CAP CLASSES

Audit Questions (a) Internal control over safeguarding of assets against unauthorised acquisition, use, or disposition may include controls relating to both financial reporting and operations objectives. Explain stating clearly the objectives of Internal Control. (b) It has been suggested that actual operation of the internal control should be tested by the application of procedural tests and examination in depth. Explain with the help of example in respect of the procedure for sales.

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Answers : (a) Control risk assessment when control deficiencies are identified: When auditor identifies deficiencies and report on internal controls, he determines the significant financial statement assertions that are affected by the ineffective controls in order to evaluate the effect on control risk assessments and strategy for the audit of the financial statements. When control deficiencies are identified and auditor identifies and tests more than one control for each relevant assertion, he evaluates control risk considering all of the controls he has tested. If auditor determines that they support a ‘rely on controls’ risk assessment, or if compensating controls are identified, tested and evaluated to be effective, he may conclude that the ‘rely on controls’ is still appropriate. Otherwise we change our control risk assessment to ‘not rely on controls.’ When a deficiency relates to an ineffective control that is the only control identified for an assertion, he revises risk assessment to ‘not rely on controls’ for associated assertions, as no other controls have been identified that mitigate the risk related to the assertion. If the deficiency relates to one WCGW (what can go wrong) out of several WCGW’s, he can ‘rely on controls’ but performs additional substantive procedures to adequately address the risks related to the deficiency. (b) Obtaining an understanding of the entity and its environment, including the entity’s internal control, is a continuous, dynamic process of gathering, updating and analysing information throughout the audit. The understanding establishes a frame of reference within which the auditor plans the audit and exercises professional judgment throughout the audit, for example, when: • Assessing risks of material misstatement of the financial statements; • Determining materiality in accordance with SA 320; • Considering the appropriateness of the selection and application of accounting policies; • Identifying areas where special audit consideration may be necessary, for example, related party transactions, the appropriateness of management’s use of the going concern assumption, or considering the business purpose of transactions; • Developing expectations for use when performing analytical procedures; • Evaluating the sufficiency and appropriateness of audit evidence obtained, such as the appropriateness of assumptions and of management’s oral and written representations.

Audit questions (a) When auditor identifies deficiencies and report on internal controls, he determines the significant financial statement assertions that are affected by the ineffective controls in order to evaluate the effect on control risk assessments and strategy for the audit of the financial statements. Explain (b) Obtaining an understanding of the entity and its environment, including the entity’s internal control, is a continuous, dynamic process of gathering, updating and analysing information throughout the audit. Analyse and explain giving examples.

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Answers (a) Positive confirmation request – A request that the confirming party respond directly to the auditor indicating whether the confirming party agrees or disagrees with the information in the request, or providing the requested information. Negative confirmation request – A request that the confirming party respond directly to the auditor only if the confirming party disagrees with the information provided in the request. Non-response – A failure of the confirming party to respond, or fully respond, to a positive confirmation request, or a confirmation request returned undelivered. Exception – A response that indicates a difference between information requested to be confirmed, or contained in the entity’s records, and information provided by the confirming party. (b) Matters relevant in planning attendance at physical inventory counting include, for example: (a) Nature of inventory. (b) Stages of completion of work in progress. (c) The risks of material misstatement related to inventory. (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.

Audit Questions (a) Define the following : (i) Positive confirmation request (ii) Negative confirmation request (iii) Non-response (iv) Exception (b) Explain clearly the examples of matters relevant in planning attendance at physical inventory counting.

Answers: (a) 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 at identifying or summarising 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. (b) 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 confirming 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.

Audit Questions (a) 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. (b) 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.

Answers : (a) If the books of account are not properly maintained and if the control system is weak, the possibility of frauds and errors are enormous and the auditor, even with the best of his efforts, may not be able to detect all of them. The fact is recognised by the Courts as is obvious from a study of the various judgments. The auditor’s performance is judicially viewed by applying the following tests: (i) whether the auditor has exercised reasonable care and skill in carrying out his work; (ii) whether the errors and frauds were such as could have been detected in the ordinary course of checking without the aid of any special efforts; (iii) whether the auditor had any reason to suspect the existence of the errors and frauds; and (iv) whether the error or fraud was so deep laid that the same might not have been detected by the application of normal audit procedures. (b) Audit Procedures in respect of Opening Balances for a New Audit Engagement: As per SA 510 “Initial Audit Engagements – Opening Balances”, the auditor should undertake the following procedures in respect of opening balances in case of new audit engagement: (i) 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. (ii) 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 Performing one or more of the following: (1) 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; (2) Evaluating whether audit procedures performed in the current period provide evidence relevant to the opening balances; or (3) Performing specific audit procedures to obtain evidence regarding the opening balances. If the auditor obtains audit evidence that the opening balances contain misstatements that could materially affect the current period’s financial statements, the auditor shall perform such additional audit procedures as are appropriate in the circumstances to determine the effect on the current period’s financial statements. If the auditor concludes that such misstatements exist in the current period’s financial statements, the auditor shall communicate the misstatements with the appropriate level of management and those charged with governance.

Audit questions (a) Shakti Cables Ltd is engaged in manufacturing and trading of cables of different types. Its Books of account are not properly maintained and the control system is weak, so the possibility of frauds and errors are enormous and the auditor, even with the best of his efforts, may not be able to detect all of them. The fact is recognised by the Courts from a study of the various judgments. State the tests that would be applied by the courts to view the auditor’s performance judicially. (b) Discuss with reference to SA 510, “Initial Audit Engagement – Opening Balances”, the procedures the auditor should undertake in respect of opening balances for a new audit engagement.

Answers (a) 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. 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 fulfillment of management’s responsibilities, or about specific assertions. The objectives of the auditor regarding written representation The objectives of the auditor are: (1) 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; (2) 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; and (3) 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. (b) 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, the auditor shall: (1) Discuss the matter with management and, where appropriate, those charged with governance. (2) Determine whether the financial statements need amendment and, if so, (3) Inquire how management intends to address the matter in the financial statements.

Audit Questions (a) 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. (b) 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 f act 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.

Answers : (a) Examples are : • The competitive environment, including demand, capacity, product and price competition as well as cyclical or seasonal activity. • Supplier and customer relationships, such as types of suppliers and customers (e.g., related parties, unified buying groups) and the related contracts with those entities. • Technological developments, such as those related to the entity’s products, energy supply and cost. • The effect of regulation on entity operations. (b) Evidence is the very basis for formulation of opinion and an audit programme is designed to provide for that by prescribing procedures and techniques. What is best evidence for testing the accuracy of any assertion is a matter of expert knowledge and experience. This is the primary task before the auditor when he draws up the audit programme. Transactions are varied in nature and impact; procedures to be prescribed depend on prior knowledge of what evidence is reasonably available in respect of each transaction. Example Sales are evidenced by: (i) invoices raised by the client; (ii) price list; (iii) forwarding notes to client; (iv) inventory-issue records; (v) sales managers’ advice to the inventory section; (vi) acknowledgements of the receipt of goods by the customers; and (vii) collection of money against sales by the client.

Today's audit questions (a) Knowledge of the Client’s business is one of the important principles in developing an overall audit plan. In fact without adequate knowledge of client’s business, a proper audit is not possible. As per SA-315, “Identifying and Assessing the Risk of Material Misstatement through Understanding the Entity and Its Environment”, the auditor shall obtain an understanding of the relevant industry, regulatory and other external factors including the applicable financial reporting framework. Substantiate with the help of examples. (b) Evidence is the very basis for formulation of opinion and an audit programme is designed to provide for that by prescribing procedures and techniques.