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Answer Paper

AUDITING & ETHICS Duration: 70

Details: Test 1 (Ch-1) Marks: 35

Instructions:

 All the questions are compulsory

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 In case of multiple choice questions, mention option number only Working notes are
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Ans-1 An audit engagement is indeed a type of assurance engagement. However, assurance
engagements are not limited to audits alone. There are various other assurance engagements
such as review engagements, engagements that offer assurance on prospective financial
information, and those that provide assurance on an entity's internal controls. These
engagements all provide assurance to users, but the level of assurance differs. While an audit
offers reasonable assurance, which is a higher level of assurance, a review engagement
provides a lower level of assurance.

Additionally, assurance engagements are not confined to historical financial information. For
example, assurance can be provided on prospective financial information, where the
practitioner ensures that the assumptions used by management are reasonable, the
information is prepared correctly based on these assumptions, it is presented appropriately,
and all significant assumptions are disclosed.

In this scenario, Raj believes that an audit engagement is the only form of assurance
engagement where a written assurance report is given, while Priya believes that assurance
engagements are broader and not limited to audits. Therefore, Priya's viewpoint is correct.

(5 MARKS)

Ans-2 The scope of the audit of ABC Company's financial statements is crucial in ensuring that
the intended users, such as shareholders, employees, customers, government and regulatory
authorities, and bankers, have a high degree of confidence in the accuracy and reliability of the
financial information. To achieve this, the following key points should be included in the scope
of the audit:

The following points are included in scope of audit of financial statements: -

(1) Coverage of all aspects of entity

Audit of financial statements should be organized adequately to cover all aspects of the entity
relevant to the financial statements being audited.

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(2) Reliability and sufficiency of financial information

The auditor should be reasonably satisfied that information contained in underlying accounting
records and other source data (like bills, vouchers, documents etc.) is reliable and sufficient
basis for preparation of financial statements.

The auditor makes a judgment of reliability and sufficiency of financial information by making a
study and assessment of accounting systems and internal controls and by carrying out
appropriate tests, enquiries and procedures.

(3) Proper disclosure of financial information

The auditor should also decide whether relevant information is properly disclosed in the
financial statements. He should also keep in mind applicable statutory requirements in this
regard.

It is done by ensuring that financial statements properly summarize transactions and events
recorded therein and by considering the judgments made by management in preparation of
financial statements.

The management responsible for preparation and presentation of financial statements makes
many judgments in this process of preparing and presenting financial statements. For example,
choosing of appropriate accounting policies in relation to various accounting issues like
choosing method of charging depreciation on fixed assets or choosing appropriate method for
valuation of inventories

The auditor evaluates selection and consistent application of accounting policies by

management; whether such a selection is proper and whether chosen policy has been applied
consistently on a period-to-period basis.

Understand that financial statements of an entity are prepared on historical financial

information basis. “Historical financial information” means information expressed in financial
terms in relation to a particular entity, derived primarily from that entity’s accounting system,

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about economic events occurring in past time periods or about economic conditions or
circumstances at points in time in the past.

For example, when purchases and sales are reflected in financial statements of an entity, these
are examples of historical financial information. These are about transactions which have
occurred in past.

(4 MARKS)

Ans-3 Rahul's interdisciplinary knowledge plays a pivotal role in conducting a comprehensive

audit of XYZ Corporation. Here's how each area of his expertise contributes to the audit
process:

Accounting Principles:

Rahul's deep understanding of accounting principles allows him to assess the accuracy and
reliability of XYZ Corporation's financial statements. He can identify inconsistencies, errors, or
irregularities in financial reporting, ensuring compliance with Generally Accepted Accounting
Principles (GAAP).

Business Laws:

Knowledge of business laws enables Rahul to ensure that XYZ Corporation's financial
transactions and operations are in accordance with legal requirements. He can identify any
potential legal issues or non-compliance with regulations that may impact the financial
statements.

Human Behavior:

Understanding human behavior aids Rahul in effective communication and interaction with XYZ
Corporation's personnel. He can ask relevant questions, gather necessary information, and

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assess the credibility of individuals providing data. This knowledge helps him identify potential
fraud or management bias.

Statistics:

Statistical methods, a key part of auditing, allow Rahul to draw meaningful samples for testing.
By applying statistical sampling techniques, he can efficiently assess the entire population of
transactions or data points, reducing the risk of missing material misstatements.

Economics:

Rahul's grasp of economics helps him comprehend the broader economic environment in which
XYZ Corporation operates. This understanding is valuable when evaluating the company's
financial performance in the context of economic factors, market conditions, and industry
trends.

Financial Management:

Knowledge of financial management principles assists Rahul in analyzing XYZ Corporation's

financial health. He can assess aspects like working capital management, liquidity, and
profitability, enabling him to identify financial risks and weaknesses that may impact the audit.

In summary, Rahul's interdisciplinary knowledge equips him to approach the audit of XYZ
Corporation holistically. He can apply a multi-faceted perspective to scrutinize financial
statements, assess compliance with laws and regulations, and consider the economic and
financial management aspects that affect the company's financial reporting. This
comprehensive approach enhances the quality and effectiveness of the audit.

(6 MARKS)

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Ans-4 Audit is distinct from investigation. Investigation is a critical examination of the accounts
with a special purpose. For example, if fraud is suspected and it is specifically called upon to
check the accounts whether fraud really exists, it takes character of investigation. The objective
of audit, on the other hand, is to obtain reasonable assurance about whether the financial
statements as a whole are free from material misstatement, whether due to fraud or error,
thereby enabling the auditor to express an opinion.

