unit 7.1 Statutory Audit, Branch Audit and Joint
Audit, Role of Audit Committee

Qualifications of a Company Auditor (Section 141, Companies Act, 2013):

1. Eligibility for Appointment:

○ A person must be a Chartered Accountant to be eligible for appointment as a
company auditor. [Section 141(1)].

2. Firm as Auditor:
○ A firm can be appointed as an auditor if the majority of its partners practicing in
India are qualified Chartered Accountants. [Section 141(1)].
○ In case a firm is appointed, only Chartered Accountant partners can act and
sign on behalf of the firm. [Section 141(2)].

3. Definition of Chartered Accountant (under The Chartered Accountants Act, 1949):

○ A Chartered Accountant is a person who is a member of the Institute of
Chartered Accountants.
○ To be a member, a person must be listed in the Register of the Institute.
○ A person can become a member by:
■ Being a registered accountant or holder of a restricted certificate at the
commencement of the Act.
■ Passing prescribed examinations and completing necessary training.
■ Passing equivalent examinations, like the Government Diploma in
Accountancy, and meeting additional conditions set by the government.
■ Being engaged in the practice of accountancy as specified by the Central
Government before the commencement of the Act.
■ Completing training and exams recognized as equivalent by the Central
Government or the Institute.

4. Additional Conditions for Membership:

○ Persons domiciled in India must reside or practice in India.
○ Foreign persons with equivalent qualifications may be granted membership,
subject to additional conditions imposed by the Institute or the Central
Government.

5. Formal Application:
○ Qualified individuals must apply formally for membership in the Institute, paying
the required fees.
○ Membership is confirmed only after the acceptance of the application and
inclusion in the Register of the Institute.
Disqualification of a Company Auditor (Section 141(3) & Rule 10,
Companies (Audit and Auditor) Rules, 2014):

1. Ineligible Persons for Appointment:

○ Body corporate (except LLP registered under the LLP Act, 2008).
○ Officers or employees of the company.
○ Partners or employees of officers or employees of the company.
○ Persons with certain financial relationships:
■ Holding securities or interest worth up to ₹1 lakh in the company or its
subsidiaries.
■ Indebted to the company or its affiliates for amounts exceeding ₹5 lakh.
■ Given guarantees or provided security exceeding ₹1 lakh for third-party
indebtedness to the company.
○ Business relationship with the company (except for permitted professional
services or transactions at arm’s length).
○ Relatives of directors or key managerial personnel of the company.
○ Full-time employees elsewhere, or partners in firms auditing more than 20
companies.
○ Convicted persons (fraud-related offense within the last 10 years).
○ Persons rendering prohibited services (e.g., accounting, internal audit,
actuarial services).

2. Vacancy due to Disqualification:

○ If an auditor incurs any disqualification after appointment, they must vacate their
office. This vacancy is considered a casual vacancy. [Section 141(4)].

3. Prohibited Services under Section 144:

○ Auditors are prohibited from rendering services such as:
■ Accounting and bookkeeping services.
■ Internal audit.
■ Design and implementation of financial systems.
■ Actuarial services.
■ Investment advisory, banking, and outsourced financial services.
■ Management services.

Appointment of a Company Auditor

1. Appointment of First Auditor in Normal Course

● For Non-Government Companies (Section 139(6)):

○ The first auditor must be appointed by the Board of Directors within 30 days of
the company's registration.
○ If the Board fails to appoint the auditor, the members must appoint the auditor at
an extraordinary general meeting within 90 days.
 ○ The appointed auditor will hold office until the conclusion of the first Annual
General Meeting (AGM).

● For Government Companies (Section 139(7)):

○ In case of a Government company (defined as a company where at least 51%
of the paid-up share capital is held by the Central or State Government):
■ The Comptroller and Auditor-General of India (CAG) must appoint the
first auditor within 60 days of the company's registration.
■ If the CAG fails, the Board of Directors has 30 days to appoint the
auditor.
■ If the Board fails, the members must appoint the auditor at an
extraordinary general meeting within 60 days.
○ The auditor so appointed will hold office until the conclusion of the first AGM.
● Note: A Government company is one where the government holds at least 51% of the
paid-up share capital. This includes subsidiaries of such companies.

Provisions Relating to Appointment of Subsequent Auditor

1. For Non-Government Companies (Section 139(1), Rule 3 and 4 of Company (Audit and
Auditors) Rules 2014):

● First AGM Appointment:

○ Appoint auditor at the first AGM.

○ Auditor holds office from first AGM conclusion till sixth AGM and thereafter till
conclusion of every sixth AGM.

● Conditions for Appointment:

○ Obtain written consent and certificate from auditor.
○ Certificate must confirm compliance with Section 141 criteria.

● Notice of Appointment:
○ Inform auditor and file notice with Registrar in Form ADT-1 within 15 days of
appointment.

2. For Government Companies (Section 139(5)):

● Appointment by CAG:
○ Comptroller and Auditor-General of India (CAG) must appoint an auditor
within 180 days from the start of the financial year.

● Auditor’s Tenure:
○ Auditor holds office till conclusion of the annual general meeting.
Appointment in Case of Filling a Casual Vacancy (Section 139(8))

1. For Non-Government Companies (Not audited by CAG):

● Filling Casual Vacancy:

○ Board of Directors must fill the vacancy within 30 days.

● Approval by Company:
○ If the vacancy is due to auditor’s resignation, the appointment must be
approved by the company at a general meeting within 3 months of the Board’s
recommendation.

● Tenure of New Auditor:

○ The newly appointed auditor holds office till the conclusion of the next AGM.

2. For Government Companies (Audited by CAG):

● Filling Casual Vacancy:

○ The Comptroller and Auditor-General of India (CAG) must fill the vacancy
within 30 days.

● If CAG Does Not Fill:

○ If CAG does not fill the vacancy within the given period, the Board of Directors
must fill it within the next 30 days.

Note:

● Casual vacancy typically refers to the cessation of an auditor’s service due to death,
resignation, disqualification, etc

Re-appointment of a Company Auditor

1. Conditions for Re-appointment (Section 139(9)):

● Not Disqualified: The retiring auditor should not be disqualified for re-appointment.
● No Notice of Unwillingness: The retiring auditor must not have submitted a notice of
unwillingness to be re-appointed.
● No Special Resolution: No special resolution should have been passed at the meeting
appointing another auditor or expressly stating that the retiring auditor will not be
re-appointed.

2. Automatic Re-appointment (Section 139(10)):

 ● If no auditor is appointed or re-appointed at an annual general meeting, the existing
auditor continues to be the auditor of the company.

Role of Audit Committee’s Recommendation:

● In companies required to constitute an Audit Committee (under Section 177), all auditor
appointments, including filling of casual vacancies, should be made after considering the
committee's recommendations.

Ceiling on the Number of Audit Assignments (Section 141(3)(g)):

● Eligibility Criteria for Auditor:

○ A person or a partner of a firm is not eligible to be appointed if:
1. They are in full-time employment elsewhere.
2. They hold the position of auditor for more than 20 companies (excluding
one-person companies, dormant companies, small companies, and
private companies with paid-up capital less than ₹100 crore).

● Key Points:
○ A qualified chartered accountant who is not in full-time employment can audit
up to 20 companies.
○ A partnership firm can audit up to 60 companies (20 companies per partner).
○ A partner who is employed full-time elsewhere is not counted toward the ceiling
in a partnership firm.
○ If a chartered accountant is a partner in multiple audit firms, the overall ceiling is
20 companies.
○ A joint audit assignment counts as one unit.
○ Each auditor (individual or firm) can accept a maximum of 60 tax audit
assignments.

● Professional Misconduct:
○ If a chartered accountant exceeds the specified number of audit assignments,
they are deemed to be guilty of professional misconduct.

Resignation by a Company Auditor (Section 140(2) of Companies Act, 2013)

1. Procedure for Resignation:

● Filing of Statement:

○ The auditor must file a statement in Form ADT-3 with both the company and the
Registrar within 30 days of resignation. This statement must outline the reasons
for resignation and any other relevant facts.
 ● Government Companies:
○ For Government companies or any company owned or controlled by the
government (Central or State), the statement must also be filed with the
Comptroller and Auditor-General of India.

2. Penalty for Non-Compliance (Section 140(3)):

● If the auditor fails to comply with the resignation filing requirement:

○ Fine: A penalty of ₹50,000 or an amount equal to the auditor's remuneration
(whichever is lower).
○ Continuing Failure: If the failure continues, an additional penalty of ₹500 per
day may be imposed, subject to a maximum of ₹2 lakh.

Rotation of Company Auditor

● Eligible Companies:
○ Listed companies (excluding one-person and small companies).
○ Unlisted public companies with paid-up capital of ₹10 crore or more.
○ Private limited companies with paid-up capital of ₹50 crore or more.
○ Companies with public borrowings of ₹50 crore or more.

● Maximum Term:
○ Individual auditor: Maximum 1 term of 5 consecutive years.
○ Audit firm: Maximum 2 terms of 5 consecutive years.

● Additional Conditions for Rotation:

○ Auditor cannot be re-appointed for 5 years after completing their term.
○ Same partner(s) from a previous audit firm cannot be re-appointed immediately.
○ Companies must comply with the rotation provisions within 3 years of the
Companies Act, 2013.
○ Companies can remove auditors, and auditors can resign.

● Rotation of Partners in Audit Firm (Section 139(3)):

○ Company may rotate the auditing partner/team or appoint more than one auditor
as decided by members.

● Manner of Rotation:
○ Audit Committee (if applicable) recommends a new auditor when the term ends.
○ Board recommends the next auditor if there is no Audit Committee.

● Notes on Rotation:
○ Pre-Act Service: Time served before the Act counts towards the term.
○ Same Network: Incoming auditor cannot be linked to the outgoing auditor via the
same network.
 ○ Five-Year Break: A five-year break is required between auditor terms.
○ Partner Change: If a partner moves firms, the new firm is ineligible for five years.

Remuneration of Company Auditor (Section 142)

● Remuneration Fixation:
○ The remuneration of the auditor is fixed in the general meeting of the company
or as decided within the meeting.
○ The Board of Directors can fix the remuneration for the first auditor appointed
by it.

● Inclusions in Remuneration:
○ The remuneration includes the audit fee and any expenses incurred by the
auditor during the audit process.
○ It also includes any facilities extended to the auditor for conducting the audit.

● Exclusions:
The remuneration does not include any payment for other services rendered by the
auditor at the company's request, outside of the audit services.

Removal of the Company Auditor (Section 140)

A. Removal of Auditor Before Expiry of Term

● Procedure:

○ An application for auditor removal must be filed with the Central Government in
Form ADT-2, along with the prescribed fee.
○ The application must be submitted within 30 days of the Board resolution for
removal.
○ The company must hold a general meeting within 60 days of receiving approval
from the Central Government, to pass a special resolution for the removal.
○ The auditor must be given a reasonable opportunity to be heard.

B. Removal of Auditor by the Tribunal

● Conditions for Removal:

○ The Tribunal can remove an auditor if it is satisfied that the auditor has acted
fraudulently or abetted fraud, either directly or indirectly, involving the company,
its directors, or officers.

● Application and Order:

○ The Central Government or any concerned person may apply to the Tribunal for
the removal.
 ○ The Tribunal must decide within 15 days of receiving the application, and if
satisfied, it will order the removal of the auditor.
○ The Central Government may appoint a new auditor in place of the removed
one.

● Consequences for the Auditor:

○ If the Tribunal passes a final order for removal, the auditor (individual or firm)
cannot be reappointed as an auditor for any company for five years.

○ The auditor will also be liable for actions under Section 447.
○ For audit firms, the firm and all its partners who were involved in the fraudulent
actions will be held liable.

Rights of the Company Auditor

● Inspect Books: Access to company’s books and vouchers, including subsidiaries.

● Obtain Information: Right to request necessary information from company officers.
● Inspect Branch Accounts: Right to inspect branch office accounts, even if another
auditor is appointed.
● Receive Branch Audit Report: Right to get branch audit reports.
● Sign Documents: Right to sign audit reports and other documents.
● Have Report Read at AGM: Right to have the audit report read at the AGM.
● Receive Notices and Attend AGM: Entitled to attend general meetings and be heard.
● Attend Audit Committee Meetings: Right to attend and be heard in Audit Committee
meetings.
● Right to Indemnity: Right to be indemnified for legal expenses in lawsuits.

These rights cannot be overridden by the company’s Articles or resolutions.

Duties of the Company Auditor

● Duty to Inquire (Section 143(1)):

○ Ensure loans and advances are properly secured and not prejudicial.
○ Check if transactions represented by book entries are in the company’s best
interest.
○ Ensure assets like shares, debentures, and securities aren’t sold below purchase
price.
○ Verify proper classification of loans, advances, and personal expenses.

○ Confirm cash received for share allotments.

● Duty to Report on Financial Statements (Section 143(2)):

 ○ Report if financial statements present a true and fair view, considering all relevant
laws and standards.

● Duty to Include Certain Matters in the Audit Report (Section 143(3)):

○ Confirm whether adequate information and explanations were obtained.
○ Ensure compliance with accounting standards and laws.
○ Report adverse comments on financial transactions.
○ Verify internal financial controls and whether the company follows accounting
standards.

● Duty to Provide Reasons for Negative Remarks (Section 143(4)):

○ Provide reasons if negative or qualified opinions are given.

● Duty to Comply with CAG Directions (Section 143(5)):

○ Report directions from the Comptroller and Auditor-General for government
companies.

● Duty to Follow Auditing Standards (Section 143(9)):

○ Ensure compliance with applicable auditing standards.

● Duty to Report Fraud (Section 143(12)):

○ Report fraud above ₹1 crore to the Central Government and details to the Board
or Audit Committee.

● Duty to Pay Penalty for Non-compliance (Section 143(15)):

○ Penalty for not reporting fraud or non-compliance: ₹5 lakh for listed companies,
₹1 lakh for others.

● Duty to Provide Comments to the Audit Committee (Section 177(5)):

○ Offer comments on internal control systems, scope of audit, and financial
statements if requested.

● Other Duties:
○ Report on the accounts included in the prospectus for new share issuance
(Section 26).
○ Sign the audit report (Section 145).

Liabilities of the Company Auditor

A. Statutory Liabilities

1. Civil Liabilities
 ○ Misstatement in Prospectus (Section 35): Auditor can be held liable if they’ve
made or consented to a misleading statement in a prospectus.
○ Liability for Misfeasance (Section 340): Auditor can be held liable for breach of
trust or negligence during liquidation.

2. Criminal Liabilities
○ Misstatement in Prospectus (Section 34): Auditor faces imprisonment (6
months to 10 years) and fines up to 3 times the fraud amount for fraud above ₹10
lakh or 1% of turnover.
○ Non-compliance with Sections 139, 144, 145 (Section 147): Fines from
₹25,000 to ₹5,00,000; imprisonment for 1 year if intentionally deceptive.
○ Refusal to Produce Documents (Section 217): Imprisonment up to 6 months
and fines between ₹25,000 to ₹1 lakh, plus daily fines for continued refusal.
○ Fraud in Company Winding-up (Section 336): Imprisonment for 3-5 years and
fines between ₹1 lakh to ₹3 lakh.
○ False Statement or Evidence (Sections 448 & 449): Punishments for deliberate
false statements or evidence leading to imprisonment (3-7 years) and significant
fines.

II. Under Other Acts

● Income Tax Act, 1961 (Section 278): Punishment for auditors inducing false statements
regarding taxable income.
● Chartered Accountants Act, 1949: Liabilities for professional misconduct.
● Life Insurance Act, 1956: False statements in reports result in imprisonment or fines.
● Banking Regulation Act, 1949: False statements or omissions in returns can lead to
liability.

B. Contractual Liabilities

● Audit Scope: Defined by the contract. Violating terms of the contract or conducting
partial audits may lead to liability.
● Disclosure of Client Information: Disclosure of client secrets to third parties leads to
liability.
● Wilde v. Cape and Dalgeish (1897): If an auditor fails to meet contract obligations and
the client suffers a loss, the auditor must compensate for the loss.

Branch Audit

1. Section 128(1) - Maintenance of Books of Account

○ Every company must prepare and keep financial statements and books of
accounts at its registered office, including those for branch offices.
○ These records must reflect a true and fair view of the company's state of affairs
and follow accrual basis and double-entry accounting.
 ○ The company can choose another place in India to keep these records, provided
the Registrar is notified within 7 days of the decision.

2. Section 128(2) - Branch Offices

○ If a company has a branch, it can be considered compliant with Section 128(1) if:
■ The branch maintains proper books of account for transactions at that
office.
■ Periodic summarized returns are sent to the registered office or another
designated place.

3. Scope of Branch Audit

○ Section 143(8) and Rule 12 of CAAR 2014 outline audit responsibilities for
branch offices, including those in India and abroad.
○ The records of transactions at branch offices need to be audited either by the
company's auditor or another qualified auditor.

4. Audit Provisions for Branch Offices

○ Branch in India: The branch’s accounts can be audited by the company's auditor
or another qualified person appointed under Section 139.
○ Branch outside India: The branch’s accounts can be audited by the company’s
auditor or a qualified accountant in compliance with the laws of that country.
○ Auditor's Duties: The company’s auditor has the same duties and powers with
respect to branch audit as outlined in Sections 143(1) to (4).
○ Branch Auditor’s Duties: If a separate branch auditor is appointed, they have
similar duties and powers as the company auditor.
○ Reporting to Company’s Auditor: The branch auditor must submit their report
to the company’s auditor.
○ Fraud Reporting: Branch auditors are also responsible for reporting fraud under
Section 143(12) to the extent it concerns the branch.

Joint Audit

● Concept: Joint audit involves multiple auditors reviewing a single organization, typically
for large companies to improve efficiency.

● Benefits:
○ Reduces individual workload
○ Ensures timely audit completion
○ Allows sharing of expertise
○ Improves audit quality
○ Encourages healthy competition
○ Leverages diverse knowledge
 ● Limitations:

○ May cause superiority issues among auditors

○ High cost for small entities
○ Coordination issues may slow down work
○ Unclear liability for tasks
○ Common concerns may be neglected
○ Fee-sharing reduces earnings

● Guidelines:

○ Work Division: Tasks should be mutually agreed upon and documented.

○ Co-ordination: Auditors must communicate issues affecting others.
○ Responsibilities: Each auditor is responsible for their work but jointly
responsible for areas handled by all.
○ Dependence: Auditors rely on each other’s work without independent review.
○ Reporting: In case of disagreement, auditors issue separate reports.

