Ethics and Terms of Audit Engagements - Test 3: answer key

Question 1 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · medium

Scenario. M/s Sharma & Associates is the statutory auditor of Alpha Infotech Ltd., a listed software group that plans to sell its data-centre subsidiary, Orbit Networks Ltd. The firm's transaction advisory division has separately been approached by Beta Capital, which is preparing a hostile bid for Orbit. Alpha has also asked the firm to advise its board on evaluating competing offers. The two mandates therefore concern opposing sides of the same proposed transaction. The engagement partner initially believes that separate departments can undertake both assignments without difficulty. During an audit planning meeting, the team identifies an unusual weakness in the client's document-management system. Valuation models, board papers and draft sale terms are stored in a shared project drive. Staff from the transaction advisory division can access folders originally created for Alpha's statutory audit, and an associate has already downloaded an Alpha valuation schedule while preparing Beta's transaction proposal. The firm has no central conflict register covering its other offices and network entities. Its existing engagement letters contain a general statement that the firm may act for other clients in the same industry, but they do not describe this transaction-specific conflict. The audit partner proposes creating separate engagement teams, introducing password-restricted folders and appointing an independent reviewer. However, Beta asks the firm to represent it in negotiations against Alpha, while Alpha refuses to permit disclosure of confidential information relating to its sale strategy. The partner is concerned that declining either mandate will result in a substantial loss of fees. The firm's ethics committee must decide whether safeguards are sufficient, what disclosures and consents are necessary, and whether both engagements can ethically continue.

Before deciding whether to accept Beta Capital's mandate, which action most accurately reflects the firm's responsibility regarding identification of conflicts of interest?

1. Identify conflicts only when the same partner is assigned to both engagements, since departmental separation otherwise establishes independence.
2. Obtain Alpha's approval first and conduct the firm's conflict assessment only if Alpha objects to the proposed advisory engagement.
3. Establish a process to identify relevant interests and relationships before accepting engagements and remain alert to changes throughout their performance. (correct answer)
4. Rely on the general engagement-letter disclosure because it already informs clients that the firm serves other entities in their industry.

Answer: C — Establish a process to identify relevant interests and relationships before accepting engagements and remain alert to changes throughout their performance.

Explanation. ICAI Code of Ethics, 13th Edition, Volume II, R310.5, requires reasonable steps to identify circumstances that might create conflicts before accepting a new engagement or business relationship. Paragraph 310.5 A1 clarifies that identification must continue throughout the engagement. Network firm relationships must also be considered under R310.7. A general industry disclosure does not replace an effective transaction-specific conflict identification process. turn336289view0

Where it goes wrong. Confusing departmental separation with conflict identification and assuming that conflicts arise only when the same individual serves both clients.

Authority. ICAI Code of Ethics

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

Assuming the firm is not required to decline either engagement on other grounds, which combination represents appropriate safeguards against unauthorised disclosure of confidential information?

1. Establish separate engagement teams, restrict access to client files, execute confidentiality agreements and arrange an appropriate independent review. (correct answer)
2. Allow both teams unrestricted access but instruct their members not to exchange commercially sensitive information without management approval.
3. Appoint separate engagement partners and retain the shared drive, provided that both partners sign an annual independence declaration.
4. Obtain a general confidentiality undertaking from the clients and permit the existing team members to continue working on both assignments.

Answer: A — Establish separate engagement teams, restrict access to client files, execute confidentiality agreements and arrange an appropriate independent review.

Explanation. ICAI Code of Ethics, Volume II, paragraphs 310.8 A2 and 310.8 A3, identify separate practice areas, restricted file access, confidentiality agreements, physical and electronic separation, dedicated training, separate engagement teams and an appropriate independent reviewer as relevant safeguards. Merely appointing separate partners or obtaining client undertakings does not prevent unauthorised internal access to confidential information. The measures must address the actual information-sharing risk. turn769318view3

Where it goes wrong. Assuming that separate engagement partners alone create an effective information barrier even when both teams retain unrestricted access to client records.

Authority. ICAI Code of Ethics

Question 3 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · medium

If the firm determines that specific disclosure and explicit consent are necessary to address the conflict, what should it ordinarily do?

1. Obtain approval from Alpha alone because it is the statutory audit client, while Beta may be treated as an advisory client.
2. Include a general reference to potential conflicts in the next engagement letter and presume acceptance if neither client objects.
3. Disclose only the existence of another engagement without explaining the circumstances or the safeguards being implemented.
4. Provide affected clients sufficient information about the conflict and planned safeguards to enable informed decisions and obtain their explicit consent. (correct answer)

Answer: D — Provide affected clients sufficient information about the conflict and planned safeguards to enable informed decisions and obtain their explicit consent.

