Test 15: answer key

Question 1 · 2 marks · Risk Assessment and Internal Control · medium

Scenario. Apex Global Ltd is a manufacturing company with automated procurement and multiple inventory locations. The statutory auditor is evaluating internal controls over procurement, related party transactions with its foreign holding company under SA 550, and physical verification of inventory under SA 501. The audit team also plans to use internal auditors for certain procedures.

In evaluating automated procurement controls at Apex Global Ltd, which of the following is a general IT control that supports the reliability of the procurement application?

1. Controls over program changes and logical access to the procurement application (correct answer)
2. Three-way match of purchase order, goods receipt note and invoice at transaction level
3. Manual approval of purchase requisitions by department heads
4. Physical verification of inventory at each warehouse location

Answer: A — Controls over program changes and logical access to the procurement application

Working. Step 1: Identify the nature of automated procurement controls. Step 2: Classify controls into general IT controls, application controls and manual controls. Step 3: Program change and access controls are general IT controls; three-way match is application; manual approval is manual; inventory verification is substantive.

Explanation. General IT controls are pervasive controls over the IT environment, such as access security and program change controls, which support the effective functioning of automated application controls. A three-way match is an application control operating at transaction level, manual approval is a manual control, and physical inventory verification is a substantive procedure. Therefore, only option (a) describes a general IT control.

Where it goes wrong. Students often confuse application controls embedded in software with general IT controls that support the entire IT environment.

Authority. SA 315: Identifying and Assessing Risks of Material Misstatement, paras A60-A65; ICAI Study Material, Chapter 3

Question 2 · 2 marks · Audit Evidence · medium

Under SA 550, when Apex Global Ltd has transactions with its foreign holding company that are outside the normal course of business, what is the auditor's most appropriate response?

1. Rely solely on a management representation that the transactions are at arm's length
2. Inquire of management and those charged with governance and inspect relevant contracts and agreements (correct answer)
3. Ignore the transactions because the foreign holding company is examined by another auditor
4. Report the transactions to the Reserve Bank of India immediately

Answer: B — Inquire of management and those charged with governance and inspect relevant contracts and agreements

Working. Step 1: Identify related party relationship with foreign holding company. Step 2: Apply SA 550 risk assessment procedures. Step 3: Inquire of management/TCWG and inspect contracts; do not rely solely on representation.

Explanation. SA 550 requires the auditor to obtain an understanding of related party relationships and transactions, including inquiring of management and those charged with governance and inspecting relevant contracts and agreements. A management representation alone is not sufficient, audit by another auditor of the holding company does not eliminate the risk, and immediate RBI reporting is not the routine audit response.

Where it goes wrong. Students may think that a management representation or audit by another auditor is enough for related party transactions.

Authority. SA 550: Related Parties, paras 13-14; ICAI Study Material, Chapter 4

Question 3 · 2 marks · Audit Evidence · hard

During physical inventory counting at Apex Global Ltd, the auditor cannot attend one material location due to unforeseen travel restrictions. What should the auditor do under SA 501?

1. Rely on the management's count sheets for that location without further procedures
2. Exclude that location from the audit scope and issue an unmodified opinion
3. Perform alternative audit procedures and, if sufficient evidence is not obtained, modify the opinion (correct answer)
4. Automatically disclaim an opinion on the financial statements

Answer: C — Perform alternative audit procedures and, if sufficient evidence is not obtained, modify the opinion

Working. Step 1: Attendance at one material location is impracticable. Step 2: Perform alternative procedures. Step 3: If evidence remains insufficient, modify opinion under SA 705; do not automatically disclaim.

Explanation. If attendance at physical inventory counting is impracticable, SA 501 requires the auditor to perform alternative audit procedures, such as inspecting documentation of subsequent sales of inventory. If sufficient appropriate evidence still cannot be obtained, the auditor modifies the opinion under SA 705. Reliance on management count sheets alone is insufficient, and automatic disclaimer is not required.

Where it goes wrong. Students may jump to a disclaimer without first attempting alternative procedures.

Authority. SA 501: Audit Evidence—Specific Considerations, paras 7-8; SA 705: Modifications to the Opinion in the Independent Auditor's Report

Question 4 · 2 marks · Audit Evidence · medium

The auditor plans to use internal auditors to provide direct assistance in testing procurement controls. Which procedure is appropriate for such direct assistance?

1. Internal auditor makes significant judgments on complex accounting estimates
2. Internal auditor designs the overall audit plan for procurement
3. Internal auditor communicates directly with the audit committee without external auditor involvement
4. Internal auditor performs specified tests under the direction, supervision and review of the external auditor (correct answer)

Answer: D — Internal auditor performs specified tests under the direction, supervision and review of the external auditor

Working. Step 1: Understand direct assistance under SA 610. Step 2: Identify restrictions: no significant judgment, no overall plan, no independent communication. Step 3: Appropriate use is specified testing under external auditor supervision.

