Test 3: answer key

Question 1 · 2 marks · Chapter 4: Audit Evidence · medium

Scenario. Orient Synthetics Ltd. has 8,400 debtor balances aggregating to ₹9.60 crore. Individual balances range from ₹3,000 to ₹24 lakh, with considerable differences in monetary value and ageing. The audit team proposes selecting certain high-value balances using professional judgement and selecting the remaining balances through computer-generated random numbers. The population is also divided into current, 90–180 days overdue and more than 180 days overdue categories. Performance materiality for trade receivables is ₹7 lakh, while the auditor has determined tolerable misstatement of ₹3 lakh for a particular substantive sampling procedure. During testing, one invoice contains a recording error of ₹1.20 lakh. Additional procedures are required to determine whether the error is isolated or representative of the population.

The auditor selects certain high-value debtor balances using professional judgement and selects the remaining balances through random selection. Which statement correctly distinguishes statistical and non-statistical sampling under SA 530?

1. Both selections constitute statistical sampling because each examines fewer than all debtor balances using a defined sample size.
2. The judgement-selected segment is non-statistical; statistical sampling requires random selection and probability-theory evaluation of sample results. (correct answer)
3. The judgement-selected segment is statistical if an experienced partner selects it; random numbers alone establish non-statistical sampling.
4. Neither selection constitutes statistical sampling because debtor balances are monetary items rather than individual transactions.

Answer: B — The judgement-selected segment is non-statistical; statistical sampling requires random selection and probability-theory evaluation of sample results.

Working. 1. Identify the selection approach used for each segment of the debtor population. 2. The high-value segment selected through professional judgement is non-statistical. 3. The remaining segment can constitute statistical sampling where random selection is accompanied by probability-theory evaluation of results and sampling risk. 4. Determine the characteristics of each segment separately rather than classifying the entire audit procedure by its sample size.

Explanation. Statistical sampling has two essential characteristics: random selection of sample units and the use of probability theory to evaluate sample results, including measurement of sampling risk. A sample selected using the auditor's personal experience and professional judgement is non-statistical, irrespective of the population size or number of items selected. The principal distractor incorrectly assumes that random selection alone makes sampling statistical. Both the selection approach and the method of evaluating results are relevant to the distinction.

Where it goes wrong. Assuming that a large sample, random numbers alone or the auditor's experience automatically makes a sampling approach statistical.

Authority. SA 530: Audit Sampling, para 5 and application material concerning statistical and non-statistical sampling; ICAI Study Material, Chapter 4, Audit Evidence, pp. 4.77–4.82

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

The auditor divides debtor balances into current, 90–180 days overdue and more than 180 days overdue strata. Separate samples are selected from each category. How should the auditor project the identified misstatements to evaluate the entire receivables population?

1. Project each stratum's results only to that stratum, then combine projected misstatements to evaluate the entire receivables population. (correct answer)
2. Project the oldest debtors' results to every balance because the highest-risk stratum provides the most conservative population estimate.
3. Project each stratum separately but omit the current balances because lower-risk items cannot affect the overall audit conclusion.
4. Combine all sampled balances before projection, irrespective of whether the individual strata have significantly different ageing characteristics.

Answer: A — Project each stratum's results only to that stratum, then combine projected misstatements to evaluate the entire receivables population.

Working. 1. Divide the debtor population into the three specified ageing strata. 2. Apply the designed audit procedures separately to the sample selected from each stratum. 3. Project the misstatements identified in each sample only to its corresponding stratum. 4. Aggregate the projected misstatements of all strata. 5. Evaluate the combined result against the applicable materiality and tolerable misstatement thresholds.

Explanation. Stratification divides a heterogeneous population into relatively homogeneous sub-populations based on identifying characteristics such as monetary value or ageing. Results from a sample selected within a particular stratum can only be projected to items belonging to that stratum. To evaluate the entire population, the auditor combines the projected misstatements from the different strata. Projecting the oldest debtors' results to all balances would disregard differences in risk and characteristics between the groups.

Where it goes wrong. Assuming that results from the highest-risk stratum can automatically be projected to the entire population.

Authority. SA 530: Audit Sampling, application material concerning stratification; ICAI Study Material, Chapter 4, Audit Evidence, pp. 4.87–4.88

Question 3 · 2 marks · Chapter 4: Audit Evidence · medium

Orient Synthetics Ltd.'s auditor reduces tolerable misstatement for a substantive sampling procedure from ₹3 lakh to ₹1.50 lakh. The assessed risk, desired assurance and other relevant factors remain unchanged. What is the likely effect on the required sample size?

