CA Inter Audit Documentation and Audit Evidence Important Questions

Auditing and Assurance Chapter 3: Audit Documentation and Audit Evidence

CA Inter Auditing and Assurance Chapter 3, Audit Documentation and Audit Evidence, Important Solved Questions for May 2021 & November 2021 Exams

Question 1

The auditor P of PAR and Co., a ﬁrm of Chartered Accountants is conducting audit of Kapur Industries Ltd. The auditor requests management to provide Banker’s certiﬁcate in support of Fixed deposits whereas management provides only written representation on the matter.

Required

Discuss how would you deal as an auditor.

Solution

Although written representations provide necessary audit evidence, they do not provide suﬃcient appropriate audit evidence on their own about any of the matters with which they deal. Furthermore, the fact that management has provided reliable written representations does not aﬀect the nature or extent of other audit evidence that the auditor obtains about the fulﬁllment of management’s responsibilities, or about speciﬁc assertions.

Applying the above to the given problem, the auditor would further request the management to provide him with the Banker’s certiﬁcate in support of ﬁxed deposits held by the company.

Question 2

Paramount Exports Ltd is a manufacturer exporter having its own production capacity and also gets the job work done through various job workers. The auditor of Paramount Exports Ltd. Considers that inventory held with job workers is material to the ﬁnancial statements.

Required

Suggest the audit procedures in the given case.

Solution

When inventory under the custody and control of a third party is material to the ﬁnancial statements, the auditor shall obtain suﬃcient appropriate audit evidence regarding the existence and condition of that inventory by performing one or both of the following:

(a) Request conﬁrmation from the third party as to the quantities and condition of inventory held on behalf of the entity.

(b) Perform inspection or other audit procedures appropriate in the circumstances.

Question 3

Pride India Ltd is a manufacturer of various FMCG (fast moving consumable goods) range of products. The company is having several cases of litigation pending in courts. The auditor wanted to identify litigation and claims resulting to risk of material misstatements.

Required

Suggest the auditor with reference to SAs.

Solution

The auditor shall design and perform audit procedures in order to identify litigation and claims involving the entity which may give rise to a risk of material misstatement, including:

(a) Inquiry of management and, where applicable, others within the entity, including in-house legal counsel;

(b) Reviewing minutes of meetings of those charged with governance and correspondence between the entity and its external legal counsel; and

If the auditor assesses a risk of material misstatement regarding litigation or claims that have been identiﬁed, or when audit procedures performed indicate that other material litigation or claims may exist, the auditor shall, in addition to the procedures required by other SAs, seek direct communication with the entity’s external legal counsel.

Further if:

(a) management refuses to give the auditor permission to communicate or meet with the entity’s external legal counsel, or the entity’s external legal counsel refuses to respond appropriately to the letter of inquiry, or is prohibited from responding; and

(b) the auditor is unable to obtain sufficient appropriate audit evidence by performing alternative audit procedures,

the auditor shall modify the opinion in the auditor’s report in accordance with SA 705.

Question 4

While conducting the audit of Jay Kay Ltd, the auditor K of KLM and Associates, Chartered Accountants observes that there are large number of Trade payables and receivables standing in the books of accounts as on 31st March. The auditor wanted to send conﬁrmation request to few trade receivables but the management refused the auditor to send conﬁrmation request.

Required

How would the auditor proceed?

Solution

If management refuses to allow the auditor to send a conﬁrmation request, the auditor shall:

(a) Inquire as to management’s reasons for the refusal, and seek audit evidence as to their validity and reasonableness;

(b) Evaluate the implications of management’s refusal on the auditor’s assessment of the relevant risks of material misstatement, including the risk of fraud, and on the nature, timing and extent of other audit procedures; and

If the auditor concludes that management’s refusal to allow the auditor to send a conﬁrmation request is unreasonable, or the auditor is unable to obtain relevant and reliable audit evidence from alternative audit procedures, the auditor shall communicate with those charged with governance in accordance with SA 260.

The auditor also shall determine the implications for the audit and the auditor’s opinion in accordance with SA 705.

Question 5

How can an auditor verify the existence of related party relationships and transactions?

