INTERMEDIATE – AUDIT

Chapter: Nature Objective and Scope of Audit, Audit Strategy Audit Planning and
Programming, Risk Assessment and Internal Control, Ethics and Terms of Audit
Engagement

Paper: Auditing and Assurance Marks: 50

SPC Receipt No: Model Answer
Test ID: 02551 Time Allowed :1.5 Hour

PART A

MULTIPLE CHOICE QUESTIONS (10 X 1 Mark each)

1) ____________ refers to an attitude that includes a questioning mind, being alert to conditions which may
indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.
a) Professional skepticism
b) Professional Judgement
c) Integrity
d) Objectivity

2) In order to form the opinion, the auditor shall conclude as to whether the auditor has obtained
_______________ about whether the financial statements as a whole are free from material misstatement,
whether due to fraud or error.
a) reasonable assurance
b) absolute assurance
c) Limited assurance
d) None of the above

3) The auditor’s safeguards the auditor’s ability to form an audit opinion without being affected by any
influences.
a) Objectivity
b) Independence
c) Confidentiality
d) Integrity

4) Once the overall audit strategy has been established, can be developed to address the various matters
identified in the overall audit strategy, taking into account the need to achieve the audit objectives
through the efficient use of the auditor’s resources.
a) audit strategy
b) audit plan
c) audit plan and audit strategy
d) audit note book

5) Planning an audit involves establishing the overall audit strategy for the engagement and
a) developing an audit plan.
b) developing an audit program
c) developing detailed strategy
d) any of the above

6) Planning an audit involves

a) establishing the overall audit strategy for the engagement and developing an audit plan.
b) establishing the overall audit plan for the engagement and developing an audit strategy.
c) establishing the overall audit plan for the engagement
d) developing an audit strategy.

7) Audit risk is a function of the

a) risks of material misstatement and detection risk.
b) audit risk and detection risk.
c) control risk and detection risk.
d) inherent risk and detection risk.

8) The assessment of the risks of material misstatement may be expressed in

a) quantitative terms, such as in percentages, or in non-quantitative terms.
b) quantitative terms, such as in percentages,
c) non-quantitative terms.
d) None of the above

9) Identify the most appropriate statement:-

(a) SA220 applies at the level of firm.
(b) SQC1 is premised on the basis that firm is subject to SA220.
(c) SA220 is premised on the basis that firm is subject to SQC1.
(d) SA220 applies to all engagements.

10) Which of the following is not a fundamental principle governing professional ethics?
(a) Professional competence and due care
(b) Integrity
(c) Objectivity
(d) Safeguards to independence

State with reasons (in short) whether the following statements are correct or incorrect: (5 X 1 Mark)
1) The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore obtain absolute
assurance that the financial statements are free from material misstatement due to fraud or error.
2) A detailed Audit Programme once prepared for a business can be used for all business under all
circumstances.
3) Control risk is the susceptibility of an account balance or class of transactions to misstatement that could
be material either individually or, when aggregated with misstatements in other balances or classes, assuming
that there were no related internal controls.
4) According to Mr. H, one of the team members of the auditor of Very Essential Limited was of the view that
no relation exists between accounting and auditing from the point of view of a company.
5) The Audit Engagement documentations should ordinarily be retained by the auditor for minimum of six
years from the date of the auditor's report or the date of the group auditor's report, whichever is later.
Answer
1) A
2) A
3) B
4) B
5) A
6) A
7) A
8) A
9) C
10) D

Answer
1) Correct: As per SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing”, the auditor is not expected to, and cannot, reduce audit risk to zero
and cannot therefore obtain absolute assurance that the financial statements are free from material
misstatement due to fraud or error. This is because there are inherent limitations of an audit, which result in
most of the audit evidence on which the auditor draws conclusions and bases the auditor’s opinion being
persuasive rather than conclusive.
2) Incorrect. Businesses vary in nature, size and composition; work which is suitable to one business may not
be suitable to others; efficiency and operation of internal controls and the exact nature of the service to be
rendered by the auditor are the other factors that vary from assignment to assignment. On account of such
variations, evolving one audit programme applicable to all business under all circumstances is not practicable
3) Incorrect: Inherent risk is the susceptibility of an account balance or class of transactions to misstatement
that could be material either individually or, when aggregated with misstatements in other balances or
classes, assuming that there were no related internal controls.
4) Incorrect: The viewpoint of Mr. H is incorrect because there exists a proper relation between accounting
and auditing from the point of view of a company. Audit is conducted for financial statements of a company
and those financial statements are prepared with the help of books of accounts of that company. In order to
properly conduct an audit of a company, an auditor is required to be aware of accounting principles and
accounting policies of that company.
5) Incorrect: SQC 1 requires firms to establish policies and procedures for the retention of engagement
documentation. The retention period for audit engagements ordinarily is no shorter than seven years from
the date of the auditor’s report, or,if later,the date of the group auditor’s report.