Explanation. ICAI Code of Ethics, Volume II, R310.9 and paragraphs 310.9 A1–A3, require professional judgment regarding the need for specific disclosure and explicit consent. Generally, the affected clients should receive sufficient details about the conflict and how threats are addressed to make an informed decision. A generic disclosure that the firm serves other clients is not necessarily sufficient for this direct transaction-specific conflict. turn336289view0

Where it goes wrong. Confusing general consent to provide services to multiple industry participants with informed and explicit consent to a particular conflicting engagement.

Authority. ICAI Code of Ethics

Question 4 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · hard

Alpha refuses disclosure of confidential information, making explicit consent impossible. Beta nevertheless requires the firm to act as its advocate in the hostile takeover against Alpha. What is the most appropriate conclusion?

1. Continue both engagements because separate teams and confidentiality agreements are sufficient to eliminate every conflict arising from competing mandates.
2. Decline or end the conflicting advocacy assignment because the conditions for continuing without disclosure under R310.12 are not satisfied. (correct answer)
3. Continue the transaction advisory assignment because the firm is permitted to represent any client whose fee is commercially significant.
4. Continue the audit and advisory assignments after obtaining approval from the audit committee of Alpha alone.

Answer: B — Decline or end the conflicting advocacy assignment because the conditions for continuing without disclosure under R310.12 are not satisfied.

Explanation. ICAI Code of Ethics, Volume II, R310.12, provides limited conditions for continuing an engagement where specific disclosure to obtain consent would breach confidentiality. These include that the firm must not act as an advocate for one client against another in the same adversarial matter, must have specific confidentiality measures and must satisfy the reasonable and informed third-party test. The proposed hostile takeover advocacy fails the first condition. turn336289view0

Where it goes wrong. Assuming that effective confidentiality barriers automatically permit the firm to act as an advocate against another existing client.

Authority. ICAI Code of Ethics

Question 5 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · medium

Scenario. M/s K. Mehta & Co. is the statutory auditor of Zenith Manufacturing Ltd., a large engineering company with operations across three states. The firm has examined under statutory audit Zenith for four years. During the current year, the company has experienced severe cash-flow difficulties following cancellation of a major export contract. A bank confirmation obtained by the audit team shows that two loan instalments remain unpaid, while management's cash-flow forecast assumes that the lender will extend the repayment schedule without a signed sanction. Several material supplier invoices also remain unpaid. Zenith owes the audit firm fees for the preceding audit and additional professional services. The outstanding amount represents a substantial sum for the firm and has remained unpaid for fourteen months. The managing director states that payment will be made only after the current audit report is issued and the company receives fresh finance. He refuses to make even a partial payment, despite having sufficient funds to pay selected other advisers. The engagement partner is worried that insisting on payment may result in replacement. At the same time, the CFO offers the engagement partner and the audit manager a four-night stay at an expensive resort, including travel and entertainment, describing it as a customary annual client courtesy. The firm also receives a proposal to make the audit fee partly dependent on the company's reported profit and partly payable only if the auditor issues an unmodified opinion. Management argues that this will align the auditor's incentives with the company's recovery. The engagement partner must decide how to address the hospitality, the proposed fee arrangement and the accumulated unpaid fees without compromising independence or the audit of going concern assumptions.

How should the engagement partner respond to the CFO's offer of an expensive resort stay, including travel and entertainment, for the audit team?

1. Accept the offer after obtaining approval from the audit committee and documenting the estimated hospitality value.
2. Accept the offer if the engagement partner does not personally participate in the audit of Zenith's hospitality expenditure.
3. Accept the offer after appointing an independent reviewer to examine the team's subsequent audit conclusions.
4. Refuse the offer because hospitality from an audit client may be accepted only when its value is trivial and inconsequential. (correct answer)

Answer: D — Refuse the offer because hospitality from an audit client may be accepted only when its value is trivial and inconsequential.

Explanation. ICAI Code of Ethics, Volume II, R420.3, prohibits a firm, network firm or audit team member from accepting gifts and hospitality from an audit client unless the value is trivial and inconsequential. An expensive resort holiday is outside this exception. Management approval or an independent review cannot convert substantial hospitality into permissible conduct. Paragraph 420.3 A2 additionally prohibits gifts or hospitality intended to improperly influence behaviour, even where their value is trivial. turn839784view2

Where it goes wrong. Believing that management approval or an independent review can cure acceptance of hospitality exceeding the permitted trivial and inconsequential value.

Authority. ICAI Code of Ethics

Question 6 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · hard

Zenith proposes that the statutory audit fee be calculated partly as a percentage of reported profits and partly made payable only when an unmodified opinion is issued. What is the correct treatment?

1. Reject the proposed contingent audit remuneration because it is prohibited except in specifically permitted circumstances under Regulation 192. (correct answer)
2. Accept the arrangement if the engagement partner does not participate in management's preparation of the profit calculation.
3. Accept the arrangement after obtaining prior consent from the audit committee and documenting the fee calculation.
4. Accept the arrangement if the audit opinion remains based on sufficient appropriate evidence and an independent review is performed.

