Paper 2 Audit and Assurance

CHARTERED ACCOUNTANCY PROFESSIONAL II
(CAP-II)
Compilation of Suggested Answers
Paper 2: Audit and Assurance

(June 2001 - June 2019)
Updated as per amendments up to August 2019
Education Department
The Institute of Chartered Accountants of Nepal
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© The Institute of Chartered Accountants of Nepal
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September 2019
Education Department
The Institute of Chartered Accountants of Nepal
Table of Content
Chapter 1 Principles and Concept of Assurance ..................................................................................... 1
Chapter 2 Regulatory and Ethical Issues .............................................................................................. 37
Chapter 3 Planning and Assurance Engagement................................................................................ 116
Chapter 4 Audit Risk and Internal Control ........................................................................................ 169
Chapter 5 Vouching ............................................................................................................................... 221
Chapter 6 Verification of Assets and liabilities ................................................................................... 251
Chapter 7 Company Audit .................................................................................................................... 284
Chapter 8 Audit of special sectors ........................................................................................................ 289
Chapter 10 Completing and reporting on an assurance engagement ............................................... 320
Chapter 11-Nepal Standards on Auditing ........................................................................................... 355
Chapter 12-Nepal Accounting Standard/ Nepal Financial Reporting Standard ............................. 426
CAP II Paper 2: Audit and Assurance
Chapter 1 Principles and Concept of Assurance
Question No 1
The work of 'Statutory Auditor' is no different than the work of 'Internal Auditor'. Write a
detailed note on their status, approach, responsibility vis-a-vis the auditee as also relation inter-
se.
(16 Marks June 2001)
There are similarities in the areas of operation of the internal auditor and the statutory auditor,
especially regarding accounting matters. Both of them have a common interest in ensuring that an
effective system of internal control exists and that the accounting system is adequate to generate
true and fair financial statement. Accordingly, the nature of work carried out by both is similar as
regards examination of the system of internal control, testing and checking of accounting books,
records and statements and verification of assets and liabilities. Both of them examine the same set
of accounting documents and carry out similar physical and other verification checks.
Despite these similarities, there are certain fundamental differences in the status responsibility,
approach and the scope of operations of an internal auditor and a statutory auditor. The internal
auditor is a representative of the management. The nature and scope of his operations are
determined by the management, and may, therefore, differ from one organization to another
according to the needs and perceptions of different managements. The rights and duties of the
statutory auditor, on the other hand, are defined by the statute. Thus, the internal auditor's approach
is to report on matters vital from the point of view of management, whereas the statutory auditor is
primarily concerned with the truth and fairness of financial statements presented to the
shareholders.
NSA 610, Using the work of an Internal Auditor, also recognizes that "the role of the internal audit
function within an entity is determined by management and its prime objective differs from that of
the external auditor who is appointed to report independently on financial information.
Nevertheless, some of the means of achieving their respective objectives are often similar and thus
much of the work of the internal auditor may be useful to the external auditor in determining the
nature, timing and extent of his procedures."
Since the internal audit function is a part of the overall internal control system, the statutory auditor
should evaluate its effectiveness. The evaluation of the internal audit function assists the statutory
auditor in determining the nature, timing and extent of his other audit procedures. Thus, if an
auditor finds the internal audit is adequate and effective in certain areas, he may limit the related
substantive procedures.
© The Institute of Chartered Accountants of Nepal 1

In evaluation the effectiveness of the internal audit function, the statutory auditor should consider
the organizational status of the internal auditor, the scope of his function, his technical competence
and the level of professional care exercised in conducting internal audit. If the internal auditor
reports to the highest level of management and is free of any operating responsibility, the statutory
auditor can place greater reliance on his work. The statutory auditor should also review whether
any constraints or restrictions have been placed on the work of the internal auditor by the
management. In particular, the internal auditor should be free to communicate fully with the
statutory auditor. The statutory auditor should also ascertain the nature and depth of coverage of
internal audit. He should review the effectiveness of the system of follow up of internal audit. The
statutory auditor should also review whether or not the internal audit work is being performed by
persons possessing adequate technical training and proficiency. Finally, he should ascertain
whether the internal audit work appears to be properly planned, supervised, reviewed and
documented.
It would be helpful if the statutory auditor ascertains the tentative plan of internal audit for the year
and discusses the same with the internal auditor to determine areas where he considers that he
could use the work of the internal auditor. The degree of reliance that a statutory auditor can place
on the work done by the internal auditor is a matter of individual judgment in a given set of
circumstances. As NSA 610 states, "the report of the external auditor is his sole responsibility and
that responsibility is not by any means reduced because of the reliance he places on the internal
auditor's work". Further, the responsibility of the internal auditor is towards the management and
he can be of specific assistance to the statutory auditor only if the management so wishes.
However, both the statutory auditor and the internal auditor can, by mutual consultations, arrange
their audit programmes in such a manner that unnecessary duplication of work is avoided.
Question No 2.
a) Distinguish between Auditing, Accounting and Investigation. (June 2002)
Answer
Accounting is concerned with the recording of the transactions and preparation of statements of
account. Accounting involves right from the stage of recording each and every transaction entered
into by the entity and ultimately communicating the information in the consolidated form to
shareholder in the form of financial statements. In nutshell, accounting deals with measurement and
communication of information to shareholders including other users of financial statements. As
against this, auditing involves examination of financial information contained in financial
statements to express an opinion whether or not the same has been prepared properly. In essence,
auditing involves independent examination of financial information prepared by the management of
an entity. Thus, accounting involves recording aspects of financial information while auditing

reviews the efficacy of recording of financial information. Therefore, both are quite distinct and
different from each other. Strictly speaking begins where accounting ends.
Auditing also is different from investigation, which is another significant service rendered by
professional accountants. Auditing and investigation differ in objectives and in their nature.
Auditing is general while investigation is specific. The object of auditing is to ensure that the
financial statements are free and fair and not misleading or unreliable. The merit of auditing lies in
its ability to pronounce in general terms whether the accounts are basically reliable or not and in
accordance with the legal requirements and regulations applicable to the particular audit. Audit is
not based on suspicion unless circumstances exist to arouse suspicion to the auditor.
Investigation implies systematic, critical and special examination of the records of a business for a
specific purpose. The examination conducted under investigation is intensive as well as exhaustive
so far as the activities or areas of accounting is concerned. Investigation requires a concentrated
focus on the subject matter of inquiry and related matters. Often, investigation may be spread over a
period longer than one year and its scope may extend to inquiry beyond the books of accounts if the
circumstances so require. For example, if fraud is suspected and an accountant is called upon to
check the accounts to determine whether a fraud really exists and if so, the amount involved the
character of the enquiry changes to investigation. Investigation can be carried out in numerous
areas of accounts. Its essence lies in going into the matter with some pre-conceived notion suited to
the objective. The objective of audit on the other hand is to determine whether the accounts show a
true and fair view
b) Errors and Fraud (4 Marks, December 2003)

Answer
Fraud refers to intentional misrepresentations of financial information by one or more individuals
among management, employees or third parties.
Fraud may involve:

a. Manipulation, falsification or alteration of records or documents.
b. Misappropriation of assets
c. Suppression or omission of the effect of transactions from records or documents.
d. Recording of transactions without substance.
e. Misapplication of accounting policies.
Error refers to unintentional mistakes in financial information such as:

a. Mathematical or clerical mistakes in the underlying records and accounting data.
b. Oversight or misinterpretation of facts; or
c. Misapplication of accounting policies.

Question No 3
"Independence of auditor must not only exist in fact, but should also appear to exist to all
reasonable persons". Discuss highlighting the advantages of an independent audit?
"Independence of auditors must not only exist in fact, but should also appear to exist to all
reasonable persons". This statement is very important as very often relationships are
misunderstood. The auditor has to conduct himself in such a way that no reasonable person can
doubt his objectivity and integrity. In fact, the word "independent" as a prefix in any audit
proposition in itself enshrines the concept of independence of an auditor and it is thus considered
fundamental concept in the theory of auditing. As per para 14 of NSA 200 "Overall Objectives of
an Independent Auditor and conduct of audit in accordance with NSA" The auditor shall comply
with relevant ethical requirements, including those pertaining to independence, relating to financial
statement audit engagements. It is however, not possible to define "independence" precisely since
independence is a state of mind and personal character. Independence is a qualitative condition.
Professional bodies frame rules to help and guide their members to preserve independence.
The relationship between the auditor and the client should be such that firstly he himself is satisfied
about his client and it is understood by others that the independence of the auditor is not affected.
The main objective of an independent audit is to enhance credibility for financial information
contained in financial statements by expressing an independent opinion. The ultimate list for
accepting the auditor's opinion on the financial information by any category of persons, say, banks,
tax authorities, creditors etc. would depend upon the fact that whether an auditor is perceived
independent or not. Reliance on the reports and opinions of the members of a profession depends
upon standard of independence prescribed by the professional body. In other words, the respect and
dignity of a profession is based on independence enjoyed by its members. If an auditor maintains
high standard of independence and impartiality, his report will be accepted and respected by all
Stakeholders Viz. banks financial institutions, Government, investors etc. Professional integrity and
independence are essential characteristics of all the professions but are more so in the case of
accounting profession. The entire objective of audit would be lost if an auditor is not independent
only in mind and as well as in appearance.
Question No 4
"The auditor should document matters which are important in providing evidence that the audit
was carried out in accordance with the basic principles governing an audit". Explain.
(16 Marks -December 2003)
Answer
NSA 230 on "Audit Documentation" requires the auditor to prepare documentation that provides:
 A sufficient and appropriate record of the basis for the auditor‟s report; and

 Evidence that the audit was planned and performed in accordance with NSAs and applicable
legal and regulatory requirements.
Working papers that are part of audit documentation are written records prepared / kept by the
auditor for:
 aiding in the planning and performance of the audit;
 aiding in the supervision and review of the audit work; and
 providing evidence of the audit work performed to support the auditor's opinion.
Working papers should be designed and properly organized to meet the circumstances of each audit
and the auditor's needs in respect thereof. The standard organization of working papers improves
the efficiency with which they are prepared and reviewed. It also facilitates the delegation of work
while providing a means to control its quality. Working Papers should be sufficiently complete and
detailed for an auditor to obtain on over-all understanding of the audit.
The working papers should record the audit plan, the nature, timing and extent of auditing
procedures performed, and the conclusions drawn from the evidence obtained. The form and
content of working papers are affected by the nature of the engagement the form of the auditor's
report, the nature and complexity of the clients business, the nature and condition of the client's
records and degree of reliance on internal controls, the needs in particular circumstances for
direction, supervision and review of work performed by assistants.
Classification: Generally working papers are classified into permanent audit files and current audit
files. A permanent audit file normally includes:
 Information concerning the legal and organizational structure of the entity. In the case of a
company, this includes the Act and Regulations under which the corporation functions.
 Extracts or copies of important legal documents, agreements and minutes relevant to the
audit.
 A record of the Study and evaluation of internal controls related to the accounting system.
This might be in the form of narrative descriptions, questionnaires or flow charts or some
combination thereof.
 Copies of audited financial statement for previous years.
 Analysis of significant ratios and trends.
 Copes of management letters issued by the auditor, if any.

 Record of communication with the retiring auditor, if any, before acceptance of the
appointment as auditor.
 Notes regarding significant accounting policies.
 Significant audit observations of earlier years.
The current files normally include:
 Correspondence relating to acceptance of annual reappointment.
 Extracts of important matters in the minutes of Board Meetings and General Meetings, as
are relevant to the audit.
 Evidence of the planning process of the audit and audit programme.
 Analysis of transactions and balances.
 A record of the nature, timing and extent of auditing procedures performed and the results
of such procedures.
 Evidence that the work performed by assistants was supervised and reviewed.
 Copies of communications with other auditors, experts and other third parties.
 Copies of letters or notes concerning audit matters communicated to or discussed with

client, including the terms of the engagement and material weaknesses in relevant internal
controls.
 Letters of representation or confirmation received from the client.
 Conclusions reached by the auditor concerning significant aspects of the audit, including the
manner in which exceptions and unusual matters, if any disclosed by the auditor's
procedures were resolved or treated.
 Copies of the financial information being reported on and the related audit reports.
Importance of Working Papers:
 It provides guidance to the audit staff with regard to the manner of checking the schedules.

 The auditor is able to fix responsibility on the staff member who signs each schedule
checked by him.
 It acts as an evidence in the court of law when a charge of negligence is brought against the
auditor.
 It acts as the process of planning for the auditor. So that he can estimate the time that may
be required for checking of the schedules.
Ownership: Working papers are the property of the auditor. The auditor should adopt reasonable
procedures for custody and confidentiality of his working papers and should retain them for a period
of time sufficient to meet the need of his practice and satisfy any pertinent legal or professional
requirements of records retention. As per NSQC-1, retention period for audit engagements ordinarily
is no shorter than five years from the date of the auditor‟s report, or, if later, the date of the group
auditor‟s report
Question No 5
Mention the main purposes of providing depreciation. (6 Marks June 2004)
Answer
Purposes of providing Depreciation:
 To keep capital intact: One of the purpose of providing depreciation on assets is to retain
in the business out of the profits in each year, an amount equal to the proportion of the cost
of the asset employed in the business that has run off, estimated on the basis of the period of
its working life and its scrap value. If, depreciation had not been charged, the net income
would have been overstated over the years of the life of the asset, and if the same was
withdrawn or distributed as dividends, the business would have no funds for the
replacement of the asset.
 To ascertain cost accurately: Unless a proper charge on account of depreciation is

included in the Profit and Loss Account, the true cost of manufacture of different products
will not be ascertained.
 To charge initial costs against earnings: The objective of depreciation accounting is to

determine on a scientific basis, the proportion of the cost of a machine which must be
charged in the accounts of each year during which the machine will be used. Each
accounting period is to be charged against profits a fair proportion of the cost of fixed
assets.

 To Prepare true and fair statements: Depreciation is provided on the assets to show its
value at true cost and to show the profit at real. Unless depreciation is provided, the balance
sheet and profit and loss account will not be true and fair.
Depreciation is to be provided on the book value of assets, irrespective of the market price of the
assets at the year-end may be either more or less than its book value.
Question No 6
Distinguish between reserves and provision. (6 Marks June 2004, 5 Marks December 2015)
Answer
Reserves are amounts appropriated out of profits, which are not intended to meet any liability,
contingency, commitment or diminution in the value of assets known to exit at date of the balance
sheet. Reserves are appropriations out of profit. Reserves are made up of amounts appropriated out of
profits, held for equalizing the dividends of the company from one period to another or for financing
the expansion of the company or for generally strengthening the company financially.
Whereas, provisions are amounts charged against revenue to provide for:

 Depreciation, renewal or diminution in the value of assets; or
 A known liability, the amount whereof cannot be determined with substantial accuracy;
or
 a claim which is disputed.
Provisions are normally charged to the profit and loss account before arriving at the amount of profit.
Provisions are amounts set apart to meet specific liabilities of diminution in assets value. Provisions
must be provided for regardless of the fact whether or not any profit has been earned by the concern.
Differences are summarized as below:
1. Reserve is an appropriation of profit whereas provision is a charge against Profit.

2. Reserves are not intended to meet any liability, contingency or diminution in the value of
assets. Provisions are made to provide for depreciation, renewal or a known liability or a
disputed claim.
3. Reserves cannot be created unless there is a profit except revaluation reserve and capital
subsidy. Provisions must be created whether or not there is profit.
4. Reserves are generally optional except in certain situations – Capital Redemption
reserve, Debenture Redemption Reserve, Declaration of dividend higher than 10% etc.
Provisions are not optional and have to be made as per generally accepted accounting
principles.
5. Reserves are shown on the liability side. Provisions for depreciation and provision for
doubtful debts are shown as deduction from respective assets. Provision for liability is
shown on the liability side.

Question No 7
Explain the responsibility of auditors for the detection of Fraud and Error. (6 Marks, December
2004)
Answer
Standards on Auditing/Auditing practices on Fraud and Error:
The responsibility for the prevention and detection of fraud and error rests with management through
the implementation and continued operation of an adequate system of internal control. Such a system
reduces but does not eliminate the possibility of fraud and error.
The objective of an audit of financial information is to enable an auditor to express an opinion on
such financial information. In forming his opinion, the auditor carries out procedures designed to
obtain evidence that will provide reasonable assurance that the financial information is properly
stated in all material respects. Consequently, the auditor seeks reasonable assurance that fraud or
error which may be material to the financial information has not occurred or that, if it has occurred,
the effect of fraud is properly reflected in the financial information or the error is corrected. The
auditor, therefore, should so plan his audit that he has a reasonable expectation of detecting material
misstatements in the financial information resulting from fraud or error. The degree of assurance of
detecting errors would normally be higher that of detecting fraud, since fraud is usually accompanied
by acts specifically designed to conceal its existence.
Question No 8
Write short notes on:
a) Prepaid Expenses and Preliminary expenditures (4 Marks, December 2004)
Answer
Prepaid Expenses: incurred in the course of regular operation of an enterprise.
Prepaid expenses are also treated as outstanding assets. Expenditure already incurred a part or whole
of which relates to a period subsequent to the date of the Balance Sheet. Some of the example of
prepaid expenses:
 Insurance charges paid in advance;
 Advertisement, etc.
Preliminary expenditure: incurred prior to the operation of an enterprise.
The expenditure incidental to the creation and floating of a company includes stamp duties,
registration fees, legal costs, accountant‟s fee cost of printing etc. Preliminary expenses are both
incurred by the company or by the promoters and reimbursed them by the company. Normally, the
preliminary expenditures are disclosed in the prospectus, statutory report and the balance sheet.
Expenditure in connection with the preliminary expenses and not written off should be separately
disclosed under the head miscellaneous expenditure. Underwriting commission and brokerage paid
for shares and debentures should not be included under the head preliminary expenses.

b) Disclosures of accounting Policies. (4 Marks December 2004)
Nature of Accounting Policies: Accounting Policies refer to the specific accounting principles and
methods of applying those principles adopted by the enterprise in the preparation and presentation of
financial statements.
Management should select and apply an enterprise‟s accounting policies so that the financial
statements comply with all the requirements of each applicable Accounting Standards. Where there is
no specific requirement management should develop policies to ensure that the financial statement
provide information that is:
i. a relevant to the decision- making needs of users; and

ii. reliable in that they:
 represent faithfully the results and financial position of the enterprise;
 reflect the economic substance of events and transactions and not merely the legal forms;
 are neutral, that is free from bias;
 are prudent; and
 are complete in all material respects.
Accounting policies are the specific principles, bases, conventions, rules and practices adopted by an
enterprise in preparing and presenting financial statements. They are going concern; accrual basis of
accounting; consistency or presentation; materially and aggregation; offsetting not in all aspects; and
comparative statement.
Any change in an accounting policy, which has a material effect, should be disclosed. Areas in which
different accounting policies may be adopted on: Depreciation accounting, expenditure during
construction; foreign currency transaction, valuation of inventories. Goodwill, investments,
retirement benefits, expenditures during construction, contingent liabilities etc.
Question No 9
Discuss the relationship of Auditing with other disciplines. (10 Marks, June 2005)
Answer.
The field of auditing as a discipline in simple words involves review of various assertions; both in
financial as well as in non-financial terms with a view to prove the variety of such assertions and
expression of opinion by auditor on the same. Thus, it is logical and natural that the functions of audit
can be performed if and only if the person also possesses a good knowledge about the fields in
respect of which he is conducting such a review.

i. Auditing and Accounting.

Auditing and accounting are closely related with each other as auditing reviews the financial
statements which are nothing but result of the overall accounting process. It naturally calls on the part
of the auditor to have a through and sound knowledge of generally accepted principles of accounting
before he can review the financial statements. In fact, auditing as a discipline is also closely related
with various other disciplines as there is lot of linkages in the work which is done by an auditor in his
day to day activities. To begin with, it may be noted that the discipline of auditing itself is a logical
construct and everything does in auditing must be bound by the rules of logic. Ethical percepts are the
foundation on which the foundation of the entire accounting profession rests. The Knowledge of
language is also considered essential in the field of auditing as the auditor shall be required to
communicate, both in writing as well as orally, in day to day work.
ii. Auditing and Law.

The relationship between auditing and law is very close one. Auditing involves examination of
various transaction from the view point of whether or not these have been properly entered into. It
necessitates that an auditor should have good knowledge of business laws affection the entity. He
should be familiar with the law of contracts, negotiable instruments etc. The knowledge of taxation
law is also in inevitable as entity is required to prepare their financial statements taking into account
various provisions affected by various tax laws. In analyzing the impact of various transaction
particularly from the accounting aspect, an auditor ought to have a good knowledge about the direct
as well as indirect tax laws.
iii. Auditing and Economics

As is well known, accounting is concerned with accumulation and presentation of data relation to
economic activity. Though the concept of income as put forward by economists is different as
compared to the accountant‟s concept of income, still there are lot of similar grounds on which
accounting has flourished. From the auditing viewpoint, the auditors are more concerned with
Microeconomics rather than with the Macroeconomics. The knowledge of Macroeconomics should
include the nature of economic force that effect the firm, relationship of price, productivity and the
role of Government and Government regulations. Auditor is expected to be familiar with the overall
economic environment in which his client is operating
iv. Auditing and Behavioral Science

The discipline of behavior science is also closely linked with the subject of auditing. While it may be
stated that an auditor, particularly the financial auditor, deals basically with the figures contained in
the financial statements but he shall be required to interest with a lot of people in the organization. As
against the financial auditor, the internal auditor or management auditors are expected to deal with
human beings rather than financial figures. As one of the basic elements in designing the internal
control are personnel. There it has been made amply clear that howsoever a sound internal control
structure is designed, it cannot work until and unless the people who are working in the organization

are competent and honest. The knowledge of human behavior is indeed very essential for an auditor
so as to effectively discharge his duties.
v. Auditing and Statistics & Mathematics

With the passage of time, test check procedures in auditing have become part of generally accepted
auditing procedures. With the emergence of test check procedure, discipline of statistics has come
quite close to auditing as the auditor is also expected to have the knowledge of statistical sampling so
as to arrive at meaningful conclusions. The knowledge of mathematics is also required on the part of
auditor particularly at the time of verification of inventories.
vi. Auditing and Data Processing

Today, organization are witnessing revolution in the field of data processing of accounts. Many
organizations are carrying out their financial accounting activities with the help of computers, which
can document, record, collate, and allocate the value accounting data and information in every large
quantity at very high speed. The dependence on the accuracy of the programme instructions given
today, the computer is able to carry out each of these activities with complete accuracy. With such
phenomenal growth, in the field of computer sciences, the auditor should have good knowledge of the
components, general capability of the system and the related terms. In fact, EDP auditing in itself is
developing as a discipline in itself.
vii. Auditing and Financial Management

Auditing is also closely related with other functional fields of business such as finance, production,
marketing, personnel and other general areas of business management. With the overgrowing
auditing, the financial services sector occupies a dominant place in our system. While in general
terms, the auditor is expected to have a fair knowledge of the institution that comprise the market
place. The knowledge of various institutions and Government activities that influence the operations
of the financial market are also required to be understood by an auditor.
viii. Auditing and Production
Regarding the production function, it may be stated that a good auditor is on who understand the
client and his business. While carrying out the audit activity, the auditor is required to evaluate
transactions for the accounting aspect in relation to the process though it has passed through as
accounting for by-product, joint products may also require to be done. The knowledge of process
shall become more essential in case of an internal auditor. The auditor shall also require
understanding the cost system in operation in the factory and assessing whether the same is adequate
for the particular company. The understanding of the terminology of the production shall enable an
auditor to communicate with production employees in connection with his work. On the similar
pattern the auditor is also expected to have good understanding about the marketing, personnel and
other general business management areas.

Question No. 10
Write short notes on the followings:
Fundamental accounting assumptions. (4 Marks December 2005, 4 Marks June 2008)
Answer
The following are the underlying assumptions:
Accrual Basis:
In order to meet their objectives, financial statements are prepared on the accrual basis of accounting.
Under this basis, the effects of transactions other events are recognized when they occur (and not as
cash or its equivalent is received or paid) and they are recorded in the accounting records and
reported in the financial statements of the periods to which they relate. Financial statements prepared
on the accrual basis inform users not only of past transactions involving the payment and receipts of
cash but also of obligations to pay cash in future and of resources that represent cash to be received in
the future. Hence, the provide the type of information about past transactions and other events that is
most t useful to users in making economic decisions.
Going Concern:
The financial statements are normally prepared on the assumptions that an enterprise is a going
concern and will continue in operation for the foreseeable future. Hence, it is assumed that the
enterprise has neither the intention not the need to liquidate or curtail materially the scale of its
operations; if such an intention or need exists, the financial statements may have to be prepare on a
different basis and, if so, the basis used is disclosed.
Consistency is also one of the generally accepted fundamental accounting assumptions. As per
consistency principle, it is assumed that accounting policies are consistent form one period to
another.
If these fundamental accounting assumptions are followed in financial statements, specific disclosure
is not required. If a fundamental accounting assumption is not followed, the fact should be disclosed.
Question No 11
Explain the responsibility of auditors for the detection of Fraud and Error. (8 Marks, December
2005, 10 Marks December 2009)

Answer.
As described in NSA 200, “Overall Objectives of Independent Auditor and Conduct of Audit in
Accordance with NSAs" the primary objective of an audit of financial statements is to enable the
auditor to express an opinion whether the financial statements are prepared, in al material respects, in
accordance with an identified financial reporting framework or relevant practices. However, the
auditor while carrying out the audit is required to consider the risk of material misstatements in the
financial statements resulting from fraud and error.
An audit conducted in accordance with NSA or relevant practices is designed to provide reasonable
assurance that the financial statements taken as a whole are free from material misstatement, whether
caused by fraud or error. The fact that an audit is carried out may act as deterrent, but the auditor is
not and cannot be held responsible for the prevention of fraud and error.
An auditor cannot obtain absolute assurance that material misstatements in the financial statements
will be detected. Owing to the inherent limitations of an audit, there is an unavoidable risk that some
material misstatements of the financial statements will not be detected, even though the audit is
properly planned and performed in accordance with NSAs. An audit does not guarantee all material
misstatements will be detected because of such factors as the use of judgment, the use of testing, the
inherent limitation of internal control and the fact that much of the evidence available to the auditor is
persuasive rather than conclusive in nature for these reasons, the auditor is able to obtain only
reasonable assurance that material misstatements in the financial statements will be detected.
The auditor‟s opinion on the financial statements is based on the concept of obtaining reasonable
assurance; hence, in an audit, the auditor does not guarantee that material misstatements, whether
from fraud or error, will be detected. Therefore, the subsequent discovery of a material misstatement
of the financial statements resulting from fraud or error does not, in and of itself, indicate:
(a) A failure to obtain reasonable assurance;
(b) Inadequate planning, performance or judgment;
(c) The absence of professional competence and due care, or;
(d) A failure to comply with NSAs
This is particularly the case for certain kinds of intentional misstatements, since auditing procedures
may be ineffective for detecting an intentional misstatement that is concealed through collusion
between or among one or more individuals among management, those charged with governance,
employees, or third parties, or involves falsified documentation. Whether the auditor has performed
an audit in accordance with NSAs is determined by the adequacy of the audit procedures performed
in the circumstances and the suitability of the auditor‟s report based on the result of these procedures.

In planning the audit, the auditor should discuss with other members of the audit team the
susceptibility of the entity to material misstatements in the financial statements resulting from fraud
or error.
The auditor should supplement his/her own knowledge of the entity‟s business by making inquiries of
management regarding management‟s own assessment of the risk of fraud and the systems in place to
prevent and detect it. In addition, the auditor should also make inquires of management regarding the
accounting and internal control systems in place to prevent and detect error. Since management is
responsible for the entity‟s accounting and internal control systems and for the preparation of the
financial statements, it is appropriate for the auditor to inquire of management how it is discharging
these responsibilities.
If the circumstances indicate the possible existence of fraud and error, the auditor should consider the
potential effect of the suspected fraud and error on the financial information. The auditor should
obtain evidence to confirm and report accordingly.
The auditor also has the responsibility to communicate the misstatement due to fraud and error to the
appropriate level of management on a timely manner and consider the need to report to it then
charged with governance. He/she should consider the effect of fraud and error and suitably made
adjustment to his report and disclosure requirements of programs and data.
Question No 12
Distinguish between Fraud and error (5 Marks June 2006)
Answer
Fraud Error
It is the deception or artifice with the It is inaccuracy or incompleteness in the
intention of cheating or injuring another. measurement or presentation of an act
It is intentional It is accidental and unintentional.
The person committing the fraud does so It may arise due to negligence or a
knowingly, willfully and with the motive genuine misunderstanding on the part of
of gaining advantage or benefit by the persons committing them.
cheating or causing loss or injury to
another person.
Question No 13
Write short notes on the following (5 Marks June 2006)
a) Auditing in depth

Answer
Audit in depth implies a detailed step-by-step examination of selected transactions tracing all the
links from the very beginning to the end. Thus, if a purchase invoice is subjected to audit in depth,
the auditor will examine the original requisition slip, the purchase order, the tenders against which the
purchase order was made, the goods receipt note, the store inspection report, the quality control
report and entries in the bin card and store ledger. Thus, while auditing a transaction in depth, the
auditor, reviews all the accounting and operational aspects of the transaction, from the origin to the
end.
b) Independence of auditor (5 Marks June 2006)

Answer
Independence means that the auditor should not subordinate his judgement to that of the client or
anyone else. In any auditing situation, be it independent financial audit, internal audit, cost audit and
so on the auditor must be independent. It is basically a state of mind. It is, therefore, important that
the auditor should not only refuse to subordinate his judgement to that of others, but he should also be
free of any such interest as might affect his independent judgement even sub-consciously.
The auditor should not only be independent in his mind but also appear to be independent so that the
degree of reliance in Audit Report is enhanced.
c) Fundamental Accounting Assumption (5 Marks June 2006)

Answer
These are the fundamental assumptions, which underlie the preparation and presentation of financial
statements. These are not specifically stated because its acceptance and use are assumed. Disclosure
is necessary if these are not followed. The following have been generally accepted as fundamental
accounting assumptions.
 Going Concern: The enterprise is normally viewed as a going concern, that is as continuing in
operation for the foreseeable future.
 Consistency: It is assumed that accounting policies are consistent from one period to another
 Accrual: revenue and costs are accrued, that is recognized as they are earned or incurred and
recognized in the financial statements of the period to which they relate.
If the fundamental accounting assumptions, viz., Going concern, Consistency and Accrual are
followed in financial statements specific disclosure is not required. If a fundamental accounting
assumption is not followed, the fact should be disclosed.
d) Going concern (5 Marks June 2006, 2.5 marks December 2013, 2.5 Marks December 2015 )
Answer
The financial statements are normally prepared on the assumption that an enterprise is a going

enterprise has neither the intention nor the need to liquidate or curtail materially the scale of its
operations; if such an intention or need exists, the financial statements may have to be prepared on a
different basis and, if so, the basis used is disclosed. As per NSA 570, the auditor is required to assess
the going concern assumption of the entity and also NSA 700 specifically requires the auditor to
report separately regarding the going concern issues identified during the course of audit.
e) Management Representation Letter (5 Marks June 2006, 5 Marks December 2009)

Answer
As per NSA 580: Written Representations, the objective of the auditor is to obtain written
representations from management and, where appropriate, those charged with governance that they
believe that they have fulfilled their responsibility for the preparation of the financial statements and
for the completeness of the information provided to the auditor
The auditor should obtain evidence that management acknowledges its responsibility for the fair
presentation of the financial statements in accordance with the relevant financial reporting
framework, and has approved the financial statements. The auditor can obtain evidence of
management's acknowledgement of such responsibility and approval from relevant minutes of
meetings of the board of directors or similar body or by obtaining a written representation from
management or a signed copy of the financial statements.
The auditor should obtain written representations from management on matters material to the
financial statements when sufficient appropriate audit evidence cannot reasonably be expected to
exist. The possibility of misunderstandings between the auditor and management is reduced when
oral representations are confirmed by management in writing.
If a representation by management is contradicted by other audit evidence, the auditor should

investigate the circumstances and, when necessary, reconsider the reliability of other representations
made by management. Also, the written representations cannot be regarded as the substitute for
sufficient appropriate audit evidence.
The auditor would ordinarily include in audit working papers evidence of management's
representations in the form of a summary of oral discussions with management or written
representations from management in the form of letter addressed to the auditor.
Question 14
Distinguish between:
Permanent Difference and Timing Difference (5 Marks June 2006, June 2009)
Tax on income is one of the significant items in the statement of profit and loss of an enterprise. In
accordance with the matching concept, taxes on income are accrued in the same period as the revenue

and expenses to which they relate. Matching of such taxes against revenue for a period poses special
problems arising from the fact that in a number of cases that in a number of cases; taxable income
may be significantly different from the accounting income. This divergence between taxable income
and accounting income arises due to two reasons:
Firstly, there are differences between items of revenue and expenses as appearing in the statement of
profit and loss and the items, which are considered as revenue, expenses or deductions for tax
purposes i.e. permanent difference. Such permanent differences are the difference between taxable
income and accounting income for a period that originate in one period and do not reverse
subsequently.
Secondly, there are differences between the amount in respect of a particular item of revenue or
expenses as recognized in the statement of profit and loss and the corresponding amount which is
recognized for the computation of taxable income. i.e. timing difference. Such timing difference are
those difference between taxable income and accounting income for a period that originate in one
period and are capable of reversal in one or more subsequent periods.
Question No 15
Briefly describe Continuous and Final Audit and mention its advantages and disadvantages.
Continuous and Final Audit
Continuous Auditing is processes that allow an on-going review and analysis of business and
financial information on a real time basis. Continuous auditing requires specialized skills of audit
personnel. Continuous auditing helps end users with timely and correct information for reporting and
decision making. Therefore, continuous audit is more useful where financial information is updated
for decision making and publishing as events occur. Therefore, main users of continuous audit are
different levels of management. The continuous audit is sometimes confused with the interim audit
and used interchangeably. The interim audit concerns with a particular period in a financial year
whereas continuous audit is not concerned with a particular period and is an ongoing process.
At the other hand final audit is commonly understood to be an audit which begins after the books of
accounts have been closed at the end of the accounting period and thereafter carried out continuously
until completed. Normally final audit is concerned with verification of books of accounts and the
financial statements generated on the basis of those books of accounts. The final auditor is required to
give opinion on the financial statements and books of accounts maintained. The main users of final
audit are shareholders/owner of the enterprise, government and other third-party users.
Advantages of final audit are:
i. Work can be carried on at stretch till the audit is over. Thus, avoiding the necessity of
frequent visits
ii. The possibility of manipulation in financial information is also avoided. Allocation of work
for staff and planning of audit becomes easier.