1. Keep the sample unchanged because the total debtor population and sampling method have not changed.
2. Reduce the sample size because a narrower tolerable misstatement requires less testing of the population.
3. Change only the selection method while retaining the same sample size and desired assurance level.
4. Increase the sample size because a lower acceptable misstatement generally requires more audit evidence. (correct answer)

Answer: D — Increase the sample size because a lower acceptable misstatement generally requires more audit evidence.

Working. 1. Initial tolerable misstatement = ₹3,00,000. 2. Revised tolerable misstatement = ₹1,50,000. 3. The auditor now requires greater assurance that the actual population misstatement will remain within a lower monetary threshold. 4. With other factors unchanged, the auditor generally increases the sample size to obtain the required assurance.

Explanation. Tolerable misstatement is the monetary amount set for a sampling procedure for which the auditor seeks an appropriate level of assurance that actual misstatement in the population will not exceed that amount. Reducing the tolerable misstatement leaves less room for undetected errors. Consequently, the auditor generally needs a larger sample when other relevant factors remain unchanged. It is incorrect to assume that the sample size remains constant merely because the total population has not changed.

Where it goes wrong. Confusing tolerable misstatement with the actual misstatement identified during audit testing or assuming it has no influence on sample size.

Authority. SA 530: Audit Sampling, para 5(i), definition of tolerable misstatement; ICAI Study Material, Chapter 4, Audit Evidence, pp. 4.93 and 4.146

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

During substantive testing, the auditor identifies an isolated invoice error of ₹1.20 lakh. Additional procedures establish that the error arose from a one-time migration issue and similar errors do not exist elsewhere. Which statement correctly describes the treatment of this error and the related sampling risk?

1. Project every identified error proportionately; risk of incorrect acceptance primarily affects audit efficiency.
2. Exclude the error immediately from projection; an isolated sample error requires no further investigation or evidence.
3. After obtaining high assurance, exclude the anomaly from projection but assess its actual uncorrected amount separately; incorrect acceptance threatens audit effectiveness. (correct answer)
4. Treat the error as a control deviation; risk of incorrect acceptance affects only the selection of sample items.

Answer: C — After obtaining high assurance, exclude the anomaly from projection but assess its actual uncorrected amount separately; incorrect acceptance threatens audit effectiveness.

Working. 1. Investigate the nature and cause of the invoice error. 2. Identify other transactions sharing the migration-related characteristics. 3. Extend audit procedures to obtain sufficient appropriate evidence that similar errors do not exist elsewhere. 4. If a high degree of assurance is obtained, exclude the anomaly from population projection. 5. Consider the actual uncorrected ₹1.20 lakh separately. 6. Recognise that failure to detect a material population misstatement creates risk of incorrect acceptance.

Explanation. An anomaly is a misstatement demonstrably not representative of misstatements in the population. The auditor must obtain a high degree of assurance through additional procedures before excluding it from projected misstatements. Even then, the actual uncorrected amount must be considered separately. Risk of incorrect acceptance arises when the auditor concludes that a material misstatement does not exist although it actually exists. This principally affects audit effectiveness because it may result in an inappropriate audit opinion.

Where it goes wrong. Treating every isolated sample error as an anomaly without additional procedures or forgetting the separate consideration of its uncorrected amount.

Authority. SA 530: Audit Sampling, provisions concerning anomalies, projecting misstatements and sampling risk; ICAI Study Material, Chapter 4, Audit Evidence, pp. 4.102–4.105

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

Scenario. Vidya Public University Trust is a registered educational trust administering a university. The University's governing Act and applicable regulations expressly prohibit capitation fees. The trust receives admission fees, government scholarship grants and donations specifically designated for constructing a science laboratory. During audit, the auditor notices certain cash collections described as admission facilitation charges that are not included in the approved fee schedule. The auditor must also examine scholarship amounts received and disbursed to eligible students and ensure that donations designated for the laboratory are not diverted towards general administrative expenditure.

While auditing Vidya Public University Trust, which combination of procedures would most appropriately address prohibited capitation fees, government scholarship disbursements and corpus donations?

