Test 14: answer key

Question 1 · 2 marks · Chapter 3: Risk Assessment and Internal Control · medium

Scenario. During the statutory audit of Nexa Manufacturing Ltd. for FY 2025-26, the auditor finds a cloud-hosted ERP with privileged user access, program change logs, batch job schedules and interfaces between production, billing and inventory. Management states that automated validations ensure complete and accurate recording. The auditor plans tests of general IT controls and application controls and considers data analytics over journal entries and population completeness.

Which of the following is a general IT control rather than an application control in Nexa Manufacturing Ltd.?

1. Batch job scheduling in data centre operations (correct answer)
2. Edit check on invoice date field at data entry
3. Sequence check on sales invoice numbers at input
4. Mandatory field validation on customer code in billing screen

Answer: A — Batch job scheduling in data centre operations

Working. Identify whether the control applies across multiple IT systems or to one application. Data centre scheduling and monitoring support the reliable operation of many applications and are therefore GITCs. Input validation, sequence checks and mandatory fields are embedded in a specific application and are application controls.

Explanation. Batch job scheduling and monitoring are pervasive controls over data centre and network operations that support many applications; hence they are general IT controls. Edit checks, sequence checks and mandatory field validations operate at the level of a specific business application and address input processing, so they are application controls. The auditor tests GITCs to assess whether system-generated reports and automated controls can be relied upon.

Where it goes wrong. Students often classify every control performed in a computer system as an application control and overlook pervasive data centre or program change controls.

Authority. SA 315: Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment; ICAI Study Material for Paper 5, Chapter 3: Automated Environment and General IT Controls

Question 2 · 2 marks · Chapter 3: Risk Assessment and Internal Control · medium

Which procedure provides the most persuasive evidence that an automated three-way match control operated throughout the year?

1. Inquiry of the AP manager about the control throughout the year
2. Observation of one three-way match near the year end
3. Reperformance of selected matches and inspection of configuration logs (correct answer)
4. Review of management representation on the control's operating effectiveness

Answer: C — Reperformance of selected matches and inspection of configuration logs

Working. Design a test of controls: select transactions across the period, reperform the three-way match, inspect system configuration and change logs, and evaluate exceptions. Inquiry and observation are combined with inspection or reperformance to obtain persuasive evidence.

Explanation. Inquiry alone and a single observation at year end give limited evidence about operation throughout the period. Reperforming selected three-way matches at intervals and inspecting configuration logs provides direct evidence that the automated control was configured and operated. Management representation supports but does not replace other audit evidence. The auditor should also consider testing general IT controls over program changes and access.

Where it goes wrong. Students often treat inquiry or one observation as sufficient for an automated control and ignore the need to test configuration and operation across the period.

Authority. SA 330: The Auditor's Responses to Assessed Risks; SA 500: Audit Evidence; ICAI Study Material for Paper 5, Chapter 3: Testing of Internal Control

Question 3 · 2 marks · Chapter 3: Risk Assessment and Internal Control · medium

The auditor uses CAAT and data analytics on the full journal entry population primarily to:

1. Replace all tests of controls with analytical review
2. Identify unusual entries and test completeness of population (correct answer)
3. Eliminate need for understanding entity's IT environment
4. Reduce audit documentation to system-generated reports only

Answer: B — Identify unusual entries and test completeness of population

Working. Use CAATs to extract the complete journal entry population, test completeness against the general ledger, analyse unusual entries by user, date, amount or account, and follow up exceptions. Document the tools, criteria and results.

Explanation. Data analytics over the full journal entry population helps the auditor identify unusual, manual or high-risk entries and test whether the population used for sampling is complete. It does not replace the need to understand the IT environment, test controls or maintain audit documentation. CAATs are audit tools that support risk assessment and substantive procedures; they do not eliminate professional judgment.

Where it goes wrong. Students often overstate data analytics as a substitute for control testing or documentation, rather than as a procedure to identify anomalies and check population completeness.

Authority. SA 315: Risk Assessment Procedures; ICAI Study Material for Paper 5, Chapter 3: Data Analytics for Audit

Question 4 · 2 marks · Chapter 3: Risk Assessment and Internal Control · hard

If general IT controls over program changes are ineffective, the auditor's appropriate response is to:

1. Rely more on automated application controls without further work
2. Reduce substantive procedures because processing is automated
3. Ignore the weakness if one application control was tested once
4. Plan alternative procedures and reduce reliance on reports (correct answer)

Answer: D — Plan alternative procedures and reduce reliance on reports

Working. Evaluate the impact of the GITC deficiency on affected applications, assess whether automated controls and reports can be relied upon, and design alternative procedures. Document the IT risk assessment and the revised audit approach.