Role of Audit Committee

● Concept: Audit committees are established to ensure auditor independence, minimize

corporate frauds, and enhance good governance. The requirement for such committees
has evolved, with India expanding the scope under the Companies Act 2013.
● Provisions under Companies Act 2013:
○ Formation:
■ Required for listed companies and public companies with:
■ Paid-up capital ≥ ₹10 crores
■ Turnover ≥ ₹100 crores
■ Outstanding loans/bonds ≥ ₹50 crores

○ Composition:

■ Minimum of 3 directors, with a majority being independent directors.

■ Members must have the ability to understand financial statements.

○ Functions:

■ Recommend auditor appointments and remuneration.

■ Review auditor’s independence and audit effectiveness.
■ Examine financial statements and auditor reports.
■ Approve modifications to related-party transactions.
■ Scrutinize inter-corporate loans, investments, and asset valuations.
■ Evaluate internal financial controls and risk management.
 ■ Monitor the use of funds raised via public offers.

● Powers:

○ Auditor’s Comment: The committee can request auditors’ comments on internal

controls, audit scope, and financial statements.
○ Investigation: The committee has the authority to investigate any relevant
matters, seek external professional advice, and access company records.
○ Board Report: The composition and recommendations of the audit committee
must be disclosed in the board's report, including any non-accepted
recommendations.
○ Whistle-Blowing: Companies must establish a mechanism for reporting
concerns, safeguarding against victimization of whistle-blowers, and ensuring
access to the Audit Committee Chairperson.
Unit 8.6 Audit of Local Self-Government
Local self-government in India operates below the state level and is recognized by the 73rd
and 74th Constitutional Amendments.
It is divided into urban and rural governance systems, with state legislations providing
additional powers.
Urban local bodies include:

● Municipal Corporation (Nagar Nigam)

● Municipality (Nagar Palika)
● Notified Area Council/Town Panchayat (Nagar Panchayat)

Rural local bodies have a three-tier system:

● Gram Panchayat (village level)

● Panchayat Samiti (block level)
● Zilla Parishad (district level)

Representatives for both urban and rural bodies are elected through a democratic process.
They receive funds from state governments and collect local taxes for public development
and maintenance.
Urban local bodies manage administration, public health, safety, education, public works,
and revenue collection.
Rural local bodies help plan, coordinate, monitor, and regulate national programs and
maintain public assets.
Since they handle public funds, their accounts are subject to audits to ensure transparency
and accountability.

Objectives of Auditing Municipalities & Panchayats

● Ensure fairness and accuracy in financial statements.

● Report on internal control adequacy.
● Verify that money spent provides full value.
● Detect fraud and errors.

Key Points for Auditors

● Confirm appointment approval as per regulations.

● Understand rules, financial controls, and accounting guidelines.
● Review documents, minutes, and resolutions of meetings.
● Check proper utilization of government grants and authorization.
● Investigate high-risk areas like revenue collection, waivers, and casual labor expenses.
● Ensure expenses align with approved provisions.
 ● Verify that large expenditures are efficient and yield expected results.

Unit 8.5 Audit of Co-Operative Societies

Unique Features of Co-Operative Societies

● Voluntary Association: Formed by individuals with a common economic goal.

● Democratic Control: Managed through equal participation of members.
● Equitable Contribution: Members contribute capital fairly and share risks & benefits.
● Elimination of Middlemen: Direct transactions increase economic gains.
● Variety of Societies: Includes consumer, housing, industrial, and banking
cooperatives.

Statutory Audit Requirements (Co-Operative Societies Act, 1912)

● Annual Audit: Conducted by the Registrar or an authorized person.

● Scope of Audit: Includes checking overdue debts and valuing assets & liabilities.
● Inspection Rights: Registrar or authorized officials can access all records at any time.
● Registrar's Role: Appointed under the Act to oversee co-operative society audits.

Key Audit Considerations for Co-Operative Societies

1. Qualifications of Auditor

○ Generally, a Chartered Accountant is required.

○ Some states allow auditors with a government diploma in co-operative
accounts or those from the Co-operative Department.
2. Appointment of Auditor

○ Appointed by the Registrar of Co-operative Societies.

○ Audit fees are based on a statutory scale set by the Registrar.
3. Books of Accounts & Records Maintained

○ Cash Book – Records receipts & expenses.

○ Stock Register – Maintains stock movement.
○ Asset & Investment Register – Tracks immovable & movable assets.
○ Fixed Deposit Register – Used by co-operative banks & credit societies.
○ Register of Sureties – Tracks loan guarantees.
4. Restrictions on Shareholding

○ No individual (except another co-op society) can hold more than 20% of total
shares or shares exceeding ₹1,000 in value.
 5. Restrictions on Loans & Borrowing

○ Loans can only be given to members (except with Registrar’s approval).

○ Borrowing must comply with bye-laws.
6. Investment of Funds

○ Funds can be invested only in:

■ Co-operative banks (Central/State)
■ Securities under Indian Trusts Act
■ Other co-operative societies with limited liability
■ Approved banks or financial institutions
7. Appropriation of Profits

○ 25% of profits must be transferred to Reserve Fund before distribution.

○ Registrar can reduce this, but not below 10%.
8. Contributions to Charity

○ Up to 10% of net profits (after Reserve Fund transfer) can be used for charitable
purposes with Registrar’s approval.

Steps to be Taken by an Auditor of a Co-Operative Society

A. General Audit Considerations

1. Review of Bye-Laws – Ensure compliance with the society’s bye-laws in both letter
and spirit.
2. Examine Member Records – Verify the Register of Members and individual
shareholdings.
3. Internal Controls & Checks – Assess the internal control system, identify
weaknesses, and plan audit procedures accordingly.

B. Audit of Income

1. Cash Receipts
○ Verify receipts against the Register of Members (for share capital contributions).
○ Cross-check sales cash memos & invoices with the Sales Account.
○ Validate loan repayments with loan agreements.
○ Ensure receipts for house construction or maintenance are matched with society
records.

C. Audit of Expenditure

1. Vouching of Expenses
 ○ Check authorization for large capital expenditures from the Managing
Committee.
○ Verify payments using bills, money receipts, bank passbooks, and cheque
counterfoils.
○ Cross-check loan disbursements with loan agreements.
○ Ensure establishment expenses align with committee resolutions and
agreements.

D. Other Important Considerations

1. Overdue Debts Classification

○Classify debts overdue for 6 months to 5+ years and report their financial
impact.
○ Assess recovery probability and make necessary provisions.
2. Overdue Interest

○ Ensure overdue interest is credited to the Overdue Interest Reserve Account,

not directly to the Interest Account.
3. Writing Off Bad Debts

○ Prior authorization from the Managing Committee is required.

○ In Maharashtra, the auditor must certify a debt as irrecoverable before it can be
written off.
○ Auditor must ensure the debt was originally created under society rules and is
genuinely bad.

Unit 8.4 Audit of Banks

Importance of Banking in the Economy

● The banking industry is the backbone of any economy and its financial system.
● Banks play a crucial role in financial intermediation, ensuring smooth capital flow in the
economy.
● A strong banking system is vital for economic stability and growth.
● Under the RBI’s leadership, banks operate in a competitive and regulated
environment, aligned with international best practices.
● India has experienced financial deepening, ensuring sustainable growth and stability in
financial markets.

Different Types of Banks in India

Banks in India are broadly classified into six categories:

 Type of Bank Key Features

Commercial Banks Provide a range of financial services like deposits, loans, and
payments to individuals and businesses.

Regional Rural Banks Focus on rural and agricultural development by providing financial
(RRBs) services in remote areas.

Co-operative Banks Operate at state, district, and primary levels to support local
communities and small businesses.

Development Banks Provide long-term funding for infrastructure, industries, and

economic development projects.

Payment Banks Offer limited banking services such as deposits and digital
transactions but cannot issue loans.

Small Finance Banks Cater to small businesses, unorganized sectors, and low-income
groups with banking and credit services.

Though all banks function under RBI regulations, they differ in nature, operations, and
target customers.

Regulatory Framework of Banks in India

Indian banks operate under various Acts and Regulations, ensuring financial discipline and
consumer protection. Key laws include:

Act Purpose

Banking Regulation Act, 1949 Governs banking operations, licensing, and

RBI's control over banks.

Companies Act, 2013 Regulates corporate governance and

financial reporting of banking companies.

State Bank of India Act, 1955 & 1959 Governs SBI and its subsidiaries.

Regional Rural Banks Act, 1976 Regulates RRBs for rural financial inclusion.

Information Technology Act, 2000 Governs digital banking and cybersecurity

regulations.

Prevention of Money Laundering Act, Ensures banks prevent money laundering

2002 activities.
 Banking Companies (Acquisition and Nationalized certain banks for better control.
Transfer of Undertakings) Act, 1980

Credit Information Companies Regulation Regulates credit rating agencies and

Act, 2005 financial data.

Payment and Settlement Systems Act, Oversees digital payments and settlement
2007 infrastructure.

Reserve Bank of India Act, 1934 Establishes RBI’s role as the monetary
authority of India.

Form and Content of Financial Statements of a Bank

The Banking Regulation Act, 1949 (Section 29(1) & (2)) governs the preparation of financial
statements for banks. These provisions apply to:

● Nationalized Banks
● State Bank of India (SBI)
● Regional Rural Banks (RRBs)

Key Requirements:

● Every banking company must prepare:

○ Balance Sheet (Form A of the Third Schedule)
○ Profit & Loss Account (Form B of the Third Schedule)
● These financial statements should be as close as possible to the prescribed format
unless specific circumstances require changes.

Statutory Audit in Banks

As per Section 30(1) of the Banking Regulation Act, 1949, the Balance Sheet and Profit &
Loss Account of a banking company must be audited by a qualified auditor.

Auditor Appointment Process:

● Banking Companies → Appointed at the Annual General Meeting (AGM) of

shareholders.
● Nationalized Banks → Appointed by the Board of Directors of the bank.
● State Bank of India (SBI) → Appointed by the Comptroller & Auditor General (CAG)
of India.
● Regional Rural Banks (RRBs) → Appointed by the bank with Central Government
approval.
Auditor’s Remuneration:

● For Banking Companies → Fixed as per Section 142 of the Companies Act, 2013.
● For Nationalized Banks → Fixed by RBI in consultation with the Central
Government.

Powers of Bank Auditors:

● The powers and duties of a bank auditor are similar to that of a company auditor.
● They ensure financial accuracy, compliance with regulations, and fair
representation of financial statements.

Auditor’s Report - Content

The auditor of a nationalized bank is required to report to the Central Government on the
following key aspects:

1. True and Fair View

○ Whether the financial statements present a true and fair view of the bank’s
affairs.
○ Whether all necessary information and explanations have been made
available.
2. Transactions within Bank’s Powers

○Whether the bank’s transactions, as observed during the audit, have been within
its authorized powers.
3. Adequacy of Returns

○ Whether the returns received from various offices and branches are
sufficient and adequate for audit purposes.
4. Other Significant Matters

○ Any other matter that should be brought to the attention of the Central
Government.

Audit Requirements for Other Banks

● The auditor of a banking company must also report on matters covered under Section
143 of the Companies Act, 2013.
● However, the Companies (Auditor’s Report) Order, 2020 (CARO 2020) is not
applicable to banking companies.

Additional Audit Requirements for Banks

 ● Long Form Audit Report (LFAR):

○ Auditors of Public Sector Banks, Private Banks, and Foreign Banks (including
branches) must submit an LFAR as per RBI guidelines.
● Audit Certificates & Reports:

○ Bank Branch Auditors and Central Statutory Auditors must issue various
certificates as required by RBI and other regulations.

Auditing Aspects of Banks’ Financial Statements

General Issues in Bank Auditing – Simplified

Understand the Bank – Know its operations, controls, and risks.

Check Accounting Process – Identify if it’s manual or computerized.
Review Risk Management – Understand how risks are handled.
Create an Audit Plan – Develop a structured approach.
Determine Materiality – Decide the error tolerance level.
Study BASEL Framework – Check applicable banking regulations.
Use Existing Reports – Refer to past audits, RBI, and internal reports

Specific Issues:

A. Advances

● Check internal controls over advances.

● Review subsidiary ledger & control accounts.
● Ensure proper documentation.
● Scrutinize overdue accounts & recovery plans.

B. Cash in Hand

● Verify internal controls.

● Inspect physical cash & match with records.
● Check foreign currency holdings & conversion rates.

C. Balance with RBI

● Verify ledger balance with RBI confirmation & reconciliation.

D. Balance with Other Banks

● Inspect reconciliation statements.

● Examine large transactions & overseas balances.
● Check currency conversion at market rates.
E. Money at Call & Short Notice

● Ensure proper authorization.

● Verify loans are not netted off incorrectly.
● Classify lending over six days correctly.

F. Fixed & Other Assets

● Check ownership documents & accounting methods.

● Verify new assets & sale transactions.
● Ensure revaluation & compliance with Banking Regulation Act.

G. Borrowings

● Verify proper disclosure of borrowings (domestic & international).

● Ensure interest rates align with borrowing duration.
● Check authorization for call & short-term borrowings.

H. Deposits

● Ensure correct interest accrual treatment.

● Check for window dressing.

I. Capital

● Verify opening balance & approvals for capital changes.

● Examine government contributions & shareholder resolutions.

J. Reserves & Surplus

● Check opening balances, additions, & appropriations.

● Ensure compliance with foreign branch regulations.

K. Bills Payable

● Review internal controls over drafts, cheques, & transfers.

● Ensure security measures for unused forms & coded messages.
● Verify signature checks & confirmation procedures.

L. Contingent Liabilities

● Identify & value all contingent liabilities.

● Ensure internal controls & authorization for transactions.
● Verify Letter of Credit payments & proper accounting.
● Conduct substantive tests for completeness.

M. Bills for Collection

 ● Ensure correct classification of bills.
● Inspect inward & outward bills at closing.
● Verify crediting process for collected bills.

N. Treasury Operations – Forex & Derivatives

● Assess controls over treasury operations.

● Conduct risk assessment for financial accuracy.
● Ensure fair disclosure in financial statements.

Unit 8.3 Audit of Organisations in Hospitality

Sector
The hospitality sector includes four main categories:
(A) Food & Beverages (Restaurants)
(B) Travel & Tourism
(C) Lodging (Hotels & Guest Houses)
(D) Recreation (Cinema Halls, Theme Parks)

Since these businesses operate differently, their audits will have unique procedures, but some
steps are common:

Understand Ownership & Regulations: Identify if the business is a proprietorship, partnership,

or company, and check for relevant legal & financial compliance.
Evaluate Internal Controls: Assess how well the business manages its finances and
operations to determine the audit approach.
Check Business Licenses: Ensure the company has a valid license from the appropriate
authority to operate.

When auditing a restaurant, the following key areas should be examined:

✅ Revenue Verification – Cross-check daily & monthly sales reports with bank statements.


Ensure cash & arrears (if any) are correctly recorded and approved.


Supplier Payments – Verify payments against orders, invoices, and bank records.


Petty Cash Review – Scrutinize small cash expenses for any irregularities.


Overhead Expenses – Check rent, electricity, and other operational costs.
Salary & Payroll – Match salary payments with payroll, attendance records, and bank


statements.
Stock Valuation – Ensure correct valuation of inventory. Large write-offs of perishable


goods should be investigated.
Asset & Investment Verification – Conduct physical checks of fixed assets and verify


investments using relevant registers.


Depreciation – Confirm proper depreciation methods and their accounting.
Liability Review – Verify all liabilities against contracts and outstanding bills.
When auditing a travel and tourism business, the following key areas should be examined:

✅ Customer Collections – Verify receipts against booking details and check pending arrears.
 Commission Revenue – Confirm earnings from tour partners and companies.
 Tour Bookings Payments – Verify payments for air, rail, road, and sea travel, along with
 Cancellations – Check transactions related to booking cancellations.
hotel accommodations.

 Discount Approvals – Ensure discounts offered to customers have proper authorization.

 Overhead Expenses – Verify payments for electricity, telephone, broadband, and local
 Salaries & Incentives – Cross-check salary payments, payroll records, attendance, and
taxes against bills.

 Asset & Investment Verification – Conduct physical verification using Fixed Asset &
incentive payouts.

 Liability Review – Ensure all liabilities match contracts and arrear bills.
Investment Registers.

When auditing hotels and guest houses, key areas to focus on include:

 Guest Payments – Verify check-in/check-out records, bills, and cash book entries.
 Room Rent & Occupancy – Cross-check daily occupancy reports and ensure justified rent
 Event Income – Verify revenue from special events like weddings or conferences using
differences. Check adjustments for unrealized rent and cancellations.

 Additional Services – Vouch income from bars, casinos, health centers, and shop rentals
receipts and cash book records.

 Procurement & Payments – Validate purchases of food, drinks, and other materials
within the premises.

 Employee Salaries – Confirm payroll payments for permanent staff and verify salaries of
against purchase orders, contracts, and invoices.

 Overhead Expenses – Check payments for utilities, internet, local taxes, etc., using proper
casual/contractual workers with management approvals.

 Stock Valuation – Participate in physical stock verification to confirm accuracy.

bills.

 Asset & Investment Verification – Ensure fixed assets and investments match records,
 Liability Review – Verify liabilities against contracts and pending bills.
and depreciation is accounted for correctly.

When auditing cinema halls, key focus areas include:

 Ticket Sales & Controls – Ensure unsold tickets are securely stored and under proper
 Advance Bookings – Check if advance bookings are properly adjusted in financial records.
control. Verify daily ticket sales reports and cash book entries.

 Rental Income – Verify hall rental collections for special events using contracts and
 Refreshment Sales – Cross-check collections from drinks and snacks with daily sales
receipts.

reports.
 ✅ Entertainment Tax Compliance – Confirm correct accounting and timely deposit of
 Film Hiring Costs – Verify payments made to distributors against contracts and receipts.
collected entertainment tax. Ensure unpaid tax is recorded as a liability.

 Advertisement Expenses – Vouch payments for advertisements with supporting

 Supplier Payments – Ensure payments for refreshments are backed by purchase orders,
agreements and receipts.

 Staff Salaries – Verify payroll, attendance records, and leave applications. Check
invoices, and cash book entries.

 Fixed Assets & Investments – Conduct physical verification and check depreciation
appointment letters for casual staff.

accounting.

When auditing amusement parks, key focus areas include:

 Ticket Sales & Controls – Ensure unsold tickets are securely stored and under proper


control. Verify ticket sales with daily reports and cash book entries.
Advance Bookings – Check if revenue from advance bookings is correctly adjusted in


accounts.
Refreshment Sales – Verify collections from drinks and snacks against sales reports and


cash book records.
Advertisement Expenses – Cross-check payments to advertising agencies with


agreements and receipts.
Supplier Payments – Ensure payments for refreshments are backed by purchase orders,


invoices, and cash book entries.
Staff Salaries – Verify payroll, attendance records, and leave applications. Check


appointment letters for casual staff.
Fixed Assets & Investments – Conduct physical verification and ensure proper
depreciation accounting.

