CLASS PRACTICE QUESTIONS CHAPTER 11
1. CA P. Suryakantam has conducted audit of accounts of an entity for a particular year. ICAI has issued a letter to
him relating to certain matters concerning audit. He didn’t even bother to reply to the letter despite reminders.
Discuss which fundamental principle governing professional ethics is disregarded by him.
2. 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 was Rs.15 crore as per records of client. Which fundamental principle governing professional
ethics is violated in this case?
3. CA Raman Gupta is offered appointment as auditor of a company. One of his distant uncles held some shares
in the same company. Holding of such shares, by a distant relative, is not prohibited under provisions of law
nor does it affect his independence. Before he could accept appointment, he received unfortunate news of
death of his uncle who had died without any children. He came to know that he was nominee of these shares
having substantial value. It landed him in a tricky situation. What should be proper course of action for him?
4. A Chartered accountant receives about 40% of his total audit fees from a single client. Discuss how it could
affect independence of Chartered accountant as auditor of this client. What are such types of threats referred
to as?
5. CA Murli Madhavan provides accounting and book keeping services to a leading NGO engaged in
environmental protection work. He is also offered audit of the accounts of NGO. Identify and discuss what kind
of threat to independence may be involved in accepting such an engagement.
6. The auditors of a company have only relied upon management representation letter regarding treatment of
certain tax matters under appeal by the company. The auditors have not carried out any other audit procedures
to justify management’s treatment of the said tax matters under appeal in the financial statements. What is
lacking on part of auditors in such a situation?
7. Chirag, as part of articled training, is part of an engagement team conducting audit of a company. He has read
somewhere that engagement letter issued by auditor to client also includes expected form and content of the
auditor’s report. He was at a loss to understand how could an auditor include form and content of the report
beforehand. Try to help Chirag by making things clear to him.
8. The management of an entity feels that it is not necessary for it to give in writing explicitly to the auditor that
it understands its responsibilities for preparation of financial statements in accordance with applicable financial
reporting framework. Discuss, whether, it is necessary for the management to do so. In case management
refuses, why should an auditor not accept the proposed engagement?
9. CA PK Nair is offered appointment as auditor of a company engaged in providing tourism services. While
making due diligence of the proposed client, he comes to know that there have been raids on premises of the
company and residences of its directors by National Investigation Agency (NIA) on suspicion of links with terror
outfits. It has been followed up with searches by Enforcement Directorate hunting for illicit money trail. There
is a strong suspicion of tourism services provided by company being façade of terror funds. Should proposed
offer be accepted by him?
10. CA Arpita has joined a mid-sized CA firm recently. She finds that partners remain too busy and the firm is
proposing to accept audit work in areas in which it has no experience or capabilities. The firm is proposing to
accept audit of some entities engaged in emerging “fin-tech” sector. Such audits may be requiring extensive
use of technology and data analytics. However, the said firm has no such capabilities and trained personnel.
Discuss, whether, firm should accept such audits with reason.
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Answers to Questions involving Test your understanding
1. The auditor shall comply with relevant ethical requirements, including those pertaining to independence.
Relevant ethical requirements ordinarily comprise the Code of Ethics issued by the Institute of Chartered
Accountants of India. The Code establishes as the fundamental principles of professional ethics relevant to the
auditor. One of the fundamental principle is professional behavior which is related to the compliance with relevant
laws and regulations and avoid such actions which may result in to discrediting the profession.
Failure to reply to professional body smacks of lack of courtesy and professional responsibility. The principle of
“Professional behavior” is disregarded.
2. “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 provided negligently or omits or obscures
required information where such omission 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.
3. When threats to independence exist, the auditor should either desist from the task or eliminate the threat or
at the very least, put in place safeguards which reduce the threats to an acceptable level.
Holding of shares involves financial interest in the company and is in nature of self-interest threat. He has come to
hold shares due to nomination made by his distant relative before accepting the appointment. Considering above,
he should take steps to eliminate the threat by selling shares immediately before accepting appointment. Holding
of shares of the same company for which he is offered appointment as auditor constitutes threat to his
independence.
4. Undue dependence on fees of a client constitutes a threat as there is fear of losing the client. Such threats are
referred to as self-interest threats. Self Interest Threats occur when an auditing firm, its partner or associate could
benefit from a financial interest in an audit client.
5. In this case, Chartered Accountant is already rendering accounting and book keeping services to an NGO. If he
accepts audit, he would be involved in reviewing own work. Therefore, the same constitutes “self-review” threat.
Such a threat occurs when a previous judgment needs to be revaluated by the auditor responsible for that
judgment.
6. In the given case, auditors have relied only upon management representation letter regarding treatment of
certain tax matters under appeal by the company. No other audit procedures to verify management’s treatment
of such matters under appeal have been performed by auditors. It shows lack of “professional skepticism” on part
of auditors. Professional skepticism is an attitude of the auditor which requires alertness towards information
provided by client. It is necessary for the auditor to maintain it throughout the Audit.
7. Engagement letter includes reference to expected form and content of audit report. It merely states that
auditor would provide opinion in this form. However, engagement letter also includes statement that the form and
content of report may need to be amended in the light of audit findings. Therefore, if in light of audit findings,
auditor needs to give a modified opinion, he shall do so.
8. It is necessary for management to give in writing explicitly to the auditor that it understands its responsibilities
for preparation of financial statements in accordance with applicable financial reporting framework. It is a
necessary precondition for an audit in accordance with SA 210.
