Test 11: answer key

Question 1 · 2 marks · Chapter 7: Completion and Review · medium

Scenario. XYZ Ltd. has incurred operating losses for three years and negative operating cash flows. A term loan has been recalled by the bank. Management plans to sell a surplus factory, obtain promoter funding and complete debt restructuring. The auditor is evaluating management's going concern assessment under SA 570.

The auditor identifies events that may cast doubt on going concern but, after evaluating management's feasible plans, concludes that no material uncertainty exists. What is the most appropriate action?

1. Evaluate whether the financial statements adequately disclose the events and conditions and the plans addressing them. (correct answer)
2. Express an adverse opinion because operating losses and loan recall indicate the going concern basis is inappropriate.
3. Disclaim an opinion because management's plans are future-oriented and cannot be examined under statutory audit.
4. Include a Material Uncertainty Related to Going Concern section even though no material uncertainty exists.

Answer: A — Evaluate whether the financial statements adequately disclose the events and conditions and the plans addressing them.

Working. Step 1: Identify events or conditions that may cast significant doubt. Step 2: Evaluate management's assessment and plans. Step 3: Conclude whether a material uncertainty exists. Step 4: If no material uncertainty exists, evaluate adequacy of disclosures about the events and conditions under SA 570.

Explanation. Where events or conditions are identified but the auditor concludes that no material uncertainty exists, SA 570 requires evaluation of whether the financial statements provide adequate disclosures about those events and conditions. An adverse opinion applies only when use of the going concern basis is inappropriate. A material uncertainty section is required only when a material uncertainty exists and adequate disclosure is made. A disclaimer is not automatic merely because management's plans involve future actions.

Where it goes wrong. Students often assume that any going concern indicator automatically requires a Material Uncertainty section or a modified opinion.

Authority. SA 570: Going Concern, paras 22-23; ICAI Study Material, Chapter 7: Completion and Review

Question 2 · 2 marks · Chapter 7: Completion and Review · hard

Management has assessed going concern for only nine months from the date of financial statements and refuses the auditor's request to extend it to at least twelve months. What is the auditor's most appropriate response?

1. Accept the nine-month assessment because the applicable financial reporting framework does not prescribe a minimum period.
2. Consider the implications for the auditor's report, including a qualified opinion or disclaimer where sufficient evidence cannot be obtained. (correct answer)
3. Issue an adverse opinion because refusal to extend the assessment proves the going concern basis is inappropriate.
4. Include an Emphasis of Matter paragraph without considering modification of the opinion.

Answer: B — Consider the implications for the auditor's report, including a qualified opinion or disclaimer where sufficient evidence cannot be obtained.

Working. Step 1: Check the period covered by management's assessment. Step 2: If less than twelve months, request extension. Step 3: If management refuses, evaluate implications for audit evidence. Step 4: Consider qualification or disclaimer under SA 705 read with SA 570.

Explanation. SA 570 requires the auditor to request management to extend its assessment to at least twelve months from the date of the financial statements if management's assessment covers a shorter period. If management is unwilling to make or extend the assessment, the auditor considers the implications for the auditor's report. A qualified opinion or disclaimer may be appropriate where sufficient appropriate audit evidence cannot be obtained. Adverse opinion is not automatic; it applies when the going concern basis is inappropriate.

Where it goes wrong. Students may treat management's refusal as conclusive evidence that the going concern basis is inappropriate, rather than as a scope limitation.

Authority. SA 570: Going Concern, para 26; ICAI Study Material, Chapter 7: Completion and Review

Question 3 · 2 marks · Chapter 7: Completion and Review · medium

The auditor concludes that a material uncertainty related to going concern exists and that the financial statements adequately disclose it. What report is appropriate?

1. An adverse opinion because a material uncertainty means the financial statements are not true and fair.
2. A disclaimer of opinion because the auditor cannot predict future events affecting going concern.
3. An unmodified opinion with a separate Material Uncertainty Related to Going Concern section. (correct answer)
4. An unmodified opinion with no reference to going concern because disclosure is already in the notes.

Answer: C — An unmodified opinion with a separate Material Uncertainty Related to Going Concern section.

Working. Step 1: Conclude that a material uncertainty exists. Step 2: Check adequacy of disclosures. Step 3: If adequate, issue unmodified opinion. Step 4: Include separate Material Uncertainty Related to Going Concern section referring to the note.

