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Saturday, November 5, 2011

Suggested Hints to Advanced Auditing, November 2011 Examination

Suggested Hints to Advanced Auditing, November 2011 Examination

Ans. 1(a): As per SA 620 on Using the Work of an Expert read with SA 500 on Audit Evidence, the appropriateness and reasonableness of assumptions and methods used and their application are the responsibility of the expert. The auditor does not have the same expertise and, therefore, cannot always challenge the expert's assumptions and methods. However, the auditor should obtain an understanding of those assumptions and methods to determine that they are reasonable based on the auditor's knowledge of the client's business and on the results of his audit procedures. If, after performing these procedures, the auditor concludes that:

· the work of the expert is inconsistent with the information in the financial statements, or that

· the work of the expert does not constitute sufficient appropriate audit evidence (e.g., where the work of the expert involves highly technical matters or where, on grounds of confidentiality, the expert refuses to make available to the auditor the source data used by him),

he should express a qualified opinion, a disclaimer of opinion or an adverse opinion, as may be appropriate. Accordingly, in the present case, the auditor should consider the impact of age adopted for actuarial valuation vis-à-vis financial statements.

Ans. 1(b): As per AS 5, the term ‘prior period items’, as defined in this Statement, refers only to income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods. The term does not include other adjustments necessitated by circumstances, which though related to prior periods, are determined in the current period, e.g., arrears payable to workers as a result of revision of wages with retrospective effect during the current period. In the present case, there is no prior period item involved as there was no occurrence of error or omission in the preceding period. However, as a result of the uncertainties inherent in business activities, many financial statement items cannot be measured with precision but can only be estimated. As per SA 540 on Audit of Accounting Estimates, "accounting estimate" means an approximation of the amount of an item in the absence of a precise means of measurement. The estimation process involves judgments based on the latest information available. Estimates may be required, for example, of bad debts, inventory obsolescence or the useful lives of depreciable assets. The use of reasonable estimates is an essential part of the preparation of financial statements and does not undermine their reliability. Accordingly, as per AS 5, in the present case, the effect of a change in an accounting estimate should be included in the determination of net profit or loss in:

(a) the period of the change, if the change affects the period only; or

(b) the period of the change and future periods, if the change affects both.

Ans. 1(c):

(i) As per Para 56 of AS 26 on Intangible Assets, in some cases, expenditure is incurred to provide future economic benefits to an enterprise, but no intangible asset or other asset is acquired or created that can be recognised. In these cases, the expenditure is recognised as an expense when it is incurred. For example, expenditure on research is always recognised as an expense when it is incurred. Therefore, expenditures for commencing new operations or launching new products or processes (pre-operating costs) should be expensed off in the year of incurrence. No qualification is required to this much of extent.

(ii) Further, as per AS 22 on Accounting for Taxes on Income, Tax expense for the period, comprising current tax and deferred tax, should be included in the determination of the net profit or loss for the period. Thus, Tax Expense = Current Tax + Deferred Tax. It may however be noted that permanent differences do not result in deferred tax assets or deferred tax liabilities. In the present case, point (a) to (c) are timing differences and for that reason Deferred Tax Liability (DTL) and/ or Assets (DTA) need to be created. In respect of DTA, the concept of prudence need to adhered to. In respect of point (d), no DTA/ DTL is required as it is a permanent difference. A prima facie look to the given balance sheet states that no tax expense has been provided for. Accordingly, qualification in audit report is required.

Ans. 1(d): As per SA 299 on Joint Audit, Where joint auditors are appointed, they should, by mutual discussion, divide the audit work among themselves. The division of work would usually be in terms of audit of identifiable units or specified areas. In some cases, due to the nature of the business of the entity under audit, such a division of work may not be possible. In such situations, the division of work may be with reference to items of assets or liabilities or income or expenditure or with reference to periods of time. Certain areas of work, owing to their importance or owing to the nature of the work involved, would often not be divided and would be covered by all the joint auditors. The division of work among joint auditors as well as the areas of work to be covered by all of them should be adequately documented and preferably communicated to the entity. In the present case, since the division of work has not been documented, there is a violation of not only SA 299 but also SA 220 on Quality Control which requires Documentation as one of the quality control policy. Further, even the requirement of SQC 1 have not been followed which state that working papers have to be preserved for atleast 7 years.