Solution

During the audit, the auditor should maintain alertness for related party information while reviewing records and documents. He may inspect the following records or documents that may provide information about related party relationships and transactions, for example:

1. Entity income tax returns.

2. Information supplied by the entity to regulatory authorities.

3. Shareholder registers to identify the entity’s principal shareholders.

4. Statements of conflicts of interest from management and those charged with governance.

5. Records of the entity’s investments and those of its pension plans.

6. Contracts and agreements with key management or those charged with governance.

7. Significant contracts and agreements not in the entity’s ordinary course of business.

8. Specific invoices and correspondence from the entity’s professional advisors.

9. Life insurance policies acquired by the entity.

10. Significant contracts re-negotiated by the entity during the period.

11. Internal auditors’ reports.

12. Documents associated with the entity’s filings with a securities regulator e.g, prospectuses.

Question 6

M/s Pankaj & Associates, Chartered Accountants, have been appointed as an auditor of ABC Limited. CA Pankaj did not apply any audit procedures regarding opening balances. He argued that since financial statements were audited by the predecessor auditor therefore he is not required to verify them. Is CA Pankaj correct in his approach?

Solution

Initial audit engagement is an engagement in which either:

(i) The financial statements for the prior period were not audited; or

(ii) The financial statements for the prior period were audited by a predecessor auditor.

From the above, it is quite clear that CA Pankaj is not correct in his approach and therefore would be required to follow the initial audit engagement and also apply audit procedures regarding opening balances.

Audit Procedures regarding Opening Balances; The auditor shall read the most recent financial statements, if any, and the predecessor auditor’s report thereon, if any, for information relevant to opening balances, including disclosures.

The auditor shall obtain sufficient appropriate audit evidence about whether the opening balances contain misstatements that materially affect the current period’s financial statements by:

(a) Determining whether the prior period’s closing balances have been correctly brought forward to the current period or, when appropriate, any adjustments have been disclosed as prior period items in the current year’s Statement of Profit and Loss;

(b) Determining whether the opening balances reflect the application of appropriate accounting policies; and

(i) Where the prior year financial statements were audited, perusing the copies of the audited financial statements including the other relevant documents relating to the prior period financial statements;

(ii) Evaluating whether audit procedures performed in the current period provide evidence relevant to the opening balances; or

(iii) Performing specific audit procedures to obtain evidence regarding the opening balances.

Question 7

Audit evidence is all the information used by the auditor in arriving at the conclusions on which the audit opinion is based. Written representations are necessary information that the auditor requires in connection with the audit of the entity’s ﬁnancial statements. Accordingly, similar to responses to inquiries, written representations are audit evidence. Explain stating clearly objectives of the auditor regarding written representation.

Solution

Written representations are requested from those responsible for the preparation and presentation of the ﬁnancial statements.

Although written representations provide necessary audit evidence, they do not provide sufficient appropriate audit evidence on their own about any of the matters with which they deal. Furthermore, the fact that management has provided reliable written representations does not affect the nature or extent of other audit evidence that the auditor obtains about the fulﬁlment of management’s responsibilities, or about speciﬁc assertions.

The objectives of the auditor regarding written representation

The objectives of the auditor are:

(a) To obtain written representations
To obtain written representations from management. Also that management believes that it has fulﬁlled its responsibility for the preparation of the ﬁnancial statements and for the completeness of the information provided to the auditor;

(b) To support other evidence
To support other audit evidence relevant to the ﬁnancial statements or speciﬁc assertions in the ﬁnancial statements by means of written representations.

(c) To respond appropriately
To respond appropriately to written representations provided by management or if management does not provide the written representations requested by the auditor.

Question 8

The auditor has no obligation to perform any audit procedures regarding the ﬁnancial statements after the date of the auditor’s report. However, when, after the date of the auditor’s report but before the date the ﬁnancial statements are issued, a fact becomes known to the auditor that, had it been known to the auditor at the date of the auditor’s report, may have caused the auditor to amend the auditor’s report. Explain the auditor’s obligation in the above situation.

Solution

(a) Discuss the matter with management and, where appropriate, those charged with governance.

(b) Determine whether the ﬁnancial statements need amendment and If so,

Question 9

The nature of related party relationships and transactions may, in some circumstances, give rise to higher risks of material misstatement of the ﬁnancial statements than transactions with unrelated parties. Explain with the help of at least three examples.

Solution

Many related party transactions are in the normal course of business. In such circumstances, they may carry no higher risk of material misstatement of the ﬁnancial statements than similar transactions with unrelated parties. However, the nature of related party relationships and transactions may, in some circumstances, give rise to higher risks of material misstatement of the ﬁnancial statements than transactions with unrelated parties.

Example

Related parties may operate through an extensive and complex range of relationships and structures, with a corresponding increase in the complexity of related party transactions.
Information systems may be ineffective in identifying transactions and outstanding balances between an entity and its related parties.
Related party transactions may not be conducted under normal market terms and conditions; for example, some related party transactions may be conducted with no exchange of consideration.

