Test 6: answer key

Question 1 · 2 marks · Audit Evidence · medium

Scenario. CA N is appointed statutory auditor of A Ltd for FY 2025-26. Prior year statements were examined by predecessor P, who issued a qualified opinion on inventory. Opening inventory and opening receivables are material. P declines to share working papers. CA N finds evidence that opening balances may contain misstatements affecting current statements.

In s1, if CA N obtains evidence that opening balances contain misstatements that could materially affect the current financial statements, what immediate course is required by SA 510?

1. Ignore the matter because the prior year statements were examined by another firm.
2. Perform additional procedures to determine the effect and communicate any current-period misstatement. (correct answer)
3. Disclaim the opinion immediately without performing any further audit procedure.
4. Report the matter only as an Other Matter and continue with an unmodified opinion.

Answer: B — Perform additional procedures to determine the effect and communicate any current-period misstatement.

Working. Step 1: Check whether opening balances may be materially misstated. Step 2: Perform additional procedures to determine effect. Step 3: If misstatements exist in current statements, communicate with management and those charged with governance.

Explanation. SA 510 requires the auditor to perform additional procedures when evidence indicates opening balances may contain misstatements materially affecting the current statements. The auditor must determine the effect on the current statements and communicate if misstatements exist. Ignoring the matter or automatically disclaiming is incorrect because the standard requires further procedures first. An Other Matter paragraph alone does not address an unresolved material misstatement.

Where it goes wrong. Students assume a predecessor audit automatically supports the opening balances or that a disclaimer is the only response.

Authority. SA 510: Initial Audit Engagements-Opening Balances, para 10; ICAI Study Material Paper 5, Chapter 4

Question 2 · 2 marks · Audit Evidence · medium

In s1, which procedure is specifically permitted by SA 510 when the prior year financial statements were examined by a predecessor auditor?

1. Demand all predecessor working papers as a legal right before accepting the engagement.
2. Reperform the predecessor auditor's entire prior-year audit before issuing any report.
3. Peruse prior examined under statutory audit statements and relevant documents such as supporting schedules. (correct answer)
4. Rely solely on a management representation about the opening balances.

Answer: C — Peruse prior examined under statutory audit statements and relevant documents such as supporting schedules.

Working. Identify permitted procedures: peruse prior statutorily examined statements; evaluate current-period procedures; perform specific opening-balance procedures. Working papers may be requested but access is not a statutory right under SA 510.

Explanation. SA 510 permits the current auditor, where prior statements were examined under statutory audit, to obtain evidence about opening balances by perusing copies of the examined under statutory audit prior financial statements and other relevant documents such as supporting schedules. There is no legal right to demand all predecessor working papers, and full reperformance is not required. Management representation alone is not sufficient appropriate evidence.

Where it goes wrong. Students think the current auditor has an absolute right to all predecessor working papers or must repeat the prior audit.

Authority. SA 510: Initial Audit Engagements-Opening Balances, para 7; ICAI Study Material Paper 5, Chapter 4

Question 3 · 2 marks · Completion and Review · hard

In s1, assume the opening balances contain a misstatement that materially affects the current financial statements and is not properly accounted for or disclosed. What reporting response is appropriate under SA 510?

1. Unmodified opinion with an Emphasis of Matter paragraph on the opening balances.
2. Qualified opinion only when the misstatement is also pervasive in the current statements.
3. Disclaimer of opinion because opening balances were examined by another auditor.
4. Qualified or adverse opinion as appropriate after considering materiality and pervasiveness. (correct answer)

Answer: D — Qualified or adverse opinion as appropriate after considering materiality and pervasiveness.

Working. Assess materiality and pervasiveness. If material but not pervasive, qualify; if material and pervasive, adverse. Disclose basis in the Basis for Qualified or Adverse Opinion section.

Explanation. If opening balances contain a material misstatement affecting the current statements and the effect is not properly accounted for or disclosed, SA 510 requires a qualified or adverse opinion as appropriate under SA 705. The choice depends on materiality and pervasiveness. An Emphasis of Matter paragraph does not replace a modified opinion. A disclaimer arises from inability to obtain evidence, not merely because a predecessor examined under statutory audit the prior year.

Where it goes wrong. Students use Emphasis of Matter as a substitute for a modified opinion when opening balances are misstated.

Authority. SA 510: Initial Audit Engagements-Opening Balances, para 13; SA 705: Modifications to the Opinion, paras 7-9

Question 4 · 2 marks · Audit Evidence · medium

In s1, the predecessor auditor declines access to working papers. What should CA N do about obtaining evidence on opening balances?