Ans. 2 (a): Under Section 6 of the Chartered Accountants Act, 1949 (as amended in 2006), the Council of ICAI clarified that once a person becomes a member of the Institute, he remains bound by the provisions of the Act and the Regulations made there under. Thus, if he is suspended and does not hold COP, he cannot practice in even any other capacity, e.g., appearing before the Income Tax Authorities as Income Tax Practitioner. Accordingly, in the present case he is guilty of professional misconduct.

Ans. 2 (b): Professional Misconduct under clause 2 for certifying financial statements without examination, for gross negligence under Clause 7 and under clause 8 for not obtaining evidence, of Part I of Second Schedule to the Chartered Accountants Act, 1949 (as amended in 2006)

Ans. 2 (c): Professional Misconduct under for gross negligence under Clause 7 and under clause 8 for not obtaining evidence, of Part I of Second Schedule to the Chartered Accountants Act, 1949 (as amended in 2006)

Ans. 2 (d): Professional Misconduct for Solicitation under clause 6 of Part I of First Schedule to the Chartered Accountants Act, 1949 (as amended in 2006)

Ans. 3 (a): Reporting under Clause 4 (ix) of CARO, 2003 (as amended in November, 2004) is required

Ans. 3 (b): See Chapter on “Other Aspects”

Ans. 3 (c): As per AS 9 on Revenue Recognition, the amount of revenue arising on a transaction is usually determined by agreement between the parties involved in the transaction. When uncertainties exist regarding the determination of the amount, or its associated costs, these uncertainties may influence the timing of revenue recognition. In a transaction involving the rendering of services, performance should be measured either under the completed service contract method or under the proportionate completion method, whichever relates the revenue to the work accomplished. Such performance should be regarded as being achieved when no significant uncertainty exists regarding the amount of the consideration that will be derived from rendering the service. In the present case, simply because the invoice is raised in subsequent period, the timing of fees to be recognised as revenue cannot be deferred. Hence it should be recognised in the current period only. However, where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, revenue recognition is postponed to the extent of uncertainty involved. In such cases, it may be appropriate to recognise revenue only when it is reasonably certain that the ultimate collection will be made. Further, when the uncertainty relating to collectability arises subsequent to the time of sale or the rendering of the service, it is more appropriate to make a separate provision to reflect the uncertainty rather than to adjust the amount of revenue originally recorded.

Ans. 4 (a): See Q. 4 (b) in the question paper of November 2003

Ans. 4 (b): See Chapter on “Audit of Indirect Taxes”

Ans. 5 (a):

(i) See Clause 18 and Clause 24 of Form 3CD in the Chapter on “Tax Audit”

(ii) See Clause 18 of Form 3CD in the Chapter on “Tax Audit”

(iii) See Clause 17 (d) of Form 3CD in the Chapter on “Tax Audit”

Ans. 5 (b): See Chapter on “Bank Audit”

Ans. 5 (c): See Clause 4 (iii) and (v) of CARO, 2003 (as amended in November, 2004)

Ans. 6 (a): See Chapter on “Other Aspects”

Ans. 6 (b): As per SA 580 on Management Representation, the basic elements of a management representation letter are as follows:

· It should be addressed to the auditor;

· It should be dated and signed by the designated authority e.g. managing director, finance director etc.;

· The date of management letter should be the date as that of in the auditor's report, or a date earlier to the auditor's report;

· In certain circumstances, in respect of specific transactions, separate representation letter may also be obtained, For example, management’s unwillingness to give representations.

Ans. 6 (c): See Chapter on “EDP Audit” / “Audit in CIS Environment”

Ans. 6 (d):

Controls Specific to a Formal Cashiering Environment (cash register)

If possible, each cashier should start his/her shift with a new beginning cash balance and his/her own cash drawer. If a register must be shared, it must have sufficient controls to allow collections to be attributed to individual cashiers (e.g., separate user IDs and passwords to access the register).

