Test 13: answer key

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

Scenario. XYZ Ltd. has a financial year ending 31 March 2026. The auditor's report was signed on 30 May 2026. The financial statements were issued to shareholders on 15 June 2026. During the audit and thereafter, the following events came to the auditor's knowledge: (i) a debtor owing Rs 40 lakh was in severe financial distress on 31 March 2026 and was declared insolvent on 20 April 2026; (ii) a fire on 5 May 2026 destroyed inventory worth Rs 25 lakh; (iii) on 20 June 2026, after the financial statements were issued, the auditor discovered that a major customer had obtained a court order on 10 March 2026 restraining the company from recovering Rs 15 lakh, which was not disclosed. The auditor is evaluating the treatment under SA 560.

How should the auditor treat the debtor's insolvency in the financial statements of XYZ Ltd. for the year ended 31 March 2026?

1. Adjust the financial statements as the condition existed at the balance sheet date. (correct answer)
2. Disclose only as a non-adjusting event in the notes to accounts.
3. Neither adjust nor disclose because it occurred after the year-end.
4. Adjust only if the insolvency was formally declared before the audit report date.

Answer: A — Adjust the financial statements as the condition existed at the balance sheet date.

Working. Step 1: Identify the condition at the balance sheet date: financial distress existed on 31 March 2026. Step 2: Determine whether the later event provides evidence about that condition: insolvency confirms recoverability issue. Step 3: Apply SA 560: adjusting event requires adjustment, not mere disclosure.

Explanation. The debtor was already in severe financial distress on 31 March 2026. The subsequent insolvency provides evidence of a condition that existed at the balance sheet date. Under SA 560, such an event is an adjusting event requiring adjustment to the carrying amount of the receivable. Mere disclosure is insufficient. The other options incorrectly treat the event as non-adjusting or ignore it, which would misstate receivables and profit.

Where it goes wrong. Students often classify every post-year-end event as non-adjusting and choose disclosure only.

Authority. SA 560: Subsequent Events, paras 3 and 6; ICAI Study Material, Paper 5, Chapter 7

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

How should the auditor deal with the fire on 5 May 2026 that destroyed inventory worth Rs 25 lakh?

1. Adjust the inventory balance in the financial statements.
2. Disclose in the notes if material as a non-adjusting event. (correct answer)
3. Ignore the event because it occurred after the balance sheet date.
4. Adjust only if the insurance claim is received before the audit report.

Answer: B — Disclose in the notes if material as a non-adjusting event.

Working. Step 1: Date of event is after the reporting date. Step 2: Condition (fire) arose after year-end; no evidence of year-end condition. Step 3: Classify as non-adjusting; disclose if material.

Explanation. The fire occurred after 31 March 2026 and does not provide evidence of a condition existing at the balance sheet date. It is a non-adjusting event. If material, it should be disclosed so that users can understand its effect on the entity's financial position. Adjusting the inventory would be incorrect because the inventory existed and was measured at the year-end. Ignoring a material event is also incorrect.

Where it goes wrong. Students sometimes adjust all subsequent events that affect assets, confusing Type I and Type II events.

Authority. SA 560: Subsequent Events, para 3 and illustrative examples; ICAI Study Material, Paper 5, Chapter 7

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

The auditor's report has been issued but the financial statements have not yet been issued. The auditor learns of a fact that, had it been known earlier, would have caused an amendment to the audit report. What should the auditor do under SA 560?

1. Take no action because the audit report has already been signed.
2. Immediately withdraw the audit report without consulting management.
3. Discuss with management, determine whether the financial statements need amendment, and inquire how management intends to address the matter. (correct answer)
4. Issue a revised audit report with the same date without performing additional procedures.

Answer: C — Discuss with management, determine whether the financial statements need amendment, and inquire how management intends to address the matter.

Working. Step 1: Date of discovery is after auditor's report but before issuance of financial statements. Step 2: Apply SA 560 paras 10-11. Step 3: Discuss with management, assess need for amendment, inquire management's plan.

Explanation. After the date of the auditor's report but before the financial statements are issued, the auditor has no obligation to perform audit procedures. However, if a fact becomes known that would have caused amendment, SA 560 requires the auditor to discuss the matter with management, determine whether the financial statements need amendment, and inquire how management intends to address it. Simply ignoring or withdrawing without discussion is not the prescribed procedure.