Answer: A — Reject the proposed contingent audit remuneration because it is prohibited except in specifically permitted circumstances under Regulation 192.

Explanation. ICAI Code of Ethics, Volume II, R410.9, prohibits fees based on a percentage of profits or contingent upon the findings or results of the work except in circumstances permitted under Regulation 192 of the Chartered Accountants Regulations, 1988. Zenith's ordinary company statutory audit does not fall within the specified exceptions. Audit committee consent or independent review cannot convert a prohibited contingent audit fee into a permissible arrangement. turn629691view2

Where it goes wrong. Assuming that contingent audit remuneration becomes permissible merely because the auditor's opinion is supported by sufficient evidence or independently reviewed.

Authority. ICAI Code of Ethics

Question 7 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · medium

Which combination represents appropriate action in addressing the self-interest threat created by Zenith's substantially overdue audit fees?

1. Ignore the outstanding balance because the auditor is entitled to recover fees after issuing the current year's report.
2. Immediately resign because any outstanding professional fee automatically makes continuation of the audit impermissible.
3. Evaluate the significance and duration of the overdue fees and the client's payment ability, while considering partial payment and independent review. (correct answer)
4. Issue an unmodified report after obtaining a fresh management representation confirming the company's intention to settle the outstanding amount.

Answer: C — Evaluate the significance and duration of the overdue fees and the client's payment ability, while considering partial payment and independent review.

Explanation. ICAI Code of Ethics, Volume II, paragraphs 410.12 A1–A4, recognises overdue fees as potentially creating a self-interest threat. Relevant factors include the significance of the amount, duration of non-payment and the client's ability and willingness to pay. Partial payment and review by an appropriate professional who did not participate in the audit are examples of safeguards. The expectation is generally to obtain payment before issuing the audit report. turn769318view1

Where it goes wrong. Treating every overdue fee as an automatic prohibition on continuation instead of evaluating its significance and applying suitable safeguards.

Authority. ICAI Code of Ethics

Question 8 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · hard

The outstanding fees represent a significant portion of the firm's dues and have remained unpaid for fourteen months. What additional assessment is specifically required under the Code?

1. Treat the outstanding amount as an automatic disqualification under the Companies Act and immediately resign from the audit.
2. Determine whether the overdue fees may be equivalent to a loan to the client and whether reappointment or continuation is appropriate. (correct answer)
3. Transfer the unpaid amount to a contingent-fee arrangement and obtain management's written agreement before the current audit report.
4. Exclude the outstanding fees from the independence assessment once an independent partner has reviewed the audit documentation.

Answer: B — Determine whether the overdue fees may be equivalent to a loan to the client and whether reappointment or continuation is appropriate.

Explanation. ICAI Code of Ethics, Volume II, R410.13, requires a firm, when a significant part of fees remains unpaid for a long time, to determine whether the outstanding amount might be equivalent to a loan to the client, in which case Section 511 becomes relevant. The firm must also determine whether it is appropriate to be reappointed or continue the engagement. An independent review does not remove this additional assessment obligation. turn769318view1

Where it goes wrong. Confusing an overdue fee safeguard with the separate mandatory assessment of whether long-standing unpaid fees are equivalent to a loan.

Authority. ICAI Code of Ethics; Section 511

Question 9 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · medium

Scenario. M/s V. Raman & LLP is conducting the proposed statutory audit of Suryodaya Sugar Mills Ltd., a company with multiple sugar plants and an ethanol division. During the annual independence declaration process, the firm's managing partner learns that CA Iyer, a proposed audit senior, is married to Suryodaya's finance director. The finance director is responsible for approving major provisions, supervising the financial reporting team and authorising adjustments to the general ledger. Iyer argues that he will not audit the finance director's individual entries and asks to remain on the engagement because he has extensive experience in the sugar industry. A second member of the proposed team, CA Nikhil, has a non-dependent brother who works as the company's financial controller. The brother supervises reconciliations and has significant influence over the preparation of accounting records, but he is not a director or key managerial person. Nikhil proposes to handle only plant visits and physical verification, leaving financial statement testing to other staff. The firm's tax practice also has a partner, CA Dev, who is not assigned to the audit. Dev has maintained a close personal friendship with Suryodaya's chairperson for more than fifteen years and frequently discusses the company's business affairs with him at private gatherings. Dev has not informed the firm's independence coordinator because he believes that the relationship is irrelevant when he is outside the audit team. During preliminary audit work, management withholds certain reconciliation files and insists that only personnel approved by the CFO may communicate with the finance department. The audit committee asks the firm to confirm whether its relationship disclosures and proposed safeguards are adequate before fieldwork continues. The firm's ethics partner must assess the distinct implications of each relationship, the roles of the individuals concerned and the steps required under the Code.

