Test 12: answer key

Question 1 · 2 marks · Chapter 8: Audit Report · medium

Scenario. CA N is finalising reports for four entities for FY 2025-26. Entity A: inventory records were destroyed and the auditor cannot obtain evidence; inventory is 8 percent of total assets and affects inventory and cost of goods sold only. Entity B: management refuses to consolidate a major subsidiary representing 65 percent of group revenue and 70 percent of assets; evidence shows the omission is a material misstatement. Entity C: capital expenditure of Rs. 12 lakh was expensed; profit before tax is Rs. 80 lakh; the effect is material but confined to PPE, depreciation and expenses. Entity D: the auditor cannot obtain evidence on receivables and inventories, together 85 percent of total assets; possible effects are material and pervasive. Overall materiality is Rs. 5 lakh.

For Entity A, which opinion is appropriate?

1. Qualified opinion, because the possible effects are material but not pervasive. (correct answer)
2. Adverse opinion, because the inability to obtain evidence is confined to inventory only.
3. Disclaimer of opinion, because any inability to obtain evidence requires a disclaimer.
4. Unmodified opinion, because inventory is only 8 percent of total assets.

Answer: A — Qualified opinion, because the possible effects are material but not pervasive.

Working. Step 1: Identify nature as inability to obtain evidence. Step 2: Assess possible effects. Step 3: Entity A is confined to inventory and cost of goods sold. Step 4: Material but not pervasive leads to qualified opinion.

Explanation. An inability to obtain sufficient appropriate audit evidence is evaluated for possible effects. If those possible effects could be material but not pervasive, a qualified opinion is appropriate. A disclaimer is used only when possible effects are material and pervasive. Adverse opinion is used for a known material and pervasive misstatement, not for a confined inability. The 8 percent figure alone does not decide pervasiveness.

Where it goes wrong. Treating every scope limitation as requiring a disclaimer of opinion.

Authority. SA 705: Modifications to the Opinion in the Independent Auditor's Report, paras 7-9; ICAI Study Manual, Chapter 8: Audit Report

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

For Entity B, which opinion is appropriate?

1. Qualified opinion, because the subsidiary omission affects only consolidation adjustments.
2. Adverse opinion, because a material and pervasive misstatement exists. (correct answer)
3. Disclaimer opinion, because management refused to provide consolidation records.
4. Unmodified opinion with an Emphasis of Matter paragraph.

Answer: B — Adverse opinion, because a material and pervasive misstatement exists.

Working. Step 1: Nature is known misstatement. Step 2: Omission affects most of group revenue and assets. Step 3: Material and pervasive. Step 4: Adverse opinion.

Explanation. The auditor has sufficient evidence that omitting a subsidiary representing 65 percent of revenue and 70 percent of assets is a material misstatement. Because the misstatement is both material and pervasive to the group financial statements, an adverse opinion is required. Management refusal does not automatically create a disclaimer when evidence of the misstatement is available. An Emphasis of Matter paragraph cannot replace a modified opinion.

Where it goes wrong. Assuming management refusal always means disclaimer instead of adverse.

Authority. SA 705: Modifications to the Opinion in the Independent Auditor's Report, para 8; SA 706: Emphasis of Matter Paragraphs and Other Matter Paragraphs

Question 3 · 2 marks · Chapter 8: Audit Report · hard

For Entity C, which heading and opinion wording is appropriate?

1. Basis for Opinion; 'because of the significance of the matter described, the financial statements do not present fairly'
2. Basis for Disclaimer of Opinion; 'we do not express an opinion on the financial statements'
3. Basis for Qualified Opinion; 'except for the effects described, the statements present fairly' (correct answer)
4. Basis for Adverse Opinion; 'except for the possible effects of the matter, the financial statements present fairly'

Answer: C — Basis for Qualified Opinion; 'except for the effects described, the statements present fairly'

Working. Step 1: Nature is misstatement. Step 2: Effect confined and material. Step 3: Qualified opinion heading. Step 4: Use 'except for the effects described'.

Explanation. Entity C has a known material misstatement that is confined to PPE, depreciation and expenses, so it is material but not pervasive. The report uses the heading Basis for Qualified Opinion and the opinion states that, except for the effects of the matter, the financial statements present fairly. The phrase about possible effects is used for an inability to obtain evidence, not for a known misstatement. Disclaimer wording is used only for a pervasive inability.

Where it goes wrong. Using 'except for possible effects' when the matter is a known misstatement.