Explanation. Ineffective program change controls mean that automated controls and system reports may not be reliable. The auditor should assess IT risks, reduce reliance on system-generated information, and plan alternative or additional procedures, such as testing data integrity or performing substantive checks. Increased reliance or reduced substantive work would be inappropriate because the reliability of automated processing is not established.

Where it goes wrong. Students often assume that an automated control is reliable merely because it exists, without considering the GITCs that support its continued operation.

Authority. SA 315: Understanding the Entity's IT Environment; SA 330: Responses to Assessed Risks; ICAI Study Material for Paper 5, Chapter 3: Impact of IT Related Risks

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

Scenario. Sunrise Foods Ltd. received a capital subsidy from the State for a new cold storage facility and a revenue grant for staff training. During the year, a condition attached to the capital subsidy was breached and refund became probable. The auditor evaluates recognition, amortisation and refund treatment under AS 12.

A capital subsidy for cold storage becomes refundable due to breach of a condition. How should the auditor evaluate its treatment under AS 12?

1. Credit the entire subsidy to profit or loss in year three as other income
2. Derecognise unamortised grant and provide refund per AS 12 (correct answer)
3. Adjust opening retained earnings only without any disclosure
4. Continue carrying the subsidy until the refund is finally paid

Answer: B — Derecognise unamortised grant and provide refund per AS 12

Working. Determine the unamortised portion of the capital grant, recognise a refund liability, adjust the related asset or charge profit or loss as required by AS 12, and ensure disclosures are adequate.

Explanation. When a government grant becomes refundable, AS 12 requires accounting for the refund. A capital grant related to an asset is derecognised to the extent unamortised, and the refund is provided for. The related asset may need write-down or the refund may be charged to profit or loss as appropriate. Simply crediting the whole subsidy to income, adjusting retained earnings without disclosure, or continuing to carry it is not compliant.

Where it goes wrong. Students often treat refund of a capital subsidy as a current-year income item and ignore the need to derecognise the unamortised grant and provide for the refund.

Authority. AS 12: Accounting for Government Grants; ICAI Study Manual for Paper 5, Chapter 5: Government Grants

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

Scenario. Orbit Exports Ltd. maintains INR and USD bank accounts. At year end, the bank reconciliation statement contains unpresented cheques older than three months, cheques deposited but not credited, unrecorded bank charges and a USD balance not restated. The auditor plans bank confirmations and scrutiny of subsequent bank statements.

At year end, unpresented cheques in the BRS are older than three months. What is the auditor's appropriate action?

1. Continue as unpresented cheque until the bank returns it unpaid
2. Add it to bank statement balance without reversing payment
3. Reverse payment, restore liability and support by bank statement (correct answer)
4. Write it off to miscellaneous expense after board approval

Answer: C — Reverse payment, restore liability and support by bank statement

Working. Obtain subsequent bank statements, identify stale cheques, confirm non-clearance, examine whether the payment entry should be reversed, restore the liability, and ensure the BRS and financial statements are adjusted.

Explanation. A cheque that has become stale, ordinarily three months or more after issue, should not remain as an unpresented cheque in the BRS. The auditor should check subsequent bank statements, verify that the cheque was not cleared, and consider reversal of the payment entry with restoration of the liability. Treating it as a continuing reconciling item, adding it without adjustment, or writing it off without basis is not appropriate.

Where it goes wrong. Students often accept all unpresented cheques as valid BRS items and overlook stale cheque monitoring and liability restoration.

Authority. ICAI Study Material for Paper 5, Chapter 5: Cash and Cash Equivalents; SA 500: Audit Evidence

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

Cheques deposited but not credited beyond a reasonable time require the auditor to:

1. Check revenue recognition for those parties and enquire (correct answer)
2. Treat as cash in hand without further procedure
3. Ignore if subsequent bank statement shows deposit
4. Classify as trade payable automatically

Answer: A — Check revenue recognition for those parties and enquire

Working. Trace deposits to subsequent bank statements, obtain bank acknowledgements, enquire into delayed clearance, and if unsatisfactory, test revenue recognition and receivable balances for the parties concerned.

Explanation. For cheques deposited but not credited beyond reasonable time, the auditor should seek management explanations and verify the underlying transactions. If explanations are unsatisfactory, the auditor should examine revenue recognition for those parties and consider whether the receivables are genuine. Treating them as cash in hand, ignoring them, or classifying them as payables without basis is not appropriate.

Where it goes wrong. Students often stop at the BRS tick mark and do not link long-outstanding deposits to revenue recognition and receivable existence.

Authority. ICAI Study Material for Paper 5, Chapter 5: Cash and Cash Equivalents; SA 500: Audit Evidence

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

How should a USD bank account balance be treated at year end under AS 11?

