Test 2: answer key

Question 1 · 2 marks · Chapter 5: Audit of Items of Financial Statements · medium

Scenario. Aethel Retail Ltd. is a large retail company with an established Audit Committee. During the statutory audit for the year ended 31 March 2026, the auditor identifies unusual manual journal entries posted by the CFO immediately before the financial year-end. Several entries debit trade receivables and credit sales revenue without corresponding dispatch documentation or evidence of delivery. Subsequent credit notes and customer correspondence indicate that certain sales may have been fictitious. Further investigation identifies two separate and unrelated suspected fraud schemes committed by company officers and employees, involving approximately ₹1.06 crore and ₹84 lakh individually. The auditor is evaluating the risk of management override of controls, procedures relating to fictitious revenue recognition and reporting obligations under Section 143(12) of the Companies Act, 2013 and Rule 13 of the Companies (Audit and Auditors) Rules, 2014.

The CFO has posted several unusual manual journal entries immediately before the reporting date, crediting sales revenue without corresponding dispatch evidence. The company's routine internal controls have otherwise operated effectively. Which audit response most appropriately addresses the risk of management override under SA 240?

1. Accept the CFO's explanation after inspecting the signed year-end journal vouchers and confirming that the ledger totals agree.
2. Test period-end and selected throughout-year journal entries, inquire about unusual processing and inspect the supporting evidence for each entry. (correct answer)
3. Rely on operating-effectiveness testing of sales controls because effective controls remove the need for separate override procedures.
4. Limit journal testing to routine recurring entries posted automatically through the approved sales billing system.

Answer: B — Test period-end and selected throughout-year journal entries, inquire about unusual processing and inspect the supporting evidence for each entry.

Working. 1. Identify unusual journal entries, particularly manual entries posted immediately before or after the reporting date. 2. Examine the accounts debited and credited, narration, supporting documents, posting date and identity of the person making and approving the entries. 3. Make inquiries of personnel involved in financial reporting about unusual journal-processing activities. 4. Test appropriateness of the selected entries and consider whether similar procedures are necessary for entries throughout the financial year. 5. Corroborate the explanations with independent supporting evidence rather than relying exclusively on management representations.

Explanation. SA 240 treats management override as a significant risk present in every audit, irrespective of how effectively routine internal controls operate. The auditor must test journal entries and other adjustments made in preparing the financial statements, particularly those recorded at period-end, make inquiries about unusual processing and consider testing entries throughout the period. The principal distractor is relying solely on tested controls or management approval; those controls do not eliminate management's ability to override them. The review of estimates and unusual transactions complements journal-entry testing.

Where it goes wrong. Assuming that effective internal controls eliminate management override risk and therefore make separate journal-entry testing unnecessary.

Authority. SA 240: The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements, paragraphs 31–33; ICAI Study Material, Chapter 5: Audit of Items of Financial Statements; SA 315: Identifying and Assessing the Risks of Material Misstatement

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

Certain year-end sales entries are unsupported by dispatch records, and subsequent credit notes raise doubts about whether the transactions actually occurred. Applying SA 240, which approach is most appropriate for evaluating the revenue-recognition fraud risk?

1. Conclude that every sales transaction is fraudulent because SA 240 presumes all revenue is misstated until disproved.
2. Test only sales invoices selected from the ledger and accept management's dispatch summary as sufficient evidence of occurrence.
3. Focus only on valuation of receivables because missing dispatch records do not affect the timing of revenue.
4. Evaluate the exposed revenue streams and assertions, then test occurrence and cut-off using dispatch, delivery, confirmation and subsequent credit-note evidence. (correct answer)

Answer: D — Evaluate the exposed revenue streams and assertions, then test occurrence and cut-off using dispatch, delivery, confirmation and subsequent credit-note evidence.

Working. 1. Identify the categories of revenue, transactions and relevant assertions susceptible to fraud. 2. Examine selected year-end sales entries and trace them to customer orders, invoices and dispatch documentation. 3. Compare dispatch and delivery dates with the revenue-recognition period to establish appropriate cut-off. 4. Obtain independent customer confirmations wherever appropriate. 5. Inspect subsequent credit notes, cancellations, returns and collections to investigate potentially fictitious transactions. 6. Evaluate whether the audit evidence supports recognition of the revenue in the financial year under examination.

Explanation. SA 240 requires the auditor to presume fraud risks in revenue recognition and evaluate which revenue streams, transaction types and assertions are exposed. The absence of dispatch and customer acceptance documents makes occurrence and cut-off particularly relevant. Substantive procedures should connect recorded entries with customer orders, invoices, dispatch records, delivery evidence, confirmations and subsequent credit notes. The principal distractor is treating every revenue transaction as automatically fraudulent; the standard requires a risk evaluation, not a conclusion that all revenue transactions are false.

Where it goes wrong. Misinterpreting the presumption of fraud risk in revenue recognition as proof that every revenue transaction constitutes fraud.