Authority. SA 705: Modifications to the Opinion in the Independent Auditor's Report, paras 10-12; ICAI Study Material, Chapter 8: Audit Report

Question 4 · 2 marks · Chapter 8: Audit Report · medium

For Entity D, which reporting treatment is appropriate?

1. State that the auditor was engaged to audit and omit Key Audit Matters unless law requires. (correct answer)
2. Express an adverse opinion because the inability to obtain evidence is material and pervasive.
3. Express a qualified opinion because some evidence was available for other balances.
4. Include an unmodified opinion with an Other Matter paragraph for the scope limitation.

Answer: A — State that the auditor was engaged to audit and omit Key Audit Matters unless law requires.

Working. Step 1: Nature is inability to obtain evidence. Step 2: Possible effects are material and pervasive. Step 3: Disclaimer opinion. Step 4: State engagement to audit; KAM omitted unless required.

Explanation. Entity D involves an inability to obtain evidence on balances representing 85 percent of total assets, with possible effects material and pervasive. A disclaimer of opinion is required. In a disclaimer, the auditor states that the auditor was engaged to audit and does not include a Key Audit Matters section unless law or regulation requires it. Adverse opinion is for known pervasive misstatements. Other Matter cannot replace a disclaimer.

Where it goes wrong. Confusing pervasive inability with adverse opinion for a known misstatement.

Authority. SA 705: Modifications to the Opinion in the Independent Auditor's Report, paras 9-10; SA 701: Communicating Key Audit Matters, para 13

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

Scenario. M/s Shine & Co. is a partnership firm. The deed authorises interest on capital at 12 percent per annum and remuneration only to working partners. The firm paid interest at 15 percent per annum to all partners and paid Rs. 3 lakh remuneration to a non-working partner. The tax provision has been computed without disallowance under section 40(b) of the Income Tax Act, 1961. The auditor is reviewing the partnership deed, partner accounts and tax computation.

What is the most appropriate audit conclusion on the firm's tax provision and partner payments?

1. Only the excess interest over 12 percent is disallowable; remuneration to the non-working partner remains allowable if paid under the deed.
2. The excess interest and the non-working partner remuneration are not allowable; the tax provision needs revision. (correct answer)
3. Both payments are allowable because the partnership deed authorises interest and remuneration to partners.
4. Neither payment is allowable; the entire interest and remuneration must be added back.

Answer: B — The excess interest and the non-working partner remuneration are not allowable; the tax provision needs revision.

Working. Step 1: Read deed for authorisation. Step 2: Check 12 percent cap on interest. Step 3: Check working partner status for remuneration. Step 4: Disallow excess and non-working remuneration; revise tax provision.

Explanation. Section 40(b) permits interest to partners only if authorised by the deed and only up to 12 percent per annum. Remuneration is allowed only to working partners and must be authorised by the deed. The excess interest and remuneration to a non-working partner are not allowable, so the tax provision is understated and needs revision. Deed authorisation alone does not make 15 percent interest or non-working partner remuneration allowable.

Where it goes wrong. Assuming any payment authorised by the partnership deed is fully allowable for tax.

Authority. Income-tax Act, 1961, section 40(b); ICAI Study Material, Chapter 9: Audit of Partnership Firm

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

Scenario. Healthy Life Ltd. has a provident fund plan under which it contributes a fixed percentage and has no further obligation, a gratuity plan and a leave encashment plan. An independent actuary appointed by management values gratuity and leave encashment. The auditor is examining the actuarial report, employee data and PF and ESI challans. March PF was deposited on 20 April and March ESI on 15 April; other months were deposited on time.

Which plan is a defined contribution plan for AS 15 purposes?

1. Provident fund where the company pays a fixed percentage and has no further obligation. (correct answer)
2. Gratuity where the company bears the actuarial risk arising from employee service and salary changes.
3. Leave encashment where the company bears the risk of salary increases and leave utilisation.
4. Pension where the company must fund any deficit in the trust after actuarial valuation.

Answer: A — Provident fund where the company pays a fixed percentage and has no further obligation.

Working. Step 1: Read plan rules. Step 2: Identify whether entity has further obligation. Step 3: Fixed contribution with no further obligation is defined contribution. Step 4: Others retain actuarial risk.

Explanation. A defined contribution plan involves fixed contributions by the entity with no further obligation. The employee bears the investment and actuarial risk. Gratuity, leave encashment and a pension plan where the employer must fund deficits are defined benefit plans because the entity retains actuarial and investment risk. The auditor should distinguish the plans before selecting audit procedures.

