“The auditing principles are necessary to conduct a financial audit in an efficient, ethical and effective way.

” Justify
the statement by explaining at least six principles of auditing in brief.

According to the Institute of Chartered Accountants of India (ICAI), auditing is the independent examination of
financial information of an entity, whether profit-oriented or not, irrespective of its size or legal form, when such
examination is conducted with a view to expressing an opinion thereon

Meaning of Auditing Principles: Auditing principles are the fundamental guidelines prescribed by the Institute of
Chartered Accountants of India (ICAI) which govern the conduct of an audit and ensure that the auditor performs his
work in an ethical, systematic and professional manner.

Auditing Principles (As per SA 200 / ICAI)

1. Integrity: The auditor must be honest, sincere and straightforward while performing audit work. Integrity
ensures that the auditor does not knowingly associate with misleading information and maintains public
confidence in the audit profession.
2. Objectivity and Independence: The auditor should remain free from bias, conflict of interest and undue
influence. Independence of mind and appearance is essential so that the audit opinion is impartial and
reliable.
3. Confidentiality: The auditor must maintain confidentiality of information acquired during the course of
audit and should not disclose such information without proper authority unless legally required to do so.
4. Professional Competence and Due Care: The auditor should possess adequate professional knowledge and
skill and should perform audit work with reasonable care, diligence and competence in accordance with
auditing standards.
5. Professional Skepticism: The auditor should maintain a questioning and critical attitude, recognising the
possibility of material misstatement due to fraud or error, and should not accept audit evidence at face
value.
6. Audit Evidence: The auditor must obtain sufficient and appropriate audit evidence through inspection,
observation, confirmation and analytical procedures to form a reasonable basis for expressing an audit
opinion.
7. Documentation: The auditor should properly document audit procedures performed, evidence obtained
and conclusions reached, so that audit work can be reviewed and accountability is ensured.
8. Planning and Supervision: The audit should be properly planned and audit assistants should be adequately
supervised so that the audit is conducted efficiently and important areas receive due attention.

Inherent Limitations of Auditing (as per SA 200)

SA 200 recognises that due to inherent limitations, an audit cannot provide absolute assurance and the auditor can
only provide reasonable assurance.

1. Nature of financial reporting: Financial statements involve subjective judgments, estimates and assumptions
(such as provisions, depreciation and valuation of inventory), which cannot be verified with absolute certainty.
2. Nature of audit procedures: Audit evidence is persuasive rather than conclusive because the auditor relies on
techniques such as sampling, analytical procedures and management representations.
3. Inherent limitations of internal control: Internal control systems, even if properly designed, may be
overridden by management or circumvented through collusion.
4. Use of test checking: Since it is impractical to examine all transactions, auditors use test checking, due to
which some misstatements may remain undiscovered.
5. Possibility of fraud: Frauds involving sophisticated planning, collusion or management override are inherently
difficult to detect during an audit.
6. Time and cost constraints: Audits are conducted within reasonable time and cost limits, which restrict the
extent of detailed verification.

Example: A well-planned management fraud supported by falsified documents may not be detected despite
compliance with auditing standards
Classification of Audit

Audit can be classified on different bases depending upon the purpose, scope and authority under which it is
conducted.

A. Classification on the Basis of Organisation / Authority

1. Statutory Audit: Audit conducted compulsorily under the provisions of law, such as Companies Act, Banking
Regulation Act, etc.
2. Government Audit: Audit conducted of government departments and public sector undertakings by
government authorities such as CAG.
3. Internal Audit: Audit conducted by an organisation’s own internal audit department for internal control and
efficiency.
B. Classification on the Basis of Time
1. Continuous Audit: Audit conducted continuously throughout the year.
2. Periodical / Final Audit: Audit conducted at the end of the accounting period.
C. Classification on the Basis of Scope
1. Complete Audit: Detailed examination of all transactions.
2. Partial Audit: Audit limited to certain areas or aspects.
D. Classification on the Basis of Objective
1. Financial Audit: Audit of financial statements to express an opinion on true and fair view.
2. Cost Audit: Audit of cost records to verify cost efficiency and correctness.
3. Management Audit: Audit of managerial policies, efficiency and performance.
4. Social Audit: Audit to examine social responsibilities and social impact of an organisation.

Q. (a) State the difference between private audit and statutory audit. Explain the advantages of statutory audit in
respect of those organisations where it is obligatory.

Basis Private Audit Statutory Audit

Audit conducted voluntarily at the request Audit conducted compulsorily under provisions
1. Meaning
of owners or management of law

Mandatory under statutes such as the

2. Legal requirement Not required by law
Companies Act

Private concerns, partnership firms, Companies, banks and other entities specified by
3. Applicability
individuals law

4. Appointment of Appointed as per legal provisions (shareholders,

Appointed by owners or management
auditor CAG, etc.)

Scope is decided by the client and may be

5. Scope of audit Scope is fixed by statute and cannot be restricted
restricted

To serve the specific needs of owners or To protect interests of shareholders and the
6. Objective
management public
Basis Private Audit Statutory Audit

Report submitted to shareholders or statutory

7. Reporting Report submitted to the client
authorities

Advantages of Statutory Audit (where it is obligatory)

1. Protection of stakeholders’ interests: Statutory audit safeguards the interests of shareholders, creditors and
the public by ensuring that financial statements present a true and fair view and comply with legal
requirements.
2. Reliability and credibility of accounts: Audited accounts prepared under statutory audit carry greater
authenticity and reliability, increasing confidence of investors, lenders, banks and regulatory authorities.
3. Detection and prevention of frauds and errors:
Compulsory audit acts as a deterrent against frauds and errors and helps in their timely detection, thereby
promoting financial discipline and transparency.
4. Compliance with law: Statutory audit ensures compliance with provisions of the Companies Act, Accounting
Standards and other statutory requirements.
5. Facilitates decision-making: Reliable audited financial statements help management, shareholders and
external users in making informed economic decisions.

Basis Statutory Audit Internal Audit Government Audit

Audit of government
Audit conducted compulsorily Audit conducted by internal
1. Meaning departments and public sector
under law staff of the organisation
units

Governed by statutes like Governed by Constitution and

2. Authority Decided by management
Companies Act laws

Appointed by shareholders or
3. Appointment Appointed by management Appointed by CAG
as per law

To express opinion on true and

To improve internal control, To ensure proper use of public
4. Objective fair view of financial
efficiency and performance funds
statements

Very wide, includes financial,

5. Scope Determined by statute Determined by management compliance and performance
audit

6. Auditor is independent of Auditor is employee of the Auditor is independent of

Independence management organisation audited entity

Report submitted to Report submitted to Report submitted to Parliament

7. Reporting
shareholders management / Legislature

Mandatory for entities covered Optional, based on Mandatory for government

8. Applicability
by law organisational needs bodies

Q. What are the challenges of auditing in a computerised environment? Discuss how these challenges can be
mitigated.
Audit in a computerised environment refers to the examination of accounting records, internal controls and financial
information where data is processed, stored and generated using computers and computer-based accounting
systems. In such an environment, the auditor is required to understand the computer system, application software
and related controls in order to obtain sufficient and appropriate audit evidence.
Challenges of Auditing in a Computerised Environment: Auditing in a computerised environment presents several
challenges due to extensive use of information technology and automated processing of data.