Authority. SA 240: paragraph 26; SA 240: paragraphs 30–33; SA 330: The Auditor's Responses to Assessed Risks; ICAI Study Material, Chapter 5: Audit of Items of Financial Statements

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

The auditor identifies two separate and unrelated suspected fraud schemes involving ₹1.06 crore and ₹84 lakh individually. Both involve company officers or employees. Applying Section 143(12) read with Rule 13, which reporting treatment is appropriate?

1. Apply the threshold separately: ₹1.06 crore follows the Central Government route; ₹84 lakh is reported to the Audit Committee. (correct answer)
2. Aggregate both unrelated schemes to ₹1.90 crore and send one Central Government report, omitting a separate Audit Committee report for the smaller scheme.
3. Report both schemes only to the Audit Committee because each arises in the same reporting period and involves company employees.
4. Report both schemes to the Central Government because their aggregate estimated exposure exceeds the prescribed amount.

Answer: A — Apply the threshold separately: ₹1.06 crore follows the Central Government route; ₹84 lakh is reported to the Audit Committee.

Working. 1. Identify each suspected fraud separately and determine the amount involved individually. 2. First suspected fraud: ₹1.06 crore. Since ₹1.06 crore is equal to or greater than ₹1 crore, Rule 13(1) and Rule 13(2) apply. 3. Second suspected fraud: ₹84 lakh. Since ₹84 lakh is below ₹1 crore, Rule 13(3) applies. 4. The ₹1.06 crore fraud follows the Central Government reporting procedure, including the prescribed preliminary communication to the Audit Committee or Board. 5. The ₹84 lakh fraud must be reported to the Audit Committee within two days of knowledge. 6. The applicable fraud disclosures under CARO 2020 clause (xi) must also be considered.

Explanation. Rule 13 applies the prescribed threshold to the amount involved individually in a fraud. The separate ₹1.06 crore scheme meets the ₹1 crore-or-above threshold and follows the Central Government reporting procedure. The separate ₹84 lakh scheme falls below that threshold and must be reported to the Audit Committee under Rule 13(3), immediately but not later than two days after knowledge. Aggregating unrelated schemes to determine the reporting threshold is incorrect because the rule expressly uses an individual-fraud threshold.

Where it goes wrong. Applying the ₹1 crore threshold to the aggregate amount of unrelated fraud schemes rather than assessing each fraud individually.

Authority. Companies Act, 2013: Section 143(12); Companies (Audit and Auditors) Rules, 2014: Rule 13(1), Rule 13(2) and Rule 13(3); Companies (Audit and Auditors) Amendment Rules, 2015: G.S.R. 972(E), dated 14 December 2015; MCA Gazette notification: Rule 13 fraud-reporting provisions

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

The auditor has sufficient reason to believe that the ₹1.06 crore fraud identified at Aethel Retail Ltd. qualifies for Central Government reporting. Which sequence correctly describes the applicable procedure under Rule 13?

1. File Form ADT-4 with the Central Government immediately and skip prior Audit Committee communication because the fraud exceeds the threshold.
2. Wait for the Audit Committee's approval before reporting to the Central Government, and treat silence beyond forty-five days as acceptance.
3. Notify the Audit Committee within two days, seek observations within forty-five days, then forward the report, reply and comments within fifteen days in Form ADT-4. (correct answer)
4. Forward the report and reply within forty-five days, then wait another fifteen days for the Audit Committee to approve the prescribed ADT-4 filing.

Answer: C — Notify the Audit Committee within two days, seek observations within forty-five days, then forward the report, reply and comments within fifteen days in Form ADT-4.

Working. 1. Establish the date on which the auditor obtains knowledge of the qualifying fraud. 2. Immediately communicate the matter to the Audit Committee or Board, but not later than two days after knowledge. 3. Seek the Committee's or Board's reply or observations within forty-five days. 4. If a reply is received, forward the auditor's report, the reply and the auditor's comments to the Central Government within fifteen days of receipt. 5. If no reply is received within forty-five days, forward the original report with a note containing the relevant particulars and explaining the absence of observations. 6. Submit the report in the prescribed Form ADT-4.

Explanation. Under Rule 13(2), the auditor must report the matter to the Board or Audit Committee immediately but not later than two days after knowledge of the fraud and seek its reply or observations within forty-five days. On receiving the reply, the auditor forwards the original report, the reply and the auditor's comments to the Central Government within fifteen days. If no reply is received within forty-five days, the auditor forwards the report with a note explaining the absence of observations. Form ADT-4 is prescribed for this reporting.

Where it goes wrong. Confusing the forty-five-day period for receiving observations with the fifteen-day period for forwarding the report to the Central Government.