Explanation. Direct assistance means internal auditors perform audit procedures under the direction, supervision and review of the external auditor. They cannot make significant audit judgments, design the overall audit plan, or communicate independently with the audit committee. The external auditor retains sole responsibility for the audit opinion and must supervise and review the work.

Where it goes wrong. Students may overestimate the role of internal auditors in direct assistance and treat them as substitute external auditors.

Authority. SA 610: Using the Work of Internal Auditors, paras 30-34; ICAI Study Material, Chapter 4

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

Scenario. A public library and cultural society receives member subscriptions, state government grant-in-aid for specific cultural activities, and purchases rare books. The auditor is planning the audit of the society for the year ended 31 March 2026.

In auditing the public library and cultural society, which procedure is most appropriate for the state government grant-in-aid received for specific cultural activities?

1. Verify the grant conditions and whether the amount was spent for the specified purpose (correct answer)
2. Recognize the entire grant as unrestricted revenue without examining conditions
3. Capitalize the grant as an intangible asset in the balance sheet
4. Rely on the management's representation that the grant was properly utilized

Answer: A — Verify the grant conditions and whether the amount was spent for the specified purpose

Working. Step 1: Identify grant as specific-purpose. Step 2: Inspect grant letter and conditions. Step 3: Vouch eligible expenditure and verify utilization for specified purpose.

Explanation. A grant-in-aid received for specific cultural activities is a specific-purpose grant. The auditor should verify the grant conditions and whether the amount was spent for the specified purpose. Treating it as unrestricted revenue, capitalizing it as an intangible asset, or relying only on management representation would not provide sufficient appropriate audit evidence.

Where it goes wrong. Students may treat all grants as revenue without considering donor-imposed conditions.

Authority. ICAI Study Material, Chapter 9: Audit of Charitable Institutions and NGOs; SA 500: Audit Evidence

Question 6 · 2 marks · Audit Evidence · medium

Scenario. During the audit of revenue and expenditure cycles, the auditor designs tests for occurrence, completeness, accuracy, cut-off, and classification. The auditor also verifies the trade payables ageing schedule under Schedule III to the Companies Act, 2013.

The auditor selects a sample of goods received notes and traces them to purchase invoices and purchase records. Which assertion is primarily being tested?

1. Occurrence of purchases
2. Completeness of purchases (correct answer)
3. Accuracy of purchase amounts
4. Cut-off of purchase transactions

Answer: B — Completeness of purchases

Working. Step 1: Note starting point is goods received notes (source). Step 2: Trace forward to purchase records. Step 3: This tests whether any receipt was omitted, i.e., completeness.

Explanation. Tracing from source documents such as goods received notes to accounting records tests completeness, because the auditor is checking whether all goods received were recorded. Occurrence tests from records to source documents; accuracy tests amounts; cut-off tests the period of recording. Therefore, the direction of testing from goods received notes to records addresses completeness.

Where it goes wrong. Students often mix the direction of testing and wrongly select occurrence.

Authority. SA 500: Audit Evidence, para A15; ICAI Study Material, Chapter 4

Question 7 · 2 marks · Audit of Items of Financial Statements · hard

While verifying the trade payables ageing schedule under Schedule III, which disclosure is required for Micro and Small Enterprises and disputed dues?

1. Only total trade payables need to be disclosed
2. Ageing is required only for creditors exceeding ₹1 crore
3. MSME dues, other dues and disputed dues must be disclosed separately in the ageing schedule (correct answer)
4. No ageing schedule is required for trade payables

Answer: C — MSME dues, other dues and disputed dues must be disclosed separately in the ageing schedule

Working. Step 1: Refer to Schedule III trade payables ageing format. Step 2: Identify required categories: MSME, Others, Disputed Dues-MSME, Disputed Dues-Others. Step 3: Verify separate disclosure and unbilled dues.

Explanation. Schedule III requires an ageing schedule for trade payables with separate disclosure of MSME, others, disputed dues to MSME and disputed dues to others, along with unbilled dues. Disclosing only total trade payables, applying a ₹1 crore threshold, or omitting the ageing schedule is not compliant. The auditor must verify these separate classifications.

Where it goes wrong. Students may overlook the separate disclosure requirements for MSME and disputed dues.

Authority. Schedule III, Part I, Companies Act 2013: Trade Payables ageing schedule; ICAI Study Material, Chapter 5

Question 8 · 2 marks · Audit Evidence · medium

The auditor compares sales invoices recorded just before and after year-end with shipping documents. Which assertion is primarily being tested?