Disadvantages of final audit include is mainly delay in completion of audit and publication of
financial audit. Particularly if the size of the business is large. It also becomes difficult to plan and
complete audit in time if financial years of several client send on the same date. Another
disadvantage is that the errors, non-compliance, manipulations and frauds are not discovered in time,
thus making difficult to make corrective measures.
Advantages of Continuous Audit:

1. Errors are discovered earlier, thus giving adequate time for taking corrective measures
2. Because of the frequent attendance of the auditor, the opportunities of committing frauds are
reduced.
3. Fraud, if perpetrated, is detected sooner with the result that size of the fraud is limited and also
the chances of recovering the defalcated amount are improved.
4. The attendance of the audit staff acts as a moral check on the client‟s staff.
5. The client‟s accounts are always kept up to date.

6. Since audit can be carried on throughout the year, there is more time for detailed checking of the
accounts when the audit is taken up at the close of the year.
7. If the audit of routine transactions is completed before the close of the year, the final accounts can
be prepared and reported upon much earlier.
8. If the auditor carries on a continuous audit, he remains constantly in touch with the client‟s affairs
thereby able to carry out his duties efficiently.
9. In the case of continuous audit, the work of the auditor is greatly facilitated since he is in a better
position to plan out his engagements and take up the job at his convenience, avoiding the pressure
at the close of the financial year when most of the business firms usually close their accounts.
Disadvantages:
1. There is a danger that the records of transactions after they have been audited may be altered
either intentionally or unintentionally.
2. The examination of an item left incomplete on a visit for being undertaking on the next visit may
be overlooked.
3. A continuous audit may involve good deal of waste of time and effort if the size of the concern is
small.
The disadvantages of a continuous audit can be avoided if the following precautions are taken:
1. During the course of each visit, work should be completed up to a definite stage so as to avoid
loose ends.
2. At the end visit, important balances should be noted down and the same should be compared at
the time of the next visit.

3. The visits should be at irregular intervals of time so that the client‟s staff may not in advance
know the exact date when the audit would be resumed and thus may be able to prepare
themselves in advance for the same.
4. The nominal accounts should be checked only at the time of final closing.
5. The client‟s staff should be instructed not to alter or correct audited figures. The auditor should
also device a special form of ticks for being placed against figures, which has been altered, and
neither its purpose nor significance should be disclosed to the client‟s staff.
Thus, it is clear from the above that final or completed audit approach is advisable in small scale
clients. On the other hand, continuous audit may be adopted in large scale clients. The continuous
audit may also be suitable to the clients where internal control is weak. The continuous audit involves
higher cost in comparison to final audit. Moreover, continuous presence of audit staff may impair
auditor‟s independence as well. Therefore, both choices should be judged as per their merits and
demerits vis-à-vis clients‟ requirement and scale of operation.
Question No 16
Distinguish between the following: (5 Marks each December 2007)
a) Joint audit and Branch audit
b) Concealed and Unconcealed Errors
c) Provisions and Contingent Liabilities
Answer
a) Answer
The practice of appointing Chartered Accountants as joint auditors is quite widespread in big
companies and corporations. Joint audit basically implies pooling together the resources and
expertise of more than one firm of auditors to render an expert job in given time period which
may be difficult to accomplish acting individually. It essentially involves sharing of the total
work. Whereas branch audit is done either under legal provision or under requirement of the
management. In certain cases, branch audit may be compulsory but joint audit is never
compulsory.
Where joint auditors are appointed, they should, by mutual discussion, divide the audit work
among themselves. The division of work would usually be in terms of audit of identifiable units
or specified areas. Whereas though branch audit may decrease workload of statutory auditor‟s
branch auditors are not concerned with the audit of other units.
For certain works, whether divided between joint auditors or not all the joint auditors are jointly
and severally responsible. In respect of audit work divided among the joint auditors, each joint
auditor is responsible only for the work allocated to him, whether or not he has prepared a
separate report on the work performed by him. In case of branch auditor, he is liable and
responsible for the matters concerned with the branch only and does not decrease liability of

statutory audit concerning the branch. Branch auditor may work under guidance of statutory
auditors whereas joint auditors work jointly.
b) Answer
As a general rule, mistakes are unconcealed but frauds are deliberately concealed. This
proposition does not need any elaboration, but exceptions are in both cases. Mistakes become
concealed if compensated by another or more mistakes in the opposite direction, or it may even
be greatly minimized by that chance happening. Mistakes may as well be concealed for wrong
arithmetical calculations or for a faulty process of verification. Depreciation and stocks are
examples which immediately come to one‟s mind. Wrong calculation of depreciation or omission
to include certain stocks in the inventory or wrong valuation of stocks is not apparent. Petty cash
defalcation is often unconcealed because petty cash is an item which on many occasions is left
out of checking. The attitude towards apparently small errors may be dangerous because its true
dimensions remain concealed and that may render the statements of account totally unacceptable.
.
c) Answer
A contingent liability is the certain liability arising out of uncertain event that is not recognized in
the accounts. Contingent liabilities are not recognized as liabilities because they are either
possible obligations or which is yet to be confirmed whether the enterprise has a present
obligation that could lead to an outflow of resources embodying economic benefits or present
obligations that do not meet the recognition criteria because either it is not probable that an
outflow of resources embodying economic benefits will be required to settle the obligation or a
sufficiently reliable estimate of the amount of the obligation cannot be made.
Examples of contingent liabilities are unexpired contract commitments, compensation amount in
respect of a law suit pending court‟s verdict etc.
Unless the possibility of any outflow in settlement is remote, an enterprise should disclose for
each class of contingent liability at the balance sheet date a brief description of the nature of the
contingent liability with certain details.
Question No 17
"Audited accounts are not free from errors" describe it. (4 Marks, June2008)
Answer
Audit is conducted on test check basis which is not a complete set of testing the whole transactions.
Auditor plans audit program in such a way that the internal control system with respect to the transaction
is effective and there exists least chance for irregularities. This lead applying test check or sampling
technique in the audit.

Once, the auditor conduct audit based on audit program, auditor satisfy himself that except the matters
stated in the audit report, all other transactions give a true and fair view of the organization.
It may be noted that auditor is not the appropriate authority to certify that financial statements are true
and correct. Auditor can express own opinion on overall status of the financial statements but cannot
certify the correctness of the statements.
In this scenario, misrepresentation or omission of transactions may lead to the error in the accounts which
the auditor might not have detected during the course of audit. Even after careful planning and execution
of audit some errors or fraud may remain undetected due to inherent limitations of auditing and control
system implemented by the management. It is the duty of the management to establish control system
that prevents and detects errors and fraud. Thus, the audited accounts may not be free from errors.
Question No 18
a) Fundamental Errors (5 Marks December 2008)
b) Contingent Liabilities (5 Marks December 2008)
c) Accounting Estimates (5 Marks December 2008)
a. Answer
Errors in the preparation of the financial statements of one or more prior periods may be
discovered in the current period. Errors may occur as a result of mathematical mistake, mistakes
in applying accounting policies, misinterpretation of facts, fraud or oversights. The correction of
these errors is normally included in the determination of net profit or loss for the current period.
In some cases, an error may have a significant effect on the financial statements of one or more
prior periods that those financial statements can no longer be considered to have been reliable at
the date of their issue. These errors are referred to as fundamental errors. Fundamental errors need
to be rectified by restatement of the financial statements of the relevant previous year else
adjusted in the retained earnings.
b. Answer
A contingent liability is a liability arising out of uncertain event that is not recognized in the
accounts. Contingent liabilities are not recognized as liabilities because they are possible
obligations which are yet to be confirmed. Hence contingent liabilities are the probable liabilities
that may arise at a future date or the happening or non-happening of a probable event giving rise
to financial obligation.
Examples of contingent liabilities are unexpired contract commitments, compensation amount in

respect of a law suit pending court‟s verdict etc.

Unless the possibility of any outflow in settlement is remote, an enterprise should disclose a brief
description of the nature of the contingent liability with certain details as at the balance sheet date
in its financial statement.
c. Answer
When a positive (revenue or profit) or negative (expenses or loss) outcome of an event or
transaction cannot be measured with the given means and such amount is estimated and
accounted for in the books of accounts they are known as accounting estimates.
Management is responsible for making accounting estimates.

Some estimates are based on past experience and data such as accrued revenue or depreciation
based on useful life of an asset. In those cases, risk of material misstatement would be generally
lower compared to the audit of accounting estimates based on uncertain events.
It is very important for the auditor to obtain appropriate audit evidence before drawing conclusion
regarding the reasonableness of accounting estimates.
General approaches to the audit of accounting estimates are:

 Obtain and review the basis of accounting estimate made by the management
 Use an independent estimate to assess the amount estimated by the management and assess its
uniformity
 Review subsequent events that confirm the estimate
Based on the above the auditor should make final assessment as to whether the estimate is
reasonable and whether there is the possibility of any material misstatement.
Question No 19
Distinguish between the following:
a) Substance over form and Neutrality. (5 Marks December 2008)
b) Internal Audit and External Audit. (5 Marks December 2008)
Answer
a) Substance over form is a qualitative characteristic of financial statements. If information is to
represent faithfully the transactions and other events that it purports, it is necessary that they are
accounted for and presented in accordance with their substance and economics reality i. e.
substance over form and not merely their legal form. The substance of transaction or other events
is not always consistent with that which is apparent from their legal or contrived form. Similarly,
another characteristic of financial statement is neutrality. The information contained in financial
statements must be neutral, that is, free from bias to be reliable. Financial statements are not
neutral if, by the selection or presentation of information, they influence a decision or judgement
in order to achieve a predetermined result or outcome.

b) On the basis of functional division, auditors can be classified into broad categories, namely,
external auditors and internal auditors. External auditors are the persons who practice the
profession of accountancy and are external vis-à-vis the organization whose books are being
audited. The external auditors are appointed by the owners of the organization, say, shareholders
of the company and thus they are treated external to the organization in which they have been
appointed.
The Internal auditors, on the other hand, may also be professionally qualified and are internal vis-
à-vis to the organization in which they are appointed to perform specific work. They are
considered internal because their appointment is done by the management and scope of work is
also specified by it. They may be appointed either on a contract basis or as employees to
undertake auditing of the books and records as a part of management control and appraisal
system.
Question No 20
Reserves and provisions (5 Marks December 2009)

Answer
Reserves and provisions

Reserves are amounts appropriated out of profits which are not intended to meet any liability,
contingency, commitment or diminution in the value of assets known to exist at the date of the
Balance Sheet. In contradistinction, provisions are amounts charged against revenue to provide for:
 depreciation, renewal or diminution in the value of assets, or
 a known liability, the amount whereof cannot be determined with substantial accuracy, or
 a claim which is dispute.
Amounts contributed or transferred from profits to make good the diminution in assets values are
described as provision. Provisions are normally charged to the profit and loss account before
arriving at the amount of profit. Reserves are appropriated out of profits.
Question No 21
Explain the difference between Continuous and Final Audit (5 Marks December 2009)
Answer:
Final Audit is commonly understood to be an audit which does not begin until the books have closed at
the end of the accounting period and thereafter is carried on continuously until completed. Whether an
audit ought to be conducted continuously after the close of the financial year should be decided on a
consideration of the size of the business and the extent of detailed checking required.

Continuous Audit is one in which the auditor's staff is engaged continuously in checking the accounts of
the client the whole year round or when for this purpose the staff attends at intervals, fixed or otherwise,
during the currency of the financial period. Strictly speaking, when auditor's staff attends the audit work at
fixed intervals it may be strictly called interim audit. This is when an audit is conducted up to a particular
date within the accounting period. The auditor may attend to audit the figures for a month or for a quarter,
as the work may require. It would differ distinctly from the final audit in the extent of the work carried
out; verification of assets, for example would be left until the final audit. In case of a continuous audit, the
work is conducted throughout the course of the financial year but is not taken to a specific accounting
period, as is an interim audit. It might be that during the course of the continuous work interim figures are
being audited, but the significant factor here is that the auditor will be engaged continuously on the audit
throughout the financial period. Staff may be in residence throughout the period or may come and go at
irregular intervals, but most of the time, the audit staff is present at the location. Thus, in case of
continuous audit, the audit staff is present at the client's premises almost during the entire accounting
period.
Question No 22
Define the 'Accounting policies'. What are the major areas in which different accounting policies may
be adopted by different enterprises? (7 Marks June 2010)
Answer
Accounting policies refer to the specific accounting principles and the methods of applying those
principles adopted by the enterprises in the preparation and presentation of financial statements. There is
no single list of accounting policies which are applicable to all circumstances. The different circumstances
in which enterprises operate in a situation of diverse and complex economic activity make alternative
accounting principles and methods of applying those principles acceptable. The choice of the appropriate
accounting principles and methods of applying those principles in the specific circumstances of each
enterprise calls for considerable judgment by the management of the enterprises.
There are various areas where different accounting policies may be adopted as per need of the enterprises
like:
- Method of depreciation, depletion and amortization,
- Treatment of expenditure during construction
- Conversion or translation of foreign currency items
- Valuation of inventories
- Treatment of retirement benefits
- Treatment of contingent liabilities
- Treatment of goodwill
Question No 23
Distinguish between Prior period items and extra ordinary items (5 Marks June 2010)

Answers:
Prior period items and extra ordinary items
Prior period items are incomes or expenses, which arise, in the current period as a result of errors or
commissions in the preparation of the financial statements of one or more prior periods. Extraordinary
items are incomes or expenses that arise from events or transactions that are clearly distinct from the
ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly.
Question No 24
Write short notes on Concept of true and fair view (5 Marks June 2010, 4 Marks June 2005)
Answers:
Concept of true and fair view.
The concept of true and fair is a fundamental concept in auditing. The phrase "true and fair" in the
auditors‟ report signifies that the auditor is required to express his opinion as to whether the state of affairs
and the results of the entity as ascertained by him in the course of his audit are truly and fairly represented
in the accounts under audit. This requires that auditor should examine the accounts with a view to verify
that all assets, liabilities, income and expenses are stated as amounts which are in accordance with
accounting principles and policies which are relevant and no material amount, items or transactions has
been omitted.
The auditor expresses an opinion that financial statements give a true and fair view when:
 Financial statements are prepared according to applicable Financial Reporting Framework.

 Financial statements have complied with all relevant laws and regulations.
 The books of accounts are arithmetically correct (i.e. arithmetical accuracy)
 The transactions are supported by sufficient appropriate evidence.
 The transactions are authorized and approved by competent body.
 The transactions are properly classified as capital and revenue.
 The assets and liabilities are neither understated nor overvalued.
 The financial statements are free from misstatements.
 The financial statements disclose all relevant facts.
Question No 25
Write short notes on the following:
a. Change in Accounting Policies (5 Marks June 2010)
Answer:
Change in accounting policies:

 The consistency is also an accounting assumption. Therefore, the accounting policies should
consistently be applied and followed from years to years.

 Change in accounting policy is permitted only if such change is to bring accounts in line with
accounting standards, provisions of law or for better presentation of financial statements.
 When change in accounting policies or method is affected, the fact of such change and its
impact on accounts must be disclosed.
 If change is made in the accounting policies which has no material effect on the financial
statements for the current period but which is reasonably expected to have a material effect in
later periods, the fact of such change should be appropriately disclosed in the period in which
the change is adopted.
Question No 26
What are the basic elements of an assurance engagement? (7 Marks December 2010)
Answer
i) Three party relationship: Assurance engagements involve three separate parties: a practitioner,
a responsible party and intended users.
ii) An appropriate subject matter: Subject matter information may be the reorganization,
measurement, presentation and disclosers represented in financial statements, key indicators,
special documents, assertion about effectiveness or statement of compliance depending on the
nature of assurance engagements.
iii) Suitable criteria: Criteria can be formal or informal depending up on the nature of assurance
engagement. It may be Nepal Standards on Auditing or an established internal control framework
or individual control objectives specifically designed for the engagement or applicable law,
regulation or contract.
iv) Sufficient appropriate evidence: The practitioner plans and performs an assurance engagement
with an attitude of professional skepticism to obtain sufficient appropriate evidence about
whether the subject matter information is free of material misstatement. The practitioner
considers materiality, assurance engagement risk, and the quantity and quality of available
evidence when planning and performing the engagement.
v) Assurance report: The practitioner provides a written report containing a conclusion that conveys
the assurance obtained about the subject matter information.
Question No 27
“An audit suffers from certain inherent limitations”. Explain. (8 Marks December 2010, 5
Marks June 2011,)
Or
What are the general limitations of audit? (5 Marks December 2017)
Answer
While conducting an audit, the auditor follows procedures designed to satisfy himself that the financial
statements reflect a true and fair view of the financial position and operating results of the enterprise. The

process of auditing, however, is such that it suffers from certain inherent limitations, i.e., the limitation
which cannot be overcome irrespective of the nature and extent of audit procedures.
The limitations are generally due to:
a. Test Checking (Sampling)

Auditor selects samples of transactions to check. Due to the time constraints, auditor cannot check each
and every transaction in detail thereby leaving a possibility that unchecked items may contain
misstatements.
b. Exercise of Judgment
Auditor‟s work involves exercise of judgment in deciding the extent of audit procedures and in assessing
the reasonableness of the judgment and estimates made by the management in preparing the financial
statements.
c. Nature of Audit Evidence

The audit evidence obtained by an auditor is generally persuasive in nature rather than conclusive in
nature due to which an auditor can draw reasonable conclusions only. Because of these factors, the auditor
can only express an opinion. There is also likelihood that some material misstatements of the financial
information resulting from fraud or error, if either exists, may not be detected.
d. dependency on existence of an effective Internal Control System

The entire audit process is generally dependent upon the existence of an effective system of internal
control. There will always be some risk of an internal control system failing to operate as designed.
Internal control system also suffers from certain inherent limitations since any system of internal control
is ineffective against fraud involving collusion among employees or fraud committed by management.
Certain levels of management may be in a position to override controls; for example, by directing subordi-
nates to record transactions incorrectly or to conceal them, or by suppressing information relating to
transactions. Such inherent limitations of internal control system also contribute to inherent limitations of
an audit.
Therefore, it is quite apparent from above that an audit suffers from certain inherent limitations.
Question No 28
Write a short note on
Continuous audit (5 Marks, June 2011)
A continuous audit is one in which the auditor‟s staff is engaged continuously in checking the accounts of
the client the whole year round or when for this purpose the staff attends at intervals, fixed or otherwise,
during the currency of the financial period. This is when an audit conducted up to a particular date within
the accounting period. The auditor may attend the audit the figures for a month for a quarter, as the work

may require. It would differ distinctly from the final audit in the extent of the work carried out;
verification of assets; for example, would be left until the final audit.
In continuous audit, the work is conducted throughout the course of the financial year but is not taken to a
specific accounting period, as in an interim audit. It might be that during the course of the continuous
work interim figures are being audited, but the significant factor here is that the auditor will be engaged
continuously on the audit throughout the financial period. Staff may be in residence throughout the period
or may come and go at irregular intervals, but most of the time, the audit staff is present at the location.
Thus, in case of continuous audit, the audit staff is present at the client‟s premises almost during the entire
accounting period.
Advantages
 Errors are discovered earlier facilitate in timely rectification
 Due to frequent presence of auditor opportunities of committing frauds are reduced.
 The attendance of audit staff acts as a moral check to the client‟s staff.
 Accounts are always kept up to date
Question No 29
Management Audit and Operational Audit (5 Marks December 2011)
Answer
Management audit is an audit of the management. The management audit is, therefore, concerned itself
with the whole field of activities of the concern, from top to bottom starting from the top, because we are
primarily concerned with whether the general management is functioning smoothly and satisfactorily.
Management audit is concerned with appraising management‟s accomplishment of organizational
objectives, the management functions of planning, organizing, directing and controlling, and the adequacy
of management‟s decisions and actions in moving towards its stated objectives.
Management audit is a complex task closely linked with the process of management. It usually involves
the following steps:
 Identification of the objectives of the organization.

 The overall objectives are to be split down into detailed targets and plans for various
segments.
 The organizational structure is to be reviewed to assess whether or not it can effectively
achieve the overall objectives and detailed targets.
 The performance of each functional area or responsibility center is to be examined and
compared with the targets and objectives.
 On the basis of above examination, a realistic course of action may be recommended.

On the other hand, operational audit is an audit for the management. It is undertaken at the instance of the
management for providing it with information and appraisal of operations and activities. Operational
auditing is essentially a review and appraisal of operations of an organization carried on by a competent
independent person. Hence, operational audit refers to a systematic independent appraisal activity within
an organization for a review of the entire departmental operations as a service to management. Operations
audit is a technique for regularly and systematically, appraising unit or function effectiveness against
corporate and industry standards by utilizing personnel who are not specialists in the area of study with
the objective of assuring a given management that its aims are being carried out in identifying conditions
capable of being improved.
Management audit deals with various aspects of the management process whereas operational audit is
confined to various activities and operations in the functional areas. Management audit attempts to
evaluate the performance of various management process and functions.
Question No 30
Give your comments on the following.
Mr. Lakhan, Statutory Auditor of Radha Krishna Pvt. Ltd wants to verify cash on hand as on 31st
Aasadh, 2069. The Management informs Mr. Lakhan that it is not possible to cooperate, as cashier
has been out of station. Advise Mr. Lakhan on how to deal with the situation.
(5 Marks December 2012)
The scope of audit may be limited for varied reasons:
 the entity may impose restriction on scope of audit,
 the limitation may be imposed by circumstances.
When the audit is carried out under and as per statute, the auditor should not accept the assignment when
his duties are curtailed by agreement, unless required by any Law.
When audit is carried out in accordance with the entity‟s terms voluntarily, the auditor may indicate
his scope in his audit report. Sometimes, the circumstances may impose restrictions on audit scope. For
example, if the auditor is appointed after the year end, he may not be able to participate in inventory
checking. Or sometimes, the records required may not be available so that the auditor may not be able to
check details in the manner he liked. Such limitations in scope may warrant an auditor to express
disclaimer of opinion or qualified opinion in his audit report depending upon the circumstances.
The non-co-operation of Radha Krishna Pvt. Limited will amount to limitation on scope of auditors.
Question No 31
An audit is not a guarantee that the financial statements are free from material misstatement,
because absolute assurance is not attainable. What are the factors which hinders the auditor to
provide absolute assurance? (5 Marks December 2012)
Answer
Factors hindering the auditor to provide absolute assurance:

Auditor provides reasonable assurance on the financial statements and is not in the position to provide
absolute assurance due to the following factors:
i. Use of testing/sampling rather than 100% checking,
ii. The inherent limitations of internal control (for example, the possibility of management override or
collusion),
iii. The fact that most audit evidence is persuasive rather than conclusive and
iv. The work undertaken by the auditor to form an audit opinion is permeated by judgment, in particular
regarding: (a) The gathering of audit evidence, for example, in deciding the nature, timing and extent
of audit procedures; and (b) The drawing of conclusions based on the audit evidence gathered, for
example, assessing the reasonableness of the estimates made by management in preparing the
Question No 32
Adverse opinion (2.5 Marks December 2013)
Answer:
An adverse opinion should be expressed by the auditor when the effect of a disagreement is so material
and pervasive to the financial statements that the auditor concludes that a qualification of the report is not
adequate to disclose the misleading or incomplete nature of the financial statements. Whenever the
auditor expresses an opinion that is other than unqualified, a clear description of all the substantive
reasons should be included in the report and, unless impracticable, a quantification of the possible
effect(s) on the financial statements. Ordinarily, this information would be set out in a separate paragraph
preceding the opinion or disclaimer of opinion on the financial statements and may include a reference to
a more extensive discussion, if any, in a note to the financial statements.
Question No 33
Auditing and Investigation (5 Marks December 2014)
 Objects: The object of auditing is to find out whether Financial Statements give a true and fair
view of business. Investigation is undertaken to know the essential facts about a matter under
inquiry. It is done with some special purpose of view.
 Period: Auditing usually covers one accounting year. Investigation may cover more than one
accounting year.
 Legally Binding: Auditing is conducted for proprietors or is normally legally binding.
Investigation is carried out on behalf of any party interested in the matter.
 Scope: Auditing is legally compulsory for companies & restricted to the financial statement.
Investigation is voluntary and carried out on certain circumstances & may be carried out beyond
the financial statement.

 Time: Auditing may be conducted at the year end. Investigation may be conducted at any time in
case of suspicion about any transaction.
 Report: In auditing form of report is prescribed. In investigation it is not prescribed.
 Appointment: In auditing appointment is made by shareholders in AGM. In investigation
appointment can be done by other delegated authorities.
 Qualification: Auditors qualification is prescribed by Laws. Investigators qualification has not
prescribed by Laws.
 Re-work: Re-audit is not generally carried out. Re-investigation may be carried out.
 Perception: Audit is not carried out with doubtful mind. Investigation may be carried out with
doubtful mind.
Question No 34
a) Objectives of Audit of the Financial Statement (2.5 Marks December 2014)
b) Qualities of an Auditor (2.5 Marks December 2014, 5 Marks December 2017)
a) Answer
In conducting an audit of financial statements, the overall objectives of the auditor are:
 To obtain reasonable assurance about whether the financial statements as a whole are free
from material misstatement, whether due to fraud or error, thereby enabling the auditor to
express an opinion on whether the financial statements are prepared, in all material respects,
in accordance with an applicable financial reporting framework; and
 To report on the financial statements, and communicate as required by the NSAs, in
accordance with the auditor‟s findings.
Audits are not conducted with the objective of identifying fraud and errors prevalent in the
company, but the audit process normally result in identification of fraud or errors while
conducting internal control evaluation and using substantive procedures. This is because the
auditing standards requires an auditor to bear in mind the possibility of the existence of frauds or
errors in the accounts under audit since they may cause the financial position to be mis-stated.
So, detection of material frauds and errors as an incidental objective of independent financial
auditing flows from the main objective of determining whether or not the financial statements
give a true and fair view.
b) Answer
An auditor should adhere to the fundamental principles applicable for the auditor. The
fundamental principles are integrity, objectivity, professional competence and due care,
confidentiality and professional behavior. The qualities required in and auditor are tact, caution,
firmness, good temper, integrity, discretion, industry judgment, patience, clear headedness and
reliability. In addition, he must have the shine of culture for attaining a great height. He must

have the highest degree of integrity backed by adequate independence. He must have a thorough
knowledge of general principles of law which govern matters with which he is likely to be
intimate contact. He must pursue an intensive program of theoretical education in subjects like
financial and management accounting, general management, business and corporate laws,
computer and information systems, taxation, economics etc. An auditor must be honest; i.e.; he
must not certify what he does not believe to be true and must take reasonable care and skill
before he believes that what he certifies is true.
Question No 35
Explain „Assurance Report‟ as an element of assurance. (5 Marks- December 2015)
Assurance engagement is an engagement in which a practitioner auditor expresses a conclusion designed to
enhance the degree of confidence of the intended users other than the responsible party about the outcome of the
evaluation or measurement of a subject matter against criteria.
The practitioner auditor provides a written report containing a conclusion that conveys the assurance obtained
about the subject matter information. NSAs, NSREs and NSAEs establish basic elements for assurance reports. In
addition, the practitioner considers other reporting responsibilities, including communicating with those charged
with governance when it is appropriate to do so. In an assertion-based engagement, the practitioner's conclusion
can be worded either:
In terms of the responsible party's assertion (for example: "In our opinion the responsible party's assertion that
internal control is effective, in all material respects, based on XYZ criteria, is fairly stated"); or
Directly in terms of the subject matter and the criteria (for example: "In our opinion internal control is effective, in
all material respects, based on XYZ criteria").
In a direct reporting engagement, the practitioner's conclusion is worded directly in terms of the subject matter and
the criteria. In a reasonable assurance engagement, the practitioner expresses the conclusion in the positive form,
for example: "In our opinion internal control is effective, in all material respects, based on XYZ criteria." This
form of expression conveys "reasonable assurance."
Having performed evidence gathering procedures of a nature, timing and extent that were reasonable given the
characteristics of the subject matter and other relevant engagement circumstances described in the assurance
report, the practitioner has obtained sufficient appropriate evidence to reduce assurance engagement risk to an
acceptably low level. In a limited assurance engagement, the practitioner expresses the conclusion in the negative
form, for example, "Based on our work described in this report, nothing has come to our attention that causes us to
believe that internal control is not effective, in all material respects, based on XYZ criteria."
This form of expression conveys a level of "limited assurance" that is proportional to the level of the practitioner's
evidence-gathering procedures given the characteristics of the subject matter and other engagement circumstances
described in the assurance report.
Question No 36
Distinguish between
a. Internal Audit and Statutory Audit (5 Marks June 2015)

Answer:
 Internal audit is the arrangement within the organization to verify on continuous basis the
correctness and truthfulness of the transactions by the salaried staff/outsourced.
 Statutory audit is the examination of the books of accounts of the business by an external auditor
and to report that the profit and loss account and balance sheet are drawn according to provisions
of law and the financial statements reveal the true and fair view of the results of operations and
financial state of affairs of the business.
 Internal audit is not compulsory.

Statutory audit is compulsory as per applicable law.
 Internal audit is carried out by the person appointed by the business enterprises. It is not necessary
that the internal auditor should possess the qualification prescribed for professional auditor.
Statutory audit can be carried out only by those who are qualified for appointment as per the
provision of the Companies Act 2063 and other Acts.
 Internal auditor is answerable to the management. His duties, responsibilities etc. regarding audit
work are determined by the management. The management can increase the powers and authority
of the internal auditor. Similarly, it can also curtail his powers.
The rights, duties, responsibilities and liabilities of statutory auditors are governed by the provisions
of law. The auditor is independent of management.
 The internal auditor points out irregularities in the procedural aspects and suggests ways and means
to rectify the same. He assures that the financial operations and other types of control in force are
carried out in conformity with the accounting systems.
The statutory auditor is concerned with the legality and validity of the transactions of business. His
audit work is based on the financial statement prepared by the business.
b. Accounting & Auditing (5 Marks June 2016)

Answer
Point of
difference Accounting Auditing
1. Meaning It is recording of all the day to It is the critical examination of
day transactions in the books of the transactions recorded in the
accounts leading to preparation books of accounts.
of financial statements.
2. Nature It is concerned with finalization It is concerned with establishment
of accounts. of reliability of financial
statements.