1. Check the published fee register, accept total scholarship expenses and combine purpose-linked donations with unrestricted receipts.
2. Compare admissions and receipts with sanctioned fee schedules, trace scholarships to sanctions and student bank credits, and follow donor-restricted corpus uses. (correct answer)
3. Confirm grants with the government only, sample general expense vouchers and classify all donations as unrestricted income.
4. Reconcile bank collections to the ledger, test scholarships only for arithmetic and transfer corpus receipts to operating revenue.

Answer: B — Compare admissions and receipts with sanctioned fee schedules, trace scholarships to sanctions and student bank credits, and follow donor-restricted corpus uses.

Working. 1. Examine the University's governing Act, applicable regulations, Trust Deed and approved fee structure. 2. Compare admission records with student fee registers and receipt books. 3. Investigate cash collections outside the sanctioned fee schedule. 4. Verify government scholarship sanction memoranda and student eligibility. 5. Match student-wise disbursement records with bank statements and payment evidence. 6. Inspect donor correspondence and identify the designated corpus purpose. 7. Trace utilisation of restricted donations to the specified laboratory construction project.

Explanation. An educational institution's audit requires examination of its governing Act or trust deed, applicable regulations, fee records, grants and donations. Admission receipts should be compared with approved fee schedules and admission records to identify prohibited additional collections. Scholarship amounts should be matched with government sanction records, eligible beneficiaries and bank disbursement evidence. Donations designated for a specific purpose must be traced to that purpose. The principal distractor incorrectly treats restricted donations as unrestricted and omits substantive scholarship verification.

Where it goes wrong. Treating all donations and grants as ordinary receipts without considering donor restrictions, scholarship eligibility or the applicable fee prohibition.

Authority. ICAI Study Material, Chapter 9, Audit of Educational Institutions, pp. 9.46–9.49; Applicable University Act, university regulations and Trust Deed governing the institution, as stipulated in the scenario

Question 6 · 2 marks · Chapter 4: Audit Evidence · hard

Scenario. Meridian Textiles Ltd. has not included a significant consulting vendor in its related-party register. During audit, the engagement team discovers that a director's spouse is a member of the vendor entity. The company has also entered into a substantial warehouse-purchase arrangement outside its normal course of business. The purchase price exceeds an independent valuation, and supporting approval records are incomplete. Management denies that the vendor is a related party and describes the transaction as commercially necessary. The auditor must investigate the relationship, assess the unusual transaction under SA 550, examine compliance with Section 188 of the Companies Act, 2013, and consider the related-party reporting requirements under CARO 2020.

Meridian Textiles Ltd.'s management denies any relationship with its consulting vendor, although the auditor discovers that a director's spouse is a member of that entity. Which audit approach most appropriately addresses the possibility of previously unidentified or undisclosed related parties under SA 550?

1. Combine management inquiries with examination of shareholder registers, conflict declarations, tax filings, regulatory records and unusual contracts. (correct answer)
2. Obtain an updated management list and treat it as complete unless the vendor independently confirms the relationship.
3. Send confirmations to all vendors and infer that non-responses establish undisclosed related-party relationships without examining ownership records.
4. Limit procedures to board minutes because shareholder registers and regulatory filings are not relevant audit evidence.

Answer: A — Combine management inquiries with examination of shareholder registers, conflict declarations, tax filings, regulatory records and unusual contracts.

Working. 1. Inquire of management regarding the identity of related parties and changes during the period. 2. Inquire of other relevant personnel regarding relationships and transactions. 3. Inspect shareholder registers and conflict-of-interest declarations. 4. Review tax returns, regulatory filings, significant contracts and agreements outside the ordinary course of business. 5. Examine relevant internal audit reports and correspondence. 6. Corroborate the spouse's membership in the vendor entity. 7. Determine whether related-party transactions were properly identified, recorded and disclosed.

Explanation. SA 550 requires the auditor to make inquiries of management regarding related-party identities, relationships and transactions, while also performing appropriate risk assessment procedures. The auditor must remain alert when reviewing records and documents that may reveal undisclosed relationships. Shareholder registers, management conflict declarations, tax returns, regulatory filings, unusual contracts and internal audit reports are relevant sources. Merely relying on management's list would not provide sufficient evidence where contradictory information has already emerged.

Where it goes wrong. Assuming that management's declaration is conclusive and ignoring contradictory ownership or governance information identified during audit.