Unit 8.2 Audit of Healthcare Organisations

Hospitals and nursing homes differ from commercial businesses, requiring auditors to focus on
their unique financial and operational aspects. Here’s a structured audit approach:

1⃣ Understanding the Organisation

 Determine its ownership structure – Trust, Partnership, or Company.

 Review legal documents: Trust deed, Partnership agreement, Memorandum & Articles
 Identify governing rules & financial reporting requirements.
of Association.

2⃣ Assessing Internal Controls

✅ Examine systems for acquisition & maintenance of assets.
 Check controls over authorisation of payments & transactions.
3⃣ Reviewing Decision-Making Records

 Inspect Minute Books of Board/Committee meetings for key financial decisions.

 Ensure compliance with approvals for bank operations & major expenses.
4⃣ Verifying Revenue Sources

ž Government Hospitals: Validate grants & funding using government orders & receipts.
Õ Private & Charitable Hospitals:
● Vouch patient collections from admission registers & bills.
● Cross-check pathology test receipts.
● Validate donations & legacies – ensure restricted funds are used for intended
purposes.
● Check guest house income, interest, & dividend receipts.

5⃣ Examining Expenses & Payments

º Capital Expenditure – Verify approval & invoices for medical equipment, vehicles, etc.
º Salaries & Doctor Fees – Cross-check payroll, attendance records & doctor visit logs.
º Medical Supplies – Verify purchases of test kits, X-ray plates, consumables against
º Overhead Expenses – Vouch electricity, telephone, fuel bills, etc.
orders & tenders.

6⃣ Verification of Assets & Liabilities

 Match medicine & equipment stock with registers and valuation reports.
 Conduct physical verification of fixed assets & investments.
 Ensure proper depreciation accounting.
 Review liabilities against contracts & outstanding bills.
7⃣ Reviewing Financial Statements

¸ Ensure financial statements are prepared in the correct format based on the hospital’s
profit or non-profit status.

Unit 8.1 Audit of Educational Institutions

Legal Framework
 ● Institutions operate under the Societies Registration Act 1960 or Public Trust Act.
● Central institutions follow Ministry of Education regulations.
● Universities may be established by special legislation.

Audit Guidelines

● Follow provisions in the Trust Deed or governing Act.

● Consider relevant government circulars.

Key Audit Procedures

a) Understanding Constitution

● Study the founding documents (Trust Deed, Act, or Regulations).

● Review financial maintenance provisions.

b) Internal Control Assessment

● Evaluate controls over asset management and transactions.

c) Review of Minute Book

● Check minutes of meetings for financial decisions.

● Ensure compliance with bank account and expenditure approvals.

d) Budget Compliance

● Verify allocations and approvals for budget overruns.

Verification of Receipts

● Tuition Fees: Match fee receipts with the register, check deposits, and confirm late fee
charges.
● Admission Fees: Ensure crediting to Capital Fund unless decided otherwise.
● Other Fees: Validate hostel, library, and development fees.
● Outstanding Fees: Confirm consideration of arrears and free studentships.
● Hostel Dues: Verify collection before refunding caution money.
● Grants & Donations: Match with sanction letters and bank statements.
● Other Income: Verify rent, endowments, interest, and dividends.
Verification of Payments

● Salaries & Wages: Check payroll calculations, arrears, and deductions (PF, TDS).
● Event Expenditure: Match expenses with funding sources.
● Recurring Expenses: Verify bills for utilities, travel, etc.
● Fixed Assets & Construction: Cross-check with purchase resolutions.
● Hostel Expenses: Validate payments for repairs, maintenance, and food.
● Endowment Funds: Ensure separate maintenance and reinvestment of excess income.

Assets & Liabilities Verification

● Fixed Assets: Conduct physical verification and match with records.

● Depreciation: Confirm provision as per policy.
● Liabilities: Check outstanding dues (TDS, PF, utility bills).
● Inventory Management: Validate stock records for furniture, stationery, and provisions.

Financial Statement Review

● Ensure compliance with prescribed formats, accounting standards, and legal

requirements.
CMA INTER AUDITING CHAPTER 6 AUDITING CONCEPTS

Chapter -6 AUDITING CONCEPTS STUDY MAT QA

The table below shows the past trend of this chapter in last 11 exams
June Dec June Dec June Dec Dec Dec June Dec June Dec
17 17 18 18 19 19 21 22 23 23 24 24

MCQ

1. Which of the following is not an audit risk? A. Quality control for an audit of Financial
A. Inherent Risk Statements
B. Detection Risk B. Agreeing the terms of Audit Engagements.
C. Control risk C. Audit Documentation
D. Omission Risk D. Responsibility of Joint Auditor

2. Permanent Audit File does not contain 7. Internal Audit is mandatory for every unlisted
A. A record of study and evaluation of internal public company having paid up share capital of
control system A. ` 100 crores during the preceding financial
B. Significant audit observations of earlier years year
C. Copies of management letters B. ` 50 crores during the preceding financial year
D. Analysis of significant ratios and trends C. ` 500 crores during the preceding financial
year
3. Audit Procedures to obtain audit evidences D. ` 200 crores during the preceding financial
include year
A. Compliance Procedure
B. Substantive Procedure 8. Check list contains the instructions to be
C. Both of A and B followed by the
D. Neither A nor B A. Employer of the organisation
B. Employee of the organisation
4. SA 530 stands for C. Banker to the organisation
A. Audit Documentation D. Audit staff engaged by the auditor of the
B. Audit Sampling organisation
C. Responsibility of Joint Auditor
D. Agreeing the terms of Audit Engagements 9. SA 210 stands for
A. Audit Planning
5. Which of the following is not a part of B. Audit Working Papers
Temporary Audit file? C. Agreeing the terms of Audit Engagements
A. Correspondence relating to acceptance of D. Audit Documentation
annual reappointment.
B. Audit programme. 10. Test checking requires application of
C. Extracts of minutes of board meetings _____________.
D. Legal and organisation structure of the A. mathematical theory
company. B. sampling theory
C. geometry theory
6. SA 230 stands for- D. stakeholder theory

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TRUE FALSE

1. There is no difference between statutory and 7. An Audit note book is a bound book in which
external audit. FALSE a large variety of matters observed during the
2. An investigation is done with the generally course of audit are recorded. TRUE
accepted auditing procedure. FALSE 8. Internal Auditing is a function distinct from
3. The primary objective of the audit is for authorisation and recording. TRUE
detecting frauds and error in the books of 9. Internal auditor of a company cannot be its
accounts and financial records of the client’s Cost Auditor. FALSE
business. FALSE 10. Risk based internal auditing (RBIA) is a
4. The concept of true or fair is a fundamental methodology that links internal auditing to an
concept in auditing. FALSE organisation’s overall risk management
5. An audit engagement is the initial stage of an framework. TRUE
audit during which the auditor notifies the client 11. Auditing in depth refers to the procedure
that he has accepted the audit work. TRUE where a few selected transactions are
6. An audit programme is a detailed plan of the meticulously examined from their beginning to
auditing. TRUE their conclusion. TRUE
12. Analytical procedure includes trend analysis.
TRUE

FILL IN THE BLANKS

1. Audit is derived from Latin word ________________. audire

2. Audit programme act as a __________ of audit procedures to be performed. checklist
3. The reliability of audit evidence depends on its source _________ or ___________. internal or external
4. An audit report is the _____________ product of every audit. final
5. Audit working papers are the record of the ___________ and execution of the audit engagement.
planning
6. Internal Audit is an Independent ___________ activity. appraisal
7. Cut off procedures are generally applied to _____________ transactions. trading
8. The Internal Auditor is appointed by the ________________. directors
9. IFC = IFC-FR + _____________ + Anti-fraud Controls operational control
10. This risk associated with sampling can broadly be divided into two categories – sampling
and____________. non-sampling risk

SHORT ESSAY TYPE QUESTIONS

1. Define the term Auditing? State the benefits that accrue out of Auditing?

According to SA 200, Basic Principles Governing an Audit, “an audit is independent examination of
financial information of any entity, whether profit oriented or not, and irrespective of its size or legal
form, when such examination is conducted with a view to expressing an opinion thereon”.

2. Distinguish between the following

a. Audit and Investigation

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b. Accounting and Auditing

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c. Statutory and Non-statutory audit

d. Continuous and Periodical Audit

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e. Traditional and Risk Based Internal Audit

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3. What are the various principles governing an Audit?

SA 200 issued by The Institute of Chartered Accountants of India gives the following basic principles that
govern the auditor’s responsibilities whenever an audit is carried out:
(i) Integrity, objectivity and independence: The auditor should be straight-forward, honest, sincere and
free form any influence on his audit work. He should maintain impartiality and be free of any interest.
(ii) Confidentiality: He should not disclose the client’s information to anybody without the client’s
permission or under any regulatory requirement.
(iii) Skills and competence: The audit should be performed and audit report be prepared by adequately
trained, experienced and competent person.
(iv) Work performed by others: The auditor should carefully supervise the work performed by others
(such as his subordinates, other auditors, experts etc.) as remains responsible for the work delegated by
him to his assistants, other auditors or experts.
(v) Documentation: Proper working papers should be maintained by the auditor to evidence the audit
work. Working paper which is maintained is to demonstrate that the audit is in adherence to the basic
principles.
(vi) Planning: The auditor should obtain the knowledge about client’s business to determine the nature,
timing and the extent of the audit procedures.
(vii)Audit evidence: The auditor should obtain sufficient appropriate audit evidence through performing
the compliance and substantive procedures.
(viii)Accounting system and internal controls: An understanding of the accounting system and the
related internal controls help in determining the nature, timing and extent of other audit procedures.
(ix) Audit conclusions and reporting: On the basis of conclusions drawn from the audit evidence obtained
the auditor should give unqualified report or qualified report or adverse report or the disclaimer report.

4. Discuss the objectives of Audit.

An audit is conducted with two main objectives:

(i) Primary Objective: The main objective of an audit is to determine whether the financial statements
present a ‘’ true & fair view’’ of the financial position and financial performance of a business during the
period. The Balance Sheet shows the financial position on a particular date (say, the last day of the
financial year), and the profit & loss Accounts shows the financial performance of the business over that
period (income and expenditure during the whole financial year). Section 143 of the companies Act, 2013
requires the auditor of the company to state if in his opinion the financial statements present “true and
fair view’’ of the state of the company’s affairs at the end of its financial year, and of the profit and loss
for its financial year. Such an opinion by the auditor increases the reliability of the Company’s financial
statements.

(ii) Secondary Objective: The auditor is also responsible for detecting frauds and errors in the books of
accounts and financial records of the client’s business. Such detection of frauds and errors is called the
secondary objective of audit because the primary responsibility for safeguarding the business assets
rests with the management. If the auditor suspects the presence of material misstatements or
defalcations in the records of the business, he is expected to look into the matter with greater detail by
applying various audit procedures to satisfy himself about their existence or non-existence. He is also to
report on the existence of such misstatement and their magnitude through his audit report.

5. Write short notes on:

a. Audit Working Paper

In course of audit of an organisation, an auditor adopts various methods and procedures to accumulate
and thereafter analyse audit evidences and other important documents to reach at some meaningful
conclusion regarding his engagement. Audit working papers include all such records kept by an auditor in
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relation to the evidences accumulated, methods and procedures adopted and conclusions reached
during the course of the audit.
As per SA-230, ‘Audit Documentation’, audit working papers (also called audit documentation) refer to
the record of audit procedures performed, relevant audit evidences obtained and conclusions the
auditor reached. Such records can be kept either in physical form or in an electronic form.

According to SA-230, ‘Audit Documentation’, audit working papers or audit documentation serves a
number of purposes as follows:
a. Providing evidence of auditor’s basis for a conclusion about the achievement of the overall objectives
of the auditor.
b. Providing evidence that audit was planned and performed in accordance with Standards of Audit (SAs)
and applicable legal and regulatory requirements.
c. Assisting the engagement team to plan and perform the audit.
d. Assisting members of the engagement team responsible for the supervision to direct and supervise
the audit work, and to discharge their review responsibilities in accordance with SA220, ‘Quality Control
for an Audit of Financial Statements’.
e. Enabling the engagement team to be accountable for its work.
f. Retaining a record of matters of continuing significance to future audits.
g. Enabling the conduct of quality control reviews and inspections in accordance with SQC 1.
h. Enabling the conduct of external inspections in accordance with applicable legal, regulatory or other
requirements.

b. Audit Note Book

In the course of conducting audit of an organisation, the audit staff may come across various
misstatements, frauds or any other issues which need further clarification from the management or
investigation and in-depth observation later on. In order to avoid any chance of such issues being
unanswered, the audit staff generally records the same in a separate note book and raises the issue in
future. Such a record is known as Audit Note Book.

c. Permanent and Temporary Audit Files

d. Limited Review

As per Clause 33 of SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015, a company
shall submit its quarterly, year-to-date and annual financial results to the stock exchange in the manner
prescribed in this clause. Accordingly, a company has an option to submit audited or unaudited quarterly

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and year to date financial results to the stock exchange within forty-five days from the end of each
quarter (other than the last quarter). Under most of these circumstances the auditor finds little time to
conduct thorough examination of books and other supporting documents. Moreover, it may also not be
possible for the client to balance books and provide all documentary evidences. So instead of conducting
a full-fledged audit, the auditor has to make restricted study of books and other documents. This system
of review is called Limited Review.
It is to be noted that in case of Limited Review, generally accepted auditing standards are not followed.
So, the scope of Limited Review is substantially narrower as compared to an audit.

e. Cut-off Procedure

For some entities, there may be a number of items especially at the end of an accounting period that
may have their impact carried to the next accounting period. Work in progress, goods in transit, goods
sent on approval basis lying with the customers, outstanding and prepaid items are only a few. Even
purchase and sale transactions during the end of the accounting period may have their impact on the
next year. Improper treatment of these items and inclusion of items relating to one year in the next or
previous year (like purchase and sales) may seriously distort the financial results and mislead the
decision makers. Hence, an auditor, during the course of his audit work, should apply definite procedure
to separate transactions at the end of one accounting period from those at the commencement of the
next accounting period. Such a procedure is known as Cut-off Examination or Cut-off Procedure. Here,
the auditor first decides a cut-off date (in case of annual audit, generally balance sheet date is
considered to be the cut-off date) and then examines all the transactions that occurred within a definite
time period prior and post such cut-off (known as cut-off period) date to discriminate transactions of
current year from that of the next year. This is essential to eliminate any scope of manipulation in
accounts.

f. Walk Through Test

Walk through test may be defined as tracing one or more transactions through the accounting system
and observing how it is actually passed through the internal control system. For example, the auditor
may decide to trace a purchase transaction from its initiation to its completion and recording. This will
require him to see how are requisitions generated, orders placed with the suppliers, goods received and
taken to the stores, bills processed and finally the accounting treatment done. If the auditor is satisfied
about the appropriateness of all the relevant stages of the transaction, he may conclude that the
internal control is functioning well. Accordingly, the auditor may decide to put reliance on the system to
a certain extent and plan his audit work to verify some selective transactions only. Alternatively, if walk
through test reveals serious weakness of the internal control system, the auditor may opt for verifying

g. Reliability of audit evidence

In order to arrive at an appropriate conclusion regarding the truthfulness and fairness of financial
statements, the audit evidences under examination must be relevant and reliable.
As per SA-500, relevance of audit evidence deals with the logical connection with the purpose of audit
procedure and is therefore affected by the direction of testing. On the other hand, the reliability of audit
evidence depends on its source - internal or external and on its nature - visual, documentary or oral.
While the reliability of audit evidence is dependent on the circumstances under which it is obtained, the
following generalizations may be useful in assessing the reliability of audit evidence:
a. External evidence (e.g., confirmation received from a third party) is generally more reliable than
internal evidence;
b. Internal evidence is more reliable when related internal control is satisfactory;
c. Evidence in the form of documents and written representation is usually more reliable than oral
representations;
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d. Evidence obtained by the auditor himself is more reliable than that obtained through the entity.

h. Components of automated environment

Following are the general components of an automated environment.

a) Databases - Oracle 19C, MS-SQL Server;
b) Operating systems - Windows, Unix, Linux;
c) Hardware and Storage devices – servers, disks, tapes, network storage;
d) Network devices - switches, routers and firewalls;
e) Networks - local area networks, wide area networks, virtual private networks, etc.;
f) Physical and environmental landscape –IT facilities like Data center, physical access control
mechanisms like biometric based access system, CCTVs, adequate HVAC system, fire suppression system
etc.
In addition, there are application software such as Package Software (e.g., Tally, QuickBooks), Small ERPs
(e.g., Tally ERP, SAP, Business One, Focus ERP) and ERP applications for medium to large enterprises
(e.g., SAP ECC, Oracle Enterprise Business Suite).

6. Discuss the contents of Audit note book.

a. Name of the business enterprise.

b. Organisation structure.
c. Important provisions of Memorandum of Association (MOA) and Articles of Association (AOA).
d. Communication with the previous auditor, if any.
e. Management representations and instructions.
f. List of books of accounts maintained by the enterprise.
g. Accounting methods, internal control systems followed by the enterprise, applicable laws etc.
h. Key managerial personnel.
i. Errors and fraud discovered.
j. Matters requiring explanations or clarifications.
k. Special points that need attention in the audit report.

7. Discuss different types of audit risks.

A. Risk of Material Misstatement

It may be defined as the risk that the financial statements are materially misstated prior to the audit
exercise either due to any unintentional error or any organised fraud. This risk may exist at two levels:
(i) At Overall Financial Statement Level: It refers to the possibility that material misstatement relates
pervasively to the financial statements as a whole and may potentially affect multiple assertions.
(ii) At Assertion1 Level: It refers to the possibility that material misstatement may exist while classifying
the transactions, calculating the balances or disclosing some material information.
The risk of material misstatement at the assertion level has two components as follows:
(a) Inherent Risk: This refers to the possibility of material misstatement due to complex transactions or
even due to organised fraud. Accordingly, this risk may be higher for some classes of transactions,
account balances and disclosures. For example, transactions such as fire damage or acquiring another
company are non-recurring and hence the auditor runs the risk of focusing too much or too little on the
unique event.
(b) Control Risk: This refers to the possibility of material misstatement due to ineffective design,
implementation and maintenance of internal control system. Thus, a sound internal control system
significantly reduces this risk. However, internal control can reduce but cannot eliminate the risk
completely because of its inherent limitations. For example, due to inefficient internal control system in
the organisations, there may be a risk that bank reconciliations have not been prepared for any month
or not appropriately reviewed, resulting in misstatement of bank balance.
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Detection Risk
This refers to the possibility that the audit procedures applied by the auditor to reduce the audit risk to
an acceptably low level will not be able to detect a misstatement which, either individually or in
aggregate, may be material. For example, if the auditor applies a testing method that checks the
accuracy of the invoice rather than the occurrence of the particular sale, he may run into a detection
risk.