3. Objects Accounting commences when Auditing begins when accounting

book keeping ends. ends.
4. Commencement It involves various financial It depends upon the agreement or
statements. It involves upon the provisions of law.
maintenance of books of
accounts.
5. Scope It does not go beyond books of It goes beyond books of accounts.
accounts.
c. Reasonable assurance and limited assurance (5 Marks December 2016)

Answer:
Reasonable Assurance and Limited Assurance
Reasonable Assurance is a concept relating to the accumulation of the audit evidence necessary for
the auditor to conclude that there are no material misstatements in the financial statements taken as a
whole. An audit in accordance with Nepal Standards on Auditing is designed to provide reasonable
assurance that the financial statements taken as a whole are free from material misstatement. Audit
cannot give an absolute assurance due to certain inherent limitations that affect the ability of detect
material misstatement which may arise generally due to use of testing, limitation of accounting and
control system and mostly due to the fact that audit evidence is persuasive rather than conclusive.
The objective of a reasonable assurance engagement is a reduction in assurance engagement risk to
an acceptably low level in the circumstances of the engagement as the basis for a positive form of
expression of the practitioner‟s conclusion. In other words, the practitioner expresses conclusion in
the positive form.
The objective of a limited assurance engagement is a reduction in assurance engagement risk to a

level that is acceptable in the circumstances of the engagement, but where that risk is greater than for
a reasonable assurance engagement, as the basis for a negative form of expression of the
practitioner‟s conclusion. In other words, the practitioner expresses conclusion in the negative form.
Question No 37
Distinguish between: (5 Marks- June 2019)
Audit and Investigation
Answer:
Audit Investigation
Description Auditing is the independent Investigation means an inquiry,

examination of financial information of or is the act of detail
any entity, whether profit oriented or examination of activities so as
not, and irrespective of its size or legal to achieve certain objectives.

form, when such an examination is

conducted with a view to expressing an
opinion thereon
Owners Audit is conducted for accountability Investigation may be conducted

purposes on behalf of owners who either by owner of the
make the appointment. undertaking or by an outsider.
Purpose To determine the true and fair view. Varies from business to
business
Process Routine process Investigation is not a regular

process
Scope It includes only an examination of the It covers an examination of the

accounts of a business accounts bur also covers an
inquiry into other matter that
are connected with the purpose
for which it is undertaken
Employees Does not examine personally May examine personally
Person Audit is to be conducted by a chartered Investigation may be taking on

performing accountant or person recognized by even by a non-chartered
work regulatory body. accountant
Legal Audit is mandatory under law There are no such legal

Obligations obligations with regard to
investigation

Chapter 2 Regulatory and Ethical Issues
Question No 1
Comment and give your observations on the following:
a. Mr. A, who was appointed the auditor of the Company in its Annual General Meeting, resigned
before the completion of his term of appointment. The casual vacancy thus created was filled in
by the Board of Directors. (5 Marks, June 2001)
b. UFO & Co. Chartered Accountants were appointed as the first auditors of newly formed public
limited company, APC Ltd. The terms of UFO & Co. have expired and APC Ltd. now proposes to
appoint new auditors due to difference of opinion with UFO & Co. without giving a special
notice. (4
Marks, June 2001
a. Answer
As per Sec. 113 of Companies Act 2063, Where the annual general meeting of a company fails to
appoint an auditor for any reason or where the annual general meeting itself cannot be held or
where the auditor appointed pursuant to this Act ceases to continue his/her office for any reason,
the Office may, at the request of the board of directors of the company, appoint another auditor.
Hence, the appointment by BOD is not valid.
b. Answer
As per Sec 119 (2) of Companies Act 2063, if any auditor breaches the code of conduct of auditors
or does any act against the interest of the company which has appointed him as the auditor or
commits any act contrary to the prevailing law, such auditor may be removed through the same
process whereby he/she was appointed as auditor, by giving prior information to the Nepal
Chartered Accountants Institute, and with the approval of the regulatory authority, if any authorized
by the prevailing law for the regulation of business of the company concerned , and failing such
authority, with the approval of the Office. While removing an auditor, the auditor shall be provided
with a reasonable opportunity to defend him/herself. (The provision of Special Notice is not
mentioned in Companies Act 2063)
Question 2
State your views on the following:
a. "The auditor can always exercise lien on books and documents of his client for non-payment of
fees due to him." (6 Marks, June 2001)

b. All-in-One Limited in general meeting authorized its Board of Directors to fill up the vacancy in
the office of auditor, which was caused by the resignation of an auditor.
(6 Marks, June 2001)
c. Some of the shareholders of RNP Limited have written letters to auditor of the company
demanding copies of audit report for their perusal and further action. The auditor is in no mood
to oblige the shareholders. (6 Marks, June 2001)
a. Answer
As per general law any person having lawful possession of property of same other person may
retain the property for non-payment of fees due to him on account of the work done by him on
such property. The Institute of Chartered Accountants of England and Wales has upheld the
auditor's right of lien on books and documents if the following conditions are fulfilled:
(i) Documents retained must belong to the client;
(ii) The documents must have come to the possession of the auditor and the authority of the
client;
(iii) The auditor has done some work on such documents for a fee but such fee was not paid
to him.
(iv) Only such of the documents on which work was done or in connection with which
work was done can be retained for non-payment of fees.
However, in the case of companies under section 2063 of the companies Act, books of accounts
and records should be kept at the registered office or at such other place upon a resolution of the
Board of Directors being passed, ultimatum where of is given to the Registrar of Companies.
Further if the books of the company are retained by the auditor, he must provide facility for
inspection by the directors and others authorized under the Act. Taking into account these
restrictions it may be said that it is mostly impractical for the auditor to exercise the right of lien
in the case of company books and records. His working papers being his own property, the
question of lien as then does not arise.
b. Answer
Casual vacancy arising in the office of auditor on account of resignation of an auditor cannot be
filled up by the Board of Directors. Only the company in general meeting shall fill up the vacancy
caused by resignation of the auditor. The power cannot be delegated to the Board of Directors, the
appointment by the Directors is not valid. As per Sec 113 of Companies Act 2063 Where the
annual general meeting of a company fails to appoint an auditor for any reason or where the
annual general meeting itself cannot be held or where the auditor appointed pursuant to this Act
ceases to continue his/her office for any reason, the Office may, at the request of the board of
directors of the company, appoint another auditor.
c. Answer
It is no part of the duty of the auditor to send a copy of his report or to allow inspection thereof by
each member of the company individually or to see that the report is read before the company in
general meeting. The duty of the auditor is confirmed only to forwarding his report on the

accounts to the secretary of the company. It will be for the secretary or the Directors to convene
the general meeting and send the financial statements and the Auditor's report to members or
others entitled to receive it.
The action of the auditor is not obliging the shareholders is perfectly held in law.
Question No 3
ABC Ltd. has made loans to (i) X, who is a Director of the Company, (ii) Y and Co. in which Y a
relative of X, is a partner and (iii) LM Private Ltd., which is the subsidiary of ABC Ltd.
Discuss briefly your duties as the Statutory Auditor of ABC Ltd (6Marks, December 2001)
Answer
As per sec 101 of the Companies Act 2063, No company shall make any loan or provide any
financial assistance to its officer, substantial shareholders or officer, shareholder of a holding
company or a close relative of such person nor shall it give any guarantee or provide security in
respect of any loan borrowed by such officer or shareholder or close relative from any other person.
Provided, however, that this provision shall not apply to any loan or facility to be made or provided to
any employee of a company in accordance with the rules of the company or to any loan made or
guarantee given by any bank or financial institution in the ordinary course of business transaction,
except as prohibited by the prevailing law. Therefore, the auditor has the following responsibilities:
 In case of loan to Director, the Auditor has to report regarding the non-compliance with the
Companies Act.
 In case of loan to Y & Co, the Auditor has to report regarding the non-compliance with the
Companies Act and also impact of Related Party Disclosures.
 There being however no prohibition against a public company making loans to its
subsidiary.
Question No 4
Discuss the validity of the appointment of the auditor in under mentioned case and give reasons for
the same. (5 Marks each, June 2002)
a. M/s AB& Co. were the Statutory Auditors of M/s MNP & Co. Ltd. for last several years. Board of
Directors were not happy with the services rendered by M/s AB & Co. Hence, they appointed M/s
CD & Co. as Statutory auditors by passing a Special resolution in the board meeting.
b. M/s P. Ltd. was incorporated on 1st April 2001. The Board of Directors of M/s P. Ltd appointed
M/s MSP & Co. as auditors within one month of its date of incorporation. The shareholders
objected to the appointment of M/s MSP & Co. as auditors and wish to remove M/s MSP & Co.
before the conclusion of the annual General Meeting.

c. Mr. X a Chartered Accountant was in full time employment with M/s YZ Ltd. Subsequently Mr. X
was appointed as auditor of PQ Pvt. Ltd. for the year 2002-2003 by the board of Directors.
d. 60% of the paid-up Capital of M/s UM Ltd. is held by the Central Government M/s XYZ & Co.
firm of Chartered Accountants were appointed as statutory Auditors of M/s UM Ltd. by passing
an ordinary resolution in the Annual General Meeting
a. Answer
As per Sec 119(2) of Companies Act 2063, if any auditor breaches the code of conduct of
auditors or does any act against the interest of the company which has appointed him as the
auditor or commits any act contrary to the prevailing law, such auditor may be removed
through the same process whereby he/she was appointed as auditor, by giving prior information
to the Nepal Chartered Accountants Institute, and with the approval of the regulatory authority,
if any authorized by the prevailing law for the regulation business of the company concerned ,
and failing such authority, with the approval of the Office. Therefore, action of BOD is not
appropriate.
b. Answer
As per Sec 111(1) of the Companies Act 2063, The auditor of accompany shall be appointed,
from amongst the auditors licensed to carry out audit under the prevailing law, by the general
meeting, in the case of a public company, and, in accordance with the provision as contained in
the memorandum of association, articles of association or consensus agreement, any failing
such provision, by the general meeting, in the case of a private company; and his/her name
shall be forwarded to the Office within fifteen days from the date of such appointment.
Provided, however, that the board of directors may appoint the auditor prior to the holding of
the first annual general meeting. Therefore, contention of Shareholders is not correct.
c. Answer
The auditor has to consider self-review threat if he was in employment with the company
immediately before the appointment as an auditor. The independence of the auditor may be
affected. Hence, necessary safeguards are to be applied and since 3 years have not elapsed the
auditor is suggested to not to accept the appointment.
d. Answer
As per Sec. 11 of Audit Act 2075, the Auditor General shall be consulted while appointing an
auditor for auditing of the corporate bodies substantially owned by Government of Nepal.
Accordingly, the auditor of company substantially owned by Government of Nepal shall be
appointed or re-appointed by advice of the Office of Auditor General.
Question No 5
Discuss the validity of appointment of auditors in the under mentioned case:

a. Mr. Y Chartered Accountant was appointed on the auditor of X Ltd. at the general meeting. Mr.
Y declined to accept the appointment since the remuneration fixed by the general meeting was
less than the proposed by Mr. Y. On Y declining to accept appointment, Board of Directors of X
Ltd. appointed Z & Co. as its auditor. (4 Marks, December 2003)
b. The shareholding pattern of R Ltd. was as follows:
Central Government 10%

Financial Institution in which state Government
holds 20% of the subscribed capital 25%
Y Ltd. (Government Company) 10%
The Annual General Meeting Appointed M/S S & Co. Chartered Accountants on the auditor for
the year 2003-04 by passing ordinary resolution. (4 Marks, December 2003)
c. Mr. Y a Chartered Accountant mentioned that he is holding the office of statutory auditor in 12
public companies, 6 Corporations and 2 foreign companies. X Ltd. a public company having paid
up share capital of Rs. 26 lacs, appointed Mr. Y as its statutory auditor as the limit specified by
the Company Act does not exceed. (4 Marks, December 2003)
a) Answer
As per Sec 113 of Companies Act 2063,
Where the annual general meeting of a company fails to appoint an auditor for any reason or
where the annual general meeting itself cannot be held or where the auditor appointed
pursuant to this Act ceases to continue his/her office for any reason, the Office may, at the
request of the board of directors of the company, appoint another auditor. Therefore, the direct
appointment by Board of Directors in not valid.
b) Answer
The answer is given in context of Audit Act 2075. As per Sec 10 of Audit Act 2075, the audit
of entity fully owned by Government of Nepal, State Government or Local Government is to
be conducted by Auditor General and the auditor of entity substantially controlled by central,
state or local government is to be appointed after consultation with Auditor General.
Therefore, In the given case the provision substantial control does not apply (being less than
50% control) and the company may itself appoint the auditor by complying with the
provisions of Companies Act 2063.

c) Answer
As per the notice of ICAN , the ceiling for an auditor is 100 Audits, out of which the public
companies should not exceed 10 but the smaller entities such as proprietorship firm,
partnership firm, religious and social institutions etc., which have turnover of less than 20
lakhs does not fall in the ceiling of 100 audits.
Question No. 6
The explanatory notes which should be adopted while applying ICAN‟s code of ethics. Give your view.
4 Marks, December, 2003
Answer:
The council of the Institute of Chartered Accountants of Nepal (ICAN) has determined that this Code
should be adopted with the explanatory notes below. This code is mandatory for all members of Institute
of Chartered Accountants of Nepal to observe in respect of the performance of professional services in
Nepal after January 15, 2004 (Magh 1, 2060).
Section 8 ICAN has determined that the shares in an accounting practice may not be held by
those who are not members of the Institute of Chartered Accountants of Nepal.
Thus Sec 8.11 of IFAC guideline has been suitably adopted.
Section 14 ICAN has determined that the professional accountants are not permitted to
advertise their services. Thus Sec. 14 of IFAC guideline has been suitably adopted.
Question No 7
What are the powers of auditors? (4 Marks, June 2004)
Answer:
i. Right to access to books, etc.- The auditor of a company, at all times, has the right of access
the books of accounts and voucher of the company whether kept at the head office or elsewhere
and he is entitled to obtain such information and explanations as he thinks necessary, for the
performance of his duties as auditor.
ii. Right to require information and explanation from officers:
This right of the auditor to obtain such information and explanation as he may think necessary
for the performance of his duties as auditor is wide and important power. In the absence of such
power, the auditor would not be able to obtain details of amount collected by the directors etc.
from any other company, firm or person as well as of as of any benefits in kind derived by the
directors from the company, which may not be known from examination of the books. It is for
the auditor to decide the matters in respect of which information and explanation are required

by him. When the auditor is not provided the information required by him or is denied access to
books etc., his only remedy would be to report that he could not obtain all the information and
explanations he had required or considered necessary for the performance of his duties as
auditors.
iii. Right to attend general meeting

The auditors of a company are entitled to attend any general meeting of the company, also to
receive all the notices and other communications relating to the general meetings, which
member are entitled to receive and to be heard at any part of the business of the meeting which
concerns them as auditors. The right of the auditor to attend any general meeting and to be head
there is only permissive.
Question No 8
Give your views on the following issues:
a) The 15th AGM of Sagarmatha Gems (P) Ltd. (SGPL) held on 15 Magh 2060 appointed Hari
Krishna Neupane FCA, sole proprietor of KKN & Co., as statutory auditor for FY 2060/. H.K.
Neupane immigrated to Los Angeles, USA on 15 Baisakh 2061 on diversity visa. Before his
departure to USA, HK Neupane converted his sole proprietorship firm into partnership firm by
admitting Shyam Prasad Chattaroy as a partner of the newly registered firm HKN &Co. The SGPL
did not allow S.P Chattaroy to audit the books of accounts of the company stating that the firm was
not appointed as auditors of the company by the AGM. (5 Marks, December 2004)
Answer
The AGM of Sagarmatha Gems (P) Ltd. (SGPL) had appointed Hari Krishna Neupane FCA, sole
proprietor of HKN & Co. as the statutory auditor for FY 2060/61. HK Neupane converted his sole
proprietorship firm HKN & Co. into a partnership firm with the same name taking SP Chattaroy FCA as
his partner, before his immigration to the Los Angeles, USA, with the objectives of retaining the audit.
As SGPL had appointed HK Neupane as the sole practitioner and not as partner of the newly registered
firm HKN & Co. the company has every right or refuse audit by the partnership firm not appointed as
auditors by the AGM. It would, therefore, be proper for HK Neupane to refuse the audit stating his
inability to carry out the audit in view of his intention to immigrate to the USA on diversity visa.
b) M.P. Bhattarai FCA, a sole practitioner, met with an accident and fractured his right wrist which
had to be put in the plaster cast. Due to his inability to write by his hand, he authorized his
employee Shyam Prasad Gautam CA to sign the audit report on his behalf so as not to delay
certification of financial statements of his clients. 5 Marks December 2004)
Answer
Only a member holding certificate of practice or partner of a firm with certificate of practice (with all
member of the firm also holding certificate of practice) can certify audited financial statements of the
client entity and issue audit report in his name or on behalf of the firm. Authority to certify financial
statements and issue audit report cannot be delegated to an employee under any circumstances. In the

given case, M.P. Bhattarai FCA, a sole practitioner, cannot authorize his employee S.P. Gautam, a
Chartered accountant, to sigh the audit report despite his physical disability.
c) The term of C & Co. as an auditor of CTZ Co. was up to FY 2059/60, and the co. did not appoint a
new auditor in the annual general meeting, held on Poush 30, 2060. (5 Marks December 2004)
Answer
As per Sec 111(1) of the Companies Act 2063, The auditor of accompany shall be appointed, from
amongst the auditors licensed to carry out audit under the prevailing law, by the general meeting, subject
to Chapter-18, in the case of a public company, and, in accordance with the provision as
contained in the memorandum of association, articles of association or consensus agreement, any failing
such provision, by the general meeting, in the case of a private company; and his/her name shall be
forwarded to the Office within fifteen days from the date of such appointment.
Provided, however, that the board of directors may appoint the auditor prior to the holding of the first
annual general meeting. Therefore, the Auditor shall be appointed by the Office of Company Registrar
only.
Question No 9
Explain on disqualifications for appointment of auditors of a company? (4 Marks, December 2004)
Answer: As per Sec 112(1) of Companies Act 2063,
None of the following persons or the firms or companies in which such persons are partners shall be
qualified for appointment as auditor and shall, despite appointment as
auditor, continue to hold office:
(a) A director, advisor appointed with entitlement to regular remuneration or cash benefit, a person
or employee or worker involved in the management of the company or a partner of any of them or
an employee of any of such partners or a close relative of a director or partner, out of them, or an
employee of such relative;
(b) A debtor who has borrowed moneys from the company in any manner, or a person who has
failed to pay any dues payable to the company within the time limit and is in such arrears or close
relative of such person;
(c) A person who has been sentenced to punishment for an offense pertaining to audit and a period
of five years has not elapsed thereafter;
(d) A person who has been declared insolvent;
(e) A substantial shareholder of the company or a shareholder holding one percent or more of the
paid-up capital of the company or his close relative;
(f) A person who has been sentenced to punishment for an offense of corruption, fraud or a criminal
offense involving moral turpitude and a period of five years has not elapsed thereafter;

(g) A person referred to in Sub-section (3) of Section 111;

(h) In the case of a public company , any person who works, whether full time or part time , for any
governmental body or anybody owned fully or partly by the Government of Nepal or any other
company or a partner of such person or a person who is working as an employee of such partner
or a person who is authorized to sign any documents or reports to be prepared by the management
of the company;
(i) A company or corporate body with limited liability;
(j) A person having interest in any transaction with the company or his/her close relative or a
director, officer or substantial shareholder of another company having any interest in any
transaction with the company.
Question No 10
Explain the provision for appointment of first auditor of the company. (2 Marks, December 2004)
Answer
As per Sec 111(1), The auditor of accompany shall be appointed, from amongst the auditors licensed to
carry out audit under the prevailing law, by the general meeting, subject to Chapter-18 ,in the case of a
public company, and, in accordance with the provision as contained in the memorandum of association,
articles of association or consensus agreement, any failing such provision, by the general meeting, in the
case of a private company; and his/her name shall be forwarded to the Office within fifteen days from the
date of such appointment.
Provided, however, that the board of directors may appoint the auditor prior to the holding of the first
annual general meeting. Therefore, First Auditor is appointed Board of Directors.
Question No 11
Comment on the following situation: (4 Marks each, June 2005)
a) The Annual General Meeting of the M/s J.J Pharmaceutical Ltd. was held recently. At the Annual
General Meeting, a resolution was passed by the entire body of shareholders restricting some
powers of the statutory Auditors.
Answer:
Restriction of Powers of Statutory Auditors:
An auditor of a company shall have right of access at all the times to the books of accounts and vouchers
of the company whether kept at the a Head Office or other places and shall be entitled to require from the
offices of the company such information and explanations as the auditor may think necessary for the
purpose of his audit. These specific rights have been conferred by the Statute on the auditor to enable him

to carry out his duties and responsibilities prescribed under the Act, which cannot be restricted or
abridged in any manner. Hence any such resolution even if passed by entire body of shareholders is ultra
vires and therefore void. Any regulations, which preclude the auditors form availing themselves of all
information to which they are entitled under the Companies Act, are inconsistent with the Act.
b) Mr. Ram Narayan, FCA is a director in finance company M/s Sun Gabha Finance Company Ltd.
He is also partner in a firm of Chartered Accountants, M/s Ram Laxman& Co. Mr. Laxman Aryal,
FCA is also a partner of that firm. He is also a proprietor of M/s Laxman& Co., Chartered
Accountants. If M/s Sun Gabha Finance Company Ltd. wants its account audited by:
i. M/s Ram Laxman& Co. and
ii. Mr. Laxman Aryal, FCA under his proprietorship firm M/s Laxman
& Co., Chartered Accountants.
Answer.
A firm of chartered accountants in which a director is a partner cannot be appointed as auditors of the
company. Similarly, any partner of such firm is also disqualified for such appointment. Therefore, (i) M/s
Ram Laxman& Co. or (ii) Mr. Laxman Aryal in his individual capacity cannot be appointed as auditor/s
of M/s Sun Gabha Finance Company Ltd.
c) M/s ABC & Co., Chartered Accountants, were appointed as the first auditors of Manakamana Bank
Ltd. by the Board of Directors.
Answer:
As per Section 86 of Company Act 2053, Auditors of a public ltd. company shall be appointed by the
General Meeting of the members. However, if an auditor needs to be appointed before the first general
meeting, the board can appoint an auditor to audit the books of account. Hence, appointment of M/S ABC
& Co., chartered accountants as first auditor of the bank by the board would be valid only
If there has been no general meeting was held already. The tenure of the first auditor will hold valid till
next annual general meeting.
Question No. 12
Auditor‟s professional responsibilities are governed by basic principles. Comment.

OR (5 Marks December 2005)
Compliance with the basic principles requires the application of auditing procedures and reporting
practices appropriate to the particular circumstances. (8 Marks, June 2006)
Answer:
Basic principle are those principles, which govern the auditor‟s professional responsibilities and same
should be complied with whenever an audit is carried out.

i. Integrity, Objectivity and Independence

The auditor should be straight forward, honest and sincere in his approach to his professional
work. He should maintain an impartial attitude and both be and appear to be free of any
interest, which might be regarded, whatever is actual effect, as being incompatible with
integrity and objectivity.
ii. Confidentiality
The auditor should respect the confidentiality of information acquired in the course of his
work and should not use or disclose any such information to third party without specific
authority or unless there is a legal or professional right or duty to disclose.
iii. Skills and Competence

The auditor should perform and report prepared with due professional care by persons who
have adequate training, experience and competence in auditing. The auditor requires
specialized skills and competence along with a continuing awareness of developments of
accounting and auditing matters and relevant regulations and statutory requirements.
iv. Work performed by others

When the auditor delegates work to assistants or uses work performed by other auditors and
experts, he continues to be responsible for forming and expressing his opinion on the financial
information. However, he will be entitled to rely on work performed by others, provided he
exercises adequate skill and care and is not aware of any reason to believe that he should not
have so relied.
v. Documentation
The auditor should document matters, which are important in providing evidence that the
audit carried out in accordance with the basic principles.
vi. Planning
The auditor should plan his work to enable him to conduct an effective audit in an efficient
and timely manner. Plants should be based on a knowledge of the client‟s business.
vii. Audit evidence.

The auditor should obtain sufficient appropriate audit evidence through the performance of
compliance and substantive procedures to enable him to draw reasonable conclusions there
from on which to base his opinion on the financial information.
viii. Accounting system and Internal Control

The auditor should gain an understanding of the accounting system and related controls and
should study and evaluate the operations of those internal controls upon, which he wishes to
rely in determining the nature, timing and extent of other audit procedures.

ix. Audit conclusion and reporting.

The auditor should review and assess the conclusions drawn from the audit evidence obtained
and from his knowledge of business of the entity as the basis for the expression of his opinion
on the financial information. The audit report should contain a clear written opinion on the
financial information and should comply the legal requirements. When a qualified opinion,
adverse opinion or a disclaimer of opinion is to be given or reservation of opinion on any
matter is to be made, the audit report should state the reason therefore.
As per Handbook of Code of Ethics for Professional Accountants issued by ICAN, A professional
accountant shall comply with the following fundamental principles:
a) Integrity – to be straightforward and honest in all professional and business relationships
b) Objectivity – to not allow bias, conflict of interest or undue influence of others to override
professional or business judgments.
c) Professional Competence and Due Care – to maintain professional knowledge and skill at the
level required to ensure that a client or employer receives competent professional service based
on current developments in practice, legislation and techniques and act diligently and in
accordance with applicable technical and professional standards.
d) Confidentiality – to respect the confidentiality of information acquired as a result of professional
and business relationships and, therefore, not disclose any such information to third parties
without proper and specific authority, unless there is a legal or professional right or duty to
disclose, nor use the information for the personal advantage of the professional accountant or
third parties.
e) `Professional Behavior – to comply with relevant laws and regulations and avoid any action that
discredits the profession
Question No 13
Give your opinion on the following issues:
a) Your spouse is a director in a public limited company. You receive an offer of appointment from
the company to audit its annual financial statements. What considerations would you have in mind
in deciding whether to accept or not to accept the offer. (5 Marks,
June 2006)
Answer Hint:
As per Sec 112 (e) A substantial shareholder of the company or a shareholder holding one percent or
more of the paid-up capital of the company or his close relative is disqualified to act as an auditor,
also the independence would be affected being a familiarity threat, So I would not accept the
appointment.
b) Mr. Ram Sundar a Chartered Accountant, is tax consultant of ABC Ltd. for the current fiscal year.
For this purpose, he has to attend the company from 9 a.m. to 3 p.m. and is paid monthly

remuneration of Rs. 50,000. ABC Ltd. intends to appoint Mr. Ram Sundar as its statutory auditor
at the annual general meeting. (5 Marks, June 2006)
Answer Hint:
Though, Mr. Ram Sundar is appointed as Tax consultant for the current year, he has to attend
company on regular basis as an employee. So, as being employee of the company, he disqualifies to
be appointed as a statutory auditor of the company.
c) In case of M/s XY Company Ltd., which is partly owned by the Government of Nepal, 50% final
dividend was declared on its paid-up capital of Rs. 1,00,00,00,000 by the Board of Directors. Such
dividend was distributed to its shareholders. Comment on above in line with the provisions of
Company Ordinance, 2062. (5Marks, each December 2006)
Answer:
As per provisions of the law, the final dividend of a company shall be declared only by the shareholders
in the general meeting based on the recommendation of Board of Directors. Under Sec 182 (2), the
company owned by Nepal Government fully or partly can distribute dividend only after prior approval of
Government of Nepal. Nepal Government may issue necessary directive for the distribution of dividend
by such company.
The Board of directors can only propose the dividend, which shall become final only after approval by
shareholders at the AGM. The Board is empowered to declare the interim dividend only.
Hence, in the given case, the action of M/s XY Ltd.'s board of directors is not in accordance with the
law and the auditor should qualify his report to this effect.
Question No 14
State the provisions of the Company Ordinance, relating to: (5 Marks, June 2006)
 Appointment of first auditor.

 Appointment of auditors at annual general meeting.
 Appointment of auditors in case of casual vacancy.
 Change an auditor other than the first auditor before the expiry of his term.
Answer:
 As per section 111 of Companies Act 2063, the Board of Directors should appoint first auditor.
 As per section 111 of Companies Act 2063, auditor of the company should be appointed at annual
general meeting. However, auditor of private limited company can be appointed as prescribed in
MOA, AOA or consensus agreement.
 As per section 113 of Companies Act 2063, Company Registrar Office shall appoint auditor upon
the request by the Board of Directors of the company to fill in casual vacancy.

 As per sub-section 119 of Company Act 2063, auditor may be removed by giving prior
information to Nepal Chartered Accountants Institute and obtaining approval from the regulatory
authority regulating the business of the company if there exists such an authority, and in the
absence of such an authority, with approval of the office by adopting the same procedure with
which he was appointed, if such an auditor breaches the code of conduct of an auditor or acts
against the interest of the company appointing him as an auditor or commits any act against the
law in force.
Question No 15
Briefly explain the power of auditors under the Company Act. (5 Marks, June 2006)
Answer:
 Right of access to books of accounts
The auditor of the company, at all times, has the right of access to the books and accounts and
voucher of the company whether kept at the head office or elsewhere and he is entitled to obtain
from the offers of the company such information and explanations as he thinks necessary, for the
performance of his duties as auditor.
 Right to acquire information and explanation from officers

This right of the auditor to obtain from the officer of the company such information and
explanations as he may think necessary for the performance of his duties as auditor is a wide and
important power. It is for the auditor to decide the matters in respect of which information and
explanations are required by him. When the auditor is not provided the information required by
him or is denied access to books; etc. his only remedy would be to report to the members that he
could not obtain all the information and explanations he had required or considered necessary for
the performance of his duties as auditors.
 Right to attend general meeting

The auditors of a company are entitled to attend any general meeting of the company; also to
receive all the notices and other communications relating to the general meetings, which members
are entitled to receive and to be heard at any general meeting in any part of the business of the
meeting which concerns them as auditors.
Question No 16
"A company auditor can exercise his rights to the extent not restricted by the terms and conditions of
appointment." Comment. 6 Marks, June 2006
Answer
To enable the auditor to discharge his duties effectively, the Act gives him certain rights. An auditor has
the right of access to the books and vouchers of the company. He is also entitled to seek information and

explanations from the officers of the company. He has the right to receive notices and other
communications pertaining to all general meetings of the company and to attend any general meeting.
These rights enable the auditor to carry out his duty of reporting to the members of the company on the
financial statements examined by him.
The rights of the company auditor cannot be limited or abridged in any way. Any resolution limiting the
powers of the auditor or any such provision in the Article of Association will be void. Similarly, any
terms and condition of appointment limiting the powers of the auditor given by the Act will also be void.
Thus, the auditor can exercise his rights to the extent given by the Act.
Question No 17
As an auditor, comment on the following situations in line with Companies Act, 2063.
a) In case of reappointment of existing auditor at the Annual General Meeting, the auditor refused
to accept appointment. State whether the Board of Directors could fill up the vacancy.
(5 Marks, December 2006)
Answer:
The appointment of an auditor is complete only on the acceptance of the office by the auditor.
Therefore, it can be deemed that in case an auditor refuses to accept the appointment then in that
case no auditor has been appointed. In such situation, the Company Registrar Office at the request
of the board of directors may appoint another audit under Sec 113 of the Companies Act 2063.
Therefore, Board of Directors could not appoint the auditor in such case directly.
b) The Chief Accountant of M/s Apex Manufacturing Ltd. is of the opinion that there is insufficient
profit in the current year to declare dividend after setting of the accumulated losses of previous
years. The company is considering to declare dividend without setting off the accumulated losses
of the previous years from the current year profit. The company also plans to set off such
accumulated losses against existing revaluation reserve. Give your comment as an auditor of M/s
Apex Manufacturing Ltd. (5 Marks, December 2006)
Answer:
As per section 182 (6) of the Companies Act 2063, the company is required to set off fully the pre-
operating expenses, depreciation as per the recognized accounting standards, any other payments that are
required to be segregated and the accumulated losses of the previous years prior to payment or
distribution of dividend from profit of the company.
In view of above provision, the amount of accumulated loss of previous years should be set off fully
against current revenue profit before payment or distribution of dividend.
Since, mere revaluation of assets does not result in realized gain, and thus, as per the sound accounting
practice, the accumulated losses should not be adjusted against revaluation reserve because this would
amount to setting off actual losses against unrealized gains. Therefore, if the accumulated loss is set off
against revaluation reserve, and then dividend is declared from out of revenue profits, it would amount to

payment of dividend out of capital without making good the amount of accumulated loss. Hence the
opinion of Chief Accountant of M/s Apex Manufacturing Ltd. is not correct.
Question No. 18
Express your views as an auditor in the following case: (5 Marks, June 2007)
You are the auditor of Honey Enterprise as well as Money Enterprise. Both of the clients are garment
industries. You came to know that in the previous year one of your audit trainees was paid Rs. 5,000
by Money Enterprise for providing some sales related information of Honey Enterprise.
Answer
As per the ethical principles governing an auditor‟s professional responsibility cited in Code of Ethics,
the auditor should maintain „Confidentiality‟ on information, which comes to the knowledge of the
auditor during the course of audit. The information should not be shared with others, other than the client
or as required by the law of the land. In the cited case the information was provided to a competitor,
which is against the basic principles of governing an audit. Therefore, the auditor should initiate action
against the Audit Trainee. The auditor should also make necessary arrangements for checking these types
of unethical activities to ensure confidentiality of information gained during the course of audit.
Question No 19
Describe the process for appointing auditor of a company by the Registrar of Company.
Answer
According to section 113 of the Company Act, 2063 on request of the Board of Directors, the Office of
the Company Registrar may appoint auditor in following cases:
 If the auditor is not appointed in Annual General Meeting of a company, or Annual General
Meeting could not be held, or
 The auditor appointed under the Company Act cannot continue due to whatever reason,
In view of above, if any of the situations prevails, Board of Directors may request to appoint an
auditor to the Office of the Company Registrar. The Office of the Company Registrar may
appoint an auditor on receiving such request.
Question No 20
Explain the provisions of Audit Committee as per the Company Act 2063.
(5 Marks, December, 2007)

Answer
As per the Section 164 of the Companies Act 2063, a listed company having paid up capital of Rs. 30
Million or more and the companies fully or partially owned by Nepal Government should constitute an
audit committee with the chairmanship of a non-executive director and with minimum of 3 members.
Further, no person defined as close relative of the chief executive of the company is eligible to be a
member of the committee. The committee should have at least one member having professional
qualification in accounting with experience or having minimum of Bachelor Degree education in
accounting, management, commerce, finance or in economics with experience in accounting and finance.
Main functions of an audit committee are:
 Review of the financial statements of the company
 Enforcement and the review of the company‟s financial management and control systems
 Supervision and review of activities relating to internal auditing of the company
 Formulating the policy regarding the short listing and appointment of auditors in line with
legal requirement
 Recommendation of possible names for the appointment of statutory auditor of the company
with terms and conditions at the AGM
 Supervision and review of the Auditor‟s compliances of professional ethics, relevant
standards and legally binding directives
 Determining the policy regarding the accounts of the company.
 Ensuring the legal compliances as to detailed reports (e.g. Long Form Audit Report) to be
included with the Audit Reports
Question 21
Express your opinion in the following cases: (5 Marks each December 2007)
a) M/s ABC Company Ltd. re-valued its assets to match up it‟s huge accumulated loss. The
company wants to increase its share capital by using the revaluation reserve.
b) Mrs. Rukmani Sharma is a shareholder of M/s Real Company Ltd. holding 2% of paid up
share capital of the company. The company wants to appoint Mrs. Rukmani‟s spouse Mr.
Janardhan Sharma, a Chartered Accountant in practice, as the auditor of the company for the
year 2064/65.
c) M/s Sunshine Co. Ltd. has decided to change inventory valuation method from LIFO to FIFO
from the year 2063/064. What will be your recommendation as a statutory auditor in above
regard?
d) M/s Durga Bhawani Hydro Power Company Limited has 8 Board members. The company
seeks your view with regards to appointment of additional Board member as per requirement of
Company Act, 2063.