Authority. Companies Act, 2013: Section 143(12); Companies (Audit and Auditors) Rules, 2014: Rule 13(2)(a)–(f); Companies (Audit and Auditors) Amendment Rules, 2015: G.S.R. 972(E), dated 14 December 2015; MCA Gazette: Form ADT-4 and fraud-reporting procedure

Question 5 · 2 marks · Chapter 4: Audit Evidence · hard

Scenario. Shivalik Heavy Machinery Ltd. maintains a remote warehouse containing inventory representing approximately 25% of its total inventory. The auditor originally planned to attend physical inventory counting on 31 March 2026. However, severe flooding and the resulting closure of access roads make attendance at the scheduled count unsafe and impracticable. Anticipating the natural calamity, management advances the physical count to 26 March 2026, which the auditor attends and observes, performing independent test counts. The company maintains perpetual inventory records updated for receipts, issues, sales and transfers. The auditor must obtain evidence regarding the existence and condition of inventory as at 31 March 2026 by examining the alternative-date count, intervening movements and final inventory records.

The auditor attends and performs test counts at the remote warehouse on 26 March 2026 because the scheduled 31 March count becomes impracticable due to flooding. Which procedure most appropriately addresses the intervening period under SA 501?

1. Accept a signed management count and uninterrupted perpetual records as conclusive, without testing receipts, issues, dispatches or transfers after the count date.
2. Observe counts on an alternative date and test intervening receipts, issues, dispatches and transfers to roll the quantities forward to 31 March. (correct answer)
3. Rely only on post-year-end sales invoices for selected items and omit movement testing because the stock count occurred before year-end.
4. Treat inability to attend as an automatic scope limitation and modify the opinion without considering alternative-date counting or other available evidence.

Answer: B — Observe counts on an alternative date and test intervening receipts, issues, dispatches and transfers to roll the quantities forward to 31 March.

Working. 1. Evaluate the reason for non-attendance and document the natural calamity and safety restrictions. 2. Attend the alternative physical count and inspect inventory, observe management's count procedures and perform independent test counts. 3. Establish the inventory quantities as at 26 March 2026. 4. Identify every relevant inventory movement between 27 March and 31 March, including receipts, issues, dispatches, returns and transfers. 5. Trace movements to supporting documents and reconcile them with perpetual inventory records. 6. Roll forward the observed quantities to the reporting date and agree them with the final inventory listing. 7. Evaluate whether sufficient appropriate evidence has been obtained. If not, consider modification under SA 705.

Explanation. SA 501 requires appropriate procedures when the auditor cannot attend physical inventory counting at the originally scheduled date. An alternative-date count can be observed, followed by procedures over intervening inventory transactions. Since the observed count is on 26 March and the reporting date is 31 March, the auditor must roll quantities forward using goods receipt notes, dispatch records, returns and transfers and reconcile the results with final inventory records. If alternative procedures cannot provide sufficient appropriate evidence, SA 705 requires a modified opinion.

Where it goes wrong. Assuming that an alternative-date physical count establishes the closing inventory balance without testing intervening inventory movements.

Authority. SA 501: Audit Evidence—Specific Considerations for Selected Items, inventory provisions; SA 500: Audit Evidence; ICAI Study Material, Chapter 4, sections 2.6, 2.7 and 2.8, pp. 4.36–4.38; SA 705: Modifications to the Opinion in the Independent Auditor's Report

Question 6 · 2 marks · Chapter 8: Audit Report · hard

Scenario. Shivalik Heavy Machinery Ltd. is subject to reporting under CARO 2020. During the financial year ended 31 March 2026, it invested ₹3 crore in the equity shares of its wholly-owned subsidiary and provided a corporate guarantee of ₹5 crore in favour of a lender for the subsidiary's borrowing. The backed by guarantee borrowing outstanding at the balance sheet date is ₹4 crore. An independent valuation indicates that the subsidiary shares may have been acquired at a substantial premium without a documented commercial justification. The company also has undisputed GST dues of ₹44 lakh payable on 15 July 2025 and ₹28 lakh payable on 20 November 2025, both remaining unpaid on 31 March 2026. Another ₹12 lakh GST liability was paid before the balance sheet date. Separately, GST demands of ₹80 lakh are pending before the GST Appellate Authority under a formal appeal, while ₹22 lakh remains unpaid solely because of a representation submitted to the GST Department, without any formal appeal or pending adjudication. The auditor must evaluate reporting under CARO 2020 clauses (iii) and (vii).

Shivalik invested ₹3 crore in its subsidiary and provided a guarantee of ₹5 crore during the year, of which ₹4 crore remained outstanding at year-end. Which disclosure correctly applies CARO 2020 clause (iii)?

1. Report ₹5 crore of guarantees made and ₹4 crore outstanding under clause (iii)(a)(A); evaluate the ₹3 crore investment under clause (iii)(b). (correct answer)
2. Show only ₹4 crore because clause (iii)(a)(A) reports year-end exposure, not the total guarantee issued during the year.
3. Combine the ₹3 crore investment, ₹5 crore guarantee and ₹4 crore year-end exposure as one balance under clause (iii)(a)(A).
4. Exclude the subsidiary altogether because clause (iii) reports transactions only with external borrowers and unrelated third parties.