Authority. SA 550: Related Parties, procedures concerning identification of related-party relationships and transactions; ICAI Study Material, Chapter 4, Audit Evidence, pp. 4.105–4.109; Companies Act, 2013, Section 2(76), definition of related party

Question 7 · 2 marks · Chapter 4: Audit Evidence · hard

The auditor discovers that Meridian Textiles Ltd. entered into a substantial warehouse-purchase transaction outside its normal course of business at a price exceeding independent valuation. Which procedure is most appropriate under SA 550?

1. Accept the transaction if invoices are genuine, since unusual contracts fall outside related-party audit procedures.
2. Test only payment authorisation and ledger posting without examining commercial rationale or counterparty relationships.
3. Treat the transaction as fraud automatically because every transaction outside the normal course is presumed fictitious.
4. Examine contracts and approvals, assess business rationale, identify related-party involvement and test accounting and disclosure. (correct answer)

Answer: D — Examine contracts and approvals, assess business rationale, identify related-party involvement and test accounting and disclosure.

Working. 1. Identify the transaction as significant and outside the normal course of business. 2. Obtain an understanding of its nature, terms and commercial purpose. 3. Inspect contracts, board minutes, authorisations and supporting valuation reports. 4. Determine whether any director, relative or other related party participated. 5. Examine whether the transaction has genuine commercial substance. 6. Check the applicable accounting treatment, related-party disclosures and statutory approvals.

Explanation. Significant transactions outside an entity's normal course of business require particular attention because they may indicate undisclosed related-party involvement, unusual commercial arrangements or possible management override. The auditor should understand the transaction's business rationale, inspect relevant contracts and approvals, establish whether a related party is involved and assess the accounting and disclosures. An unusual transaction is not automatically fraudulent, but merely matching an invoice with payment does not establish its commercial substance or proper treatment.

Where it goes wrong. Assuming that an unusual transaction is automatically fraudulent or that ordinary invoice and payment testing is sufficient for its audit.

Authority. SA 550: Related Parties, requirements concerning significant transactions outside the normal course of business; SA 500: Audit Evidence; ICAI Study Material, Chapter 4, Audit Evidence, pp. 4.107–4.109

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

Meridian Textiles Ltd. argues that its warehouse purchase from a director's spouse-owned entity is exempt from Section 188 because management considers the price commercially acceptable. However, the acquisition is outside the company's ordinary course of business. Which conclusion is correct?

1. The exception applies whenever the transaction is at arm's length, even if it is outside the ordinary course of business.
2. The exception applies whenever the transaction is in the ordinary course, even if it is not at arm's length.
3. The exception requires both ordinary-course conduct and arm's-length terms; otherwise Section 188 approval requirements apply. (correct answer)
4. The exception applies whenever management approves the transaction, irrespective of its commercial nature or pricing.

Answer: C — The exception requires both ordinary-course conduct and arm's-length terms; otherwise Section 188 approval requirements apply.

Working. 1. Establish whether the vendor qualifies as a related party under Section 2(76). 2. Identify the transaction as a purchase of property from a related party. 3. Test whether the transaction is in the ordinary course of business. 4. Separately assess whether the transaction is at arm's length. 5. Since the ordinary-course condition is not satisfied, the Section 188 exception is unavailable. 6. Examine Board approval by resolution at a meeting and any applicable prior shareholder approval under the prescribed thresholds.

Explanation. Section 188(1) provides an exception for transactions entered into in the ordinary course of business and on an arm's-length basis. Both conditions must be satisfied. A transaction outside the ordinary course cannot claim this exception merely because management considers its pricing acceptable. The auditor should therefore examine the applicable Board approval requirements and determine whether prior shareholder approval is also necessary under the prescribed thresholds. The principal distractors incorrectly treat either condition individually as sufficient.

Where it goes wrong. Reading the ordinary-course and arm's-length conditions as alternative conditions instead of cumulative conditions.

Authority. Companies Act, 2013, Section 188(1), including the ordinary-course-of-business and arm's-length exception; Companies Act, 2013, Section 188(2) and applicable Companies (Meetings of Board and its Powers) Rules, 2014

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

While reporting under CARO 2020, the auditor identifies related-party transactions that have not been properly recorded in the company's related-party register. Which disclosure responsibility specifically arises under Clause 3(xiii)?