As audit risk comprises risk of material misstatement and detection risk, it may be said that,
Audit risk = Risk of material misstatement × Detection risk.
Again, Risk of material misstatement (at the assertion level) = Inherent Risk × Control Risk.

Therefore, Audit risk = Inherent Risk (I) × Control Risk (C) × Detection Risk (D).

8. ‘Checklist and Internal Control Questionnaire are not the same’ – Discuss.

9. Distinguish between Statutory Audit and Internal Audit

10. Does reliance on internal auditor reduce the risk of the statutory audit? Discuss.
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Reliance on internal auditors can impact the risk associated with statutory audits in several ways. Here’s
a detailed discussion:

Benefits of Relying on Internal Auditors

Enhanced Understanding of Internal Controls:
Internal auditors have a deep understanding of the company's internal controls and operations. Their
insights can help statutory auditors identify key risk areas and understand the effectiveness of internal
controls, leading to a more focused and efficient audit.

Increased Efficiency:
By leveraging the work of internal auditors, statutory auditors can save time and resources. This allows
them to allocate their efforts to areas of higher risk and significance.

Early Detection of Issues:

Internal auditors often conduct continuous or periodic reviews, which can help in early detection and
rectification of issues. This proactive approach can reduce the likelihood of significant issues arising
during the statutory audit.

Collaboration and Coordination:

Effective collaboration between internal and statutory auditors can lead to a more coordinated audit
process. Sharing information and findings can enhance the overall audit quality and reduce redundancy.

11. ‘Internal Audit and Internal Check are not synonymous’ –Discuss.

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12. ‘An auditor applies various techniques to evaluate the internal control system of an organisation’ –
Discuss.

a. Narrative Record: It is a complete and exhaustive description of the system. It is appropriate in

circumstances where a formal control system is lacking, like in the case of small businesses. Gaps in the
control system are difficult to identify using a narrative record.
b. Check List: The Internal Control Checklist is a tool to help evaluate and strengthen internal controls,
promote effective and efficient business practices, and improve compliance in a department or
functional unit. The checklist is not meant to be absolute but informative when reviewing controls in a
given area. In fact, checklist is a series of instructions and/or questions which the auditor or the audit
staff must follow and answer. When he completes the instructions, he initials the space against the
instruction. Answers to the checklist instructions are usually ‘Yes’, ‘No’ or ‘Not Applicable’.
c. Flow Chart: It is a pictorial representation of the internal control system depicting its various elements
such as operations, processes and controls, which help in giving a concise and comprehensive view of the
organisation’s working to the auditor. A complete flow chart would depict the process of raising
documents, personnel involved in doing so, the flow of documents through various departments,
maintenance of records, flow of goods and consideration, and dealing with results. The internal control
evaluation process becomes easier through a flow chart as a broad picture of all the controls involved
can be gauged in a glimpse.
d. Internal Control Questionnaire: This is the most widely used method for collecting information
regarding the internal control system and involves asking questions to various people at different levels
in the organisation. The questionnaire is in a pre-designed format to ensure collection of complete and
all relevant information. The questions are formed in a manner that would facilitate obtaining full
information through answers in ‘Yes’ or ‘No’, whereby the answer ‘Yes’ is satisfactory, whereas the
answers ‘No’ appear to indicate a weakness. However, not always the questionnaire is designed to
receive responses in ‘Yes-No’ format as the same may not provide adequate information. Hence,
questionnaire may receive descriptive responses also.

13. Discuss different types of internal control systems.

The type of internal control system to be employed in an organisation depends upon the requirements
and nature of the business. Generally, there are two types of Internal Control in an Organisation:
preventive and detective controls. Both types of controls are essential to an effective internal control
system. From a quality standpoint, preventive controls are essential because they are proactive and
emphasize quality. However, detective controls play a critical role by providing evidence that the
preventive controls are functioning as intended.
a. Preventive Control: Preventive Controls are designed to discourage errors or irregularities from
occurring. They are proactive controls that help to ensure achievement of departmental. Examples of
preventive controls are:

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(i) Segregation of Duties: Duties are segregated among different people to reduce the risk of error or
inappropriate action. Normally, responsibilities for authorizing transactions (approval), recording
transactions (accounting) and handling the related asset (custody) are divided.
(ii) Approvals, Authorizations, and Verifications: Management authorizes employees to perform certain
activities and to execute certain transactions within limited parameters. In addition, management
specifies those activities or transactions that need supervisory approval before they are performed or
executed by employees. A supervisor’s approval (manual or electronic) implies that he or she has
verified and validated that the activity or transaction conforms to established policies and procedures.
(iii) Security of Assets (Preventive and Detective): Access to equipment, inventories, securities, cash and
other assets is restricted; assets are periodically counted and compared to amounts shown on control
records.
b. Detective Control: Detective Controls are designed to find errors or irregularities after they have
occurred.
Examples of detective controls are:
(i) Reviews of Performance: Management compares information about current performance to budgets,
forecasts, prior periods, or other benchmarks to measure the extent to which goals and objectives are
being achieved and to identify unexpected results or unusual conditions that require follow-up.
(ii) Reconciliations: An employee relates different sets of data to one another, identifies and investigates
differences, and takes corrective action, when necessary.
(iii) Physical Verification of Inventories: The auditor may conduct physical verification of inventory to
detect any misappropriation.

14. Discuss the procedures for issuing standards on auditing.

Auditing and Assurance Standards Board (AASB) of the Institute formulates the auditing standards.
Broadly, the following procedure is adopted for the formulation of Standards on Auditing (SAs):
a) The Auditing and Assurance Standards Board identifies the areas where auditing standards need to be
formulated and the priority in regard to their selection.
b) In the preparation of Auditing Standards, AASB is assisted by study groups/task force constitute to
consider specific project. Study group comprising of a cross section of members of the Institute. The
study group/task force will consider the specific subject and prepare the primarily draft of Standards.
c) Based on the work of the study groups, an exposure draft of the proposed Standards is prepared by
the Committee and issued for comments by members of The Institute of Chartered Accountants of India
d) After taking the comments into consideration, AASB finalize the draft and submit to the Council of the
Institute.
e) The Council on its review of the draft, makes suitable modifications in consultations with the AASB
and then Standards/Statements is issued under the authority of the Council. While formulating the
auditing standards, the Board also takes into consideration International Standards on Auditing (ISA)
issued by the International Auditing Practices Committee (IAPC), applicable laws, customs, usages and
business environment in the India.

15. How will you distinguish IFC and IFC-FR.

Internal Financial Control over Financial Reporting (IFC-FR) covers those controls which are elements of
Financial Reporting i.e., of balance sheet, profit and loss accounts. IFC-FR processes like order to cash,
procurement to pay, Human Resource, Inventory Management cover risks only to the extend having
direct or indirect impact on financial reporting. Therefore, IFC-FR majorly ensures controls which provide
reasonable assurance that financial statements are free from material misstatements.
Internal Financial Control (IFC), in addition to ICFR, covers controls which ensure efficient and effective
functions of business, controls which safeguard assets and ensure compliance of policies.
To put it differently, IFC as a concept is much wider in scope when compared to IFC-FR.
In fact, IFC = IFC-FR + Operational Controls + Anti-fraud Controls
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Thus, it can be said that IFC-FR is a concept which is more intended towards users/readers of financial
statement whereas IFC is more intended towards functions and management of the business.

16. Discuss the risks associated with audit sampling.

According to SA-500, an auditor may use audit sampling in selecting items required to conduct an
effective test to provide appropriate audit evidence. However, it cannot be denied that such a method
will always involve some amount of risk. This risk associated with sampling can broadly be divided into
two categories:
a. Sampling Risk: Since sample is only a selected part of the population, it can never reflect all the
characteristics of the population. Thus, there will always be some amount of risk unavoidable in this
process. This sampling risk can again be of two types as follows:
(i) Sampling Risk associated with Compliance Procedure (i.e., Test of Control): Here, the auditor, based
on sampling procedure, may come to the conclusion that that the controls are more effective (or less
effective) while they are not.
(ii) Sampling Risk associated with Substantive Procedure (i.e., Test of Details): Here, the auditor, based
on sampling procedure, may come to the conclusion that that the financial statements are free from any
material misstatements while they are not.
b. Non-Sampling Risk: While conducting sampling, error may also arise due to improper processing of
data, lack of expertise to analysis, etc. These are called non-sampling error or bias. Accordingly, risk of
any wrong opinion on the part of the auditor due to such errors is called non-sampling risk.
Non-sampling risk is avoidable. If the sampling is done by experienced audit clerks and they remain alert
while analysing the selected transaction, non-sampling risk can be reduced to minimum or even zero. On
the other hand, sampling risk is unavoidable. The auditor can only reduce it to the possible extent by
adhering to a proper method of sampling and by increasing the sample size reasonably.

17. What are the benefits of audit trail?

A well-functioning audit trail offers the following benefits:

a. User Accountability: In an automated environment, a well-functioning audit trail system records the
activities of every user. This promotes appropriate user behaviour because everyone is held accountable
for their doings. Thus, introduction of virus to the system or unauthorised alteration of data can be
prevented. Additionally, it helps to identify the intruders.
b. Promotes Organisation’s Data Security: A well-functioning audit trail system ensures data security as it
protects data from unauthorized access and fraudulent activities by staff and external parties.
c. Allows Reconstruction of Events: An excellent audit log system allows organisations to understand the
operations of users, including cyber attackers. Data retrieval is also possible in some cases.
d. Detection of System Interference and Errors: A functioning audit trails system indicates upcoming
system interference, failures, and errors. Such detections allow an organisation to respond accordingly
to allow a smooth continuation of its operations.

ESSAY TYPE QUESTIONS

1. Define ‘Audit Engagement Letter’. What are the general contents of an audit engagement letter?

As per SA-210, Agreeing the Terms of Audit Engagements, an auditor and the client should agree to the
terms of audit engagement prior to commencement of the audit. The agreed terms should then be
recorded by the auditor in an audit engagement letter or any other suitable form of written agreement.
However, if the law or regulation prescribes in sufficient detail the terms of audit engagement, the
auditor need not record them in written agreement.

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As per SA-210, Agreeing the Terms of Audit Engagements, every engagement letter as per should contain
the following:
a. Objective & scope of engagement
b. Management responsibility
c. Existence of inherent limitations
d. Need for use of Internal Auditor
e. Management confirmation letter
f. Restrictions & limitations of Auditor liabilities
g. Basis of computation of Audit fees
h. Billing arrangement
i. Form of report & Other communications of engagement
j. Validity of report
k. Limits on submission of report to other authorities

2. Define Audit Evidence. Discuss the methods of obtaining Audit Evidence.

As per SA-500, ‘Audit Evidence’, the term ‘audit evidence’ includes information used by the auditor in
arriving at the conclusions on which the auditor’s opinion is based. Audit evidence includes both
information contained in the accounting records underlying the financial statements and other
information.

Methods
a. Inspection - It consists of examining records, documents, or tangible assets. Inspection of records and
documents provides evidence of varying degrees of reliability depending on their nature, source and the
effectiveness of internal controls over their processing.
b. Observation - It consists of witnessing a process or procedure being performed by others.
c. Inquiry and Confirmation - Inquiry consists of seeking appropriate information from a knowledgeable
person inside or outside the entity, Confirmation consists of the response to an inquiry to corroborate
information contained in the accounting records.
d. Computation - It consists of checking the arithmetic al accuracy of source documents and accounting
records or performing independent calculations.
e. Analytical Review - It consists of studying signific ant ratios and trends and investigating unusual
fluctuations and items.

3. What do you mean by Audit Programme? Discuss its advantages

An audit programme is a detailed plan of the auditing work to be performed, specifying the procedures
to be followed in verification of each item and the financial statements and the estimated time required.
To be more comprehensive, an audit programme is written plan containing exact details with regard to
the conduct of a particular audit. It is a description or memorandum of the work to be done during an
audit. Audit programme serves as a guide in arranging and distributing the audit work as well as
checking against the possibility of the omissions.

The main advantages of an audit programme are enumerated below;

(i) It serves as a ready check list of audit procedures to be performed.
(ii) The audit work can be properly allocated to the audit assistants or the article clerks.
(iii) The auditor may easily know the extent of work done at any point of time. Thus, the progress of
work done can be under the supervision and control of the auditor.
(iv) Audit programme would not only be useful for the audit assistants in carrying the audit work but for
the principal too as he would be in a position to account for the individual responsibilities.
(v) A uniformity of the work can be attained as the same programme would be followed from time to
time.
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(vi) It is a useful basis for planning the programme for the following year it is useful in selection of team
members & delegation of responsibilities to them.
(vii)It may be used as evidence by the auditor in the event when any charge is brought against him.
(viii)It is useful in selection of Team members and delegation of responsibilities to them.
(ix) He can prove that there has no negligence on his part and he exercised reasonable care and skill
while performing the task.

4. Discuss the objectives and functions of the Auditing and Assurance Standards Board:

a) To review the existing and emerging auditing practices worldwide and identify areas in which
Standards on Quality Control, Engagement Standards and Statements on Auditing need to be developed.
b) To formulate Engagement Standards, Standards on Quality Control and Statements on Auditing so
that these may be issued under the authority of the Council of the Institute.
c) To review the existing Standards and Statements on Auditing to assess their relevance in the changed
conditions and to undertake their revision, if necessary.
d) To develop Guidance Notes on issues arising out of any Standard, auditing issues pertaining to any
specific industry or on generic issues, so that those may be issued under the authority of the Council of
the Institute.
e) To review the existing Guidance Notes to assess their relevance in the changed circumstances and to
undertake their revision, if necessary.
f) To formulate General Clarifications, where necessary, on issues arising from Standards.
g) To formulate and issue Technical Guides, Practice Manuals, Studies and other papers under its own
authority for guidance of professional accountants in the cases felt appropriate by the Board.

5. What is Risk Based Internal Audit? Discuss its advantages.

Institute of Internal Auditors (IIA) defines risk based internal auditing (RBIA) as a methodology that links
internal auditing to an organisation’s overall risk management framework. RBIA allows internal audit to
provide assurance to the board that risk management processes are managing risks effectively, in
relation to the risk appetite. Thus, while traditional internal audit only provides control assurance based
on routine audit, RBIA provides Assurance on the effectiveness of risk management in addition to
control assurance. To put it differently, RBIAs give auditors a larger role in your risk reduction program.
Beyond simply diagnosing the problems, they are also a part of the creation of effective controls and
maintaining risk management efforts over time.

Risk-based internal auditing has a number of benefits over a more traditional audit approach.
a. Consistency: Developing a consistent and comprehensive approach to risk management makes it
easier for an organisation to adapt to changing conditions. Adjusting audit schedule to risk management
framework will also help switch tactics quickly when business objectives need to change.
b. Transparency: A risk-based approach to audit enables the internal auditors to identify risks correctly
and allows management to put the right internal controls in place for the best performance. This
provides a better understanding of the risks and enables organisation to better manage them.
c. Specificity: Ranking and mapping risks with RBIA will allow allocate activity and funds to the areas that
need the most attention, creating a unique risk management program rather than relying on external
frameworks and recommendations. While compliance frameworks are necessary for many industries,
they don’t account for every potential risk the entity could face; relying on those requirements alone
could result in risks going unnoticed and unattended.

6. What are analytical procedures? Discuss the tools and techniques of analytical procedures.

According to SA 520, Analytical Procedures, analytical procedure means evaluation of financial

information through analysis of plausible relationships among both financial and non-financial data.
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CMA INTER AUDITING CHAPTER 6 AUDITING CONCEPTS

Analytical procedure also encompasses 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.
As per SA-520, analytical procedures include application of the following tools and techniques:
a. Trend Analysis: Under this method, analysis is done for to assess fluctuation of the amount of any item
over the year or years.
b. Testing of Reasonableness: This is done by comparing certain items or account balances with other
accounts or balances. Some examples are as follows;
(i) Raw material consumption to production (quantity)
(ii) Percentage of wastage and scrap against production and raw material consumption
(iii) Work-in-progress based on material issued
c. Ratio Analysis: This technique calculates different ratios between various items of financial statements
in order to study their relationships. Some common ratios include: (i) Gross Profit Ratio
(ii) Receivable Turnover Ratio
(iii) Inventory Turnover Ratio
d. Sources of Information: Analytical procedures also require analysing the following sources of
information.
(i) Interim financial information
(ii) Budgets
(iii) Management Accounts
(iv) Non-financial information etc.

7. Discuss different types of controls in an automated environment.

(a) Application controls

Application controls are those controls (manual and computerised) that relate to the transaction and
standing data pertaining to a computer-based accounting system. Application controls need to be
ascertained, recorded and evaluated by the auditor as part of the process of determining the risk of
material misstatement in the audit client’s financial statements.

(b) Input controls

Control activities designed to ensure that input is authorised, complete, accurate and timely are referred
to as input controls. The auditor needs to apply specific input validation checks to evaluate the same.
(i) Range checks: These ensure that information input is reasonable in line with expectations.
(ii) Compatibility checks: These ensure that data input from two or more fields is compatible. For
example, a sales invoice value should be compatible with the amount of sales tax charged on the invoice.
(iii) Validity checks: These ensure that the data input is valid.
(iv) Exception checks: These ensure that an exception report is produced highlighting unusual situations
that have arisen following the input of a specific item.
(v) Sequence checks: These facilitate completeness of processing by ensuring that documents processed
out of sequence are rejected.
(vi) Control totals: These also facilitate completeness of processing by ensuring that pre-input, manually
prepared control totals are compared to control totals input.
(vii)Check digit verification: This process uses algorithms to ensure that data input is accurate.

(c) Processing controls

Processing controls exist to ensure that all data input is processed correctly and that data files are
appropriately updated accurately in a timely manner. The processing controls for a specified application
program should be designed and then tested prior to ‘live’ running with real data.

(d) Output controls

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CMA INTER AUDITING CHAPTER 6 AUDITING CONCEPTS

Output controls exist to ensure that all data is processed and that output is distributed only to
prescribed authorised users. While the degree of output controls will vary from one organisation to
another (dependent on the confidentiality of the information and size of the organisation), common
controls comprise use of batch control totals, exception reports etc. The auditor must ensure that output
is kept confidential and available to authorized users only.

(e) Master file controls

The purpose of master file controls is to ensure the ongoing integrity of the standing data contained in
the master files. It is vitally important that stringent ‘security’ controls should be exercised over all
master files. The auditor must ensure that master file controls are effective and adequate.