Where it goes wrong. Students often think the auditor can do nothing once the report is signed, or must automatically withdraw.

Authority. SA 560: Subsequent Events, paras 10 and 11; ICAI Study Material, Paper 5, Chapter 7

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

After the financial statements have been issued, management amends them because of a fact discovered by the auditor that would have caused an amendment to the audit report. What must the auditor do?

1. Issue the same audit report with a new date without any further procedures.
2. Refuse to do anything because the financial statements were already issued.
3. Only review the amended note and not perform any audit procedures.
4. Carry out audit procedures on the amendment, review steps to inform recipients, and extend procedures to the new report date. (correct answer)

Answer: D — Carry out audit procedures on the amendment, review steps to inform recipients, and extend procedures to the new report date.

Working. Step 1: Financial statements were issued and then amended. Step 2: SA 560 requires procedures on the amendment. Step 3: Review management's steps to inform recipients. Step 4: Extend procedures to new report date and issue new report.

Explanation. When management amends the financial statements after they have been issued, the auditor must carry out audit procedures on the amendment, review the steps taken by management to ensure that anyone in receipt of the previously issued financial statements is informed, and extend audit procedures to the date of the new auditor's report. The new report must not be dated earlier than the approval of the amended financial statements. Options a, b and c understate the auditor's responsibilities.

Where it goes wrong. Students may think a new report date alone is sufficient, ignoring the need for procedures and communication review.

Authority. SA 560: Subsequent Events, paras 14 and 15; ICAI Study Material, Paper 5, Chapter 7

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

Scenario. A Multi-State Cooperative Society (MSCS) has operations in three states. The Central Registrar receives a request from a creditor to inspect the society's working and financial condition under Section 79 of the Multi-State Cooperative Societies Act, 2002. The society contends that no inspection can be made without its consent and that the inspection report need not be communicated.

Which statement is correct regarding inspection of a Multi-State Cooperative Society under Section 79 of the Multi-State Cooperative Societies Act, 2002?

1. The Central Registrar may inspect after giving not less than 15 days' notice, and the report must be communicated within three months. (correct answer)
2. Inspection can be made without any notice and the report need not be communicated.
3. Only the Central Government can order inspection, not the Central Registrar.
4. Inspection can be made only if the society's board passes a resolution.

Answer: A — The Central Registrar may inspect after giving not less than 15 days' notice, and the report must be communicated within three months.

Working. Step 1: Recall Section 79 conditions. Step 2: Notice minimum 15 days. Step 3: Report communication within 3 months. Step 4: Select option matching these requirements.

Explanation. Section 79 permits the Central Registrar to inspect or direct inspection on a request from a federal cooperative, a creditor, one-third of board members, or one-fifth of total members. A notice of not less than 15 days must be given, and the inspection report must be communicated to the society within three months of completion. Consent of the society or a board resolution is not required. The report must be communicated.

Where it goes wrong. Students may confuse the notice period with 15 days or 30 days and may think society consent is necessary.

Authority. Multi-State Cooperative Societies Act, 2002, Section 79; ICAI Study Manual on Special Entities

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

Scenario. During the audit of PQR Ltd. for FY 2025-26, the auditor examines legal and professional expenses, repairs and maintenance, CSR expenditure, and advertisement expenses. The following issues arise: (i) legal fees of Rs 8 lakh paid to a lawyer defending a director in a personal criminal case; (ii) replacement of a major plant component at Rs 12 lakh that extends the plant's useful life by four years; (iii) CSR expenditure of Rs 20 lakh incurred under Section 135; (iv) an advertisement bill dated 28 March 2026 for a campaign to be run from April to June 2026.

While vouching legal fees of Rs 8 lakh paid to a lawyer defending a director in a personal criminal case, which audit procedure is least appropriate?

1. Verify the legal invoice and the engagement letter with the lawyer.
2. Treat all legal fees as capital expenditure without examining the nature. (correct answer)
3. Confirm whether the expense relates to the company's business.
4. Check compliance with TDS provisions on legal fees.

Answer: B — Treat all legal fees as capital expenditure without examining the nature.