1. Lack of visible audit trail: Computerised systems often process transactions electronically without generating
physical documents, making it difficult to trace transactions from source to final output.
2. Dependence on IT controls: Auditors rely heavily on general and application controls. Weak system controls
can lead to increased risk of material misstatements.
3. Risk of unauthorised access: Computer systems are vulnerable to hacking, data manipulation and
unauthorised access, which may result in fraud or data loss.
4. Program and processing errors: Errors in software programs or system logic may cause incorrect processing
of transactions affecting large volumes of data.
5. Data integrity and security risks: Data may be altered, deleted or corrupted due to system failures, malware
or improper access controls.
6. Reduced human intervention: Automation reduces manual checks, increasing the risk that errors or frauds
may go undetected for longer periods.
7. Technical complexity: Complex accounting software, ERP systems and databases require specialised IT
knowledge, which auditors may lack.
8. Dependence on system-generated evidence: Audit evidence is often generated by the system itself, raising
concerns about its reliability if controls are weak.

Mitigation of Challenges in a Computerised Environment

1. Use of CAATs: Computer Assisted Audit Techniques enable auditors to analyse entire data populations,
identify anomalies and improve audit effectiveness.
2. Evaluation and testing of IT controls: Auditors should evaluate and test general IT controls and application
controls to ensure system reliability.
3. Strengthening audit trail: Use of system logs, transaction IDs and automated audit trails helps in tracing
transactions.
4. Use of IT experts: Engaging IT specialists helps auditors understand complex systems and assess system risks
effectively.
5. Training of auditors: Continuous training in IT and computerised accounting systems enhances auditors’
competence.
6. Data security controls: Strong access controls, passwords, encryption and backup procedures reduce risk of
data manipulation and loss.
7. Periodic system review: Regular review and testing of software programs and system updates help detect
errors early.

Role of Auditor in Cases of Fraud and Error (as per SA 240):

1. Obtaining reasonable assurance: The auditor is responsible for obtaining reasonable assurance that the
financial statements as a whole are free from material misstatement, whether caused by fraud or error.
2. Professional scepticism: The auditor should maintain an attitude of professional scepticism throughout the
audit, recognising the possibility that material misstatements due to fraud or error may exist irrespective of
past experience with management.
3. Risk assessment: The auditor should identify and assess the risks of material misstatement due to fraud and
error at the financial statement level and at the assertion level.
 4. Inquiry and discussion: The auditor should make inquiries of management and those charged with
governance regarding their assessment of fraud risk, internal controls and any detected or suspected frauds
or errors.
5. Designing audit procedures: Based on the assessed risks, the auditor should design and perform appropriate
audit procedures to obtain sufficient and appropriate audit evidence.
6. Detection of fraud and error: Although prevention and detection of fraud and error is primarily the
responsibility of management, the auditor is responsible for detecting material frauds and errors affecting
the financial statements.
7. Reporting: If fraud or material error is identified or suspected, the auditor should communicate the matter to
management and those charged with governance and report to appropriate authorities where required by
law.

“Auditor is a watchdog, not a bloodhound.” Comment:

This statement highlights the true role and responsibility of an auditor. It means that an auditor is expected to be
alert, vigilant, and cautious like a watchdog, but is not required to suspect dishonesty everywhere or hunt for fraud
like a bloodhound.
Meaning: An auditor’s primary duty is to examine financial statements and express an opinion on whether they
present a true and fair view. The auditor is not an investigator whose main job is to detect fraud at all costs.
Explanation of the Statement:
• A watchdog performs duties with care, attentiveness, and professional scepticism, responding when
something appears unusual.
• A bloodhound aggressively searches for wrongdoing even when there is no reasonable suspicion.
• Auditing standards do not expect auditors to assume management is dishonest unless there are indications
to the contrary.
Position under Auditing Standards (SA 200 & SA 240):
• The auditor provides reasonable assurance, not absolute assurance.
• The auditor must maintain professional scepticism, meaning a questioning mind, but not constant suspicion.
• Responsibility for prevention and detection of fraud lies primarily with management, not the auditor.
Judicial View:
This principle was emphasised in the famous case Kingston Cotton Mill Co. (1896), where it was held that an auditor
is not bound to be a detective or approach the work with suspicion unless circumstances demand it.
Examples:
1. If stock records appear reasonable, the auditor may rely on them instead of physically checking every
item.
2. If internal controls are strong, the auditor need not conduct exhaustive verification.
3. However, if unusual trends or inconsistencies arise, the auditor must investigate further.
Critical View (Modern Perspective):
While the statement is still valid, modern auditing places greater responsibility on auditors regarding fraud
detection due to corporate scandals. Hence, auditors today are expected to be more alert than earlier, though still
not bloodhounds.
Conclusion:
The statement rightly defines the auditor’s role. An auditor is a watchdog who exercises due care, skill, and
professional scepticism, but is not expected to relentlessly search for fraud unless there are reasonable grounds for
suspicion.

Kingston Cotton Mills Co. (1896)

Facts: The company’s balance sheet showed inflated stock values due to fraud by the manager. The auditors relied on
stock certificates provided by management and did not physically verify stock.
Issue: Whether the auditor was negligent for failing to detect the fraud.
Decision: The court held that the auditor was not negligent.
Principle / Significance: An auditor is a watchdog, not a bloodhound. The auditor is expected to exercise reasonable
care and skill but is not required to suspect fraud unless circumstances arouse suspicion. Auditors are entitled to rely
on representations made by responsible officers of the company unless there is reason to doubt them.

Caparo Industries plc v. Dickman (1990)

Facts: Caparo Industries purchased shares of Fidelity plc relying on audited financial statements. Later, the company’s
financial position turned out to be weaker, causing Caparo losses.
Issue: Whether auditors owed a duty of care to investors who relied on audited accounts to make investment
decisions.
Decision: The court held that auditors do not owe a duty of care to individual investors or the public at large.
Principle / Significance: Auditors owe a duty of care only to the company and its shareholders as a body, not to
outsiders relying on financial statements for investment decisions. This case established limits on auditors’ liability to
third parties.
Westminster Road Construction & Engineering Co. Ltd. (1932)
Facts: The auditor failed to verify cash balances and relied entirely on management statements. As a result, cash
misappropriation went undetected.
Issue: Whether the auditor had exercised reasonable care and skill.
Decision: The court held that the auditor was negligent.
Principle / Significance: An auditor must not rely blindly on management representations. He must verify material
items such as cash balances and apply reasonable care and professional scepticism. Failure to do so amounts to
negligence.

“Secretarial audit is necessary to ensure good corporate governance, compliance, and risk management.” What
are the objectives of secretarial audit and briefly explain the legal provisions included in the Companies Act, 2013.

Meaning of Secretarial Audit: Secretarial audit is a mechanism to examine and verify whether a company has
complied with the provisions of the Companies Act, 2013, rules made thereunder, and other applicable corporate
laws, with the objective of ensuring good corporate governance, legal compliance, and effective risk management.

Objectives of Secretarial Audit

1. To ensure legal and regulatory compliance: Secretarial audit ensures that the company complies with the
provisions of the Companies Act, SEBI regulations, and other applicable corporate laws.
2. To promote good corporate governance: It helps in strengthening governance practices by ensuring proper
board processes, transparency, and ethical conduct.
 3. To identify and manage compliance risks: Secretarial audit helps in early identification of non-compliances,
thereby reducing the risk of penalties and legal actions.
4. To protect stakeholders’ interests: It safeguards the interests of shareholders, investors, creditors, and
regulators by ensuring statutory compliance.
5. To improve corporate discipline and systems: It encourages companies to establish effective compliance
management systems and standard operating procedures.

Supporting Reference (limited): Secretarial audit acts as a preventive compliance tool rather than a corrective one.