8. What is the significance of Audit?

From Legal Point of View:

(i) Filing of Income Tax Return — Income Tax authorities generally accept the profit and loss account that
has been prepared by a qualified auditor and they do not go into details of the accounts.
(ii) Borrowing of Money from External Sources — Money can be borrowed easily on the basis of audited
balance sheet from the external sources. Most of the financial institution sanctions various loans on the
basis of audited financial statements.
(iii) Statement of Insurance Claim — In case of flood, fire, other natural calamities and the like
unexpected happenings the insurance company may settle the claim for loss or damages on the basis of
audited accounts of the previous year.
(iv) Sales Tax Payments — The audited books of accounts may generally be accepted by the sales tax
authorities.
(v) Action Against Bankruptcy — The audited accounts serve as a basis to determine action in bankruptcy
and insolvency cases.

From Internal Control Point of View

(i) Quick Discovery of Errors and Frauds — Errors and frauds are located at an early date, so that in future
no attempt is made to commit such frauds as one is rather careful not to commit an error or a fraud as
the accounts are subject to regular audit.
(ii) Moral Check on the Employees — The auditing of the accounts keeps the accounts clerks and the
accountants regular and vigilant as they know that the auditor would complain against them if the
accounts are not prepared up to date or if there is any irregularity.
(iii) Advice to the Management — It may happen that the management may consult the auditor and seek
advice on certain technic al points although it is not the duty of the auditor to give advice.
(iv) Uniformity in Accounts — If the accounts have been prepared on a uniform basis, accounts of one
year can be compared with other years and if there is any discrepancy, the cause may be enquired into.

From External Affairs Point of View

(i) Settlement of accounts — The audited accounts would facilitate the settlement of accounts of a
deceased partner.
(ii) Valuation of assets and goodwill — If the business is to be sold as a going concern basis, there may
not be much difficulty regarding the valuation of assets and goodwill as the accounts have already been
audited by an independent person.
(iii) Future trend of the business — From the audited books of accounts, the future trend of the business
can be assessed easily with certainty.

9. Discuss the advantages of Audit.

The advantages of audit are as follows:

(i) Audit is a tool, which different stakeholders can use to protect their interests in the enterprise.
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CMA INTER AUDITING CHAPTER 6 AUDITING CONCEPTS

(ii) Audit is not only a corrective measure but has a deterrent effect. It serves as a moral check on the
employees from committing defalcations or embezzlements.
(iii) The employees of the organisation remain alert and vigilant as regards the updating of books of
accounts and other records.
(iv) Audited accounts are considered more reliable by different cadres of Government. For example, the
tax audit report filed with the taxation authorities.
(v) It facilitates detection of wastages and losses and helps in instituting corrective actions.
(vi) Audited accounts are taken to be more reliable and useful during corporate restructuring exercises,
valuations etc.
(vii)Banks, Financial Institutions and Government require audited accounts before granting any financial
assistance to the enterprise.
(viii)Audited accounts are taken to be more helpful in the settlement of accounts between the partners
and thus avoiding any dispute amongst them.

10. What is audit trail? Discuss the statutory provisions relating to audit trail.

Audit trail may be defined as the documents, records relating to transactions that enables an auditor to
trace the transactions from the source documents to the summarised total in accounting reports. It is an
orderly, step-bystep record of transactions that serves as a proof of a transaction’s history, right from
recording to tracking all changes that may take place. For example, a sequentially numbered sales
invoice copies would normally be listed in a Register and subsequently filed either in numerical or
chronological order. Thus, it would be possible to trace a particular invoice from the daybook to the
original file by reference to the number or date of the invoice.
In an automated environment accounting software provides the ideal example of audit trails. For
example, when a transaction is entered in the software, the software will maintain a record of it. Any
further edits made to the details, such as a change in the name or amount will also be tracked by the
software along with the user who made the changes and the time of change. Even if some transactions
were to be deleted, the software will track that as well and keep the record of everything since the
original entry was made.

Statutory Requirement for Audit Trail

According to Rule 3(1) of Companies (Accounts) Rules, 2014, as amended by Companies (Accounts)
Amendment Rules, 2021, for the financial year commencing on or after the 1st day of April, 2022, every
company which uses accounting software for maintaining its books of account, shall use only such
accounting software which has a feature of recording audit trail of each and every transaction, creating
an edit log of each change made in books of account along with the date when such changes were made
and ensuring that the audit trail cannot be disabled.
In simple words, the expectation is to maintain the edit log of every transition right from recording to
tracking the changes that may take place.

11. Distinguish between Internal Control, Internal Check and Internal Audit.

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CMA INTER AUDITING CHAPTER 6 AUDITING CONCEPTS

UNSOLVED CASES - SOLVED

Case 1
XYZ Ltd., an unlisted public company, is required to appoint an internal auditor as per the provisions of
Companies Act, 2013. Accordingly, it has appointed Mr. A as the internal auditor who is a qualified
Chartered Accountant. The statutory auditor of XYZ Ltd., M/S PQR and Associates is of the view that as
the company has an internal auditor, they can rely on the direct assistance of the internal auditor and it
can sufficiently reduce their audit work and liability. Give your opinion citing the guidance from relevant
Standard.

The statutory auditor of XYZ Ltd., M/S PQR and Associates, cannot rely solely on the internal auditor's
work to reduce their audit work and liability. According to SA 610 (Revised) “Using the Work of Internal
Auditors,” the statutory auditor can use the work of the internal auditor to some extent but cannot use
their direct assistance. The statutory auditor retains overall responsibility for the audit opinion
expressed and must perform sufficient audit work to draw their conclusions.

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CMA INTER AUDITING CHAPTER 6 AUDITING CONCEPTS

SA 610 (Revised) clearly states that the external auditor should determine whether the work of the
internal audit function can be used and to what extent, but it does not permit using internal auditors to
provide direct assistance in performing audit procedures. This guidance ensures that the statutory
auditor maintains sufficient control over the audit to form an independent and objective opinion.

Therefore, the view that having an internal auditor reduces the statutory auditor's audit work and
liability by using direct assistance from the internal auditor is incorrect according to the standards.

Case 2
The cashier of a trading firm has also control of all the financial books. He also opens all incoming mails
comprising cash and cheques. Under these circumstances, what malpractices are open to the cashier in
respect of both receipts and payments and what checks would you, as an auditor, suggest to the
company.

In the described scenario, the cashier’s control over financial books and handling of incoming mail,
including cash and cheques, opens several opportunities for malpractices. Here are potential
malpractices and the checks an auditor should suggest:

Potential Malpractices

Misappropriation of Cash Receipts:

The cashier could pocket cash receipts without recording them.
They could issue unauthorized receipts and keep the cash.

Misappropriation of Cheques:
The cashier could alter cheques or forge endorsements.
They could delay depositing cheques, benefiting from the interest or other gains.
Fictitious Entries:

The cashier could create fictitious entries to balance accounts and cover up stolen cash.
They might manipulate financial records to hide discrepancies or misappropriations.
Unauthorized Payments:

The cashier could make unauthorized payments or divert funds to personal accounts.
They might create fictitious vendors or inflate payment amounts to siphon funds.
Suppression of Mail:

The cashier could intercept and destroy or manipulate mail containing customer payments or important
financial documents.

Suggested Checks and Controls

Segregation of Duties:
Separate the roles of handling cash, recording transactions, and reconciling accounts. Ensure that the
cashier does not have control over both cash handling and bookkeeping.
Mail Handling Procedures:

Assign a different employee to open incoming mail, log all cash and cheques received, and ensure they
are promptly deposited in the bank.
Independent Reconciliation:

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CMA INTER AUDITING CHAPTER 6 AUDITING CONCEPTS

Implement regular and independent reconciliation of bank statements with cash receipts and
disbursements by someone not involved in cash handling.
Authorization of Payments:
Require dual authorization for payments. Payments should be approved by a person other than the
cashier.
Implement a system where payments are authorized by a manager and cross-verified with original
invoices.

Surprise Cash Counts:

Conduct unannounced cash counts to ensure that recorded cash balances match the actual cash on
hand.

Use of Lockbox Services:

Implement lockbox services where customers send payments directly to the bank, minimizing the
handling of cash and cheques by the cashier.

Regular Audits:
Schedule periodic internal and external audits to review financial records, cash handling procedures, and
compliance with established controls.

Electronic Payments:
Encourage customers to make payments electronically to reduce the risk associated with handling cash
and cheques.

Rotation of Duties:
Periodically rotate employees’ duties, including the cashier’s responsibilities, to prevent prolonged
opportunities for malpractices.

Installation of Security Cameras:

Use security cameras to monitor areas where cash is handled and mail is opened, providing a deterrent
against theft and a means of investigating discrepancies.
By implementing these controls, the trading firm can significantly reduce the risk of malpractices and
ensure a more secure and transparent financial environment.

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CMA INTER AUDITING CHAPTER 7 Company Audit

Chapter -7 COMPANY AUDIT STUDY MAT QA

The table below shows the past trend of this chapter in last 11 exams
June Dec June Dec June Dec Dec Dec June Dec June Dec
17 17 18 18 19 19 21 22 23 23 24 24

MCQ

1. Any casual vacancy in a govt. company is D. Auditor’s address

filled by the CAG of India within _________
days. 6. An auditor shall submit a unmodified report
A. 15 when ______________.
B. 30 A. The financial statements exhibit true and fair
C. 45 view
D. 60 B. The financial statements are partially correct
C. The financial statements are incomplete
2. Which of the following is not a content of D. The financial statements are unavailable
audit report as per CARO?
A. Inventory 7. Cost Audit is covered under
B. Acceptance of deposit A. Section 204
C. Recruitment of employees B. Section 148
D. Repayment of loan C. Section 139
D. None of the above
3. No audit firm shall be appointed or
reappointed as auditor for more than two terms 8. Secretarial Audit is covered under section
of __________consecutive years. A. Section 204
A. 3 B. Section 148
B. 5 C. Section 139
C. 7 D. None of the above
D. 10
9. An Audit Committee should have a minimum
4. Each qualified chartered accountant not in of _________ number of directors.
full time employment can be the auditor of at A. 4
most _________companies. B. 3
A. 10 C. 5
B. 15 D. 6
C. 20
D. 30 10. A cost auditor submits his report along with
reservations and observations in Form No.
5. Which of the following is not a content of A. CRA 1
audit report? B. CRA 2
A. Signature of the auditor C. CRA 3
B. Date of the report D. CRA 4
C. Attachment of audit evidences

TRUE FALSE

1. An audit report should have a proper title. 2. Appointment of a statutory company auditor
TRUE is governed by Section 139 of Companies Act,
2013. TRUE
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CMA INTER AUDITING CHAPTER 7 Company Audit

3. Application for removal of a company auditor 7. The auditor gives a clean report when he
before the expiry of his term is to be made to doesn’t have any significant reservation in
the Central Govt. in form no. ADT-1. FALSE respect of matters contained in the Financial
4. SA 705 deals with modifications to the Statements. TRUE
opinion in the independent auditor’s report. 8. A disclaimer of opinion is issued by the
TRUE auditor when he cannot form an overall opinion
5. In case of a partnership firm the maximum no about the matters contained in the Financial
of companies to which the firm can be Statements. FALSE
appointed as the auditor shall be limited to 10 9. The Branch Auditor shall prepare report on
companies. FALSE the Accounts of the Branch examined by him
6. An audit report is addressed to the authority and send it to Audit Committee. TRUE
appointing the Auditor. TRUE 10. Casual vacancy in the office of Cost Auditor
is filled by Board of Directors. TRUE

FILL IN THE BLANKS

1. Audit report reflects the work done by the ____________. auditor

2. The audit report should be signed in the personal name of the _____________. auditor
3. For any default on the part of the company to deposit to the unpaid dividend account within the
stipulated time, the company needs to pay interest @ ______ p.a. 12%
4. The first auditor of a Govt. Company is appointed by the shareholders of the company at the general
meeting. CAG
5. Secretarial audit is conducted by__________. company secretary
6. Cost Records are to be maintained as per Form ____________. CRA-1
7. Reappointment of company auditor is guided by ________ of the Companies Act, 2013 139(9)

SHORT ESSAY TYPE QUESTIONS

1. Discuss the provisions of Companies Act, 2013 as regards reporting of frauds by Company Auditor.
According to Section 143(12) read with Rule 13 of the Company (Audit and Auditors) Rules 2014 -
(1) If an auditor of a company, in the course of the performance of his duties as statutory auditor, has
reason to believe that an offence of fraud, which involves or is expected to involve individually an amount
of rupees one crore or above, is being or has been committed against the company by its officers or
employees, the auditor shall report the matter to the Central Government.

(2) The auditor shall report the matter to the Central Government as under:
(a) the auditor shall report the matter to the Board or the Audit Committee, as the case may be,
immediately but not later than two days of his knowledge of the fraud, seeking their reply or observations
within forty-five days;
(b) on receipt of such reply or observations, the auditor shall forward his report and the reply or
observations of the Board or the Audit Committee along with his comments (on such reply or observations
of the Board or the Audit Committee) to the Central Government within fifteen days from the date of
receipt of such reply or observations;
(c) in case the auditor fails to get any reply or observations from the Board or the Audit Committee within
the stipulated period of forty-five days, he shall forward his report to the Central Government along with a
note containing the details of his report that was earlier forwarded to the Board or the Audit Committee
for which he has not received any reply or observations;
(d) the report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by Registered
Post with Acknowledgement Due or by Speed Post followed by an e-mail in confirmation of the same;
(e) the report shall be on the letter-head of the auditor containing postal address, e-mail address and
contact telephone number or mobile number and be signed by the auditor with his seal and shall indicate
his Membership Number; and
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CMA INTER AUDITING CHAPTER 7 Company Audit

(f) The report shall be in the form of a statement as specified in Form ADT-4.
(3) In case of a fraud involving lesser than the amount specified in sub-rule (1), the auditor shall report the
matter to Audit Committee constituted under Section 177 or to the Board immediately but not later than
two days of his knowledge of the fraud and he shall report the matter specifying the following:
(a) Nature of Fraud with description;
(b) Approximate amount involved; and
(c) Parties involved.
The provisions of this section regarding the duties of an auditor also apply to the cost accountant
conducting cost audit under Section 148 and the company secretary in practice conducting secretarial
audit under Section 204 [Section 143(14)].

2. Discuss about the manner in which rotation of Auditors may be done by the company on expiry of
their term.
As per Section 139(4), the Central Government may, by rules, prescribe the manner in which the
companies shall rotate their auditors in pursuance of Section 139(2). Accordingly, the Central Government
has prescribed the following provisions under Rule 6 of the Company (Audit and Auditor) Rules 2014.
(i) Where a company is required to constitute an Audit Committee u/s 177 of the Act, the Audit Committee
shall recommend to the Board, the name of an individual auditor or of an audit firm who may replace the
incumbent auditor on expiry of the term of such incumbent.
(ii) Where a company is not required to constitute an Audit Committee u/s 177 of the Act, the Board shall
consider the matter of rotation of auditors and make its recommendation for appointment of the next
auditor by the members in annual general meeting.

Note: For the purpose of the rotation of auditors –

(i) the period for which the individual or the firm has held office as auditor prior to the commencement of
the Act shall be taken into account for calculating the period of five consecutive years or ten consecutive
years, as the case may be;
(ii) the incoming auditor or audit firm shall not be eligible if such auditor or audit firm is associated with the
outgoing auditor or audit firm under the same network of audit firms.

The term “same network” shall include the firms operating or functioning, hitherto or in future, under the
same brand name, trade name or common control.

Note: For the purpose of rotation,

(i) a break in the term for a continuous period of five years shall be considered as fulfilling the requirement
of rotation;
(ii) if a partner, who is in charge of an audit firm and also certifies the financial statements of the company,
retires from the said firm and joins another firm of chartered accountants, such other firm shall also be
ineligible to be appointed for a period of five years.

3. Discuss the disqualification of a Company Auditor.

As per Section 141(3), read with Rule 10 of Company (Audit and Auditor) Rule 2014, the following persons
shall not be eligible for appointment as an auditor of a company:
(a) a body corporate other than a limited liability partnership registered under the Limited Liability
Partnership Act, 2008;
(b) an officer or employee of the company;
(c) a person who is a partner, or who is in the employment, of an officer or employee of the company;
(d) a person who, or his relative or partner:
(i) is holding any security of or interest in the company or its subsidiary, or of its holding or associate
company or a subsidiary of such holding company, of face value not exceeding rupees one lakh;
(ii) is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such
holding company, in excess of rupees five lakh;
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CMA INTER AUDITING CHAPTER 7 Company Audit

(iii) has given a guarantee or provided any security in connection with the indebtedness of any third person
to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding
company, in excess of rupees one lakh;
(e) a person or a firm who, whether directly or indirectly, has business relationship with the company, or its
subsidiary, or its holding or associate company or subsidiary of such holding company or associate
company of such nature as may be prescribed;
(f) a person whose relative is a director or is in the employment of the company as a director or key
managerial personnel;
(g) a person who is in full time employment elsewhere or a person or a partner of a firm holding
appointment as its auditor, if such persons or partner is at the date of such appointment or reappointment
holding appointment as auditor of more than twenty companies;
(h) a person who has been convicted by a court of an offence involving fraud and a period of ten years has
not elapsed from the date of such conviction; (i) a person who, directly or indirectly, renders any service
referred to in Section 144 to the company or its holding company or its subsidiary company.
Where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in sub-
section (3) after his appointment, he shall vacate his office as such auditor and such vacation shall be
deemed to be a casual vacancy in the office of the auditor [Section 141(4)].

4. What is the procedure for appointment of cost auditor under the Companies Act, 2013?
As per Rule 8 of the Companies (Meetings of Board and its Powers) Rules, 2014, read with Section 179 of
the Companies Act, 2013, secretarial auditor is required to be appointed by means of resolution at a duly
convened board meeting.
It is advisable for the Secretarial Auditor to get a letter of engagement from the company. Secretarial
Auditor should accept the letter of engagement. The company shall report any change in the secretarial
auditor during the financial year to the members through the Board’s Report. The qualifications,
observations or comments / remarks of the secretarial Audit Report shall be read at the annual general
meeting of the company along with the explanation and comments of the Board of Directors (Clause 13 of
Secretarial Standard 2).

5. Who can be appointed as a cost auditor?

As per Section 148(3) of the Companies Act 2013, cost audit shall be conducted by a Cost Accountant who
shall be appointed by the Board. No person appointed under Section 139 as an auditor of the company
shall be appointed for conducting the audit of cost records.

6. What are the eligibility criteria for appointment as a cost auditor?

As per Section 148(3) of the Companies Act 2013, cost audit shall be conducted by a Cost Accountant who
shall be appointed by the Board. No person appointed under Section 139 as an auditor of the company
shall be appointed for conducting the audit of cost records.