Explanation. When a material uncertainty exists but adequate disclosure is made in the financial statements, the auditor expresses an unmodified opinion and includes a separate section under the heading Material Uncertainty Related to Going Concern. The section draws attention to the note disclosing the uncertainty and states that the opinion is not modified. Adverse opinion and disclaimer are not appropriate solely because a material uncertainty exists if disclosures are adequate.

Where it goes wrong. Students often equate a material uncertainty with a modified opinion and overlook the separate going concern section.

Authority. SA 570: Going Concern, para 22; SA 700: Forming an Opinion and Reporting on Financial Statements

Question 4 · 2 marks · Chapter 7: Completion and Review · hard

The auditor concludes that management's use of the going concern basis of accounting is inappropriate. What opinion should the auditor express?

1. An unmodified opinion with an Emphasis of Matter paragraph describing the inappropriate basis.
2. A qualified opinion because the matter is material but not pervasive.
3. A disclaimer of opinion because future events cannot be predicted.
4. An adverse opinion because the financial statements are prepared on an inappropriate basis. (correct answer)

Answer: D — An adverse opinion because the financial statements are prepared on an inappropriate basis.

Working. Step 1: Distinguish inappropriate basis from material uncertainty. Step 2: If basis is inappropriate, the financial statements are materially misstated. Step 3: Because the basis affects the financial statements as a whole, express adverse opinion under SA 570 para 21.

Explanation. If the financial statements have been prepared using the going concern basis but, in the auditor's judgement, that basis is inappropriate, SA 570 requires an adverse opinion. A qualified opinion is used where the matter is material but not pervasive; an adverse opinion is used where the effects are material and pervasive. A disclaimer is a scope limitation, not a conclusion that the basis is inappropriate.

Where it goes wrong. Students may confuse an inappropriate going concern basis with a material uncertainty and choose a qualified opinion or EOM.

Authority. SA 570: Going Concern, para 21; SA 705: Modifications to the Opinion in the Independent Auditor's Report

Question 5 · 2 marks · Chapter 9: Special Features of Audit of Different Types of Entities · medium

Scenario. ABC Hire Purchase Ltd. enters into hire purchase agreements for commercial vehicles. The auditor is examining whether finance charges are separated from principal, whether the cash price and hire purchase price are disclosed in agreements, and how repossession and overdue instalments are accounted for.

Which audit procedure is most appropriate for a hire purchase enterprise's agreements and instalment accounting?

1. Examine each agreement for cash price, hire purchase price and instalment terms, and check that finance charge is allocated over the term and principal recovery is tracked. (correct answer)
2. Check only that the total number of instalments received agrees with the total hire purchase price shown in the agreement.
3. Treat the full instalment received as sales revenue because ownership passes only after the last instalment.
4. Ignore repossession accounting until legal ownership has been transferred to the hirer.

Answer: A — Examine each agreement for cash price, hire purchase price and instalment terms, and check that finance charge is allocated over the term and principal recovery is tracked.

Working. Step 1: Inspect the hire purchase agreement for cash price, hire purchase price and instalments. Step 2: Verify computation and allocation of finance charge. Step 3: Check principal recovery and overdue instalments. Step 4: Examine repossession and termination accounting where applicable.

Explanation. In a hire purchase transaction, the agreement must clearly specify the cash price, hire purchase price, instalment amounts and dates, and the goods. The auditor checks segregation of the finance charge from the principal and verifies that principal recovery and interest income are accounted for over the term. Treating the entire instalment as revenue ignores the financing element, and repossession accounting cannot be deferred merely because legal title has not passed.

Where it goes wrong. Students often treat hire purchase like an outright sale and ignore the financing charge and repossession accounting.

Authority. ICAI Study Material, Chapter 9: Special Features of Audit of Different Types of Entities; Hire Purchase Act, 1972: definition and agreement requirements

Question 6 · 2 marks · Chapter 5: Audit of Items of Financial Statements · medium

Scenario. PQR Ltd. has a pending income tax dispute, a product warranty obligation and a financial guarantee issued for a subsidiary's loan. The auditor is applying AS 29 to decide whether each item is a provision, a contingent liability or a contingent asset.

An entity has a present obligation arising from a past event, probable outflow of economic benefits and a reliable estimate of the amount. How should the auditor treat this item under AS 29?

1. Disclose it as a contingent liability because the amount is an estimate.
2. Recognise a provision because all recognition criteria under AS 29 are met. (correct answer)
3. Recognise a contingent asset because the entity may settle at a lower amount.
4. Ignore it until the obligation is finally settled by a court or regulator.