What is the correct independence conclusion regarding CA Iyer's proposed participation when his spouse is the client's finance director and exercises significant influence over financial reporting?

1. Iyer shall not participate as an audit team member because his immediate family member is an officer or employee with significant influence over financial reporting. (correct answer)
2. Iyer may participate if he does not audit the individual journal entries authorised by his spouse.
3. Iyer may participate after the audit committee gives written consent to the relationship and approves his audit responsibilities.
4. Iyer may participate if another partner reviews the final audit report without examining his individual audit work.

Answer: A — Iyer shall not participate as an audit team member because his immediate family member is an officer or employee with significant influence over financial reporting.

Explanation. ICAI Code of Ethics, Volume II, R521.5, prohibits an individual from participating as an audit team member where any immediate family member is a director or officer of the audit client, or an employee with significant influence over the preparation of accounting records or financial statements, including during the covered period. Restricting Iyer to selected audit areas does not satisfy this prohibition. Removal from the engagement team is required. turn629691view4

Where it goes wrong. Confusing the safeguards applicable to certain close-family relationships with the stricter non-participation requirement for specified immediate-family relationships.

Authority. ICAI Code of Ethics

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

How should the firm deal with CA Nikhil's relationship with his non-dependent brother, who is the client's financial controller with significant influence over accounting records?

1. Ignore the relationship because siblings who are not financially dependent are outside the scope of independence requirements.
2. Automatically treat the firm as statutorily ineligible under Section 141(3)(f), irrespective of Nikhil's employment status.
3. Allow Nikhil to perform financial statement testing because his brother is neither a director nor a key managerial person.
4. Evaluate the close-family threat and consider removing Nikhil or structuring his responsibilities so he does not examine matters under his brother's responsibility. (correct answer)

Answer: D — Evaluate the close-family threat and consider removing Nikhil or structuring his responsibilities so he does not examine matters under his brother's responsibility.

Explanation. ICAI Code of Ethics, Volume II, paragraphs 521.6 A1–A4, address threats arising when a close family member of an audit team member is a director, officer or employee with significant influence over financial reporting. Relevant safeguards include removing the individual from the audit team or structuring responsibilities to exclude matters under the relative's control. This is distinct from the immediate-family prohibition under R521.5. turn727216view2

Where it goes wrong. Assuming that every family relationship is treated identically under the Code, without distinguishing immediate family from close family.

Authority. ICAI Code of Ethics

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

What should the firm do after discovering that CA Dev, a partner outside the engagement team, has a close personal friendship with Suryodaya's chairperson?

1. Ignore the relationship because partners outside the audit team are entirely excluded from independence requirements.
2. Require consultation under firm policies and procedures, evaluate the relationship's significance and consider suitable safeguards. (correct answer)
3. Automatically withdraw from the engagement because every personal friendship involving any firm partner is prohibited.
4. Obtain a confidentiality undertaking from the chairperson because personal relationships do not affect independence when audit files are restricted.

Answer: B — Require consultation under firm policies and procedures, evaluate the relationship's significance and consider suitable safeguards.

Explanation. ICAI Code of Ethics, Volume II, R521.8 and paragraphs 521.8 A1–A2, require partners and employees outside the audit team to consult in accordance with firm policies when they have a personal or family relationship with an audit client's director, officer or influential employee. Relevant considerations include the nature of the relationship, degree of interaction and positions held by both individuals. The relationship is not automatically ignored or automatically prohibited. turn919800view1

Where it goes wrong. Assuming that independence procedures apply exclusively to engagement team members and do not extend to other partners and employees of the firm.

Authority. ICAI Code of Ethics

Question 12 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · hard

Which factors should the firm principally consider when evaluating whether CA Dev's relationship creates an unacceptable independence threat?

1. Only the total audit fee and the number of years for which the firm has examined under statutory audit Suryodaya.
2. Only whether the chairperson has previously challenged the auditor's accounting judgments or reporting decisions.
3. The nature of the relationship, Dev's position within the firm, his interaction with the audit team and the chairperson's position within the client. (correct answer)
4. Only whether Dev has access to the company's financial statements and whether he personally signs the audit report.

Answer: C — The nature of the relationship, Dev's position within the firm, his interaction with the audit team and the chairperson's position within the client.

Explanation. ICAI Code of Ethics, Volume II, paragraph 521.8 A1, identifies factors relevant to evaluating a threat created by a relationship involving a partner or employee who is not an audit team member. These include the nature of the relationship, the person's degree of interaction with the audit team, their position within the firm and the client's individual's position. Absence from the audit team does not make the evaluation unnecessary. turn919800view1

Where it goes wrong. Focusing exclusively on direct audit participation and overlooking the influence that senior non-team partners can have on the engagement.

Authority. ICAI Code of Ethics

Question 13 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · medium

Scenario. A medium-sized CA firm is strengthening its independence framework after several staff members failed to report financial interests and personal relationships with audit clients. Which arrangement represents an appropriate firm-wide safeguard under SQC 1?

