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CA IPCC : Sample / Mock Test Paper (with Model Answers) - AUDITING & ASSURANCE Oct 2014

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Test Series: October, 2014 MOCK TEST PAPER 2 INTERMEDIATE (IPC): GROUP II PAPER 6: AUDITING AND ASSURANCE Question No.1 is compulsory. Attempt any five questions from the remaining six questions. Time Allowed 3 Hours 1. Maximum Marks 100 (a) In performing an audit of financial statements, the auditor should have or obtain knowledge of the business. Explain in the light of SA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and (5 Marks) its Environment . (b) Explain with reference to the relevant Standard on Auditing- Events or Conditions that may cast doubt about Going Concern Assumption. (5 Marks) (c) Auditor of AAS Ltd. was unable to confirm the existence and valuation of imported goods lying with the transporter and accepted a certificate from the management without obtaining other audit evidence. Comment with reference to relevant SA. (5 Marks) (d) What are the factors that determine the extent of reliance that the auditor places on results of analytical procedures? Explain with reference to SA-520 on "Analytical Procedures . (5 Marks) 2. State with reason (in short) whether the following statements are correct or incorrect. (Answer any eight): (i) Balance confirmations from debtors/ creditors can only be obtained for balances standing in their accounts at the year-end. (ii) Assets purchased under hire-purchase system were reflected at their full value and the outstanding installments payable have been included under Sundry Creditors. (iii) Auditor has no right to access Minute Books of the Company. (iv) It is necessary to issue audit engagement letter each year for repetitive audits. (v) Permission of Central Government is not required, when the auditors are to be removed before the expiry of their term, but the same is needed when the auditors are changed after the expiry of his term. (vi) Share Premium can be used for Payment of Dividend. The Institute of Chartered Accountants of India (vii) Rupees 5 lakhs paid by a pharmacy company to the legal advisor defending the patent of a product treated as Capital Expenditure. (viii) SA 230 deals with auditor s responsibilities relating to fraud in an Audit of Financial Statement. (ix) A Body Corporate is not qualified for appointment as Auditors of a Company. (x) Operational Audit involves examination of all operations and activities of the entity. (2 x 8 = 16 Marks) 3. (a) What are accounting estimates according to the Standards on Auditing 540? Give (4 Marks) examples. (b) Doing a statutory audit is full of risk . Narrate the factors which cause the risk. (4 Marks) (c) Comment on the following: (i) The auditor of Trilok Ltd. did not report on the matters specified in sub-section (1A) of Section 227 of the Companies Act, 1956, as he was satisfied that no comment is required. (ii) Give your comment on The Central Government has appointed Mr. Sushil, a retired Finance Director of a reputed company, a non-practising member of ICAI, as a special auditor of MM Ltd., on the ground that the company was not being managed on sound business principles. Mr. Ajay, MD of MM Ltd. feels that the appointment of Mr. Sushil is not valid as he does not hold a certificate of practice . (4 x 2 = 8 Marks) 4 How will you vouch and/or verify the following? (a) Sale proceeds of Scrap Material. (b) Trade Marks and Copyrights. (c) Machinery acquired under Hire-purchase system. (d) Work-in-progress 5. (4 x 4 =16 Marks) (a) An NGO operating in Delhi had collected large scale donations for Tsunami victims. The donations so collected were sent to different NGOs operating in Tamil Nadu for relief operations. This NGO operating in Delhi has appointed you to audit its accounts for the year in which it collected and remitted donations for Tsunami victims. Draft audit programme for audit of receipts of donations and remittance of the collected amount to different NGOs. Mention six points each, peculiar to the situation, which you will like to incorporate in your audit programme for audit of said receipts and remittances of donations. (8 Marks) (b) What special steps are involved in audit of a Cinema Hall? The Institute of Chartered Accountants of India (8 Marks) 6. (a) One customer from whom Rs. 5 lacs are recoverable for credit sales gives a motor car in full settlement of the dues. The directors estimate that the market value of the motor car transferred is Rs. 5.25 lacs. As on the date of the balance sheet the car has not been registered in the name of the auditee. Comment. (6 Marks) (b) Explain the important requirements which should be kept in mind to establish or evaluate a system of internal control for application process at Service Bureau? (6 Marks) (c) In auditing, the auditor checks the specific assertions of the items appearing in the financial statements and opines about the overall assertions they signify. Explain specific assertions and overall assertions in this context. (4 Marks) 7. Write short notes on any four of the following: (a) Disclosure requirements of bank balances of a limited company (b) Substantive Procedures (c) Contents of Audit Note-book (d) Inherent limitations of Internal Control system (e) Types of audits