Question 10

When using external conﬁrmation procedures, the auditor shall maintain control over external conﬁrmation requests including sending the requests, including follow-up requests when applicable, to the conﬁrming party. Explain the other points as to when using external confirmation procedures, the auditor would be required to maintain control over external confirmation requests.

Solution

When using external conﬁrmation procedures, the auditor shall maintain control over external conﬁrmation requests, including:

(a) Determining the information to be conﬁrmed or requested;

(b) Selecting the appropriate conﬁrIg party;

(c) Designing the conﬁrmation requests, including determining that requests are properly addressed and contain return information for responses to be sent directly to the auditor; and

(d) Sending the requests, including follow-up requests when applicable, to the conﬁrming party.

Question 11

Explain clearly the examples of matters relevant in planning attendance at physical inventory counting.

Solution

Matters relevant in planning attendance at physical inventory counting include, for example:

(a) Nature of inventory.

(b) Stages of completion of work in progress.

(d) The nature of the internal control related to inventory.

(e) Whether adequate procedures are expected to be established and proper instructions issued for physical inventory counting.

(f) The timing of physical inventory counting.

(g) Whether the entity maintains a perpetual inventory system.

(h) The locations at which inventory is held, including the materiality of the inventory and the risks of material misstatement at different locations, in deciding at which locations attendance is appropriate

(i) Whether the assistance of an auditor’s expert is needed.

Question 12

The auditor P of PAR and Co., a firm of Chartered Accountants is conducting audit of AB Industries Ltd. The auditor requests management to provide Banker’s certificate in support of Fixed deposits whereas management provides only written representation on the matter. Analyse how would you deal as an auditor.

Solution

Although written representations provide necessary audit evidence, they do not provide sufficient appropriate audit evidence on their own about any of the matters with which they deal. Furthermore, the fact that management has provided reliable written representations does not affect the nature or extent of other audit evidence that the auditor obtains about the fulfillment of management’s responsibilities, or about specific assertions.

Applying the above to the given problem, the auditor would further request the management to provide him with the Banker’s certificate in support of fixed deposits held by the company.

Question 13

Most of the auditor’s work in forming the auditor’s opinion consists of obtaining and evaluating audit evidence. Explain

Solution

Audit evidence is necessary to support the auditor’s opinion and report. It is cumulative in nature and is primarily obtained from audit procedures performed during the course of the audit. It may, however, also include information obtained from other sources such as previous audits. In addition to other sources inside and outside the entity, the entity’s accounting records are an important source of audit evidence. Also, information that may be used as audit evidence may have been prepared using the work of a management’s expert. Audit evidence comprises both information that supports and corroborates management’s assertions, and any information that contradicts such assertions. In addition, in some cases the absence of information (for example, management’s refusal to provide a requested representation) is used by the auditor, and therefore, also constitutes audit evidence.

Most of the auditor’s work in forming the auditor’s opinion consists of obtaining and evaluating audit evidence. Audit procedures to obtain audit evidence can include inspection, observation, confirmation, recalculation, re-performance and analytical procedures, often in some combination, in addition to inquiry. Although inquiry may provide important audit evidence, and may even produce evidence of a misstatement, inquiry alone ordinarily does not provide sufficient audit evidence of the absence of a material misstatement at the assertion level, nor of the operating effectiveness of controls.

As explained in SA 200, “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing”, reasonable assurance is obtained when the auditor has obtained sufficient appropriate audit evidence to reduce audit risk (i.e., the risk that the auditor expresses an inappropriate opinion when the financial statements are materially misstated) to an acceptably low level. The sufficiency and appropriateness of audit evidence are interrelated.

Question 14

Irrespective of the assessed risks of material misstatement, the auditor shall design and perform substantive procedures for each material class of transactions, account balance, and disclosure. Analyse and explain.

Solution

Irrespective of the assessed risks of material misstatement, the auditor shall design and perform substantive procedures for each material class of transactions, account balance, and disclosure.

1. This requirement reflects the facts that:

the auditor’s assessment of risk is judgmental and so may not identify all risks of material misstatement; and
there are inherent limitations to internal control, including management override.

2. Depending on the circumstances, the auditor may determine that:

Performing only substantive analytical procedures will be sufficient to reduce audit risk to an acceptably low level. For example, where the auditor’s assessment of risk is supported by audit evidence from tests of controls.
Only tests of details are appropriate.
A combination of substantive analytical procedures and tests of details are most responsive to the assessed risks.