A medium-sized CA firm is strengthening its independence framework after several staff members failed to report financial interests and personal relationships with audit clients. Which arrangement represents an appropriate firm-wide safeguard under SQC 1?

1. Allow each engagement partner to establish independent procedures without common firm-wide policies or central monitoring.
2. Communicate independence requirements, establish a reporting mechanism for threats and breaches, and obtain annual written compliance confirmations from relevant personnel. (correct answer)
3. Obtain written independence declarations only from statutory audit clients because employees are covered by their employment contracts.
4. Conduct an independence review only after a regulator identifies a breach, thereby avoiding unnecessary administrative procedures.

Answer: B — Communicate independence requirements, establish a reporting mechanism for threats and breaches, and obtain annual written compliance confirmations from relevant personnel.

Explanation. ICAI Study Material, Chapter 11, §17(B), under SQC 1, requires firm-wide policies to communicate independence requirements, identify and evaluate relationships creating threats, and take appropriate action. Personnel should promptly notify the firm of circumstances and breaches. The firm should obtain written confirmation at least annually from personnel required to be independent. These are firm-level policies rather than isolated engagement decisions.

Where it goes wrong. Confusing firm-wide independence infrastructure with engagement-level action taken only after a specific threat has been identified.

Authority. SQC 1

Question 14 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · hard

Scenario. A firm audits an unlisted non-public-interest entity. Fees from that client and its related entities have represented 44% of the firm's total fees for five consecutive years. The firm's total annual fees exceed ₹50 lakh and the client's related-group fees exceed ₹20 lakh. Which requirement applies under the ICAI Code of Ethics, 13th Edition?

A firm audits an unlisted non-public-interest entity. Fees from that client and its related entities have represented 44% of the firm's total fees for five consecutive years. The firm's total annual fees exceed ₹50 lakh and the client's related-group fees exceed ₹20 lakh. Which requirement applies under the ICAI Code of Ethics, 13th Edition?

1. The firm must resign immediately because dependence exceeding 40% for five years automatically makes the audit appointment invalid.
2. The firm must disclose the matter to the Registrar of Companies within 30 days of signing the audit report.
3. The firm must obtain permission from the National Financial Reporting Authority before continuing the audit engagement.
4. The firm shall disclose to ICAI that the fees have exceeded 40% of total firm fees for five consecutive years. (correct answer)

Answer: D — The firm shall disclose to ICAI that the fees have exceeded 40% of total firm fees for five consecutive years.

Explanation. ICAI Code of Ethics, 13th Edition, Volume II, R410.15, requires disclosure to the Institute when, for five consecutive years, fees from a non-PIE audit client and related entities exceed 40% of the firm's total fees. The stated exemptions for firms with total fees not exceeding ₹50 lakh, clients with fees not exceeding ₹20 lakh and specified government appointments do not apply here. Disclosure is required; automatic resignation is not prescribed. turn727216view0

Where it goes wrong. Confusing the fee-dependency disclosure threshold with an automatic prohibition on audit continuation or assuming that exceeding the percentage in one year is sufficient.

Authority. ICAI Code of Ethics

Question 15 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · medium

Scenario. A firm audits a listed public-interest entity. Fees from the entity and its related entities represent 24% of the firm's total gross annual professional fees in each of the last two consecutive years. No exemption under the relevant provision applies. What is the prescribed action?

A firm audits a listed public-interest entity. Fees from the entity and its related entities represent 24% of the firm's total gross annual professional fees in each of the last two consecutive years. No exemption under the relevant provision applies. What is the prescribed action?

1. Disclose to ICAI that fees from the public-interest entity and its related entities have exceeded 20% of the firm's total fees for two consecutive years. (correct answer)
2. Disclose to the Registrar of Companies that fees from the client have exceeded 20% of the firm's total fees for two consecutive years.
3. Immediately relinquish the engagement because the 20% threshold operates as an absolute ceiling on fees from listed entities.
4. Obtain written approval from the audit committee because no disclosure to the Institute is required for public-interest entities.

Answer: A — Disclose to ICAI that fees from the public-interest entity and its related entities have exceeded 20% of the firm's total fees for two consecutive years.

Explanation. ICAI Code of Ethics, 13th Edition, Volume II, R410.18, requires disclosure to the Institute when fees from a public-interest entity and related entities exceed 20% of the firm's total gross annual professional fees for two consecutive years. R410.20 addresses continuing excess after the two-year period. The rule requires disclosure to ICAI, not automatic resignation or disclosure to the Registrar of Companies. turn727216view0

Where it goes wrong. Confusing the disclosure threshold for public-interest entities with an absolute fee ceiling or the disclosure requirements applicable to non-PIE clients.

Authority. ICAI Code of Ethics

Question 16 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · hard

Scenario. A key audit partner receives a performance bonus partly calculated on the value of non-assurance services that he successfully sells to his statutory audit client. Which action is required under the Code?

