CORRECT/ INCORRECT QUESTIONS

CH1 – NATURE, SCOPE AND OBJECTIVES OF AUDIT

(i) The basic objective of audit does not change with reference to nature, size or form of an entity.
Correct: An audit is an independent examination of financial information of any entity, whether profit
oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a
view to expressing an opinion thereon. It is clear that the basic objective of auditing, i.e., expression of opinion
on financial statements does not change with reference to nature, size or form of an entity.

(ii) The purpose of an audit is to enhance the degree of confidence of intended users in the financial
statements .

Correct: As per SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing”, the purpose of an audit is to enhance the degree of
confidence of intended users in the financial statements. This is achieved by the expression of an
opinion by the auditor on whether the financial statements are prepared, in all material respects, in
accordance with an applicable financial reporting framework.

(iii) The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore obtain
absolute assurance that the financial statements are free from material misstatement due to fraud or
error.

Correct: As per SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing”, the auditor is not expected to, and cannot, reduce audit
risk to zero and cannot therefore obtain absolute assurance that the financial statements are free
from material misstatement due to fraud or error. This is because there are inherent limitations of an
audit, which result in most of the audit evidence on which the auditor draws conclusions and bases
the auditor’s opinion being persuasive rather than conclusive.

(iv) The audit engagement letter is sent by the client to auditor.

Incorrect: As per SA 210 “Agreeing the Terms of Audit Engagements”, the Audit engagement letter is
sent by the auditor to his client.

(v) Specific disclosure is required of the fundamental accounting assumptions followed in the financial
statements.

Incorrect, as per AS 1, “Disclosure of Accounting Policies”, specific disclosure of the fundamental

accounting assumption is required if they are not followed in the financial statements.
(vi) An Auditor is considered to lack independence if the partner of the audit firm deals with shares and
securities of the audited entity.

Correct: As per section 141 (3)(d), a person shall not be eligible for appointment as an auditor of a
company namely- a person, or his relative or partner is holding any security of or interest in the
company or its subsidiary, or of its holding or associate company or a subsidiary of such holding
company. From the above it can be concluded that if the partner deals with shares and securities of
the audited entity, he would be lacking independence, hence, disqualified to be appointed as an
auditor.
Further, the Code of Ethics for Professional Accountants, prepared by the International Federation of
Accountants (IFAC) identifies five types of threats and if partner of the firm deals with shares and
securities of the audited firm then such threat is known as the Advocacy Threats and auditor will be
lacking independence.

(vii) The Audit Engagement documentations should ordinarily be retained by the auditor for minimum of
six years from the date of the auditor's report or the date of the group auditor's report, whichever
is later.

Incorrect: SQC 1 requires firms to establish policies and procedures for the retention of engagement
documentation. The retention period for audit engagements ordinarily is no shorter than seven years
from the date of the auditor’s report, or, if later, the date of the group auditor’s report.

(viii) Mr. S, one of the new team members of the auditor of Extremely Effective Limited was of the view
that for the purpose of conducting an audit, only knowledge of direct tax is required whereas no
knowledge of indirect tax is required.

Incorrect: The viewpoint of Mr. S is incorrect because for the purpose of conducting an audit, proper
knowledge of both direct tax as well as indirect tax is required.

(ix) According to Mr. H, one of the team members of the auditor of Very Essential Limited was of the view that
no relation exists between accounting and auditing from the point of view of a company.

Incorrect: The viewpoint of Mr. H is incorrect because there exists a proper relation between accounting and
auditing from the point of view of a company. Audit is conducted for financial statements of a company and
those financial statements are prepared with the help of books of accounts of that company. In order to
properly conduct an audit of a company, an auditor is required to be aware of accounting principles and
accounting policies of that company.
 Ch2 : AUDIT STRATEGY, AUDIT PLANNING AND AUDIT PROGRAMME

1. The establishment of the overall audit strategy and the detailed audit plan are not necessarily discrete or
sequential processes, but are closely inter-related since changes in one may result in consequential changes
to the other.

Correct: Once the overall audit strategy has been established, an audit plan can be developed to achieve the
audit objectives through the efficient use of the auditor’s resources. The establishment of the overall audit
strategy and the detailed audit plan are not necessarily discrete or sequential processes, but are closely inter-
related since changes in one may result in consequential changes to the other.

2. Establishing an overall audit strategy that sets the scope, timing and direction of the audit, and that
guides the development of the audit plan is prerogative of the management.

Incorrect. The auditor shall establish an overall audit strategy that sets the scope, timing and direction
of the audit, and that guides the development of the audit plan.

3. Planning is a discrete phase of an audit

Incorrect. Planning is not a discrete phase of an audit, but rather a continual and iterative process that
often begin shortly after (or in connection with) the completion of the previous audit and continues
until the completion of the current audit engagement. Planning, however, includes consideration of
the timing of certain activities and audit procedures that need to be completed prior to the
performance of further audit procedures.

4. Materiality for the financial statements as a whole (and, if applicable, the materiality level or levels
for particular classes of transactions, account balances or disclosures) does not need any revision.

Incorrect: Materiality for the financial statements as a whole (and, if applicable, the materiality level
or levels for particular classes of transactions, account balances or disclosures) may need to be revised
as a result of a change in circumstances that occurred during the audit (for example, a decision to
dispose of a major part of the entity’s business), new information, or a change in the auditor’s
understanding of the entity and its operations as a result of performing further audit procedures.