3. Substantive analytical procedures are generally more applicable to large volumes of transactions that tend to be predictable over time. SA 520, “Analytical Procedures” establishes requirements and provides guidance on the application of analytical procedures during an audit.

4. The nature of the risk and assertion is relevant to the design of tests of details. For example, tests of details related to the existence or occurrence assertion may involve selecting from items contained in a financial statement amount and obtaining the relevant audit evidence. On the other hand, tests of details related to the completeness assertion may involve selecting from items that are expected to be included in the relevant financial statement amount and investigating whether they are included.

5. Because the assessment of the risk of material misstatement takes account of internal control, the extent of substantive procedures may need to be increased when the results from tests of controls are unsatisfactory.

6. In designing tests of details, the extent of testing is ordinarily thought of in terms of the sample size. However, other matters are also relevant, including whether it is more eﬀective to use other selective means of testing.

Question 15

M/s ANS & Associates has been appointed as the statutory auditors of MNO Ltd. The company has been suffering losses due to the emergence of highly successful competitor, thereby leading to negative networth. Also, the sales head, key management personnel, of the company left the company due to health issues. When CA Amar, the engagement partner discussed the scenario with the management of the company, he did not get any satisfactory reply from the management. What is the responsibility of M/s ANS & Associates with regard to SA 570?

Solution

As per SA 570, one of the objectives of the auditor regarding going concern is to obtain sufficient and appropriate audit evidence regarding the same and to conclude on the appropriateness of the management’s use of the going concern basis of accounting in the preparation of the financial statements.

Further it also contains the list of events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern which are:

Financial indicator- Negative networth
Operating indicator- Loss of key management and emergence of highly successful competitor.

In the present case, MNO Ltd. has negative networth on account of emergence of highly successful competitor and the sales head of the company has also left the company.

Also, CA Amar did not get any satisfactory reply when he discussed the going concern matter with the management.

Thus, from the above facts, it appears that MNO Ltd. is not going concern.

If the management of MNO Ltd. has used the going concern basis of accounting, the auditor should first ask the management to adjust the financial statements.

If the management of MNO Ltd. does not agree with the same, CA Amar shall consider the impact on his audit report.

Question 16

M/s PQR and associates are the statutory auditors of TUV Ltd. for the FY 2020-21-. They have been appointed as statutory auditors of TUV Ltd. for the first time. What is the objective of the engagement partner in terms of SA 510?

Solution

As per SA 510, “Initial Engagement- Opening balances” the objective of the auditor with respect to the opening balances is to obtain sufficient and appropriate audit evidence about whether:

(a) Opening balances contain misstatements that materially aﬀect the current period’s ﬁnancial statements; and

(b) Appropriate accounting policies reﬂected in the opening balances have been consistently applied in the current period’s ﬁnancial statements, or changes thereto are properly accounted for and adequately presented and disclosed in accordance with the applicable ﬁnancial reporting framework.

Question 17

What is meant by sufficiency of Audit Evidence? Explain the factors affecting the auditor’s judgement as to the sufficiency of audit evidence.

Solution

Suﬃciency is the measure of the quantity of audit evidence. The quantity of audit evidence needed is aﬀected by the auditor’s assessment of the risks of misstatement (the higher the assessed risks, the more audit evidence is likely to be required) and also by the quality of such audit evidence (the higher the quality, the less may be required). Obtaining more audit evidence, however, may not compensate for its poor quality.

Following are the factors affecting the auditor’s judgement as to the sufficiency of audit evidence:

(a) Materiality: It may be deﬁned as the signiﬁcance of classes of transactions, account balances and presentation and disclosures to the users of the ﬁnancial statements. Less evidence would be required in case assertions are less material to users of the ﬁnancial statements. But on the other hand if assertions are more material to the users of the ﬁnancial statements, more evidence would be required.

(b) Risk of material misstatement: It may be deﬁned as the risk that the ﬁnancial statements are materially misstated prior to audit. This consists of two components described as follows at the assertion level :

Inherent risk—The susceptibility of an assertion to a misstatement that could be material before consideration of any related controls.
Control risk—The risk that a misstatement that could occur in an assertion that could be material will not be prevented or detected and corrected on a timely basis by the entity’s internal control.

Less evidence would be required in case assertions that have a lower risk of material misstatement. But on the other hand, if assertions have a higher risk of material misstatement, more evidence would be required.

(c) Size of a population: It refers to the number of items included in the population. Less evidence would be required in case of smaller, more homogeneous population but on the other hand in case of larger, more heterogeneous populations, more evidence would be required.

Auditing and Assurance Chapter 3: Audit Documentation and Audit Evidence

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