Legal Provisions of Secretarial Audit under the Companies Act, 2013

Applicability (Section 204):

• Secretarial audit is mandatory for Every listed company,

• Certain classes of public companies as prescribed under rules

Appointment of Secretarial Auditor:

• Appointed by the Board of Directors

• Must be a Practising Company Secretary (PCS)

Scope of Secretarial Audit:

• Compliance with the Companies Act, 2013

• Compliance with rules, regulations, guidelines, and standards applicable to the company
• Proper functioning of Board and committee meetings

Secretarial Audit Report:

• The auditor submits a Secretarial Audit Report in Form MR-3
• The report is annexed to the Board’s Report

Responsibility of the Company:

• The company must provide all records, explanations, and assistance required by the secretarial auditor.

Importance in Corporate Governance and Risk Management: Secretarial audit ensures systematic compliance,
enhances transparency, and helps in timely detection of non-compliances, thereby reducing governance failures and
compliance risks.

Example (only one, for support): Non-compliance with board meeting procedures can be identified early through
secretarial audit, avoiding regulatory penalties.

Q. State the characteristics of a sound system of Internal Check. Differentiate between internal check and internal
control.

Internal check refers to a system of allocation of duties and responsibilities among staff in such a way that the work
of one person is automatically checked by another, thereby reducing the chances of errors and frauds.

Characteristics of a Sound System of Internal Check

A sound system of internal check ensures that the work of one employee is automatically checked by another and
reduces the possibility of errors and frauds.

1. Proper division of work: Duties and responsibilities should be clearly divided among different employees so
that no single person handles a transaction from beginning to end.
2. Separation of duties: Authorisation, execution, recording and custody of assets should be performed by
different persons to avoid misuse or manipulation.
3. Proper authorisation: All transactions should be carried out only with proper approval of a responsible
authority.
 4. Rotation of duties: Periodic rotation of duties among employees helps in detecting irregularities and
prevents collusion.
5. Independent checking: Work performed by one employee should be independently checked by another to
ensure accuracy and reliability.
6. Use of documents and records: Proper use of vouchers, invoices, receipts and records should be ensured to
create accountability.

Internal Check with Reference to Sales Transactions

1. Order receiving: Sales orders should be received by a separate department and properly authorised.
2. Credit approval: Credit sales should be approved by the credit department after checking customer
creditworthiness
3. Dispatch of goods: Goods should be dispatched by the dispatch department on the basis of authorised sales
orders.
4. Invoicing: Sales invoices should be prepared by an independent billing department.
5. Recording: Sales should be recorded in the sales book by accounts department.
6. Collection of dues: Collection of cash from customers should be handled by a separate person, and receipts
should be issued.
Internal Check with Reference to Purchase Transactions
1. Purchase requisition: Purchase requisitions should be initiated by the stores or production department.
2. Supplier selection: Purchase orders should be issued by the purchase department after approval by
competent authority.
3. Receipt of goods: Goods received should be checked by the receiving department for quantity and quality.
4. Inspection: An independent inspection department should verify goods received.
5. Recording: Purchase invoices should be checked and recorded by the accounts department.
6. Payment: Payments to suppliers should be authorised and made by a person other than the one recording
purchases.
Difference between Internal Check and Internal Control

Basis Internal Check Internal Control

Internal control is the overall system of policies,

Internal check is an arrangement of duties
procedures and practices adopted by
1. Meaning among employees in such a way that the work of
management to ensure orderly conduct of
one person is automatically checked by another.
business.

2. Nature Mainly preventive in nature. Both preventive and detective in nature.

Narrow in scope; forms only a part of internal Very wide in scope; includes internal check,
3. Scope
control. internal audit and other controls.

Covers financial, operational, administrative and

4. Coverage Limited mainly to routine financial transactions.
compliance aspects of business.

To ensure reliability of records, safeguarding of

To reduce the chances of errors and frauds by
5. Objective assets, efficiency of operations and compliance
division of work.
with laws.

Operates automatically through division of Established deliberately by management

6. Authority
duties among employees. through policies and procedures.
Basis Internal Check Internal Control

More flexible; can be modified according to

7. Flexibility Less flexible; based on fixed allocation of duties.
organisational needs.

8. Dependence Highly dependent on honesty and efficiency of Depends on both human element and system-
on staff employees. based controls.

9. Detection of Helps in prevention but limited in detecting Better ability to detect frauds due to multiple
fraud frauds involving collusion. layers of controls.

10. Legal Mandatory responsibility of management under

Not a legal requirement by itself.
requirement company law and auditing standards.

11. Relation to Provides a base on which the auditor may rely Auditor evaluates internal control to assess audit
audit while planning audit procedures. risk and design audit procedures.

Q. What is audit documentation? Discuss the contents of permanent audit file and current audit file.

Audit documentation refers to the written record of audit procedures performed, relevant audit evidence obtained
and conclusions reached by the auditor.
As per SA 230 – Audit Documentation, it provides evidence that the audit was planned and performed in accordance
with the Standards on Auditing and supports the auditor’s opinion.

Permanent Audit File

A permanent audit file contains information of continuing relevance to the audit of an entity and is useful for audits
of future periods.

Contents of Permanent Audit File

1. Legal documents: Memorandum of Association, Articles of Association and certificate of incorporation.

2. Organisational structure: Details of management, organisational chart and key managerial personnel.
3. Accounting policies: Significant accounting policies followed consistently by the entity.
4. Internal control system: Notes on internal control and internal check system.
5. Important agreements: Long-term contracts, lease agreements, loan agreements and debenture trust deeds.
6. Fixed assets details: Nature of fixed assets and methods of depreciation.
7. Statutory matters: Details of statutory requirements applicable to the entity.
8. Past audit reports: Copies of previous years’ audit reports and management letters.

Current Audit File

A current audit file contains information relevant to the audit of a particular accounting period and supports the
auditor’s opinion for that year.

Contents of Current Audit File

1. Audit plan and audit programme: Overall audit strategy and detailed audit procedures for the current year.
2. Working papers: Audit working papers relating to vouching, verification and test checking.
3. Trial balance and financial statements: Trial balance, balance sheet, profit and loss account and notes.
4. Audit evidence: Confirmations, reconciliations, schedules and analytical review working papers.
5. Details of adjustments: Proposed audit adjustments and management explanations.
6. Correspondence: Communication with management, internal auditors and third parties.
7. Significant matters: Notes on significant judgments, estimates and audit issues.
8. Final audit report: Draft and signed audit report for the current period.
Audit Planning (with reference to SA 210)
SA 210 – Agreeing the Terms of Audit Engagements deals with the auditor’s responsibilities in agreeing the terms of
the audit engagement with management or those charged with governance. Audit planning begins with clearly
defining and agreeing these terms.
Meaning of Audit Planning: Audit planning refers to the process of establishing the overall audit strategy and
developing an audit plan so that the audit is performed in an effective and timely manner.
Audit Planning as per SA 210:
1. Agreement of audit engagement: The auditor should agree on the terms of the audit engagement with
management before commencement of the audit to avoid misunderstandings.
2. Preconditions for an audit: The auditor should assess whether the preconditions for an audit exist, including
acceptability of the financial reporting framework and acknowledgement by management of its
responsibilities.
3. Management’s responsibilities: Management must acknowledge its responsibility for preparation of
financial statements, internal control and providing the auditor access to information.
4. Engagement letter: The agreed terms of audit are documented through an engagement letter, which
includes objective and scope of audit, responsibilities of auditor and management, applicable financial
reporting framework and form of audit report.
5. Changes in terms of engagement: Any change in the terms of engagement should be agreed upon and
documented, provided there is reasonable justification for such change.
Proper audit planning ensures clarity of roles, smooth conduct of audit and reduces audit risk.