Answer
a) Revaluation reserves created out of revaluation of assets are not distributable profit Section
56(10) of Companies Act, 2063 debars such reserve to be distributed as bonus shares or to be
capitalized as shares. Hence company cannot increase share capital by using the revaluation
reserve.
b) As per section 112(e) of Companies Act, 2063 any shareholder or his/her close relative having
shares of 1 % or more of the paid-up capital of the company is disqualified to be appointed by the
auditor of that company. In the given case, Mrs. Rukmani Sharma is the shareholder of M/s Real
Company Ltd. holding 2% of paid up share capital of the company i.e. more than 1 % of paid up
capital of the company. Her spouse, Mr. Janardhan Sharma being the close relative within the
definition of the Act is thus not qualified for the appointment as the auditor of M/s Real Company
Ltd.
c) The presentation and classification of items in the financial statements should be retained from
one period to the next unless the change will result in a more appropriate presentation or is
required by the Nepal Accounting Standard. If the inventory valuation method has been changed
due to the above reason, M/s ABC & Co. should reclassify its comparative information in
accordance with of Nepal Accounting Standard -1, "Presentation of Financial Statements" and
disclose accordingly. However, if the reclassification is not possible, the reason should be
disclosed.
d) Section 86 of the Companies Act, 2063, has provision regarding appointment of members of
Board of Director. The public company which has more than seven Board members, should
appoint at least two independent having knowledge of the business of the Company as Board
members. This limit is restricted to at least one Board member by the public Company which has
Board members up to seven. In this case, Durga Bhawani Hydro Power Company Limited should
appoint at least two independent Board members as per provision of section86(3) of the
Companies Act 2063.
Question No 22
Express your opinion in the following cases: (5×2=10 Marks June 2008)
a) Mr. Balaram Sharma is a retired employee of a company. The company provided him 7 years
pension in lump sum and deducted TDS on whole amount in the year of receipt on the ground
that remuneration income is liable for tax on cash basis. As a tax consultant, you are required
to judge whether the action of the company to deduct TDS on whole amount in the year of
receipt is justifiable?

b) Directors of M/s MN Company Ltd. were paid 5% of company‟s profit before tax during the
year as profit incentive and showed the distributed amount in the accounts as promotional
expenses. Comment in line with the provisions of Company Act 2063.
Answers
a) The income from remuneration is liable for tax on cash basis as per Section 22 of the Income Tax
Act 2058. Pension is the income from remuneration as defined by Section 8 of the same Act.
Based on this, pension received by Mr. Balaram Sharma is liable for TDS on whole amount at the
time of receipt. However, Section 3 of the Income Tax Act deals with the imposing tax on
income. As per this section, Income Tax is imposed on yearly basis of income. Supreme court on
the issue of Past employees of Nepal Rastra Bank vide case no. 2677, decided on 2064/04/23 that
Income Tax on pension income should be calculated on yearly basis. Thus, action of the company
to deduct TDS on whole amount in the year of receipt is not justifiable.
b) As per Section 91 of the Company Act, 2063 the full-time working directors of a company can be
paid a maximum of 3% of profit after tax as incentive through a special resolution at the Annual
General Meeting of the company. As per the Act any amount paid in excess of 3 % of profit after
tax is recoverable from the directors. Further, such distribution is an appropriation of profit and
the amount is not allowed as deductible expenses for income tax calculation.
In the given case, the directors were paid 5% of company‟s profit before tax and shown as
expenses deductible for income tax purpose. Now, the company has to re-calculate the maximum
amount of money that can be paid to the directors after adjustment of income tax figures. The
excess amount paid should be recovered from the directors.
Question No. 23
Independence of auditor (4 Marks June 2008)
The audit is governed by certain principles and ethics.

When an auditor expresses his opinion on the financial statements, the financial decisions of the users of
the financial statements are at stake. Vital financial and investment decisions are taken relying on the
auditor‟s report.
The principle of independence highlights true nature of an auditor‟s function and forms essence of an
audit.
An auditor has to form his opinion based on evidences not on any preconceived notions. An auditor‟s
opinion should not be influenced by personal prejudice or bias.

He should be or appear to be free of any interest which might be regarded whatever its actual effect, as a
barrier to his independency.
Thus, the auditor should be independent of the entity under audit both in fact and appearance that is he
should be independent in reality and other should not doubt his independence. Though there are legal
provisions and code of ethics illustrating the independency of an auditor, the underlying basic principal is
that an auditor should not have any financial and other interest or any presence or relation in the
management of the entity under audit to preserve his independency.
Question No 24
What are the additional disclosures a foreign company registered in Nepal has to include in its annual
accounts as per the Company Act 2063? (5 Marks December 2008)
Answer
As per the Section 156 of the Company Act, a foreign company registered in Nepal has to make the
following disclosures to be included in its annual accounts:
i) Detailed Statement of the company‟s assets in Nepal classified as Fixed, Current and Other
Assets
ii) A Clear statement of the company‟s bank balances with banks resident in Nepal
iii) The details of loans and overdraft taken by the company from the banks resident in Nepal
iv) Any outstanding loans or liabilities to be paid to a resident person or resident company
registered in Nepal.
Question No 25
a) Mr. A, a practicing-chartered accountant receives commission from Mr. X, another practicing
chartered accountant Rs. 50,000 being 50% of the audit fee for the referral of statutory audit of
Xerox Company Limited, a listed company. State your views. 5 Marks, June 2009
b) Mr. Nimesh, a partner of TMS & Associates, a practicing Chartered Accountant in its business
letter head prints its previous association as member Secretary to one of the reputed political
party of the country. State your views. 5 Marks, June 2009
Answer:
a) According to Section 240.5 of Code of Ethics, 2018 issued by Institute of Chartered Accountants of
Nepal, the payment or receipt of commission by a professional accountant in public practice could
impair objectivity and independence. A professional accountant in public practice, should not
therefore pay a commission to obtain a client nor should a commission be accepted for referral of a
client to a third party. The payment and receipt of commission are permitted only for the such

engagements for which independence is not required and the professional account in practice should
nonetheless disclose the facts to the client. In the above case since the above assignment requires
independence, Mr. A and Mr. X both are not complying with the ethical requirements under Code of
Ethics issued by ICAN. The disciplinary action can be taken by the Council on fulfilling the petition
requirements and after recommendation of Disciplinary Committee.
b) According to preface directives issued by ICAN related to then existing Code of Ethics of ICAN,
2060, a professional accountant in practice, should not print or write its positions not related to the
accounting profession in the name plate, identity card, visiting card, business card and business
stationeries used for the purpose of its profession. Hence, Mr. Nimesh has violated ethical
requirements under Code of Ethics issued by ICAN and hence attracts the disciplinary actions by
Council under the recommendation of Disciplinary Committee.
Question No 26
a) Mr. Shah has recently joined as Audit Partner of SSS & Co., Chartered Accountants. On
assuming the responsibility, he discovered that the firm does not have comprehensive guidelines
for “Engagement Quality Control Review”. He wants to bring this issue to the notice of Managing
Partner.
You are required to prepare discussion points for Mr. Shah explaining the
followings:
i) The basis of selecting engagements for review;

ii) Nature and timing of review; and
iii) Criteria for eligibility of engagement quality control reviewer. (10 Marks June 2009)
Answer
Discussion points with respect to the issues asked in the questions are based on the provisions of Nepal
Standards on Quality Control 1: Quality Control For Firms That Perform Audits And Reviews Of Historical
Financial Information, And Other Assurance And Related Services Engagements which requires that the
firm should establish a system of quality control designed to provide it with reasonable assurance that the
firm and its personnel comply with professional standards and regulatory and legal requirements, and that
reports issued by the firm or engagement partners are appropriate in the circumstances.
i) With respect to the basis of selecting engagements for review
The firm shall have established policies and procedures requiring, for appropriate engagements, an
engagement quality control review that provides an objective evaluation of the significant judgements
made by the engagement team and the conclusions reached in formulating the report. Such policies
and procedures shall:

 Require an engagement quality control review for all audits of financial statements of listed
entities;
 Set out criteria against which all other audits and reviews of historical financial information,
and other assurance and related services engagements should be evaluated to determine whether
an engagement quality control review should be performed; and
 Require an engagement quality control review for all engagements meeting the criteria
established in compliance with subparagraph (b).
Criteria that a firm considers when determining which engagements other than audits of financial
statements of listed entities are to be subject to an engagement quality control review include the
following:
 The nature of the engagement, including the extent to which it involves a matter of public
interest.
 The identification of unusual circumstances or risks in an engagement or class of engagements.
 Whether laws or regulations require an engagement quality control review.
ii) With respect to nature and timing of review

An engagement quality control review ordinarily involves discussion with the engagement partner, a
review of the financial statements or other subject matter information and the report, and, in
particular, consideration of whether the report is appropriate. It also involves a review of selected
working papers relating to the significant judgements the engagement team made and the conclusions
they reached. The extent of the review depends on the complexity of the engagement and the risk that
the report might not be appropriate in the circumstances. The review does not reduce the
responsibilities of the engagement partner.
An engagement quality control review for audits of financial statements of listed entities includes
considering the following:
 The engagement team‟s evaluation of the firm‟s independence in relation to the specific
engagement.
 Significant risks identified during the engagement and the responses to those risks.
 Judgements made, particularly with respect to materiality and significant risks.
 Whether appropriate consultation has taken place on matters involving differences of opinion or
other difficult or contentious matters, and the conclusions arising from those consultations.
 The significance and disposition of corrected and uncorrected misstatements identified during
the engagement.
 The matters to be communicated to management and those charged with governance and, where
applicable, other parties such as regulatory bodies.

 Whether working papers selected for review reflect the work performed in relation to the
significant judgements and support the conclusions reached.
 The appropriateness of the report to be issued.
Engagement quality control reviews for engagements other than audits of financial statements of
listed entities may, depending on the circumstances, include some or all of these considerations.
The engagement quality control reviewer conducts the review in a timely manner at appropriate
stages during the engagement so that significant matters may be promptly resolved to the reviewer‟s
satisfaction before the report is issued.
Where the engagement quality control reviewer makes recommendations that the engagement partner
does not accept and the matter is not resolved to the reviewer‟s satisfaction, the report is not issued
until the matter is resolved by following the firm‟s procedures for dealing with differences of
opinion.
iii) With respect to criteria for eligibility of engagement quality control reviewer
The firm‟s policies and procedures should address the appointment of engagement quality control
reviewers and establish their eligibility through:
 The technical qualifications required to perform the role, including the necessary experience
and authority; and
 The degree to which an engagement quality control reviewer can be consulted on the
engagement without compromising the reviewer‟s objectivity.
The firm‟s policies and procedures on the technical qualifications of engagement quality control
reviewers address the technical expertise, experience and authority necessary to perform the role.
What constitutes sufficient and appropriate technical expertise, experience and authority depends on
the circumstances of the engagement. In addition, the engagement quality control reviewer for an
audit of the financial statements of a listed entity is an individual with sufficient and appropriate
experience and authority to act as an audit engagement partner on audits of financial statements of
listed entities.
The firm‟s policies and procedures are designed to maintain the objectivity of the engagement quality
control reviewer. For example, the engagement quality control reviewer:
 Is not selected by the engagement partner;

 Does not otherwise participate in the engagement during the period of review;
 Does not make decisions for the engagement team; and
 Is not subject to other considerations that would threaten the reviewer‟s objectivity.

Question No 27
Your firm is a member of an internationally recognized network of accountancy firms and provides
wide range of professional services. A large multinational company, East to South wishes to have a
business presence in Nepal. Having completed the necessary regulatory formalities, the management of
the company has approached your firm for appointment as auditors. The management has also
requested you to provide the following services in the current year:
i) Carry out market search to identify the parties engaged in distribution business. The fee
will be dependent on the eventual appointment of the distributor by the management;
ii) Recruit professionals in the position of Head of Finance and Internal Audit;
iii) Provide a general ledger package that has been developed by your firm.
Explain your company's position to accept or reject assignments offered in light with the provisions of
Code of Ethics and other pronouncement of the Institute( 5 Marks June 2009)
Answer
As per the Code of Ethics issued by ICAN, the principle of objectivity imposes the obligation on all
professional accountants to be fair, intellectually honest and free of conflicts of interest. Professional
accountants in public practice when undertaking a reporting assignment, should be and appear to be free
of any interest which might be regarded, whatever its actual effect, as being incompatible with integrity,
objectivity and independence.
When a professional accountant in public practice, in addition to carrying out an audit or other reporting
function, provides other services to a client, care should be taken not to perform management functions
or make management decisions, responsibility for which remains with the board of directors and
management.
Keeping in view the above provisions, all the services so offered are management responsibilities and
hence it is to be decided whether your firm wants to take up audit assignment or other services offered,
but not the both.
Question No 28
Comment on the following: ( 5 Marks each December 2009)

a) Mr. A, a Chartered Accountant gave 50% of the audit fees received by him to the person,
who was not a Chartered Accountant, under the classification of office allowance and such
an arrangement continued for a number of years.
b) Mr. Baidya, who is a practicing Chartered Accountant, accepted his appointment as an

auditor at a lower fee than the audit fee charged by the previous auditor. Some of the
practicing accountants claimed that Mr. Baidya had obtained the audit by undercutting.

a) Answer
Mr. A, Chartered Accountant had shared his profits with a non-CA and, therefore, is guilty of
professional misconduct under section 34(3) of ICAN Act. It is not the nomenclature to a
transaction that is material but it is the substance of the transaction, which has to be looked
into.
b) Answer
As per the Code of Ethics issued by ICAN, a professional accountant in public practice should
charge fees taking into account:
i) The skill and knowledge required for the type of services involved
ii) The level of training and experience necessary for the person necessarily engaged in
performing the services
iii) The time necessarily occupied by each person engaged in performing the services
iv) The degree of responsibility that performing those service entails.
Further, a professional accountant in public practice should not make a representation that
specific professional services in current or future periods will be performed for either a stated
fee, estimated fee or fee range if it is likely at the time of the representation that such fees will
be substantially increased and the prospective client is not advised of that likelihood.
It is not improper for a professional accountant in public practice to charge a client a lower fee
than has previously been charged to similar services, provided the fee has been calculated in
accordance with the requirements of Code of Ethics issued by ICAN.
In the given case, it would not amount to the undercutting if the fees are based on the quantum of
work, incidental and pocket expenses and other terms of appointment and hence the claim of the
other accountants may not be held tenable.
Question No 29
M/s Joshi & Joshi is a practicing Chartered Accountants firm. One of the senior partners of the firm
is also associated with import/export trade and he is the sole proprietor of that business. Mr. Joshi has
also taken huge amount of loan from various banks and he is found visiting more to government
offices than in his own firm or to his clients. Comment on given case with reference to „Code of
Ethics‟. (5 Marks June 2010)
Answer
A professional accountant in public practice should not concurrently engage in any business, occupation
or activity which impairs or might impair integrity, objectivity or independence, or the good reputation of
the profession and therefore would be incompatible with the rendering of professional services. The
simultaneous engagement in other business, occupation or activity unrelated to professional services,
which have the effect of not allowing the professional accountant in public practice properly to conduct a
professional practice in accordance with the fundamental ethical principles of the accountancy profession
should be regarded as inconsistent with the practice of public accountancy.

Question No 30
As an auditor, comment on the following situation (5 Marks June 2010)

During the audit period, the liaison officer deputed by the client constantly asks you to participate in
lunch arranged outside office premises. He has also informed you that there is a program of welcome
and farewell dinner too. Liaison officer has also informed you that you need not worry about time
schedule, as there would be someone available among client's staff to bailout if needed. Daily
newspapers and magazines are made available in plenty in the audit room. Other staff of the client are
also having regular visit in the working area.
Answer
An auditor is expected to maintain the highest degree of integrity, professionalism and independence. He
represents the trust and faith of the whole professional body. There could be various obstacle and
impediments while conducting his professional duty. However, he should remain intact and vigilant
towards achieving his professional goal. Receiving tea etc. is not the problem as courtesy but it must be
seen that there would be no compromise in the professional ethics and standards.
Also, the auditor has to be aware whether the exchange of significant gifts and hospitality creates the
familiarity threat. (Students are advised to briefly explain the context of Familiarity Threat)
Question No 31
As a newly-qualified Chartered Certified Accountant, you have been asked to write an „ethics column‟
for a trainee accountant on ICAN News Letter. In particular, you have been asked to draft guidance on
the following questions addressed to the News Letter‟s helpline:
(5 Marks each June 2010)
a) What gifts or hospitality are acceptable and when do they become an inducement?
b) If a partner, who is an actuary, provides valuation services to an audit client, can we continue
with the audit?
c) Can internal audit services be undertaken for an audit client?
Answers:
a) Gifts and hospitality - Gifts and hospitality may be offered as an inducement i.e. to unduly
influence actions or decisions, encourage illegal or dishonest behavior or to obtain confidential
information. An offer of gifts and/or hospitality from a client ordinarily gives rise to threats to
compliance with the fundamental principles, for example:
 Self-interest threats to objectivity and/or confidentiality may be created if a gift from a
client is accepted provided such gift is of significant value.
 intimidation threats to objectivity and/or confidentiality may arise through the possibility
of such offers being made public and damaging the reputation of the professional

accountant (or close family member). The significance of such threats will depend on the
nature, value and intent behind the offer. There may be no significant threat to compliance
with the fundamental principles if a reasonable and informed third party would consider
gifts and hospitality to be clearly insignificant. For example, if the offer of gifts or
hospitality is made in the normal course of business without the specific intent to influence
decision making or to obtain information.
If evaluated threats are other than clearly insignificant, safeguards should be considered and
applied as necessary to eliminate them or reduce them to an acceptable level. Offers of gifts and
hospitality should not be accepted if the threats cannot be eliminated or reduced to an acceptable
level through the application of safeguards. As the real or apparent threats to compliance with the
fundamental principles do not merely arise from acceptance of an inducement but, sometimes,
merely from the fact of the offer having been made, additional safeguards should be adopted. For
example:
 immediately informing higher levels of management or those charged with governance that
an inducement has been offered;
 informing third parties (e.g. a professional body) of the offer (after seeking legal advice);
 advising immediate or close family members of relevant threats and safeguards where they
are potentially in positions that might result in offers of inducements (e.g. as a result of
their employment situation); and
 informing higher levels of management or those charged with governance where
immediate or close family members are employed by competitors or potential suppliers of
that organization.
b) Actuarial services to an audit client- IFAC‟s „Code of Ethics for Professional Accountants‟ does
not deal specifically with actuarial valuation services but with valuation services in general. A
valuation comprises:
 making assumptions about the future;
 applying certain methodologies and techniques;
 computing a value (or range of values) for an asset, a liability or for a business as a whole.
A self-review threat may be created when a firm or network firm performs a valuation for a
financial statement audit client that is to be incorporated into the client‟s financial statements. As
an actuarial valuation service is likely to involve the valuation of matters material to the financial
statements (e.g. the present value of obligations) and the valuation involves a significant degree of
subjectivity (e.g. length of service), the self-review threat created cannot be reduced to an
acceptable level of the application of any safeguard. Accordingly:
 such valuation services should not be provided; or
 the firm should withdraw from the financial statement audit engagement. If the net liability
was not material to the financial statements the self-review threat may be reduced to an
acceptable level by the application of safeguards such as:

 involving an additional professional accountant who was not a member of the audit team to
review the work done by the actuary;
 confirming with the audit client their understanding of the underlying assumptions of the
valuation and the methodology to be used and obtaining approval for their use;
 obtaining the audit client „s acknowledgement of responsibility for the results of the work
performed by the firm; and
 making arrangement so that the partner providing the actuarial services does not participate
in the audit engagement.
c) Internal audit services - A self-review threat may be created when a firm, or network firm,
provides internal audit services to a financial statement audit client. Internal audit services may
comprise:
 an extension of the firm‟s audit service beyond requirements of Nepal Standards on
Auditing (NSAs);
 assistance in the performance of a client‟s internal audit activities; or
 outsourcing of the activities.
The nature of the service must be considered in evaluating any threats to independence. (For this
purpose, internal audit services do not include operational internal audit services unrelated to the
internal accounting controls, financial systems or financial statements.) Services involving an
extension of the procedures required to conduct a financial statement audit in accordance with
NSAs would not be considered to impair independence with respect to the audit client provided
that the firm‟s or network firm‟s personnel do not act or appear to act in a capacity equivalent to a
member of audit client management. When the firm, or a network firm, provides an audit client
with assistance in the performance of internal audit activities or undertakes the outsourcing, any
self-review threat created may be reduced to an acceptable level by a clear separation of:
 the management and control of the internal audit by client management;

 the internal audit activities. Performing a significant portion of an audit client‟s internal
audit activities may create a self-review threat. Appropriate safeguards should include the
audit client‟s acknowledgement of its responsibilities for establishing, maintaining and
monitoring the system of internal controls. Other safeguards include:
 the audit client designating a competent employee, preferably within senior management,
to be responsible for internal audit activities;
 the audit client, audit committee or supervisory body approving the scope, risk and
frequency of internal audit work;
 the audit client being responsible for evaluating and determining which recommendations
of the firm should be implemented;
 the audit client evaluating the adequacy of the internal audit procedures performed and the
resultant findings by obtaining and acting on reports from the firm; and

 appropriate reporting of findings and recommendations resulting from the internal audit
activities to the audit committee or supervisory body. Consideration should also be given to
whether such non-assurance services should be provided only by personnel not involved in
the financial statement audit engagement and with different reporting lines within the firm.
Question No. 32
Express your views on following cases:
a) Annual General Meeting of Nepal Petro Limited failed to appoint auditor for the fiscal year
2066-67. The Board of Directors appointed the previous auditor reasoning that the previous
auditor has conducted audit for two consecutive years only and hence he is eligible. (4 Marks
December 2010)
b) Managing Director of East Nepal Bank Limited tells you that since AGM has appointed you as
Auditor of the Company and every shareholder knows it, there is no necessity of executing
/signing audit engagement letter. Express your view on this matter. (4 Marks December
2010)
Answer
a) Only the Annual General of a Company can appoint Auditor as per Company Act 2063 as per
Section 111. The Board of Directors is empowered to appoint auditors only before the first annual
general meeting. In the given case, the board of directors cannot continue the previous auditor
though he may be eligible as the board of directors cannot appoint auditors. As per Section 113 of
the Act, only the Office of the Company Registrar can appoint auditor on request of the Board of
Directors.
b) Though the auditor is appointed by AGM, it generally appoints for statutory audit of financial
statements only and it is appointed under relevant act. However, an Audit Engagement Letter
executed for the purpose as NAS 210 on „Terms of Audit Engagement” states that the auditor and
the client should agree on the terms of the engagement. The agreed terms would need to be
recorded in an audit engagement letter or other suitable form of contract. It is in the interest of
both client and auditor that the auditor sends an engagement letter, preferably before the
commencement of the engagement, to help in avoiding misunderstandings with respect to the
engagement. The engagement letter documents and confirms the auditor's acceptance of the
appointment, the objective and scope of the audit, the extent of the auditor's responsibilities to the
client and the form of any reports.
The principle contents shall be:
 The objective of the audit of financial statements.
 Management's responsibility for the financial statements.

 The scope of the audit, including reference to applicable legislation, regulations or

pronouncements of the Institute of Chartered Accountants of Nepal (ICAN).
 The form of any reports or other communication of results of the engagement
 The fact that because of the test nature and other inherent limitations of an audit, together
with the inherent limitations of any accounting and internal control system, there is an
unavoidable risk that even some material misstatement may remain undiscovered.
 Unrestricted access to whatever records, documentation and other information requested
in connection with the audit.
Question No. 33
Ramila & Associates is a proprietorship firm of chartered accountant. Ramila, the proprietor of the
firm, was the board member of Lalima Bank Ltd till 32 Asadh, 2067. During the AGM of Bank for the
financial year 2066/67, she has been appointed as statutory auditor for the financial year 2067/68.
Should she accept the said appointment?(5 Marks December 2010)
Answer
As per the provisions of Code of Ethics issued by ICAN, “when professional accountants in public
practice are or were, within the period under current review or immediately preceding an assignment:
a) a member of the board, an officer or employee of a company; or
b) a partner of or in the employment of, a member of the board or an officer or employee of a company.
They would be regarded as having an interest which could detract from independence when reporting on
that company”.
As per Sec 34 (12) of Nepal Chartered Accountant Act, 1997 One shall not perform audit of accounts of
any organization where he has served until the elapse of at least three years of his leaving the service.
Accordingly, as per above Para, CA Ramila was board member of the bank immediately preceding an
assignment, hence she should not accept this assignment as statutory auditor for the financial year
2067/68.
Question No. 34
The Board of Directors meeting of M/s Dikpal Commercial Bank Limited, proposed dividend @ 50 %
for the fiscal year 2066/067. The Annual General Meeting approved the dividend @ 70% instead of the
proposed dividend by the Board of Directors. Examine the decision of the Annual General Meeting to
approve dividend in excess of the proposed dividend by the Board of Directors and whether it is
commensurate with the company Act, 2063. (5 Marks June 2011)

Answer
The Annual General Meeting is authorized body to approve dividend under section 77 (6) of the
Company Act, 2063. The proviso to the said section has however, restricted the Annual General Meeting
to approve the dividend in excess of the dividend proposed by the Board of Directors. However, the
dividend at lower rate can be approved. Thus, the decision of Annual General Meeting of Ms. Shangrila
Commercial Bank Ltd. to approve dividend in excess of the dividend proposed by the Board of Directors
is void and Annual General Meeting can only approve the dividend at the lower rate or at the rate
proposed by the Board of Directors.
Question No. 35
As an auditor, express your comments/views on the following situation: (5 marks June 2011)
a) The Board of Directors meeting of M/s Universal Commercial Bank Limited having its registered
office at Kathmandu, Nepal proposed dividend @ 30% for the year 2066/067. The Annual General
Meeting approved the dividend @ 25% instead of the proposed dividend by the Board of Directors.
Examine the decision of the Annual General Meeting to approve dividend less than the dividend
proposed by the Board of Directors whether it is commensurate with the company Act, 2063?
Answer
The Annual General Meeting is authorized body to approve dividend under section 77 (6) of the
Company Act 2063. The proviso of the said section has however, restricted the Annual General Meeting
to approve the dividend in excess of the dividend proposed by the Board of Directors. However, the
dividend at lower rate can be approved. Thus, the decision of Annual General Meeting of M/s Universal
Commercial Bank Limited to approve dividend @ 25% (at the rate lower than the rate proposed by the
Board of Directors) is commensurate with the provision of the Companies Act, 2063.
Question No. 36
Mr. Yadav, a Chartered Accountant in practice enters into an agreement with Mr. Puspa Adhikari, an
individual who has passed one group of CA final 2 years back. The agreement provides that Mr.
Puspa Adhikari shall work in all professional assignments of Mr. Yadav and shall receive 15 percent
of fee received from such assignments as remuneration. Explain whether the agreement is in order as
per Code of Ethics or any other relevant reference? If remuneration is based on cash flow, does it
violate the provisions of the Code of Ethics? (5Marks June 2011)
Answer
As per section 34(3) of Nepal Chartered Accountants Act, 1997, one shall not share the auditing fees or
remuneration or distribute as profit with any person other than a member of the institute and shall not pay any
commission, brokerage, etc. out of the professional fees earned to any person or member.