Where it goes wrong. Treating every provident fund as a defined benefit plan without examining the obligation.

Authority. AS 15: Employee Benefits; ICAI Study Material, Chapter 5: Employee Benefit Expenses

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

For the actuary's gratuity valuation, which auditor action is least appropriate?

1. Evaluate the actuary's competence, capabilities and objectivity, including independence from the company.
2. Obtain an understanding of the actuary's work and the assumptions used in the valuation.
3. Assess whether the actuary's findings support the relevant assertion in the financial statements.
4. Accept the valuation solely because the actuary is independent of the company. (correct answer)

Answer: D — Accept the valuation solely because the actuary is independent of the company.

Working. Step 1: Identify use of management expert. Step 2: Apply SA 500 evaluation requirements. Step 3: Independence is only one factor. Step 4: Sole reliance is least appropriate.

Explanation. When information prepared by a management's expert is used as audit evidence, the auditor must evaluate the expert's competence, capabilities and objectivity; obtain an understanding of the work; and evaluate the appropriateness of the work for the relevant assertion. Independence alone is not enough, and the auditor cannot accept the valuation solely on that basis. This is a common trap in actuarial valuation audits.

Where it goes wrong. Relying solely on the independence of the actuary and ignoring assumptions and work evaluation.

Authority. SA 500: Audit Evidence, paras 8 and A34-A49; ICAI Study Material, Chapter 5: Management's Expert

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

Which procedure most appropriate addresses PF and ESI deposit compliance?

1. Recompute gratuity liability from employee salary data only.
2. Vouch challans, compare deposit dates with due dates and reconcile deductions. (correct answer)
3. Compare total payroll with the prior year, investigate variances and review appointment letters for new employees.
4. Inspect appointment letters for a sample of new employees only.

Answer: B — Vouch challans, compare deposit dates with due dates and reconcile deductions.

Working. Step 1: Obtain payroll and deduction registers. Step 2: Obtain PF and ESI challans. Step 3: Compare deposit dates with due dates. Step 4: Reconcile deductions with deposits; report delays.

Explanation. PF and ESI compliance requires checking the amounts deducted, the amounts deposited, the due dates and the challans. The auditor should reconcile payroll deductions with challans and compare deposit dates with statutory due dates. Recomputing gratuity addresses a different defined benefit plan. Payroll comparison and appointment letters alone do not establish deposit compliance. This procedure also supports CARO reporting on statutory dues.

Where it goes wrong. Checking payroll totals without linking deductions to PF and ESI challans and due dates.

Authority. ICAI Study Material, Chapter 5: Employee Benefit Expenses; CARO 2020, clause 3(vii) on statutory dues

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

In auditing the leave encashment provision, which approach is most appropriate?

1. Recalculate the arithmetic total of the actuary's report and compare it with the general ledger balance only.
2. Rely on the prior year provision if employee numbers and salary scales are broadly similar.
3. Test only the leave applications approved during the year and ignore the actuarial assumptions.
4. Evaluate assumptions and completeness of employee data used by the actuary. (correct answer)

Answer: D — Evaluate assumptions and completeness of employee data used by the actuary.

Working. Step 1: Identify defined benefit nature. Step 2: Evaluate actuary's assumptions and data. Step 3: Test completeness of employee data. Step 4: Compare result with financial statements.

Explanation. Leave encashment is generally a defined benefit obligation requiring actuarial valuation. The auditor should evaluate the assumptions, the completeness and accuracy of employee data and the methodology used. Recomputing the total only checks arithmetic, not the reasonableness of the liability. Prior year reliance and testing only leave applications do not address the actuarial estimate. This is a substantive testing judgement.

Where it goes wrong. Treating the actuary's report as conclusive and testing only arithmetic accuracy.

Authority. AS 15: Employee Benefits; SA 500: Audit Evidence, management's expert requirements

Question 10 · 2 marks · Chapter 1: Nature, Objective and Scope of Audit · medium

Scenario. During the audit of Orion Ltd., management provides invoices that look unusually uniform, lacks standard trade markings and gives oral explanations that conflict with a supplier confirmation. Management has a good past record and requests the auditor to accept the documents because it is honest. The auditor is considering the effect on further procedures.

What is the most appropriate response to the conflicting evidence?

1. Accept the invoices because management has an honest past record and the supplier confirmation is only one item.
2. Ignore the supplier confirmation because it is external evidence and external evidence is always reliable.
3. Investigate reliability, obtain further evidence and consider fraud risk. (correct answer)
4. Issue a qualified opinion without performing further procedures.