Q. Explain the meaning and significance of audit evidence. In this context, state what is meant by compliance
procedures and substantive procedures.

Meaning of Audit Evidence: As per SA 500 – Audit Evidence, audit evidence refers to the information used by the
auditor in arriving at the conclusions on which the auditor’s opinion is based. It includes information contained in
accounting records and other information obtained by the auditor from various sources through audit procedures.

Significance of Audit Evidence: Audit evidence is significant because it forms the foundation of the auditor’s opinion
on the financial statements.

1. Basis of audit opinion: The auditor’s opinion is based on sufficient and appropriate audit evidence obtained during
the audit.

2. Reliability of financial statements: Proper audit evidence ensures that financial statements are reliable and free
from material misstatement.

3. Detection of errors and frauds: Adequate evidence helps in detecting material errors and frauds affecting the
accounts.

4. Reduction of audit risk: Obtaining sufficient and appropriate audit evidence reduces audit risk to an acceptably
low level.

5. Support for professional judgment: Audit evidence supports the auditor’s professional judgment and conclusions.

6. Legal defence: Audit evidence serves as documentary proof in case the auditor’s work or opinion is questioned in
legal proceedings.

Compliance Procedures

Meaning: Compliance procedures are audit procedures designed to test whether the internal controls of an entity
are operating effectively and are being complied with as prescribed.
Purpose: To obtain evidence regarding the effectiveness of internal control system.

Examples: Checking whether purchase orders are properly authorised, verifying adherence to approval limits,
observing compliance with internal control policies.

Substantive Procedures

Meaning: Substantive procedures are audit procedures designed to detect material misstatements at the assertion
level in financial statements.

Purpose: To verify the correctness, completeness and validity of transactions, balances and disclosures.

Types:
1. Substantive tests of details: Vouching transactions, verification of assets and liabilities.
2. Substantive analytical procedures: Analysis of relationships and trends to identify unusual fluctuations.

Techniques of Obtaining Audit Evidence (As per SA 500)

1. Inspection: Inspection involves examination of records, documents or tangible assets to obtain audit
evidence. It may relate to inspection of documents or physical verification of assets.
Example: Inspecting purchase invoices, title deeds of land, or physically verifying plant and
machinery.
2. Observation: Observation consists of watching a process or procedure being performed by others. It
provides evidence about the performance of a process at a specific point of time.
Example: Observing the physical stock-taking process conducted by management.
3. Inquiry: Inquiry involves seeking information from knowledgeable persons inside or outside the
entity. It may be formal or informal, written or oral.
Example: Asking management about reasons for abnormal increase in expenses.
4. Confirmation: Confirmation is the process of obtaining a direct written response from a third party
to verify balances or transactions. It provides reliable audit evidence when obtained directly by the
auditor.
Example: Obtaining balance confirmation from debtors or banks.
5. Computation: Computation involves checking the mathematical accuracy of documents and
records. It may be done manually or electronically. Example: Recalculating depreciation or interest on
loans.
6. Analytical Procedures: Analytical procedures involve evaluation of financial information through
analysis of relationships and trends. They help in identifying unusual fluctuations requiring further
investigation.
Example: Comparing current year gross profit ratio with previous years.

Appropriateness of Audit Evidence

Appropriateness refers to the quality of audit evidence, that is, its relevance and reliability.
1. Relevance: Audit evidence must be relevant to the audit objective and the assertion being tested.
2. Reliability: Evidence must be trustworthy and dependable.
3. Assertion-based: Evidence should appropriately support assertions relating to existence, completeness,
accuracy, valuation and presentation.
Reliability of Audit Evidence: Reliability refers to the degree to which audit evidence can be relied upon by the
auditor.
1. Source of evidence: Evidence obtained from external sources is more reliable than that obtained internally.
2. Nature of evidence: Documentary evidence is more reliable than oral representations.
3. Original documents: Original documents are more reliable than photocopies or scanned copies.
4. Internal controls: Evidence generated from systems with effective internal controls is more reliable.
 5. Direct evidence: Evidence obtained directly by the auditor (such as physical verification) is more reliable.

Q. “Internal audit has become an important managerial tool.” Explain the meaning and scope of internal audit.

Internal audit is an independent and objective assurance and consulting activity established within an organisation
to examine and evaluate the adequacy and effectiveness of internal controls, risk management and governance
processes. It is a management-oriented function that helps management in achieving organisational objectives
efficiently and effectively.

The statement “internal audit has become an important managerial tool” is justified because internal audit assists
management by providing timely information, identifying weaknesses in systems and suggesting improvements for
better control and performance.

Scope of Internal Audit

The scope of internal audit is wide and extends beyond mere verification of accounts. It includes the following areas:

1. Review of internal control system: Examining the adequacy and effectiveness of internal control and internal
check systems.
2. Verification of financial records: Checking accuracy, reliability and completeness of accounting records and
financial information.
3. Operational audit: Evaluating efficiency and effectiveness of operations and utilisation of resources.
4. Compliance audit: Ensuring compliance with laws, regulations, accounting standards and internal policies.
5. Risk management: Identifying and assessing business, financial and operational risks and suggesting control
measures.
6. Detection and prevention of frauds: Helping in early detection and prevention of frauds, errors and
irregularities.
7. Review of assets and inventory: Safeguarding of assets through verification and review of inventory
management.
8. Performance appraisal: Assessing performance of departments and suggesting improvements.
9. Advisory role: Providing recommendations and consultancy services to management for improving systems
and procedures.

Need for Mandatory Internal Audit for Corporate Governance: Corporate governance requires transparency,
accountability, compliance and effective risk management. Internal audit plays a vital role in achieving these
objectives by continuously reviewing systems and controls and reporting weaknesses to management and the Board.

Legal Provisions under the Companies Act, 201

Section 138 – Internal Audit:

Section 138 of the Companies Act, 2013 provides that certain prescribed classes of companies shall be required to
appoint an internal auditor, who may be a Chartered Accountant, Cost Accountant or other professional as decided
by the Board.

Classes of Companies Covered:

Internal audit is mandatory for Every listed company, Certain prescribed public companies, Certain prescribed
private companies

Q. Explain the difference between verification and valuation of assets. What are the duties of an auditor with
respect to valuation of assets?

Verification of Assets is the process by which the auditor satisfies himself about the existence, ownership, possession
and proper disclosure of assets appearing in the balance sheet on a particular date. It is mainly concerned with
establishing the reality of assets.
Valuation of assets refers to the process of determining the monetary value at which assets should be shown in the
balance sheet in accordance with generally accepted accounting principles, accounting standards and statutory
requirements.