Answer: A — Report ₹5 crore of guarantees made and ₹4 crore outstanding under clause (iii)(a)(A); evaluate the ₹3 crore investment under clause (iii)(b).

Working. 1. Identify the transactions falling within paragraph 3(iii) of CARO 2020. 2. Equity investment in subsidiary: ₹3 crore. This falls within the investment evaluation requirement of clause (iii)(b). 3. Guarantee issued during the year: ₹5 crore. 4. Guarantee exposure outstanding at the balance sheet date: ₹4 crore. 5. Clause (iii)(a)(A) requires both the aggregate guarantee amount during the year and the closing outstanding balance to be indicated. 6. Therefore, report ₹5 crore and ₹4 crore separately under clause (iii)(a)(A), and evaluate whether the investment and guarantee are not prejudicial under clause (iii)(b).

Explanation. CARO clause (iii)(a)(A) requires the aggregate amount during the year and the balance outstanding at the balance sheet date for guarantees, security, loans and advances in the nature of loans to subsidiaries, joint ventures and associates. Accordingly, the ₹5 crore guarantee and ₹4 crore outstanding exposure must be reported. The ₹3 crore equity investment is separately within the scope of clause (iii) and must be evaluated under clause (iii)(b), which addresses whether investments and guarantees are not prejudicial to the company's interest.

Where it goes wrong. Combining investments with guarantee balances when determining the aggregate amounts required by clause (iii)(a)(A).

Authority. CARO 2020: Paragraph 3(iii)(a)(A); CARO 2020: Paragraph 3(iii)(b); Companies Act, 2013: Sections 185 and 186, where applicable; ICAI Study Material, Chapter 8, pp. 8.75–8.76

Question 7 · 2 marks · Chapter 8: Audit Report · hard

An independent valuation indicates that Shivalik acquired subsidiary shares at ₹100 per share when their assessed value was ₹62, without documented commercial justification. The subsidiary's guarantee is also unsecured and carries no fee. How should the auditor approach reporting under CARO 2020 clause (iii)(b)?

1. Treat Board approval as sufficient evidence that the investment and guarantee terms protect the company's interests.
2. Report every unsecured guarantee as prejudicial without considering commercial rationale, valuation or the subsidiary's financial position.
3. Assess valuation, commercial purpose, subsidiary's financial condition and guarantee terms before concluding whether the arrangements are not prejudicial. (correct answer)
4. Compare the investment amount with the subsidiary's share capital and classify every exposure exceeding that amount as prejudicial.

Answer: C — Assess valuation, commercial purpose, subsidiary's financial condition and guarantee terms before concluding whether the arrangements are not prejudicial.

Working. 1. Examine the company's investment documentation and the independent valuation supporting the ₹100 purchase price. 2. Investigate the difference between the purchase price of ₹100 and the assessed value of ₹62. 3. Examine the business rationale, expected returns and financial condition of the subsidiary. 4. Review the guarantee terms, including security, consideration, counter-indemnity, financial exposure and associated risks. 5. Evaluate whether the arrangements protect or prejudice the company's interest based on available audit evidence. 6. Report the auditor's conclusion under CARO clause (iii)(b).

Explanation. Clause (iii)(b) requires the auditor to evaluate whether investments made, guarantees provided and security given, along with relevant loan and guarantee terms, are not prejudicial to the company's interest. Board approval or a strategic label is not sufficient evidence that the arrangements are commercially justified. The auditor should examine valuation, the purpose of the investment, the subsidiary's financial position, guarantee conditions and commercial rationale before reaching a conclusion. Treating every unsecured guarantee as automatically prejudicial is equally inappropriate.

Where it goes wrong. Assuming that formal Board approval or an intra-group relationship automatically establishes that an investment or guarantee is in the company's interest.

Authority. CARO 2020: Paragraph 3(iii)(b); ICAI Study Material, Chapter 8, section 12: Reporting under CARO 2020; Companies Act, 2013: Sections 185 and 186, where applicable

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

At 31 March 2026, Shivalik has unpaid undisputed GST dues of ₹44 lakh due on 15 July 2025 and ₹28 lakh due on 20 November 2025. Another ₹12 lakh, due earlier, was paid on 15 March 2026. What amount must be reported as arrears outstanding for more than six months under CARO clause (vii)(a)?

1. Report the full ₹84 lakh unpaid balance during the financial year, since clause (vii)(a) does not distinguish the due dates of individual GST liabilities.
2. Report ₹72 lakh because every GST liability remaining unpaid at year-end qualifies, regardless of the period outstanding.
3. Report ₹12 lakh because the arrears test includes amounts paid before year-end if their original due date exceeds six months.
4. Report ₹44 lakh because only the July due amount remains unpaid at year-end for more than six months from its payable date. (correct answer)

Answer: D — Report ₹44 lakh because only the July due amount remains unpaid at year-end for more than six months from its payable date.