5. A detailed Audit Programme once prepared for a business can be used for all business under all
circumstances.

Incorrect. Businesses vary in nature, size and composition; work which is suitable to one business may
not be suitable to others; efficiency and operation of internal controls and the exact nature of the
service to be rendered by the auditor are the other factors that vary from assignment to assignment.
On account of such variations, evolving one audit programme applicable to all business under all
circumstances is not practicable

6. The audit plan is more detailed than the overall audit strategy.

Correct. The audit plan is more detailed than the overall audit strategy that includes the nature, timing and
extent of audit procedures to be performed by engagement team members. Planning for these audit
procedures takes place over the course of the audit as the audit plan for the engagement develops.
 CH:3 – AUDIT DOCUMENTATION AND AUDIT EVIDENCE

(i) As per SA 230 on “Audit Documentation”, the working papers are not the property
of the auditor.

Incorrect: As per SA 230 on “Audit Documentation” the working papers are the
property of the auditor and the auditor has right to retain them. He may at his
discretion can make available working papers to his client. The auditor should retain
them long enough to meet the needs of his practice and legal or professional
requirement.
(ii) Purchase invoice is an example of internal evidence.

Incorrect: Internal evidence is the evidence that originates within the client’s
organisation. Since purchase invoice originates outside the client’s organisation,
therefore, it is an example of external evidence.

(iii) Sufficiency is the measure of the quality of audit evidence.

Incorrect: Sufficiency is the measure of the quantity of audit evidence. On the

other hand, appropriateness is the measure of the quality of audit evidence.

(iv) Inquiry alone is sufficient to test the operating effectiveness of controls.

Incorrect: Inquiry along with other audit procedures (for example observation,
inspection, external confirmation etc.) would only enable the auditor to test the
operating effectiveness of controls. Inquiry alone is not sufficient to test the
operating effectiveness of controls.

(v) Mr. A is a statutory auditor of ABC Ltd. The branch of ABC Ltd. is audited by Mr.
B, another Chartered Accountant. Mr. A requests for the photocopies of the
audit documentation of Mr. B pertaining to the branch audit.

Incorrect: SA 230 issued by ICAI on Audit Documentation, and “Standard on

Quality Control (SQC) 1, provides that, unless otherwise specified by law or
regulation, audit documentation is the property of the auditor. He may at his
discretion, make portions of, or extracts from, audit documentation available to
clients, provided such disclosure does not undermine the validity of the work
 performed, or, in the case of assurance engagements, the independence of the
auditor or of his personnel.

(vi) When auditor inquires the management as part of the audit procedures it
should be formal written form only and not informal oral inquiries.

Incorrect: When auditor inquires the management as part of audit procedures

such inquiries may range from formal written inquiries to informal oral inquiries.

(vii) Assertions refer to the representations by the auditor to consider the different
types of the potential misstatements that may occur.

Incorrect: Assertions refer to representations by management that are embodied in

the financial statements as used by the auditor to consider the different types of the
potential misstatements that may occur.
 CH4 : RISK ASSESSMENT AND INTERNAL CONTROL

(i) As per section 138 of the Companies Act, 2013 private companies are not required to appoint
internal auditor.

Incorrect: Section 138 of the Companies Act, 2013 requires every private company to appoint an
internal auditor having turnover of ` 200 crore or more during the preceding financial year; or
outstanding loans or borrowings from banks or public financial institutions exceeding ` 100 crore or
more at any point of time during the preceding financial year.

(ii) There is direct relationship between materiality and the degree of audit risk.

Incorrect: There is an inverse relationship between materiality and the degree of audit risk. The
higher the materiality level, the lower the audit risk and vice versa. For example, the risk that a
particular account balance or class of transactions could be misstated by an extremely large amount
might be very low but the risk that it could be misstated by an extremely small amount might be
very high.

(iii) Control risk is the susceptibility of an account balance or class of transactions to misstatement
that could be material either individually or, when aggregated with misstatements in other
balances or classes, assuming that there were no related internal controls.

Incorrect: Inherent risk is the susceptibility of an account balance or class of transactions to

misstatement that could be material either individually or, when aggregated with misstatements in
other balances or classes, assuming that there were no related internal controls.

(iv) Tests of control are performed to obtain audit evidence about the effectiveness of Internal
Controls Systems.

Correct: Tests of Control are performed to obtain audit evidence about the effectiveness of:
(a) the design of the accounting and internal control systems that is whether, they are suitably
designed to prevent or detect or correct material misstatements and
(b) the operation of the internal controls throughout the period.

(v) Maintenance of Internal Control System is the responsibility of the Statutory Auditor.

Incorrect: The management is responsible for maintaining an adequate accounting system

incorporating various internal controls to the extent appropriate to the size and nature of the
business. Maintenance of Internal Control System is responsibility of management because the
internal control is the process designed, implemented and maintained by those charged with
governance/management to provide reasonable assurance about the achievement of entity’s
objectives.

(vi) One of the directors of Very Fresh Fruits Limited was of the view that internal auditor to be
appointed must be an employee of Very Fresh Fruits Limited.
 Incorrect: As per section 138, the internal auditor shall either be a chartered accountant or a cost
accountant (whether engaged in practice or not), or such other professional as may be decided by
the Board to conduct internal audit of the functions and activities of the companies. The internal
auditor may or may not be an employee of the company.

(vii) Mr. W, one of the team members of auditor of Different Limited was of the view that
understanding the Internal Control of Different Limited will not help in developing an Audit
Programme.

Incorrect: Understanding the Internal Control of Different Limited will help in developing an Audit
Programme because it will assist the auditor and his team to understand as to how much they can
rely on internal control of the company and what audit procedures would be appropriate to be used
during the course of audit.

(viii) Information obtained by performing risk assessment procedures shall not be used by the auditor as
audit evidence to support assessments of the risks of material misstatement.

Incorrect: Information obtained by performing risk assessment procedures and related activities may
be used by the auditor as audit evidence to support assessments of the risks of material misstatement.
 CH 5: FRAUD AND RESPONSIBILITES OF AUDITOR

(i) Teeming and lading is one of the techniques of inflating cash payments.