1. Carry at historical rate under AS 11 without restatement
2. Translate at average rate for the year under AS 11
3. Keep at opening rate if no remittance occurred during year
4. Restate at closing spot rate under AS 11 (correct answer)

Answer: D — Restate at closing spot rate under AS 11

Working. Obtain the closing spot rate, restate the USD balance, recompute the exchange difference, agree it to the general ledger and ensure the difference is recognised in profit or loss.

Explanation. Foreign currency bank balances are monetary items and should be restated at the closing spot rate under AS 11. Exchange differences are recognised in profit or loss. Historical rate, average rate or opening rate is not appropriate for year-end monetary balances. The auditor should check the closing rate and recompute the restatement.

Where it goes wrong. Students often use the average rate or historical rate for foreign currency bank balances and ignore the monetary item restatement requirement.

Authority. AS 11: The Effects of Changes in Foreign Exchange Rates; ICAI Study Material for Paper 5, Chapter 5: Cash and Cash Equivalents

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

In bank confirmation procedures, the auditor should:

1. Allow client to receive all bank replies
2. Send only to banks with large balances
3. Control requests and receipts for significant accounts (correct answer)
4. Rely on client's online screenshot

Answer: C — Control requests and receipts for significant accounts

Working. Select significant bank accounts, send requests under the auditor's control, receive replies directly, reconcile differences and perform alternative procedures for non-responses.

Explanation. The auditor should maintain control over bank confirmation requests and responses, including determining the information, selecting the confirming party, designing and sending requests, and receiving replies directly. Bank confirmations should cover significant accounts and not be limited to large balances. Client screenshots are not a substitute for direct confirmation.

Where it goes wrong. Students often allow the client to control confirmation correspondence, which compromises the reliability of external confirmation evidence.

Authority. SA 505: External Confirmations; ICAI Study Material for Paper 5, Chapter 5: Cash and Cash Equivalents

Question 10 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · hard

Scenario. CA Meera is statutory auditor of a listed company. The client asks her to act as authorised representative before a tax appellate tribunal in a tax dispute. Another audit client threatens litigation if the auditor issues a modified opinion. CA Meera evaluates threats to independence and possible safeguards.

Acting as authorised representative before a tax appellate tribunal for an audit client primarily creates which threat?

1. Advocacy threat; safeguard or decline (correct answer)
2. Self-review threat only because tax numbers examined under statutory audit
3. No threat if fee approved by board
4. Familiarity threat only if same partner signs report

Answer: A — Advocacy threat; safeguard or decline

Working. Identify the threat, evaluate its significance, consider safeguards such as separate personnel and independent review, and decline the representation if safeguards are insufficient.

Explanation. Representing a client before a tax appellate tribunal involves promoting the client's position and can create an advocacy threat to objectivity. The auditor should evaluate the significance of the threat and apply safeguards, such as using a separate team or declining the engagement if objectivity cannot be maintained. Self-review, familiarity or fee approval do not adequately address the advocacy threat.

Where it goes wrong. Students often focus only on self-review or familiarity and miss that acting as an advocate for the client creates an advocacy threat.

Authority. ICAI Code of Ethics: Threats to Independence; SA 220: Quality Control for an Audit of Financial Statements

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

Scenario. PQR Ltd. prepares consolidated financial statements including subsidiary S, associate A and joint venture J examined by other auditors. Their CARO reports contain qualifications and adverse remarks. The principal auditor plans reporting under CARO 2020 clause 3(xxi) and considers component exemptions.

Under CARO 2020 clause 3(xxi), the principal auditor reporting on consolidated financial statements must:

1. Reproduce all CARO paragraphs of component auditors in full
2. State component CARO qualifications or adverse remarks (correct answer)
3. Report only if component auditor is same firm
4. Ignore component CARO remarks if consolidated FS examined under statutory audit

Answer: B — State component CARO qualifications or adverse remarks

Working. Obtain component CARO reports, identify qualifications or adverse remarks, and include a statement in the consolidated CARO report indicating the companies and paragraph numbers.

Explanation. Clause 3(xxi) requires the auditor's report on consolidated financial statements to state whether there have been any qualifications or adverse remarks in the CARO reports of the companies included in the consolidation. The principal auditor indicates the details of the companies and paragraph numbers. It does not require reproducing all paragraphs or limiting the statement to audits by the same firm.

Where it goes wrong. Students often think clause 3(xxi) requires copying component CARO reports in full or applies only when the same auditor audits all components.

Authority. CARO 2020, clause 3(xxi); ICAI Study Material for Paper 5, Chapter 8: CARO 2020

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

A subsidiary's CARO report contains a qualification on inventory. How should the principal auditor report it under clause 3(xxi)?