Working. 1. Determine the relevant reporting date: 31 March 2026. 2. July GST dues: ₹44 lakh, payable on 15 July 2025. Outstanding on 31 March 2026 for more than six months. Include. 3. November GST dues: ₹28 lakh, payable on 20 November 2025. Outstanding for less than six months. Exclude. 4. Earlier GST dues: ₹12 lakh, paid on 15 March 2026. Not outstanding on the balance sheet date. Exclude. 5. Total reportable arrears = ₹44 lakh.

Explanation. Clause (vii)(a) requires the extent of undisputed statutory dues outstanding on the last day of the financial year for more than six months from the date they became payable to be disclosed. The ₹44 lakh July liability satisfies both conditions on 31 March 2026. The ₹28 lakh November liability has not remained outstanding for more than six months, and the ₹12 lakh payment was completed before the balance sheet date. Therefore, only ₹44 lakh qualifies. The principal distractor ignores the reporting-date and ageing requirements.

Where it goes wrong. Applying the six-month test to all statutory dues unpaid at some point during the year instead of dues outstanding at the balance sheet date.

Authority. CARO 2020: Paragraph 3(vii)(a); ICAI Study Material, Chapter 8, p. 8.77; Companies (Auditor's Report) Order, 2020: Statutory dues reporting requirements

Question 9 · 2 marks · Chapter 8: Audit Report · hard

Shivalik has not deposited ₹80 lakh of GST dues because a formal appeal is pending before the GST Appellate Authority. Another ₹22 lakh is withheld only because the company submitted a representation to the GST Department, without filing an appeal. What is the appropriate CARO clause (vii)(b) reporting treatment?

1. Report ₹1.02 crore and identify the GST Appellate Authority because all unpaid amounts qualify as disputed dues irrespective of the procedure adopted.
2. Report ₹80 lakh and identify the GST Appellate Authority; exclude ₹22 lakh supported only by a departmental representation. (correct answer)
3. Report ₹22 lakh and name the GST Department because a written representation by itself constitutes a pending statutory dispute.
4. Omit both amounts because disputed GST dues are outside clause (vii) until the appeal is finally decided.

Answer: B — Report ₹80 lakh and identify the GST Appellate Authority; exclude ₹22 lakh supported only by a departmental representation.

Working. 1. Identify the statutory dues that have not been deposited on account of a dispute. 2. GST demand of ₹80 lakh: A formal appeal has been filed and is pending before the GST Appellate Authority. Include this amount. 3. GST demand of ₹22 lakh: The company has only submitted a representation. No formal appeal or proceeding is pending. 4. CARO expressly states that a mere representation to the concerned department is not treated as a dispute. 5. Report ₹80 lakh and specify the GST Appellate Authority as the forum where the dispute is pending.

Explanation. Clause (vii)(b) requires the auditor to disclose the amounts involved and the forum where a dispute concerning statutory dues is pending. The ₹80 lakh GST demand is covered because a formal appeal is pending before the GST Appellate Authority. The ₹22 lakh amount is not covered as a disputed statutory due merely because the company has submitted a representation to the department. CARO expressly excludes a mere representation to the concerned department from being treated as a dispute.

Where it goes wrong. Treating a representation submitted to a tax department as equivalent to a formal statutory appeal or pending legal proceeding.

Authority. CARO 2020: Paragraph 3(vii)(b); ICAI Study Material, Chapter 8, p. 8.77; Companies (Auditor's Report) Order, 2020: Statutory dues reporting requirements

Question 10 · 2 marks · Chapter 9: Special Features of Audit of Different Types of Entities · medium

Scenario. A charitable trust operates a 300-bed non-profit hospital providing inpatient, outpatient, diagnostic, surgical and pharmacy services. The hospital provides free treatment and concessional billing to eligible indigent patients under its approved policies. Patient services are recorded through a Hospital Management Information System and transferred to billing software. The hospital also maintains pharmacy inventory consisting of medicines, surgical consumables and medical supplies. During the year, it received ₹70 lakh in donations specifically restricted for purchasing dialysis equipment and ₹1.20 crore in Government grants intended to support treatment of economically disadvantaged patients. The auditor must examine patient billing, concessions, internal controls over pharmaceutical inventory and the application and accounting of donor-restricted funds and Government grants.

During the hospital audit, the auditor is required to examine patient billing, concessions to indigent patients, pharmacy controls and restricted donor grants. Which combination of procedures is most appropriate?

1. Trace patient registers to bills and attendance, test concession approvals, check medicine receipts and authorised issues, and trace restricted donations and grants to their stated purposes. (correct answer)
2. Reconcile only total admissions to annual revenue and accept pharmacy purchase invoices without checking medicine issues or physical stock.
3. Treat patient concessions as unrecorded receivables, charge every discount to bad debts and record restricted donations as unrestricted income.
4. Confirm total annual income with trustees, accept a signed pharmacy stock certificate and compare grant receipts with bank credits without tracing restricted expenditure.