Incorrect: Teeming and Lading is one of the techniques of suppressing cash receipts and not of
inflating cash payments. Money received from one customer is misappropriated and the account is
adjusted with the subsequent receipt from another customer and so on.

(iI) Fraud can be termed as intentional error.

Correct: Fraud is the word used to mean intentional error. This is done deliberately which implies
that there is intent to deceive, to mislead or at least to conceal the truth. It follows that other things
being equal they are more serious than unintentional errors because of the implication of dishonestly
which accompanies them.

iii) Auditor needs to report to Central Government in case of fraud involving 20 lakhs rupees.

Incorrect: As per section 143(12) of the Companies Act, 2013, if an auditor of a company, in the
course of the performance of his duties as auditor, has reason to believe that an offence involving
fraud is being or has been committed against the company by officers or employees of the company,
he shall immediately report the matter to the Central Government (in case amount of fraud is ` 1
crore or above) or Audit Committee or Board in other cases (in case the amount of fraud involved is
less than 1 crore) within such time and in such manner as may be prescribed.
Thus, fraud involving amount of 20 lakh rupees should be reported to Audit Committee.

(iv) The primary responsibility for the prevention and detection of fraud rests with both those
charged with governance of the entity and management.

Correct: As per SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial
Statements’. It is important that management, with the oversight of those charged with governance
place a strong emphasis on fraud prevention, which may reduce opportunities for fraud to take
place, and fraud deterrence, which could persuade individuals not to commit fraud because of the
likelihood of detention and punishment. This involves a commitment to create a culture of honesty
and ethical behavior which can be reinforced by an active oversight by those charged with
governance.

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

accounting records or supporting documents from which financial statements are prepared.

Incorrect: As per SA 240, ”The Auditor’s Responsibilities Relating to fraud in an Audit of Financial
Statements’, fraudulent financial reporting may involve manipulation, falsification or alteration of
accounting records or supporting documents from which financial statements are prepared,
misrepresentation in or intentional omission from, financial statements of events, transaction or
other significant information or intentional misapplication of accounting principles relating to
amounts, classification, manner of presentation or disclosure.
 (vi) Unusual delays by the entity in providing requested information shows problematic or
unusual relationships between the auditor and management.

Correct: It is a strong example of circumstances that indicate the possibility of fraud. This happiness
only because of the Management’s intolerance towards the auditor’s Professional skepticism

(viii) In comparing management fraud with employee fraud, the auditor’s risk of failing to discover
the fraud is less for management fraud.

Incorrect: In comparing management fraud with employee fraud, the auditor’s risk of failing to
discover the fraud is greater for management fraud because of management’s ability to override
existing internal controls.

(ix) Excessive interest by management in maintaining or increasing the entity’s inventory price or
earnings trend is an example of Fraud Risk Factor related to Opportunities.

Incorrect: Excessive interest by management in maintaining or increasing the entity’s inventory

price or earnings trend is an example of Fraud Risk Factor related to Rationalization.

(x) Misstatements in the financial statements can arise from fraud only.

Incorrect: Misstatements in the financial statements can arise from either fraud or error. The
distinguishing factor between fraud and error is whether the underlying action that results in the
misstatement of the financial statements is intentional or unintentional.

(xi) Misappropriation of Assets involves the theft of an entity’s assets and is often perpetrated by
employees in relatively large and material amounts.

Incorrect:- Misappropriation of Assets involves the theft of an entity’s assets and is often perpetrated
by employees in relatively small and immaterial amounts.

(xii) An auditor conducting an audit in accordance with SAs is responsible for obtaining absolute
assurance that the financial statements taken as a whole are free from material
misstatement, whether caused by fraud or error.

Incorrect:- An auditor conducting an audit in accordance with SAs is responsible for obtaining
reasonable assurance that the financial statements taken as a whole are free from material
misstatement, whether caused by fraud or error. As described in SA200, “Overall Objectives of the
Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing,” owing
to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of
the financial statements will not be detected, even though the audit is properly planned and performed
in accordance with the SAs.
 CH6: AUDIT IN AN AUTOMATED ENVIRONMENT

(i) All automated environments are complex.

Incorrect: The complexity of an automated environment depends on various factors

including the nature of business, level of automation, volume of transactions, use of ERP
and so on. There could be environment where dependence on IT and automation is
relatively less or minimal and hence, considered less complex or even non-complex.

(ii) In an audit of financial statements, the auditor should plan response to all IT risks.

Incorrect. The auditor should plan response to those IT risks that are relevant to financial
reporting and not “all” IT risks.

(iii) General IT controls support the functioning of Application controls.

Correct. General IT controls support the functioning of automated application controls

and IT dependent controls.

(iv) Inquiry is often the most efficient audit testing method, but least effective.

Correct. Inquiry is the most efficient but least effective. Moreover, testing through inquiry
alone is not sufficient. Inquiry should be corroborated by applying any one or a
combination of observation, inspection or reperformance.

(v) Specialised audit tools like IDEA, ACL are required to perform data analytics.

Incorrect. Even though specialised audit tools are very useful, such tools are not always
required or necessary to carry out data analytics. More commonly available spreadsheet
applications like MS-Excel can also be effectively used for carrying out data analytics

(vi) A combination of processes, tools and techniques that are used to tap vast amounts of
electronic data to obtain meaningful information is known as meaningful data.

Incorrect. A combination of processes, tools and techniques that are used to tap vast
amounts of electronic data to obtain meaningful information is known as Data Analytics.

(vii) During the assessment of Internal Controls , if the auditor can test Compensating controls , he
should obtain evidence of other mitigating factors.

Incorrect. If the auditor can test Compensating controls , he should obtain additional
evidence that may be required. Obtaining evidence of other mitigating factors is required
when he can’t test compensating controls during his assessment of the Internal Controls.