1. Perform alternative procedures to obtain sufficient appropriate evidence about opening balances. (correct answer)
2. Withdraw from the engagement because working-paper access is mandatory.
3. Issue a disclaimer solely because the predecessor declined access.
4. Treat prior examined under statutory audit statements as sole evidence and issue an unmodified opinion.

Answer: A — Perform alternative procedures to obtain sufficient appropriate evidence about opening balances.

Working. Consider perusal of prior statutorily examined statements, current-period evidence, and specific opening-balance procedures. If evidence remains insufficient, consider implications under SA 705.

Explanation. Access to predecessor working papers is not a mandatory statutory right. If access is declined, the current auditor should perform alternative procedures to obtain sufficient appropriate evidence about opening balances. Withdrawal or disclaimer is not automatic. Prior examined under statutory audit statements alone may not be sufficient, and the auditor cannot simply issue an unmodified opinion without adequate evidence.

Where it goes wrong. Students treat predecessor working papers as indispensable and assume refusal forces withdrawal or disclaimer.

Authority. SA 510: Initial Audit Engagements-Opening Balances, paras 6-7; ICAI Study Material Paper 5, Chapter 4

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

Scenario. CA R audits Cineplex Ltd, a cinema hall with online booking, printed tickets, QR entry and a canteen run by a franchise. Management asks for focus on ticket revenue, refunds and franchise sharing.

In s2, which audit procedure is most appropriate for online cinema ticket revenue?

1. Check only the serial control over printed ticket stock used at the cinema entrance.
2. Reconcile platform settlement reports with ticketing records, bank credits and refunds. (correct answer)
3. Obtain a management representation that all online ticket sales are fully recorded.
4. Examine only the franchise agreement for canteen sales and ignore ticket revenue.

Answer: B — Reconcile platform settlement reports with ticketing records, bank credits and refunds.

Working. Obtain ticketing system reports, platform settlement reports and bank statements. Reconcile gross ticket sales, cancellations, refunds, charges and net bank credits. Test QR scan reports for completeness.

Explanation. For online cinema ticket revenue, the auditor should reconcile third-party booking platform settlement reports with the ticketing system, bank credits, refunds, cancellations and convenience fees. Checking only printed ticket stock ignores online sales. Management representation alone is insufficient. Canteen franchise revenue is relevant but does not replace testing ticket revenue.

Where it goes wrong. Students focus on physical ticket stock and overlook online platform reconciliation, refunds and settlement timing.

Authority. ICAI Study Manual Paper 5, Chapter 9: Audit of Cinema; SA 500: Audit Evidence, para 6

Question 6 · 2 marks · Audit of Items of Financial Statements · medium

Scenario. CA S audits Retail Ltd. Year-end sales include goods dispatched before year-end but invoiced after, bill-and-hold sales, goods sent on approval, and volume rebates. The auditor designs cut-off and revenue recognition procedures.

In s3, goods are dispatched before year-end but the invoice is dated after year-end, and risks and rewards transferred before year-end. How should the auditor treat the sale?

1. Exclude the sale from current year because the invoice is dated after year-end.
2. Include the sale in next year unless cash was received before year-end.
3. Include in current year when transfer occurred before year-end and cut-off evidence supports it. (correct answer)
4. Defer recognition until the customer confirms acceptance in writing.

Answer: C — Include in current year when transfer occurred before year-end and cut-off evidence supports it.

Working. Compare dispatch documents, shipping logs, customer acceptance and invoice dates. Trace transactions around year-end to determine the correct accounting period.

Explanation. Cut-off testing focuses on when risks and rewards of ownership transfer, not merely the invoice date. If goods were dispatched and control transferred before year-end, revenue should be recognized in the current year even if invoicing occurs later. Excluding it solely due to invoice date would understate revenue. Cash receipt is not the sole recognition criterion.

Where it goes wrong. Students use the invoice date as the only cut-off criterion and ignore transfer of risks and rewards.

Authority. SA 500: Audit Evidence; AS 9: Revenue Recognition; ICAI Study Material Paper 5, Chapter 5

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

In s3, which condition is essential before revenue can be recognized on a bill-and-hold sale?

1. Customer controls goods, items identified and ready, and substantive business reason exists. (correct answer)
2. Goods remain in production and are not separately identified for the customer.
3. Invoice is raised solely to meet a sales target at the reporting date.
4. Customer may cancel without penalty and goods remain interchangeable.

Answer: A — Customer controls goods, items identified and ready, and substantive business reason exists.

Working. Examine the contract, customer acknowledgement, identification of goods, delivery readiness and business purpose. If control has not passed, defer revenue.