required under law. The Institute of Chartered Accountants of India (4 x 4 = 16 Marks) Test Series: October, 2014 MOCK TEST PAPER 2 INTERMEDIATE (IPC): GROUP II PAPER 6: AUDITING AND ASSURANCE SUGGESTED ANSWERS/HINTS 1. (a) Obtaining Knowledge of the business: The auditor needs to obtain a level of knowledge of the client s business that will enable him to identify the events, transactions and practices that, in his judgment, may have significant effect on the financial information among other things. As per SA 315 Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and its Environment , the auditor shall obtain an understanding of the following: (a) Relevant industry, regulatory, and other external factors including the applicable financial reporting framework (b) The nature of the entity, including: (i) its operations; (ii) its ownership and governance structures; (iii) the types of investments that the entity is making and plans to make, including investments in special-purpose entities; and (iv) the way that the entity is structured and how it is financed; to enable the auditor to understand the classes of transactions, account balances, and disclosures to be expected in the financial statements. (c) The entity s selection and application of accounting policies, including the reasons for changes thereto. The auditor shall evaluate whether the entity s accounting policies are appropriate for its business and consistent with the applicable financial reporting framework and accounting policies used in the relevant industry. (d) The entity s objectives and strategies, and those related business risks that may result in risks of material misstatement. (e) The measurement and review of the entity s financial performance. In addition to the importance of knowledge of the client s business in establishing the overall audit plan, such knowledge helps the auditor to identify areas of special audit consideration, to evaluate the reasonableness both of accounting estimates and management representations, and to make judgement regarding the appropriateness of accounting policies and disclosures. The Institute of Chartered Accountants of India (b) Events or Conditions that may cast doubt about Going Concern Assumption: As per SA 570 "Going Concern", events or conditions that may cast significant doubt on an entity s ability to continue as a going concern may include situations where such type of entity lacks funding for its continued existence or when policy decisions are made that affect the services provided by such an entity. However, the auditor should consider the risk that the going concern assumption may no longer be appropriate. The following are examples of events or conditions that, individually or collectively, may cast significant doubt about the going concern assumption. This listing is not all-inclusive nor does the existence of one or more of the items always signify that a material uncertainty exists. Financial Net liability or net current liability position. Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment; or excessive reliance on short-term borrowings to finance long-term assets. Indications of withdrawal of financial support by creditors. Negative operating cash flows indicated by historical or prospective financial statements. Adverse key financial ratios. Substantial operating losses or significant deterioration in the value of assets used to generate cash flows. Arrears or discontinuance of dividends. Inability to pay creditors on due dates. Inability to comply with the terms of loan agreements. Change from credit to cash-on-delivery transactions with suppliers. Inability to obtain financing for essential new product development or other essential investments. Operating Management intentions to liquidate the entity or to cease operations. Loss of key management without replacement. Loss of a major market, key customer(s), franchise, license, or principal supplier(s). Labour difficulties. Shortages of important supplies. Emergence of a highly successful competitor. The Institute of Chartered Accountants of India Other Non-compliance with capital or other statutory requirements. Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that the entity is unlikely to be able to satisfy. Changes in law or regulation or government policy expected to adversely affect the entity. Uninsured or underinsured catastrophes when they occur. The significance of such events or conditions often can be mitigated by other factors. For example, the effect of an entity being unable to make its normal debt repayments may be counter-balanced by management s plans to maintain adequate cash flows by alternative means, such as by disposing of assets, rescheduling loan repayments, or obtaining additional capital. Similarly, the loss of a principal supplier may be mitigated by the availability of a suitable alternative source of supply. (c) Certificate from the management without obtaining other audit evidence: As per SA 580 on Written Representations , in the course of audit, an auditor comes across various matters in respect of which he is not able to obtain sufficient appropriate audit evidence. In such a situation he may rely on the submission by the management but he should seek corroborative audit evidence from sources inside or outside the entity