7. Who can conduct the Secretarial Audit and which company have to undergo such?
According to the provisions of Section 204, only a member of the Institute of Company Secretaries of India
holding a certificate of Practice (i.e., PCS) is qualified to conduct secretarial audit of the company.

8. Discuss about the applicability of secretarial audit for companies.

As per the provision of Section 204(1) of the Companies Act, 2013 read with Rule 9 of the Companies
(Appointment and Remuneration of Managerial Personnel) Rules, 2014:
1. Every listed company;
2. Every public company having a paid-up share capital of 50 crore rupees or more; or
3. Every public company having a turnover of 250 crore rupees or more; or
4. Every company having outstanding loans or borrowings from banks or public financial institutions of 100
crore rupees or more.

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CMA INTER AUDITING CHAPTER 7 Company Audit

As per Regulation 24A of the SEBI(LODR) Regulations, 2015, every listed entity and its material unlisted
subsidiaries incorporated in India shall undertake secretarial audit and shall annex a secretarial audit report
given by a company secretary in practice, in such form as specified, with the annual report of the listed
entity.
In addition to the above, every listed entity shall submit a secretarial compliance report in such form as
specified, to stock exchanges, within sixty days from end of each financial year. (Amended by the SEBI
(Listing Obligations and Disclosure Requirements) (Second Amendment) Regulations, 2021 w.e.f. 5.5.2021).

9. Write Short Notes:

(i) Auditor’s duty regarding unclaimed dividend
(ii) Responsibility of a Joint Auditor
(iii) Auditor’s duty regarding Issue of Debentures
(iv) Audit’s duty regarding bonus issue
(v) Branch Audit

ESSAY TYPE QUESTIONS

1. Discuss the provisions of Companies Act, 2013 as regards reporting of frauds by Company Auditor.
2. Discuss about the manner in which rotation of Auditors may be done by the company on expiry of
their term.
3. What is the procedure to be followed for fixing the remuneration of a Cost Auditor?
As per Section 148(3) of the Companies Act 2013 read with Rule 14 of the Companies (Audit and Auditors)
Rules 2014, the remuneration of the cost auditor shall be decided by the Board as recommended by the
Audit Committee, if any, which shall be ratified by the shareholders subsequently. In the case of companies
which are not required to constitute an audit committee, the Board shall appoint an individual who is a
cost accountant or a firm of cost accountants in practice as cost auditor and the remuneration of such cost
auditor shall be ratified by shareholders subsequently.

4. Distinguish between ‘Audit Report’ and ‘Audit Certificate’.

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CMA INTER AUDITING CHAPTER 7 Company Audit

5. Discuss the functions and power of the Audit Committee.

Broad Functions of Audit Committee:

As per Section 177(4) of the Act, The Board shall specify, in writing,
the terms of reference for the Audit Committee which shall, inter alia, include —
(i) the recommendation for appointment, remuneration and terms of appointment of auditors of the
company;
(ii) review and monitor the auditor’s independence and performance, and effectiveness of audit process;
(iii) examination of the financial statement and the auditors’ report thereon;
(iv) approval or any subsequent modification of transactions of the company with related parties:
(v) scrutiny of inter-corporate loans and investments;
(vi) valuation of undertakings or assets of the company, wherever it is necessary;
(vii) evaluation of internal financial controls and risk management systems;
(viii) monitoring the end use of funds raised through public offers and related matters.

Power of Audit Committee

(a) Committee may ask for Auditor’s Comment: The Audit Committee may call for the comments of the
auditors about internal control systems, the scope of audit, the observations of the auditors and review of
financial statement before their submission to the Board. The Committee may also discuss any related
issues with the internal and statutory auditors and the management of the company. [Section 177(5)]
(b) Investigation: The Audit Committee shall have authority to investigate into any matter in relation to the
items specified in Section 177(4) or referred to it by the Board. For this purpose, the Committee shall have
power to obtain professional advice from external sources and have full access to information contained in
the records of the company. [Section 177(6)]
(c) Board’s Report and Audit Committee: The Board’s report under sub-section (3) of section 134 shall
disclose the composition of an Audit Committee and where the Board had not accepted any
recommendation of the Audit Committee, the same shall be disclosed in such report along with the
reasons therefor. [Section 177(8)]
(d) Whistle Blowing Policy: Every listed company and company accepting public deposits or borrowing in
excess of fifty crore rupees from banks and financial institutions shall establish a vigil mechanism for
directors and employees to report genuine concerns in such manner as may be prescribed. [Section 177(9)]
(e) Safeguards against Victimization: The vigil mechanism under sub-section (9) shall provide for adequate
safeguards against victimization of persons who use such mechanism and make provision for direct access
to the chairperson of the Audit Committee in appropriate or exceptional cases. The company shall disclose
establishment of such mechanism on its website, if any, and in the Board’s report. [Section 177(10)]

6. Discuss the procedure for appointment for first Auditor of the Company and his tenure.

(a) In case of a company other than a Government Company [Section 139(6)]

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The first auditor of a company, other than a Government company, shall be appointed by the Board of
Directors within thirty days from the date of registration of the company.
In the case of failure of the Board to appoint such auditor, it shall inform the members of the company,
who shall appoint such auditor within ninety days at an extraordinary general meeting.
The auditor, so appointed, shall hold office till the conclusion of the first annual general meeting.

(b) In case of a Government Company [Section 139(7)]

In the case of a Government company or any other company owned or controlled, directly or indirectly,
by the Central Government, or by any State Government, or Governments, or partly by the Central
Government and partly by one or more State Governments, the first auditor shall be appointed by the
Comptroller and Auditor-General of India within sixty days from the date of registration of the company.
In case the Comptroller and Auditor-General of India does not appoint such auditor within the aforesaid
period, the Board of Directors of the company shall appoint such auditor within the next thirty days.
Further, in the case of failure of the Board to appoint such auditor within the next thirty days, it shall
inform the members of the company who shall appoint such auditor within sixty days at an extraordinary
general meeting.
The auditor, so appointed, shall hold office till the conclusion of the first annual general meeting.

7. Discuss the relevant provisions of Companies (Cost Records and Audit) Rules 2014 on applicability of
Cost Audit to different sectors.

1) Every company specified in item (A) of rule 3 shall get its cost records audited in accordance with these
rules if the overall annual turnover of the company from all its products and services during the
immediately preceding financial year is rupees fifty crore or more and the aggregate turnover of the
individual product or products or service or services for which cost records are required to be maintained
under rule 3 is rupees twenty-five crore or more.

2) Every company specified in item (B) of rule 3 shall get its cost records audited in accordance with these
rules if the overall annual turnover of the company from all its products and services during the
immediately preceding financial year is rupees one hundred crore or more and the aggregate turnover of
the individual product or products or service or services for which cost records are required to be
maintained under rule 3 is rupees thirty-five crore or more.

3) The requirement for cost audit under these rules shall not apply to a company which is covered in rule 3;
and (i). whose revenue from exports, in foreign exchange, exceeds seventy-five per cent of its total
revenue;
Or (ii). which is operating from a special economic zone;
(iii). which is engaged in generation of electricity for captive consumption through Captive Generating
Plant.
For this purpose, the term “Captive Generating Plant” shall have the same meaning as assigned in rule 3 of
the Electricity Rules, 2005”.

8. What is a qualified Audit Report? Discuss the circumstances when an Auditor shall qualify his report.
An auditor expresses qualified opinion on financial statements when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements,
either individually or in aggregate, are material but not pervasive (i.e., not highly significant);
(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base his opinion, but
concludes that the possible effects of undetected misstatements on the financial statements could be
material but not pervasive. In case of a qualified opinion, the heading of the ‘Basis for Opinion’ paragraph
must be modified as ‘Basis for Qualified Opinion’.

Some situations when an auditor should express a qualified opinion are:

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(i) Non-adherence to AS-2 with regard to inventory valuation at the lower of cost and net realisable value.
(ii) Auditor being prevented by the management from observing the counting of physical inventory where
such action is material to the financial statements.

9. Discuss the qualifications of a Company Auditor.

As per Section 141 of Companies Act, 2013, the following persons should be considered as qualified for
being a company auditor:
(i) A person shall be eligible for appointment as an auditor of a company, only if he is a Chartered
Accountant [Section 141(1)].
(ii) A firm can also be appointed by its firm name to act as the auditor of a company if majority of its
partners practicing in India are qualified for appointment as company auditor [Section 141(1)].
(iii) Where a firm, including a limited liability partnership, is appointed as an auditor of a company, only the
partners who are Chartered Accountants shall be authorized to act and sign on behalf of the firm [Section
141(2)].
Note: In this context, the meaning of the term ‘Chartered Accountant’ shall be interpreted based on the
provisions of The Chartered Accountants Act, 1949 as follows:
(i) “Chartered Accountant” means a person who is a member of the Institute [Section 2].
(ii) A person is a member of the Institute if his name appears in the Register of the Institute [Section 3].
(iii) The following persons shall be entitled to have his name entered in the Register [Section 4]:
(a) any person who is a registered accountant or a holder of a restricted certificate at the commencement
of this Act.
(b) any person who has passed such examination and completed such training as may be prescribed for
members of the Institute.
(c) any person who has passed the examination for the Government Diploma in Accountancy or an
examination recognized as equivalent thereto by the rules for the award of the Government Diploma in
Accountancy before the commencement of this Act and fulfils such conditions as specified by the Central
Government in this behalf.
(d) any person who, at the commencement of this Act, is engaged in the practice of accountancy in any
State and fulfils such conditions as specified by the Central Government in this behalf.
(e) any person who has passed such other examination and completed such other training without India as
is recognized by the Central Government or the Council as being equivalent to the examination and
training prescribed for members of the Institute.
(f) any person domiciled in India, who at the commencement of this Act is studying for any foreign
examination and is at the same time undergoing training, whether within or without India, have passed the
examination or completes the training within five years after the commencement of this Act.

In order to become the member of the Institute, the aforesaid persons must reside in India or must be in
practice in India. For any person outside India with all other requisite qualifications, the Central
Government or the Institute may impose additional conditions. Moreover, any qualified persons will have
to formally apply for the membership to the Institute with requisite fees. His name will be included in the
Register only if the application is accepted.

10. Discuss the provisions of Companies Act regarding resignation of an auditor.

According to Section 140(2) of Companies Act, 2013 read with Rule 8 of Company (Audit and Auditors) Rule
2014, a company auditor resigning from his post must comply with the following steps:

(i) The auditor shall file within a period of thirty days from the date of resignation, a statement in the
prescribed Form ADT-3 with the company and the Registrar, indicating the reasons and other facts as may
be relevant with regard to his resignation.
(ii) In case of companies referred to in sub-section (5) of Section 139, i.e., Govt. Companies or any other
company owned or controlled, directly or indirectly, by the Central Government, or by any State

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Government or Governments, or partly by the Central Government and partly by one or more State
Governments, the auditor shall file such statement with the Comptroller and Auditor-General of India.
If the auditor does not comply with the above provision, he or it shall be punishable with fine of fifty
thousand rupees or the amount equal to the remuneration of the auditor, whichever is less, and in case of
continuing failure, with further penalty of five hundred rupees for each day after the first during which
such failure continues, subject to a maximum of two lakh rupees. [Section 140(3)]

11. Discuss the provisions of Companies Act regarding remuneration of an auditor.

Section 142 of Companies Act, 2013 contains the statutory provisions in relation to remuneration of
auditors are contained in. These are as follows:
(1) The remuneration of the auditor of a company shall be fixed in its general meeting or in such manner as
may be determined therein. The Board may, however, fix remuneration of the first auditor appointed by it.
(2) The above remuneration shall be in addition to the fee payable to an auditor and shall include the
expenses, if any, incurred by the auditor in connection with the audit of the company and any facility
extended to him. However, it must not include any remuneration paid to him for any other service
rendered by him at the request of the company.

12. Discuss the provisions of Companies Act regarding ceiling on the number of audit assignments.
As per Section 141(3)(g), a person or a partner of a firm shall not be eligible for appointment as the auditor
of a company if –
(i) Such person is in full time employment elsewhere; or
(ii) Such person or partner is, at the date of such appointment or reappointment, holding appointment as
auditor of more than twenty companies, other than one person companies, dormant companies, small
companies and private companies having paid up capital less than `100 crore.

Accordingly, the following points shall be kept in mind:

Every qualified chartered accountant who is not in full time employment can be the auditor of a
maximum of twenty companies.
In case of a partnership firm, the limit will be twenty companies for each individual partner. Hence, for a
firm with three partners, the overall limit will be (20 × 3) = 60 companies.
While computing the ceiling in case of a partnership firm, a partner with full time employment elsewhere
should not be taken into account.
If any chartered accountant is a partner in a number of audit firms, then all the firms together will be
entitled to audit 20 companies with respect to such common partner.
Similarly, if a chartered accountant is practicing individually and is also the partner in other firm or firms,
the overall ceiling with respect to him as individual and also the partner will be 20 companies.
While calculating the above ceiling, a joint audit assignment will be taken as one unit. Moreover, if an
auditor is appointed to audit even a part of company’s accounts, it will be considered as one unit.
Every auditor, as an individual or as a partner of a firm can accept a maximum of 60 tax audit
assignments.

13. Discuss the disqualification of a Company Auditor.

14. How a company auditor is removed from his office?
According to Companies Act, 2013, a company auditor can be removed from his office in two ways as
follows: A. Removal of the Auditor before Expiry of his Term The auditor appointed under Section 139 may
be removed from his office before the expiry of his term, subject to the fulfilment of the following
conditions under Section 140 (1) read with Rule 7 of CAAR 2014:

(i) An application to the Central Government for removal of the auditor shall be made in Form ADT-2. The
application shall be accompanied with fees as provided for this purpose under the Companies (Registration
Offices and Fees) Rules, 2014.

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(ii) The application shall be made to the Central Government within thirty days of the resolution passed by
the Board.

(iii) The company shall hold the general meeting within sixty days of receipt of approval of the Central
Government for passing the special resolution for removal of the said auditor.

(iv) The auditor concerned shall be given a reasonable opportunity of being heard.

B. Removal of the Auditor by the Tribunal

As per Section 140(5), an auditor can be removed from his office by the Tribunal in the following manner:
(i) The Tribunal either suo motu or on an application made to it by the Central Government or by any
person concerned, may, by order, direct the company to change its auditor, if it is satisfied that the auditor
has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or
in relation to, the company or its directors or officers.
(ii) If the application is made by the Central Government and the Tribunal is satisfied that any change of the
auditor is required, it shall within fifteen days of receipt of such application, make an order to the removal
of the auditor from his office.
(iii) The Central Government may appoint another auditor in his place.
(iv) An auditor, whether individual or firm, against whom final order has been passed by the Tribunal under
this Section shall not be eligible to be appointed as an auditor of any company for a period of five years
from the date of passing of the order and the auditor shall also be liable for action under Section 447.

15. Discuss the rights of a company auditor

(i) Inspect Books of Accounts and Vouchers: Every auditor of a company shall have the right of access, at
all times, to the books of account and vouchers of the company, whether kept at the registered office of
the company or at any other place. In addition, auditor of a holding company shall also have the right of
access to the records of all its subsidiaries and associate companies in so far as it relates to the
consolidation of its financial statements with that of its subsidiaries [Section 143(1)].

(ii) Obtain Information and Explanations: The auditor shall be entitled to require from the officers of the
company such information and explanation as he may consider necessary for the performance of his duties
as the auditor [Section 143(1)].

(iii) Inspect Branch Offices and Branch Accounts: The company auditor is also entitled to inspect the
accounts of any branch office in case he considers it necessary in order to discharge his duties as the
company auditor. He can do so, even if a separate auditor has already been appointed to audit the branch
accounts [Section 143(8)].

(iv) Receive the Report of Branch Audit from the Branch Auditor: In case a separate auditor has been
appointed to audit the branch accounts, the company auditor has the right to receive the branch audit
report from the branch auditor so appointed and use it to prepare the overall audit report [Section 143(8)].

(v) Sign the Audit Report and Other Documents: The company auditor also has the right to sign the
auditor’s report or sign or certify any other document of the company in accordance with the provisions of
sub-section (2) of Section 141 [Section 145].

(vi) Have Audit Report Read at the AGM: The company auditor has the right to have the report read before
the company in the General Meeting (especially in case the qualifications, observations or comments on
financial transactions or matters, mentioned in the auditor’s report, have any adverse effect on the
functioning of the company) and the same shall be open to inspection by any member of the company
[Section 145].

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(vii)Receive Notices and Attend General Meetings: The company auditor is entitled to receive all notices of,
and other communications relating to, any general meeting and to attend such meetings either by himself
or through his authorised representative, who shall also be qualified to be an auditor. The auditor shall also
have the right to be heard at such meeting on any part of the business which concerns him as the auditor
[Section 146].

(viii)Attend the Meeting of the Audit Committee: The auditors of a company shall have a right to attend the
meetings of the Audit Committee and to be heard in the meetings when the Committee considers the
auditor’s report, but shall not have the right to vote [Section 177(7)].

(ix) Right to be Indemnified: The auditor of a company shall also have the right to be indemnified for any
expenses incurred by him in defending himself in case the judgement in any law suit (whether civil or
criminal) against the company goes in favour of the auditor.

16. What do you mean by Joint Audit? Discuss the advantages and disadvantages of Joint Audit.
Joint audit refers to the process of conducting the audit of a single organisation by more than one auditor.
Large Companies with diversified business operations often resort to this process of auditing where they
employ multiple auditors to conduct statutory audit. The basic aim in applying joint audit is to pull the
resources of multiple auditors to conduct audit efficiently and within lesser amount of time.

Benefits of Joint Audit

The benefits of joint audit are as follows:
a) Joint audit reduces the workload of a single auditor.
b) Since different auditors may be engaged to handle different parts of accounts, timely completion of
work is possible even in a large organisation.
c) The auditors may share their expertise and solve critical problems in the process.
d) Joint audit improves the quality of audit work to a great extent.
e) There may be healthy competition among the auditors which improves the quality and speed of the
audit work.
f) Under joint audit, it is possible to get the benefit of extensive knowledge of different auditors at the
same time.

Limitations of Joint Audit

The limitations of joint audit are enumerated below:
a) Established auditors may have a superiority complex over the less experienced one.
b) It is not suitable for a small entity due to substantial cost burden.
c) At times, lack of coordination among the auditors may slow down the speed of work.
d) There may be uncertainty about the liability of any work.
e) Areas of common concern may be neglected.
f) The auditors have to share the fees.