(viii) An automated environment basically refers to a business environment where the

processes, operations, accounting except the decisions are carried out by using computer
systems.
 Incorrect. An automated environment basically refers to a business environment where
the processes, operations, accounting and even decisions are carried out by using
computer systems

(ix) The Company auditor need not report on the efficacy of Internal Financial controls in his
Audit Report in the case of a One Person Company .

Correct. A One Person Company and Small Company are exempted frpm this requirement
as per proviso to Section 143(3)(i).

(x) Generally, applying inquiry in combination with reperformance as audit testing

method gives the most effective and efficient audit evidence

Incorrect. Generally, applying inquiry in combination with inspection gives the most effective
and efficient audit evidence
 CH: AUDIT SAMPLING

(i) The method which involves dividing the population into groups of items is knows
as block sampling.

Incorrect: The method which involves dividing the population into groups of items is
known as cluster sampling whereas block sampling involves the selection of a defined
block of consecutive items.

(ii) Universe refers to the entire set of data from which a sample is selected and
about which the auditor wishes to draw conclusions.

Incorrect: Population refers to the entire set of data from which a sample is selected and
about which the auditor wishes to draw conclusions.

(iii) Non Statistical sampling is an approach to sampling that has the random
selection of the sample items; and the use of probability theory to evaluate
sample results, including measurement of sampling risk characteristics.

Incorrect: Statistical sampling is an approach to sampling that has the random selection of
the sample items; and the use of probability theory to evaluate sample results, including
measurement of sampling risk characteristics.

(iv) Sample need not be representative

Incorrect: Whatever may be the approach non-statistical or statistical sampling, the

sample must be representative. This means that it must be closely similar to the whole
population although not necessarily exactly the same. The sample must be large enough
to provide statistically meaningful results.

(v) The objective of stratification is to increase the variability of items within

each stratum and therefore allow sample size to be reduced without increasing
sampling risk.

Incorrect: The objective of stratification is to reduce the variability of items within each
stratum and therefore allow sample size to be reduced without increasing sampling risk.

(vi) When statistical sampling is used to select a sample, sample need not be
representative because the statistical sampling takes care of the representation.

Incorrect: Whatever may be the approach non-statistical or statistical sampling, the

sample must be representative. This means that it must be closely similar to the whole
population although not necessarily exactly the same. The sample must be large enough
to provide statistically meaningful results.

(vii) Stratified Sampling is used for homogeneous population.

Incorrect: Stratified sampling is used when the population is diversified i.e

heterogeneous. The population is divided into sub population having similar
 characteristics. Sample are then chosen from these sub populations which are called as
Stratum. Therefore, stratified sampling is not useful in case of homogeneous population.

(viii) Non statistical sampling is considered to be more scientific than the statistical
sampling.

Incorrect: Statistical sampling uses scientific method of choosing samples from a given
population. The use of probability theory is involved in statistical sampling so that every
sampling unit has an equal chance of getting selected. In the non statistical sampling,
auditors’ judgment and past experience is used to choose samples without any scientific
method.

(ix) In case of Statistical sampling, auditor’s bias in choosing sample is involved.

Incorrect: Statistical sampling uses scientific method choosing samples from a given
population. The use of probability theory is involved in statistical sampling so that every
sampling unit has an equal chance of getting selected. In the non statistical sampling,
auditor’s judgment and past experience is used to choose samples without and scientific
method. Hence, personal bias is involved in Non statistical sampling and not Statistical.

(x) In stratified sampling, the conclusion drawn on each stratum can be directly
projected to the whole population.

Incorrect: In case of stratified sampling, the conclusions are drawn on the stratum. The
combination of all the conclusions on stratum together will be used to determine the
possible effect of misstatement or deviation. Hence the samples are used to derive
conclusion only on the respective stratum from where they are drawn and not the whole
population.

(xi) Low acceptable sampling risk requires larger sample size.

Correct: Sampling risk arises from possibility that the auditor’s conclusion based upon
sample may be different from conclusion that would have been reached if same audit
procedures were applied on the entire population. If acceptable sampling risk is low, large
sample size is needed.
 CH:8 ANALYTICAL PROCEDURES

1. As per the Standard on Auditing (SA) 520 “Analytical Procedures” ‘the term
“analytical procedures” means evaluations of financial information through
analysis of plausible relationships among financial data only.

Incorrect. As per the Standard on Auditing (SA) 520 “Analytical Procedures” the term
“analytical procedures” means evaluations of financial information through analysis of
plausible relationships among both financial and non-financial data.

2. Auditor can depend on routine checks to disclose all the mistakes or manipulation
that may exist in accounts.

Incorrect. Routine checks cannot be depended upon to disclose all the mistakes or
manipulation that may exist in accounts, certain other procedures also have to be applied like
trend and ratio analysis in addition to reasonable tests.

3. Only purpose of analytical procedures is to obtain relevant and reliable audit

evidence when using substantive analytical procedures.

Incorrect. Analytical procedures use comparisons and relationships to assess whether account
balances or other data appear reasonable. Analytical procedures are used for the following
purposes:
(i) To obtain relevant and reliable audit evidence when using substantive analytical
procedures; and
(ii) To design and perform analytical procedures near the end of the audit that assist the
auditor when forming an overall conclusion as to whether the financial statements are
consistent with the auditor’s understanding of the entity.

4. Analytical Procedures are required in the planning phase only.

Incorrect. Analytical Procedures are required in the planning phase and it is often done during
the testing phase. In addition these are also required during the completion phase.

5. Substantive analytical procedures are generally less applicable to large volumes of

transactions that tend to be predictable over time

Incorrect. Substantive analytical procedures are generally more applicable to large volumes of
transactions that tend to be predictable over time.

6. Ratio analysis is useful in analyzing revenue and expense account only.

Incorrect: Ratio analysis is useful for analysing asset and liability accounts as well as revenue
and expense accounts

7. Reasonableness test rely only on the events of the prior period like other analytical
procedures.
 Incorrect: Unlike trend analysis, Reasonableness test does not rely on events of prior periods,
but upon non-financial data for the audit period under consideration.