and evaluate the representation made by management. Management representation is not a substitute for other audit evidence. The auditor should seek and apply normal audit procedure. Mere possession of a certificate does not absolve the auditor from his liability. He should not seek or accept certificates when subject matter is such that it is capable of verification from internal and/or external evidences. In the instant case, the stock of imported material lying with the transporter can be easily verified with purchase order, invoice, bill of entry, custom document, payment of F.C. etc. Therefore, the auditor of AAS Ltd. has not used available evidences. He should not have rested with the certificate obtained from the management and could have evaluated other evidences. He may be held liable for negligence and professional misjudgment. (d) Reliance on the results of analytical procedures: As per SA 520 Analytical Procedures , the application of analytical procedures is based on the expectation that relationships among data exist and continue in the absence of known conditions to the contrary. The presence of these relationships provides audit evidence as to the completeness, accuracy and validity of the data produced by the accounting system. However, reliance on the results of analytical procedures will The Institute of Chartered Accountants of India depend on the auditor's assessment of the risk that the analytical procedures may identify relationships as expected when, in fact, a material misstatement exists. The extent of reliance that the auditor places on the results of analytical procedures depends on the following factors: (i) Materiality of the items involved, for example, when inventory balances are material, the auditor does not rely only on analytical procedures in forming conclusions. However, the auditor may rely solely on analytical procedures for certain income and expense items when they are not individually material. (ii) Other audit procedures directed toward the same audit objectives, for example, other procedures performed by the auditor in reviewing the collectability of accounts receivable, such as the review of subsequent cash receipts, might confirm or dispel questions raised from the application of analytical procedures to an ageing schedule of customers' accounts. (iii) Accuracy with which the expected results of analytical procedures can be predicted. For example, the auditor will ordinarily expect greater consistency in comparing gross profit margins from one period to another than in comparing discretionary expenses, such as research or advertising. (iv) Assessments of inherent and control risks, for example, if internal control over sales order processing is weak and, therefore, control risk is high, more reliance on tests of details of transactions and balances than on analytical procedures in drawing conclusions on receivables may be required. (v) The auditor will need to consider testing the controls, if any, over the preparation of information used in applying analytical procedures. When such controls are effective, the auditor will have greater confidence in the reliability of the information and, therefore, in the results of analytical procedures. The controls over non-financial information can often be tested in conjunction with tests of accounting-related controls. For example, an entity in establishing controls over the processing of sales invoices may include controls over the recording of unit sales. In these circumstances, the auditor could test the controls over the recording of unit sales in conjunction with tests of the controls over the processing of sales invoices. 2. (i) Incorrect: The above statement is not correct as it is not necessary that balances of debtors/ creditors should necessarily be verified only at the end of the year only. In fact, in order to incorporate an element of surprise, the auditor may consider different confirmation dates periodically, i.e., Dec 31 as a cut-off date in one year and June 30 in another year and so on. Therefore, the statement given is not correct. (ii) Correct: Assets acquired under Hire Purchase System should be recorded at the full cash value with corresponding liability of the same amount. In case cash value is not readily available, it should be calculated presuming an appropriate rate of The Institute of Chartered Accountants of India interest. Hire purchased assets are shown in the balance sheet with an appropriate narration to indicate that the enterprise does not have full ownership thereof. Thus the treatment followed by the company is correct. (iii) Incorrect: Section 227 of the Companies Act, 1956 grants powers to the auditor that every auditor has a right of access, at all times, to the books and account including all statutory records such as minute books, fixed assets register, etc. of the company for conducting the audit. (iv) Incorrect: As per SA 210, Agreeing the Terms of Audit Engagements , it is not necessary to issue audit engagement letter each year for repetitive audit. It is enough if the same had been issued at the time of taking initial engagement. Therefore, the statement that it is necessary to issue audit engagement letter each year for repetitive audits is not correct. (v) Incorrect: As per Section 224(7) of the Companies Act, 1956, an