17. Discuss the audit procedure to be followed for the audit of:
(i) Inventory
(ii) Property, Plant and Equipment
(iii) Borrowings
(iv) Trade Receivable

18. Discuss the audit procedure to be followed for the audit of:
(i) Employee Benefits

Employee benefit expenses represents the total amount payable by the organisation to its employees and
essentially includes, apart from the wages and salaries in cash, all types of perquisites, post-employment
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benefits including gratuity, superannuation, leave encashment, provident fund contribution, ESI
contribution as well as employee welfare expenses etc. In a company, often, these expenses constitute a
significant portion of total cost and hence an auditor must put especial emphasis while auditing these
items.
While conducting an audit of employee benefit expenses, an auditor must, at the beginning, obtain a detail
understanding of the company’s recruitment, promotion and retirement policies, remuneration schemes,
various post-employment benefits. He should evaluate the internal control associated with these expenses.
He should also apply substantive procedure to determine the reasonability of monthly cash outflow,
consistency with the previous year’s figures etc. so as to determine an expectation of monthly expenses
and whether the same is consistent with peers.

Audit Procedure to be Followed

In addition, the auditor shall resort to the following audit procedure:
(a) Occurrence
(i) The auditor should ensure that all expenses included in the ‘employee benefit expenses’ are genuine.
(ii) He should obtain a complete list of employees with data on new hires, their appointment dates and
remuneration terms and conditions.
(iii) For a sample of newly appointed employees, he may conduct a complete examination of their
appointment and remuneration paid as per terms.
(iv) Similarly, he may collect a list of employees resigned or terminated during the year and see that their
payments have been appropriately decided and settled.
(v) He should obtain the pay roll register and conduct and examination of reasonability of remuneration
and investigate irregularities, if any.
(vi) He should also see that all adjustments such as outstanding salary, PF contribution, deposit of TDS, PF
and ESI premium have been appropriately recorded.

(b) Cut-off
The auditor must ensure that only employee benefit expenses relating to current year have been
recognised.

(c) Completeness
(i) The auditor shall see that all the employee benefit expenses have been appropriately recorded in the
books of accounts.
(ii) He should also check whether all the amount of money deducted from salary have been duly deposited
and if not, the same have been shown as a current liability.

(d) Measurement
(i) The auditor must see that the total amount of remuneration is correctly determined. He may conduct a
test on a sample to check the same.
(ii) He should check whether statutory deductions have been accurate and post-employment benefits have
been determined as per the policy adopted.

(e) Presentation and Disclosure

The auditor must see that the following disclosure requirements as per Schedule III (Part 1) have been duly
complied with:
(i) Employee Benefits Expense shall be shown separately as (i) salaries and wages, (ii) contribution to
provident and other funds, (iii) expense on Employee Stock Option Scheme (ESOP) and Employee Stock
Purchase Plan (ESPP), (iv) staff welfare expenses.

(ii) Purchases

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It is another important element of financial statements and is includes purchase of raw materials to be
included in the cost of materials consumed in case of a manufacturing organisation and purchase of
merchandise in case of a trading organisation. As a part of an audit exercise, the auditor examines the
purchase transactions and related internal control to ensure that there is no material misstatement in the
amount of purchase and accounts payable reported in the financial statements.

Audit Procedure to be Followed

The auditor shall resort to the following audit procedure to audit purchases:
(a) Occurrence
(i) The auditor must ensure that only genuine purchases have been recorded in the books of accounts. He
may examine the purchase orders, goods received notes and purchase invoices to satisfy himself.
(ii) Photocopy of purchase invoices should not be allowed. Moreover, purchase invoices must be in the
name of the entity.
(iii) He shall see whether all the purchases are approved by the relevant authority. The same is extremely
important for purchases from related parties.

(b) Cut-off
The auditor shall see that only purchases during the year have been recognised as expense.

(c) Completeness
(i) He should apply the cut-off procedure to ensure that purchases effected during the year are only
recognised in the current accounting period.
(ii) The auditor should see that purchase invoice should be booked only once the risk and reward incidental
to the ownership has been transferred. He should be careful with delivery terms such as F.O.B and C.I.F
etc.
(iii) The auditor must check the return transactions carefully based on relevant documents.
(iv) He shall ensure correct accounting for goods-in-transit.

(d) Measurement
(i) The auditor shall see that purchase transaction values have been correctly calculated considering the
trade discount applied.
(ii) Information relating to input tax credit shall be verified. The auditor shall see that appropriate
adjustments have been made in this respect.

(e) Presentation and Disclosure

The auditor shall see that the following disclosure as per Schedule III (Part 1) has been appropriately done:
(i) In the case of manufacturing companies, —
(1) raw materials under broad heads;
(2) goods purchased under broad heads;
(ii) In the case of trading companies, purchases in respect of goods traded in by the company under broad
heads.
(iii) Transactions with related parties.

(iii) Revenue from Operation

Revenue from operation comprises sale of goods, sale of services and other operating revenues. Other
operating revenue includes any revenue earned by the company from its operations other than its
principal activities. For example, Discount Received, Bad Debt Recovery etc. For a finance company,
revenue from operation primarily includes interest income and income from other financial services.

Audit Procedure to be Followed

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Apart from evaluating the adequacy of internal control with respect to revenue related transactions, the
auditor shall resort to the following audit procedure to audit the revenue from operations.
(a) Occurrence:
(i) The auditor should ensure that all revenue items recognised are genuine and no sale transactions have
been recorded twice.
(ii) He may test check a few invoices with accounting entries. Further, he should check the sequence of
sales invoices, review the recording of unusual transactions, verify the return transactions with sales
invoice, challan, credit note and stock records.
(iii) He should also obtain confirmation from few customers to check whether the transactions are genuine.
(iv) He should ensure that no fake sale transactions have been recorded.
(v) For services, he must see that revenue has been recognised based on the policy undertaken.

(b) Cut-off
He shall see whether revenue from operation includes the sale made and services performed during the
year only.

(c) Completeness
The auditor should verify that all sales effected during the year have been included in revenue. He should
apply the cut-off procedure to ensure that revenues are recognised in the current accounting period and
check if year end sale transactions have been tempered.

(d) Measurement
(i) The auditor shall see that revenues are accurately measured based on applicable Accounting Standards.
(ii) Trade discount allowed to the customers should be checked. No separate entry for trade discount
should be passed in the books. If there is any significant variation in trade discount allowed to different
customers, the auditor is required to inquire into the reason for such variations.
(iii) The sales tax, insurance charges, etc. collected through sales invoices must be recorded under separate
accounts.

(e) Presentation and Disclosures

The auditor shall ensure the following disclosure for revenue from operation in respect of a company other
than a finance company as per Schedule III (Part 2):
(i) Disclosure should be available for each class of goods.
(ii) Revenue from operations shall disclose separately in the notes revenue from –
(a) Sale of products; (b) Sale of services; (c) Other operating revenues; Less: (d) Excise duty.
(iii) In respect of a finance company, revenue from operations shall include revenue from –
(a) Interest; and (b) Other financial services
(iv) Discount other than usual trade discount must be disclosed. Similarly, transactions with related parties
should be separately disclosed in the Notes.
(v) In the case of companies rendering or supplying services, gross income derived from services rendered
or supplied under broad heads.

(iv) Depreciation and Amortisation

Depreciation is the charge representing the cost of a tangible asset allocated over its effective life. The
similar charge for an intangible asset is known as amortization. Depreciation and amortisation constitute a
significant portion of a company’s total expenditure and hence have a direct bearing on profitability.
Hence, the auditor needs to be extra careful in determining the appropriateness, accuracy and accounting
of depreciation and amortization.

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While conducting the audit of depreciation and amortization charges, the auditor should obtain a detail
understanding of the organisation’s depreciation policy, accounting policy relating to depreciation and
should check the validity of the charge and calculation accuracy.

Audit Procedure to be Followed

In addition, the auditor shall resort to the following audit procedure:
(a) Occurrence
(i) The auditor shall obtain the fixed asset register and identify the items of assets acquired, sold and
discarded during the year. This will help him to determine the items of assets eligible for depreciation and
amortisation during the year.
(ii) He may select a sample of assets on materiality considerations and verify the rates and amount of
depreciation and amortisation calculated.

(b) Cut-off
The auditor needs to ensure that depreciation is charged on the assets purchased from its date of put to
use and not form purchase date. Moreover, he shall also see that, in case the company has a policy of
charging depreciation on time basis, deprecation on items acquired during the year is calculated from the
date of put to use to year end and for items sold, from the beginning of the year up to the date of sale.

(c) Completeness
(i) He must ensure that depreciation and amortisation have been charged on all eligible tangible and
intangible assets respectively and no fake assets have been considered for this purpose.
(ii) The auditor shall see that the amount of depreciation and amortisation have been appropriately
accounted in primary books and posted to appropriate accounts.
(iii) He shall also ensure that depreciation on revalued amount has been properly accounted from
revaluation reserve.
(iv) He should also ensure that for any retrospective change in the method of depreciation, due effect has
been given in the Income Statement.

(d) Measurement
(i) The auditor shall see that the rate of depreciation is consistent with the rates suggested in Schedule II
and the amount of depreciation and amortisation has been calculated accurately based on the rates and
time involved.
(ii) He shall ensure that the rates have been decided in conformity with the effective life of assets.
(iii) He should also see that residual value has been properly determined.
(iv) The auditor shall also see that in case of change in estimation of useful life or in case of impairment,
the amount of depreciation has been calculated appropriately.

(e) Presentation and Disclosure

The auditor must see that the following disclosure requirements as per Schedule III (Part 1) have been duly
complied with:
(i) Accounting policy for depreciation and amortisation.
(ii) Useful life of assets as per Schedule II.
(iii) Residual value and the method of depreciation.

19. What is the procedure for appointment of cost auditor under the Companies Act, 2013?
20. Who can be appointed as a cost auditor?
21. What are the eligibility criteria for appointment as a cost auditor?
22. Who can conduct the Secretarial Audit and which company have to undergo such?
23. Discuss about the applicability of secretarial audit for companies.
24. Discuss auditor’s responsibility for reporting on Internal Financial Control over Financial Reporting.

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As mentioned earlier, Sec 143(3)(i) of Companies Act, 2013 requires that the report of the auditor should
state as to whether the company has adequate Internal Financial Control system in place and the operating
effectiveness of such controls.
Further, Rule 10A of Companies (Audit & Auditors) Rules 2014 states that:
a) For the financial years commencing on or after 1st April 2015, the report of the auditor should state
about existence of adequate Internal financial controls and its operating effectiveness.
b) The auditor of a company may voluntarily include the statement referred to in this rule for the financial
year commencing on or after 1st April 2014 and ending on or before 31st March 2015.
As per the Guidance Note issued by The Institute of Chartered Accountants of India in this respect -
The auditor’s objective in an audit of internal financial controls over financial reporting is to express an
opinion on the effectiveness of the company’s internal financial controls over financial reporting and the
procedures in respect thereof are carried out along with an audit of the financial statements. Globally,
auditor’s reporting on internal controls is together with the reporting on the financial statements and such
internal controls reported upon relate to only internal controls over financial reporting.

Accordingly, the term ‘internal financial controls’ wherever used in this Guidance Note in the context of the
responsibility of the auditor for reporting on such controls under Section 143(3)(i) of the Act, per se implies
and relates to internal financial controls over financial reporting.
Therefore, ‘internal financial controls over financial reporting’ shall mean ‘A process designed to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
company’s internal financial control over financial reporting includes those policies and procedures that –

(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorisations of management and
directors of the company; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorised acquisition,
use, or disposition of the company’s assets that could have a material effect on the financial statements.
An auditor needs to conduct an audit of IFC-FR though a proper planning followed by testing the design
effectiveness of control and operating effectiveness of control and thereafter report on IFC over Financial
Reporting.
The Guidance Note also provides that reporting on the adequacy and operating effectiveness of IFC-FR
would apply even in case of consolidated financial statements, for the respective components included in
the consolidated financial statements only if it is a company under the 2013 Act. However, reporting on IFC
will not be applicable with respect to interim financial statements, such as quarterly or half-yearly financial
statements, unless such reporting is required under any other law or regulation.

25. State the functions of NFRA.

As per Section 132(2) of the Companies Act, 2013, the duties of the NFRA are to:
(i) Recommend accounting and auditing policies and standards to be adopted by companies for approval
by the Central Government;
(ii) Monitor and enforce compliance with accounting standards and auditing standards;
(iii) Oversee the quality of service of the professions associated with ensuring compliance with such
standards and suggest measures for improvement in the quality of service;
(iv) Perform such other functions and duties as may be necessary or incidental to the aforesaid functions
and duties.
Sub Rule (1) of Rule 4 of the NFRA Rules, 2018, provides that the Authority shall protect the public interest
and the interests of investors, creditors and others associated with the companies or bodies corporate
governed under Rule 3 by establishing high quality standards of accounting and auditing and exercising
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CMA INTER AUDITING CHAPTER 7 Company Audit

effective oversight of accounting functions performed by the companies and bodies corporate and auditing
functions performed by auditors.

26. Discuss the role of NFRA in monitoring and enforcing compliance with auditing standards.
(1) For the purpose of monitoring and enforcing compliance with auditing standards under the Act by a
company or a body corporate governed under Rule 3, the Authority may:
(a) review working papers (including audit plan and other audit documents) and communications related
to the audit;
(b) evaluate the sufficiency of the quality control system of the auditor and the manner of documentation
of the system by the auditor; and
(c) perform such other testing of the audit, supervisory, and quality control procedures of the auditor as
may be considered necessary or appropriate.
(2) The Authority may require an auditor to report on its governance practices and internal processes
designed to promote audit quality, protect its reputation and reduce risks including risk of failure of the
auditor and may take such action on the report as may be necessary.
(3) The Authority may seek additional information or may require the personal presence of the auditor for
seeking additional information or explanation in connection with the conduct of an audit.
(4) The Authority shall perform its monitoring and enforcement activities through its officers or experts
with sufficient experience in audit of the relevant industry.
(5) The Authority shall publish its findings relating to non-compliances on its website and in such other
manner as it considers fit, unless it has reasons not to do so in the public interest and it records the reasons
in writing.
(6) The Authority shall not publish proprietary or confidential information, unless it has reasons to do so in
the public interest and it records the reasons in writing.
(7) The Authority may send a separate report containing proprietary or confidential information to the
Central Government for its information.
(8) Where the Authority finds or has reason to believe that any law or professional or other standard has or
may have been violated by an auditor, it may decide on the further course of investigation or enforcement
action through its concerned Division.

27. Write Short Notes:

(i) Auditor’s duty regarding unclaimed dividend
(ii) Responsibility of a Joint Auditor
(iii) Auditor’s duty regarding Issue of Debentures
(iv) Audit’s duty regarding bonus issue
(v) Branch Audit
28. Discuss the functions and power of the Audit Committee.
29. Discuss the procedure for appointment for first Auditor of the Company and his tenure.
30. Discuss the relevant provisions of Companies (Cost Records and Audit) Rules 2014 on applicability
of Cost Audit to different sectors.
31. What is a qualified Audit Report? Discuss the circumstances when an Auditor shall qualify his report.
32. Discuss the qualifications of a Company Auditor.
33. Discuss the provisions of Companies Act regarding resignation of an auditor.
34. Discuss the provisions of Companies Act regarding remuneration of an auditor.
35. Discuss the provisions of Companies Act regarding ceiling on the number of audit assignments.
36. How a company auditor is removed from his office?
37. Discuss the rights of a company auditor
38. What do you mean by Joint Audit? Discuss the advantages and disadvantages of Joint Audit.
39. Discuss the audit procedure to be followed for the audit of:
(i) Inventory
(ii) Property, Plant and Equipment
(iii) Borrowings
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CMA INTER AUDITING CHAPTER 7 Company Audit

(iv) Trade Receivable

40. Discuss the audit procedure to be followed for the audit of:
(i) Employee Benefits
(ii) Purchases
(iii) Revenue from Operation
(iv) Depreciation and Amortisation
41. Discuss auditor’s responsibility for reporting on Internal Financial Control over Financial Reporting.
42. State the functions of NFRA.
43. Discuss the role of NFRA in monitoring and enforcing compliance with auditing standards.

UNSOLVED CASES - SOLVED

Case 1
In 2017, Mr. X, Mr. Y and Mr. Z, three qualified chartered accountants established a partnership firm
XYZ & Co. Till the financial year 2019-20, the firm mostly handled the audit of sole proprietorship
organisations and a few partnership firms and LLPs. In the financial year 2021-22, they got their first
corporate client ABC Enterprise Ltd. All the three partners are confident enough to carry out the new
assignment effectively as they have a very efficient team of audit clerks. However, they also feel that
they should be extra cautious this time as every aspect of statutory audit is well regulated by the
relevant
provisions of Companies Act 2013. They have, therefore, approached you to guide them in
comprehending
the relevant provisions of Companies Act 2013 in discharging their duties in an appropriate
manner.
a. Suggest them about their duties to prepare and submit report on financial statements of the company
as per Section 143 of the Act.
b. Suggest them about their duty to report any fraud to the Central Government as per Section 143
of the Act.

a. Duties to Prepare and Submit Report on Financial Statements as per Section 143 of the Companies Act,
2013:

1. Expression of Opinion:
o The auditors must express an opinion on whether the financial statements provide a true
and fair view of the state of affairs of the company, its profit or loss, and its cash flows for
the period under audit.
2. Compliance with Standards:
o Ensure that the audit is conducted in accordance with the auditing standards prescribed by
the ICAI and the relevant provisions of the Companies Act, 2013.
3. Examination of Books and Records:
o Examine the books of accounts and other relevant records maintained by the company to
ascertain whether they are accurate, complete, and in compliance with accounting
standards.
4. Verification of Transactions:
o Verify that the transactions reflected in the financial statements are genuine and
supported by appropriate documentation.
5. Adequacy of Internal Controls:
o Assess whether the company has adequate internal financial controls with reference to
financial statements and report any inadequacies identified.
6. Audit Report Contents:
o The audit report must include:
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CMA INTER AUDITING CHAPTER 7 Company Audit

▪ A statement on whether the financial statements comply with accounting

standards.
▪ Observations or comments on financial transactions or matters which have any
adverse effect on the functioning of the company.
▪ Comments on the maintenance of proper books of accounts by the company.
▪ Any qualification, reservation, or adverse remark relating to the maintenance of
accounts and other connected documents.
▪ Information required by the Companies Act, 2013 and other applicable laws.
7. Reporting on Other Matters:
o Report on any other matter as prescribed by the Companies (Audit and Auditors) Rules,
2014, such as:
▪ Whether the company has disclosed the impact of pending litigations.
▪ Whether the company has made provision for foreseeable losses on long-term
contracts.
▪ Compliance with statutory dues and any delays in remitting the same.

b. Duty to Report Any Fraud to the Central Government as per Section 143 of the Act:

1. Detection of Fraud:
o If during the course of the audit, the auditor has reason to believe that an offence involving
fraud is being or has been committed against the company by its officers or employees,
they are required to report the matter to the Central Government.
2. Procedure for Reporting:
o Report the fraud to the Board of Directors or the Audit Committee of the company within
two days of their knowledge of the fraud.
o Within 45 days of the above communication, the auditor should send a report to the
Central Government in the prescribed form, which includes:
▪ A description of the nature of the fraud with the approximate amount involved.
▪ Details of the parties involved in the fraud.
▪ Any other relevant information.
3. Form ADT-4:
o The report to the Central Government must be in the form ADT-4 and submitted along
with the necessary details and documents supporting the auditor's findings.
4. Confidentiality:
o Maintain confidentiality of the information reported and ensure that the disclosure is
made only to the extent required by law.
5. Documentation:
o Keep proper documentation of the steps taken during the investigation and reporting of
the fraud, including communications with the company's management and the Central
Government.