In the above case also, Mr. Yadav a Chartered Accountant in practice enter into agreement to share
auditing fees. Accordingly, Mr. Yadav would be held guilty of professional misconduct since he agreed
to share the fees to his employee.
Even if remuneration were based on cash flow, it would tantamount to be based on fees received on
cash and accordingly Mr. Yadav would be held guilty of professional misconduct.
Question No. 37
During the audit period, the liaison officer deputed by the client Lumbini Insurance Company
constantly asks you to participate in lunch arranged outside office premises. He has also informed you
that there is a program of welcome and farewell dinner too. Liaison officer has also informed you that
you need not worry about time schedule, as there would be someone available among client's staff to
bailout if needed. Daily newspapers and magazines are made available in plenty in the audit room.
Other staff of the client are also having regular visit in the working area. (5 Marks, December 2011)
Answer
Section 250 of Code of Ethics 2018 for the members of the Institute of Chartered Accountants of Nepal
states about the gift and hospitality to the auditors by the client.
The existence and significance of any threat will depend on the nature, value, and intent of the offer.
Where gifts or hospitality are offered that a reasonable and informed third party, weighing all the specific
facts and circumstances, would consider trivial and inconsequential, a professional accountant in public
practice may conclude that the offer is made in the normal course of business without the specific intent
to influence decision making or to obtain information. In such cases, the professional accountant in
public practice may generally conclude that any threat to compliance with the fundamental principles is
at an acceptable level.
The objectives of the accountancy profession are to work to the highest standards of professionalism, to
attain the highest levels of performance and generally to meet the public interest requirement set out
above. These objectives require four basic needs to be met. They are credibility, professionalism, quality
of services and confidence. An auditor is expected to maintain the highest degree of integrity,
professionalism and independence. He represents the trust and faith of the whole professional body.
There could be various obstacle and impediments while conducting his professional duty. However, he
should remain intact and vigilant towards achieving his professional goal.
Provision of lunch is governed by conditions laid in engagement letter and appointment letter. If the
contract states provision of lunch, it should not be construed as accepting any undue advantage whether
arranged inside or outside. However, attendance in farewell party is not concerned with the auditor. Thus,
the auditor needs to avoid such attendance. Receiving Newspapers as courtesy from the client and the

regular visits by the staff of the client in the working place is not the problem but it must be seen that
there would be no compromise in the professional ethics and standards.
Question No 38
You are appointed as manager of quality control section in one of the leading audit firm of Nepal, the
senior partner of the firm instructs you to draft objectives statement for quality control policies &
procedures. (8 Marks December 2011)
Answer
As per Nepal Standards on Quality Control (NSQC) 1, it is necessary for quality control for firm`s that
perform audits and review of historical financial information and other, accordingly, the relevance of
quality control the relevance of quality control issue in auditing services is equal importance like in other
services. If quality control could not be done in auditing work, quality services could not be provided to
client which may result negative consequences both for auditor and client including in overall all
economy. Hence, every auditor should carry out the audit work based on formal quality control policy &
procedures. The objective statement of quality control policies & procedures would be:
i. Professional Requirements
personnel in the firm should adhere to the principles of independence, integrity, objectivity,
confidentiality and professional behavioral number of procedures may be framed to achieve this
objective .for example, a firm may require all its personnel to make a written statement every year
as to whether they hold any shares or any other interest in the enterprises being audited by the firm.
ii. Skills and Competence

the audit skills firm should be staffed by personnel who have attained and maintain the technical
standards and professional required to enable them to fulfill their responsibilities with due care .for
example, a firm can achieve this objective through proper recruitment procedures, periodic staff
and a system whereby latest information relating to current development in professional standards,
law, etc. is regularly communicated to audit staff.
iii. Assignment
Audit work should be assigned to such personnel as have the degree of technical training and
proficiency required in the circumstances.
iv. Delegation
There should be sufficient direction, supervision and review of work at all levels to provide
reasonable assurance that the work performed meets appropriate quality standards. For example, a
firm may establish guidelines relating to the form and content of working papers; use of
standardized forms, etc. similarly, the audit plans may identify the staffing requirements and timing
of various phases of audit to facilitate delegation of audit now.
v. Consultation
Where ever necessary, persons having appropriate expertise, within or outside the firm, should be
consulted.

vi. Acceptance and Retention of Clients

Before accepting an audit, the firm should evaluate its independence and ability to serve the
prospective client properly. A similar review should be made, on-going basis, of association with
the existing clients.
vii. Monitoring
The continued adequacy and operational effectiveness of the quality control policies and procedures
should be maintained.
Question No. 39
Himalayan Co. Ltd. reappointed Ram and Ramita as their joint auditors in the Annual General
Meeting. The AGM authorized the Board for fill up the vacancy on their own in the event of both or
either of auditors declined to accept the assignment. The Board passed a resolution to appoint Prabhat
if any of the auditors declined to accept the assignment. Later on, Ramita declined to accept the
assignment and Board of Directors appointed Prabhat in place of Ramita as per its resolution.
(5 Marks June 2012)
Answer
In the present case Ramita is one of the joint auditors who was appointed in Annual General Meeting, but
declined to accept the appointment. The Board of Directors as per their resolution, appointed Prabhat as a
joint auditor in her place. In this case, the vacancy created by Ramita is neither caused by resignation of
Ramita nor is it a casual vacancy because Ramita‟s appointment had not become effective. Hence,
appointment of Prabhat as joint auditor by the Board is not valid. Prabhat can only be appointed as joint
auditor by shareholders in the General Meeting.
Question No. 40
A member of Board of Directors of M/s XYZ Company Limited elected for four years tenure by the
annual general meeting of the company resigned from his post after two years from the date he elected
for that post. The Board of Directors wants to propose for appointment of a member for that vacant
post for the rest of the period by calling special general meeting of the company. You are required to
examine whether the process of the Board of Directors is commensurate with the company Act, 2063.
(5 Marks June 2012)
Answer
As per section 87 of the company Act, 2063, the Annual General Meeting is authorized body to appoint
member of board of directors of the company. However, if any of the elected member of the board of
directors resigns or the post is vacant due to any other reason, section 87 (2) states that the board of

directors have to appoint member of board of director for such vacant post. The board of directors can't
refer the annual general meeting of the company to appoint a member in such vacant post. Therefore, the
move of the board of director is not commensurate with the provision of company Act, 2063.
Question No. 41
Answer the following: (5 Marks each December 2011)
a) Mr. Shushil Maharjan, a Chartered Accountant published a book and gave his personal details
as the author. These details also mentioned his professional experience and his present
association as partner with M/s Daniel Brisk, a Swedish firm of Chartered Accountant Firm.
What will be your opinion in this respect?
b) Mr. Shanti Das a Chartered Accountant audited a religious institution established for purely
promoting social values without charging any audit fee. Give your comment.
Answer
a) The supplementary Directive to code of ethics issued by the Institute of Chartered Accountants of
Nepal on “Publicity and Advertisement” prescribes the provisions for publishing book or article. It
allows the members to state their name, professional qualification and the name of their firms but
restricts the members from disclosing the services provided by them. In the given case, Mr. Shushil
Maharjan. a chartered accountant, published the book and mentioned his professional experience and
his association as a partner with M/s Daniel Brisk, a Swedish firm of chartered accountants. Mr.
Shushil Maharjan being a chartered accountant in practice has committed the professional
misconduct by mentioning that at present he is a partner in M/s Daniel Brisk, a Swedish firm of
chartered accountants.
b) The Code of Ethics issued by the Institute of Chartered Accountants of Nepal on “Soliciting
Business, Accepting New Engagement, Fees and Commission” prescribes the provisions for
providing service free of cost. Subject to non-compromise in the quality of professional services
being offered, it allows the members to provide services without charging any fee to the welfare or
spiritual institutions established with an objective of providing social services. Further, the council of
The Institute of Chartered Accountants of Nepal has waved (vide decision dated 2071/11/4- 194th
Meeting) requirement of minimum fee for the religious organizations which have annual transactions
of less than 20 lacs.
Accordingly, in the given case, if the transactions of the institution does not exceed 20 lacs, it will not
be termed as guilty of professional misconduct as the service was provided to a religious institution
established for purely promoting social values. However, if the transactions of the institution exceeds
20 lacs, the auditor shall be guilty of violating code of conduct.

Question No 42
M/s D & D Associates was the auditor of M/s Paraline Company Pvt. Ltd. One of the shareholders of
the company filed a case in court against the company. The court sought some information from the
auditor M/s D & D Associates and one of the partners of the firm disclosed the required information
to the court without informing the client. Judge whether the Auditor has complied with the code of
ethics issued by The Institute of Chartered Accountants of Nepal? (8 Marks December 2011)
Answer
Code of ethics issued by The Institute of Chartered Accountants of Nepal has outlined the detail of
ethics that Professional accountants have an obligation to respect the confidentiality of information
about a client‟s or employer‟s affairs acquired in the course of professional services. The duty of
confidentiality continues even after the end of the relationship between the professional accountant and
the client or employer. Confidentiality should always be observed by a professional accountant unless
specific authority has been given to disclose information or there is a legal or professional duty to
disclose. The following are examples of the points which should be considered in determining whether
confidential information may be disclosed:
a. When disclosure is authorized. When authorization to disclose is given by the client or the
employer the interests of all the parties including those third parties whose interests might be
affected should be considered.
b. When disclosure is required by law. Examples of when a professional accountant is required by
law to disclose confidential information are:
i. to produce documents or to give evidence in the course of legal proceedings; and
ii. to disclose to the appropriate public authorities infringements of the law which come to light.
In the light of code of ethics issued by The Institute of Chartered Accountants of Nepal, the auditor who
provided information about the clients business to the court without informing the client has complied
the code of ethics and it is not necessary to inform the client for any information sought by the court to
produce documents or to give evidence in the course of legal proceedings.
Question No 43
Comment on the following situations/statements.
a) A firm or a member of the audit team accepts gifts or hospitality of which the value is not trivial
and inconsequential. (Give your answer on the basis of the Provision of IFAC Code of Ethics
adopted by ICAN.)
b) ABC Commercial Bank provided loan to an audit team member under terms and conditions other
than normal. (Give your answer on the basis of the Provision of IFAC Code of Ethics adopted by
ICAN.)

Answers
a) There will be self-interest and familiarity threat to compliance with the fundamental principles
which the auditors are required to comply. The threat would be so significant that no safeguards
could reduce it to an acceptable level. The firm or the member of the audit team shall not accept
such gifts or hospitality. (Students are advised to explain familiarity threat)
b) There will be self-interest threat and the significance of the threat would be so significant that no
safeguard could reduce it to an acceptable level. So such loan shall not be accepted. (Students are
advised to explain self-interest threat)
Question No 44
At the Annual General Meeting of the Company, a resolution was passed by the entire body of
shareholders restricting some of the powers of the statutory auditors. Can powers of the statutory
auditors be restricted? (5 Marks June 2012)
Answer
Section 114 of the Company Act 2063 provides that an auditor of a company shall have right of access at
all office time to the books of account and records of the company. Auditor shall be entitled to require
from the offices of the company such information and explanations as he / she may think necessary for
the purpose of his audit.
These specific rights have been conferred by the statute on the auditor to enable him to carry out his
duties and responsibilities prescribed under the Act, which cannot be restricted or abridged in any
manner. Hence any such resolution even if passed by entire body of shareholders is ultra vires and
therefore void.
In the case of Newton vs. Birmingham Small Arms Co, it was held that any regulations which preclude
the auditors from availing themselves of all the information to which they are entitled under the
Companies Act, are inconsistent with the Act.
Question No. 45
Akash, statutory auditor of Sagarmatha Ltd., was not permitted by the board of directors to attend
general meeting of the company on the ground that his right to attend general meeting is restricted
only to those meetings at which the accounts audited by him are to be Comment.
(5 Marks June 2012)
Answer
As per Section 110 of the Companies Act, 2063 every company shall appoint an auditor under this Act to
have its accounts audited. The auditor appointed pursuant to Sub-section (1) shall hold office only until

the next annual general meeting. Similarly, as per Section 119 of the same Act no auditor appointed
under this Act shall be removed pending the completion of audit of accounts of any financial year for
which he/she was appointed as the auditor. The Auditor shall be entitled to attend any general meeting
and to be heard at any general meeting, which concerns him as auditor. The right is not restricted only to
those meetings at which the accounts audited by him are to be presented and discussed.
There may also be situations where the accounts are not yet finalized, but the general meeting is called
for. The statutory auditor is entitled to attend every such general meeting, during his tenure as auditor.
Question No. 46
What are the basic fundamental principles should a professional accountant have to observe in order
to achieve the objectives of the accountancy profession? (8 Marks June 2012)
Answer
The Code of Ethics for the members of the Institute of Chartered Accountants of Nepal, recognizes that
the objectives of the accountancy profession are to work to the highest standards of professionalism, to
attain the highest levels of performance and generally to meet the public interest requirement set out in
the codes like credibility in information and information systems, professionalism in the accountancy
field, assurance about the quality of service and confidence in the profession.
As per the Code of Ethics for the members of the Institute of Chartered Accountants of Nepal, in order to
achieve the objectives of the accountancy profession, professional accountants have to observe a number
of prerequisites or fundamental principles. The fundamental principles can be explained as under:
 Integrity
A professional accountant should be straightforward and honest in performing professional
services.
 Objectivity
A professional accountant should be fair and should not allow prejudice or bias, conflict of interest
or influence of others to override objectivity.
 Professional Competence and Due Care

A professional accountant should perform professional services with due care, competence and
diligence and has a continuing duty to maintain professional knowledge and skill at a level
required to ensure that a client or employer receives the advantage of competent professional
service based on up-to-date developments in practice, legislation and techniques.

 Confidentiality
A professional accountant should respect the confidentiality of information acquired during the
course of performing professional services and should not use or disclose any such information
without proper and specific authority or unless there is a legal or professional right or duty to
disclose.
 Professional Behavior
A professional accountant should act in a manner consistent with the good reputation of the
profession and refrain from any conduct which might bring discredit to the profession.
 Technical Standards
A professional accountant should carry out professional services in accordance with the relevant
technical and professional standards. Professional accountants have a duty to carry out with care
and skill, the instructions of the client or employer in so far as they are compatible with the
requirements of integrity, objectivity and, in the case of professional accountants in public
practice, independence.
Question No. 47
Define the ethical requirements that a professional accountant residing in Nepal should comply with
for Cross Boarder Activities. (5 Marks June 2012)
(a) When the ethical requirements of the country in which the services are being performed are less
strict than the ICAN Code of Ethics, then the ICAN Code of Ethics should be applied.
(b) When the ethical requirements of the country in which services are being performed are stricter
than the ICAN Code of Ethics, then the ethical requirements in the country where services are being
performed should be applied.
(c) When the ethical requirements of Nepal are mandatory for services performed outside that
country and are stricter than set out in (a) and (b) above, then the ethical requirements of Nepal
should be applied.
Question No. 48
A proprietary audit firm of Chartered Accountant has accepted the engagement to audit the accounts
of a private school with annual turnover of Rs 10 lakhs at the audit fee of Rs 8,500. The firm
anticipates that the audit will consume estimated time of 2-man days of the Chartered Accountant. (5
Marks December 2012)
As per the notice of the 194th meeting on 2071/11/4, a CA member holding COP shall charge the audit
fee to his audit client and the fee shall not be less than Rs 20,000. If the audit client is a financial
institution regulated by Nepal Rastra Bank or insurance company regulated by the Insurance Board, the
audit fee shall not be less than Rs 100,000. However, above minimum fee does not apply where the audit

client is a Government Primary School/Community School with annual turnover of less than Rs 20 lakhs.
In the present case the CA member has charged the audit fee of Rs 8,500 to a private school with annual
turnover of Rs 10 lakhs which would not contradict the provisions the minimum fees.
Question No. 49
Express your comments/views on the following situation
a) Puran (A practicing Chartered Accountant) has been appointed as statutory auditor of ABC
Development Bank Limited for the fiscal year 2068/69. Puran has been holding certain paid up
share capital of the bank since the year 2060. Is the appointment of Puran is valid?
Answer
Section 112 of the Companies Act, 2063 stated the disqualifications of auditor: As per Act None of the
certain persons or the firms or companies in which such persons are partners shall be qualified for
appointment as auditor and shall, despite appointment as auditor, continue to hold office.
Provision regarding appointing shareholder as auditor as per Companies Act stated that: persons or the
firms or companies who is substantial shareholder of the company or a shareholder holding one percent
or more of the paid up capital of the company or his close relative cannot be appointed as auditor.
In the instance case the % of holding paid up capital is not mentioned, if the Puran himself or firm or
company he is partner or shareholder or his close relative do not hold one percent or more than one
percent of the paid up capital of ABC Development Bank Limited only than Puran is qualified to be
appointed as auditor.
b) Ramesh Sharma was Chief Finance Officer of A Ltd for the period 1 Shrawan 2064 to 15 Ashad,
2069. He joined XYZ Chartered Accountant firm from 1 Shrawan 2069 as Senior Audit Manager.
A Ltd. has approached the firm on 15 Shrawan 2069 for the audit of accounts for the year 2068/69
with Ramesh Sharma as Engagement Manager of the audit team. Please provide your opinion on
what the audit firm should do? (5 Marks December 2012)
Answer:
Ramesh Sharma was the Chief Finance Officer of A Ltd. for almost entire year 2068/69. He has left A
Ltd just a month before the audit firm was approached by A Ltd for audit of 2068/69 and proposes his
name to be engaged as engagement manager in the audit team. This situation may result into self-interest,
self-review and familiarity threat to the firm. Hence the firm should request A Ltd. that the firm cannot
assign Ramesh as an audit team member. If A Ltd does not accept the audit team without Ramesh as
senior member in the audit team from the firm, the audit firm should not accept this engagement.

c) Mr. Robin, a Chartered Accountant, is an employee of M/s SA & Associates, a firm of Chartered
Accountants of Nepal. The firm is the Auditors of ABC & Co. Ltd. After auditing the accounts of
the Company, the Auditor firm allowed Mr. Robin, their employee, to sign the audit report; which
he did. (5 Marks December 2012)
Answer
An employee Chartered Accountant cannot sign the auditor‟s report on behalf of the auditing firm.
Fulltime employee is not considered Chartered Accountant in practice, so Mr. Robin, who is employee of
SA & Associates cannot sign the auditor‟s report on behalf his firm. Only a partner in the firm can sign
the audit report in compliance with the provisions of company act 2063.
d) XYZ Co. Ltd. reappointed A and B as their joint auditors in the Annual General Meeting. The
AGM authorized the Board for fill up the vacancy on their own in the event of both or either of
auditors declined to accept the assignment. The Board passed a resolution to appoint C if any of
the auditors declined to accept the assignment. B declined to accept the assignment and Board of
Directors appointed C in place of B as per its resolution. (5 Marks December 2012)
Answer
In the present case B is one of the joint auditors who was appointed in Annual General Meeting, but
declined to accept the appointment. The Board of Directors as per their resolution, appointed C as a joint
auditor in his place.
In this case, the vacancy created by B is neither caused by resignation of B nor is it a casual vacancy
because B‟s appointment had not become effective. Hence, appointment of C as joint auditor by the
Board is not valid. C can only be appointed as joint auditor in the General Meeting.
e) Richak & Associates, a chartered accountant firm, was appointed as an auditor of a company on
15 Aswin 2069 for the year 2068/69 where Ram Lal, one of the partners of the audit firm, was
holding 5% shares of the company since 2065. But Ram Lal sold all his shares of the company on
30 Aswin 2069. It was further noted that the audit report was signed by another partner of the firm
on 15 Falgun 2069 only. (5 Marks June 2013)
Answer
A person or a firm in which such person has substantial shareholding of the company or a shareholder
holding one percent or more of the paid-up capital of the company or his/her close relative is not
qualified for appointment as an auditor as per section 112(1) of the Companies Act. So, in the present
case since Ram Lal, a partner of Richak & Associates, holds 5% shares of the company, Richak &
Associates is disqualified from appointment as an auditor as on 15 Asoj 2069. But Ram Lal disposes all
his shares after appointment of his firm as an auditor and audit report is signed after his disposal of
shares. Despite this fact as per section 112(4) of the Companies Act since the appointment of auditor is in
contravention of the provisions of the Companies Act, the audit cannot be considered as valid.

Question No. 50
Siddhi & Co., a chartered accountant firm is appointed a fund manager of an INGO situated in Nepal.
The INGO has then transferred money in the current account of Siddhi & Co. for the operation of
project activities. Opine on the act of Siddhi & Co. for:
i) transferring certain money to saving bank account and
ii) charging/ drawing fee due from the client. (5 Marks, June 2013)
a) Section 12 of the Code of Ethics of the Institute of the Chartered Accountants of Nepal permits
keeping client‟s money for using on legal activities on behalf of client and which is also permitted
by the ToR and the agreement with the client.
i) The act of transferring client‟s money in saving bank account for reasonable time is
valid only when it seems likely that the client‟s monies remain on current account for
a significant period of time and Siddhi & Co. have taken prior concurrence of the
client.
ii) Siddhi & Co., can charge/draw fees due from a client‟s monies provided that client,
after being notified of the amount of such fees, has agreed to such withdrawal.
Comment on the following situations/statement. (5 Marks, June 2013)
RB Associates, a firm of chartered accountants has two partners, R and B. The firm is already holding
audit of 130 companies including audit of 90 NGOs. The firm is offered the audit of Labour Welfare
Association.
As per the notification issued by the ICAN:
i) In case of partnership firms of auditor, the ceiling on audit is hundred entities per
partner of the firm.
ii) The maximum number of audits of the public company registered under Company Act is
10 and number of audits of other entities is 90 per partner.
iii) The firm can take maximum of two hundred audits (100 × 2), but the number of Audits
of NGOs should not exceed 90. There are two partners – R and B.
iv) The firm is holding 90 audits of NGOs at present.
v) The firm can, therefore, accept audit of Labour Welfare Association assuming that
Labour Welfare Association is registered under the Association Registration Act, 2034.
Question No. 51
Commission for the Investigation of Abuse of Authority (CIAA) has asked certain information from
XYZ & Co.; Chartered Accountants relating to certain client of the audit firm for which legal
proceeding is in process with CIAA. The XYZ & Co. refused to provide such information to CIAA. Is
the action of XYZ & Co. is tenable? (5 Marks June 2013)

Section 110 (114) of the Code of Ethics of the Institute of the Chartered Accountants of Nepal deals with
"Confidentiality" A professional accountant shall comply with the principle of confidentiality, which
requires an accountant to respect the confidentiality of information acquired as a result of professional
and business relationships. An accountant shall:
a. Be alert to the possibility of inadvertent disclosure, including in a social environment, and

particularly to a close business associate or an immediate or a close family member;
b. Maintain confidentiality of information within the firm or employing organization;
c. Maintain confidentiality of information disclosed by a prospective client or employing organization;
d. Not disclose confidential information acquired as a result of professional and business relationships
outside the firm or employing organization without proper and specific authority, unless there is a
legal or professional duty or right to disclose;
e. Not use confidential information acquired as a result of professional and business relationships for
the personal advantage of the accountant or for the advantage of a third party;
f. Not use or disclose any confidential information, either acquired or received as a result of a
professional or business relationship, after that relationship has ended; and
g. Take reasonable steps to ensure that personnel under the accountant‟s control, and individuals from
whom advice and assistance are obtained, respect the accountant‟s duty of confidentiality.
114.1 A1 Confidentiality serves the public interest because it facilitates the free flow of information from
the professional accountant‟s client or employing organization to the accountant in the knowledge that
the information will not be disclosed to a third party. Nevertheless, the following are circumstances
where professional accountants are or might be required to disclose confidential information or when
such disclosure might be appropriate:
(a) Disclosure is required by law, for example:
i) Production of documents or other provision of evidence in the course of legal proceedings; or
ii) Disclosure to the appropriate public authorities of infringements of the law that come to light;
(b) Disclosure is permitted by law and is authorized by the client or the employing organization; and
(c) There is a professional duty or right to disclose, when not prohibited by law:
i. To comply with the quality review of a professional body;

ii. To respond to an inquiry or investigation by a professional or regulatory body;
iii. To protect the professional interests of a professional accountant in legal proceedings; or
iv. To comply with technical and professional standards, including ethics requirements.
In view of the above provision of Code of Ethics of the Institute of the Chartered Accountants of Nepal ;
XYZ & Co. has the professional liability for disclosing the client`s information to CIAA , since a
professional accountant is required by law to disclose confidential information are to produce documents
or to give evidence in the course of legal proceedings .
Hence the action of XYZ & Co. is not tenable, though the audit firm may consult ICAN before
providing client`s information to CIAA.

Question No. 52
Answer the following:
a) Mr. Raj, a fellow member of the Institute of Chartered Accountants of Nepal, working as manager
of Rahul & Associates, a chartered accountant firm, signed the audit report of Om Ltd. on behalf
of Rahul & Associates. (5 Marks June
2013)
Answer:
Signature on Audit Report: Section 116 of the Companies Act, 2063 requires that only a person
appointed as the auditor of the company or where a firm is so appointed, the member who has been
authorized by a decision of the partners of such institution, may sign the auditor‟s report or sign or
authenticate any other document of the company required by law to be signed or authenticated by the
auditor. Therefore, Mr. Raj, a fellow member of the Institute and a manager of M/s Ram & Associates.,
Chartered Accountants, cannot sign on behalf of the firm in view of the specific requirements of the
Companies Act, 2063.
b) Ramu & Co. had conducted the audit of XYZ Limited for the financial years 2067/68, 2068/69 and
2069/70. CA. Raman Saha, partner of Ramu & Co, left the firm on 1 Baishakh 2069. CA. Raman
Saha has been appointed as the auditor of XYZ limited for the year 2070/71. ( 5 Marks December
2013)
Answer:
As per section 111(3) of the Companies Act, no auditor or his/her partner or ex-partner or employee or
ex-employee shall be appointed as auditor for more than three consecutive terms to perform the audit of a
public company. Provided, however, that this restriction shall not apply to any partner who ended
partnership or any employee who left the service of such auditor three years before.
In the present case, Ramu & Co has been auditor of XYZ Ltd for three consecutive years till 2069/70.
Since Raman Saha is the ex-partner of Ramu & Co and 3 years has not elapsed from the date of ending
his partnership with Ramu & Co (as date of separation being 1 Baisakh 2069), his appointment as auditor
of the company for the year 2070/71 cannot be considered as lawful.
c) Firm of Ms. KD was appointed as auditor in 10th AGM of Neupane Limited. She was removed by
Board of Directors when she was out of Nepal on personal visit. (5 Marks June 2014)
Answer
Section 119 (1) of the Company Act, 2063 provides that no auditor appointed pursuant to Companies Act
shall be removed pending the completion of audit of accounts of any financial year for which he/she was
appointed as the auditor.

As per Sub-section (2), notwithstanding anything contained in Sub-section (1) , if any auditor breaches
the code of conduct of auditors or does any act against the interest of the company which has appointed
him/her as the auditor or commits any act contrary to the prevailing law, such auditor may be removed
through the same process whereby he/she was appointed as auditor, by giving prior information to the
ICAN, and with the approval of the regulatory authority, if any authorized by the prevailing law for the
regulation of business of the company concerned , and failing such authority, with the approval of the
Office of Registrar.
While removing an auditor pursuant to Sub-section (2) above, the auditor shall be provided with a
reasonable opportunity to defend him/herself.
Thus, Board of Directors cannot remove if auditor has been appointed through AGM. Further, reasonable
opportunity to defend herself should be provided.
Question No. 53
Comment on the following situations/statements: (35 =15 Marks December 2013)

a) Ram, a Chartered Accountant prepared a project report for one of his clients to obtain bank
finance (long-term) of Rs. 50 lakhs from a commercial bank. Consequent to the sanction of the
loan by the bank, Ram charged 2% fee on the figures of loan sanctioned.
b) Goma Limited, a leading trading business in electronic goods, has appointed CA. Ranaji Ojha
a statutory auditor with Rs. 1.5 lakhs audit fees. Besides, the company has offered 5 latest
model iPhone costing of Rs. 1.5 lakhs to his family members as gift.
c) While submitting the financial proposal on consultancy works of Emiliya Gypsum Limited,
PZT Associates, a CA. firm has calculated the cost as follows:
FCA Rs. 5,000 Per day/person

ACA Rs. 2,500 Per day/person
RA Rs. 2,000 Per day/person
Assistants Rs. 1,000 Per day/person
a) Answer
As per Code of Ethics 2018, Professional fees should be a fair reflection of the value of the
professional services performed for the client, taking into account:
a. The skill and knowledge required for the type of professional services involved.
b. The level of training and experience of the persons necessarily engaged in performing the
professional services.
c. The time necessarily occupied by each person engaged in performing the professional
services.
d. The degree of responsibility that performing those services entails.

Professional fees should normally be computed on the basis of appropriate rates per hour or per
day for the time of each person engaged in performing professional services. These rates should
be based on the fundamental premise that the organization and conduct of the professional
accountant in public practice and the services provided to clients are well planned, controlled
and managed. It is for each professional accountant in public practice to determine the
appropriate rates.
A professional accountant in public practice should not make a representation that specific
professional services in current or future periods will be performed for either a stated fee,
estimated fee, or fee range if it is likely at the time of the representation that such fees will be
substantially increased and the prospective client is not advised of that likelihood.
When performing professional services for a client it may be necessary or expedient to charge a
pre-arranged fee, in which event the professional accountant in public practice should estimate a
fee taking into account the referred matters.
Section 34(10) of Nepal Chartered Accountants Act, 1997 states that “Members holding
Certificate of Practice shall not base their remuneration as a percentage on the profit or on any
other uncertain results”.
Entering into a contingent fee arrangement relating to an assurance engagement is an example

of self-interest threat. In the present case, audit fee is contingent upon the profit after tax of the
client. So, this is the situation of self-interest threat to the auditor and hence it is advisable for
the auditor not to accept the engagement under such fee arrangement.
b) Answer
A professional accountant should not accept any gifts or goods from the client which threat the
independence. Code of Conduct Section 8.6 and 8.9 attracts to the professional accountant to
accept the gift and goods. Section 8.6 says personal and family relationships can affect
independence. There is a particular need to ensure that an independent approach to any
assignment is not endangered as a consequence of any personal or family relationship.
It is recognized that it would be impracticable to attempt to prescribe in detail in ethical
requirements the permissible extent of a personal relationship between a professional
accountant in public practice and a client, or those occupying responsible executive positions
(e.g., director, chief executive, financial officer or another employee in a similar position) with
a client.
Section 340.8 of the Code of Conduct has defined not to accept any goods and services from the
client. Acceptance of goods and services from a client may be a threat to independence.
Acceptance of undue hospitality poses a similar threat. Goods and services should not be
accepted by professional accountants in public practice, their spouses or dependent children
except on business terms no more favorable than those generally available to others. Hospitality

and gifts on a scale which is not commensurate with the normal courtesies of social life should
not be accepted.
In a given case offering of 5 mobile sets of significant value to the auditor by Goma Limited
seems to have the intent of influencing the decision making of the auditor. Hence this is the
situation of self-interest threat, familiarity threat and intimidation threat. In this situation the
auditor should evaluate the significance of the threats and apply safeguards to eliminate threats
or reduce them to an acceptable level. If the threat cannot be eliminated or reduced to an
acceptable level, the gifts shall not be accepted by the auditor.
c) Answer
Nepal Chartered Accountant Act, 2053, Nepal Chartered Accountants Rules, 2061 and the Code
of Conduct of the Institute have given authority to make certain standards on the charging of
fees by its members. Applying the power as provided in the above statutes, the Council has
decided and fixed certain fundamental principles on minimum fees, consultancy services fee
and fee on certification work. work. As per the decision of the meeting no 194 held on
2071/11/04, the Council has fixed the minimum consultancy charges as follows:
FCA member Rs. 10,000/- per working days
CA member Rs. 7500/- per working days
RA member Rs. 5000/- per working days
Other/assistants Rs. 3000/- per working days
In a given case, the fee as quoted by the CA firm is not complying with the decision was made
by the Council except RA member charge which is as per the decision of the Council.
Question No. 54
Auditors of a commercial bank was interviewed by the inspection team of Nepal Rastra Bank and
requested the auditors to share their views on the quality of loans of the bank to assist inspection. Will
this situation affect the confidentiality clause in code of ethics? (5 Marks June 2014)
Answer:
a) The principle of confidentiality imposes an obligation on all professional accountants to
maintain confidentiality of information acquired as a result of professional or business
relationship unless there is legal or professional right or duty to disclose. However, there are
certain circumstances when confidential information can be disclosed.
As per 110.114 of the Code of Ethics of ICAN provides the circumstances where confidential
information can be disclosed as below
a. When disclosure is authorized.
b. When disclosure is required by law.

c. When there is a professional duty or right to disclose.

i. To comply with the quality review of a professional body;
ii. To respond to an inquiry or investigation by a professional or regulatory body;
iii. To protect the professional interests of a professional accountant in legal proceedings; or
iv. To comply with technical and professional standards, including ethics requirements.
In view of the above requirement of 110.114.1 A1 (a) (ii) auditor can assist the regulator for
inspection.
Questions No. 55
Mr. A, a practicing Chartered Accountant has been found guilty in respect of Professional
Misconduct. So, Mr. A, a Chartered Accountant in practice has been suspended from practice for a
period of 4 months. During the said period, though he did not undertake the audit assignment since
he had surrendered certificate of practice, he had appeared before Income Tax authorities in his
capacity as a Chartered Accountant. (5 Marks June 2014)
Undertaking Tax Representation Work:
A chartered accountant not holding certificate of practice cannot take up any other work because it would
amount to violation of the relevant provisions of the Chartered Accountants Act, 2053. In case a member
is suspended and is not holding Certificate of Practice, he cannot in any other capacity take up any
practice separable from his capacity to practices as a member of the Institute. This is because once a
member becomes a member of the Institute; he is bound by the provisions of the Chartered Accountants
Act, 2053 and its Regulations. If he appears before the income tax authorities, he is only doing so in his
capacity as a chartered accountant and a member of the Institute. Having bound himself by the said Act
and its Regulations made there under, he cannot then set the Regulations at naught by contending that
even though he continues to be a member and has been punished by suspension, he would be entitled to
practice in some other capacity. Thus, in the instant case, a chartered accountant would not be allowed to
represent before the income tax authorities for the period he remains suspended. Accordingly, in the
present case he is guilty of professional misconduct. However, if the Chartered Accountant is summoned
by Income Tax Authorities for any work conducted by the person before suspension of COP by ICAN,
the Chartered Accountant will be answerable to the authorities.
Questions No. 56
Aashriya & Associates has two Partners holding Certificate of practice. It has 14 Public company
clients and other small clients. The firm is in dilemma as to accept the forthcoming audit request of
two Public companies. Give your opinion with reasons. (5 Marks December 2014)
Answer
The Directive issued by ICAN on Ceiling over the number of audits requires that a member holding COP
can audit the books of accounts of a maximum 100 clients only, in a financial year. Out of these 100

clients, number of Public Companies shall not exceed 10. The above limit is applicable for each member
of a partnership firm. Provided, organizations whose annual turnover is less than NRs. 20 lakhs, such as
small Cooperatives, Religious organizations, Social Organizations, Consumer Group, Different
Committees, Trade Unions, Professional Associations and other entities of similar nature are not included
while calculating the above limit. Thus, in view of above requirement, new audit can be accommodated
subject to total limit for two partners.
Question No. 57
Comment on the following situations/statements: (5 Marks each December 2014)

a) Explain the types of threat as explained in ICAN Code of ethics.
b) Lalu and Associates has been appointed as auditor for the year 2070/71 of ABC Bank Limited,
a commercial bank in the general meeting dated 25 Paush 2070 for remuneration of Rs.
500,000. In the course of the audit, the auditor finds that the audit fee is too low and negotiates
with the management for increase of the fees to the tune of Rs. 700,000. The board approves
the increased fee.
Answer
a) The various types of threats explained in ICAN code of ethics are as follows:
 Self-interest threat – the threat that a financial or other interest will inappropriately influence
the professional accountant‟s judgment or behavior; For e.g. lowballing, hospitality or other
benefits, contingent fees, loans to clients etc.
 Self-review threat – the threat that a professional accountant will not appropriately evaluate
the results of a previous judgment made or service performed by the professional accountant,
or by another individual within the professional accountant‟s firm or employing organization,
on which the accountant will rely when forming a judgment as part of providing a current
service; For e.g. valuation services along with audit service, accounting services.
 Advocacy threat – the threat that a professional accountant will promote a client‟s or
employer‟s position to the point that the professional accountant‟s objectivity is compromised;
For e.g. the auditor Should not offer legal services to a client and defend them in dispute or
litigation which is material to the financial statement
 Familiarity threat - the threat that due to a long or close relationship with a client or
employer, a professional accountant will be too sympathetic to their interests or too accepting
of their work. For e.g. participation in client affairs, family and personal relationship, audit
partners leaving to join clients etc.
 Intimidation threat – the threat that a professional accountant will be deterred from acting
objectively because of actual or perceived pressures, including attempts to exercise undue
influence over the professional accountant. For e.g. if there is actual or threatened litigation
between client and assurance firm, the firm should not continue to act.

c) As per section 67 of Bank and Financial Institutions Act, 2063, the remuneration of the auditor shall
be as prescribed by the general meeting if he or she has been appointed by the general meeting and
by the board if he or she has been appointed by the board. In the given case Lalu and Associates has
been appointed by the general meeting of ABC Bank Limited and hence his remuneration shall be
as prescribed by general meeting. So, the revision in the audit fees by the board in this case is not
valid.
Question No 58
An INGO invites bid from interested CA firms for audit service for the calendar year 2014. Upon
request by Lakhe & Co, Chartered Accountants, the INGO does not provide information about the
audit fees for the year 2013. Please advise whether Lakhe & Co should submit his bid for the audit or
not. (5 Marks July 2015)
As per council decision/code of ethics in relation to minimum audit fee, an audit firm shall take into
account the audit fees of the previous year while quoting audit fees such that the current year‟s fee
should not be less than the previous year. If information about the previous year‟s fee cannot be
obtained, the auditor shall specify in his proposal that his fee shall be higher of the proposed audit fee
and previous year‟s audit fee.
So, in the given case, Lakhe & Co can submit his proposal by clearly mentioning that the audit fee
shall be the higher of the proposed audit fee or previous year‟s audit fee.
Question No. 59
Answer the following: (5 Marks each July 2015)

Explain the provisions of Custody of Client Assets as given in Code of Ethics. What are the
safeguards or measures to be taken to balance this threat?
While taking custody of Client Assets following things needs to be evaluated:
 Keep such assets separately from personal or firm assets;

 Use such assets only for the purpose for which they are intended;
 At all times be ready to account for those assets and any income, dividends, or gains generated,
to any persons entitled to such accounting;
 Comply with all relevant laws and regulations relevant to the holding of and accounting for
such assets.
 Make appropriate inquiries about the source of such assets and consider legal and regulatory
obligations.
 Consider seeking legal advice where needed.
Question No. 60
Answer the following: (5 Marks each, December 2015)

a) Elephant Bank Ltd. is the "A" Class Commercial Bank. As per audited financial statement of
FY 2071/72 , its gross loan is Rs. 50,000 million and its gross deposit is Rs. 63,000 million. The
Annual General Meeting of the bank for FY 2071/72 was conducted on 12 Aswin 2072. The
auditor for FY 2072/73 has been appointed by the bank with audit fees (other than other audit
related expenses) of Rs. 1,100,000. Comment.
b) Is there any conflict of interest if the engagement auditor prepares financial regulation and
internal control system of the same client?
c) Raman & Associates is the audit firm of registered auditor (B Class). He has carried out the
audit of Prabhu Ltd. for FY 2071/72. The Total Assets or Liabilities of Prabhu Ltd. for FY
2071/72 as per Financial Statement is Rs. 650 million. Comment.
a) Answer
The decision of 194th Meeting of the Council of the Institute of the Chartered Accountants of
Nepal (ICAN), the minimum fees for listed public financial institutions has been prescribed
which is applicable for appointments made from 1 Shrawan 2072. The fees should be determined
based on Gross Loan or Deposit whichever is higher of immediately preceding year as follows:
Loan or Deposit Amount (Rs.) Minimum Audit Fees (Rs.)