auditor may be removed from office before the expiry of his term, by the company in a general meeting, after obtaining prior permission of Central Government as removal of auditor before expiry of his term i.e. before he has submitted his report is a serious matter and may adversely affect his independence. On the other hand if auditor has completed his term i.e. has submitted his report and thereafter he is not re-appointed then the matter is not serious enough for central government to call for its intervention. In view of the above, the permission of the Central Government is required when auditors are removed before expiry of their term and the same is not needed when they are not re-appointed after expiry of their term. (vi) Incorrect: Section 78 of Companies Act, 1956 deals with the application of Securities Premium. Further, Section 205 of Companies Act, 1956 also specifies the sources from which dividend can be paid and requires the same to be only paid out of past profits, general reserve or any other free reserve. Hence declaration of dividend from Securities Premium is not proper. (vii) Incorrect: Legal expenses of Rs. 5 lakhs incurred to defend the patent of a product of the pharmacy company is revenue expenditure pertaining to the asset since by this expenditure neither any endurable benefit can be obtained in future in addition to what is presently available nor the capacity of the asset would be increased. Payment of legal fees is normally revenue expenditure irrespective of the amount involved unless same is incurred to bring any new asset into existence. Therefore, the statement given is not correct. (viii) Incorrect: SA 230 deals with Audit Documentation whereas SA 240 deals with The Auditor s responsibilities Relating to Fraud in an Audit of Financial Statements . The Institute of Chartered Accountants of India (ix) Correct: Section 226(3) of the Companies Act, 1956 evidently excludes a body corporate to be qualified for appointment as auditors of a company. Therefore, the statement that a Body Corporate is not qualified for appointment as Auditors of a Company is correct. (x) Correct: Operational Audit involves examination of all operations and activities of the entity. The objects of operational audit include the examination of the control structure and of the relation of department controls to general policies. It provides an appraisal of whether the department is operating in conformity with prescribed standards and procedures and whether standards of efficiency and economy are maintained. Therefore, the statement given is correct. 3. (a) Accounting Estimates: According to the SA 540, Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosure , accounting estimate means an approximation of a monetary amount in the absence of a precise means of measurement. This term is used for an amount measured at fair value where there is estimation uncertainty, as well as for other amounts that require estimation. SA 540 addresses only accounting estimates involving measurement at fair value, the term fair value accounting estimates is used. Because of the uncertainties inherent in business activities, some financial statement items can only be estimated. Further, the specific characteristics of an asset, liability or component of equity, or the basis of or method of measurement prescribed by the financial reporting framework, may give rise to the need to estimate a financial statement item. Some financial reporting frameworks prescribe specific methods of measurement and the disclosures that are required to be made in the financial statements, while other financial reporting frameworks are less specific. Some accounting estimates involve relatively low estimation uncertainty and may give rise to lower risks of material misstatements, for example: Accounting estimates arising in entities that engage in business activities that are not complex. Accounting estimates that are frequently made and updated because they relate to routine transactions. For some accounting estimates, however, there may be relatively high estimation uncertainty, particularly where they are based on significant assumptions, for example: Accounting estimates relating to the outcome of litigation. Fair value accounting estimates for derivative financial instruments not publicly traded. The Institute of Chartered Accountants of India Additional examples of accounting estimates are: Allowance for doubtful accounts. Warranty obligations. Inventory obsolescence. Depreciation method or asset useful life. (b) Provision against the carrying amount of an investment where there is uncertainty regarding its recoverability. Outcome of long term contracts. Financial Obligations/Costs arising from litigation settlements and judgments. Factors which cause Risk: As Per SA 200 Overall Objectives of the Independent Auditor and the conduct of an audit in accordance with standards on auditing , the purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework. In the case of most general purpose frameworks, that opinion is on whether the financial statements are presented fairly, in all material respects, or give a true and fair view in accordance with the framework. An audit conducted in accordance with SAs and relevant ethical requirements enables the auditor to form that opinion. An