Working. Step 1: Identify the nature of the legal fee. Step 2: Determine whether it relates to the company's business. Step 3: Vouch invoice, check TDS. Step 4: Least appropriate is blanket capitalization without examination.

Explanation. Legal fees must be examined for business purpose, proper documentation, and TDS compliance. A personal legal expense of a director is not a business expense and should not be charged to the company. Treating all legal fees as capital expenditure without examining the nature is the least appropriate procedure because it ignores the need to determine whether the expenditure is revenue, capital, or personal. The other options are valid audit procedures.

Where it goes wrong. Students may think all legal fees are capital or all are revenue, without examining the underlying nature.

Authority. ICAI Study Material, Paper 5, Chapter 5: Other Expenses; SA 500: Audit Evidence

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

How should the auditor treat the replacement of a major plant component at Rs 12 lakh that extends the plant's useful life by four years?

1. Charge the entire Rs 12 lakh to profit and loss as repairs.
2. Defer the expense and amortize over two years.
3. Capitalize the expenditure as it enhances the useful life of the asset. (correct answer)
4. Disclose the expenditure only in the notes without any accounting entry.

Answer: C — Capitalize the expenditure as it enhances the useful life of the asset.

Working. Step 1: Assess nature of expenditure: major component replacement. Step 2: Determine whether it enhances useful life: yes, by four years. Step 3: Capitalize under AS 10. Step 4: Depreciate over revised useful life.

Explanation. Expenditure that extends the useful life of an asset or enhances its capacity is capital in nature. The replacement of a major component that extends the plant's useful life by four years should be capitalized and depreciated over the revised useful life. Charging it to profit and loss as repairs would understate profit and the asset value. Deferring and amortizing over two years is not appropriate accounting treatment.

Where it goes wrong. Students often treat all replacement expenditure as revenue repairs, ignoring the enhancement of useful life.

Authority. AS 10 (Revised): Property, Plant and Equipment; ICAI Study Material, Paper 5, Chapter 5: PPE

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

How should CSR expenditure of Rs 20 lakh incurred under Section 135 of the Companies Act, 2013 be classified in the financial statements?

1. Capitalize as an intangible asset under CSR.
2. Debit the amount to general reserve.
3. Treat it as a dividend paid to shareholders.
4. Charge it to profit and loss and disclose separately in the notes. (correct answer)

Answer: D — Charge it to profit and loss and disclose separately in the notes.

Working. Step 1: Identify CSR expenditure under Section 135. Step 2: Apply Schedule III disclosure requirements. Step 3: Charge to P&L and disclose separately in notes.

Explanation. CSR expenditure under Section 135 is an expense and should be charged to the statement of profit and loss. It should be disclosed separately in the notes, including the amount required to be spent, amount spent, and shortfall, if any. It cannot be capitalized as an intangible asset, debited to general reserve, or treated as a dividend. Proper classification and disclosure are essential for compliance and transparency.

Where it goes wrong. Students may think CSR is an appropriation of profit or can be capitalized.

Authority. Companies Act, 2013, Section 135 and Schedule III; ICAI Study Material, Paper 5, Chapter 5: CSR

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

The auditor finds an advertisement bill dated 28 March 2026 for a campaign to be run from April to June 2026. What risk does this create?

1. Cut-off misstatement because the expense relates to a future period. (correct answer)
2. Valuation misstatement because the advertisement rates may be incorrect.
3. Presentation misstatement because advertisement is not a business expense.
4. No misstatement because the invoice is dated before year-end.

Answer: A — Cut-off misstatement because the expense relates to a future period.

Working. Step 1: Read the bill date and campaign period. Step 2: Identify that service period is after year-end. Step 3: Assess cut-off assertion. Step 4: Expense should be apportioned; prepaid portion recognized as asset.

Explanation. The advertisement campaign runs from April to June 2026, which is after the year-end. Recording the entire expense in FY 2025-26 would violate the cut-off assertion, as the expense relates to a future period. The auditor should verify the period of the campaign and consider prepaid expense treatment. Valuation, presentation, or ignoring the issue would not address the timing misstatement.

Where it goes wrong. Students may focus only on the invoice date and ignore the service period.