8. The statutory auditor of the company can apply analytical procedures to the
standalone financial statements of a company only and not to the consolidated
financial statements.

Incorrect: Analytical procedures may be applied to consolidated financial statements,

components and individual elements of information.
 CH 9: AUDIT OF ITEMS OF FINANCIAL ITEMS

1. Employee benefits expenses represent the sum an entity pays to its employees
for their labour/ efforts only.

Incorrect: Employee benefits expenses, commonly called payroll expenses, represent the
aggregate sum an entity pays to its employees for their labour/ efforts, as well as
associated expenses such as perquisites/ benefits, post- employment benefits like gratuity,
superannuation, leave encashment, provident fund contribution etc. as well as towards their
hiring, their welfare and training.

2. Dividends are recognised in the statement of profit and loss only when the
entity’s right to receive payment of the dividend is established.

Incorrect: Dividends are recognised in the statement of profit and loss only when:
(i) the entity’s right to receive payment of the dividend is established;
(ii) it is probable that the economic benefits associated with the dividend will flow to
the entity; and
(ii) the amount of the dividend can be measured reliably.

3. “Sweat Equity Shares” means equity shares issued by the company to employees
or directors at a premium or for consideration other than cash for providing
know-how or making available right in the nature of intellectual property rights
or value additions, by whatever name called.

Incorrect: “Sweat Equity Shares” means equity shares issued by the company to employees
or directors at a discount or for consideration other than cash for providing know-how or
making available right in the nature of intellectual property rights or value additions, by
whatever name called.

4. Capital reserves represent profits that are available for distribution to

shareholders held for the time being or any one or more purpose.

Incorrect: Revenue reserves represent profits that are available for distribution to
shareholders.

5. A capital reserve, generally, can be utilised for writing down fictitious assets or
losses or (subject to provisions in the Articles) for issuing bonus shares if it is
realised.

Correct: A capital reserve, generally, can be utilised for writing down fictitious assets or
losses or (subject to provisions in the Articles) for issuing bonus shares if it is realised.
But the amount of share premium or capital redemption reserve account can be utilised only
for the purpose specified in Sections 52 and 55 respectively of the Companies Act, 2013.

6. If Company X’s balance sheet shows building with carrying amount of ` 100
lakh, the auditor shall assume only one point that the management has only
 asserted that the building recognized in the balance sheet exists as at the
period-end.

Incorrect: If Company X’s balance sheet shows building with carrying amount of ` 100 lakh,
the auditor shall assume that the management has claimed/ asserted that:
The building recognized in the balance sheet exists as at the period- end (existence
assertion);
Company X owns and controls such building (Rights and obligations assertion);
The building has been valued accurately in accordance with the measurement principles
(Valuation assertion);

All buildings owned and controlled by Company X are included within the carrying amount of
` 100 lakh (Completeness assertion).

7. The securities premium account may only be applied by the Company towards
the issue of unissued shares of the company to the members of the company as
fully paid bonus shares.

Incorrect: The securities premium account may be applied by the Company:

(a) towards the issue of unissued shares of the company to the members of the company as
fully paid bonus shares;
(b) in writing off the preliminary expenses of the Company;
(c) in writing off the expenses of, or the commission paid or discount allowed on, any issue of
shares or debentures of the company;
(d) in providing for the premium payable on the redemption of any redeemable preference
shares or of any debentures of the company; or
(e) for the purchase of its own shares or other securities under section 68.

8. Material and wages are considered to be revenue expenditure when incurred for
construction of building.

Incorrect: Material and Wages incurred on construction of building qualify to be capital

expenditure as per AS 10 “Plant, Property and Equitment”. Therefore, these have to
be added to the cost of the asset i.e building and shall not be expensed off to
Statement of Profit and Loss.

9. Tangible assets are depreciated when the asset is actually put to active use.

Incorrect: Depreciation is a fall in value of asset due to obsolescence, usage and

effluxion of time, Therefore, depreciation is charged when the asset is ready for use .
Active use of asset is not a mandatory criteria for charge of depreciation.

10. Increase in authorised capital of the company requires special resolution to be

passed at the general meeting.

Incorrect: Increase in Authorised capital requires alteration of capital clause of

memorandum of Association. Therefore, ordinary resolution is passed for increase in
authorised capital of the company as per the Companies Act, 2013.

11. Capital redemption reserve can be used for distribution of dividends.

 Incorrect: Capital Redemption reserve is not a free reserve. It is a restrictive reserve
and can be used only for purposes given in the Act. Since it is not a free reserve, it
cannot be utilised for payment of dividends. CRR can be used only for the purpose of issuing
fully paid up bonus shares.

12. Dividends are recommended by the Board, and declared by the

Shareholders.

Correct: The dividends are recommended by the Board of Directors by passing a

resolution at the board meeting. The Shareholders declare the dividends at the AGM
by passing an ordinary resolution. Declaration of dividend is an item of ordinary business.
However, the shareholders can decrease the amount of dividends recommended by
the board but cannot increase it.

13. In verifying Trade Receivables balance, Direct Confirmation

Procedure is one of the important audit activity.

Correct: While auditing trade receivable balance, direct confirmations as per SA 505, is
considered to be the most important audit activity. Direct confirmation can be sought
from the debtors directly confirming their balance due. The replies to the confirmation
can be then matched with the records maintained by the client. Any discrepancies so
revealed, can be investigated and checked in detail for possibility of any risk of material
misstatement. Auditor selects few debtors’ balances and ask the client to prepare the
confirmations properly addressed to the debtors. Auditor maintains strict control over
this process.
 CH:10 COMPANY AUDIT

(i) The first auditor of a Government company was appointed by the Board in its
meeting after 10 days from the date of registration.