Answer: A — Trace patient registers to bills and attendance, test concession approvals, check medicine receipts and authorised issues, and trace restricted donations and grants to their stated purposes.

Working. 1. Patient billing: Vouch the patient register with copies of bills and compare selected bills with patient attendance records. 2. Verify that bills have been issued for all patients from whom amounts are recoverable under hospital rules. 3. Concessions: Examine eligibility records, approved concession policies and supporting authorisations for indigent patients. 4. Pharmacy inventory: Examine internal checks over receipt and issue of medicines and verify that purchases are recorded in the inventory register and issues are properly authorised. 5. Physical inventory: Obtain stock details, perform physical checks of selected medicines and reconcile inventory totals with ledger balances. 6. Restricted donations: Trace the ₹70 lakh donation to expenditure on dialysis equipment in accordance with donor conditions. 7. Government grants: Verify accounting of the ₹1.20 crore grant and examine whether utilisation corresponds with its stated purpose.

Explanation. ICAI's hospital-audit guidance links patient registers with bills and attendance records and requires billing for amounts recoverable under hospital rules. It also calls for examining internal control over receipt and issue of medicines, recording purchases in inventory registers, proper authorisation of issues and physical verification of stock. Purpose-specific donations must be applied as agreed, while Government grants must be properly accounted for. The principal distractor wrongly treats indigent concessions as automatic bad debts and restricted donations as unrestricted income.

Where it goes wrong. Treating a charitable hospital like an ordinary commercial enterprise and overlooking concessions, restricted donations and controls over medicines.

Authority. ICAI Study Material, Chapter 9, section 8: Audit of Hospital, pp. 9.50–9.53; ICAI Study Material: Hospital audit procedures relating to patient registers, collections, donations, grants, internal check and inventories

Question 11 · 2 marks · Chapter 7: Completion and Review · medium

Scenario. Novus Logistics Ltd. prepares its financial statements for the year ended 31 March 2026. A significant lawsuit arising from an incident occurring before the balance sheet date was pending at year-end. On 15 May 2026, before the auditor's report is signed, the court delivers its final judgment confirming an obligation of ₹5.20 crore, whereas the company had recognised a provision of only ₹3 crore. The company is also experiencing recurring cash-flow difficulties and has a substantial borrowing of ₹20 crore falling due in September 2026. Management's initial going concern assessment covers only the period up to 31 December 2026. Following further assessment, management concludes that the going concern basis remains appropriate, although refinancing uncertainty and other financial pressures create a material uncertainty. Its revised financial statement disclosures adequately describe the relevant conditions, management's plans and the material uncertainty. The auditor must evaluate the subsequent judgment, the assessment period and the reporting consequences under SA 560 and SA 570.

The court delivers a final judgment on 15 May 2026, before the auditor's report, confirming a liability arising from an incident that occurred before 31 March 2026. The company had recognised an inadequate provision. Applying SA 560, how should this subsequent event be treated?

1. Treat the judgment as non-adjusting because the court issued it after 31 March and disclose it only in a subsequent-events note.
2. Reverse the entire provision because any judgment after year-end creates a new condition outside the reporting period.
3. Wait for payment to occur after year-end before considering whether a provision is required in the financial statements.
4. Revise the provision because the judgment confirms an obligation arising from conditions existing before 31 March. (correct answer)

Answer: D — Revise the provision because the judgment confirms an obligation arising from conditions existing before 31 March.

Working. 1. Identify the date of the financial statements: 31 March 2026. 2. Identify the date of the court judgment: 15 May 2026, before the auditor's report. 3. Establish when the underlying incident and obligation arose. Here, both existed before 31 March. 4. Determine whether the judgment provides additional evidence about the existing obligation or creates an entirely new condition. 5. The judgment confirms and quantifies the pre-existing liability and therefore represents an adjusting subsequent event. 6. Ensure that management revises the provision from ₹3 crore to reflect the appropriate amount under the applicable financial reporting framework. 7. If management refuses a material adjustment, consider the effect on the audit opinion under SA 705.

Explanation. A judgment delivered after year-end may constitute an adjusting subsequent event when it provides evidence of a condition that already existed at the reporting date. Here, the underlying claim arose before 31 March and the final judgment quantifies the obligation existing at that date. The provision should therefore be revised to reflect the most appropriate estimate required by the applicable financial reporting framework. Mere disclosure is insufficient for an adjusting event. The principal distractor confuses this with a new condition arising after year-end.

Where it goes wrong. Classifying every event occurring after the balance sheet date as a non-adjusting event solely because of its date.

Authority. SA 560: Subsequent Events, paragraphs 5(a) and 6; ICAI Study Material, Chapter 7, section 1: Subsequent Events, pp. 7.4–7.7; ICAI Study Material, Chapter 7: Examples of subsequent events providing evidence of conditions existing at the reporting date

Question 12 · 2 marks · Chapter 7: Completion and Review · medium

Novus Logistics Ltd.'s financial statements are dated 31 March 2026. Management's going concern assessment extends only up to 31 December 2026. What further action is required from the auditor under SA 570?