Exceeding 100,000 Million 25 Lakh
Minimum 01 Lakh
Further it has been mentioned that audit fee of the “A" Class Commercial Bank should not be less
than Rs. 10 Lakh.
In view of the aforesaid council decision, the minimum audit fee (other than other audit related
expenses) of the Elephant Bank Ltd. should be Rs. 20 Lakh since its gross deposit is exceeding
Rs. 50,000 million as of 31 Asadh 2072.
Accordingly decision made by AGM of Elephant Bank Ltd. for audit fees for FY 2072/73 is not
consistent with decision of 194th Meeting of the Council of the Institute of the Chartered
Accountants of Nepal (ICAN).
b) Answer
It will not be treated as conflict of interest only on the ground that financial regulation and
internal control system has been prepared by the Auditor. Though auditor has to assess the
effectiveness of such imposed system during the course of audit. Accordingly the chances of

excusing by the auditor on the lapses of implementation of those system observed during auditing
process could not be ruled out which will impair the very efficiency and independence of the
auditor. Hence chances of arising the situation of conflict of interest have been existed in such
circumstances.
c) Answer
As per the Rule 53 of the Nepal Chartered Accountants Regulations 2061 (as amended); the limit
(threshold) for audit of entities based on volume of total assets or total liabilities has been
prescribed unlimited amount for CA member and up to Rs. 1 billion, Rs.250 million and Rs. 50
million for B, C & D class members respectively.
In view of the above amended rule of the ICAN Regulation 2061, Raman & Associates, being B
class audit firm is eligible for carrying out the audit of Prabhu Ltd. for FY 2075/76, since total
assets or total liabilities of the company do not exceed the prescribed limit of Rs. 1 Billion.
Question No. 61
KP is Chartered Accountant Member of the Institute of Chartered Accountants of Nepal. He could
not pay off the loan taken from one of the Commercial Bank. The Bank blacklisted and published the
name in national daily newspaper. The Bank wrote a letter to ICAN for action.
(5 Marks June 2016)
As per section 22 of Nepal Chartered Accountants Act, 1997 on provision of removal of names and re-
instatement, the Council may issue an order to remove the name of any member from the Membership
Register on any of the following circumstances:-
a. If he is convicted by a court in a criminal offense involving moral turpitude and punished
therefor,
b. If he fails to pay any fees required to be paid to the Institute,
c. If he fails to abide by the professional conduct referred to in this Act and the Rules framed under
this Act,
d. If he becomes unsound-minded, or
e. If he is dead.
Based on the above provision, mere on the ground of loan defaulter, ICAN cannot initiate action.
Question No 62
Answer the following: (5 Marks each June 2016)
a) What is the requirement of Code of Ethics regarding use and disclosure of confidential
information of client acquired by a professional accountant as a result of his service to the client?
b) What are the fundamental principles of the Code of Ethics issued by ICAN?

c) A Chartered accountant who is a member of ICAN is a full-time employee of ABCD & Associates
(a CA firm registered with ICAN). During the audit of an INGO from his firm (ABCD), he was
requested by the client to audit a partner organization of INGO in his personal capacity. Shall he
accept the appointment of auditor of Partner Organization of INGO?
Answer
a) Use and Disclosure of Confidential Information of Client:
The principle of confidentiality imposes an obligation on all professional accountants to maintain
confidentiality of information acquired as a result of professional or business relationship unless there is
legal or professional right or duty to disclose. However, there are certain circumstances when
confidential information can be disclosed.
As per 110.114 of the Code of Ethics of ICAN provides the circumstances where confidential
information can be disclosed as below
a. When disclosure is authorized.

b. When disclosure is required by law.
c. When there is a professional duty or right to disclose.
i) To comply with the quality review of a professional body;
ii) To respond to an inquiry or investigation by a professional or regulatory body;
iii) To protect the professional interests of a professional accountant in legal proceedings; or
iv) To comply with technical and professional standards, including ethics requirements.
b) Fundamental Principles of Code of Ethics: There are the following fundamental principles:
i. Integrity – to be straightforward and honest in all professional and business relationships
ii. Objectivity– to not allow bias, conflict of interest or undue influence of others to override
professional or business judgments.
iii. Professional Competence and Due Care – to maintain professional knowledge and skill
at the level required to ensure that a client or employer receives competent professional
service.
iv. Confidentiality– neither discloses any confidential information to third parties without
proper and specific authority nor use the information for the personal advantage of the
professional accountant or third parties.

v. Professional Behavior – to comply with relevant laws and regulations and avoid any
action that discredits the profession.
c) Audit by a CA member in employment: As per decision of the council of ICAN, a CA

member of ICAN who is in full time employment is not entitled to hold active Certificate of
Practice. In other words, a CA member can either be in full time employment or in practice
(also popularly known as one man one profession). So, in the give case the CA member
should not accept the audit assignment in his personal name.
Question No. 63
a) Write down the functions, duties and powers of audit committee Company Act, 2063.
b) Write down the disqualifications of the auditor as per Company Act, 2063.
a) Answer
Section 165 of the company act 2063 has prescribed the functions, duties and powers of audit
committee: The functions, duties and powers of the audit committee formed pursuant to subsection (1)
of Section 164 shall be as follows:
i. To review the accounts and financial statements of the company and ascertain the truth
of the facts mentioned in such statements;
ii. To review the internal financial control system and the risk management system of the
company;
iii. To supervise and review the internal auditing activity or the company;
iv. To recommend the names of potential auditors for the appointment of the auditor of the
company, fix the remuneration and terms and conditions of appointment of the auditor
and present the same in the general meeting for the ratification thereof;
v. To review and supervise as to whether the auditor of the company has observed such
conduct, standards and directives determined by the competent body pursuant to the
prevailing law as required to be observed in the course of doing auditing work;
vi. Based on the conduct, standard and directives determined by the competent body
pursuant to the prevailing law, to formulate the polices required to be observed by the
company in respect of the appointment and selection of the auditor;
vii. To prepare the accounts related policy of the company and enforce, or cause to be
enforced, the same;
viii. Where any regulatory body has provided for the long-term audit report to be set out in
the audit report of the company, to comply with the terms required preparing such
report;

ix. To perform such other terms as prescribed by the board of directors in respect of the
accounts, financial management and audit of the company.
b) Answer
Section 112 (1) of the company act 2063 stated the disqualification of auditor. Accordingly, none of
the following persons or the firms or companies in which such persons are partners shall be
qualified for appointment as auditor and shall, despite appointment as auditor, continue to hold
office:
 A director, advisor appointed with entitlement to regular remuneration or cash benefit, a person
or employee or worker involved in the management of the company or a partner of any of them
or an employee of any of such partners or a close relative of a director or partner, out of them,
or an employee of such relative;
 A debtor who has borrowed moneys from the company in any manner, or a person who has
failed to pay any dues payable to the company within the time limit and is in such arrears or
close relative of such person;
 A person who has been sentenced to punishment for an offense pertaining to audit and a period
of five years has not elapsed thereafter;
 A person who has been declared insolvent;
 A substantial shareholder of the company or a shareholder holding one percent or more of the
paid-up capital of the company or his close relative;
 A person who has been sentenced to punishment for an offense of corruption, fraud or a
criminal offense involving moral turpitude and a period of five years has not elapsed thereafter;
 A person referred to in Sub-section (3) of Section 111;
 In the case of a public company, any person who works, whether full time or part time, for any
or a person who is authorized to sign any documents or reports to be prepared by the
management of the company;
 A company or corporate body with limited liability;
 A person having interest in any transaction with the company or his/her close relative or a
Question No. 64

a) Explain the procedures for appointment of auditor of corporate bodies wholly owned by
Government of Nepal.
b) Define the term "Performance Audit".

Answers (a):
Section 10 of Audit Act 2075 (2018 AD), deals with the provision for appointing Auditor of Corporate
Bodies Wholly Owned by Government of Nepal. The related provisions are:
 As per Section 3 (kha); the audit of the corporate bodies wholly owned by Government of Nepal
shall be audited by the Auditor General pursuant to this Act.
 As per section 6 (1); notwithstanding anything contained in the section 3 (kha), he/she may appoint
license holder auditors under the prevailing laws an assistant. While appointing auditor as such,
he/she shall give priority to the Nepali citizen.
 As per section 6 (2); The auditor appointed pursuant to Sub-section (2) shall act under the direction,
supervision and control of the Auditor General.
 As per section 6 (3); The powers, functions, duties and responsibilities of the auditors appointed
pursuant to Sub-section (2) and the procedures to be followed by them in course audit and
provisions relating to their report shall be as prescribed by the Auditor General.
 As per section 6 (4); The remuneration to be paid by the concerned organization to the auditors
appointed pursuant to Sub-section (2) shall be fixed by the Auditor General keeping in view the
volume of financial transactions, status of accounts, number of branches and sub-branches, work
load and work progress of the concerned organization.
Answers (b):
According to INTOSAI‟s Auditing Standards, performance audit is an independent examination of the

efficiency and effectiveness of government undertakings, programs or organizations, with due regard to
economy, and the aim of leading to improvements.
Performance audit is based on decisions made or goals established by the legislature, and it may be
carried out throughout the whole public sector.
Performance audit is concerned with the audit of economy, efficiency and effectiveness (the three E‟s).
A performance audit assignment may include all/one or a combination of two aspects of “3Es”.
“Economy” means the acquisition of the appropriate quality and quantity of human, financial, physical
and information resources at the appropriate times and at the lower cost possible. It is minimising the
cost of resources used for an activity (input), having due regard to appropriate quality.
“Efficiency” means the use of human, financial, physical and information resources such that the output
is maximized for any given set of resource inputs, or input is minimized for any given quantity and
quality of output.

“Effectiveness” means the achievement of the objectives or other intended effects of activities. It
addresses whether policy objectives or goals have been met and whether this can be attributed to the
policy pursued.
The concept of performance auditing emerged in response to:
 increasing demand for information on efficiency and economy in managing resources and the
effectiveness with which objectives are met;
 need to determine whether:
 the operations of audit entities were conducted in a way that ensures the best possible use of
resources or considering the 3Es;
 officials in the public sector have met their accountability obligations;
 reporting on performance is credible and adequate.
Regularity and propriety related issues which impact performance may be considered in the conduct of
performance audits.
Question No 65
Give your comments on the following cases: (5 Marks each December 2016)
a) CA. Oli has been appointed as Tax auditor for the year 2072/73 by ABC Private Limited. He finds
that the company has wrongly claimed excess carry-forward loss of Rs.1 crore in the previous
year‟s (2071/72) tax return in which he was not associated at all. This has no effect in the tax
return for the year 2072/73.
b) CA. Ram was appointed as auditor of Alpha Traders Ltd. for 2071/72 for a fee of Rs.300,000. The
turnover for that year was Rs.3 billion, 90 % of the revenue was from sale of electronic products
of “Samsung” for which the company is authorized distributor. In the early month of 2072/73, the
authorized distributorship of “Samsung” was terminated. Alpha Traders has requested CA Ram to
accept the audit of 2072/73 for a fee of Rs.100,000 as there would be negligible transactions as
compared to previous year and the time to conduct that audit shall be only 1/3 as compared to
previous year audits.
a) Answer
Section 300.6 and 360.13 of Code of Ethics 2018 deals with tax practice by professional
accountants. It states that when a professional accountant learns of a material error or omission in a
tax return for previous year (with which the professional accountant may or may not have been
associated), the client should be advised promptly to disclose the fact to tax authority. However,
CA Oli is not obliged to inform the tax authorities.

CA Oli should inform the client that it is not possible to act for them in connection with that return
or other related information submitted to the authorities. Since, the prior error does not have any
effect in tax return for the year in which he is associated, he may continue professional relation with
client but all reasonable steps should be taken to ensure that the error is not repeated in subsequent
returns.
b) Answer
As per section 330.3-A2, A professional accountant might quote whatever fee is considered
appropriate. Quoting a fee lower than another accountant is not in itself unethical. However, the
level of fees quoted creates a self-interest threat to compliance with the principle of professional
competence and due care if the fee quoted is so low that it might be difficult to perform the
engagement in accordance with applicable technical and professional standards.
It means professional accountant in public practice shall not quote lower fees than the previously
paid fees without justifiable reasons of reduction in the volume of transactions or time involvement.
In the given case above, it is seen that the company has lost major distributorship securing 90% of
its revenue and hence the work volume and time involvement is expected to decrease drastically.
Hence, CA. Ram may accept the lower fees as compared to previous year on those justifiable
grounds. However, it should be taken care that the quality of work shall not be impaired and that
due care will be applied to comply with all professional standards and quality control procedures.
Question No. 66
a) What are the basic needs to be met to achieve objectives of accounting profession as per code of
ethics?
b) Write briefly on the composition and function of Disciplinary Committee under ICAN Act, 2053.
c) What due care should a professional accountant in public practice adopt while handling client‟s
monies?
a) Answer
The code of ethics recognizes that the objectives of the accountancy profession are to work to the
highest standards of professionalism, to attain the highest levels of performance and generally to
meet the public interest requirement set out above. These objectives require four basis needs to be
met:
 Credibility: In the whole of society, there is need for credibility in information and information
systems

 Professionalism: There is need for individuals who can be clearly identified by clients, employers
and other interested parties as professional persons in the accountancy field.
 Quality of Services: There is a need for assurance that all services obtained from a professional
accountant are carried out to the highest standards of performance
 Confidence: Users of the services of professional accountants should be able to feel confident that
there exists a framework of professional ethics which govern the provision of those services.
b) Answer
As per Section 14 of ICAN Act, a disciplinary committee comprising of following members shall
be constituted:
a. FCA member designated by council from amongst elected CA council member-

Chairman
b. three persons nominated by the council from amongst the council members- Member
c. Two persons nominated by the council amongst the members-Member
d. One person nominated by the Auditor General-Member
The main function of the disciplinary committee is to recommend the council to take necessary
actions after investigations upon complaints lodged against any action contrary to the ICAN Act or
regulations, by-laws or code of conduct framed under the ICAN Act rendered by any member , or
the institute receives any information of such kind.
The chairman or members are not allowed to attend any meeting that hears complaint against the
Chairman or member of disciplinary committee. The Disciplinary committee has the authority,
similar to a Judicial Court, in respect of summoning concerned person and investigating evidences
and witnesses.
The disciplinary committee recommends to the council, along with its opinion and finding, for
necessary action against a member.
c) Answer
As per ICAN‟s Code of Ethics, a professional accountant in public practice should:
a. not hold client‟s money if there is reason to believe that they were obtained form, or are to
be used for, illegal activities.
b. keep such client‟s monies separately from personal or firms‟ monies

c. use only for the intended purpose and always be ready to account for those monies to any
persons entitled
d. maintain separate bank account for such monies and any monies received should be
deposited without delay to credit of a client account.
e. monies should only be drawn from the client account on instruction form the client
f. fees may be drawn from client‟s monies only after intimating the amount of fees and
client has agreed to such withdrawal.
g. provide a statement of account to client at least once a year
h. if the monies remain for a significant time, place such monies in interest bearing account
with concurrence from such client. All the interest earned should be credited to the client
account.
Question No. 67
CA. M Khatri is Chairman of Dotel Consulting Ltd. AGM of KC Textile Ltd. is planning to appoint
Dotel Consulting Ltd. as an auditor for financial year 2073/74.
Section 112 of Companies Act, 2063 has explained the disqualification of auditor as follows:
i. A director, advisor appointed with entitlement to regular remuneration or cash benefit, a person
or employee or worker involved in the management of the company or a partner of any of them
or an employee of any of such partners or a close relative of a director or partner, out of them,
or an employee of such relative;
ii. A debtor who has borrowed moneys from the company in any manner, or a person who has
failed to pay any dues payable to the company within the time limit and is in such arrears or
close relative of such person;
iii. A person who has been sentenced to punishment for an offense pertaining to audit and a period
of Three years has not elapsed thereafter;
iv. A person who has been declared insolvent;
v. A substantial shareholder of the company or a shareholder holding one percent or more of the
paid-up capital of the company or his/her close relative;
vi. A person who has been sentenced to punishment for an offense of corruption, fraud or a
criminal offense involving moral turpitude and a period of five years has not elapsed thereafter;
vii. A person referred to in Sub-section (3) of Section 111;
viii. In the case of a public company, any person who works, whether full time or part time, for any
or a person who is authorized to sign any documents or reports to be prepared by the
management of the company;
ix. A company or corporate body with limited liability;

x. A person having interest in any transaction with the company or his/her close relative or a
The auditor shall, prior to his/her appointment, give information in writing to the company that
he/she is not disqualified pursuant to Subsection (1).
Where any auditor becomes disqualified to audit the accounts of a company or there arises a
situation where he/she becomes disqualified for appointment or can no longer continue to act as
an auditor of the company, he/she shall immediately stop performing audit which is required to be
performed or is being performed by him/her and give information thereof to the company in
writing.
The audit performed by an auditor who has been appointed in contravention of this Section shall
be invalid.
Thus, even though M Khatri is a Chartered Accountant, company cannot be appointed as auditor
of KC Textile Limited.
Question No. 68
a) Discuss about the procedure mentioned in Companies Act, 2063 regarding appointment of
auditors.
b) Discuss about provision relating to removal of appointed auditor as per Companies Act, 2063.
Answer:
a) As per Section 110 of Companies Act 2063, every company shall appoint an auditor under to
have its accounts audited. In cases where any company has a branch office outside Nepal, the
auditor so appointed may also audit the accounts of that branch office except as otherwise
provided in the prevailing law of the country where such branch office is situated. Similarly, as
persection111, the auditor of a company shall be appointed, from amongst the auditors licensed to
carry out audit under the prevailing law, by the general meeting subject to provisions contained in
chapter 18 of this act, in the case of a public company, and, in accordance with the provision as
contained in the memorandum of association, articles of association or consensus agreement, any
failing such provision, by the general meeting, in the case of a private company; and his/her name
shall be forwarded to the Office within fifteen days from the date of such appointment.
Provided, however, that the board of directors may appoint the auditor prior to the holding of the
first annual general meeting.

The auditor appointed shall hold office only until the next annual general meeting. No auditor or
his/her partner or ex-partner or employee or ex-employee shall be appointed as auditor for more
than three consecutive terms to perform the audit of a public company.
Provided, however, that this restriction shall not apply to any partner who ended partnership or
any employee who left the service of such audit or three years before.
As per section 113, Where the annual general meeting of a company fails to appoint an auditor
for any reason or where the annual general meeting itself cannot be held or where the auditor
appointed pursuant to this Act ceases to continue his/her office for any reason, the Office may, at
the request of the board of directors of the company, appoint another auditor.
b) Answer
As per section 119 of Companies act 2063, no auditor appointed pursuant to provisions laid down
in this act shall be removed pending the completion of audit of accounts of any financial year for
which he/she was appointed as the auditor. Notwithstanding anything contained in this section, if
any auditor breaches the code of conduct of auditors or does any act against the interest of the
company which has appointed him as the auditor or commits any act contrary to the prevailing
law, such auditor may be removed through the same process whereby he/she was appointed as
auditor, by giving prior information to the ICAN, and with the approval of the regulatory
authority, if any authorized by the prevailing law for the regulation of business of the company
concerned , and failing such authority, with the approval of the Office.
While removing an auditor, the auditor shall be provided with a reasonable opportunity to defend
him/herself.
Question No. 69
CA Aarjit Dongol has been appointed as statutory auditor of MNO Limited for the fiscal year
2072/73. He has been holding certain paid up share capital of the company since the year 2070. Is
the appointment of CA Dongol valid? (5 Marks each June 2017)
Answer
Section 112 of the Companies Act, 2063 states the disqualifications of an auditor. As per the Act, none of
the certain persons or the firms or companies in which such persons are partners shall be qualified for
appointment as auditor and shall, despite appointment as auditor, continue to hold office.
Provision regarding appointing shareholder as auditor as per Section 112 Sub Section c of Companies
Act, 2063 states that: persons or the firms or companies who is substantial shareholder of the company
or a shareholder holding one percent or more of the paid-up capital of the company or his close relative
cannot be appointed as auditor.

In the given case, the percentage of holding of paid up capital is not mentioned. If CA Dongol himself or
firm or company in which he is partner or shareholder, or his close relative do not hold one percent or
more than one percent of the paid-up capital of MNO Limited only then he is qualified to be appointed as
auditor.
Question No 70
Give your comments on the following cases: (5 Marks each June 2017)
a) The Joint Merger Committee of Alpha Bank and Beta Bank has appointed CA Ramarjun as Due
Diligence Auditor of both banks for the merger process. The appointment letter has following
clause regarding fees: “Fees amounting to Rs.300, 000 for each bank (exclusive of VAT) shall be
paid on submission of DDA report. Additional payment of Rs.150,000 (inclusive of VAT) shall be
made, if the merger is successful.”
b) CA Chandan was appointed auditor of Delta Telecom Ltd. He presented audit plan where in ten
teams comprising 4 personnel in each team will be visiting 40 branches (out of 50) across the
country for a total of around 4 months. The finance controller of Delta Telecom offered SIM
cards for all the team members engaged in the audit with one-year free 4G data and voice services
and unlimited one year free 10 MB internet to Auditor‟s Office as logistic support so that
communication/emails with all the members are uninterrupted during the course of audit. It is
expected that CA Chandan will be appointed as auditor for next two years as well. The general
one-time price of SIM cards and installation charges for internet however shall have to be paid
for. The Finance Controller requests for replacing some of the branches with others for audit.
Answer (a)
Section 330 “Fees and other types of remuneration” of Code of Ethics of ICAN , states that
Professional services should not be offered or rendered to a client under an arrangement whereby
no fee will be charged unless a specified finding or result is obtained or when the fee is otherwise
contingent upon the findings or results of such services. Fees charged on a percentage or similar
basis should be regarded as contingent.
In the given instance; though the first part of the clause of fee is straight forward and will be
received on submission of the DDA report, the second part of the fee is contingent upon the
successful merger. The second part of the fee will not be there if the merger is unsuccessful. It is
understood that the success of merger shall be significantly influenced by the DDA Report. This
may also cause self-interest threat on the objectivity of the assignment. Given the facts, CA
Ramarjun should not accept the assignment based on the given terms of fee.
Answer:(b)
Section 340 “Gifts & Hospitality” of Code of Ethics ICAN, states that acceptance of goods and
services from a client may create a threat to self-interest threat or familiarity threat to objectivity.
Goods and services should not be accepted except on business terms no more favorable than those

generally available to others. The existence and significance of any threat will depend on the nature,
value, and intent of the offer.
In the given case, the purchase of SIM cards at regular price seem no more favorable that to others
and the facility seemed normal in terms of logistic support for smooth conduction of the audit
works. However, the offer for free 4G data charges, voice service and internet for one year which is
extended beyond the normal course (4 months) of audit execution period. Therefore, it may not be
concluded that the offer is in normal course without the specific intent to influence the decision
making. Acceptance of the offer may pose a threat on independence and objectivity and hence
should not be accepted.
Question No. 71
Answer/Comment on the following: (5 Marks each June 2017)

Rabin & Associates; Chartered Accountants has been operating a separate bank account for keeping
client`s money in course of availing fund manager service to the client. The interest earned on such
account during financial year 2072/73 amounting Rs. 100,000 has been transferred to firm`s bank
account and booked as miscellaneous income with corresponding miscellaneous income &
expenditure in client`s bank account.
Answer:
As per Section 350 “Custody of Client Assets” of Code of Ethics of the Institute of Chartered
Accountants of Nepal, it has been clearly stated that: “All interest earned on clients` monies should be
credited to the client`s account".
The accounting entries made by Rabin & Associates; chartered accountants for interest income in client`s
account is initially correct. But subsequent transfer of interest income to firm's account by booking as
miscellaneous expense in client`s account is not correct.
In the light of the provision contained in Section 350 of Code of Ethics, a professional accountant in
public practice entrusted with money (or other assets) belonging to others shall therefore;
a) Keep such assets separately from personal or firm assets;
b) Use such assets only for the intended purpose;
c) Be ready to present accounting of those assets and any income generated from such assets at all
time to the client; and
d) Comply all the relevant laws and regulations applicable for the custody of client\s assets.
Hence, Rabin & Associates has breached the code of ethics as prescribed by ICAN and is under the
disciplinary action for non-compliance of ICAN code of ethics.
Question No. 72

Give your comments on the following cases: (5 Marks each December 2017)
a) A proprietary audit firm of Fellow Chartered Accountants has accepted the engagement to audit
the accounts of a company with annual turnover of Rs. 10 million at the audit fee of Rs. 12,000.
The firm anticipates that the audit will consume estimated time of 3-man days of the Chartered
Accountant.
b) During the course of audit of a company for fiscal year 2073/74, the finance director of the
company offered your audit team a free weekend at Fulbari Resort Pokhara.
c) Mr. A Kumar and Mr. B Kumar are the two chartered accountants just qualified their exams and
took membership from ICAN in Bhadra 2074. A Kumar, who without holding the Certificate of
Practice, signed a document in capacity of the member holding Certificate of Practice and B
Kumar, as being a member of ICAN, committed an act contrary to the provisions of Section 41of
ICAN Act.
Answer
a) Answer
As per the decision of the council, an FCA member holding COP shall charge the audit fee to his
clients and the fee shall not be less than Rs. 15,000. In the present case, the FCA member has
charged Rs. 12,000 to a private company is less than the minimum fee. The auditor should have
charged at least Rs. 15,000 as the audit fee. Hence the member seems to have not followed the
directives of the council and accordingly may be subject to disciplinary action.
b) Answer
As per the Section 250 of code of ethics issued by ICAN, accepting gifts or hospitality from an
audit client may create self-interest threat and familiarity threats. If a firm or member of audit team
accepts gifts or hospitality unless the value is nominal and inconsequential the threat created would
be so significant that no safeguard could reduce the threats to an acceptable low level.
Consequently, a firm or member of the audit team shall not accept such gifts or hospitality.
The given case represents a self-interest threat as the acceptance of goods and services unless value
of such goods or service offered is very insignificant. As it is unlikely that a weekend at a luxury
hotel for whole audit team has an insignificant value, then, this offer should politely be declined.
c) Answer
Section 41 of Nepal Chartered Accountants Act, 2053 has made different level of punishment for
different levels of culpability. Here in case of A Kumar, If a person, who has not obtained a
Certificate of Practice and is proved to have signed any document in capacity of the member
holding Certificate of Practice, shall be liable to punishment with a penalty up to two thousand
rupees or imprisonment for a period of up to three months or both.

In case of B Kumar, if a member, who commits any act contrary to the provisions of this Act or
Regulations framed under this Act other than the provisions of this section, shall be suspended for a
maximum period of five years and shall be liable of punishment with a maximum penalty of two
thousand rupees or imprisonment for a maximum period of three months or both. So, A Kumar and
B Kumar are to be punished accordingly.
Question No. 73
Answer/Comment on the following: (5 Marks each December 2017)
a) Explain the provision related to Second Opinions with reference to Code of Ethics.
b) Explain the various types of threat explained in ICAN Code of Ethics along with examples.
c) Pradhan Ghimire & Associates, a firm of chartered accountant has two partners. The firm is
already holding audit of 100 companies including audit of 20 public limited companies. The
firm is further offered for the audit of Premier Investment Limited.
a) Answer
Section 321 of Code of Ethics contains the provision relating to Second Opinions.
When asked to provide second opinion on the application of accounting, auditing, reporting or other
standards or principles to specific circumstances or transactions by a company or on behalf of a
company or any entity that is not an existing client, a professional accountant in public practice
shall evaluate the significance of any threats and apply safeguards where necessary to eliminate
them or reduce them to an acceptable level.
The existence and significance of the threat will depend on the circumstances of the request and all
the other available facts and assumptions relevant to the expression of professional judgment.
Examples of such safeguards include seeking client permission to contact the existing accountant,
describing the limitations surrounding any opinion on communications with the client and
providing the existing accountant with a copy of the opinion. If the company or entity seeking the
opinion will not permit communication with the existing accountant, a professional accountant in
public practice shall determine whether, taking all the circumstances into account, it is appropriate
to provide the opinion sought.
b) Answer
The various kinds of threats as explained in section 120.6.A3 of code of ethics are as follows:
 Self Interest Threat: The threat which occur when an auditing firm, its partner or associate could
benefit from a financial interest in an audit client Examples include direct financial interest or
materially significant indirect financial interest in a client, loan or guarantee from concerned client,
close business relationship with an audit client, potential employment with client.