Incorrect: According to section 139(7) of the Companies Act, 2013, in the case of a
Government company, the first auditor shall be appointed by the Comptroller and
Auditor- General of India within 60 days from the date of registration of the
company. If CAG fails to make the appointment within 60 days, the Board shall
appoint in next 30 days.

(ii) Director's relative can act as an auditor of the company.

Incorrect: As per section 141(3) of the Companies Act, 2013, a person shall not be
eligible for appointment as an auditor of a company whose relative is a Director or is
in the employment of the Company as a director or key Managerial Personnel.

(iii) If an LLP (Limited Liability Partnership Firm) is appointed as an auditor of a

company, every partner of a firm shall be authorized to act as an auditor.

Incorrect: As per section 141(2) of the Companies Act, 2013, where a firm including
a limited liability partnership (LLP) is appointed as an auditor of a company, only
the partners who are Chartered Accountants shall be authorised to act and sign on
behalf of the firm.

(iv) AB & Co. is an audit firm having partners Mr. A and Mr. B. Mr. C, the relative
of Mr. B is holding securities having face value of ` 2,00,000 in XYZ Ltd. AB &
Co. is qualified for being appointed as an auditor of XYZ Ltd.

Incorrect: As per the provisions of the Companies Act, 2013, a person is disqualified to be
appointed as an auditor of a company if his relative is holding any security of or interest in the
company of face value exceeding ` 1 lakh.
Therefore, AB & Co. shall be disqualified for being appointed as an auditor of XYZ
Ltd. as Mr. C, the relative of Mr. B who is a partner in AB & Co., is holding
securities in XYZ Ltd. having face value of ` 2 lakh.

(v) The auditor of a Ltd. Company wanted to refer to the minute books during
audit but board of directors refused to show the minute books to the
auditors.

Incorrect: The provisions of Companies Act, 2013 grant rights to the auditor to
access books of account and vouchers of the company. He is also entitled to
require information and explanations from the company. Therefore, he has a
statutory right to inspect the minute book.

(vi) Manner of rotation of auditor will not be applicable to company A, which is

having paid up share capital of ` 15 crores and having public borrowing from
nationalized bank of ` 50 crore because it is a Private Limited Company.
Incorrect: According to section 139 of the Companies Act, 2013, the provisions related to
rotation of auditor are applicable to all private limited companies having paid up share capital
of ` 20 crore or more; and all companies having paid up share capital of below threshold limit
mentioned above, but having public borrowings from financial institutions, banks or public
deposits of ` 50 crore or more.
Although company A is a private limited company yet it is having public borrowings
from nationalized bank of ` 50 crores, therefore it would be governed by provisions
of rotation of auditor.

(vii) The auditor should study the Memorandum and Articles of Association to
see the validity of his appointment.

Incorrect: The auditor should study the Memorandum of Association to check the objective
of the company to be carried on, amount of authorized share capital etc. and Articles of
Association to check the internal rules, regulations and ensuring the validity of transactions
relating to accounts of the company.
To see the validity of appointment, the auditor should ensure the compliance of the
provisions of section 139, 140 and 141 of the Companies Act, 2013. In addition, the
auditor should study the appointment letter & the prescribed Form submitted to the
Registrar of the Companies to see the validity of his appointment.

(viii) Managing director of A Ltd. himself appointed the first auditor of the
company.

Incorrect: As per section 139(6) of the Companies Act, 2013, the first auditor of a company,
other than a government company, shall be appointed by the Board of directors within 30
days from the date of registration of the company.
Therefore, the appointment of first auditor made by the managing director of A Ltd.
is in violation of the provisions of the Companies Act, 2013.

(ix) A Chartered Accountant holding securities of S Ltd. having face value of `

950 is qualified for appointment as an auditor of S Ltd.

Incorrect: As per the provisions of the Companies Act, 2013, a person is disqualified to be
appointed as an auditor of a company if he is holding any security of or interest in the
company.
As the chartered accountant is holding securities of S Ltd. having face value of `
950, he is not eligible for appointment as an auditor of S Ltd.

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

be appointed as auditor of XYZ Limited.

Incorrect: As per section 141 of the Companies Act, 2013, a person shall be eligible for
appointment as an auditor of a company only if he is a chartered accountant.
Thus, Mr. N is disqualified to be appointed as an auditor of XYZ Limited

(xi) The Board of Director of ABC Ltd., a listed company at Bombay Stock
Exchange, is required to fill the casual vacancy of an auditor only after
taking into account the recommendations of the audit committee.

Correct: Where a company is required to constitute an Audit Committee under

section 177, all appointments, including the filling of a casual vacancy of an auditor
 under this section shall be made after taking into account the recommendations of
such committee.

(xii) Bhartiya Gas Ltd. a Government Company, the Comptroller and Auditor-
General of India shall, in respect of a financial year, appoint an auditor duly
qualified to be appointed as an auditor of companies under this Act, within a
period of 180 days from the end of the financial year, who shall hold office till
the end of the next Financial year.

Incorrect- As per section 139(5), in the case of a Government company or any

other company owned or controlled, directly or indirectly, by the Central
Government, or by any State Government or Governments, or partly by the Central
Government and partly by one or more State Governments, the Comptroller and
Auditor-General of India shall, in respect of a financial year, appoint an auditor duly
qualified to be appointed as an auditor of companies under this Act, within a period
of 180 days from the commencement of the financial year, who shall hold office till
the conclusion of the annual general meeting.

(xiii) CA K has resigned as an auditor after 2 months of his appointment in NML

Ltd. He needs to file ADT-3 with the Registrar within 60 days from the date of
resignation.

Incorrect: As per section140(2) of the Companies Act, 2013, the auditor who has
resigned from the company shall file within a period of 30 days from the date of
resignation, a statement in the prescribed Form ADT–3(as per Rule 8 of CAAR)
with the company and the Registrar.