Answer: C — Investigate reliability, obtain further evidence and consider fraud risk.

Working. Step 1: Identify conflicting evidence. Step 2: Apply professional skepticism. Step 3: Investigate documents and confirmation. Step 4: Consider fraud risk and further procedures.

Explanation. Professional skepticism requires a questioning mind, alertness to possible misstatement and critical assessment of audit evidence. Conflicting external confirmation and suspicious documents require further investigation and consideration of fraud risk. A good past record does not relieve the auditor of skepticism. External evidence is not automatically reliable, and a modified opinion cannot be issued without completing appropriate procedures.

Where it goes wrong. Believing management honesty removes the need for professional skepticism.

Authority. SA 200: Overall Objectives of the Independent Auditor, paras 15 and A18-A22; ICAI Study Material, Chapter 1: Professional Skepticism

Question 11 · 2 marks · Chapter 8: Audit Report · medium

Scenario. Nidhi Company Sneh Ltd. has paid-up equity of Rs. 2 crore, free reserves of Rs. 80 lakh and accumulated losses of Rs. 20 lakh. Outstanding deposits are Rs. 40 crore. It maintained unencumbered term deposits of Rs. 3.2 crore. It also defaulted for 45 days in repaying a matured deposit of Rs. 25 lakh. Another Nidhi, Nidhi Beta, has NOF of Rs. 2.6 crore and outstanding deposits of Rs. 60 crore. The auditor is applying CARO 2020 clause (xii).

For Nidhi Sneh Ltd., what is the correct CARO 2020 clause (xii)(a) conclusion on NOF to deposits?

1. Complied; deposits of Rs. 40 crore are within 20 times NOF of Rs. 2.6 crore. (correct answer)
2. Not complied; deposits exceed 20 times NOF of Rs. 2.6 crore.
3. Complied only if NOF excludes free reserves and is taken at Rs. 1.8 crore after deducting accumulated losses.
4. Not complied; the ratio must be 1:10 for all Nidhi companies.

Answer: A — Complied; deposits of Rs. 40 crore are within 20 times NOF of Rs. 2.6 crore.

Working. Step 1: Compute NOF = 2 + 0.8 - 0.2 = Rs. 2.6 crore. Step 2: Maximum deposits = 20 x 2.6 = Rs. 52 crore. Step 3: Deposits Rs. 40 crore are within limit. Step 4: Report compliance.

Explanation. NOF is computed as paid-up equity of Rs. 2 crore plus free reserves of Rs. 80 lakh less accumulated losses of Rs. 20 lakh, giving Rs. 2.6 crore. Twenty times NOF is Rs. 52 crore. Outstanding deposits of Rs. 40 crore are within that limit, so clause (xii)(a) is complied with. Excluding free reserves or applying 1:10 is incorrect for this Nidhi reporting requirement.

Where it goes wrong. Computing NOF without adding free reserves or applying the wrong 1:10 ratio.

Authority. CARO 2020, clause 3(xii)(a); ICAI Study Material, Chapter 8: CARO 2020

Question 12 · 2 marks · Chapter 8: Audit Report · medium

For Nidhi Sneh Ltd., what is the CARO 2020 clause (xii)(b) conclusion on 10 percent unencumbered term deposits?

1. Complied; Rs. 3.2 crore maintained exceeds 10 percent of the NOF of Rs. 2.6 crore.
2. Not complied; required Rs. 4 crore and shortfall is Rs. 0.8 crore. (correct answer)
3. Complied; term deposits are measured against paid-up capital only.
4. Not complied; required Rs. 8 crore and shortfall is Rs. 4.8 crore.

Answer: B — Not complied; required Rs. 4 crore and shortfall is Rs. 0.8 crore.

Working. Step 1: Base = outstanding deposits Rs. 40 crore. Step 2: Required = 10 percent = Rs. 4 crore. Step 3: Maintained = Rs. 3.2 crore. Step 4: Shortfall = Rs. 0.8 crore; report non-compliance.

Explanation. The Nidhi company must maintain unencumbered term deposits equal to at least 10 percent of outstanding deposits. Ten percent of Rs. 40 crore is Rs. 4 crore. The company maintained Rs. 3.2 crore, creating a shortfall of Rs. 0.8 crore. The auditor should report this non-compliance under CARO 2020 clause (xii)(b). Using NOF or paid-up capital as the base is incorrect.