1. Accept 31 December 2026 because management already supplied a nine-month forecast and the remaining period can be covered by a representation letter.
2. Extend the forecast to twelve months after the auditor's report date, regardless of the financial statement date.
3. Request an assessment through 31 March 2027, giving at least twelve months from the 31 March 2026 financial-statement date. (correct answer)
4. Request a forecast only to the next quarter-end, then assess refinancing plans without extending management's assessment.

Answer: C — Request an assessment through 31 March 2027, giving at least twelve months from the 31 March 2026 financial-statement date.

Working. 1. Financial statement date: 31 March 2026. 2. Management assessment currently ends: 31 December 2026. 3. Period assessed: April 2026 to December 2026, covering only nine months after the reporting date. 4. SA 570 paragraph 13 requires an assessment period of at least twelve months from the financial statement date. 5. Minimum required assessment horizon = 31 March 2026 + 12 months = 31 March 2027. 6. The auditor should request management to extend its assessment up to at least 31 March 2027 and evaluate the assumptions and supporting evidence.

Explanation. SA 570 paragraph 13 requires the auditor to evaluate the same period covered by management's going concern assessment. However, when that assessment covers less than twelve months from the date of the financial statements, the auditor must request management to extend it to at least twelve months from that date. For a 31 March 2026 reporting date, the minimum assessment period ends on 31 March 2027. The principal distractor incorrectly measures the twelve months from the auditor's report date.

Where it goes wrong. Calculating the minimum going concern assessment period from the auditor's report date rather than the date of the financial statements.

Authority. SA 570 (Revised): Going Concern, paragraphs 12–15; SA 560: Subsequent Events; ICAI Study Material, Chapter 7: Going Concern

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

After evaluating Novus Logistics Ltd.'s revised cash-flow forecast and management's refinancing plans, the auditor concludes that the going concern basis remains appropriate but a material uncertainty exists. The financial statements adequately disclose the principal conditions, management's plans and the material uncertainty. What reporting treatment is required under SA 570?

1. Express a qualified opinion with a Basis for Qualified Opinion section because the funding uncertainty remains material despite management's adequate disclosure.
2. Express an unmodified opinion and include a separate Material Uncertainty Related to Going Concern section drawing attention to the adequate note and stating that the opinion is not modified. (correct answer)
3. Express an adverse opinion because the presence of going concern uncertainty proves that management's basis is inappropriate, regardless of its mitigation plans.
4. Include only an Emphasis of Matter paragraph and omit the separate going concern section because the financial statements already disclose the conditions.

Answer: B — Express an unmodified opinion and include a separate Material Uncertainty Related to Going Concern section drawing attention to the adequate note and stating that the opinion is not modified.

Working. 1. Evaluate whether the going concern basis of accounting remains appropriate. 2. Determine whether the audit evidence establishes a material uncertainty capable of casting significant doubt on the entity's ability to continue as a going concern. 3. Examine whether the financial statements adequately disclose the principal events and conditions, their implications and management's plans. 4. Confirm that the disclosures clearly identify the existence of the material uncertainty. 5. Since the basis is appropriate and disclosures are adequate, express an unmodified opinion. 6. Add a separate section titled Material Uncertainty Related to Going Concern, drawing attention to the relevant note and stating that the opinion is not modified in respect of the matter.

Explanation. Where the going concern basis remains appropriate but the auditor concludes that a material uncertainty exists, SA 570 requires evaluation of the adequacy of the related disclosures. If adequate disclosure is made, the auditor expresses an unmodified opinion and includes a separate section titled Material Uncertainty Related to Going Concern. This section draws attention to the relevant financial statement note and explains that the auditor's opinion is not modified in respect of the matter. A qualified opinion solely because a material uncertainty exists is incorrect when disclosure is adequate.

Where it goes wrong. Assuming that the existence of a material uncertainty automatically requires a qualified or adverse opinion, even when the going concern basis is appropriate and disclosure is adequate.

Authority. SA 570 (Revised): Going Concern, paragraphs 18–22; SA 705 (Revised): Modifications to the Opinion in the Independent Auditor's Report; ICAI Study Material, Chapter 7: Going Concern; ICAI Study Material, Chapter 8: Audit Report

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

In a further evaluation of Novus Logistics Ltd., the auditor establishes that the Board has decided to cease operations and liquidate the company's assets, and there is no realistic alternative available. Management nevertheless prepares financial statements using the going concern basis. What opinion is required under SA 570?

1. Express an adverse opinion because the going concern basis is inappropriate when liquidation is the only realistic alternative. (correct answer)
2. Express an unmodified opinion with a Material Uncertainty Related to Going Concern section because management disclosed its liquidation plans.
3. Express a qualified opinion only because the auditor cannot decide whether the liquidation plan is commercially feasible.
4. Add an Emphasis of Matter paragraph while retaining an unmodified opinion because the event occurred after the year-end.