Explanation. Bill-and-hold revenue is recognized only when the customer obtains control, the goods are identified and ready for delivery, and a substantive business reason exists for the arrangement. If goods are interchangeable, still in production, or can be cancelled without penalty, recognition is generally not appropriate. Invoicing alone or meeting a sales target is not sufficient.

Where it goes wrong. Students accept bill-and-hold sales merely because an invoice has been raised.

Authority. AS 9: Revenue Recognition; SA 500: Audit Evidence; ICAI Study Material Paper 5, Chapter 5

Question 8 · 2 marks · Audit of Items of Financial Statements · medium

In s3, goods are sent to a customer on an approval basis. When should the auditor expect revenue recognition?

1. On dispatch of goods to the customer under the approval arrangement.
2. On issue of invoice even if the customer has not accepted the goods.
3. On receipt of cash from the customer under the approval arrangement.
4. On customer acceptance or expiry of the approval period without return. (correct answer)

Answer: D — On customer acceptance or expiry of the approval period without return.

Working. Inspect approval terms, customer acceptance records and return records. Adjust inventory and revenue for goods not accepted or returned within the approval period.

Explanation. For goods sent on approval, revenue is recognized when the customer accepts the goods or the approval period expires without return. Dispatch or invoicing alone does not transfer the significant risks and rewards. Cash receipt is not the sole criterion. Until acceptance or expiry, the goods are generally treated as inventory of the seller.

Where it goes wrong. Students recognize revenue on dispatch or invoice for approval sales.

Authority. AS 9: Revenue Recognition; ICAI Study Material Paper 5, Chapter 5

Question 9 · 2 marks · Audit of Items of Financial Statements · medium

In s3, the entity has volume rebates and expects some sales returns at year-end. What should the auditor ensure about revenue measurement?

1. Record gross revenue and ignore rebates until a claim is received.
2. Record revenue net of rebates and provide for expected returns where appropriate. (correct answer)
3. Record rebates only when paid and treat returns as prior-period items.
4. Record gross revenue and disclose rebates only in the directors' report.

Answer: B — Record revenue net of rebates and provide for expected returns where appropriate.

Working. Review rebate agreements, sales return history, credit notes after year-end and accrual calculations. Test whether revenue and provisions reflect net amounts.

Explanation. Revenue is measured at the fair value of consideration received or receivable, net of discounts and volume rebates. Expected sales returns should be accounted for where appropriate so that revenue and receivables are not overstated. Ignoring rebates until claimed or treating returns as prior-period items would misstate current revenue.

Where it goes wrong. Students record gross revenue and ignore expected rebates or returns at year-end.

Authority. AS 9: Revenue Recognition; ICAI Study Material Paper 5, Chapter 5

Question 10 · 2 marks · Audit Report · hard

Scenario. CA T audits Mfg Ltd. FY 2025-26 loss after tax is 120 lakh. Depreciation is 40 lakh; amortisation is 10 lakh; no other non-cash items. CARO 2020 applies.

In s4, what is the amount of cash loss for FY 2025-26 for CARO 2020 clause (xvii)?

1. 120 lakh
2. 50 lakh
3. 70 lakh (correct answer)
4. 170 lakh

Answer: C — 70 lakh

Working. Start with net loss after tax ₹120 lakh. Deduct non-cash items: depreciation ₹40 lakh and amortisation ₹10 lakh. Cash loss = 120 - 50 = ₹70 lakh.

Explanation. Cash loss under CARO 2020 clause (xvii) is derived by adjusting the net loss after tax for non-cash items such as depreciation and amortisation. Here, net loss after tax ₹120 lakh less non-cash expenses of ₹50 lakh (depreciation ₹40 lakh + amortisation ₹10 lakh) equals ₹70 lakh. Option (d) ₹170 lakh is a trap that incorrectly adds non-cash items to the loss instead of deducting them.

Where it goes wrong. Incorrectly adding non-cash depreciation and amortisation to net loss rather than deducting them gives ₹170 lakh.

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

Question 11 · 2 marks · Audit of Banks · medium

Scenario. CA U audits a bank branch. It has short-duration crop loans, long-duration crop loans, natural calamity restructured accounts and interest subvention claims. Auditor checks NPA and subsidy treatment.

In s5, a short-duration crop loan is overdue for one crop season. How should the auditor classify it under RBI norms?

1. Standard, since NPA arises only after overdue for two crop seasons. (correct answer)
2. Substandard immediately on expiry of one crop season.
3. Doubtful after 90 days from the balance sheet date.
4. Loss asset because the crop season has ended.

Answer: A — Standard, since NPA arises only after overdue for two crop seasons.

Working. Identify crop duration. For short-duration crops, compare overdue period with two crop seasons. If only one season is overdue, treat as standard subject to other norms.