1. Occurrence of revenue
2. Completeness of revenue
3. Accuracy of revenue
4. Cut-off of revenue (correct answer)

Answer: D — Cut-off of revenue

Working. Step 1: Identify procedure as year-end sales and shipping matching. Step 2: Relate to period of recording. Step 3: This is cut-off assertion.

Explanation. Cut-off testing ensures that transactions are recorded in the correct accounting period. Comparing sales invoices around year-end with shipping documents tests whether revenue was recorded in the proper period. Occurrence tests whether recorded sales actually occurred; completeness tests understatement; accuracy tests amounts. The focus on timing makes cut-off the relevant assertion.

Where it goes wrong. Students may confuse cut-off with occurrence because both involve sales invoices.

Authority. SA 500: Audit Evidence, assertions about classes of transactions; ICAI Study Material, Chapter 4

Question 9 · 2 marks · Audit Evidence · medium

The auditor recomputes GST on selected expenditure transactions and compares it with the ledger. Which assertion is primarily being tested?

1. Accuracy of expenditure (correct answer)
2. Occurrence of expenditure
3. Cut-off of expenditure
4. Classification of expenditure

Answer: A — Accuracy of expenditure

Working. Step 1: Note the procedure is recomputation of amount. Step 2: Relate to assertion of accurate recording. Step 3: This is accuracy.

Explanation. Recomputing GST on selected expenditure transactions tests the accuracy assertion, which concerns whether amounts and other data relating to recorded transactions have been recorded appropriately. Occurrence tests whether the expenditure actually occurred; cut-off tests the period; classification tests whether it was recorded in the proper account.

Where it goes wrong. Students may confuse accuracy with occurrence when recomputation is involved.

Authority. SA 500: Audit Evidence, assertions about classes of transactions; ICAI Study Material, Chapter 4

Question 10 · 2 marks · Audit Report · medium

Scenario. The auditor of a listed company is determining Key Audit Matters (KAM) for the auditor's report under SA 701. The company has complex revenue recognition estimates and routine payroll transactions.

Which of the following matters is most likely to be identified as a Key Audit Matter under SA 701?

1. Routine payroll processing with no significant risks
2. Complex revenue recognition estimate involving high estimation uncertainty and significant auditor judgment (correct answer)
3. Board meeting minutes approval of routine resolutions
4. Standard monthly bank reconciliations performed by client

Answer: B — Complex revenue recognition estimate involving high estimation uncertainty and significant auditor judgment

Working. Step 1: Recall SA 701 factors. Step 2: Identify complex revenue recognition estimate as high RMM and significant judgment. Step 3: Conclude it is most likely a KAM.

Explanation. Key Audit Matters are those matters that, in the auditor's professional judgment, were of most significance in the audit. Areas of higher assessed risk of material misstatement and significant auditor judgments, including complex accounting estimates with high estimation uncertainty, are likely KAM. Routine payroll, routine board resolutions and standard bank reconciliations are less likely to be KAM.

Where it goes wrong. Students may select any complex area without considering whether it was of most significance in the audit.

Authority. SA 701: Communicating Key Audit Matters, para 9; ICAI Study Material, Chapter 8

Question 11 · 2 marks · Audit Report · hard

Scenario. Falcon Tech Ltd has defaulted in repayment of a bank loan, has sanctioned working capital limits of ₹6 crore from banks, and the auditor is evaluating the company's ability to meet liabilities within one year using ratios. The auditor must apply CARO 2020 clauses ix, ii and xix.

Under CARO 2020 clause ix, if Falcon Tech Ltd has defaulted in repayment of a bank loan, what must the auditor report?

1. Only the total amount of default without lender-wise details
2. No reporting if the bank has not filed a legal suit
3. The period and amount of default and whether principal or interest, with lender-wise details (correct answer)
4. The default only in the board's report, not in the auditor's report

Answer: C — The period and amount of default and whether principal or interest, with lender-wise details

Working. Step 1: Identify clause ix default. Step 2: Recall required format: nature of borrowing, lender name, amount not paid, principal or interest, delay days. Step 3: Select option with period, amount, nature and lender-wise details.

Explanation. CARO 2020 clause ix requires the auditor to report the period and amount of default in repayment of loans or borrowings or payment of interest, whether the default relates to principal or interest, and lender-wise details in case of banks, financial institutions and government. Reporting only total amount, waiting for a legal suit, or reporting only in the board's report is not sufficient.

Where it goes wrong. Students may omit lender-wise details or incorrectly think no reporting is needed until legal action.

Authority. CARO 2020, Clause 3(ix)(a); ICAI Study Material, Chapter 8

Question 12 · 2 marks · Audit Report · hard

Falcon Tech Ltd has sanctioned working capital limits of ₹6 crore from banks. The quarterly statements filed with banks do not agree with the books. What is the auditor's reporting requirement under CARO 2020 clause ii?