 Self-Review Threat: The threat that a professional accountant will inappropriately evaluate the
result of a previous judgment made or service performed by the professional accountant or another
individual within the professional accountant‟s firm or employing organization on which the
accountant will rely when forming a judgement as part of providing a current service. For e.g.:
valuation service along with audit service, accounting service.
 Advocacy Threat: The threat that a professional accountant will promote client‟s opinion to the
point where people may believe that objectivity is getting compromised. For e.g.: Auditor acting as
an advocate on behalf of audit client in litigation or dispute with the third parties.
 Familiarity Threat: The threat that a profession accountant due to a long or close relationship
with a client, will be too sympathetic to their interests or too accepting of their work. For e.g.:
participation in client‟s affair, family and personal relationship, audit partners leaving to join the
clients etc.
 Intimidation Threat: The threat that a professional accountant will be deterred from acting
objectively because of actual or perceived pressure, including attempts to exercise undue influence
over professional accountant. For e.g.: A firm being treated with dismissal from a client
engagement.
c) Answer
The council vide its meeting no 194 dated Falgun 4, 2071 has amended provision relating to ceiling
over the number of audit. The amended provision is as below and is effective for appointment from
Shrawan 1, 2072.
A member holding Certificate of Practice of can perform the audit of not more than 100 entities in a
financial year, out of which audit of public companies shall not exceed 10. The above limit is
applicable for each member of a partnership firm. However, audit of certain entity having turnover
of less than 20 lacs is not included while calculating the above limit.
Thus, the firm can take maximum of 200 audits (100*2), but the number of public company audit
can‟t exceed 20. As, the firm is already holding audit of 20 public limited companies Pradhan,
Ghimire & Associates can‟t take the audit of the Premier Investment Limited.
Question No. 74
As an auditor, give your opinion with explanations on the following case:

You are an engagement manager for an audit team for M/s Sun Life Ltd. for financial statements as
on Ashadh 31, 2073. Your team is about to drafting management letter after all transaction testing and
review; the board of director of M/s Sun Life Ltd. has appointed new CEO. After assuming his office,
he decided to change few general managers and auditor for FY 2072-73 with immediate effect.
As per provision contained in Section 119 of companies Act 2063 relating to removal of appointed
auditor, no auditor appointed pursuant to Companies Act shall be removed pending the completion of
audit of accounts of any financial year for which he/she was appointed as the auditor.
However, if any auditor breaches the code of conduct of auditors or does any act against the interest of
the company which has appointed him as the auditor or commits any act contrary to the prevailing law,
such auditor may be removed through the same process whereby he/she was appointed as auditor, by
giving prior information to the Nepal Chartered Accountants Institute, and with the approval of the
regulatory authority, if any authorized by the prevailing law for the regulation of business of the
company concerned , and failing such authority, with the approval of the Office of company registrar.
In case of M/s Sun Life Ltd, CEO is not the person to appoint and remove statutory auditor and the
actions taken by the CEO is null and void and additionally, an appropriate communication to those
charged with governance is required.
Question No. 75
Mr. KC, Partner of CA firm involved in Audit of X Limited was offered with luxury car by X Limited
for his personal use till financial statements is approved in AGM. Give your comments (5 Marks June
2018)
Answer
A professional accountant in public practice or an immediate or close family member may be offered
gifts and hospitality from a client that may create threats to compliance with the fundamental principles
of code of ethics.
When a professional accountant in public practice or an immediate or close family member is offered
gift and hospitality, the situation shall be evaluated. In the instant case, an offer of using luxury car for
personal use may influence the opinion of professional accountant in public practice. Self-interest
threats to objectivity or confidentiality are created when gifts and hospitality is made to unduly
influence actions or decisions, encourage illegal or dishonest behavior, or obtain confidential
information. Intimidation threats to objectivity or confidentiality are created if such gifts & hospitality
is accepted by the professional accountant in public practice or an immediate or close family member.
A professional accountant in public practice shall evaluate the significance of such threats and apply
safeguards when necessary to eliminate the threats or reduce them to an acceptable level. Accordingly,

when the threats cannot be eliminated or reduced to an acceptable level through the application of
safeguards, such offer shall not be accepted.
Question No. 76
Answer/Comment on the following: (5 Marks each June 2018)
a) What is „Independence of Mind‟ and „Independence in Appearance‟?
b) You are the statutory auditor of PQR Ltd., while carrying out the audit you found existence of
certain threats to objectivity at significant level. What is your duty in such situation? Give the
examples of safeguards you will apply in such situation?
c) Explain the provision relating to 'Conflicts of Interest' with reference to Part B of Code of Ethics.
Answer:
a) In case of audit engagements, it is in the public interest and, therefore, required by section 290 0f
Code of ethics, that members of audit teams, firms and network firms shall be independent of audit
clients.
 Independence of Mind
Independence is a state of mind and personal character and an enlightened view of the professional
duties involved. The state of mind that permits the expression of a conclusion without being affected
by influences that compromise professional judgment, thereby allowing an individual to act with
integrity and exercise objectivity and professional skepticism.
 Independence in Appearance
Independence of auditor must not only exist in fact, but should also appear to exist to all reasonable
persons. The avoidance of facts and circumstances that are so significant that a reasonable and
informed third party would be likely to conclude, weighing all the specific facts and circumstances,
that a firm‟s, or a member of the audit team‟s, integrity, objectivity or professional skepticism has
been compromised.
b. As per Section 280 (4) of ICAN Code of Ethics, I should evaluate the significance of such threats and
should apply safeguards when necessary to eliminate them or reduce them to an acceptable level.
The safeguards that should be applied are:
i. Withdrawing from the engagement team;
ii. Supervisory procedures;
iii. Terminating the financial or business relationship giving rise to the threat;
iv. Discussing the issue with higher levels of management within the firm;
v. Discussing the issue with those charged with governance of the client.
If safeguards cannot eliminate or reduce the threat to an acceptable level, I should decline or
terminate the audit engagement of PQR Ltd.
c. Section 210 of Code of Ethics contains the provision relating to Conflict of Interest. A professional
accountant in public practice may be faced with a conflict of interest when performing a professional

service. A conflict of interest creates a threat to objectivity and may create threats to other
fundamental principles.
Such threats may be created when:
 The professional accountant provides a professional service related to a particular matter for two
or more clients whose interests with respect to that matter are in conflict or
 The interests of the professional accountant with respect to a particular matter and the interests of
the client for whom the professional accountant provides a professional service related to that
matter are in conflict.
A professional accountant shall not allow a conflict of interest to compromise professional or
business judgement. The professional accountant in public practice shall apply safeguards, when
necessary, to eliminate the threats to compliance or reduce them to acceptable level.
Question No. 77
Describe the functions and duties of auditors as per Companies Act, 2063. (5 Marks June 2018)
Answer:
The function and duties of auditors as per section 115 of the Companies Act, 2063 are as follows:
(1) The auditor shall, addressing the shareholders or the appointing authority, submit to the company
his/her report, certifying the balance sheet, profit and loss account and cash flow statement based
on the books of account, records and accounts audited by him/her.
(2) The audit report shall be prepared in accordance with the prevailing law or in consonance with the
audit standards prescribed by the competent body; and such report shall state the matters to be set
out under this Act, as per necessity.
(3) The audit report as referred to in Sub-section (2) shall also indicate the following matters, inter
alia:
(i) Whether such information and explanations have been made available as were required for the
completion of audit;
(ii) Whether the books of account as required by this Act have been properly maintained by the
company in a manner to reflect the real affairs of its business;
(iii) Whether the balance sheet, profit and loss account and cash flow statements received have
been prepared in compliance with the accounting standards prescribed under the prevailing
law and whether such statements are in agreement with the books of account maintained by
the company;
(iv) Whether, in the opinion of the auditor based on the explanations and information made
available in the course of auditing, the present balance sheet properly reflects the financial
situation of the company, and the profit and loss account and cash flow statement for the year

ended on the same date properly reflect the profit and loss, cash flow of the company,
respectively;
(v) Whether the board of directors or any representative or any employee has acted contrary to
law or misappropriated any property of the company or caused any loss or damage to the
company or not;
(vi) Whether any accounting fraud has been committed in the company
(vii) Suggestion, if any
Question No 78
Give your comments on the following cases (5 Marks each December 2018)
a) Mr. A, an auditor of Cold Drink Company has obtained trade secret formula during audit process.
A Case was lodged against Cold Drink Company for putting non-edible components in the drink.
Subsequently, auditor was called by Supreme Court to provide documents and his knowing in the
formulae. He shared the information he has received on formula of Cold Drink Company. Mr. B,
lodged complaints to ICAN that, Mr. A has violated Code of Ethics on the ground of breach of
confidentiality.
b) Mr. Ajay, a practicing Chartered Accountant receives commission from Mr. Sanjay, another
practicing Chartered Accountant Rs. 175,000 being 25% of the audit fee for the referral of
statutory audit of company limited, a listed company.
a) Section 114 of Code of Ethics of ICAN, specifies about the Confidentiality to be observed by
members and professional accountants. The principle of confidentiality imposes an obligation on
all professional accountants to refrain from: (a) Disclosing outside the firm or employing
organization confidential information acquired as a result of professional and business
relationships without proper and specific authority or unless there is a legal or professional right or
duty to disclose; and (b) Using confidential information acquired as a result of professional and
business relationships to their personal advantage or the advantage of third parties.
However, section 114, outlines circumstances where professional accountants are required to
disclose confidential information or when such disclosure is appropriate and once such
circumstances arise as required by law, for example i.e. production of documents or other
provision of evidence in the course of legal proceedings.
Hence, in given case, complaint of Mr. B is not valid, as Mr. A has well followed the code of
Ethics and release confidential information on trade secret only upon order of supreme court and
such release of trade secret is allowed by Ethical Code of ICAN and cannot be construed as release
of confidential information by breaching Ethical Code of ICAN for professional accountants.
b) Section 330.5 of Code of Ethics of ICAN, accepting certain a referral fee or commission creates a
self-interest threat to objectivity and professional competence and due care. According to Code of

Ethics issued by ICAN, the payment or receipt of commission by a professional accountant in

public practice could impair objectivity and independence. A professional accountant in public
practice should not therefore pay a commission to obtain a client nor should a commission be
accepted for referral of a client to a third party. The payment and receipt of commission are
permitted only for such engagements for which independence is not required and the professional
accountant in practice should nonetheless disclose the facts to the client.
In the above case since the above assignments requires independence, Mr. Ajay and Mr. Sanjay
both are not complying with ethical requirements under Code of Ethics issued by ICAN. The
disciplinary action can be taken against Mr. Ajay and Mr. Sanjay.
Question No 79
Answer/Comment on the following: (5 Marks December 2018)
a) Significant Familiarity and self-interest threats are noted due to using of same senior personnel
on an audit engagement over a long period of time. What are the safeguards to be applied to
eliminate such threats or reduce them to an acceptable level?
b) Explain situation resulting in threat to objectivity and threat to fundamental principles arising
from conflict of interest with examples.
c) During the fiscal year 2073/74 ABC & Co., Chartered Accountants, a proprietor Firm have done
the following Statutory Audits.
Listed Company: 3
Limited Company: 10
Private Limited Company: 75
INGOs: 5
In the fiscal year 2074/75, one existing listed company did not continue as auditor and other two
companies have approached to the firm to appoint as auditor. In addition, 2 other limited company
and 2 NGOs approached to the firm for the audit of FY 2074/75.
a) Answer
Section 540.3.A6 of ICAN Code of Ethics deals with this matter. The significance of threat depends
on time duration the individual has been a member of audit team, role given to her/him, structure of
Firm, nature of audit engagement, whether the entity's management team is same or changed and
the nature or complexity of the Client's accounting and reporting issues. Accordingly, the
safeguards to be applied to eliminate such threats or reduce them to an acceptable level are:
 Rotating the senior personnel off the audit team;

 Having a professional accountant who was not a member of the audit team review the work
of the senior personnel; or
 Regular independent internal or external quality reviews of the engagement.
b) Answer
Section 210 of ICAN Code of Ethics deals with this matter. A professional accountant in public
practice may be faced with a conflict of interest when performing a professional service. A conflict
of interest creates a threat to objectivity and may create threats to the other fundamental principles.
Such threats may be created when:
i. The professional accountant provides a professional service related to a particular matter for two or
more clients whose interests with respect to that matter are in conflict; or
ii. The interests of the professional accountant with respect to a particular matter and the interests of
the client for whom the professional accountant provides a professional service related to that
matter are in conflict.
Examples of Conflicts of interest may include but not limited to:
 Providing a transaction advisory service to a client seeking to acquire an audit client of the
firm, where the firm has obtained confidential information during the course of the audit
that may be relevant to the transaction.
 Advising two clients at the same time who are competing to acquire the same company
where the advice might be relevant to the parties‟ competitive positions.
 Providing services to both a vendor and a purchaser in relation to the same transaction.
 Preparing valuations of assets for two parties who are in an adversarial position with respect
to the assets.
 Representing two clients regarding the same matter that is in a legal dispute with each other,
such as during divorce proceedings or the dissolution of a partnership.
 Providing an assurance report for a licensor on royalties due under a license agreement
when at the same time advising the licensee of the correctness of the amounts payable.
 Advising a client to invest in a business in which, for example, the spouse of the
professional accountant in public practice has a financial interest.
 Providing strategic advice to a client on its competitive position while having a joint
venture or similar interest with a major competitor of the client.
 Advising a client on the acquisition of a business which the firm is also interested in
acquiring.
 Advising a client on the purchase of a product or service while having a royalty or
commission agreement with one of the potential vendors of that product or service.
c) Answer
194th ICAN Council meeting dated 16th February 2015 had revised the earlier council decision for
the number of audits that can be carried out by the ICAN COP holder with effect from 17th July

2015. As per revised decision, a member in practice can conduct the audit of 100 organizations in a
fiscal year including the maximum 10 public companies.
In the given case the number of audit engagements of ABC & Co for the fiscal year 2074/75 as are
follows:
Listed Company 3-1+2= 4

Limited Company: 10+2= 12
Private Limited Company: 75
INGOs: 5
NGOs: 2
Total: 98
Public Limited Company: 4+12 = 16.
As per the provision, a member in practice can audit 100 numbers of organizations however the
public limited company shall not exceed 10. In the given case, the total number is below 100
however the public limited company has exceeded 10. So he can accept only 10 audit engagements
of public companies. He should not accept the audit of either 6 public companies.
Question No. 80
Mr. Kumar KC is practicing as a Chartered Accountant from his proprietorship firm. He nominated
Mr. LK Khatri as partner on profit sharing basis. Mr. Khatri, is not the member of ICAN. (5 Marks
December 2018)
Answer:
a) Chapter VIII of Section 34.3 of Nepal Chartered Accountant Act, 1997 states that one shall not
share or distribute as profit the auditing fees or remuneration with any person other than a member
of the Institute; and shall not pay any commission, brokerage etc. out of the professional fees
earned to any person or member.
In the given instance; Mr. Kumar, has nominated Mr. Khatri as a partner, who is not member of
ICAN on profit sharing basis, which is against the code of conduct prescribed by ICAN.
Given the facts, Mr. Kumar is not allowed to nominate Mr. Khatri, who is not member of ICAN as
partner on profit sharing basis. Upon complaint to the Institute against Mr., Kumar, for not
upholding the conduct mentioned in this Act or the Regulations framed under this Act, the
Executive Director shall, if he finds convincing information that proves Mr. Kumar, is not
observing the conduct, submit the proposal along with the related facts to the Council for further
action against such member or member holding Certificate of Practice, and Mr. Kumar, may face
disciplinary action by ICAN.

Question No. 81
As an auditor, give your opinion with explanations on the following case:

The annual general meeting of Nepal Hydropower Limited failed to appoint the auditor for the fiscal
year 2074/75 due to time constraint and delegated power to the board under the terms recommended
by the audit committee. The board of directors appoints M/s ABC & Co., Chartered Accountants as
auditor. Do you think the appointment is valid?
Answer
According to Section 110 of the Companies Act 2063, every company shall appoint auditor under the act
to have its accounts audited. As per the Section 111, the general meeting shall appoint the auditor of the
company from the amongst the auditors licensed to carry out audit under the prevailing laws subject to
Chapter 18 of the act in case of a public limited company. The act also provides that the board of
directors may appoint the auditor prior to holding first annual general meeting. There is no any provision
to delegate the authority to anyone for appointment of an auditor. In the case of a public limited company
the annual general meeting has authority to appoint the auditor under the terms and conditions as
recommended by the Audit Committee as per Section 165 of the act.
As per section 113 of the act, in case of failure to appoint an auditor in the general meeting of the
company for any reason or where annual general meeting cannot be held, the auditor is appointed by the
Company Registrar‟s Office at the request of the board of directors of the company.
Hence, the companies Act does not have any provision of delegating power of the appointment of the
auditor and no one can appoint auditor except the annual general meeting and Company Register's Office
in case of failure to appoint the auditors by the AGM.
In the above context, the appointment of M/s ABC & Co., Chartered Accountants by the board of Nepal
Hydropower Limited is not valid. The Company Register's Office can only appoint the auditor at the
request of board of directors where annual general meeting fails to appoint auditor.
Question No 82
Miss Shristi, a Chartered Accountant, has been appointed as an auditor in the 22 nd AGM of M/s
Kantipur Ltd. She was removed by Board of Directors when she was abroad for her personal visit.
Answer:
Section 119 (1) of the Company Act, 2063 provides that no auditor appointed pursuant to Companies Act
shall be removed pending the completion of audit of accounts of any financial year for which he/she was
appointed as the auditor.

As per Sub-section (2), notwithstanding anything contained in sub-section (1), if any auditor breaches the
code of conduct of auditors or does any act against the interest of the company which has appointed
him/her as the auditor or commits any act contrary to the prevailing law, such auditor may be removed
through the same process whereby he/she was appointed as auditor, by giving prior information to the
ICAN, and with the approval of the regulatory authority, if any authorized by the prevailing law for the
regulation of business of the company concerned , and if there is no such authority, with the approval of
the Office of Registrar. While removing an auditor pursuant to sub-section (2) above, the auditor shall be
provided with a reasonable opportunity to defend him/herself.
Thus, Board of Directors cannot remove if auditor has been appointed through AGM. Further, reasonable
opportunity to defend should be provided.
Question No 83
a) Mr. Kumar, a practicing Chartered Accountant was ordered to surrender his Certificate of Practice
and he was suspended for one year on certain professional misconduct against him. During the
period of suspension, Mr. Kumar, designating himself as Tax Consultant, did the work of filing of
tax returns and made appearance as a consultant before various related authorities. He contended
that there is nothing wrong in it as he, like any other tax consultant, could take such work and his
engagement as such in no way violates the order of suspension inflicted on him.
b) A Ltd. has the total Assets of Rs. 1.2 Arab up to Chaitra end 2075 for financial year 2075/76. It has
been estimated that its total assets would be Rs.1.5 Arab for FY 2075/76. A Ltd. has appointed
Ramesh & Associates, the B class audit firm for the audit of financial year 2075/76, during its AGM
held on 2nd Baishakh 2076.
c) H Ltd. declared dividend amounting to Rs. 3 lakhs out of profits for the year ended 2074/75.
Subsequently, it was noticed that company had failed to make provisions for outstanding expenses
of Rs. 4.2 lakhs and the stock were also overvalued, which was not reported by auditors of the
company. Management of H Ltd. held auditors responsible for this situation.
Answer
a) A chartered accountant not holding certificate of practice cannot take up any other work in the
capacity of Chartered Accountant in practice because it would amount to violation of the relevant
provisions of the Nepal Chartered Accountants Act, 2053 and Code of Ethics. In case a member is
suspended and is not holding Certificate of Practice, he cannot in any other capacity to practice as a
member of the Institute. This is because once a person becomes a member of the Institute; he is
bound by the provisions of the Act and its Regulations.
In the instant case, Mr. Kumar was a practicing-chartered accountant and he was ordered to surrender
his certificate of practice and was suspended for one year. Mr. Kumar is doing the work of filing tax

returns and has appeared as a consultant before various related authorities as tax Consultant which is
not in capacity of a practicing-chartered accountant rather in capacity of authorized
representative. Any person who has been authorized to act as a tax practitioner on behalf of the
concerned registered person can become authorized representative. Thus, filing tax return and
appearing as tax consultant by Mr. Kumar is not professional misconduct under Nepal Chartered
Accountants Act, 2053 and Regulation therein and the code of ethics. Therefore, Mr. Kumar will not
be held guilty for misconduct.
b) As per rule 53 of ICAN Rule 2061 (amended in 2075), the B class registered auditor is allowed to
carry out the audit of company having total assets or liabilities up to Rs. 1Arab. In the light of such
changes in ICAN Rule, since A Ltd. has actual total Assets of Rs. 1.2 Arab during the financial year
2075/76 till Chaitra end 2075 and total estimated assets would be Rs. 1.5 Arab for FY 2075/76, the
appointment of Ramesh & Associates, the B class audit firm for the audit of financial year 2075/76
is invalid.
c) Failure to detect incorrect financial position of a company: In the given case, profit of the company
has been inflated by non-provisioning for expenses of Rs. 4.2 lakhs and by overvaluation of stock
and based on such inflated profit, the company has declared and paid dividend of Rs. 3 Lakhs.
Thus, it can be said that dividend has not been paid out of real profit. If there is insufficient profit
after adjustment of outstanding expenses and correctness of stock valuation and there is no past
reserve, it would amount to payment of dividend out of capital.
It was the duty of auditor to ascertain whether the Balance sheet and Statement of Profit and Loss
of the company show a true and fair view of the financial position and its performance. For that, he
has to exercise proper audit procedure of substantive test and evaluation of various items of Balance
sheet and Statement of profit and loss. The auditor should have checked whether all the outstanding
expenses have been provided or not and whether closing stock has been properly valued as per
NAS 2. If he was not satisfied, he should have issued a qualified report or adverse report.
In the instant case, the auditor has failed to do so; he will be guilty of gross negligence in the
performance of his duty.
Question No 84
Answer/Comment on the following: (35=15, June 2019)
d) Dayahang & Co. is being considered as external auditor for audit of Nischal Pvt. Ltd.
Dayahang quoted an audit fee of Rs. 3 Lakhs plus 5% of profit.
e) Write down the provision for "Marketing Professional Services" for professional
accountant in public practice.
f) A Chartered Accountancy Firm has known that before issuing audit report of certain client
"the independence" has breached. How the audit firm shall ensure the significance of such
breach?

Answer:
a) Answer
In the given case, Dayahang & Co. is quoting a fee which is based on percentage of profit.
Contingent fees may create a self-interest threat to objectivity. The existence and significance of
such threats will depend on factors such as the nature of the engagement, range of possible fee
amounts, basis for determining the fee, whether the outcome or result of the transaction is to be
reviewed by an independent third party etc.
Code of ethics requires that professional accountant in public practice shall not quote contingent
fees for any professional services.
Also, as per Section 34 of Nepal Chartered Accountants‟ Act, Members holding Certificate of
Practice shall not base their remuneration as a percentage on the profit or on any other uncertain
results. Hence, quoting of contingent fee is not allowed by code of ethics and Nepal Chartered
Accountant‟s Act. If the Dayahang & Co. does so they will be liable for professional
misconduct.
b) Answer
Section 250 of ICAN Code of Ethics has stated the provision regarding Marketing Professional
Services". Such provisions are:
When a professional accountant in public practice solicits new work through advertising or other
forms of marketing, there may be a threat to compliance with the fundamental principles. For
example, a self-interest threat to compliance with the principle of professional behavior is created
if services, achievements, or products are marketed in a way that is inconsistent with that
principle.
A professional accountant in public practice shall not bring the profession into disrepute when
marketing professional services. The professional accountant in public practice shall be honest
and truthful, and not:
(a) Make exaggerated claims for services offered, qualifications possessed, or experience gained;
or
(b) Make disparaging references or unsubstantiated comparisons to the work of another.
If the professional accountant in public practice is in doubt about whether a proposed form of
advertising or marketing is appropriate, the professional accountant in public practice shall
consider consulting with the relevant professional body.
Notwithstanding anything mentioned hereinbefore, no professional accountant in public practice
shall solicit clients through any manner such as advertisement, designing web site etc. except in
accordance with the Guidelines on Ethical Marketing & Publicity Practices by Professional
Accountants issued by the ICAN.

c) Answer
Section 290 (42) of ICAN Code of Ethics deals with the matter. Accordingly, the audit firm
shall ensure the significance breach of independence considering the following factors:
 The nature and duration of the breach;
 The number and nature of any previous breaches with respect to the current audit
engagement;
 Whether a member of the audit team had knowledge of the interest or relationship that
caused the breach;
 Whether the individual who caused the breach is a member of the audit team or another
individual for whom there are independence requirements;
 If the breach relates to a member of the audit team, the role of that individual;
 If the breach was caused by the provision of a professional service, the impact of that
service, if any, on the accounting records or the amounts recorded in the financial statements
on which the firm will express an opinion; and
 The extent of the self-interest, advocacy, intimidation or other threats created by the breach.

Chapter 3 Planning and Assurance Engagement

Question No. 1
Discuss briefly the terms Internal Control and Internal Audit. What are the distinguishing features
between them? (10 Marks, June 2001)
Answer
Internal control is the plan of organization and all the methods and procedures adopted by the
management of an entity to assist in achieving management's objective of ensuring, as far as practicable,
the orderly and efficient conduct of its business including adherence to management policies, the
safeguarding of assets, the prevention and detection of fraud and error and accuracy and completeness of
the accounting records and the timely preparation of reliable financial information. The system of
internal control extends beyond those matters which relate directly to the functions of the accounting
system. Internal audit means the independent appraisal activity within an organization for the review of
accounting, financial and other business operations. It consists of a continuous critical review of financial
and operating activities by a staff of auditors. Internal audit is a managerial tool and it aids the
management as a control function.
Distinguish features between internal control and internal audit:
Internal control, as the definition clearly shows, is a very broad term which encompasses internal audit
also in its folds. Though internal auditing is a part of total internal control system, it is indeed a
significant part in as much as through this, actualities of performance and compliance with management
policies and practices are ascertained on a continuous and timely basis and brought to the notice of
management. Another important aspect of internal audit is that it also reviews the overall internal control
system, its efficacy or redundancy, though it itself as a part of the total internal control system. In other
words, internal audit, though a part of the total internal control system is also a significant complement of
the system in so far as it reviews the system itself and checks its operation so that management can be
posted with up to date information on the effectiveness of control and the underlying operation
Question No. 2
a. What do you understand by "auditing around the computer" and "auditing through the
computer"? (6 Marks, December 2001)
b. State the circumstances in which "auditing through computer" must be used.
a) Answer
The auditor must plan whether to use the computer to assist the audit or whether to audit without
using the computer. The former approach is known as "auditing through the computer", the latter is
called "auditing around the computer".

Auditing around the computer involves arriving at an audit opinion through examining internal
control for computer installation and the input and output only for application systems. On the basis
of quality of input and output of application systems, the auditor infers the quality of processing
carried out. Application system processing is not examined directly. The auditor views the computer
as a black box.
Auditing through computer: The auditor can use the computer to test: (a) the logic and controls
existing within the system and (b) the records produced by the system. Depending upon the
complexity of application system being audited, the approach may be fairly simple or require
extensive technical competence on the part of the auditor.
b) Answer
a. There are several circumstances where auditing through computer must be used:
 Application system processes large where volume of input and produces large volume of
output that makes extensive direct examination of the validity of input and output difficult.
 Significant parts of internal control systems are embodied in the computer system.
 The logic of the system is complex and there are large portions that facilitate use of the
system for efficient processing.
 Because of cost-benefit considerations, there are substantial gaps in visible audit trial.
Question No. 3
Write short explanatory notes on Cut-off Procedures. (4 Marks December 2001)
Answer
Cut-off procedures mean procedures employed to ensure the separation of transactions at the end of
one year from those in the commencement of the next year. Usually, the problem of overlap is found
in inventory accounting since quite often goods are sold but passed on to the buyer only after the year
is over or goods are bought but received only after the close of the year. This situation may create
considerable problem in quantification of inventory. Therefore, the principal areas of application of
cut-off procedures involve sales, purchases and stock. The auditor should satisfy himself by
examination and test-check that these procedures adequately ensure that:
 Goods purchased for which property has passed to the client have in fact been included in the
inventories and that the liability if any, has been provided for;
 Goods sold for which property has passed to the owner have been excluded from the inventories
and credit has been taken for the sales and debit has been given to the customer.

Question No. 4
What are the important features of distinction between computer-based system of according and those
of a Conventional nature? (June 2002)
Answer
The important features of distinction between computer-based system of accounting from that of a
conventional nature are as follows:
1. Absence of input documents: In computerized environment, during online data entry data entry
is done live. In such circumstances input documents are not used.
2. Design: It is more difficult and time consuming to design and install a computer-based system of
accounting than a conventional one.
3. Complexity & Reliability: Computer system is often more complex than a conventional system
(e.g. the combination if traditionally separate accounting operations within one computer
application); computerized system are generally very reliable.
4. Organization Structure: A large part of the whole system of processing becomes concentrated
in the computer department (i.e. that part of the EDP installation becomes responsible to the EDP
manager);
5. Lack of Visible Audit Trail: The steps in computer processing and the records hell on magnetic
files are not visible unless printed out. There is lack of a visible audit trail in a computer-based
system.
Question No. 5
Briefly explain the types of controls in a computerized environment. (5 Marks June 2002)
Answer
The following types of internal control are available in a computer-based system.
1. Administrative Control
2. System development control
3. Procedural Control
The controls which are designed to ensure the acceptable standard of discipline and maintenance of the
efficiency of the computer department are known as administrative control.
System development controls are those which are designed to ensure a satisfactory standard of designing
and testing system and programming and implementing and documenting them.
Procedural Controls are those exercised over separate computer application, different techniques will be
appropriate for different applications.
Administrative Controls include division of responsibilities, control over operations and file control. On
the other hand, System Development Controls include standard procedures and documentation, system
and programme testing, file conversion and systems and program amendments.
Question No. 6
The use of computer facilities by a small enterprise may increase the control risk, comment.

Answer
The statement in question is correct because of the limited segregation of duties and functions whereby
users of computers may be able to perform two or more of the following functions in the accounting
systems viz. initiating and authorizing source document; operating and entering data into the computer
system, changing / modifying of programmes and data files as also operating systems using or
distributing output. Thus, the principle that one man should not record a transaction independently is not
followed since it is not cost effective. In such a situation it is quite reasonable to expect that the risk of
not detecting errors may go up substantially. Under the circumstances, in case of a small entity the
auditor may perform substantive tests in detail and takes large sample sizes.
Question No. 7
State with reasons your views on the following:
a. Mr. X, a partner of X & Co., Chartered Accountant died of a heart attack on 30.3.2003 after
completing the entire routine audit work of T Ltd. Mr. Y one of the partners of the firm, therefore
signed the accounts of T Ltd. Without reviewing the finalization work done by the assistants.
(5 Marks June 2003)
b. A senior assistant of X & Co. Chartered Accountants drew up his audit programme without
evaluating internal controls of T Ltd. When the partner asked for the reason, he stated that the
controls were developed by the General Manager (Finance) of T Ltd. Who is a Chartered
Accountant and had written few books on "Internal Control" and therefore there was no need to
review the said area. (5 Marks June 2003)
c. An assistant of X & Co. Chartered Accountants detected an error of Rs. 5 per interest payment
which recurred number of times. The General Manager (Finance) of T Ltd. advised him not to
request for passing any adjustment entry as individually the errors were of small amounts. The
company had 2,000 Deposit Accounts and interest was paid quarterly. (5 Marks June 2003)
d. An assistant of X & Co., Chartered Accountants wanted to verify the cash in hand and investment
of T Ltd. The General Manager (Finance) of T Ltd. suggested to the assistant of X & Co. that it
was not necessary as his staff had done the same only few days back and no discrepancies were
noted.
(5 Marks June 2003
a. Answer
When the auditor delegates work to assistants or uses work performed by other auditors and experts,
he will continue to be responsible for forming and expressing his opinion on the financial information.
However, he will be entitled to rely on work performed by others, provided he exercises adequate skill
and care and is not aware of any reason to believe that he should not how so relied. Further, the
auditor should carefully direct, supervise and review work delegated to assistants. Thus, the auditor is
responsible for forming and expressing his opinion on the financial statements. He is however, entitled
to rely on work performed by others, provided he exercises adequate skill and care. In any case the
work performed by each assistant needs to be reviewed to consider whether.

i. The work has been performed in accordance with the audit programme
ii. The work performed and the results obtained have been adequately documented;
iii. All significant audit matters have been resolved or are reflected in audit conclusions;
iv. The objectives of the audit procedures have been achieved; and
v. The conclusions expressed are consistent with the results of the work performed and support the
audit opinion.
In the instant case, it is not clear whether Mr. X did review the work performed by assistants or not.
Now, it is the duty of Mr. Y to ensure irrespective of the fact of paucity of time, to review the work
performed by the assistants before he expresses an opinion on financial statements. In fact, Mr. Y
should have reviewed working papers carefully, carry test checks and scrutinize audit file thoroughly.
Accordingly, Mr. Y had failed to exercise adequate skill and care since he did not review the
finalization work performed by the assistants.
b. Answer
A proper understanding of the internal control system enables the auditor to decide upon the nature,
extent and timing of the appropriate substantive audit procedures to the performed for the different
areas to be covered under the audit programme. The management is responsible for maintaining an
adequate accounting system in cooperating various internal controls to the extent appropriate to the
size and nature of the business. The mere fact that the controls have been developed by a chartered
accountant is not important. In any case, the auditor should independently gain an understanding of
the accounting system and related internal controls and should study and evaluate the operation of
those internal controls upon which he wishes to rely in determining their nature and timing. In cases
where internal control is weak, the auditor might choose an auditing procedure or test that otherwise
might not be required, he might extend certain tests to cover a large number of transactions or other
items than he otherwise would examine at times and perform additional tests for his satisfaction. Also,
NSA 610 "Using the work of internal auditors" specifically requires the statutory auditor to read and
consider the internal audit report to determine the NTE of his audit procedures.
Accordingly, just because the internal control was developed by a chartered accountant who had also
authored a of book on internal control is of no consequence. The auditor must understand and
evaluate internal control to develop a proper audit programme.
c. Answer
The auditor is primarily concerned with items which either individually or as a group are material in
relation to the affairs of an enterprise. Therefore, the auditor while carrying out his attest function
needs to consider the possibility of misstatements of relatively small amounts that cumulatively could
have a material effect on the financial statements.