independent audit whether performed in terms of applicable financial reporting framework or in terms of the engagement, the auditor has to be reasonably satisfied as to whether the information contained in the underlying accounting records and other source data is reliable for the preparation of financial statements. Since the entire process of auditing is based on the assessment of judgements made by the management of the entity as well as evaluation of internal controls, the audit suffers certain inherent risks. Factors which may cause such risk in conducting an audit are discussed below: (i) Exercising judgement on the part of the auditor: The auditor s work involves exercise of judgement, for example, in deciding the extent of audit procedures and in assessing the reasonableness of the judgements and estimates made by management in preparing the financial statements. (ii) Nature of audit evidence: Much of the evidence available to the auditor can enable him to draw only reasonable conclusions therefrom. The auditor normally relies upon persuasive evidence rather than conclusive evidence. Even in circumstances where conclusive evidence is available, the cost of obtaining such an evidence may far exceed the benefits. The Institute of Chartered Accountants of India (iii) Inherent limitations of internal control: Internal control can provide only reasonable, but not absolute, assurance on account of several inherent limitations such as potential for human error, possibility of circumstances of control through collusion, etc. On account of above, it is quite clear that an audit suffers from control risk on account of inherent limitations of internal control and detection risk on account of test nature of audit and judgement and estimates involved in formulating accounting policies. (c) (i) Comment on Matters Contained under Section 227(1A) of the Companies Act, 1956: Section 227(1A) of the Act deals with duties of an auditors requiring auditor to make an enquiry in respect of specified matters. The matters in respect of which the enquiry has to be made by the auditor include relating to loans and advances on the basis of security have been properly secured, transactions represented merely by book entries, investments sold at less than cost price, loans and advances shown as deposits, personal expenses charged to revenue account etc. Since the law requires the auditor to make an enquiry, the Research Committee of the Institute of Chartered Accountants of India opined that the auditor is not required to report on the matters specified in sub-section (1A) unless he has any special comments to make on any of the items referred to therein. If the auditor is satisfied as a result of the enquiries, he has no further duty to report that he is so satisfied. Therefore, the auditor of Trilok Ltd. is correct in non-reporting on the matters specified in Section 227(1A) of the Act. (ii) Appointment of Special Auditor: Section 233A of the Companies Act, 1956, under the circumstances as specified in the section, empowers the Central Government that it may issue directions to the effect that a special audit of the company s accounts for the specified period shall be conducted. Amongst others, one of the circumstances specified is in case a company is not being managed in accordance with some business principles or prudent commercial practices. Further the said section also provides that for the purpose, it may appoint a chartered accountant, whether or not the chartered accountant is in practice, or the company s auditor itself to conduct such special audit. Therefore, the appointment of Mr. Sushil, a non-practising member of Institute of Chartered Accountants of India is within the provisions of law and, accordingly, the contention of Mr. Ajay, M.D. of MM Ltd., is not correct. 4. (a) Sale Proceeds of Scrap Material (i) Review the internal control on scrap materials, as regards its generation, storage and disposal and see whether it was properly followed at every stage. The Institute of Chartered Accountants of India (ii) Ascertain whether the organisation is maintaining reasonable records for the sale and disposal of scrap materials. (iii) Review the production and cost records for determination of the extent of scrap materials that may arise in a given period. (iv) Compare the income from the sale of scrap materials with the corresponding figures of the preceding three years. (v) Check the rates at which different types of scrap materials have been sold and compare the same with the rates that prevailed in the preceding year. (vi) See that scrap materials sold have been billed and check the calculations on the invoices. (vii) Ensure that there exists a proper procedure to identify the scrap material and good quality material is not mixed up with it. (viii) Make an overall assessment of the value of the realisation from the sale of scrap materials as to its reasonableness. (b) Trade Marks and Copyrights (i) Obtain schedule of Trade Marks and Copyrights duly signed by the responsible officer and scrutinise the same and confirm that all of them are shown in the Balance Sheet. (ii) Examine the written agreement in case of assignment of Copyrights and Assignment Deed in case of transfer of trade marks. Also ensure that trade marks and copyrights have been duly