1. Report whether transactions comply with Section 185 and whether related-party details appear only in the directors' report.
2. Report compliance with Sections 177 and 188 where applicable and disclosure of related-party details under applicable accounting standards. (correct answer)
3. Report whether every related-party transaction received prior shareholder approval regardless of statutory thresholds or applicable exceptions.
4. Report only the monetary value of related-party transactions without examining statutory compliance or financial-statement disclosure.

Answer: B — Report compliance with Sections 177 and 188 where applicable and disclosure of related-party details under applicable accounting standards.

Working. 1. Obtain the related-party register and identify all related-party transactions during the year. 2. Examine the nature and value of each transaction. 3. Check compliance with Section 177, where applicable. 4. Examine compliance with Section 188, including applicable approvals and exemptions. 5. Compare transaction details with the disclosures in the financial statements. 6. Determine whether the applicable accounting standards' disclosure requirements have been satisfied. 7. Report the findings under CARO 2020 Clause 3(xiii).

Explanation. CARO 2020 Clause 3(xiii) requires the auditor to report whether all related-party transactions comply with Sections 177 and 188 of the Companies Act, 2013, where applicable, and whether their details have been disclosed in the financial statements as required by applicable accounting standards. This reporting requirement addresses both statutory compliance and accounting disclosure. It does not require shareholder approval for every related-party transaction regardless of the applicable exemptions and prescribed thresholds.

Where it goes wrong. Confusing CARO Clause 3(xiii) with an unconditional requirement for shareholder approval or treating it merely as an accounting disclosure requirement.

Authority. CARO 2020, Paragraph 3, Clause (xiii); Companies Act, 2013, Sections 177 and 188; Applicable Accounting Standards, including AS 18 or Ind AS 24, as applicable; ICAI Study Material, Chapter 8, Audit Report, p. 8.79

Question 10 · 2 marks · Chapter 7: Completion and Review · hard

Scenario. During completion of the audit of Crestline Industries Ltd., the auditor requests written representations from management confirming its responsibility for preparation of financial statements, completeness of information supplied and recording of all transactions, including liabilities that may not otherwise be evident from the accounting records. Management refuses to provide these representations, including the representation concerning the completeness of liabilities. The auditor is unable to obtain sufficient appropriate alternative audit evidence regarding the completeness of liabilities and has serious concerns about management's integrity. The auditor must determine the appropriate action under SA 580 and the resulting reporting implications under SA 705.

Management of Crestline Industries Ltd. refuses to provide written representations concerning its responsibility for preparation of financial statements and completeness of information supplied to the auditor, including the recording of all liabilities. The auditor has concerns regarding management integrity and cannot obtain sufficient appropriate alternative evidence on liability completeness. What is the appropriate course of action?

1. Discuss refusal, reassess integrity and evidence, and disclaim an opinion when management withholds core responsibility representations. (correct answer)
2. Issue an unmodified opinion if management has orally confirmed that no liabilities have been intentionally omitted.
3. Issue a qualified opinion in every case because refusal of any written representation never affects the overall audit opinion.
4. Withdraw immediately without assessing whether missing representations concern management responsibilities or specific financial-statement assertions.

Answer: A — Discuss refusal, reassess integrity and evidence, and disclaim an opinion when management withholds core responsibility representations.

Working. 1. Identify whether the missing representations concern management's fundamental responsibilities under SA 580. 2. Discuss the refusal with management. 3. Re-evaluate management's integrity and the reliability of representations and other audit evidence. 4. Assess the effect of missing information on the auditor's ability to obtain sufficient appropriate evidence. 5. Since management refuses representations regarding preparation and completeness of information and transactions, apply SA 580 paragraph 20. 6. Disclaim an opinion under SA 705 and explain the basis in the auditor's report.

Explanation. SA 580 requires management representations concerning its responsibility for preparing the financial statements and the completeness of information and transactions supplied to the auditor. When management refuses these fundamental responsibility representations, the auditor is required to disclaim an opinion in accordance with SA 705. Before reporting, the auditor should discuss the refusal and reassess management's integrity and the reliability of other audit evidence. The principal distractor incorrectly suggests that oral confirmation can replace the required written representations.

Where it goes wrong. Assuming that a qualified opinion is always sufficient when management refuses representations, or that oral assurances can replace fundamental written representations.