A key audit partner receives a performance bonus partly calculated on the value of non-assurance services that he successfully sells to his statutory audit client. Which action is required under the Code?

1. Permit the arrangement because the firm separately reviews the audit work before signing the report.
2. Permit the arrangement if the audit partner has no involvement in delivering the non-assurance services.
3. Do not evaluate or compensate the key audit partner based on success in selling non-assurance services to that audit client. (correct answer)
4. Permit the arrangement after obtaining written approval from the client and disclosing the bonus in the engagement letter.

Answer: C — Do not evaluate or compensate the key audit partner based on success in selling non-assurance services to that audit client.

Explanation. ICAI Code of Ethics, 13th Edition, Volume II, R411.4, prohibits a firm from evaluating or compensating a key audit partner based on that partner's success in selling non-assurance services to the partner's audit client. The requirement does not prevent normal profit-sharing arrangements between firm partners. An independent audit review or client approval cannot override this express restriction. turn727216view1

Where it goes wrong. Confusing an expressly prohibited partner compensation arrangement with a self-interest threat that might be addressed merely through additional audit review.

Authority. ICAI Code of Ethics

Question 17 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · medium

Scenario. A firm provides both statutory audit and implementation consultancy to a client. While calculating the audit fee, the firm considers the cost savings achieved because of its previous consultancy experience. Which statement is correct?

A firm provides both statutory audit and implementation consultancy to a client. While calculating the audit fee, the firm considers the cost savings achieved because of its previous consultancy experience. Which statement is correct?

1. The firm may freely determine the audit fee by adding the entire consultancy fee to the audit remuneration.
2. The firm must not allow the audit fee to be influenced by other services, except that relevant cost savings from experience gained through such services may be considered. (correct answer)
3. The firm must charge an identical audit fee to every client irrespective of engagement complexity or available cost savings.
4. The firm may base the audit fee on the client's profits because consultancy services have already reduced the firm's audit costs.

Answer: B — The firm must not allow the audit fee to be influenced by other services, except that relevant cost savings from experience gained through such services may be considered.

Explanation. ICAI Code of Ethics, 13th Edition, Volume II, R410.6, provides that audit fees shall not be influenced by the provision of non-audit services to the audit client by the firm or its network firm. However, R410.7 permits consideration of cost savings achieved through experience derived from those non-audit services. This limited exception does not permit unrestricted cross-subsidisation or contingent audit remuneration. turn629691view2

Where it goes wrong. Treating the permitted consideration of experience-related cost savings as permission to link audit fees generally with non-audit service revenues.

Authority. ICAI Code of Ethics

Question 18 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · hard

Scenario. A senior audit associate unexpectedly receives direct shares in an audit client through inheritance during the course of the engagement. What action is required under the independence provisions?

A senior audit associate unexpectedly receives direct shares in an audit client through inheritance during the course of the engagement. What action is required under the independence provisions?

1. Retain the shares until the audit report is issued because the associate did not voluntarily purchase the investment.
2. Transfer the shares to an immediate family member and continue the audit without reporting the inheritance to the firm.
3. Retain the shares if their market value has not changed significantly since the date of inheritance.
4. Dispose of the direct financial interest immediately and ensure that the firm addresses the resulting independence threat. (correct answer)

Answer: D — Dispose of the direct financial interest immediately and ensure that the firm addresses the resulting independence threat.

Explanation. ICAI Code of Ethics, 13th Edition, Volume II, R510.9, specifically deals with financial interests received unintentionally, including through inheritance or gift. Where a firm, partner or employee, or an audit team member or their immediate family receives a direct financial interest in an audit client that is otherwise not permitted, it must be disposed of immediately. The involuntary nature of acquisition does not permit continued holding by the audit team member. turn919800view3

Where it goes wrong. Assuming that an inherited financial interest is exempt from the independence requirements because the individual did not voluntarily acquire it.

Authority. ICAI Code of Ethics

Question 19 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · medium

Scenario. A major audit client contributes a substantial proportion of the revenue of one particular partner's office, although it represents only a modest proportion of the firm's overall revenue. Which safeguard is most appropriate?

A major audit client contributes a substantial proportion of the revenue of one particular partner's office, although it represents only a modest proportion of the firm's overall revenue. Which safeguard is most appropriate?

1. Arrange an appropriate review by an independent professional, reduce dependence on the client and ensure partner compensation is not significantly linked to its fees. (correct answer)
2. Ignore the concentration because firm-wide fee dependence is low and the individual office operates as part of the larger firm.
3. Obtain a management representation that the client will not replace the firm during the next audit cycle.
4. Allow the office to retain the client relationship without additional safeguards because individual office revenue is irrelevant to independence.

Answer: A — Arrange an appropriate review by an independent professional, reduce dependence on the client and ensure partner compensation is not significantly linked to its fees.