registered. (iii) Verify existence of copyright by reference to contract between the another and noting down the terms of payment of royalty. (iv) See that the value has been determined properly and the costs incurred for the purpose of obtaining the trade marks and copyrights have been capitalised. (v) Verify existence of copyright by reference to contact between the author and the entity and to check the payments of royalty made to author. (vi) Ascertain that the legal life of the trade marks and copyrights have not expired. (vii) Ensure that amount paid for both the intangible assets is properly amortised having regard to appropriate legal and commercial considerations, as per the principles enunciated under AS 26 on Intangible Assets. (c) Machinery acquired under Hire-purchase system (i) Examine the Board s Minute Book approving the purchase on hire-purchase terms. The Institute of Chartered Accountants of India (ii) Examine the hire-purchase agreement carefully and note the description of the machinery, cost of the machinery, hire purchase charges, and terms of payment and rate of purchase. (iii) Assets acquired under Hire Purchase System should be recorded at the full cash value with corresponding liability of the same amount. In case cash value is not readily available, it should be calculated presuming an appropriate rate of interest. (iv) Hire purchased assets are shown in the balance sheet with an appropriate narration to indicate that the enterprise does not have full ownership thereof. The interest payable along with each installments, whether separately or included therein should be debited to the interest account and not to the asset account. (d) Work-in-Progress: The audit procedures regarding work-in-progress are similar to those used for raw materials and finished goods. However, the auditor has to carefully assess the stage of completion of the work-in-progress for assessing the appropriateness of its valuation. For this purpose, the auditor may examine the production/costing records (i.e., cost sheets), hold discussions with the personnel concerned, and obtain expert opinion, where necessary. The auditor may advise his client that where possible the work-in-progress should be reduced to the minimum before the closing date. Cost sheets of work-in-progress should be verified as follows: (i) Ascertain that the cost sheets are duly attested by the works engineer and works manager. (ii) Test the correctness of the cost as disclosed by the cost records by verification of quantities and cost of materials, wages and other charges included in the cost sheets by reference to the records maintained in respect thereof. (iii) Compare the unit cost or job cost as shown by the cost sheet with the standard cost or the estimated cost expected. (iv) Ensure that the allocation of overhead expenses had been made on a rational basis. Compare the cost sheet in detail with that of the previous year. If they vary materially, investigate the cause thereof. (v) Ensure that the Work-in-Progress as at Balance Sheet date has been appropriately disclosed in Balance Sheet as per the requirements of Part I of Revised Schedule VI to the Companies Act, 1956. The Institute of Chartered Accountants of India 5 (a) Receipt of Donations (i) Internal Control System: Existence of internal control system particularly with reference to division of responsibilities in respect of authorised collection of donations, custody of receipt books and safe custody of money. (ii) Custody of Receipt Books: Existence of system regarding issue of receipt books, whether unused receipt books are returned and the same are verified physically including checking of number of receipt books and sequence of numbering therein. (iii) Receipt of Cheques: Receipt Book should have carbon copy for duplicate receipt and signed by a responsible official. All details relating to date of cheque, bank s name, date, amount, etc. should be clearly stated. (iv) Bank Reconciliation: Reconciliation of bank statements with reference to all cash deposits not only with reference to date and amount but also with reference to receipt book. (v) Cash Receipts: Register of cash donations to be vouched more extensively. If addresses are available of donors who had given cash, the same may be cross-checked by asking entity to post thank you letters mentioning amount, date and receipt number. (vi) Foreign Contributions, if any, to receive special attention to compliance with applicable laws and regulations. Remittance of donations to different NGOs (i) Mode of Sending Remittance: All remittances are through account payee cheques. Remittances through Demand Draft would also need to be scrutinised thoroughly with reference to recipient. (ii) Confirming Receipt of Remittance: All remittances are supported by receipts and acknowledgements. (iii) Identity: Recipient NGO is a genuine entity. Verify address, 80G Registration Number, etc. (iv) Direct Confirmation Procedure: Send confirmation letters to entities to whom donations have been paid. (v) Donation Utilisation: Utilisation of donations for providing relief to Tsunami victims and not for any other purpose. (vi) System of NGOs Selection: System for selecting NGO to whom donations have been sent. (b) Special steps involved in audit of a Cinema Hall (i) Verify The Institute