(xiv) The Board of Director of ABC Ltd., a listed company at Bombay Stock
Exchange, is required to fill the casual vacancy of an auditor only after taking
into account the recommendations of the audit committee.

Correct: Where a company is required to constitute an Audit Committee under

section 177, all appointments, including the filling of a casual vacancy of an auditor
under this section shall be made after taking into account the recommendations of
such committee.

(xv) Any partner of an LLP, who is appointed as an auditor of a company, can sign
the audit report.

Incorrect: Section 141(2) of the Companies Act, 2013 states that where a firm
including a limited liability partnership is appointed as an auditor of a company,
only the partners who are chartered accountants shall be authorised to act and
sign on behalf of the firm.

(xvi) Audit committee is to be constituted by every public company to ensure

better standards of corporate governance.

Incorrect. Under Section 177 of Companies Act, 2013 read together with Rule 4 of
Companies( Appointment and qualification of Directors) Rules, 2014 prescribe that audit
committee is to be constituted by every listed public company and following classes of public
companies only:-
(i) the Public Companies having paid up share capital of ten crore rupees or more; or
(ii) the Public Companies having turnover of one hundred crore rupees or more; or
(iii) the Public Companies which have, in aggregate, outstanding loans, debentures and
deposits, exceeding fifty crore rupees:
Hence, the statement that all public companies are required to constitute audit
committee is incorrect.

(xvii) XYZ Ltd is engaged in manufacture of textiles specified under prescribed rules
having total revenue of Rs.100 crore (including export turnover of Rs.88
crores in foreign exchange) in immediately preceding financial year. The said
company is required to get cost audit conducted for immediately preceding
financial year.

Incorrect. The provisions of cost audit are not applicable in case of companies
having revenue from exports in foreign exchange being more than 75% of its total
revenue. As the company is having export turnover of Rs.88 crore in total revenues
of Rs.100 core, the provisions of cost audit are not applicable to the said company.

(xviii) The auditor has to report under section 143 of companies act, 2013 whether
company has adequate internal controls in place and overall effectiveness of
such internal controls.

Incorrect: Under provisions of Section 143 of the companies Act, 2013, auditor has
to report whether the company has adequate internal financial controls with
reference to financial statements in place and operating effectiveness of such
controls. The auditor has to report on adequacy and effectiveness of internal
financial controls only and not internal controls.

(xix) Discovery of an offence of a fraud of Rs.100 lakh by auditor against the

company committed by its officers is to be reported to Serious Fraud
Investigation office(SFIO).

Incorrect: Fraud of Rs.100.00 lakhs or above (i.e. Rs.1.00 crore or above) has to be
reported to Central government ( precisely to Secretary, Ministry of Corporate
affairs) in Form ADT-4.

(xx) The concept of “joint audit” has legal foothold under the Companies Act,
2013.

Correct: Under provisions of section 139(3), the members of a company may

resolve to provide that audit shall be conducted by more than one auditor. Hence,
the concept of “joint audit” has legal foothold also under Companies Act, 2013.
 CH 11: AUDIT REPORT

(i) The auditor shall express a qualified opinion when the auditor concludes that
the financial statements are prepared, in all material respects, in
accordance with the applicable financial reporting framework.

Incorrect: The auditor shall express an unmodified opinion when the auditor
concludes that the financial statements are prepared, in all material
respects, in accordance with the applicable financial reporting framework.

(ii) There is no need of addressee in the Auditor’s report.

Incorrect: The auditor’s report shall be addressed, as appropriate, based on

the circumstances of the engagement. Law, regulation or the terms of the
engagement may specify to whom the auditor’s report is to be addressed.
The auditor’s report is normally addressed to those for whom the report is
prepared, often either to the shareholders or to those charged with
governance of the entity whose financial statements are being audited.

(iii) The auditor shall modify the opinion in the auditor’s report only when
the auditor concludes that, based on the audit evidence obtained, the
financial statements as a whole are not free from material
misstatement.

Incorrect: The auditor shall modify the opinion in the auditor’s report when:
(a) The auditor concludes that, based on the audit evidence obtained, the
financial statements as a whole are not free from material misstatement; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence to
conclude that the financial statements as a whole are free from material
misstatement.

(iv) The auditor shall express a disclaimer of opinion when the auditor, having
obtained sufficient appropriate audit evidence, concludes that
misstatements, individually or in the aggregate, are both material and
pervasive to the financial statements.

Correct: The auditor shall express an adverse opinion when the auditor, having
obtained sufficient appropriate audit evidence, concludes that
misstatements, individually or in the aggregate, are both material and
pervasive to the financial statements.

(v) Communicating key audit matter in the auditor’s report constitutes a

substitute for disclosure in the financial statements.
 Incorrect: Communicating key audit matters in the auditor’s report is in the
context of the auditor having formed an opinion on the financial statements as a whole.
Communicating key audit matters in the auditor’s report is not a substitute
for disclosures in the financial statements that the applicable financial
reporting framework requires management to make, or that are otherwise
necessary to achieve fair presentation

(vi) When the auditor has to express an adverse opinion, he need not
communicate with those charged with governance as this may have an
impact on payment of his audit fees.

Incorrect: When the auditor expects to modify the opinion in the auditor’s
report, the auditor shall communicate with those charged with governance
the circumstances that led to the expected modification and the wording of
the modification.

(vii) Instead of modifying an opinion in accordance with SA 705, the

statutory auditor can use Key Audit Matter paragraph in the audit
report with an unmodified opinion.

Incorrect: Communicating key audit matters in the auditor’s report is not a

substitute for the auditor expressing a modified opinion when required by
the circumstances of a specific audit engagement in accordance with SA 705
(Revised);
 CH 12: AUDIT OF BANKS
(1) RBI has been entrusted with the responsibility of regulating the
activities of commercial banks only.

