The Hindu Business Line : How good are your auditing skills

a) A company issued debentures for financing its project in 2002. Their accounts manager suggests capitalising the interest on debentures as per AS 16 since the asset was still not operative.

As the book value of the asset was exceeding the fair market value of the asset, the management proposes to start charging the interest on debentures to revenue w.e.f. April 1, 2004. (5 marks)

b) A company had an existing building constructed in 1975 at a cost of Rs 10 lakh. A new floor was constructed on the building at a cost of Rs 20 lakh during 2006. The estimated useful life of the building was 50 years.

Accordingly, depreciation on the old building was being charged at 2 per cent per annum on the assumption that there would be no residual value of the building after its useful life. The accounts officer proposes a depreciation of Rs 60,000 for the year, being 2 per cent of Rs 30 lakh. (5 marks)

c) A company has Rs 10 lakh worth of preference shares, which were over due for redemption. The board of directors passes a resolution to redeem these preference shares out of proceeds of a fresh issue and to declare dividends out of the balance to the credit of its profit and loss account. (4 marks)

d) A hospital admits a patient for surgery on March 27, 2006, on payment of Rs 1,00,000 as a package fees. The surgery was done only on April 5, 2006. The entire amount was taken to profit and loss account for the year ended March 31, 2006. (4 marks)

Q2: Discuss the validity of the following:

a) A listed company issues 10 lakh of equity shares of Rs 100 each to the public, of which 30 per cent is reserved for allotment to IDBI and LIC of India. Rs 70 was called up. Calls in arrears were Rs 50 due from holders of six lakh shares held by public. The auditors were appointed by passing a special resolution at the AGM. (5 marks)

b) A company was incorporated on February 1, 2007, in which the State Government held 26 per cent of subscribed capital. First auditor was appointed y the board of directors on 1st march 2007. (5 marks)

c) Mr Kumar is the promoter of AJK (P) Ltd. This company holds 35 per cent of equity capital of Big Boys Ltd. It is proposed to appoint Mr Kumar as auditor of Big Boys. (4 marks)

d) A holding company has two subsidiary companies, S1 Ltd and S2 Ltd. Mr A, a chartered accountant, holds 5 per cent of shares of S2 Ltd. He is proposed to be appointed as auditor of S1 Ltd. (4 marks)

Q3: a) What is a test check? How does it differ from sampling? (4 marks)

b) What are the considerations to decide the extent of test check? (5 marks)

c) What are the matters which cannot be audited on a test-check basis? (4 marks)

d) What precautions do you take while carrying out a test-check? (3 marks)

Q4: How do you vouch/verify the following?

a) Calls in advance; b) loss on issue of debentures; c) stock in transit; and d) preliminary expenses. (4x4 = 16 marks)

Q5: a) What are the requirements of an audit report? Explain with reference to AAS 28. (10 marks)

b) What are the requirements of reporting under Section 227(1A). (6 marks)

Q6: a) Who are joint auditors? How are they appointed? (4 marks)

b) What are the liabilities of joint auditors individually and jointly? (4 marks)

c) What are the interpersonal liabilities of joint auditors? (4 marks)

d) What are the reporting requirements of joint auditors? (4 marks)

Q7: a) How is audit of government grants carried out? (6 marks)

b) What are computer aided audit techniques? (5 marks)

c) How do you audit health cards issued by a hospital? (5 marks)

Q8: Write short notes on the following: a) performance audit; b) letter of engagement; c) audit trail; d) tolerable error. (4x4 = 16 marks).

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Solutions to last week's model paper on auditing for CA (Final) students

Q1(a): The I-T department has clarified that fringe benefit tax (FBT) is not applicable to expenses incurred on auditors.

Therefore, the company is justified in saying that FBT is not applicable to hospitality and other expenses incurred on the auditors.

Q1(b): According to the RBI Act, an NBFC has to maintain SLR securities which should be deposited with a designated bank, generally a nationalised bank, for safe custody. Such securities should be released by the designated bank only against a certificate issued by the statutory auditor of the company.

In the given situation, an NBFC secures release of securities from the designated bank against a certificate issued by a chartered accountant.

These securities cannot be released by the scheduled bank unless the certificate is issued by the statutory auditor of the company.

Since the release is not based on a certificate issued by the statutory auditor of the company, such a release is bad in law.

Q1(c): Independence is the hallmark of a chartered accountant. He should both be and appear to be independent in his approach to work (AAS 1). Section 226 (3) emphasise this.

Those restrictions are for appointment as statutory auditor of the company and not to the tax auditor. A person qualified to be appointed as an auditor can be appointed as a tax auditor.

An auditor is said to be guilty of professional misconduct if he does not state if he or his partner have a substantial interest in the entity while expressing an opinion.

In the given question, a partner of a director of the company is appointed as tax auditor of the company. There is no legal restriction as such, but the auditor should consider the impairment of independence and decide whether or not to accept the appointment.

If he accepts the appointment, he should state in the report the fact that his partner is a director of the company

Q1(d): AS 2, dealing with inventories, requires such inventories to be valued on FIFO or weighted average basis. LIFO basis is not permissible. It does not confine itself to raw materials only, but extends to finished goods and work-in-progress too.

In the given question, the company values its issues to production on LIFO basis. Such a practice tends to show value of closing stock of finished goods on LIFO basis and, thereby, amounts to non-compliance of AS 2. True, AS 2 does not apply to issues to production but, the finished goods should be reworked on FIFO method as the basis.

If such an adjustment to value of finished goods is made, the company is justified in their contention.

Q2(a): Clause 9 of schedule I requires the auditor to ensure that his appointment is as permissible under Sections 224 and 225, failing which, the auditor would be held guilty of professional misconduct.

In the given question, the auditor was appointed by the audit committee and the auditor accepts the appointment as statutory auditor.

Company law permits a casual vacancy caused by the death of the existing partner to be filled in by the board of directors. Section 292 lays down the business to be carried out by the board only at a meeting of the board of directors, which does not include appointment of auditor in a casual vacancy.

It implies that the appointment need not be only at a meeting of the bard of directors. In the context of corporate governance, audit committee is constituted under the chairmanship of a director of the company. It would, therefore, be permissible for the audit committee to appoint an auditor in a casual vacancy.

As this is permissible under law, the auditor can accept the appointment and it does not amount to any misconduct on his part.

Q2(b): Part II of schedule 1 holds a member in service guilty of misconduct if he pays or allows/agrees to pay directly/indirectly to any person any share in the emoluments of the employment undertaken by him.

In the given question, the member in employment has secured employment by agreeing to pay certain fees to the placement agency, which cannot be taken as share in the emoluments of the employment undertaken by him.

He has agreed to pay 10 per cent of the salary for the first year only. Therefore, there is no misconduct on his part.

Q2(c): Clauses 6 and 7 of schedule 1 prohibit an auditor from soliciting work or advertising his professional attainments. In the given case, the member is contesting public elections and mentions that he is a chartered accountant in the election handouts and sets up huge cut-outs. Mere stating that he is a chartered accountant in the election material does not make him liable for professional misconduct. As long as he does not indicate the name of his firm and the details of his expertise, it does not amount to professional misconduct.

But if the content is of such a nature to constitute a needless publicity of his professional attainments or can be construed to be soliciting professional work, he would be liable for professional misconduct. The matter is to be decided on a case-to-case basis.

Q2(d): In the given case, the firm of chartered accountants releases an advertisement congratulating his staff and also those who were associated with the firm earlier. If the name of the firm is mentioned in the advertisement, it amounts to misconduct, as it is taken as needless publicity to the firm.