of Chartered Accountants of India (a) that entrance to the cinema hall is only through printed tickets; (b) tickets are serially numbered and bound into books; (c) that the number of tickets issues for each show and class are different; (d) that for advance booking a separate series of tickets is issued and (e) stock of tickets is kept in proper custody. (ii) If tickets are issued through computer- audit the system to ensure its reliability and authenticity of data generated by it. (iii) System should provide that at the end of each show a proper statement should be prepared and cash collected be tallied. (iv) Cash collected is deposited in banks partly on the same day and rest on the next day depending upon the banking facility available. (v) Verify that proper record is kept for free passes issued and the same are issued under proper authority. (vi) Cross check the entertainment tax deposited. (vii) Verify the income from advertisements and slides showed before the show. (viii) Vouch the expenditure incurred on publicity of picture, maintenance of hall, electricity expenses etc. (ix) Vouch recoveries of advertisement expenses etc from film distributors. (x) Vouch payment of film hire with reference to agreement with distributor or producer. (xi) Verify the basis of other incomes earned like restaurant, car and scooter parking and display windows etc. (xii) Confirm that depreciation on machinery and furniture has been charged at appropriate rates which are higher, as compared to those admissible in the case of other businesses, in respect of similar assets. 6 (a) Determination of cost in case of exchange of assets: An enterprise may acquire an asset through exchange process. In the instant case, the company has acquired a motor car from a customer in exchange of amount due from him. However, the motor car has not been registered in the name of the company on the date of the balance sheet. Having regard to the principle of substance over form, the auditor should see that the transaction is recorded though the car is not registered in the name of the auditee. As far as determination of the cost is concerned, AS 10 broadly lays down the following principle: When a fixed asset is acquired in exchange for another asset, its cost is usually determined by reference to the fair market value of the consideration given. It may The Institute of Chartered Accountants of India be appropriate to consider also the fair market value of the asset acquired if this is more clearly evident. An alternative accounting treatment that is sometimes used for an exchange of assets, particularly when the assets exchanged are similar, is to record the asset acquired at the net book value of the asset given up; in each case an adjustment is made for any balancing receipt or payment of cash or other consideration. Consequently, it shall be more appropriate to record the cost of motor car at Rs. 5 lacs since the value of asset given up is more clearly evident than the fair value of assets acquired i.e. motor car which happens to be estimation on the part of directors. Accordingly, the customer s account should also be credited by Rs. 5 lacs. Note: However, directors may revalue the asset and write up the value of motor car to Rs. 5.25 lacs. Then Rs. 25,000 should be transferred to Revaluation Reserve. (b) Requirements of Internal Control System at a Service Bureau: Various requirements to establish or evaluate a system of internal control for applications processed at a service bureau are stated below: (i) Liaison between bureau and user should be clearly defined. Senior member of the user s staff is appointed as liaison officer. (ii) Need for a system testing including all clerical procedures at the user company. (iii) Control over physical movement of data and in this respect whether a copy or microfilm of documents sent to the service bureau is kept. (iv) Planning procedure so that error is identified by documents provided by the bureau. The user must ensure that prompt correction and resubmission of rejection to meet the bureau processing schedule. (v) Establishing a system in the user company to ensure that all exceptional reports are received from bureau. (vi) Establish clerical control to verify the accuracy of computer processing. (vii) Normally, user has no physical control over the files, therefore, high control over the maintenance of data on master files should be established. (c) Assertions: Auditor checks specific assertions that the items of financial statements portray and also gives his opinion in the form of overall assertion in respect of financial statements taken as a whole. The specific assertions are (i) Existence That the asset or liability exists at a given date. (ii) Rights and obligations The asset is a right of the entity and the liability is an obligation of the entity at a given date. The Institute of Chartered Accountants of India (iii) Occurrence That a transaction or event has occurred which pertains to the entity. (iv) Completeness There are no unrecorded asset/liabilities or transactions. (v) Valuation An asset or liability is recorded in the proper amount and recorded at appropriate carrying value. (vi) Measurement A transaction is recorded in the proper amount and revenue or expenses is allocated to proper period. (vii) Presentation An item is disclosed, classified and described in accordance with accounting policies and legal requirements. The overall assertions opined by the auditor about the financial statements are: (i) The profit and loss account give a true and fair view of the results profit or loss for the period ended on the last date of the accounting period. (ii) The balance sheet gives a true and fair view of the status or financial position of the entity as on the last date of the accounting period. 