Incorrect. RBI has been entrusted with the responsibility of regulating the
activities of commercial and other banks.

(2) In the computerised environment, the auditor need not be familiar

with latest applicable RBI guidelines that have bearing on the
classification/ provisions and income recognition.

Incorrect. In the Computerized environment, it is imperative that the

auditor is familiar with, and is satisfied that, all the norms/parameters as
per the latest applicable RBI guidelines are incorporated and built into the
system that generates information/data having a bearing on the
classification/ provisions and income recognition.

(3) The auditor can assume that the system generated information is
correct and relied upon without evidence that demonstrates that the
system driven information is based on validation of the required
parameters for the time being in force and applicable.

Incorrect. The auditor should not go by the assumption that the system
generated information is correct and can be relied upon without evidence
that demonstrates that the system driven information is based on
validation of the required parameters for the time being in force and
applicable.

(4) Collateral security refers to the security offered by the borrower for
bank finance or the one against which credit has been extended by
the bank.

Incorrect. Primary security refers to the security offered by the borrower

for bank finance or the one against which credit has been extended by the
bank. This security is the principal security for an advance.

(5) Registered mortgage is effected by a mere delivery of title deeds or

other documents of title with intent to create security thereof

Incorrect. Equitable mortgage, on the other hand, is effected by a mere

delivery of title deeds or other documents of title with intent to create
security thereof.
(6) Any amount due to the bank under any credit facility is ‘overdue’ if it
is not paid within 90 days of becoming due.

Incorrect. Any amount due to the bank under any credit facility is ‘overdue’
if it is not paid on the due date fixed by the bank.

(7) An account should be treated as 'out of order' if the outstanding

balance remains continuously in excess of the sanctioned
limit/drawing power.

Correct. An account should be treated as 'out of order' if the outstanding

balance remains continuously in excess of the sanctioned limit/drawing
power.

(8) Banks recognize income on Non-Performing Assets on accrual

basis.

Incorrect: Income from non-performing assets (NPA) is not recognised on

accrual basis due to its uncertainty but is booked as income only when it
is actually received.

(9) Auditor of a Nationalised bank is to be appointed at the annual general meeting of

the shareholders.

Incorrect- Auditor of a nationalized bank is to be appointed by the bank

concerned acting through its Boards of Directors and approval of the
Reserve bank is required before the appointment is made.
 CH 13: AUDIT OF DIFFERENT TYPE OF ENTITIES

1. Article 150 of the Constitution provides that the accounts of the Union and of
the States shall be kept in such form as the Finance Minister may on the advice
of the C&AG prescribe.

Incorrect. Article 150 of the Constitution provides that the accounts of the
Union and of the States shall be kept in such form as the President may
on the advice of the C&AG prescribe.

1. According to ‘propriety audit’, the auditors try to bring out cases

of improper, avoidable, or infructuous expenditure even though
the expenditure has been incurred in conformity with the existing
rules and regulations.

Correct. According to ‘propriety audit’, the auditors try to bring out cases
of improper, avoidable, or infructuous expenditure even though the
expenditure has been incurred in conformity with the existing rules and
regulations.

2. Expenditure incurred by the municipalities and corporations can

be broadly classified under the following heads: (a) general administration
and revenue collection, (b) public health, (c) public safety, (d)
education, (e) public works, and (f) others such as interest
payments.

Correct . Expenditure incurred by the municipalities and corporations

can be broadly classified under the following heads: (a) general
administration and revenue collection, (b) public health, (c) public
safety, (d) education, (e) public works, and (f) others such as interest
payments, etc.

3. The external control of municipal expenditure is exercised by the

Central Government through the appointment of auditors to
examine municipal accounts.
 Incorrect. The external control of municipal expenditure is exercised by
the state governments through the appointment of auditors to examine
municipal accounts.

4. NGOs may be defined as non-profit making organisations which

raise funds from members, donors or contributors apart from
receiving donation of time, energy and skills for achieving their
social objectives.

Correct. NGOs can be defined as non-profit making organisations which raise

funds from members, donors or contributors apart from receiving
donation of time, energy and skills for achieving their social objectives
like imparting education, providing medical facilities, economic
assistance to poor, managing disasters and emergent situations.

5. The accounts of every LLP shall be audited in accordance with

rule 24 of LLP Rules 2009.

Incorrect- Rule 24 of LLP Rules 2009 provides that any LLP, whose
turnover does not exceed, in any financial year, forty lakh rupees, or
whose contribution does not exceed twenty five lakh rupees, is not required
to get its accounts audited. However, if the partners of such limited
liability partnership decide to get the accounts of such LLP audited, the
accounts shall be audited only in accordance with such rules.

6. The auditor of an LLP may be appointed by the Designated

Partners or other Partners whosoever is available at the time of
appointment.

Incorrect- The auditor is to be appointed by the designated partners of

the LLP. However , the Partners may appoint the auditors only if the
Designated Partners have failed to appoint them.

7. The Comptroller and Auditor General does not have any authority
to audit the accounts of stores and inventory kept in any office or
department of the Union or of a State .

Incorrect- The Comptroller and Auditor General shall have authority to

audit and report on the accounts of stores and inventory kept in any office or
department of the Union or of a State.

8. An Operating Lease is a kind of Financing arrangement.

Incorrect- A Finance Lease is a Financing arrangement. An Operating

lease, on the other hand, is a simple arrangement where, in return for
rent, the lessor allows the lessee to use the asset for a certain period.
9. An auditor should ensure that proper valuation of occupancy-in-
progress at the balance sheet date is made and included in the
accounts in the case of audit of a Hotel.

Correct- The auditor should ensure that proper valuation of occupancy-in-

progress at the balance sheet date is made and included in the accounts
for proper recording of closing and opening entries and maintainance of
accounts on Accrual basis as per the Matching concept.