1. Omit because subsidiary examined by other auditor
2. Convert into modification of consolidated audit opinion automatically
3. Indicate company name, paragraph number and qualification details (correct answer)
4. Disclose only in management representation letter

Answer: C — Indicate company name, paragraph number and qualification details

Working. Review the subsidiary CARO report, identify the qualification and paragraph number, and include the required disclosure in the consolidated CARO report. Separately evaluate any impact on the consolidated audit opinion under SA 600 and SA 705.

Explanation. Clause 3(xxi) requires disclosure in the consolidated CARO report of qualifications or adverse remarks in component CARO reports. The principal auditor should indicate the company name and paragraph number containing the qualification or adverse remark. It does not automatically modify the consolidated audit opinion, nor is it omitted because another auditor examined under statutory audit the subsidiary.

Where it goes wrong. Students often confuse the CARO clause 3(xxi) disclosure with a modification of the consolidated audit opinion.

Authority. CARO 2020, clause 3(xxi); SA 600: Using the Work of Another Auditor

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

A component is exempt from CARO and has no CARO report. How does clause 3(xxi) apply?

1. Yes, all adverse remarks under any law must be reproduced
2. Yes, if component is material to consolidation
3. No, clause xxi covers only statutory audit qualifications
4. No; clause xxi covers CARO reports of included companies (correct answer)

Answer: D — No; clause xxi covers CARO reports of included companies

Working. Check whether the component is covered by CARO. If exempt, no CARO report exists; therefore clause 3(xxi) does not require reporting a CARO qualification for that component. Consider other reporting implications separately.

Explanation. Clause 3(xxi) deals with qualifications or adverse remarks in the CARO reports of companies included in the consolidated financial statements. If a component is exempt from CARO and has no CARO report, there is no CARO qualification or adverse remark to report under this clause. Other adverse remarks under the Companies Act may require separate consideration but are not clause 3(xxi) CARO remarks.

Where it goes wrong. Students often extend clause 3(xxi) to all adverse remarks under any law or to every component regardless of CARO applicability.

Authority. CARO 2020, applicability and clause 3(xxi); ICAI Study Manual for Paper 5, Chapter 8: CARO 2020

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

What details should the principal auditor include in the clause 3(xxi) statement?

1. Names and paragraph numbers of CARO remarks (correct answer)
2. Only total number of subsidiaries
3. Only management comments on each qualification
4. Only consolidated turnover impact of qualifications

Answer: A — Names and paragraph numbers of CARO remarks

Working. Compile component CARO reports, note the company name and paragraph number for each qualification or adverse remark, and include those details in the consolidated CARO report.

Explanation. The clause 3(xxi) statement should indicate the details of the companies and the paragraph numbers of the CARO reports containing qualifications or adverse remarks. This enables users to locate the relevant component CARO remarks. Reporting only the number of subsidiaries, management comments or turnover impact does not meet the clause.

Where it goes wrong. Students often provide a general statement without identifying the component and paragraph number, which weakens the required disclosure.

Authority. CARO 2020, clause 3(xxi); ICAI Study Material for Paper 5, Chapter 8: CARO 2020

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

Scenario. Zenith Bank has a borrower account of INR 180 crore classified as substandard. A consortium inter-creditor agreement was signed, but the resolution plan was not implemented within the prescribed timeline. The auditor evaluates additional provisioning under the RBI Prudential Framework for Resolution of Stressed Assets.

Under the RBI Prudential Framework, if a resolution plan is not implemented within the prescribed timeline, the bank should:

1. Make no additional provision if the ICA is signed
2. Make additional 20 percent provision on delayed resolution (correct answer)
3. Upgrade the account to standard once the ICA is signed
4. Provide only 5 percent pending tribunal approval of plan

Answer: B — Make additional 20 percent provision on delayed resolution

Working. Check the date of the review period and resolution timeline, determine whether the plan was implemented, and if not, compute the additional provision at 20 percent of the outstanding loan and assess classification and disclosure.

Explanation. Under the RBI Prudential Framework, if the resolution plan is not implemented within the prescribed timeline, lenders are required to make additional provisioning of 20 percent of the outstanding loan. Signing an inter-creditor agreement alone does not remove the requirement. The account is not automatically upgraded to standard, and a 5 percent provision is not the specified additional provision.

Where it goes wrong. Students often assume that signing an ICA or a consortium arrangement automatically prevents NPA classification or additional provisioning.

Authority. RBI Prudential Framework for Resolution of Stressed Assets, June 2019; ICAI Study Material for Paper 5, Chapter 10: Audit of Banks