Authority. SA 500: Audit Evidence, assertions; ICAI Study Material, Paper 5, Chapter 5: Other Expenses

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

Scenario. During the audit of LMN Ltd., the auditor initially accepted management's explanation that a Rs 50 lakh payment to a related party was for business consultancy. Later, the auditor obtained a legal opinion and bank statements showing the payment was a loan to a director's relative, inconsistent with the earlier explanation.

Under SA 230, what must the auditor document when information is found to be inconsistent with the auditor's final conclusion on a significant matter?

1. Only the final conclusion that the payment is a related-party loan.
2. How the auditor addressed the inconsistency between the initial explanation and the final conclusion. (correct answer)
3. The initial explanation but not the resolution of the inconsistency.
4. No documentation is required because the auditor's final conclusion is correct.

Answer: B — How the auditor addressed the inconsistency between the initial explanation and the final conclusion.

Working. Step 1: Identify inconsistency between management explanation and later evidence. Step 2: SA 230 requires documentation of how the inconsistency was addressed. Step 3: Select option that includes resolution of inconsistency.

Explanation. SA 230 requires the auditor to document significant matters arising during the audit, the conclusions reached, and significant professional judgements. If the auditor identifies information inconsistent with the final conclusion on a significant matter, the auditor must document how the inconsistency was addressed. Documenting only the final conclusion or only the initial explanation is insufficient. No documentation would violate SA 230.

Where it goes wrong. Students often think documenting the final conclusion is enough and ignore the requirement to document how inconsistencies were resolved.

Authority. SA 230: Audit Documentation, paras 8 and 11; ICAI Study Material, Paper 5, Chapter 6

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

Scenario. The statutory auditor of DEF Ltd. resigned on 15 July 2026. The outgoing auditor filed Form ADT-3 with the company and the Registrar of Companies. The incoming auditor, GHI & Co., is appointed on 1 August 2026. During the audit, GHI & Co. becomes aware of certain objections raised by the outgoing auditor regarding revenue recognition and inventory valuation.

Under CARO 2020 clause (xviii), what must the incoming auditor report regarding the resignation of the previous statutory auditor?

1. Only whether the outgoing auditor's resignation was accepted by the board.
2. Only the date of resignation and the name of the outgoing auditor.
3. Whether the incoming auditor has considered the issues, objections, or concerns raised by the outgoing auditor. (correct answer)
4. Whether the outgoing auditor was paid all audit fees before resignation.

Answer: C — Whether the incoming auditor has considered the issues, objections, or concerns raised by the outgoing auditor.

Working. Step 1: Recall CARO 2020 clause (xviii). Step 2: Identify two reporting requirements: fact of resignation and consideration of issues raised. Step 3: Select option that captures consideration of concerns.

Explanation. CARO 2020 clause (xviii) requires the auditor to report whether there has been any resignation of the statutory auditors during the year and, if so, whether the auditor has taken into consideration the issues, objections, or concerns raised by the outgoing auditors. Reporting only acceptance, date, name, or fee payment is insufficient. The focus is on whether the incoming auditor considered the outgoing auditor's concerns.

Where it goes wrong. Students may focus on procedural resignation details and miss the substantive requirement to consider the outgoing auditor's objections.

Authority. CARO 2020, clause (xviii) of paragraph 3; Companies Act, 2013, Section 140(2)

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

Under Section 140(2) of the Companies Act, 2013, what is the outgoing auditor required to do upon resignation?

1. File Form ADT-3 with the Central Government within 60 days.
2. Obtain board approval before resigning.
3. Publish the resignation in a newspaper.
4. File a statement in Form ADT-3 with the company and the Registrar within 30 days. (correct answer)

Answer: D — File a statement in Form ADT-3 with the company and the Registrar within 30 days.

Working. Step 1: Recall Section 140(2). Step 2: Form ADT-3 within 30 days. Step 3: File with company and ROC. Step 4: Select matching option.

Explanation. Section 140(2) requires the auditor who resigns to file a statement in Form ADT-3 with the company and the Registrar of Companies within 30 days of resignation. The statement must contain the reasons and other prescribed details. Filing with the Central Government within 60 days, obtaining board approval, or newspaper publication is not the requirement under Section 140(2).

Where it goes wrong. Students may confuse the 30-day requirement and the recipient of Form ADT-3.