Authority. SA 580: Written Representations, paragraphs 19 and 20; SA 705: Modifications to the Opinion in the Independent Auditor's Report; ICAI Study Material, Chapter 7, Completion and Review, pp. 7.39–7.40

Question 11 · 2 marks · Chapter 10: Audit of Banks · medium

Scenario. Apex Bank Ltd. is undergoing its annual statutory audit. The engagement team is examining the classification and provisioning of advances under applicable RBI prudential norms. The relevant borrower accounts are as follows: Account A is a term loan with ₹80 lakh outstanding, where principal has remained overdue for 104 days and the account has been classified as NPA for four months. Account B has ₹240 lakh outstanding and has remained in the doubtful category for eight months; its eligible tangible security has a realistic realisable value of ₹150 lakh. Account C has ₹180 lakh outstanding and has remained doubtful for two years; its eligible security is valued at ₹110 lakh. Account D has ₹300 lakh outstanding and has remained doubtful for three years and eight months; primary security is realisable at ₹180 lakh and validly charged collateral security at ₹70 lakh. Account E has ₹500 lakh outstanding, with combined realisable values of primary and validly charged collateral security of only ₹42 lakh. Assume no ECGC or other credit-protection cover and no special accelerated provisioning applicable to wilful defaulters. The auditor must determine the correct classification and provision.

Account A of Apex Bank Ltd. is a term loan with ₹80 lakh outstanding. Principal has remained overdue for 104 days, and the account has been classified as NPA for four months. The realisable value of valid tangible security is ₹70 lakh. What is the appropriate classification and provision?

1. Standard asset; no specific NPA provision because the realisable security exceeds the unsecured portion.
2. Doubtful D1 asset; provision of ₹27.50 lakh after applying D1 secured and unsecured provisioning rates.
3. Loss asset; provision of ₹80 lakh because the principal instalment remained unpaid beyond ninety days.
4. Substandard asset; provision of ₹12 lakh, being 15 percent of the full ₹80 lakh outstanding. (correct answer)

Answer: D — Substandard asset; provision of ₹12 lakh, being 15 percent of the full ₹80 lakh outstanding.

Working. 1. Identify the facility as a term loan. 2. Check the overdue period: 104 days, exceeding 90 days; therefore, it is an NPA. 3. Determine the period for which it has remained NPA: four months. 4. Since this period is less than or equal to twelve months, classify it as substandard. 5. Applicable provision = 15 percent of ₹80 lakh. 6. Required provision = ₹12 lakh. 7. Do not deduct the ₹70 lakh security value while calculating this substandard provision.

Explanation. A term loan becomes an NPA when principal or interest remains overdue for more than 90 days. Since Account A has remained NPA for only four months, it falls within the substandard category because it has not remained NPA beyond twelve months. The provision for a secured substandard asset is 15 percent of total outstanding without deducting the value of available security. The D1 provisioning rate applies only after the account becomes doubtful, making the principal distractor incorrect.

Where it goes wrong. Applying doubtful-asset provisioning merely because a loan has crossed the 90-day NPA threshold or deducting security while calculating a substandard asset provision.

Authority. RBI (Commercial Banks – Income Recognition, Asset Classification and Provisioning) Directions, 2025, definitions of NPA and substandard asset and paragraph 85; ICAI Study Material, Chapter 10, Audit of Banks, pp. 10.27–10.28

Question 12 · 2 marks · Chapter 10: Audit of Banks · hard

Account B of Apex Bank Ltd. has remained in the doubtful category for eight months. Its outstanding balance is ₹240 lakh, and the realistic realisable value of valid tangible security is ₹150 lakh. There is no credit-protection cover. Calculate the required provision under RBI prudential norms.

1. ₹37.50 lakh, being 25 percent of the secured portion only.
2. ₹90 lakh, being 100 percent of the unsecured portion only.
3. ₹127.50 lakh, being 25 percent of the secured portion plus 100 percent of the unsecured portion. (correct answer)
4. ₹240 lakh, being 100 percent of the entire outstanding balance irrespective of the doubtful period.

Answer: C — ₹127.50 lakh, being 25 percent of the secured portion plus 100 percent of the unsecured portion.

Working. 1. Outstanding balance = ₹240 lakh. 2. Realisable value of eligible security = ₹150 lakh. 3. Secured portion = ₹150 lakh. 4. Unsecured portion = ₹240 lakh minus ₹150 lakh = ₹90 lakh. 5. D1 provision on secured portion = 25 percent of ₹150 lakh = ₹37.50 lakh. 6. D1 provision on unsecured portion = 100 percent of ₹90 lakh = ₹90 lakh. 7. Total required provision = ₹37.50 lakh + ₹90 lakh = ₹127.50 lakh.