If the preconditions for an audit are not present, the auditor shall discuss the matter with management. Unless
required by law or regulation to do so, the auditor shall not accept the proposed audit engagement: -
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(a) If the auditor has determined that the financial reporting framework to be applied in the preparation of the
financial statements is unacceptable or
(b) If the agreement of management is not obtained on matters relating to understanding of responsibility of
management on preparation of financial statements, internal controls for preparation of financial statements,
providing access to all information to auditor and unrestricted access to persons within the entity.
Unless required by law or regulation to do so, such a refusal on the part of auditor is necessary as management is
not willing to accept its responsibility for preparation of financial statements in accordance with applicable financial
reporting framework. An audit is conducted on this basic premise according to SA 210. When basic premise on
which audit is conducted is not fulfilled, refusal by auditor is necessary.
9. Integrity of principal owners has to be considered before accepting an audit engagement in accordance with
SA 220. In this regard, SA 220 states requirements on lines of SQC 1. SQC 1 clearly states that in cases where there
are indications that the client might be involved in money laundering or other criminal activities, appointment
should not be accepted.
In the instant case, there have been raids of NIA on suspected links with terror outfits which is a criminal activity.
Further, raids by Enforcement Directorate also point towards money laundering. Therefore, proposed offer should
not be accepted.
10. SQC 1 requires that before accepting an engagement, competence (including capabilities, time and resources)
to perform engagement have to be considered.
In the given case, the proposed engagements involve use of technology and data analytics. The firm has no prior
experience of audits in emerging “fin- tech” sector. The firm does not have trained personnel to carry out these
audits. Hence, offer for these audits should not be accepted.
Theoretical Questions
(1) Briefly outline how principles-based approach differs from rules-based approach to ethics.
(2) How application of professional skepticism throughout audit is helpful in reducing audit risk?
(3) A Chartered accountant is conducting audit of a client for last two years. Before proceeding to start audit for
next year, he notices that there is substantial change in management. Besides, client has ventured into areas of
business activity which were not present at time of accepting initial audit engagement. Discuss responsibility of
auditor in this regard in context of SA 210.
(4) How does SQC 1 ensure that independence in engagements is not breached by an audit firm?
(5) An engagement partner takes overall responsibility for maintaining audit quality in an audit engagement in
accordance with SA 220. What are his objectives in taking and emphasizing such responsibility?
Answers
1. Ethical guidance may follow principles-based approach or rules-based approach.
A. Principles-based approach
• The essence of principles-based approach to ethics is that it requires compliance with spirit of ethics.
• It requires accountants to exercise professional judgment in every situation based upon their professional
knowledge, skill and expertise.
• It requires that accountants should use professional judgment to evaluate every situation to arrive at
conclusions.
B. Rules-based approach
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• Rules-based approach to ethics strictly follows clearly established rules.
• It may lead to a narrow outlook and spirit of ethics may be overlooked while strictly adhering to rules.
• Further, rules- based approach is somewhat rigid as it may not be possible to deal with every practical situation
relying upon rules.
Therefore, it is necessary that spirit of code is followed.
2. Professional skepticism is an attitude of the auditor which requires alertness towards information provided by
client. It is necessary for the auditor to maintain it throughout the Audit. Application of professional skepticism
throughout audit is helpful in reducing audit risk of-
i. Overlooking unusual circumstances
ii. Overgeneralising when drawing conclusions from audit observations
iii. Using inappropriate assumptions in determining NTE of audit procedure and evaluating the results thereof.
3. In case of a recurring audit, the auditor shall assess whether circumstances require revision in the terms of audit
engagement or there is no need to revision. If revision requires than new engagement letter must be send,
otherwise not required.
However, the following factors may make it appropriate to send a new letter-
a. Any indication that the client misunderstands the objective and scope of the audit.
b. Any revised or special terms of the engagement.
c. A recent change in senior management, board of directors or ownership.
d. A significant change in nature or size of the client’s business.
e. Legal requirements or pronouncements of the Institute of Chartered Accountants of India, or changes in the
existing ones.
In this case a Chartered accountant is conducting audit of a client for last two years. Before proceeding to start
audit for next year, he notices that there is substantial change in management. Besides, client has ventured into
areas of business activity which were not present at time of accepting initial audit engagement. So he must send
new engagement letter.
4. As per SQC 1 and SA 220 the auditor shall comply with relevant ethical requirements, including those pertaining
to independence. Relevant ethical requirements ordinarily comprise the Code of Ethics issued by the Institute of
Chartered Accountants of India. The Code establishes the fundamental principles of professional ethics relevant to
the auditor like Integrity, objectivity, confidentiality, professional competence and due care and professional
behavior. As per SQC 1 the firm should establish policies and procedures designed to provide it with reasonable
assurance that the firm and engagement team maintain independence to ensure that independence in
engagements is not breached by an audit firm.
5. The engagement partner shall take responsibility for the overall quality on each audit engagement to which that
partner is assigned. This emphasize
(a) The importance to audit quality of:
(i) Performing work that complies with professional standards and regulatory and legal requirements;
(ii) Complying with the firm’s quality control policies and procedures as applicable;
(iii) Issuing auditor’s reports that are appropriate in the circumstances; and
(iv) The engagement team’s ability to raise concerns without fear of reprisals; and
(b) The fact that quality is essential in performing audit engagements
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