Cash register entries should be made at the time of the transaction, and the payer should be given a cash register receipt.

Each cashier should balance his/her register activity at the end of the business shift.

An independent, designated individual must verify that the cash received matches the cash register’s report of business by cashier.

All voids and refunds should be reviewed and approved by department management and should be documented.

Controls Specific to an Informal Cashiering Environment (no cash register)

Specific persons should be delegated the authority to receive cash.

All collections should be immediately recorded on Official Receipts say in two-part Sequentially-Numbered Books, or other approved receipts.

The payer should be given a copy of the receipt at the time of purchase.

All voids and refunds should be reviewed and approved by department management and should be documented.

Safeguarding Handling and Storage of Cash

A mail log should be used to document collections received through the mail.

Collections should be held in a secure manner until deposited. This may be accomplished by such means as a fireproof safe, a locked desk drawer, or other locked device. The amount of collections should be considered when choosing the locking device.

At night and on weekends, cash registers should be emptied and funds secured.

Access to secure locations via keys or combinations should be limited to authorized individuals only.

Collections should be handled by as few people as possible.

If cash is transferred to another person in a department, accountability procedures should be followed.

Safe combinations should be changed regularly and whenever security may have been compromised. Departments should also change safe combinations when an employee with knowledge of the combination leaves the department.

Locks should be changed whenever security may have been compromised.

Departments should ensure keys are returned when an employee leaves the department.

All cash collected should be deposited. Collections should not be used to pay expenditures, to reserve for petty cash, or for any other reason.

Recommended Controls – Depositing Cash

Collections should never be sent through mail. All collections should be deposited with the Cashier’s Office, or the bank.

All deposits remitted to the Cashier’s Office must be accompanied by a completed Collections Report/Receipts Voucher (Collections Report). The Collections Report must identify the source of the funds and note the Banner numbers to be credited.

All supporting documentation, including daily cashier reports (in a formal cashiering environment), a daily summation of receipts (in an informal cashiering environment), and bank deposit slips should be included with the deposit.

Persons collecting and recording funds should not prepare deposits.

Deposits must be made in a timely manner, with as little cash as possible being kept in departmental offices after business hours. Departments receiving cash every day should make daily deposits.

When cash is deposited or when large sums of cash are on hand, departments are encouraged to ask for a police escort.

Recommended Controls – Reconciling Cash-Related Activity

Reconciliations should be completed by a specified individual who does not collect funds. If this is not feasible within a department, someone outside of the collections process should review the reconciliation.

Daily reconciliations should be performed by a specified individual, comparing the following (i)o the cash receipt records (e.g., cash register balancing records, pre-numbered receipts, and bank deposit slip, if applicable), (ii) the completed Collections Report.

Monthly reconciliation should be performed by a specified individual, comparing deposit information to the Organization Detail Activity Report from Banner.

All differences should be documented and resolved promptly.

Ans. 7:

(a) See Chapter on “Audit of Members of Stock Exchanges”“Other Aspects”

(b) See Chapter on “Other Aspects”

(c) See Chapter on “Audit of General Insurance Companies”

(d) U/s 217 of the Companies Act, 1949, the Board of Directors are not under any obligation to explain C&AG Comments

(e) See Chapter on “CARO”

2 comments:

  1. Dear sir,

    With due respect to you,
    I know that you have the great knowledge and expertise in audit but in my opinion the answer of the Question 1(a.) would be :-

    Solution :-

    The answer of this question prior to issue of SA 620 (Revised) was based on earlier SA 620. But as this
    case is particularly on use of Management Expert’s and not a case of use of Auditor’s Expert, hence,
    now the answer of this questions should be based on SA 500 (Revised) – Audit Evidence, which
    contains the provisions relating with use of management’s Expert and not on the basis of SA 620 (Revised).

    These are just my personal opinion sir, correct me if i am wrong.

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