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PART B – THEORY
(7 x 5 Marks each)
Q1) A Chartered accountant in practice issued a certificate showing original cost of plant and machinery
installed in premises of a client for Rs. 9 crores to save some regulatory fees for his client. However, original
cost of plant and machinery wasRs.15 crore as per records of client. Which fundamental principle governing
professional ethics is violated in this case?
Answer
“Integrity” requires that a professional accountant shall not knowingly be associated with reports, returns,
communications or other information where the accountant believes that the information contains a
materially false or misleading statement; contains statements or information
providednegligentlyoromitsorobscuresrequiredinformationwheresuchomission or obscurity would be
misleading.
In the given case, a false certificate is knowingly issued showing misstated original cost of machinery.
Therefore, fundamental principle of “integrity” is violated.
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Q2) There are practical and legal limitations on the auditor’s ability to obtain audit evidence. Explain with
examples.
Answer
The Nature of Audit Procedures: There are practical and legal limitations on the auditor’s ability to obtain
audit evidence. For example:
1. There is the possibility that management or others may not provide, intentionally or unintentionally,
the complete information that is relevant to the preparation and presentation of the financial statements or
that has been requested by the auditor.
2. Fraud may involve sophisticated and carefully organised schemes designed to conceal it. Therefore,
audit procedures used to gather audit evidence may be ineffective for detecting an intentional misstatement
that involves, for example, collusion to falsify documentation which may cause the auditor to believe that
audit evidence is valid when it is not.
The auditor is neither trained as nor expected to be an expert in the authentication of documents.
3. An audit is not an official investigation into alleged wrongdoing. Accordingly, the auditor is not given
specific legal powers, such as the power of search, which may be necessary for such an investigation.
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Q3) When auditor identifies deficiencies and report on internal controls, he determines the significant
financial statement assertions that are affected by the ineffective controls in order to evaluate the effect on
control risk assessments and strategy for the audit of the financial statements. Explain
Answer
Control risk assessment when control deficiencies are identified: When auditor identifies deficiencies and
report on internal controls, he determines the significant financial statement assertions that are affected by
the ineffective controls in order to evaluate the effect on control risk assessments and strategy for the audit
of the financial statements.
When control deficiencies are identified and auditor identifies and tests more than one control for each
relevant assertion, he evaluates control risk considering all of the controls he has tested. If auditor determines
that they support a ‘rely on controls’ risk assessment, or if compensating controls are identified, tested and
evaluated to be effective, he may conclude that the ‘rely on controls’ is still appropriate. Otherwise we
change our control risk assessment to ‘not rely on controls.’
When a deficiency relates to an ineffective control that is the only control identified for an assertion, he
revises risk assessment to ‘not rely on controls’ for associated assertions, as no other controls have been
identified that mitigate the risk related to the assertion. If the deficiency relates to one WCGW (what can go
wrong) out of several WCGW’s, he can ‘rely on controls’ but performs additional substantive procedures to
adequately address the risks related to the deficiency.
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Q4) Engagement Partner CA Hitesh Kapur of Kapur and Associates wanted to develop an audit plan of
Sampurna Fabrics Ltd. Discuss the matters to be described in such an audit plan.
Answer
The auditor shall develop an audit plan that shall include a description of :
(i) The nature, timing and extent of planned risk assessment procedures, as determined under SA 315
“Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its
Environment”.
(ii) The nature, timing and extent of planned further audit procedures at the assertion level, as
determined under SA 330 “The Auditor’s Responses to Assessed Risks”.
(iii) Other planned audit procedures that are required to be carried out so that the engagement complies
with SAs.
The audit plan is more detailed than the overall audit strategy that includes the nature, timing and extent of
audit procedures to be performed by engagement team members. Planning for these audit procedures takes
place over the course of the audit as the audit plan for the engagement develops.
Example
Planning of the auditor’s risk assessment procedures occurs early in the audit process.
However, planning the nature, timing and extent of specific further audit procedures depends on the
outcome of those risk assessment procedures. In addition, the auditor may begin the execution of further
audit procedures for some classes of transactions, account balances and disclosures before planning all
remaining further audit procedures.
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Q5) You are being appointed as the auditor of Track Ltd. for the first time. You want to determine the
materiality level and for that you have applied percentage to choose benchmark as a starting point in
determining materiality for the financial statements as a whole. What are the factors that may affect the
identification of an appropriate benchmark?
Answer
SA 320 “Materiality in Planning and Performing an Audit” prescribes the use of Benchmarks in Determining
Materiality for the Financial Statements as a Whole.
Determining materiality involves the exercise of professional judgment. A percentage is often applied to a
chosen benchmark as a starting point in determining materiality for the financial statements as a whole.
Factors that may affect the identification of an appropriate benchmark include the following:
i. The elements of the financial statements (for example, assets, liabilities, equity, revenue, expenses);
ii. Whether there are items on which the attention of the users of the particular entity's financial
statements tends to be focused (for example, for the purpose of evaluating financial performance, users may
tend to focus on profit, revenue or net assets);
iii. The nature of the entity, where the entity is at in its life cycle, and the industry and economic
environment in which the entity operates.
iv. The entity's ownership structure and the way it is financed (for example, if an entity is financed solely
by debt rather than equity, users may put more emphasis on assets, and claims on them, than on the entity's
earnings); and
v. The relative volatility of the bench.
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Q6) While conducting the audit of Smart TV Ltd, engagement team of HTR& Co, has considered materiality
and audit risk throughout the audit. Discuss explaining the meaning of audit risk.
Answer
Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements
are materially misstated. Audit risk is a function of the risks of material misstatement and detection risk.
Materiality and audit risk are considered throughout the audit, in particular, when:
(a) Identifying and assessing the risks of material misstatement;
(b) Determining the nature, timing and extent of further audit procedures; and
(c) Evaluating the effect of uncorrected misstatements, if any, on the financial statements and in forming
the opinion in the auditor’s report.
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Q7) In case of certain subject matters, limitations on the auditor’s ability to detect material misstatements are
particularly significant. Explain such assertions or subject matters.
Answer
In the case of certain subject matters, limitations on the auditor’s ability to detect material misstatements
are particularly significant. Such assertions or subject matters include:
- Fraud, particularly fraud involving senior management or collusion.
- The existence and completeness of related party relationships and transactions.
- The occurrence of non-compliance with laws and regulations.
- Future events or conditions that may cause an entity to cease to continue as a going concern.