Answer: B — Recognise a provision because all recognition criteria under AS 29 are met.

Working. Step 1: Identify present obligation from past event. Step 2: Assess probability of outflow. Step 3: Assess reliability of estimate. Step 4: If all three criteria are met, recognise provision under AS 29.

Explanation. AS 29 requires recognition of a provision when there is a present obligation as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle it, and a reliable estimate can be made. A contingent liability is disclosed, not recognised, where one or more criteria are not met. A contingent asset is a possible asset, not a liability, and is not recognised.

Where it goes wrong. Students often confuse a reliable estimate with uncertainty and disclose a provision as a contingent liability.

Authority. AS 29: Provisions, Contingent Liabilities and Contingent Assets, para 14; ICAI Study Material, Chapter 5: Audit of Items of Financial Statements

Question 7 · 2 marks · Chapter 5: Audit of Items of Financial Statements · hard

A pending income tax dispute is a possible obligation whose existence will be confirmed only by a future tax authority decision. Outflow is not probable but is not remote. What is the appropriate accounting treatment?

1. Recognise a provision for the full amount claimed by the tax authority.
2. Recognise a provision only for the amount admitted by management.
3. Disclose a contingent liability unless the possibility of outflow is remote. (correct answer)
4. Recognise a contingent asset because the dispute may be decided in the entity's favour.

Answer: C — Disclose a contingent liability unless the possibility of outflow is remote.

Working. Step 1: Determine whether obligation is present or possible. Step 2: Assess probability of outflow. Step 3: If not probable and not remote, disclose contingent liability. Step 4: Do not recognise provision or contingent asset.

Explanation. A possible obligation whose existence will be confirmed only by uncertain future events is a contingent liability. Where outflow is not probable, no provision is recognised; disclosure is required unless the possibility of outflow is remote. A provision is recognised only when a present obligation, probable outflow and reliable estimate exist. A contingent asset is not recognised.

Where it goes wrong. Students often recognise a provision for every tax dispute or treat a possible obligation as a present obligation.

Authority. AS 29: Provisions, Contingent Liabilities and Contingent Assets, paras 10 and 68; ICAI Study Material, Chapter 5: Audit of Items of Financial Statements

Question 8 · 2 marks · Chapter 5: Audit of Items of Financial Statements · hard

An entity recognises a product warranty provision. Which measurement approach is most appropriate under AS 29?

1. Measure the provision at the maximum possible claim under the warranty terms.
2. Measure the provision at the amount claimed by customers before the balance sheet date.
3. Measure the provision at the amount already paid for warranty claims during the year.
4. Measure the provision at the most appropriate estimate of expenditure required to settle the present obligation at the reporting date. (correct answer)

Answer: D — Measure the provision at the most appropriate estimate of expenditure required to settle the present obligation at the reporting date.

Working. Step 1: Confirm provision recognition criteria are met. Step 2: Obtain management's most appropriate estimate. Step 3: Evaluate risks and uncertainties. Step 4: Assess reasonableness of measurement and disclosures under AS 29.

Explanation. AS 29 requires a provision to be measured at the most appropriate estimate of the expenditure required to settle the present obligation at the balance sheet date, considering risks and uncertainties. It is not measured at the maximum possible claim, nor at amounts already paid. The auditor evaluates whether management's estimate is reasonable and whether disclosures about uncertainties are adequate.

Where it goes wrong. Students often choose the maximum claim or past payments instead of the most appropriate estimate at the reporting date.

Authority. AS 29: Provisions, Contingent Liabilities and Contingent Assets, paras 23-25; ICAI Study Material, Chapter 5: Audit of Items of Financial Statements

Question 9 · 2 marks · Chapter 5: Audit of Items of Financial Statements · medium

An entity has issued a financial guarantee for a subsidiary's loan. At the reporting date, it is probable that the entity will be required to pay under the guarantee and a reliable estimate can be made. What is the appropriate treatment?

1. Recognise a provision because the present obligation, probable outflow and reliable estimate criteria are met. (correct answer)
2. Disclose a contingent liability because a financial guarantee is always a possible obligation.
3. Recognise a contingent asset because the subsidiary may repay the loan.
4. Ignore the guarantee until the lender formally invokes it.

Answer: A — Recognise a provision because the present obligation, probable outflow and reliable estimate criteria are met.