Objectives of Verification of Assets:

1. Existence: To confirm that assets actually exist on the balance sheet date.
2. Ownership: To ensure that assets are owned by the entity and not by others.
3. Possession: To verify that the assets are in the possession or control of the business.
4. Proper valuation: To see that assets are valued correctly and in accordance with accepted accounting
principles.
5. Disclosure: To ensure that assets are properly classified and disclosed in the financial statements.
6. Detection of fraud and error: To detect overstatement, understatement or fictitious assets.
Procedure of Verification of Assets:
1. Physical verification: Inspecting tangible assets such as cash, stock, land, buildings and machinery.
2. Examination of documents: Verifying title deeds, invoices, contracts, insurance policies and ownership
documents.
3. Confirmation: Obtaining confirmations from third parties in case of assets held by others.
4. Comparison with records: Comparing physical assets with records maintained in asset registers.
5. Checking additions and disposals: Verifying purchases, sales and depreciation of assets during the year.
6. Review of disclosure: Ensuring proper presentation and disclosure in the balance sheet.
Difference between Verification and Valuation of Assets (Comprehensive)

Basis Verification of Assets Valuation of Assets

Examination to confirm existence, ownership and Determination of correct monetary value of

1. Meaning
possession of assets assets

To ensure assets shown in balance sheet are real To ensure assets are neither overvalued nor
2. Objective
and belong to the business undervalued

3. Scope Wider in scope Narrower in scope

4. Nature Mainly factual and physical Mainly judgmental and subjective

Based on conditions prevailing at the balance

5. Time Conducted at or near the balance sheet date
sheet date

6. Auditor’s Auditor personally verifies existence and Auditor generally relies on management and
role ownership experts, but must be satisfied

Physical inspection, examination of documents Application of accounting principles, estimates

7. Method
and confirmations and assumptions

8. Based on estimates, calculations and expert

Based on direct evidence
Dependence opinions

9. Risk Risk of overstatement or understatement of asset

Risk of showing fictitious or non-existent assets
involved values

10.
Verification includes valuation Valuation is a part of verification
Relationship
Duties of an Auditor with Respect to Valuation of Assets
While valuation is primarily the responsibility of management, the auditor has important duties to ensure
correctness and reasonableness of valuation.

1. Ensure compliance with accounting principles: The auditor must ensure that assets are valued in accordance with
applicable Accounting Standards and generally accepted accounting principles.

2. Consistency in valuation: The auditor should check that valuation methods are applied consistently from year to
year and any change is properly disclosed.

3. Verification of basis of valuation: The auditor should examine the basis, assumptions and calculations used for
valuation of assets.

4. Reliance on expert valuation: Where valuation requires technical expertise (e.g., land, buildings, machinery), the
auditor may rely on expert valuation reports but must assess their reasonableness.

5. Detection of overvaluation or undervaluation: The auditor should ensure that assets are not deliberately
overvalued to inflate profits or undervalued to create secret reserves.

6. Depreciation: The auditor must verify that depreciation is properly calculated and charged in accordance with
accounting standards and company policy.

7. Provision for impairment: The auditor should ensure that impairment losses are recognised wherever required
and assets are not carried at values exceeding recoverable amount.

8. Valuation of inventories: The auditor must ensure inventories are valued at cost or net realisable value, whichever
is lower.

9. Adequate disclosure: The auditor should ensure that valuation methods and significant assumptions are properly
disclosed in the financial statements.

10. Professional judgment and scepticism: The auditor should apply professional judgment and scepticism while
evaluating valuations, especially where estimates involve high uncertainty.

Q. Explain the provisions of the Companies Act, 2013 relating to the ceiling on number of audits and remuneration
to the auditor.

Ceiling on Number of Audits: The provisions relating to the ceiling on number of audits are contained in Section
141(3)(g) of the Companies Act, 2013.

Meaning: To ensure quality of audit and prevent overburdening of auditors, the Act prescribes a maximum limit on
the number of companies that an auditor can audit at a time.

Provisions:

1. Maximum limit: An individual auditor shall not be appointed as auditor of more than 20 companies at one
time.
2. Exclusion of certain companies: For the purpose of calculating the limit of 20 companies, the following are
excluded: One Person Companies, Dormant companies, Small companies, Private companies
3. Firm of auditors: In case of a firm, the ceiling applies per partner, i.e., each partner of the firm can audit up
to the prescribed limit of companies.
4. Objective of the provision: The provision aims to maintain audit quality, ensure adequate time and attention
to each audit assignment, and protect stakeholders’ interests.

Remuneration of Auditor
The provisions relating to remuneration of auditors are contained in Section 142 of the Companies Act, 2013.

Meaning: Remuneration refers to the fees payable to the auditor for audit services and expenses incurred in
connection with the audit.
Provisions:

1. Fixation of remuneration: The remuneration of the auditor is fixed by the members of the company in
general meeting. The members may authorise the Board of Directors to fix the remuneration.
2. First auditor: In case of the first auditor appointed by the Board, the remuneration is fixed by the Board of
Directors.
3. Auditor appointed by Central Government: Where the auditor is appointed by the Central Government, the
remuneration is fixed by the Central Government.
4. Meaning of remuneration: Remuneration includes the audit fee and expenses incurred by the auditor in
connection with the audit, but does not include fees for any other services rendered by the auditor.
5. Disclosure: The remuneration paid to the auditor must be properly disclosed in the financial statements of
the company.

Appointment of Auditor in Government Companies

As per Section 139(7) of the Companies Act, 2013, the appointment of auditor in a Government company is as
follows:
1. Appointing authority: The auditor is appointed by the Comptroller and Auditor General of India (CAG)
2. Time limit: The appointment is made within 180 days from the commencement of the financial year.
3. Applicability: Applies to Government companies and companies controlled by the Central or State
Government.
4. Reappointment: The CAG may reappoint or appoint a new auditor for subsequent years.
Auditor’s lien refers to the right of the auditor to retain possession of the books of accounts and documents of the
company until his audit fees are paid.
1. Nature of lien: It is a particular lien, not a general lien.
2. Condition: Lien can be exercised only over documents lawfully obtained during audit and in the auditor’s
possession.
3. Limitation: The auditor cannot exercise lien on books required to be submitted to statutory authorities.
4. Purpose: To secure payment of audit remuneration.

Leeds Estate Building Co. v. Shepherd

Facts: The auditor failed to verify cash in hand properly and relied on management representations. Cash balances
were overstated and misappropriation went undetected.
Decision: The auditor was held negligent.
Principle / Significance: An auditor must verify important items like cash balances personally. Blind reliance on
management statements without independent verification amounts to negligence.
London Oil Storage Co. Ltd. v. Sear, Hasluck & Co.
Facts: The auditors failed to verify the existence of oil stocks shown in the balance sheet and relied on stock records
without adequate physical verification.
Decision: The auditors were held liable for negligence.
Principle / Significance: Auditors have a duty to verify existence of material assets. Failure to perform reasonable
checks, especially when verification is possible, constitutes negligence.

Q. Describe the procedure for removal and resignation of a company auditor. Can a properly appointed company
auditor be removed before the expiry of his term? If so, explain the procedure of removal.

Yes, a properly appointed company auditor can be removed before the expiry of his term, but only by following the
procedure laid down in the Companies Act, 2013. The provisions relating to removal are contained in Section
140(1).
Procedure for Removal of Auditor before Expiry of Term

1. Removal before expiry: An auditor appointed under Section 139 can be removed before the expiry of his
term only by following the prescribed legal procedure.
2. Previous approval of Central Government: Prior approval of the Central Government is mandatory before
removing the auditor, except in the case of the first auditor appointed by the Board.
3. Board resolution: The Board of Directors must first pass a resolution proposing the removal of the auditor.
4. Application to Central Government: An application seeking approval must be made to the Central
Government in the prescribed form within 30 days of passing the Board resolution.
5. Opportunity of being heard: The auditor proposed to be removed must be given a reasonable opportunity
of being heard.
6. Special resolution of shareholders: After obtaining Central Government approval, the company must pass a
special resolution at a general meeting for removal of the auditor.
7. Filing with Registrar: The special resolution must be filed with the Registrar of Companies within the
prescribed time.

Resignation of a Company Auditor: The provisions relating to resignation of an auditor are contained in Section
140(2).