Explanation. For short-duration crops, a loan becomes NPA only when the instalment or interest remains overdue for two crop seasons. Overdue for one crop season does not by itself make it NPA. The 90-day rule is modified for agricultural advances by crop-season norms. Substandard, doubtful or loss classification follows only after NPA.

Where it goes wrong. Students apply the general 90-day rule to agricultural crop loans.

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

Question 12 · 2 marks · Audit of Banks · medium

In s5, a long-duration crop loan is overdue for one crop season. How should the auditor classify it under RBI norms?

1. Standard until overdue for two crop seasons.
2. SMA-2 only until 90 days past due.
3. NPA only after 90 days from the balance sheet date.
4. NPA because overdue for one crop season. (correct answer)

Answer: D — NPA because overdue for one crop season.

Working. Determine whether the crop is long duration. Compare overdue period with one crop season. If overdue for one season, classify as NPA and apply provisioning and income recognition norms.

Explanation. For long-duration crops, a loan becomes NPA if the instalment or interest remains overdue for one crop season. The two-crop-season rule applies to short-duration crops. SMA classification is an early-stress indicator, not a substitute for the crop-season NPA rule. The 90-day rule is modified for these agricultural advances.

Where it goes wrong. Students apply the two-crop-season rule to all agricultural advances.

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

Question 13 · 2 marks · Audit of Banks · hard

In s5, a crop loan affected by a natural calamity is restructured. What governs its NPA classification?

1. Original contractual due dates without considering the calamity relief.
2. Rescheduled terms under the RBI master circular on natural calamity relief. (correct answer)
3. Uniform 90-day rule without any relief for natural calamity.
4. Management discretion after informing the statutory auditor.

Answer: B — Rescheduled terms under the RBI master circular on natural calamity relief.

Working. Inspect restructuring documents and RBI scheme eligibility. Check whether rescheduled terms are applied and whether classification and provisioning follow the master circular.

Explanation. For agricultural advances affected by natural calamities, RBI permits relief measures such as conversion or rescheduling. The NPA classification is governed by the rescheduled terms under the applicable master circular. Original due dates or a uniform 90-day rule may not reflect the relief. Management cannot choose classification at its discretion.

Where it goes wrong. Students ignore RBI natural calamity relief and apply ordinary due dates.

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

Question 14 · 2 marks · Audit of Banks · medium

In s5, what is the most appropriate audit procedure for an agricultural interest subvention claim?

1. Accept the subsidy amount as recorded by management in the books.
2. Check only the bank credit for subsidy and ignore the claim computation.
3. Check eligibility, claim computation and receipt, and ensure correct accounting. (correct answer)
4. Ignore subsidy because it is a government scheme outside audit scope.

Answer: C — Check eligibility, claim computation and receipt, and ensure correct accounting.

Working. Obtain scheme guidelines and claim forms. Recompute eligible interest subvention. Trace receipt to bank statements. Check accounting treatment and disclosure.

Explanation. The auditor should examine scheme eligibility, loan sanction and disbursement records, the interest subvention computation, and evidence of receipt. Accounting should reflect the subsidy correctly and not net amounts inappropriately. Accepting management figures or checking only bank credit is insufficient. Government schemes are not outside audit scope.

Where it goes wrong. Students treat subsidy as a government matter and rely only on the amount credited by the bank.

Authority. SA 500: Audit Evidence; ICAI Study Material Paper 5, Chapter 10

Question 15 · 2 marks · Audit Report · medium

Scenario. During a tax search, Q Ltd surrendered unrecorded income. CARO 2020 applies. Auditor considers clause (viii) reporting and accounting treatment.

In s6, what should the auditor report under CARO 2020 clause (viii) regarding income surrendered in a tax search?

1. Whether such income was surrendered and whether it and related assets are now recorded. (correct answer)
2. Only the amount of tax paid on the surrendered income during the year.
3. Only whether a tax search took place during the financial year.
4. No reporting is needed because it is a taxation matter.

Answer: A — Whether such income was surrendered and whether it and related assets are now recorded.

Working. Inspect tax search assessment, surrender statements and accounting entries. Check whether unrecorded income and related assets are recorded in the books. Report under clause (viii).

Explanation. CARO 2020 clause (viii) requires reporting whether transactions not recorded in books were surrendered or disclosed as income in tax assessments and whether the previously unrecorded income and related assets were properly recorded in the books during the year. Reporting only tax paid or existence of search is incomplete. It is not excluded merely because it arises in taxation.

Where it goes wrong. Students treat surrendered income as purely a tax matter and omit CARO reporting.

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