Working. Step 1: Identify the obligation under the guarantee. Step 2: Assess probability of outflow. Step 3: Assess reliability of estimate. Step 4: If criteria met, recognise provision under AS 29.

Explanation. A financial guarantee can create a present obligation where it is probable that the guarantor will be required to pay and a reliable estimate can be made. In such a case, a provision is recognised. A contingent liability is disclosed only where the recognition criteria are not met. The guarantee is not ignored until invocation, and a contingent asset is not recognised.

Where it goes wrong. Students may classify every guarantee as a contingent liability without applying the present obligation and probability criteria.

Authority. AS 29: Provisions, Contingent Liabilities and Contingent Assets, para 14; ICAI Study Material, Chapter 5: Audit of Items of Financial Statements

Question 10 · 2 marks · Chapter 6: Audit Documentation · medium

Scenario. The auditor of LMN Ltd. signed the audit report on 30 June 2026. The final audit file is being assembled. A team member asks which changes are permissible during final file assembly under SA 230.

After the audit report date, which change is permissible during final assembly of the audit file under SA 230?

1. Perform new audit procedures to resolve an inconsistency identified after the report date.
2. Delete superseded documentation and sort, collate and cross-reference working papers. (correct answer)
3. Discard audit evidence obtained before the report date to reduce file size.
4. Change a conclusion without documenting the reason for the change.

Answer: B — Delete superseded documentation and sort, collate and cross-reference working papers.

Working. Step 1: Identify whether the action is administrative. Step 2: Administrative actions include deletion of superseded papers and cross-referencing. Step 3: New procedures or changes to conclusions are not administrative. Step 4: Retain documentation for the retention period after final file assembly.

Explanation. Final assembly is an administrative process and does not involve new audit procedures or new conclusions. Permissible changes include deleting superseded documentation, sorting, collating and cross-referencing working papers, and signing off completion checklists. Performing new audit procedures, discarding valid evidence or changing conclusions without documentation is not permissible during final assembly.

Where it goes wrong. Students often believe final assembly allows new audit work or changes to conclusions.

Authority. SA 230: Audit Documentation, paras 14-16; SQC 1: Quality Control for Firms

Question 11 · 2 marks · Chapter 10: Audit of Banks · hard

Scenario. During audit of DEF Bank Ltd., the auditor is examining an NPA account where the borrower has paid overdue instalments and interest, and a written-off account where a recovery has been received. The auditor must apply RBI prudential norms on upgradation and income recognition.

What is the primary prerequisite for upgrading an NPA account to Standard status under RBI prudential norms?

1. The borrower has paid one overdue instalment and has requested restructuring.
2. The bank has obtained additional security covering the overdue amount.
3. The entire arrears of interest and principal have been paid and the account remains regular. (correct answer)
4. The account has been classified as SMA 2 for a continuous period of ninety days.

Answer: C — The entire arrears of interest and principal have been paid and the account remains regular.

Working. Step 1: Check arrears of interest and principal. Step 2: Confirm full payment of all arrears. Step 3: Verify account remains regular. Step 4: Only then upgrade to Standard status.

Explanation. An NPA account can be upgraded to Standard only when the entire arrears of interest and principal are paid and the account remains regular. Payment of one instalment, additional security or mere restructuring does not satisfy the upgradation requirement. SMA classification indicates incipient stress and is not a basis for upgrading an NPA.

Where it goes wrong. Students often think restructuring or partial payment is sufficient for upgradation.

Authority. RBI Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances; ICAI Study Material, Chapter 10: Audit of Banks

Question 12 · 2 marks · Chapter 10: Audit of Banks · medium

A bank receives a recovery in an account that had already been written off. How should the recovery generally be accounted for under RBI norms?

1. Reduce the existing provision for standard assets.
2. Ignore the recovery because the account no longer appears in the loan book.
3. Credit the recovery directly to capital reserve.
4. Recognise the recovery as income in the profit and loss account. (correct answer)

Answer: D — Recognise the recovery as income in the profit and loss account.

Working. Step 1: Identify that the account was written off. Step 2: Verify the recovery received. Step 3: Recognise recovery as income. Step 4: Check period and disclosure.

Explanation. Recoveries in written-off accounts are recognised as income in the profit and loss account, because the account has already been written off and the recovery represents a realisation. Such recovery is not credited to capital reserve, nor ignored, nor adjusted against standard asset provisions. The auditor checks whether the recovery is bona fide and recorded in the correct period.