Explanation. ICAI Code of Ethics, 13th Edition, Volume II, paragraphs 410.14 A5–A7, recognises that fees representing a large proportion of an individual partner's or office's revenue may create self-interest and intimidation threats even where firm-wide concentration is lower. Safeguards include independent review, ensuring partner remuneration is not significantly influenced by the client, reducing other services and diversifying the client base. turn727216view0

Where it goes wrong. Assessing fee dependence only at the total firm level and overlooking significant financial dependence at individual partner or office level.

Authority. ICAI Code of Ethics

Question 20 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · hard

Scenario. A partner of an audit firm has a brother who is appointed as Chief Financial Officer and key managerial personnel of a company for which the firm is proposed to be statutory auditor. The firm proposes to remove that partner from the audit engagement. What is the correct legal position?

A partner of an audit firm has a brother who is appointed as Chief Financial Officer and key managerial personnel of a company for which the firm is proposed to be statutory auditor. The firm proposes to remove that partner from the audit engagement. What is the correct legal position?

1. The firm may accept the appointment because removal of the concerned partner automatically eliminates every statutory disqualification.
2. The firm may accept the appointment after obtaining consent from the audit committee and disclosing the relationship to shareholders.
3. The firm is ineligible for appointment under Section 141(3)(f), because the partner's relative is employed as key managerial personnel. (correct answer)
4. The firm may accept the appointment after appointing an independent engagement quality control reviewer.

Answer: C — The firm is ineligible for appointment under Section 141(3)(f), because the partner's relative is employed as key managerial personnel.

Explanation. Section 141(3)(f) of the Companies Act, 2013, makes an individual practitioner, sole proprietor or firm ineligible for appointment where a relative of the individual, proprietor or partner is a director or employed by the company as a director or key managerial personnel. A brother is a relative under Section 2(77), read with the applicable rules. Removing the partner from the engagement team cannot cure this statutory disqualification. turn727216view2

Where it goes wrong. Confusing an engagement-level safeguard, such as removing a partner from the team, with a statutory disqualification that applies to the audit firm itself.

Authority. Section 141; Section 2

Question 21 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · medium

Scenario. An audit client offers a low-value gift to an audit partner with the express intention of influencing the partner's treatment of a disputed accounting estimate. The value is otherwise trivial. What is the correct response?

An audit client offers a low-value gift to an audit partner with the express intention of influencing the partner's treatment of a disputed accounting estimate. The value is otherwise trivial. What is the correct response?

1. Accept the gift because its value is trivial and record the incident in the audit working papers.
2. Refuse the gift because an intention to improperly influence behaviour prevents acceptance even when the value is trivial. (correct answer)
3. Accept the gift after obtaining consent from the engagement quality control reviewer and the managing partner.
4. Transfer the gift to the firm's administrative department because only gifts personally retained by the partner are restricted.

Answer: B — Refuse the gift because an intention to improperly influence behaviour prevents acceptance even when the value is trivial.

Explanation. ICAI Code of Ethics, 13th Edition, Volume II, R420.3, permits acceptance only where the value is trivial and inconsequential. Paragraph 420.3 A2 further clarifies that gifts or hospitality intended to improperly influence behaviour cannot be accepted even where their value is trivial and inconsequential. The intention to influence the accounting judgment makes acceptance impermissible. turn727216view1

Where it goes wrong. Treating trivial monetary value as an unconditional exception without considering the donor's intention to improperly influence the auditor.

Authority. ICAI Code of Ethics

Question 22 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · hard

Scenario. A CA is appointed auditor of a cooperative society. The society proposes determining the audit remuneration as a percentage of its net profit. Which statement correctly applies Regulation 192 of the Chartered Accountants Regulations, 1988?

A CA is appointed auditor of a cooperative society. The society proposes determining the audit remuneration as a percentage of its net profit. Which statement correctly applies Regulation 192 of the Chartered Accountants Regulations, 1988?

1. The fee arrangement is prohibited because contingent remuneration is never permissible for any statutory audit assignment.
2. The fee arrangement is permitted only when the audit partner receives no separate remuneration from the audit firm.
3. The fee arrangement is prohibited unless the audit committee independently certifies that the contingent fee will not influence the opinion.
4. The arrangement is permitted under the specified exception allowing a cooperative society auditor's fee to be based on paid-up capital, working capital, gross income, net income or profits. (correct answer)

Answer: D — The arrangement is permitted under the specified exception allowing a cooperative society auditor's fee to be based on paid-up capital, working capital, gross income, net income or profits.

Explanation. ICAI Code of Ethics, 13th Edition, Volume II, R410.9, refers to Regulation 192 of the Chartered Accountants Regulations, 1988, which specifies permitted exceptions to the general restriction on contingent fees. Under the cooperative society exception, an auditor's fee may be based on paid-up capital, working capital, gross or net income, or profits. This is a specific exception and does not extend automatically to ordinary company audits. turn629691view2

Where it goes wrong. Memorising the general prohibition on contingent fees without examining the expressly permitted exceptions under Regulation 192.