Explanation. An advance that has remained doubtful for eight months falls in D1. The secured portion is determined using the realistic realisable value of security to which the bank has valid recourse. The balance represents the unsecured portion. D1 provisioning requires 25 percent on the secured portion and 100 percent on the unsecured portion. Applying 25 percent to the entire outstanding balance would materially understate the provision because it ignores the separate full provisioning requirement applicable to the unsecured amount.

Where it goes wrong. Applying the secured-portion rate to the entire outstanding balance instead of separately providing for the unsecured portion.

Authority. RBI (Commercial Banks – Income Recognition, Asset Classification and Provisioning) Directions, 2025, paragraphs 90 and 91; ICAI Study Material, Chapter 10, Audit of Banks, pp. 10.28 and 10.65

Question 13 · 2 marks · Chapter 10: Audit of Banks · hard

Account C of Apex Bank Ltd. has remained doubtful for two years. Its outstanding balance is ₹180 lakh and the realistic realisable value of eligible tangible security is ₹110 lakh. No credit-protection cover is available. Determine the required provision.

1. ₹44 lakh, being 40 percent of the secured portion only.
2. ₹114 lakh, being 40 percent of the secured portion plus 100 percent of the unsecured portion. (correct answer)
3. ₹72 lakh, being 40 percent of the entire outstanding balance.
4. ₹180 lakh, being 100 percent of the entire outstanding balance irrespective of the doubtful period.

Answer: B — ₹114 lakh, being 40 percent of the secured portion plus 100 percent of the unsecured portion.

Working. 1. Outstanding balance = ₹180 lakh. 2. Realisable security value = ₹110 lakh. 3. Secured portion = ₹110 lakh. 4. Unsecured portion = ₹180 lakh minus ₹110 lakh = ₹70 lakh. 5. D2 provision on secured portion = 40 percent of ₹110 lakh = ₹44 lakh. 6. D2 provision on unsecured portion = 100 percent of ₹70 lakh = ₹70 lakh. 7. Total provision = ₹44 lakh + ₹70 lakh = ₹114 lakh.

Explanation. An advance remaining doubtful for two years falls within D2. Under the applicable provisioning requirements, the secured portion attracts a provision of 40 percent, while the unsecured portion requires a provision of 100 percent. The security value is deducted from the outstanding balance to determine the unsecured amount. Applying 40 percent to the entire outstanding balance would incorrectly reduce the provision on the unsecured portion, which must be fully provided for.

Where it goes wrong. Applying the D2 secured-portion percentage to the entire advance instead of separately identifying the unsecured portion.

Authority. RBI (Commercial Banks – Income Recognition, Asset Classification and Provisioning) Directions, 2025, paragraphs 90 and 91; ICAI Study Material, Chapter 10, Audit of Banks, pp. 10.28 and 10.66–10.67

Question 14 · 2 marks · Chapter 10: Audit of Banks · hard

Consider Accounts D and E of Apex Bank Ltd. Account D has remained doubtful for three years and eight months, with ₹300 lakh outstanding, primary security realisable at ₹180 lakh and validly charged collateral realisable at ₹70 lakh. Account E has ₹500 lakh outstanding, with combined realisable values of primary and validly charged collateral security of ₹42 lakh. Which treatment is correct?

1. D: D3, provision ₹300 lakh; E: Loss asset, provision ₹500 lakh after ignoring security. (correct answer)
2. D: D2, provision ₹250 lakh; E: Doubtful asset, provision ₹468.50 lakh using D1 rates.
3. D: D3, provision ₹250 lakh; E: Substandard asset, provision ₹75 lakh on gross balance.
4. D: D1, provision ₹112.50 lakh; E: Standard asset, provision ₹2 lakh on gross balance.

Answer: A — D: D3, provision ₹300 lakh; E: Loss asset, provision ₹500 lakh after ignoring security.