Where it goes wrong. Students often think written-off accounts are outside the books and recoveries need no income recognition.

Authority. RBI Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances; ICAI Study Material, Chapter 10: Audit of Banks

Question 13 · 2 marks · Chapter 10: Audit of Banks · medium

Which statement about upgradation of an NPA account is correct?

1. Upgradation requires payment of all arrears and the account must not remain out of order. (correct answer)
2. Upgradation is automatic once the borrower pays the next instalment after the balance sheet date.
3. Upgradation is permitted if the bank obtains a fresh valuation of security covering the loan.
4. Upgradation is permitted if the account is restructured and the borrower agrees to a new repayment schedule.

Answer: A — Upgradation requires payment of all arrears and the account must not remain out of order.

Working. Step 1: Confirm all arrears are paid. Step 2: Check account is not out of order. Step 3: Verify record of recovery. Step 4: Upgrade only if conditions are satisfied.

Explanation. Upgradation of an NPA requires payment of all arrears of interest and principal and the account must not remain out of order. Payment of the next instalment, fresh security valuation or restructuring does not by itself justify upgradation. The auditor verifies record of recovery and regularity as required by RBI norms.

Where it goes wrong. Students may treat restructuring or additional security as sufficient for NPA upgradation.

Authority. RBI Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances; ICAI Study Material, Chapter 10: Audit of Banks

Question 14 · 2 marks · Chapter 10: Audit of Banks · hard

How should a bank treat interest partly realised in an NPA account where there is no agreement on appropriation of recoveries?

1. Recognise all recoveries as interest income irrespective of whether they arise from fresh credit facilities.
2. Recognise income only when certainty attaches to realisation and ensure credits are not out of fresh or additional facilities. (correct answer)
3. Credit all recoveries to principal first and recognise interest income only after principal is fully recovered.
4. Recognise interest income on accrual basis even though the account remains NPA.

Answer: B — Recognise income only when certainty attaches to realisation and ensure credits are not out of fresh or additional facilities.

Working. Step 1: Confirm account is NPA. Step 2: Check whether appropriation agreement exists. Step 3: Apply uniform policy and recognise income only when certainty attaches. Step 4: Verify credits are not from fresh or additional facilities.

Explanation. In the absence of an agreement on appropriation, banks must adopt a uniform and consistent policy. Interest partly or fully realised in NPAs can be taken to income only when certainty attaches to realisation, and it must be ensured that credits towards interest are not out of fresh or additional credit facilities. Accrual recognition is not permitted for NPAs, and rigid principal-first appropriation is not the prescribed uniform policy.

Where it goes wrong. Students often apply normal accrual accounting to NPAs or assume all recoveries are automatically interest income.

Authority. RBI Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances; AS 9: Revenue Recognition; ICAI Study Material, Chapter 10: Audit of Banks

Question 15 · 2 marks · Chapter 8: Audit Report · medium

Scenario. GHI Ltd. acquired immovable property from one of its directors and allotted equity shares as consideration instead of paying cash. The title deed was transferred to the company. The auditor is considering CARO 2020 reporting on non-cash transactions with directors.

A company acquired immovable property from a director and allotted equity shares as consideration. What is the auditor's reporting responsibility under CARO 2020?

1. No CARO reporting is required because the title deed has been transferred to the company.
2. Report under the clause dealing with consolidated financial statements qualifications.
3. Report under clause (xv) whether provisions of section 192 of the Companies Act, 2013 have been complied with. (correct answer)
4. Report under the clause dealing with statutory dues because shares were allotted instead of cash.

Answer: C — Report under clause (xv) whether provisions of section 192 of the Companies Act, 2013 have been complied with.

Working. Step 1: Identify transaction as non-cash with a director. Step 2: Check section 192 compliance. Step 3: Report under CARO 2020 clause (xv). Step 4: Disclose non-compliance, if any, with reasons.

Explanation. CARO 2020 clause (xv) requires the auditor to report whether the company has entered into any non-cash transactions with directors or persons connected with them and, if so, whether the provisions of section 192 of the Companies Act, 2013 have been complied with. Acquisition of property from a director in exchange for shares is a non-cash transaction with a director. Transfer of title does not eliminate the reporting requirement.

Where it goes wrong. Students may think that a valid title transfer or share allotment removes the need for CARO reporting.

Authority. CARO 2020, para 3(xv); Companies Act, 2013, section 192; ICAI Study Material, Chapter 8: Audit Report and CARO