1. Ignore the discrepancy because the limit is not fully utilized
2. Report only if the discrepancy exceeds 10 percent of the limit
3. Report the discrepancy only to the bank, not in the CARO report
4. Report whether quarterly returns/statements are in agreement with books; if not, give details (correct answer)

Answer: D — Report whether quarterly returns/statements are in agreement with books; if not, give details

Working. Step 1: Check sanctioned limit exceeds ₹5 crore. Step 2: Apply clause ii(b). Step 3: Report agreement or disagreement with details.

Explanation. CARO 2020 clause ii(b) applies where the company has been sanctioned working capital limits in excess of ₹5 crore from banks or financial institutions on the basis of security of current assets. The auditor must report whether the quarterly returns or statements filed are in agreement with the books; if not, give details. There is no exemption based on utilization or a 10 percent threshold, and reporting only to the bank is not sufficient.

Where it goes wrong. Students may incorrectly apply a materiality threshold or assume no reporting if the limit is not fully drawn.

Authority. CARO 2020, Clause 3(ii)(b); ICAI Study Material, Chapter 8

Question 13 · 2 marks · Audit Report · medium

Under CARO 2020 clause xix, if the auditor concludes that no material uncertainty exists about Falcon Tech Ltd's ability to meet liabilities within one year, what should the auditor state?

1. That no material uncertainty exists as on the date of the audit report (correct answer)
2. A disclaimer of opinion on the financial statements
3. A qualified opinion due to going concern uncertainty
4. No statement is required under CARO 2020

Answer: A — That no material uncertainty exists as on the date of the audit report

Working. Step 1: Recall clause xix requirement. Step 2: If no material uncertainty, state that conclusion. Step 3: Do not modify opinion unless SA 570 requires.

Explanation. CARO 2020 clause xix requires the auditor to state whether, on the basis of financial ratios, ageing and expected dates of realisation of financial assets and payment of financial liabilities, and other information, no material uncertainty exists as on the date of the audit report about the company's ability to meet its liabilities within one year. If the auditor concludes no material uncertainty exists, that fact is stated. A disclaimer or qualification is not automatic, and silence is not permitted.

Where it goes wrong. Students may confuse CARO clause xix reporting with a SA 570 modified opinion.

Authority. CARO 2020, Clause 3(xix); ICAI Study Material, Chapter 8

Question 14 · 2 marks · Audit Report · medium

Where should the matters specified under CARO 2020 be included in the auditor's report?

1. In the main opinion paragraph itself
2. In an annexure to the auditor's report (correct answer)
3. In the notes to accounts prepared by management
4. In the Board's report under section 134

Answer: B — In an annexure to the auditor's report

Working. Step 1: Recall CARO reporting format. Step 2: CARO matters are in an annexure referred to in the auditor's report. Step 3: Select annexure.

Explanation. CARO 2020 requires the auditor's report to contain a statement on the specified matters in an annexure to the auditor's report. The main report refers to the annexure. These matters are not part of the opinion paragraph, the notes to accounts, or the Board's report. This structure separates the statutory CARO statements from the audit opinion.

Where it goes wrong. Students may place CARO matters in the notes to accounts or the Board's report.

Authority. CARO 2020, para 4; ICAI Study Material, Chapter 8

Question 15 · 2 marks · Audit of Banks · hard

Scenario. A bank is a member of a consortium lending arrangement where the lead bank has received borrower remittances but has not transferred the member bank's share. The auditor is evaluating NPA classification in the member bank's books.

In a consortium lending arrangement, the lead bank has received borrower remittances but has not transferred the member bank's share. How should the member bank classify its share of the advance?

1. Standard, because the borrower has remitted funds to the lead bank
2. Standard, provided the security value is sufficient
3. NPA, because the record of recovery in the member bank's books shows the account is not serviced (correct answer)
4. Restructured, because the consortium arrangement is in place

Answer: C — NPA, because the record of recovery in the member bank's books shows the account is not serviced

Working. Step 1: Identify member bank has not received its share. Step 2: Apply record of recovery principle. Step 3: Classify as NPA in member bank's books.

Explanation. In consortium lending, asset classification is based on the record of recovery in each member bank's books. If the member bank has not received its share of recovery from the lead bank, its account is not serviced and should be classified as NPA. Receipt by the lead bank or adequacy of security does not change this. The consortium arrangement itself does not justify standard classification.

Where it goes wrong. Students may assume that borrower remittance to the lead bank is sufficient for all consortium members.

Authority. RBI Prudential Norms on Income Recognition, Asset Classification and Provisioning; ICAI Study Material, Chapter 10