Procedure for Resignation of Auditor

1. Notice of resignation: An auditor who resigns from office must file a statement of resignation.
2. Filing of statement: The statement must be filed with the company and the Registrar of Companies.
3. Time limit: The statement should be filed within 30 days from the date of resignation.
4. Contents of statement: The statement must specify the reasons and circumstances connected with the
resignation.
5. Government companies: In the case of Government companies, the statement must also be filed with the
Comptroller and Auditor General of India (CAG).
6. Filling of casual vacancy: The resulting casual vacancy is filled in accordance with the provisions of the
Companies Act, 2013.

Conclusion: Thus, a properly appointed auditor can be removed before the expiry of his term, but only with Central
Government approval and by passing a special resolution, ensuring protection of auditor independence.

Q. Discuss the qualifications and disqualifications of a company auditor as per the Companies Act, 2013.
Qualifications of a Company Auditor: As per Section 141(1) of the Companies Act, 2013, the following persons are
qualified to be appointed as an auditor of a company:
1. Chartered Accountant: A person who is a CA within the meaning of the Chartered Accountants Act, 1949 is
qualified to be appointed as a company auditor.
2. Firm of Chartered Accountants: A firm where the majority of partners practising in India are Chartered
Accountants may be appointed as auditor. Only Chartered Accountant partners can act and sign on behalf of
the firm.

Disqualifications of a Company Auditor

As per Section 141(3) of the Companies Act, 2013, the following persons are disqualified from being appointed as an
auditor of a company:
1. Body corporate: A body corporate other than an LLP registered under the LLP Act, 2008 cannot be appointed
as auditor.
2. Officer or employee of the company: An officer or employee of the company is disqualified.
 3. Partner or employee of an officer or employee: A person who is a partner or employee of an officer or
employee of the company is disqualified.
4. Holding of securities: A person who, or whose relative or partner, holds any security or interest in the
company, its holding, subsidiary or associate company is disqualified.
Exception: Holding of securities by a relative up to the prescribed limit is permitted.
5. Indebtedness: A person who, or whose relative or partner, is indebted to the company, its holding, subsidiary
or associate company beyond the prescribed limit is disqualified.
6. Guarantee or security: A person who has given a guarantee or provided security in connection with
indebtedness of a third person to the company beyond the prescribed limit is disqualified.
7. Business relationship: A person or firm having a business relationship with the company, its holding,
subsidiary or associate company is disqualified.
8. Relative as director or KMP: A person whose relative is director or key managerial personnel of the company
is disqualified.
9. Full-time employment elsewhere: A person in full-time employment elsewhere or a person holding
appointment as auditor of more companies than the prescribed number is disqualified.
10. Conviction for fraud: A person convicted of an offence involving fraud and ten years have not elapsed from
the date of such conviction is disqualified.

Q. What are the duties of a company auditor as per the Companies Act, 2013?

The duties of a company auditor are mainly laid down in Section 143 of the Companies Act, 2013. These duties
ensure that the auditor independently examines the accounts of the company and reports truthfully to the
shareholders.

Duties of Company Auditor under the Companies Act, 2013

1. Duty to report on financial statements (Section 143(2)): The auditor must make a report to the members of
the company stating whether the financial statements give a true and fair view of the state of affairs, profit
or loss and cash flows of the company.
2. Duty to inquire into specific matters (Section 143(1)): The auditor must inquire into matters such as loans
and advances made on proper terms, transactions represented merely by book entries, personal expenses
charged to revenue, and, assets sold at less than cost.
3. Duty to comply with auditing standards (Section 143(9)): The auditor must conduct the audit in accordance
with the Standards on Auditing prescribed by ICAI.
4. Duty to obtain information and explanations: The auditor must obtain all information and explanations
necessary for the audit and state in the report whether such information was obtained.
5. Duty to report on internal financial controls (Section 143(3)(i)): The auditor must report on the adequacy
and operating effectiveness of internal financial controls with reference to financial statements.
6. Duty to report fraud (Section 143(12)): If the auditor detects fraud involving certain amounts, he must
report it to the Central Government or to the Audit Committee/Board, as applicable.
7. Duty regarding proper books of account (Section 143(3)): The auditor must report whether proper books of
account have been kept as required by law.
8. Duty to verify compliance with law: The auditor must ensure compliance with provisions of the Companies
Act, Accounting Standards and other statutory requirements.
9. Duty to sign and date the audit report: The auditor must sign the audit report and mention the place and
date of signing.
10. Duty of care and diligence: The auditor must perform audit duties with reasonable care, skill, professional
scepticism and independence.

Q. Explain the liabilities of an auditor under the Companies Act, 2013.

An auditor is legally responsible for the proper and honest discharge of his duties. Under the Companies Act, 2013,
an auditor may be held liable for negligence, misconduct, misstatements or fraud. The liabilities of an auditor can be
broadly classified into civil liability and criminal liability.

Liabilities of an Auditor under the Companies Act, 2013

Civil Liability of an Auditor

Civil liability arises when the auditor’s negligence or breach of duty causes loss to the company or its members. The
purpose is compensation, not punishment.

1. Liability for negligence

If an auditor fails to exercise reasonable care, skill and diligence expected of him and the company suffers
loss as a result, he is liable for negligence.
Example: Failure to verify cash balances or ignoring suspicious circumstances.
2. Liability for misfeasance
Under the Companies Act, if an auditor commits misfeasance (wrongful act, dishonesty) or breach of
trust in the performance of duties, he may be required to compensate the company for losses suffered.
3. Liability for misleading statements
If an auditor makes a misleading statement in the audit report and the company or its members suffer
loss, he may be held liable.
4. Liability to the Company
The auditor is appointed by the company and owes a duty of care to it. Any loss suffered by the company
due to auditor’s negligence makes him liable.
5. Liability to Third Parties
Generally, the auditor is not liable to third parties. However, liability may arise if the auditor knew that
the third party would rely on the audit report, and the third party suffered loss due to auditor’s
negligence.

Criminal Liability of an Auditor

Criminal liability arises when the auditor commits an offence involving fraud, wilful misstatement or deliberate
concealment. The objective is punishment.

1. Liability for fraud (Section 447)

If an auditor is found guilty of fraud, he is punishable with imprisonment, and/or fine as prescribed under the
Act.
2. False statements in audit report (Section 143)
If an auditor knowingly makes a false statement or omits a material fact in the audit report, he may face
criminal liability.
3. Failure to report fraud (Section 143(12))
If the auditor fails to report fraud detected during the course of audit to the appropriate authority, he is
liable to penal action.
4. Destruction or falsification of records
Wilful destruction, alteration or falsification of audit working papers or company records attracts criminal
liability.

Professional Liability
Apart from civil and criminal liabilities, the auditor may also face professional disciplinary action by ICAI for
professional misconduct, including suspension or removal of membership.

Distinction between Civil and Criminal Liability

Basis Civil Liability Criminal Liability

1. Nature Compensatory Punitive appointment

2. Purpose To compensate loss To punish the offender

3. Arises due to Negligence or breach of duty Fraud, wilful misstatement or concealment

4. Who initiates Company or aggrieved party State or regulatory authority

5. Outcome Payment of damages Fine and/or imprisonment

Q. Discuss the provisions of Section 139 of the Companies Act, 2013 for of first auditor and subsequent auditor in a
listed company.

Appointment of Auditors under Section 139, Companies Act, 2013

Section 139 of the Companies Act, 2013 lays down the provisions relating to the appointment of auditors, including
the first auditor and subsequent auditors. In the case of a listed company, these provisions operate along with the
mandatory rotation of auditors.