The scope of audit is general and broad whereas scope of investigation is specific and narrow.

In the given situation, management of company suspects that some of its employees may be
involved in making fraudulent payments on account of dummy workers at its different plants in
the country. Such an assignment is in the nature of “investigation”.

Therefore, Mr. P is right in objecting the use of word “audit” in the proposed assignment.

(4 MARKS)

Ans-5 In conducting audit of financial statements, objectives of auditor in accordance with SA-
200 “Overall Objectives of the Independent auditor and the conduct of an audit in accordance
with Standards on Auditing” are: -

(a) To obtain reasonable assurance about whether the financial statements as a whole are free
from material misstatement, whether due to fraud or error, thereby enabling the auditor to
express an opinion on whether the financial statements are prepared, in all material respects,
in accordance with an applicable financial reporting framework; and

(b) To report on the financial statements, and communicate as required by the SAs, in
accordance with the auditor’s findings.

An analysis of above brings out following points clearly: -

(1) Auditor’s objective is to obtain a reasonable assurance whether financial statements as a

whole are free from material misstatement whether due to fraud or error.

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Reasonable assurance is to be distinguished from absolute assurance. Absolute assurance is a
complete assurance or a guarantee that financial statements are free from material
misstatements. However, reasonable assurance is not a complete guarantee. Although it is a
high-level of assurance but it is not complete assurance.

Audit of financial statements is carried out by the auditor with professional competence and
skills in accordance with Standards on Auditing. Audit procedures are applied in accordance
with SAs, audit evidence is obtained and evaluated. On the basis of that, conclusions are drawn
and opinion is formed. It leads to high level of assurance which is called as reasonable
assurance but it is not absolute assurance.

(2) Misstatements in financial statements can occur due to fraud or error or both. The auditor
seeks to obtain reasonable assurance whether financial statements as a whole are free from
material misstatements caused by fraud or error. He has to see effect of misstatements on
financial statements as a whole, in totality.

(3) Obtaining reasonable assurance that financial statements as a whole are free from material
misstatements enables the auditor to express an opinion on whether the financial statements
are prepared, in all material respects, in accordance with an applicable financial reporting
framework.

(4) The opinion is reported and communicated in accordance with audit findings through a
written report as required by Standards on Auditing.

Therefore, perception of both assistants is not proper. Auditor of financial statements does not
seek to provide guarantee that financial statements are free from material misstatements
caused by frauds or errors. He obtains reasonable assurance.

(6 MARKS)

Ans-6 MCQS

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1. A) The thorough examination aligns with reasonable assurance engagement, and the less
extensive review aligns with limited assurance engagement.

Explanation:

A reasonable assurance engagement involves elaborate and extensive procedures to obtain

sufficient appropriate evidence, providing a high level of confidence. In this case, the thorough
examination aligns with the concept of reasonable assurance engagement. On the other hand,
a limited assurance engagement involves performing fewer procedures and obtaining limited
evidence, offering a lower level of confidence. Therefore, the less extensive review aligns with
the concept of limited assurance engagement.

2. D) Standards on Related Services (SRSs).

Explanation:

Standards on Related Services (SRSs) encompass a range of engagements, including agreed-

upon procedures, compilation engagements, and other related service engagements. These
standards provide guidance for various non-audit and non-review services, ensuring
consistency and quality in these engagements.

3. B) To enhance the degree of confidence of intended users of financial statements.

Explanation:

The primary purpose of external audit engagements is to provide reasonable assurance that the
financial statements are free from material misstatement. This assurance enhances the
confidence of intended users, such as investors, creditors, and regulators, in the reliability and
accuracy of the financial information presented by an organization. External audits are
independent assessments, which help ensure that the financial statements reflect a true and
fair view of the company's financial position and performance.

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4. B) Practitioner: Independent Assessor, Responsible Party: CFO, Intended Users: Board of
Directors

Explanation:

Practitioner: This is the independent practitioner hired to assess the effectiveness of the
internal controls over financial reporting. They are responsible for conducting the assessment
and providing the report.

Responsible Party: This is the CFO of ABC Corp., who is responsible for preparing the internal
control documentation. The responsible party is the person or group accountable for the
subject matter of the assurance engagement.

Intended Users: These are the individuals or groups who will use the assurance report to make
decisions. In this case, it's the company's board of directors, who will use the report for risk
management decisions.

The other options are incorrect because they misalign these roles:

A) Incorrectly places the CFO as the practitioner and the board as the responsible party.

C) Incorrectly places the board as the practitioner and the independent assessor as the
intended users.

D) Incorrectly places the CFO as the practitioner and the independent assessor as the
responsible party.

In assurance engagements, it's crucial to correctly identify these three parties as they each have
distinct roles and responsibilities in the process.

5. B) An audit provides reasonable assurance, while a review provides limited assurance.

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Explanation:

An audit is designed to provide a high level of assurance (reasonable assurance) that financial
statements are free from material misstatement. This involves extensive procedures such as
verification of records, testing, and evaluating internal controls. On the other hand, a review
provides a lower level of assurance (limited assurance) and involves fewer procedures,
primarily focusing on inquiry and analytical review rather than detailed testing.

(5×2 = 10 MARKS)

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