Authority. ICAI Code of Ethics

Question 23 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · medium

Scenario. A firm has an outstanding audit fee from a client for two months. The amount is relatively insignificant to the firm, and the client has a documented temporary payment-processing difficulty. Which approach is most appropriate?

A firm has an outstanding audit fee from a client for two months. The amount is relatively insignificant to the firm, and the client has a documented temporary payment-processing difficulty. Which approach is most appropriate?

1. Evaluate the threat using the amount overdue, duration and ability or willingness to pay, and consider safeguards appropriate to the circumstances. (correct answer)
2. Treat the outstanding amount as an automatic loan under Section 511 and resign regardless of its significance or duration.
3. Accept the outstanding balance without further evaluation because unpaid audit fees cannot create independence threats during the engagement.
4. Treat the client as permanently ineligible for audit services until every outstanding professional fee has been recovered through litigation.

Answer: A — Evaluate the threat using the amount overdue, duration and ability or willingness to pay, and consider safeguards appropriate to the circumstances.

Explanation. ICAI Code of Ethics, 13th Edition, Volume II, paragraphs 410.12 A1–A4, requires evaluation of the significance and duration of overdue fees and the client's ability and willingness to pay. A relatively insignificant amount outstanding for a short period is not automatically equivalent to a loan. Possible safeguards depend on the assessment. R410.13 separately requires a loan-equivalence and continuation assessment where a significant part remains unpaid for a long time. turn769318view1

Where it goes wrong. Applying the long-standing unpaid-fee loan assessment automatically to every minor and temporary delay in payment.

Authority. ICAI Code of Ethics

Question 24 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · hard

Scenario. A firm obtains verbal consent from two affected clients after disclosing a conflict of interest and the safeguards implemented. The clients do not insist on written consent. What should the firm additionally do?

A firm obtains verbal consent from two affected clients after disclosing a conflict of interest and the safeguards implemented. The clients do not insist on written consent. What should the firm additionally do?

1. Take no further action because verbal consent automatically removes the need for professional documentation.
2. Obtain fresh consent only after completing the engagement, because disclosure before acceptance is sufficient.
3. Document the nature of the conflict, safeguards applied where relevant and the consent obtained, despite the consent not being in writing. (correct answer)
4. Treat the verbal consent as invalid and automatically withdraw from both engagements without evaluating the circumstances.

Answer: C — Document the nature of the conflict, safeguards applied where relevant and the consent obtained, despite the consent not being in writing.

Explanation. ICAI Code of Ethics, 13th Edition, Volume II, paragraph 310.9 A4, encourages documentation where disclosure or consent is not in writing. The documentation should cover the circumstances giving rise to the conflict, the safeguards applied where applicable and the consent obtained. Oral consent does not remove the value of maintaining a reliable record demonstrating how the conflict was addressed.

Where it goes wrong. Assuming that oral consent makes documentation unnecessary or that every conflict automatically requires withdrawal regardless of the safeguards and consent obtained. turn336289view0

Authority. ICAI Code of Ethics

Question 25 · 2 marks · Chapter 11: Ethics and Terms of Audit Engagements · medium

Scenario. After evaluating a significant conflict of interest, a firm concludes that available safeguards cannot eliminate the threat or reduce it to an acceptable level. The affected client also refuses the required explicit consent. What should the firm do?

After evaluating a significant conflict of interest, a firm concludes that available safeguards cannot eliminate the threat or reduce it to an acceptable level. The affected client also refuses the required explicit consent. What should the firm do?

1. Continue the engagement after recording the client's refusal and obtaining approval from the firm's managing partner.
2. Decline or end the conflicting professional service and, where appropriate, terminate the relevant relationship or dispose of the interest creating the threat. (correct answer)
3. Continue the engagement after assigning the matter to a different office, irrespective of whether the underlying conflict remains unresolved.
4. Obtain an indemnity from the client and appoint an additional reviewer to compensate for the absence of adequate safeguards.

Answer: B — Decline or end the conflicting professional service and, where appropriate, terminate the relevant relationship or dispose of the interest creating the threat.

Explanation. ICAI Code of Ethics, Volume II, R310.10, requires a chartered accountant, where necessary explicit consent is refused, to end or decline the professional services that would result in the conflict or end relevant relationships or dispose of relevant interests to eliminate the threat or reduce it to an acceptable level. The conceptual framework under Section 120 requires threats to be adequately addressed; management consent, indemnities and administrative reviews cannot substitute for sufficient safeguards. turn336289view0

Where it goes wrong. Assuming that management approval, an indemnity or additional supervision can justify continuing an engagement when independence threats remain at an unacceptable level.

Authority. ICAI Code of Ethics; Section 120