7 (a) Disclosure Requirements for Bank Balance: Under the Revised Schedule VI to the Companies Act, 1956, the following disclosure requirements are mandated: General Instructions for Current Assets under Revised Schedule VI: (b) Cash and cash equivalents: 1. Cash and cash equivalents shall be classified as: (a) Balances with banks; (b) Cheques, drafts on hand; (c) Cash on hand; (d) Others (specify nature). 2. Earmarked balances with banks (for example, for unpaid dividend) shall be separately stated; 3. Balances with banks to the extent held as margin money or security against the borrowings, guarantees, other commitments shall be disclosed separately; 4. Repatriation restrictions, if any, in respect of cash and bank balances shall be separately stated; 5. Bank deposits with more than 12 months maturity shall be disclosed separately. Substantive Procedures: These procedures are audit tests designed to obtain evidence to verify balance of an account or a specific financial statement assertion i.e. they test the validity and propriety of the accounting treatment of the transaction. They The Institute of Chartered Accountants of India can be classified as either test of details of transactions and balances or as analytical review procedures. They provide assurance to the auditor in respect of the following assertions: (i) The asset or a liability should exist at a given date. (ii) The asset should be owned by the entity and the liability is an obligation of the entity at a given date. (iii) There should not be any unrecorded assets, liabilities or transactions. (iv) Assets or liabilities should be recorded at appropriate carrying values. (v) Transaction or event that took place should pertain to the entity during the relevant period. (vi) Transaction should be recorded in the proper amount and revenue or expense should be allocated to the proper period. (vii) Various items should be disclosed, classified, and described in accordance with recognised accounting policies and practices and relevant statutory requirements, if any. (c) Contents of Audit Note book: Audit note book contains large variety of matters observed during the course of audit. Significant matters observed during audit which should be recorded in audit note book are normally the following: (i) Audit queries not cleared immediately. (ii) Mistakes or irregularities observed during the course of audit. (iii) Unsatisfactory book-keeping arrangements, costing method. (iv) Important information about the company which is not apparent from the accounts. (v) Special points requiring consideration at the time of verification of annual accounts. (vi) Important matters for future reference. (d) Inherent limitations of Internal Control system: Internal control can provide only reasonable but not absolute assurance that its objective relating to prevention and detection of errors/frauds, safeguarding of assets etc., are achieved. This is because it suffers from some inherent limitations, such as:(i) Management s consideration that cost of an internal control does not exceeds the expected benefits. (ii) Most controls do not tend to be directed at unusual transactions. (iii) The potential of human error due to carelessness, misjudgment and misunderstanding of instructions. (iv) The possibility that control may be circumvented through collusion with employees or outsiders. The Institute of Chartered Accountants of India (v) The possibility that a person responsible for exercising control may abuse that authority. (vi) Compliance with procedures may deteriorate because the procedures becoming inadequate due to change in condition. (vii) Manipulation by management with respect to transactions or estimates and judgements required in the preparation of financial statements. (viii) Inherent limitations of Audit. (e) Types of audits required under law: Audit is not legally obligatory for all types of business organisations or institutions. On this basis audits may be of two broad categories i.e., audit required under law and voluntary audits. The organisations which require audit under law are the following: (i) Companies governed by the Companies Act; (ii) Banking companies governed by the Banking Regulation Act, 1949; (iii) Electricity supply companies governed by the Electricity Supply Act, 1948; (iv) Co-operative societies registered under the Co-operative Societies Act, 1912; (v) Public and charitable trusts registered under various Religious and Endowment Acts; (vi) Corporations set up under an Act of Parliament or State Legislature such as the Life Insurance Corporation of India. (vii) Specified entities under various sections of the Income-tax Act, 1961. (viii) Audit required under Sales-tax and VAT by various State Government. The Institute of Chartered Accountants of India

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