Authority. Companies Act, 2013, Section 140(2); Companies (Audit and Auditors) Rules, 2014, Rule 13

Question 13 · 2 marks · Chapter 8: Audit Report and CARO · hard

The incoming auditor finds that the outgoing auditor's concerns about revenue recognition are valid and have not been addressed by management. What is the appropriate course of action?

1. Consider the concerns in planning the audit and modify audit procedures or opinion as necessary. (correct answer)
2. Ignore the concerns because they belong to the previous auditor.
3. Report only the fact of resignation under CARO and not the concerns.
4. Automatically issue a disclaimer of opinion without further procedures.

Answer: A — Consider the concerns in planning the audit and modify audit procedures or opinion as necessary.

Working. Step 1: Identify valid unresolved concerns. Step 2: Consider in audit planning and risk assessment. Step 3: Perform procedures and modify opinion if needed. Step 4: Select option reflecting this responsibility.

Explanation. The incoming auditor must consider the outgoing auditor's concerns under CARO 2020. If the concerns are valid and unresolved, the incoming auditor should incorporate them into risk assessment, plan appropriate audit procedures, and modify the opinion if sufficient appropriate audit evidence is not obtained. Ignoring the concerns, reporting only resignation, or automatically disclaiming without procedures is inappropriate.

Where it goes wrong. Students may think the incoming auditor has no responsibility for the predecessor's concerns or must automatically disclaim.

Authority. CARO 2020, clause (xviii); SA 705: Modifications to the Opinion

Question 14 · 2 marks · Chapter 8: Audit Report and CARO · medium

Which of the following is not a requirement under CARO 2020 clause (xviii) regarding resignation of statutory auditors?

1. Report whether any resignation of statutory auditors occurred during the year.
2. Report the professional fees paid to the outgoing auditor. (correct answer)
3. Report whether the incoming auditor considered the issues raised by the outgoing auditor.
4. Report whether the outgoing auditor's concerns were addressed.

Answer: B — Report the professional fees paid to the outgoing auditor.

Working. Step 1: Recall specific wording of CARO clause (xviii). Step 2: Identify requirements: fact of resignation and consideration of concerns. Step 3: Note that fees paid is not required. Step 4: Select option b.

Explanation. CARO 2020 clause (xviii) requires reporting on whether any resignation occurred and whether the incoming auditor considered the issues, objections, or concerns raised by the outgoing auditor. It does not require reporting the professional fees paid to the outgoing auditor. Therefore, option b is not a CARO requirement. The other options are related to the resignation reporting requirement.

Where it goes wrong. Students may confuse general audit reporting matters with specific CARO clause requirements.

Authority. CARO 2020, clause (xviii) of paragraph 3

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

Scenario. During the audit of a scheduled commercial bank, the auditor computes the Provision Coverage Ratio (PCR). The bank has gross NPAs of Rs 500 crore and provisions held (including technical write-offs) of Rs 370 crore. RBI guidelines require a minimum PCR of 70 percent.

Based on the given figures, what is the Provision Coverage Ratio (PCR) of the bank and does it meet the RBI benchmark?

1. 70 percent; it exactly meets the benchmark.
2. 66 percent; it does not meet the benchmark.
3. 74 percent; it meets the benchmark. (correct answer)
4. 68 percent; it does not meet the benchmark.

Answer: C — 74 percent; it meets the benchmark.

Working. Step 1: Formula: PCR = (Technical write-offs + Provisions held) / Gross NPAs. Step 2: Numerator = Rs 370 crore. Step 3: Denominator = Rs 500 crore. Step 4: PCR = 370 / 500 = 74 percent. Step 5: Compare with RBI benchmark of 70 percent; 74 percent >= 70 percent, so it meets the benchmark.

Explanation. Provision Coverage Ratio (PCR) is computed as (technical write-offs + provisions held) divided by gross NPAs. Here, provisions held including technical write-offs are Rs 370 crore and gross NPAs are Rs 500 crore. PCR = 370 / 500 = 74 percent. Since 74 percent exceeds the RBI benchmark of 70 percent, the bank meets the benchmark.

Where it goes wrong. Students may include floating provisions or use only specific provisions, or miscompute the ratio.

Authority. RBI Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning; ICAI Study Material, Paper 5, Chapter 10: Bank Audit