Case 2
ABC & Co. has been appointed as the statutory auditor of X Ltd. from the financial year 2020-2021. X Ltd.
is a well-established company and has a track record of following a stable dividend policy over the years.
The company pays interim dividend every year based on its quarterly results up to second quarter and
also declares additional dividend as the final dividend in its AGM. With respect to the current year, the
company has already declared and paid an interim dividend @ 10% of the paid-up equity share capital in
the month of October 2020. The AGM of the company is scheduled on 10.09.2021 where the BODs are
going to recommend a final dividend of another 15% over and above the interim dividend already paid,
thus taking the total dividend payment to 25% of the paid-up equity share capital for the financial year
2020-2021.
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CMA INTER AUDITING CHAPTER 7 Company Audit

Since, this is the first ever corporate audit assignment for ABC & Co., the partners seek your valuable
expertise in the process of conducting an audit of payment interim dividend and the upcoming final
dividend.
a. Advise ABC & Co. on an auditor’s duty in conducting the audit of interim dividend.
b. Advise ABC & Co. on an auditor’s duty in conducting the audit of final dividend.

a. Auditor’s Duty in Conducting the Audit of Interim Dividend:

1. Verification of Authorization and Compliance:

o Ensure that the interim dividend declaration is in accordance with the company’s Articles
of Association and relevant provisions of the Companies Act, 2013.
o Verify the resolution passed by the Board of Directors authorizing the interim dividend.
2. Examination of Financial Statements:
o Check the financial statements up to the quarter ended before the interim dividend
declaration to ensure there are sufficient profits.
o Verify that the interim dividend does not exceed the amount of profits earned during the
period up to the end of the quarter for which the interim financial statements have been
prepared.
3. Payment Verification:
o Confirm that the dividend has been paid within the stipulated time frame as per Section
123 of the Companies Act, 2013.
o Check the bank statements and other relevant documents to ensure the payment has been
made to all eligible shareholders.
4. Compliance with Dividend Distribution Tax:
o Verify that the dividend distribution tax (if applicable for the relevant period) has been
appropriately calculated and paid to the government within the prescribed time.
5. Disclosure in Financial Statements:
o Ensure proper disclosure of the interim dividend in the financial statements, including the
amount of dividend, date of declaration, and payment details.

b. Auditor’s Duty in Conducting the Audit of Final Dividend:

1. Verification of Authorization and Compliance:

o Ensure that the final dividend declaration is approved by the shareholders in the Annual
General Meeting (AGM).
o Verify compliance with the provisions of the Companies Act, 2013, and the company’s
Articles of Association regarding dividend declaration.
2. Examination of Financial Statements:
o Check the annual financial statements to ensure there are adequate profits after providing
for depreciation and other necessary adjustments to declare the final dividend.
o Confirm that the final dividend amount, combined with the interim dividend, does not
exceed the total available profits.
3. Payment Verification:
o Ensure the final dividend is paid within 30 days from the date of declaration in the AGM.
o Verify the payment process, including checking bank statements, to ensure the dividend is
paid to all eligible shareholders.
4. Compliance with Dividend Distribution Tax:
o Verify the calculation and payment of dividend distribution tax (if applicable for the
relevant period) to the government within the prescribed time.
5. Disclosure in Financial Statements:

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CMA INTER AUDITING CHAPTER 7 Company Audit

o Ensure proper disclosure of the final dividend in the financial statements, including the
amount of dividend, date of declaration, and payment details.

Additional Considerations:

1. Audit Working Papers:

o Maintain detailed audit working papers documenting the procedures performed, evidence
obtained, and conclusions reached regarding both interim and final dividends.
2. Written Representations:
o Obtain written representations from the management regarding the authorization,
compliance, and payment of dividends.
3. Audit Trail and Documentation:
o Ensure proper documentation of the audit trail for dividend payments as required under
relevant auditing standards.

By following these steps, ABC & Co. can ensure that their audit of the interim and final dividends of X Ltd. is
thorough, compliant with regulatory requirements, and well-documented.

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CMA INTER AUDITING CHAPTER 3 Special Audit

Chapter -8 SPECIAL AUDIT STUDY MAT QA

The table below shows the past trend of this chapter in last 11 exams
June Dec June Dec June Dec Dec Dec June Dec June Dec
17 17 18 18 19 19 21 22 23 23 24 24

MCQ

1. Which of the following is not a part of urban _______ and ________.

self-governance system in India? A. 53 and 54
A. Municipal Corporation B. 63 and 64
B. Town Panchayat C. 73 and 74
C. Municipality D. 83 and 84
D. Municipal Society
4. According to the Central Co-operatives
2. Which of the following is not a part of rural Societies Act, ______ of the profits of a co-
self-governance system in India? operative society
A. Gram Panchayat should be transferred to a Reserve Fund before
B. Gram Parishad distribution of dividend or payment of bonus to
C. Panchayat Samiti its members.
D. Zilla Parishad A. 20%
B. 25%
3. The amendments that gave the local self- C. 30%
governance in India the constitutional D. 35%
protection are

TRUE FALSE

1. The Banking Regulations Act, 1949 is an 4. Statutory audit requirements have been
important source of regulation in case of banks. covered in Co-Operative Societies Act, 1912.
TRUE TRUE
2. The educational institutions in India are 5. Companies (Auditor’s Report) Order, 2020 is
mostly structured as Public Trusts. TRUE not applicable to a banking company. TRUE
3. The rural self-governance in India is
structured in four layers. FALSE

FILL IN THE BLANKS

1. Auditor in a co-operative society is appointed by the _________ of Co-operative Societies. Registrar

2. Section __________ of Banking Regulations Act, 1949 dealwith the form and content of financial
statements of a banking company. 29
3. In case of nationalised banks, the remuneration of an auditor is fixed by ____________. RBI
4. The auditor of a banking company is to be appointed by the ____________.shareholders

SHORT ESSAY TYPE QUESTIONS

1. Write a short note on audit of a hotel.

2. Write a short note on audit of a travelling agency.
3. Write a short note on audit of a cinema hall.
4. Write a short note on audit of a restaurant.
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CMA INTER AUDITING CHAPTER 3 Special Audit

5. Write a short note on audit of Local Bodies.

1. Audit of a Hotel

• Revenue Sources: Examine room rentals, food and beverage sales, and ancillary services (e.g.,
event hosting, spa).
• Room Occupancy: Verify occupancy rates and accuracy of bookings and cancellations.
• Internal Controls: Assess controls over cash handling and inventory management in restaurants
and bars.
• Compliance: Check for adherence to health and safety regulations.
• Fixed Assets: Ensure proper accounting and depreciation of furnishings and equipment.

2. Audit of a Travelling Agency

• Revenue Verification: Review ticket sales, travel packages, and commissions.

• Contracts: Examine agreements with suppliers and partners for accurate revenue recognition.
• Booking Accuracy: Check the accuracy of bookings, cancellations, and refunds.
• Cash and Credit Controls: Assess controls over financial transactions.
• Compliance: Ensure adherence to regulatory requirements and licensing.

3. Audit of a Cinema Hall

• Ticket Sales: Verify the accuracy and reconciliation of ticket sales with cash and credit receipts.
• Concession Revenue: Check inventory management and revenue from concessions.
• Compliance: Review adherence to entertainment tax regulations and licensing requirements.
• Fixed Assets: Ensure proper accounting for audiovisual equipment and capital expenditures.

4. Audit of a Restaurant

• Revenue Accuracy: Verify sales records, including cash and credit transactions.
• Inventory Management: Assess control over the purchase, storage, and use of raw materials.
• Payroll Records: Ensure proper accounting for staff wages and benefits.
• Compliance: Check adherence to health and safety regulations, including food safety standards.

5. Audit of Local Bodies

• Revenue and Expenditure: Review sources of revenue (taxes, fees, grants) and ensure proper
recording of expenditures.
• Internal Controls: Assess controls over financial management, procurement, and asset
management.
• Budget Compliance: Check adherence to budgeting processes and use of public funds.
• Transparency and Accountability: Ensure proper management and reporting of public resources,
including project efficiency and effectiveness.

ESSAY TYPE QUESTIONS

1. While carrying an audit of a Bank how will you deal with each of the following?
a) Advances
b) Balance with other banks

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CMA INTER AUDITING CHAPTER 3 Special Audit

c) Money at call and short notice

d) Fixed Assets
e) Bills sent for collection
f) Contingent liabilities
g) Bills Payable
h) Borrowings and Deposits

2. Mention the special steps involved in conducting the audit of college?

3. What are the points which you as an Auditor would look into while auditing the accounts of a
hospital?

4. Discuss the important points in an audit of Co-operative Society.

1. Audit of a Bank: Key Areas

a) Advances

• Review Loan Documentation: Check for proper documentation, including loan agreements and
approval from the credit committee.
• Assess Classification: Verify correct classification of advances into standard, sub-standard,
doubtful, and loss categories.
• Provisioning: Ensure appropriate provisioning for non-performing assets (NPAs) as per regulatory
guidelines.
• Collateral Valuation: Check the valuation and adequacy of collateral securing the advances.
• Loan Monitoring: Assess the bank's process for ongoing monitoring and recovery efforts.

b) Balance with Other Banks

• Reconciliation: Verify reconciliation of balances with statements from correspondent banks.

• Confirmations: Obtain confirmations from other banks to confirm the balances as of the audit
date.
• Foreign Exchange: Review controls over foreign currency transactions if applicable.

c) Money at Call and Short Notice

• Verification: Confirm balances and review agreements for such short-term funds placements.
• Interest Calculation: Check accuracy of interest calculation and accrual.
• Liquidity Assessment: Evaluate the adequacy of such funds for liquidity management.

d) Fixed Assets

• Physical Verification: Conduct physical verification of assets.

• Depreciation: Ensure accurate calculation and recording of depreciation.
• Asset Register: Verify the maintenance and accuracy of the fixed asset register.
• Disposal and Acquisition: Review documentation for acquisition and disposal of assets.

e) Bills Sent for Collection

• Tracking and Recording: Verify that bills sent for collection are properly tracked and recorded.
• Confirmations: Obtain confirmations from the collecting agents.

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CMA INTER AUDITING CHAPTER 3 Special Audit

• Outstanding Bills: Review and assess outstanding bills and follow-up procedures.

f) Contingent Liabilities

• Disclosure: Ensure proper disclosure of contingent liabilities in the financial statements.

• Assessment: Review and assess the likelihood and potential impact of these liabilities.
• Legal Opinions: Obtain and review legal opinions if necessary.

g) Bills Payable

• Verification: Verify bills payable by reviewing bank records and confirming with third parties.
• Reconciliation: Ensure that all bills payable are properly reconciled with accounting records.
• Authorization: Check for proper authorization and processing of bills.

h) Borrowings and Deposits

• Documentation: Review agreements for borrowings and deposit accounts.

• Interest and Maturity: Verify the calculation of interest and check the maturity schedule of
deposits and borrowings.
• Regulatory Compliance: Ensure compliance with regulatory requirements for capital adequacy and
reserve maintenance.

2. Special Steps in Auditing a College

• Revenue Streams: Review tuition fees, government grants, donations, and other income sources
for completeness and accuracy.
• Student Enrollment Records: Verify student enrollment records to confirm the basis of fee
collection.
• Endowments and Donations: Check the use and accounting of endowments and donations
according to donor specifications.
• Expenses Review: Scrutinize expenses, including staff salaries, scholarships, and capital
expenditures.
• Internal Controls: Assess the adequacy of internal controls over cash handling, procurement, and
inventory.
• Regulatory Compliance: Ensure compliance with educational regulations and reporting
requirements.

3. Key Points in Auditing a Hospital

• Revenue Verification: Verify revenue from patient services, insurance claims, and government
reimbursements.
• Billing and Collection: Check the accuracy and completeness of billing systems and the
effectiveness of collection procedures.
• Inventory Management: Review inventory management for pharmaceuticals, medical supplies,
and equipment.
• Expense Control: Assess controls over expenses, particularly payroll, utilities, and maintenance.
• Regulatory Compliance: Ensure compliance with healthcare regulations, including patient
confidentiality and safety standards.
• Donations and Grants: Verify proper use and accounting for donations and grants.

4. Important Points in Auditing a Co-operative Society

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CMA INTER AUDITING CHAPTER 3 Special Audit

• Membership Records: Verify the accuracy of membership records and the proper collection of
membership fees.
• Loans and Advances: Review the approval, disbursement, and recovery of loans given to members.
• Financial Management: Assess the management of funds, including investments, borrowings, and
reserves.
• Internal Controls: Evaluate the effectiveness of internal controls over financial transactions and
asset management.
• Statutory Compliance: Ensure compliance with cooperative laws and regulations, including timely
filing of returns and maintenance of statutory records.
• Dividend Distribution: Check the calculation and distribution of dividends to members.
• Subsidiary Operations: If applicable, review the activities and financial statements of any
subsidiaries or associated entities.

UNSOLVED CASES - SOLVED

Case 1
You have been appointed as the auditor of Imperial University for the financial year 2021-22. The
University has 3 campuses located in Mumbai, Ahmedabad and Kolkata. It conducts 5 Year integrated
courses in different subjects and also offer Ph.D. programme. There are both domestic and foreign
students. The university offers hostel facilities to all its students for which separate fees are collected. All
the fees are collected up-front on semester basis and students need to pay fine if the fees are not paid
within 15th of the first month of the concerned semester. The caution deposit for the course is payable
only if a student completes his/her course. The University regularly conducts symposiums, conferences
and workshops in which faculty members and students of other institutions also participate. Prepare a
detail audit programme with respect to the receipt related transactions for this audit engagement.

Audit Programme for Receipts Related Transactions at Imperial University

1. Scope and Objective

• Scope: The audit will cover all receipts related transactions, including fees, fines, caution deposits,
and income from symposiums, conferences, and workshops across all three campuses (Mumbai,
Ahmedabad, and Kolkata).
• Objective: To ensure completeness, accuracy, and validity of the recorded receipts, and to verify
compliance with university policies and applicable regulations.

2. Audit Planning

• Understanding the Process: Review the university's policies and procedures related to fee
collection, fines, deposits, and other income.
• Data Collection: Obtain and review the list of enrolled students, fee structure, and payment
records for the audit period.
• Risk Assessment: Identify and assess risks related to receipt handling, such as cash handling risks,
underreporting of income, and improper accounting of deposits.

3. Audit Procedures
A. Fees Collection (Tuition and Hostel)

• Verification of Records:

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CMA INTER AUDITING CHAPTER 3 Special Audit

o Obtain a detailed schedule of fees collected for each semester, including tuition and hostel
fees.
o Cross-verify the collected fees with the student enrollment records and the fee structure.
• Cut-off Procedures:
o Ensure that all fees are recorded in the correct period, especially those paid around the
semester start and end dates.
• Delayed Payments and Fines:
o Review records of fines levied for late payments and ensure they are in accordance with
the university's policy.
o Verify the accuracy and completeness of fines recorded and collected.

B. Caution Deposits

• Receipt Verification:
o Verify the collection of caution deposits from new students and ensure it is in line with the
university’s policy.
• Refunds:
o Check the process and documentation for refunding caution deposits to students who
have completed their courses.
o Ensure that unclaimed caution deposits are adequately disclosed and accounted for.

C. Income from Symposiums, Conferences, and Workshops

• Registration Fees:
o Verify the collection of registration fees from participants, including faculty and students
from other institutions.
• Grants and Sponsorships:
o Review the records of grants and sponsorships received for these events, ensuring proper
documentation and agreement terms are met.
• Expenses Matching:
o Cross-check the income from these events against the expenses incurred to ensure proper
accounting.

D. Reconciliation and Review

• Bank Reconciliation:
o Perform a reconciliation of bank statements with the receipts recorded in the university’s
books.
o Investigate and resolve any discrepancies noted during the reconciliation process.
• Cash Handling and Security:
o Assess the internal controls over cash handling, including the security of cash receipts and
their timely deposit in the bank.

4. Compliance and Reporting

• Regulatory Compliance:
o Ensure compliance with statutory requirements related to the collection and reporting of
income, such as GST or other applicable taxes.
• Internal Policies:
o Check adherence to the university’s internal policies on fee collection, fine imposition, and
refund processes.

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CMA INTER AUDITING CHAPTER 3 Special Audit

• Reporting:
o Document findings, highlighting any discrepancies, weaknesses in internal controls, or non-
compliance with policies.
o Provide recommendations for improvement in processes and controls.

5. Audit Documentation and Review

• Working Papers:
o Maintain comprehensive working papers documenting all audit procedures performed and
evidence obtained.
• Audit Report:
o Prepare a detailed audit report summarizing the findings, conclusions, and
recommendations.
• Follow-up:
o Plan for a follow-up review to ensure that recommendations are implemented and any
issues are addressed.

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 Basic Concepts of Auditing

Exercise:
• Multiple Choice Questions
1. Which of the following is not an audit risk?
A. Inherent Risk
B. Detection Risk
C. Control risk
D. Omission Risk
2. Permanent Audit File does not contain
A. A record of study and evaluation of internal control system
B. Significant audit observations of earlier years
C. Copies of management letters
D. Analysis of significant ratios and trends
3. Audit Procedures to obtain audit evidences include
A. Compliance Procedure
B. Substantive Procedure
C. Both of A and B
D. Neither A nor B
4. SA 530 stands for
A. Audit Documentation
B. Audit Sampling
C. Responsibility of Joint Auditor
D. Agreeing the terms of Audit Engagements
5. Which of the following is not a part of Temporary Audit file?
A. Correspondence relating to acceptance of annual reappointment.
B. Audit programme.
C. Extracts of minutes of board meetings
D. Legal and organisation structure of the company.
6. SA 230 stands for-
A. Quality control for an audit of Financial Statements
B. Agreeing the terms of Audit Engagements.
C. Audit Documentation
D. Responsibility of Joint Auditor
7. Internal Audit is mandatory for every unlisted public company having paid up share capital of
A. ` 100 crores during the preceding financial year
B. ` 50 crores during the preceding financial year

The Institute of Cost Accountants of India 615