Working. ACCOUNT D: 1. Period in doubtful category = 3 years and 8 months; therefore, D3. 2. Secured portion = ₹180 lakh + ₹70 lakh = ₹250 lakh. 3. Unsecured portion = ₹300 lakh minus ₹250 lakh = ₹50 lakh. 4. D3 provision = 100 percent of ₹250 lakh + 100 percent of ₹50 lakh = ₹300 lakh. ACCOUNT E: 5. Combined realisable security = ₹42 lakh. 6. Security as a percentage of outstanding = ₹42 lakh divided by ₹500 lakh multiplied by 100 = 8.4 percent. 7. Since 8.4 percent is below 10 percent, the existence of security is ignored and the account is straightaway classified as a loss asset. 8. Required provision = 100 percent of ₹500 lakh = ₹500 lakh.

Explanation. Account D has remained doubtful for more than three years and therefore falls under D3. Its secured and unsecured portions both attract provisioning at 100 percent, requiring ₹300 lakh. For Account E, combined realisable security of ₹42 lakh represents only 8.4 percent of the ₹500 lakh outstanding. Under the security-erosion provisions, where realisable security is below 10 percent of outstanding, the security is ignored and the advance is classified directly as a loss asset, requiring full provision.

Where it goes wrong. Applying D2 or D1 provisioning to a D3 account, or overlooking the special loss-asset classification rule when realisable security falls below 10 percent of outstanding.

Authority. RBI (Commercial Banks – Income Recognition, Asset Classification and Provisioning) Directions, 2025, paragraphs 67, 68(2), 90, 91 and 94–95; ICAI Study Material, Chapter 10, Audit of Banks, pp. 10.28, 10.32 and 10.65–10.67

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

Scenario. Orbit Industries Ltd. is a public company. During the financial year, it granted loans to a director and to a private company in which a director's relative is a member. The auditor must examine the applicability and compliance of Sections 185 and 186 of the Companies Act, 2013. The company also raised ₹5 crore through an initial public offer, which was utilised for the stated plant-expansion purpose, and ₹2 crore through private placement of shares. Contrary to the stated purpose, the private-placement proceeds were utilised to settle existing promoter-related borrowings. The auditor is required to determine the separate reporting implications under the relevant clauses of CARO 2020.

Orbit Industries Ltd. has granted loans to directors and an entity in which a director's relative is interested. It has also raised IPO proceeds and private-placement proceeds, but private-placement funds have been diverted from their stated purpose. Which combination of CARO 2020 reporting requirements is correct?

1. Report director lending under Clause 3(x)(a), IPO utilisation under Clause 3(iv) and private placement under Clause 3(xiii).
2. Report director lending only under Clause 3(iii), while private-placement proceeds do not require separate reporting under CARO.
3. Report Section 185 and 186 compliance under Clause 3(iv), IPO utilisation under Clause 3(x)(a), and private-placement compliance and utilisation under Clause 3(x)(b). (correct answer)
4. Report both IPO and private-placement proceeds under Clause 3(xiii), while examining director lending only under Section 188.

Answer: C — Report Section 185 and 186 compliance under Clause 3(iv), IPO utilisation under Clause 3(x)(a), and private-placement compliance and utilisation under Clause 3(x)(b).

Working. 1. Identify loans, investments, guarantees and security arrangements. 2. Examine applicability and compliance with Sections 185 and 186. 3. Report the compliance position under CARO Clause 3(iv), providing details where non-compliance exists. 4. Examine IPO proceeds under Clause 3(x)(a) and compare actual utilisation with the stated purpose. 5. Since the IPO funds were properly utilised, report the appropriate utilisation position. 6. Examine the private placement under Clause 3(x)(b), including compliance with Sections 42 and 62. 7. Identify the amount diverted and the nature of non-compliance and report the details under Clause 3(x)(b).

Explanation. CARO 2020 distinguishes these reporting matters. Clause 3(iv) requires reporting on compliance with Sections 185 and 186 concerning loans, investments, guarantees and security. Clause 3(x)(a) concerns utilisation of money raised through IPO or FPO, including debt instruments. Clause 3(x)(b) addresses preferential allotments and private placements, including compliance with Sections 42 and 62 and utilisation of proceeds for their stated purposes. The private-placement diversion must therefore be specifically reported with relevant details.

Where it goes wrong. Confusing the IPO utilisation requirement with the private-placement compliance requirement or treating director loans as a matter exclusively covered by Section 188.

Authority. CARO 2020, Paragraph 3, Clause (iv); CARO 2020, Paragraph 3, Clause (x)(a) and Clause (x)(b); Companies Act, 2013, Sections 185 and 186; Companies Act, 2013, Sections 42 and 62; ICAI Study Material, Chapter 8, Audit Report, pp. 8.76–8.78