Where it goes wrong. Applying the 10 percent requirement to NOF or paid-up capital instead of outstanding deposits.

Authority. CARO 2020, clause 3(xii)(b); ICAI Study Material, Chapter 8: CARO 2020

Question 13 · 2 marks · Chapter 8: Audit Report · medium

For the 45-day default in repaying a matured deposit, what should the auditor report under CARO 2020?

1. No report is required because the default is below 90 days and the deposit is below materiality.
2. Only in the audit report as an Emphasis of Matter paragraph.
3. The default and its details under clause (xii)(c). (correct answer)
4. Only in the management representation letter.

Answer: C — The default and its details under clause (xii)(c).

Working. Step 1: Identify default in repayment. Step 2: Duration is 45 days, which is still a default for CARO. Step 3: Report details under clause (xii)(c). Step 4: Do not apply bank NPA threshold.

Explanation. CARO 2020 clause (xii)(c) requires reporting whether there has been any default in payment of interest on deposits or repayment thereof for any period and, if so, the details. The 90-day NPA threshold used for bank advances does not apply to this Nidhi company reporting requirement. An Emphasis of Matter paragraph is not a substitute for the specific CARO reporting.

Where it goes wrong. Applying the 90-day NPA norm to Nidhi company deposit default reporting.

Authority. CARO 2020, clause 3(xii)(c); ICAI Study Material, Chapter 8: CARO 2020

Question 14 · 2 marks · Chapter 8: Audit Report · hard

For Nidhi Beta, NOF Rs. 2.6 crore and deposits Rs. 60 crore, what is the CARO 2020 clause (xii)(a) conclusion?

1. Complied; deposits are within 20 times NOF of Rs. 2.6 crore.
2. Complied; the 1:20 ratio applies only to unencumbered term deposits and not to outstanding deposits.
3. Not complied; the permitted maximum deposits are Rs. 26 crore.
4. Not complied; deposits exceed 20 times NOF by Rs. 8 crore. (correct answer)

Answer: D — Not complied; deposits exceed 20 times NOF by Rs. 8 crore.

Working. Step 1: Maximum deposits = 20 x 2.6 = Rs. 52 crore. Step 2: Actual deposits = Rs. 60 crore. Step 3: Excess = Rs. 8 crore. Step 4: Report non-compliance under clause (xii)(a).

Explanation. The permitted deposits are 20 times NOF. Twenty times Rs. 2.6 crore is Rs. 52 crore. Outstanding deposits are Rs. 60 crore, so the excess is Rs. 8 crore. The auditor should report non-compliance with the 1:20 NOF to deposits ratio. Applying 10 times NOF or limiting the ratio to term deposits is incorrect.

Where it goes wrong. Using 10 times NOF or failing to compute the excess over the permitted deposits.

Authority. CARO 2020, clause 3(xii)(a); ICAI Study Material, Chapter 8: CARO 2020

Question 15 · 2 marks · Chapter 10: Audit of Banks · hard

Scenario. A bank branch has claimed interest subvention under a crop loan scheme. The auditor is checking borrower eligibility, scheme rate, claim computation, subsidy received and direct benefit transfer entries. The branch says the subsidy credit in the bank account is enough evidence.

Which audit approach most appropriate verifies the interest subvention claim?

1. Rely on the subsidy credit in the bank account because it is external and independent evidence of receipt.
2. Verify only the scheme rate applied in the branch's claim statement.
3. Reconcile eligible accounts, borrower eligibility, claim computation and subsidy receipt. (correct answer)
4. Compare the claim with the prior year and investigate large variances only.

Answer: C — Reconcile eligible accounts, borrower eligibility, claim computation and subsidy receipt.

Working. Step 1: Identify scheme eligibility conditions. Step 2: Reconcile eligible loan accounts and borrowers. Step 3: Recompute claim at scheme rate. Step 4: Trace subsidy receipt or DBT and report discrepancies.

Explanation. Interest subvention claims depend on borrower eligibility, the eligible loan accounts, the scheme rate, the claim computation and the subsidy received or direct benefit transfer. A subsidy credit alone does not establish that the claim was correctly computed or that the borrower was eligible. Rate checking alone and prior year comparison are insufficient. The auditor should reconcile all these elements.

Where it goes wrong. Treating the subsidy credit in the bank account as sufficient evidence for the entire claim.

Authority. ICAI Study Material, Chapter 10: Audit of Banks; RBI guidelines on interest subvention and direct benefit transfer