Answer: A — Express an adverse opinion because the going concern basis is inappropriate when liquidation is the only realistic alternative.

Working. 1. Determine whether the company intends to continue operations or cease them. 2. Examine the Board's decision to discontinue operations and liquidate assets. 3. Evaluate whether any realistic alternative to liquidation exists. 4. The facts establish that there is no realistic alternative to liquidation. 5. Consequently, management's use of the going concern basis is inappropriate. 6. Under SA 570 paragraph 21, the auditor must express an adverse opinion. 7. A separate Material Uncertainty Related to Going Concern section cannot substitute for an adverse opinion when the accounting basis itself is inappropriate.

Explanation. SA 570 paragraph 21 specifically requires an adverse opinion when the financial statements have been prepared using the going concern basis but, in the auditor's judgment, that basis is inappropriate. Here, the Board has decided to cease operations and liquidate the company's assets, with no realistic alternative. An adequate disclosure of this situation does not make an inappropriate accounting basis acceptable. The principal distractor wrongly applies the Material Uncertainty Related to Going Concern treatment, which applies when the going concern basis remains appropriate.

Where it goes wrong. Confusing an inappropriate going concern basis with an appropriate going concern basis accompanied by a material uncertainty.

Authority. SA 570 (Revised): Going Concern, paragraph 21; SA 705 (Revised): Modifications to the Opinion in the Independent Auditor's Report; ICAI Study Material, Chapter 7: Going Concern; ICAI Study Material, Chapter 8: Audit Report

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

Scenario. Two Chartered Accountant firms, Firm A and Firm B, are appointed as joint statutory auditors of a large manufacturing company. Before commencement of the audit, they jointly establish the overall audit strategy and document their work allocation. Firm A is assigned inventory and property, plant and equipment, while Firm B is assigned revenue and trade receivables. Certain matters, including overall financial statement presentation, statutory compliance and common audit planning decisions, remain undivided. During the audit, Firm B discovers an inventory-related matter relevant to Firm A's allocated area and communicates it to Firm A in writing before completion of the audit. Despite discussion and evaluation of the audit evidence, the two firms ultimately disagree regarding the appropriate audit opinion. Their responsibilities and reporting obligations must be determined in accordance with SA 299 (Revised).

Firm A and Firm B are joint auditors of a manufacturing company. Their work is divided between inventory and revenue, while certain overall matters remain undivided. Despite discussions, they disagree on the audit opinion. Which statement correctly reflects their responsibilities and reporting obligations under SA 299 (Revised)?

1. Each auditor is liable for every step performed by the other auditor, including divided areas, while any disagreement is resolved through majority decision.
2. Each auditor is responsible only for allocated areas, common work is divided equally and the majority's opinion binds the dissenting auditor.
3. Each is responsible for assigned work; common and specified matters are joint and several; disagreement requires separate reports referring to each other. (correct answer)
4. Both are jointly and severally responsible for all allocated and unallocated work, but must still issue one agreed audit opinion.

Answer: C — Each is responsible for assigned work; common and specified matters are joint and several; disagreement requires separate reports referring to each other.

Working. 1. Examine the documented allocation of work and identify the areas specifically assigned to each joint auditor. 2. Firm A is individually responsible for the inventory and property, plant and equipment work allocated to it. 3. Firm B is individually responsible for the revenue and trade receivables work allocated to it. 4. Identify undivided areas and matters attracting joint and several responsibility, including common audit work, common planning decisions, agreed matters, statutory compliance and financial statement presentation and disclosure. 5. Firm B must communicate the relevant inventory observation to Firm A in writing before completion of the audit. 6. Both auditors must discuss their respective conclusions before finalising the report. 7. If disagreement on the opinion remains, each auditor issues a separate audit report expressing the opinion independently formed by that auditor. 8. Each separate report must refer to the other joint auditor's report under an Other Matter Paragraph.

Explanation. SA 299 distinguishes divided from undivided audit work. Each joint auditor is individually responsible for the work specifically allocated to that auditor, including proper execution of audit procedures. All joint auditors are jointly and severally responsible for common or undivided work, agreed matters, common planning decisions, statutory compliance, financial statement presentation and disclosure, and compliance of the audit report. Where opinions differ, a majority cannot bind the dissenting auditor. Separate audit reports must refer to each other under an Other Matter Paragraph.

Where it goes wrong. Assuming either that joint auditors are jointly and severally liable for every allocated area or that a majority opinion automatically binds a dissenting joint auditor.

Authority. SA 299 (Revised): Joint Audit of Financial Statements, paragraphs 8, 12–17; SA 299 (Revised): Paragraphs 13–14 on responsibilities of joint auditors; SA 299 (Revised): Paragraph 17 on audit conclusion and reporting; SA 706 (Revised): Other Matter Paragraph; ICAI Study Material, Chapter 8, section 10: Joint Audit of Financial Statements, pp. 8.65–8.67