Appointment of First Auditor (Section 139(6))

1. Authority of appointment: The Board of Directors shall appoint the first auditor of the company.
2. Time limit: The first auditor must be appointed within 30 days from the date of incorporation of the
company.
3. Failure by the Board: If the Board fails to appoint the first auditor within 30 days, the members of the
company shall appoint the auditor within 90 days at an Extraordinary General Meeting (EGM).
4. Tenure of first auditor: The first auditor shall hold office till the conclusion of the first Annual General
Meeting (AGM).
5. Applicability to listed company: These provisions apply equally to listed companies.

Appointment of Subsequent Auditor in a Listed Company (Section 139(1))

1. Appointment at first AGM: At the first AGM, the company shall appoint an auditor who shall hold office for a
term of five consecutive years, subject to the provisions relating to rotation.
2. Manner of appointment: The auditor is appointed by the members of the company by passing an ordinary
resolution at the AGM.
3. Filing requirement: The company must file a notice of appointment with the Registrar of Companies in the
prescribed form within the specified time.
4. Tenure: The auditor appointed at the AGM holds office from the conclusion of that AGM till the conclusion of
the sixth AGM, subject to ratification as applicable.

Special Provisions for Listed Companies – Rotation of Auditors (Section 139(2))- Since the company is a listed
company, the following rotation provisions apply:

1. Individual auditor: An individual auditor shall not be appointed for more than one term of five consecutive
years.
2. Audit firm: An audit firm shall not be appointed for more than two terms of five consecutive years, i.e., ten
years.
3. Cooling-off period: After completion of the maximum term, the auditor or audit firm shall not be eligible for
reappointment for a cooling-off period of five years.
 4. Common partners restriction: Audit firms having common partners are treated as the same audit firm for
the purpose of rotation.

Rotation of Auditor (Companies Act, 2013)

Rotation of auditors is a statutory mechanism introduced to ensure auditor independence, objectivity and audit
quality by restricting long association of auditors with a company.

Legal Provision: The provisions relating to rotation of auditors are contained in Section 139(2) of the Companies Act,
2013, read with the relevant Rules.

Applicability of Rotation: Rotation of auditors is mandatory for the following classes of companies:

1. Listed companies
2. Unlisted public companies having paid-up share capital of ₹10 crore or more
3. Private companies having paid-up share capital of ₹50 crore or more

Rotation Period

1. Individual auditor: An individual auditor can be appointed for one term of five consecutive years only.
2. Audit firm: An audit firm can be appointed for two terms of five consecutive years, i.e., a maximum of ten
consecutive years.

Cooling-off Period- After completion of the maximum permissible term:

1. Cooling-off period: The outgoing auditor or audit firm shall not be eligible for reappointment in the same
company for a period of five years.
2. Common partners restriction: Audit firms having common partners are treated as the same audit firm and
cannot bypass rotation requirements.

Joint Audit: In case of joint auditors, rotation provisions apply individually to each auditor.

Purpose / Significance of Rotation

1. Ensures auditor independence

2. Prevents long-term familiarity threats
3. Enhances audit quality and credibility
4. Protects interests of shareholders and investors

Exception: Rotation provisions do not apply to a One Person Companies or Small companies

Q. What are the elements of an audit report as per Auditing Standards?

The elements of an audit report are prescribed under SA 700 – Forming an Opinion and Reporting on Financial
Statements. These elements ensure clarity, uniformity and reliability of the auditor’s report.

Elements of an Audit Report (as per SA 700)

1. Title: The audit report should have an appropriate title indicating that it is the report of an Independent
Auditor.
2. Addressee: The report should be addressed to the members of the company or as required by law or
circumstances of the engagement.
3. Opinion: The auditor must clearly express an opinion on whether the financial statements present a true and
fair view (or are fairly presented) in accordance with the applicable financial reporting framework.
4. Basis for Opinion: This section states that the audit was conducted in accordance with Standards on
Auditing, describes the auditor’s responsibilities, and declares the auditor’s independence and ethical
compliance.
 5. Going Concern (where applicable): If relevant, the auditor reports on matters related to the entity’s ability to
continue as a going concern.
6. Key Audit Matters (where applicable): For listed entities, this section describes matters that were of most
significance in the audit.
7. Responsibilities of Management and Those Charged with Governance: This section explains management’s
responsibility for preparation of financial statements, internal control and assessment of going concern.
8. Auditor’s Responsibilities for the Audit of Financial Statements: Describes the scope of audit, nature of
audit procedures, professional judgement and reasonable assurance.
9. Other Reporting Responsibilities: Includes matters required to be reported under laws and regulations, such
as Companies Act, 2013.
10. Signature of the Auditor: The report must be signed by the auditor, indicating responsibility and
accountability.
11. Place of Signature: The location where the audit report is signed.
12. Date of Audit Report: The date indicates the point up to which audit evidence has been obtained.

Types of Audit Report

Unmodified Audit Report (SA 700)
An unmodified audit report is issued when the auditor concludes that the financial statements are prepared, in all
material respects, in accordance with the applicable financial reporting framework.
Modified Audit Report (SA 705)
SA 705 – Modifications to the Opinion in the Independent Auditor’s Report deals with circumstances requiring
modification.
Types of Modified Opinions:
1. Qualified Opinion:
Issued when misstatements are material but not pervasive, or when the auditor is unable to obtain sufficient
appropriate audit evidence but the possible effects are material but not pervasive.
2. Adverse Opinion:
Issued when misstatements are both material and pervasive, resulting in financial statements not presenting
a true and fair view.
3. Disclaimer of Opinion:
Issued when the auditor is unable to obtain sufficient appropriate audit evidence and the possible effects are
both material and pervasive
Unqualified Audit Report (Clean Report)
An unqualified audit report is issued when the auditor concludes that the financial statements present a true and
fair view in accordance with the applicable financial reporting framework and there are no material misstatements.
Features of an Unqualified Audit Report:
1. True and fair view: Financial statements are free from material misstatement.
2. Compliance: Accounts comply with Accounting Standards and legal requirements.
3. Sufficient evidence: Auditor has obtained sufficient and appropriate audit evidence.
4. No reservations: No material qualification, limitation or disagreement exists.
5. Positive assurance: Auditor expresses a clean opinion without modification.
Significance: An unqualified report increases users’ confidence in the financial statements and indicates sound
financial reporting practices.
Qualified Audit Report
A qualified audit report is issued when the auditor concludes that except for certain specific matters, the financial
statements present a true and fair view. The qualification arises due to material but not pervasive issues.
Circumstances Leading to a Qualified Report:
1. Material misstatement: Where misstatements are material but not pervasive.
2. Limitation on scope: Where the auditor is unable to obtain sufficient appropriate audit evidence, but the
effect is not pervasive.
3. Disagreement with management: On accounting treatment, disclosure or accounting policy.
4. Inadequate disclosure: Material information is not properly disclosed.
Features of a Qualified Audit Report:
1. “Except for” opinion: The opinion is modified using the phrase “except for”.
2. Specific reasons stated: The auditor clearly explains the reasons for qualification.
3. Limited impact: The issue affects only certain aspects of financial statements.
4. Disclosure: Basis for qualification is disclosed in the audit report.
Significance: A qualified report alerts users to specific problems while still allowing reliance on the remaining
financial information.

Q. Explain the audit procedure in a bank audit with regard to (i) loans and advances and (ii) interest (interest
income and interest expense).

A. Audit Procedure in a Bank Audit – Loans and Advances

Loans and advances constitute the most significant asset of a bank and therefore require detailed audit scrutiny.

1. Sanction and authority: Verify that loans and advances are sanctioned by the competent authority as per the
bank’s delegation of powers and loan policy.
2. Documentation: Examine loan agreements, demand promissory notes, hypothecation deeds, mortgage
deeds and guarantee documents to ensure completeness and validity.
3. Classification of advances: Check proper classification of advances into standard, sub-standard, doubtful
and loss assets as per RBI guidelines.
4. Security and margin: Verify existence, adequacy and valuation of securities charged against advances and
compliance with prescribed margin requirements.
5. End-use of funds: Examine whether advances are utilised for the purpose for which they were sanctioned.
6. Non-performing assets (NPAs): Ensure correct identification of NPAs and verify that interest on NPAs is not
recognised on accrual basis.
7. Provisioning: Check adequacy of provisions made for doubtful and bad debts in accordance with RBI norms.
8. Balance confirmation: Obtain and verify balance confirmations from borrowers, wherever applicable.

B. Audit Procedure in a Bank Audit – Interest

Interest forms the principal source of income and a major expense for banks. The auditor must verify both interest
income and interest expense.

Audit of Interest Income

1. Accuracy of calculation: Verify interest calculations on loans and advances with reference to applicable
interest rates, loan terms and RBI directives.
2. Income recognition norms: Ensure interest income is recognised in accordance with RBI guidelines,
especially that interest on NPAs is not taken to income.
3. Cut-off: Check that interest income is recorded in the correct accounting period.
Audit of Interest Expense

1. Deposit interest rates: Verify that interest on deposits is calculated as per RBI directives and bank policy.
2. Accuracy and completeness: Check correctness of interest calculations on savings, fixed and recurring
deposits.
3. Accrued interest: Ensure proper provision for interest accrued but not due on deposits at the balance sheet
date.
4. Cut-off and classification: Verify that interest expense is recorded in the correct period and classified under
appropriate heads.
5. Reconciliation: Reconcile interest expense with deposit registers and general ledger balances.

Q. What is the difference between forensic audit and financial audit? Discuss the fraud triangle used by a forensic
auditor.

Difference between Forensic Audit and Financial Audit

Basis Forensic Audit Financial Audit

Specialised audit to detect, investigate and Independent examination of financial

1. Meaning
establish frauds statements

To identify fraud, determine responsibility and To express an opinion on true and fair view of
2. Objective
collect legal evidence financial statements

3. Nature Investigative and analytical Routine, compliance-oriented

4. Scope Specific and focused on suspected areas Broad, covers entire financial statements

5. Time period May cover several years if required Usually covers one accounting period

6. Evidence Collected for use in courts and legal proceedings Collected to support audit opinion

Based on test checking and reasonable

7. Approach In-depth examination with sceptical mindset
assurance

Identification of fraud, culprits and quantum of

8. Outcome Audit report (qualified or unqualified)
loss

9. Legal
Strong legal orientation Limited legal orientation
orientation

Report may be used in courts, tribunals or

10. Reporting Report addressed to shareholders
investigations

Fraud Triangle Used by Forensic Auditor

The fraud triangle is a widely used model by forensic auditors to understand why individuals commit fraud. It
consists of three interrelated elements:

1. Pressure (Motivation)
Pressure refers to the financial or non-financial stress that motivates an individual to commit fraud.
Examples:
- Financial difficulties or personal debt
- Pressure to meet performance targets
- Greed or desire for higher lifestyle
- Job insecurity or fear of failure
A forensic auditor looks for signs of unusual pressure on employees or management.

2. Opportunity
Opportunity exists when weak internal controls or lack of supervision allow fraud to be committed without
detection.
Examples: Poor segregation of duties, Weak internal control system, Excessive authority vested in one person, Lack
of internal audit or oversight. Forensic auditors closely examine internal controls to identify such opportunities.

3. Rationalisation
Rationalisation is the mindset that allows the fraudster to justify unethical behaviour.

Examples: “I am underpaid”, “I am only borrowing the money”, “The company can afford it”, “Everyone else is doing
it”. Forensic auditors analyse behavioural patterns and attitudes to understand rationalisation.

Q. Explain the role, powers and functions of NFRA. How is it different from ICAI?
National Financial Reporting Authority (NFRA)
NFRA is a statutory body constituted under Section 132 of the Companies Act, 2013 to oversee matters relating to
accounting and auditing standards and to regulate the audit profession in the public interest.
Role of NFRA: The role of NFRA is to ensure transparency, accountability and quality in financial reporting and
auditing.
1. Oversight of audit profession: To monitor and enforce compliance with accounting and auditing standards.
2. Protection of public interest: To safeguard the interests of investors, creditors and other stakeholders.
3. Strengthening audit quality: To improve the quality and reliability of audits of large and public interest entities.
4. Independent regulator: To act as an independent regulatory authority separate from professional bodies.
Powers of NFRA: NFRA has wide quasi-judicial and regulatory powers.
1. Power to investigate: NFRA can investigate matters of professional or other misconduct by chartered
accountants or audit firms.
2. Power to summon: It has powers similar to a civil court to summon persons, enforce attendance and
examine on oath.
3. Power to impose penalties: NFRA can impose monetary penalties on auditors and audit firms for
misconduct.
4. Power to debar auditors: It can debar auditors or audit firms from practice for a specified period.
5. Power to monitor compliance: NFRA can monitor and enforce compliance with accounting and auditing
standards.
Functions of NFRA
1. Recommendation of accounting standards: To recommend accounting standards and auditing standards to
the Central Government for adoption.
2. Monitoring compliance with standards: To monitor and enforce compliance with notified accounting
standards and auditing standards by companies and auditors.
3. Oversight of audit quality: To oversee the quality of service provided by auditors and audit firms, especially
in respect of listed companies and large public interest entities.
4. Investigation of professional misconduct: To investigate cases of professional or other misconduct by
chartered accountants and audit firms covered under its jurisdiction.
5. Disciplinary action: To take disciplinary action, including: imposing monetary penalties, and debarring
auditors or audit firms from practice for a specified period.
 6. Power similar to civil court:
NFRA has powers similar to a civil court for summoning persons, enforcing attendance, examining on oath,
and inspection of documents.
7. Advisory role to Government: To advise the Central Government on matters relating to financial reporting,
accounting and auditing.
8. Protection of public interest: To safeguard the interests of investors, creditors and other stakeholders by
ensuring transparency, accountability and reliability in financial reporting.

Difference between NFRA and ICAI

Basis NFRA ICAI

1. Nature Statutory regulatory authority Professional body

2. Governing
Companies Act, 2013 (Section 132) Chartered Accountants Act, 1949
law

Regulation and oversight of auditing and Education, regulation and development of CA

3. Primary role
accounting profession

4. Powers Investigative and penal powers Disciplinary powers limited to members

Mainly large companies and public interest

5. Applicability All members (Chartered Accountants)
entities

6.
Independent of the profession Self-regulatory body
Independence

7. Objective Public interest and audit quality Professional development and regulation

Basis Random Sampling Stratified Sampling

Each item in the population has an equal and Population is divided into strata (sub-groups) and
Meaning
independent chance of selection. samples are drawn from each stratum.

Nature of
Suitable for a homogeneous population. Suitable for a heterogeneous population.
Population

Method of Items are selected purely by chance using Items are selected after classifying the population
Selection random numbers or computer methods. into similar groups.

Auditor’s Auditor has no control over which specific

Auditor has greater control over sample selection.
Control items are selected.

Less efficient when population size is large and More efficient and precise, especially for large
Efficiency
varied. populations.

Ensures better coverage of high-value or risky

Risk Coverage May miss high-value or high-risk items.
items.

Selecting sales invoices using random number Selecting more samples from high-value debtors
Example
tables. and fewer from small balances.