In the instant case, an error of Rs. 5 in the interest computation, even if small individually, will have a
material effect due to the number of transactions. NSA 320 "Audit Materiality" along with NSA 450
on, "Evaluation of Misstatements Identified during the Audit" states that the auditor needs to consider
the possibility of misstatements of relatively small amounts that, cumulatively, could have a material
effect on the financial information. For example, an error in a month-end (or other periodic) procedure
could be an indication of a potential material misstatement if that error is repeated each month or each
period as the case may be.
The auditor should therefore, determine the cumulative error and then take a decision as to whether an
adjustment is required or not. Accordingly, they need not pay any attention to the advice made by the
General Manager (Finance) of T Ltd.
d. Answer
It is the responsibility of the auditor to ensure that an audit is organized to cover adequately all aspects
of the enterprise as far as they are relevant of the financial statements being audited. The auditor
assesses the reliability and sufficiency/adequacy of the information contained in the accounting
records and other source date by:
i. Evaluating the accounting and internal control system and testing the control to determine the
nature, extent and timing of other audit procedures and,
ii. Carrying out such audit steps, enquires and vouching and verification procedures of accounting
transactions and account balances respectively as he considers appropriate in the particular
circumstances.
Generally, both cash and investments constitute a significant proportion of the total assets of an entity.
Physical verification of both these items to verify their existence constitutes an important auditing
procedure. Since, it is normally not possible to verify the existence of these items on the date of the
balance sheet, the Institute has recommended that surprise checks must be conducted during the year.
If necessary, in case of investments in the custody of third party‟s confirmation shall have to be
obtained.
Therefore, the auditor has to verify the cash in hand and investments even though the sum has been
verified by personnel of the Finance Department of T Ltd. for obtaining confirmation as the case may
be.
Question No. 8
Briefly describe, "auditing through the computer". (8 Marks December 2003)
Or
What do you understand by carrying out audit through the computer? (5 Marks, June 2006)
Answer
Auditing through the computer requires that the auditor submit data to the computer for processing.
The results are then analyzed for the processing reliability and accuracy of the computer programme.
Technological and other developments that required this approach include the following:

1. On line Data entry- In some systems, customers‟ orders are received by phone and entered
directly into the system with cathode ray tube input devices. No source documents are
created. The auditor cannot trace from source documents to output. The auditors are forced to
enter the system to determine the reliability and accuracy of controls and processing.
2. Elimination or reduction of print outs- With on line direct enquiry and reports prepared
only on an exception basis, print outs may not be available to trace transactions and auditors
has to enter the system to determine the accuracy of processing and contents of files.
3. Real time file updating- With real time file updating; transactions are posted as soon as they
occur. A print out supplied to the auditors showing the contents of such files may not be
accurate even for an instant.
In addition to the above some auditors decided to audit through the system for the following
reasons:
 An inability to locate the source documents

 An apprehension that the amounts shown on the computer print outs might not agree with
the balance actually contained in the computer files.
Question No. 9
Distinguish between Concurrent audit and Annual audit. (4 Marks June 2003)
Answer
A continuous or concurrent audit is one in which the auditor's staff is engaged continuously in
checking the accounts of the client the whole year round or when for this purpose the staff attends at
intervals, fixed or otherwise, during the currency of the financial period.
A final or annual audit on the other hand is commonly understood to be an audit which does not begin
until the books have been closed at the end of the accounting period and thereafter is carried on
continuously until completed.
Whether an audit ought to be conducted continuously or after the close of the financial year should be
decided on a consideration of the size of the business and the extent of detailed checking required.
Question No. 10
What are the advantages of a continuous audit? (8 Marks, December 2003)

Answer
The advantages of continuous audit are:

 Errors are discovered earlier with the result that there is adequate time for making the
necessary rectification.
 Because of the frequent attendance of the auditor, the opportunities of committing fraud are
reduced.
 Fraud, if perpetrated, is detected sooner with the result that size of the fraud is limited and
also the chances of recovering the amount lost are improved.
 The attendance of audit staff acts as a moral check on the client's staff.
 The client's accounts are always kept unto date.
 Since audit can be carried on throughout the year there is more time for detailed checking of
the accounts.
 If the audit of routine transactions is completed before the close of the year, the final accounts
can be prepared and reported upon much earlier.
 If the auditor carries on a continuous audit, he remains constantly in touch with the client's
affairs thereby able to carry out his duties efficiently.
 In the case of continuous audit, the work of the auditor is greatly facilitated since he is in a
better position to plan out his engagements and take up the job at his convenience, avoiding
the pressure at the close of the year when most of the business firms usually close their
accounts.
Question No. 11
Explain the contents of Permanent and Current files. (8Marks, June 2004, June 2009, December
2009, December 2010, December 2014)
Answer
A Permanent file normally include:
company, this includes the Memorandum and Articles of Association. In the case of a
statutory corporation, this includes the Act and Regulations under which the corporation
functions.
 Extracts or copies of important legal documents, agreements and minutes relevant to the audit.
 A record of the study and evaluation of the internal controls related to the accounting system.
This might be in the form of narrative descriptions, questionnaires or flow charts, or some
 Copies of audited financial statements for previous years.
 Analysis of significant rations and trends.
 Copies of Management letters issued by the auditor; if any.
 Record of communication with retiring auditor, if any, before acceptance of the appointment
as auditor.

A Current file normally include:

 Correspondence relating to acceptance of annual reappointment.
 Extracts of important matters in the minutes of Board Meetings and General Meetings as
relevant to audit.
 Evidence of the planning process of the audit and audit programme.
 Analysis of transactions and balances.
 A record of the nature, timing and extent of auditing procedures performed, and the results of
such procedures.
 Evidence that the work performed by assistants was supervised and reviewed.
 Copies of communication with other auditors, experts and other third parties.
 Letters of representation or confirmation received from the client.
 Conclusions reached by the auditor concerning significant aspects of the audit, including the
manner in which exceptions and unusual matters, if any, disclosed by the auditor's procedures
were resolved or treated.
 Copies of the financial information being reported on and the related audit report.
Importance of Working Papers:

 It provides guidance to the audit staff with regard to the manner of checking the schedules.
 The auditor is able to fix responsibility on the staff member who signs each schedule checked
by him.
 It acts as an evidence in the court of law when a charge of negligence is brought against the
auditor.
 It acts as the process of planning for the auditor. So that he can estimate the time that may be
required for checking of the schedules.
Ownership: Working papers are the property of the auditor. The auditor should adopt reasonable
procedures for custody and confidentiality of his working papers and should retain them for a period
of time sufficient to meet the need of his practice and satisfy any pertinent legal or professional
requirements of records retention. As per NSQC-1, retention period for audit engagements ordinarily
is no shorter than five years from the date of the auditor‟s report, or, if later, the date of the group
auditor‟s report
Question No. 12
Distinguish between principles of auditing and techniques of auditing. (4 Marks, June 2003, June 2004,
December 2005)
Answer
Auditing principles are the basic principles, which underlie every audit. An auditor has to ensure
compliance with these principles in carrying out any audit. To comply with these principles, he has to

design his audit procedures and reporting practices in an auditing situation. These principles provide the
benchmark against which an auditor's performance is evaluated. These principles are:
 Integrity, objectivity and independence
 Confidentiality
 Skills and competence
 Work performed by others
 Documentation
 Planning
 Audit evidence
 Accounting system and internal control
 Audit conclusion and reporting
Whereas, the techniques by which an auditor collects evidence are known as techniques of auditing.
These techniques are:
 Inspection of documents and records
 Physical inspection of tangible assets
 Observation
 Inquiry
 Confirmation
 Computation and re-tracing book-keeping procedures
 Analytical procedures
Thus, auditing principles are of fundamental nature which underlie the conduct of the audit. These
principles are not liable to change frequently while audit techniques may vary according to the nature of
propositions to be tested. For instance, audit technique to test the existence of cash in hand will be
different from the method to verify recover ability of sundry debtors. Further audit techniques may vary
from organization to organization depending upon the nature of business but the principles of auditing
will remain the same irrespective of the nature of the organization.
Question No. 13

a. Risk Based Auditing. (4 Marks December2004)
Answer
Risk-based auditing is an approach resorted to by the auditors with a view to avoid over-auditing in a
low-risk situations and under-auditing in the high-risk situations, thereby, wasting much of the valuable
time or exposing himself to the high risk of material misstatement going unnoticed. Under the risk-based
auditing approach, the auditor attempts to plan his audit work on the basis of his assessment of the
potential risk of existence of material errors, discrepancies, etc. In the financial statements as a whole as
in specific accounts, transactions and balances. The approach suggests that in designing an audit
programme, the assessment of the risk involved in a situation is the most important criteria to be

considered as it affects nature, timing and extent of the audit procedures. Where the auditor‟s assessment
shows a potentially low-risk in a particular situation, the extent of auditing procedures may be scaled
down as considered appropriate under the circumstances. In situations characterized by high-risk,
auditing procedures should be made more elaborate and thorough.
Question No. 14
Briefly describe, “EDP Application Controls” (6 Marks, December 2004, 5 Marks June 2006)
Answer
The purpose of EDP application control is to establish separate control procedures over the accounting
applications in order to provide reasonable assurance that all transactions are authorized and recorded
and are processed completely, accurately and on a timely basis.
EDP application controls include:
I Controls over input: to provide reasonable assurance that.

 Transaction are properly authorized before being processed by the computer.
 Transaction are accurately converted onto machine readable from and recorded in the computer
date files.
 Transaction are not lost, added, duplicated or improperly changed,
 Incorrect transactions are rejected, corrected and, if necessary, resubmitted on a timely basis.
II. Control over Processing and computer data files:
 Transaction are properly processed by the computer

 Transaction are not lost, added, duplicated or improperly changed.
 Processing errors are identified and corrected on a timely basis.
III. Control over Output:

 Results of processing are accurate.
 Access to output is restricted to authorized personnel.
 Output is provided to appropriate authorized personnel.
 Output is provided to appropriate authorized personnel on timely basis.
Question No. 15
Write Short notes Audit techniques (4 Marks, June 2004)
Answer
For collection and accumulation of audit evidence, certain methods and means are available and these are
known as audit techniques. Some of the techniques commonly adopted by the auditors are the following:
 Posting checking
 Casting checking

 Physical examination and count

 Confirmation
 Inquiry
 Year-end scrutiny
 Re-computation
 Tracing in subsequent period
 Bank Reconciliation
Question No. 16
Distinguish between Permanent Audit Files and Current audit files.
Answer
Permanent audit files, in case of recurring audits, are working paper file which are updated with
new information of continuing importance to succeeding audits. The permanent audit file normally
includes:
 Information concerning the legal and organizational structure of the clients. In the case of a
company, this includes the Memorandum and Articles of Association. In case of statutory
corporation, this includes the Act and Regulation under which the corporation functions.
 Copies of audited financial statements of prior years.
 Copies of management letters issued by the auditor, if any.
 Record of communication with the retiring auditor, if any, before acceptance of the appointment
as auditor.
 Significant audit observation or earlier years, etc.
Current audit files contain information relevant for the audit of a single period.
A current audit file normally includes.

 Correspondence relating to acceptance of annual re-appointment.
 Extracts or important matters in the minutes of Board Meetings and General Meetings, as are
relevant to audit.
 Evidence of planning process of audit and audit programme.
 Analysis of transaction and balances.
 A record of the nature, timing and extent of auditing procedures performed and the results of such
procedures.
 Evidence that work performed by assistants was supervised and reviewed.

 Copies of letters or notes concerning audit matters communicated to or discussed with the client, including
the terms of the engagement and material weaknesses in relevant internal controls.
 Letters of representations or confirmation received from the client.
 Conclusions reached by the auditor concerning significant aspects of the audit, including the manner in
which expectations and unusual matters, if any, disclosed by auditor‟s procedure where resolved or
treated.
 Copies of the financial information being reported on and the related audit reports, etc.
Question No 17
Explain about Audit Note Book. (5 Marks, June 2005, December 2008, December 2017)
Answer.
An audit note is usually a bound book in which a larger variety of matters overserved during the course
of audit are recorded. It is thus a part of the permanent record of the auditor available for reference later
on, if required. The audit note also provides a valuable help to the auditor in picking up the links of work
when the concerned assistant is away or the work is stopped temporarily because it is recorded along
with observations the various queries, explanations obtained and evidence seen, while observations the
various queries, explanations obtained and evidence seen, while queries remaining undisposed of would
be noted for follow up. It is more satisfactory in some ways, however, to use loose sheets for entering
queries and notes which, subsequently, on being punched, may be filed in a special query file maintained
for each client or along with the clients‟ accounts papers, separately for each year.
 Audit queries not cleared immediately e.g. missing receipts, vouchers etc.
 The mistakes or irregularities observed during the course of audit e.g. cases of failure to comply
with the requirements of Companies Act or the provisions contained in the Memorandum or
Articles, a change in the valuation of finished stock and work in progress or in the computation of
depreciation, failure to provide adequate depreciation etc.
 Unsatisfactory book-keeping arrangements, costing method, internal or financial administration
or organization.
 Important book-keeping arrangements, costing method, internal or financial administration or
organization.
 Special information about the company, which is not apparent from the accounts.
 Special points requiring consideration at the time of finalizing accounts.
 Important matter for future reference.
Question No 18
What do you understand by the term “audit trail”? Explain carefully the developments of data
processing, which have resulted in the auditor often finding the audit trail has been lost.
(6 Marks June 2005)

Answer.
“The audit trail” is the visible means whereby the auditor may trace a business transaction through all
the stages in which if features in the records of the business. For example, sequentially numbered copy
sales invoices would normally be listed in a register or daybook and subsequently filed either in
numerical or chronological sequence. In either case, it would be possible, by reference to the number of
the date, to trace a particular invoice from the day book to the original on file or vice versa.
Developments in computer technology have resulted in substantial increases in the speed and ease by
which data may be processed. Consequently there is a strong disincentive to leaving a visible trail or
record of all information which has been processed (even though this would enable the auditor to
perform his tasks, as it were, “around” the computer) since this necessitates the use of a line printer and
other peripheral equipment which, by contrast with the speed of computer itself, is extremely slow.
Thus, instead of the creation of comprehensive “hard copy” which was prevalent with first- and
second-generation computers, management have come to rely heavily on reporting by exception and
such reliance is inevitably complementary to the loss of the audit trail.
Question No 19
Explain the concept of Audit Materiality. (December 2005, December 2005, December 2010-
CAPII, June 2010, December 2010-Intermediate, June 2011, December 2015, December 2016)
Answer.
As per NSA 320: Audit Materiality, the auditor should consider materiality and its relationship with audit
risk when conducting an audit.
“Materiality” is defined in the Nepal Accounting Standards Board‟s “Framework for the Preparation and
Presentation of Financial Statements” in the following terms:
“Information is material if its omission or misstatement could influence the economic decisions of users
taken on the basis of the financial statements. Materially depends on the size of the item or error judged
in the particular circumstances of its omission or misstatement. Thus, materially provides a threshold or
cut-off point rather than being a primary qualitative characteristic, which information must have if it is to
be useful.”
The objective of an audit of financial statements is to enable the auditor to express an opinion whether
the financial statements are prepared, in all material respects, in accordance with an identified financial
reporting framework. The assessment of what is material is a matter of professional judgment.
In designing the audit plan, the auditor establishes an acceptable materiality level so as to detect
quantitatively material misstatements. However, both the amount (quantity) and nature (quality) of

misstatements need to be considered. Example of qualitative misstatements would be the inadequate of

improper description of an accounting policy when it is likely that a user of the financial statements
would be misled by the descriptions, and failure to disclose the breach of regulatory requirement when it
is likely that the consequent imposition of regulatory restrictions will significantly impair operating
capability.
The auditor needs to consider the possibility of misstatements of relatively small amounts that,
cumulatively, could have a material effect on the financial statements. For example, an error in a month
end procedure could be an indication of potential material misstatement if that error is repeated each
month.
The auditor considers materiality at both the overall financial statement level and in relation to individual
account balances, classes of transaction and disclosures. Materiality may be influenced by considerations
such as legal and regulatory requirements and considerations relating to individual financial statement
account balances and relationships. The process may result in different materiality levels depending on
the aspect of the financial statements being considered.
Materiality should be considered by the auditor when:
(a) Determining the nature, timing and extent of audit procedure; and
(b) Evaluating the effect of misstatements.
Question No 20
a. Materiality and Audit Risk (4 Marks June 2005, 7 Marks December 2009)
Answer:
As per NSA 320 " Audit Materiality", The auditor should consider materiality and its relationship with
audit risk when conducting an audit. According to it, information is material if its misstatement (i.e.
omission or erroneous statement) could influence the economic decisions of users taken on the basis of
the financial information. Materiality depends on the size and nature of item, judge in the particular
circumstances of its misstatement. Thus, materiality provides a threshold or cut off point rather than
being a primary qualitative characteristic, which the information must have if it is to be useful. It stresses
that the assessment of what is material is matter of professional judgment.
The audit should be planned so that audit risk is kept at an acceptable low level. After the auditor has
assessed the inherent and control risks, he should consider the level of detection risk that he is prepared
to accept and based upon his judgment, select appropriate substantive audit procedures. If the auditor
does not perform any substantive procedures, detection risk, that is the risk that the auditor will fail to
detect a misstatement, will be high. The auditor reduces detection risk by performing substantive

procedures the more extensive the procedures will also affect the detection risk than reliance on internal
data, as will procedures have carried out closure to year-end.
The auditor's assessment of audit risk may change during the course of an audit. For example, in
planning the audit, the auditor may believe that he has low inherent and control risk based on his
assessment of the probability of errors occurring and, on his review, and testing of the system of internal
control. After performing audit procedures, however, the auditor may conclude that his earlier
assessment was too low. In this case he will have to carry out additional audit procedures in order to
reduce the level of detection risk and achieve audit risk at the level originally planned.
b. Auditing in Depth. (4 Marks December 2005)

Answer:
Auditing in Depth is a system of audit, which involves tracing a transaction through its various stages
form origin to conclusion examining at each stage to an appropriate extent the vouchers, records and
authorities relating to that stage and observing the incidence of internal check and delegated authority.
Thus, if a particular purchase invoice is subjected to audit in depth, the auditor will examine the original
requisition slip, the purchase order, the tenders against which the purchase order was made, the good
receipt note, stores inspection report, the quality control report and entries in the bin card and store
ledger.
Thus, while auditing in depth, the auditor reviews all the accounting and operational aspects of the
transaction form the origin to the end. This enables him to have an overall view and evaluate the
procedures through selected transactions.
c. Audit planning & materiality (5 Marks December 2007)

Answer
Materiality is an important consideration for an auditor to evaluate whether the financial statements
reflects a true or fair view or not. Auditor should plan his audit based on audit materiality and its
relationship with audit risk while conducting an audit. When planning the audit, the auditor should
consider what would make the financial information materially mis-stated. Auditors assessment of
materiality and audit risk may be different at the time of initially planning of the audit as against at the
time of evaluating the results of audit procedures.
d. Audit Working Papers. (4 Marks December 2005)

Answer
NSA 230 “Documentations”, states that the audit working papers were written records kept by the
auditor of the evidence gathered during the course of an audit, the methods and procedures followed and
the conclusions reached. These papers generally include his examination and provide support for his
audit report. It also includes a summary of all significant matters identified, which may require the

exercise of judgment together with auditor‟s conclusions thereon. Thus, the auditor is required to
documents maters, which are important in providing evidence that the audit was carried out in
accordance with the basic principles. The documentation for the purpose refers to the performance of an
audit.
NSA 230 also requires that the auditor should adopt reasonable procedures for custody and
confidentiality of his working papers and should retain them for a period of time sufficient to meet the
needs of his practice and satisfy and pertinent legal or professional requirements of record retention.
The audit working papers demonstrate the extent of audit work carried out and by whom as well as
carried forward matters for the future. The maintenance of such working papers facilitates in conducting
each year‟s audit and provide a basis of the auditor. In fact, there can be circumstances when legal suit is
brought against the auditor and to ascertain whether or not the exercised “reasonable care and skill”
while discharging his duties would be evident form working paper only. Thus, it is imperative for an
auditor to carefully preserve the audit working papers. Moreover, they would also provide the evidence
of work performed to support the auditor‟s opinion.
e. Testing of the Internal Control System. (5 Marks December 2006)

Answer:
The auditor in forming his opinion on financial information/ statements needs reasonable assurance that
transactions should be properly authorized and recorded in the accounting, records and that transactions
have not been omitted. Internal controls, even though if fairly simple, may contribute to the reasonable
assurance the auditor seeks. The auditor's objective in studying and evaluating internal controls is to
establish the reliance he can place thereon in determining the nature, timing and extent of his substantive
audit procedures.
The auditor should acquaint himself with the important features of the business carried on by the
concern, the nature of activities and the system followed in the entire process of manufacturing, trading
and administration; such knowledge will give the auditor an awareness of the physical realities behind
the book entries and records, which he examines. He should also find out the basis on which the control
and procedures are laid down by the management. This knowledge he can always obtain by having
discussion with the various managers of organization. He should also look at the company's procedures,
manuals, study organizations flow charts to ascertain the character, scope and efficiency of the control
system. Sometimes, manuals and charts are not available or very little information available. In that case,
the auditor should contact the right officers and employee to get the desired information. He can use one
of the following to obtain correct and necessary information.
a) Narrative record
b) Check list
c) Questionnaire
d) Flow Chart

All these assessment techniques will help the auditor to understand and evaluate the internal control
system in the correct perspective.
Question No. 21
What are characteristic of an EDP organizational structure in an EDP environment?
Answer.
In an EDP environment, an entity will establish an organizational structure and procedures to manage
the EDP activities. Characteristics of an EDP organizational structure include:
Concentration of functions and Knowledge-although most systems employing EDP methods will
include certain manual operations, generally the number of persons involved in the processing of
financial information is significantly reduced. Furthermore, certain data processing personnel may be
the only ones with a detailed knowledge of the interrelationship between the source of data, how it is
processed and distribution and use of the output. It is also likely that they are aware of any inte4rnal
control weaknesses and, therefore, may be in a position to alter programs or data while stored or
during processing. Moreover, many conventional controls based on adequate segregation of
incompatible functions may not exist, or in the absence of access and other controls, may be less
effective.
Concentration of programs and data – Transactions and master file data are often concentrated,
usually in machine-readable form, either in one computer installation located centrally or in a number
of installations distributed throughout an entity. Computer programs, which provide the ability to
obtain access to and alter such data are likely to be stored at the same location as the data. Therefore,
in the absence of appropriate controls, there is an increased potential for unauthorized access to, and
alteration
Question No. 22
a. Judgmental sampling and Statistical sampling (5 Marks June 2006)
Judgmental Sampling Statistical Sampling
Traditionally, auditors have carried out Whereas, Statistical sampling means any
selective checking by what is popularly approach having characteristics of random
called the test checking or judgmental selection of a sample and use of
sampling approach. It consists of selecting probability theory to evaluate sample
and checking a predetermined proportion results, including measurement of
of transactions on the basis of the sampling risk.
auditor‟s own judgement and without
using statistical procedures. Any sampling

method that does not measure the

sampling risk can be termed as
judgmental sampling.
It is not used mechanically. This approach It helps the auditor in determining the size
should involve a careful consideration of of the sample scientifically, reduces the
the circumstances of each case, on the chance of biasness in selection of the
basis of which the auditor should sample and can give results with a
determine the items to be test checked, calculated degree of risk.
select sample, examine them and evaluate
the results in the light of his knowledge of
the business of the enterprise.
b. Audit program and Audit note book (5 Marks June 2006)
Audit Program Audit Notebook
This is a list of the audit procedures to be Audit note book is a bound book
applied in an audit in the given containing the audit program, significant
circumstances along with proper audit observations, objections, queries etc.
instructions. Thus, an audit program
contains the description of the specific
audit procedures to be performed in
respect of different aspects to be covered,
the extent to which those tests will be
performed and timing of such tests. It also
lays down the responsibilities of various
members of the audit team for carrying
out different tasks.
Question No 23
Who is responsible to prepare and present financial statements of a company?
Answer:
While the auditor is responsible for forming and expressing an opinion on the financial statements, the
responsibility for preparing and presenting the financial statements is that of the management of the
entity. The audit of the financial statement does not relieve management of its responsibility.

Question No 24
An auditor is required to develop an audit plan. Do you agree? What are the matters to be considered in
developing the overall audit plan? (8Marks, June 2006)
Answer:
Yes, I agree with this statement. As per NSA 300 planning, the auditor should plan the audit work so that
the audit will be performed in an effective manner.
Matters to be considered by the auditor in developing the overall audit plan include:
i) Knowledge of the business

 General economic factors and industry conditions affecting the entity's business.
 Important characteristics of the entity, its business, its financial performance and its reporting
requirements including changes since the date of the prior audit.
 The general level of competence of management.
ii) Understanding the accounting and internal control systems

 Accounting policies adopted and changes thereon.
 Effect of new accounting or auditing pronouncements.
 The auditor's cumulative knowledge of the accounting and internal control systems and the
relative emphasis expected to be placed on tests of control and substantive procedures.
iii) Risk and Materiality

 The expected assessments of inherent and control risks and identification of significant audit
areas.
 The setting of materiality levels for audit purposes.
 The possibility of material misstatement, including the experience of past periods, or fraud.
 The identification of complex accounting areas including those involving accounting estimates.
iv) Nature, timing and Extent of Procedures

 Possible change of emphasis on specific audit areas.
 The effect of information technology on the audit.
 The works of internal auditing and its expected effect on external audit procedures.
v) Coordination, Direction, Supervision and Review

 The involvement of other auditors in the audit of components-branches, subsidiaries and
divisions.
 The involvement of experts.
 The number of locations.
 Staffing requirements.

vi) Other Matters

 The possibility that the going concern assumption may be subject to question.
 Conditions requiring special attention, such as the existence of related parties.
 The terms of engagement and any statutory responsibilities.
 The nature and timing of reports or other communication with the entity that are expected under
the engagement.
Question No 25
Write short notes Analytical Review Procedures. (5 Marks December 2006)
Answer:
It is the analysis of significant ratios and trends including the resulting investigation of fluctuations and
relationships that are inconsistent with other relevant information or which deviate from predicted
amounts. Analytical procedures include comparison of financial information with prior period
information, anticipated results, such as, budgets and similar industry information. Analytical procedures
are used for the following purposes:
a. to assist the auditor in planning the nature and extent of audit procedures;
b. as a substantive test to obtain evidential matter related to account balances or classes of
transactions; and
c. as an overall review of the financial information in the review stage of the audit.
The auditor should apply analytical procedures at the planning stage to assist in understanding the
business and in identifying the business and in identifying areas of potential risk. Application of
analytical procedures may indicate aspects of the business of which the auditor was unaware and will
assist in determining the nature, timing and extent of other audit procedures.
Analytical procedure also constitutes substantive audit procedures to reduce detection risk relating to
specific financial statements. The auditor should apply analytical procedures at or near the end of the
audit when forming and overall conclusion as to whether the financial statements as a whole are
consistent with the auditor's knowledge of the business. In totality, analytical procedures are a valuable
tool for an auditor to identify significant fluctuations or relationships that are in consistent with other
relevant information or that deviate from predicted amounts, the auditor should investigate and obtain
adequate explanations and appropriate corroborative evidence.
Question No 26
How will you review EDP Application Controls in an audit? (5 Marks, December 2006)
Answer:
Control over input, processing, data files and output may be carried out by EDP personnel, by users of
the system, by a separate control group, or may be programmed into application software, EDP
application controls which the auditor may wish to test include:

i. Manual controls exercised by the user-if manual controls exercised by the user of the
application system are capable of providing reasonable assurance that the systems' output is
complete, accurate and authorized, the auditor may decide to limit tests of control to these
manual controls (e.g. the manual controls exercised by the user over a computerized payroll
system for salaried employees could include an anticipatory input control total for gross pay,
the test checking of net salary output computations, the approval of the payments and
transfer of funds, comparison to payroll register amounts, and prompt bank reconciliation).
In this case, the auditor may wish to test only the manual controls exercised by the user.
ii. Controls over system output-if, in addition to manual controls exercised by the user, the
controls to be tested use information produced by the computer or are contained within
computer programs; it may be possible to test such controls by examining the system's output
using either manual or computer-assisted audit techniques. Such output may be in the form
of magnetic media, microfilm or printouts (e.g. the auditor may test controls exercised by the
entity over the reconciliation of report totals to the general ledger controls accounts and may
perform manual tests of those reconciliations). Alternatively, where the reconciliation is
performed by computer, the auditor may wish to test the reconciliation by reperforming the
control with the use of computer-assisted audit techniques.
ii. Programmed control procedures – in the case of certain computer systems, the auditor
may find that it is not possible or, in some cases, not practical to test controls by examining
only user controls or the system's output (e.g. in an application that does not provide printout
of critical approvals or override to normal policies, the auditor may want to test control
procedures contained within the application program). The auditor may consider performing
tests of control by using computer assisted audit techniques, such as test data, reprocessing
transactions data or in unusual situations, examining the coding of the application program.
Question No 27

a. Terms of Audit Engagements. (5 Marks December 2006, June 2011)
Answer:
As per NSA 210 " Agreeing Upon Terms of Engagement", the auditor and the client should agree on the
term of the engagement to reduce audit expectation gap. The agreed terms would need to be recorded in
an audit engagement letter or other suitable form of contract. It is in the interest of both client and auditor
that the auditor sends an engagement letter, preferably before the commencement of the engagement, to
help in avoiding misunderstandings with respect to the engagement. The engagement letter documents
and confirms the auditor's acceptance of the appointment, the objective and scope of the audit, the extent
of the auditor's responsibilities to the client and the form of any reports.

Principle Contents
The form and content of audit engagement letters may vary for each client, but they would generally
include reference to:

 Managements' responsibility for the financial statements.
pronouncements of the Institute of the Chartered Accountants of Nepal.
 The forms of any reports or other communication of results of the engagement.
 The fact that because of the test nature and other inherent limitations of an audit, together with the
inherent limitations of any accounting and internal control system, there is an unavoidable risk
that even some material misstatement may remain undiscovered.
 Unrestricted access to whatever records, documentation and other information requested in
connection with the audit.
Question No. 28
Distinguish between
a. Audit files and Audit working papers (5 Marks June 2007)
Audit files are the record or a set of audits working papers of the planning and execution of the audit
engagement. Auditors retain a set of working papers for each audit engagement for each year. These
working papers are systematically filed in files. These files are called Audit Files. The file of audit
working papers for the current year is referred to as the current file. The file of working papers that are
relevant to more than one audit engagement or core documents are often kept separately in a file referred
to as permanent file. Filing of audit documents is as important as audit work.
In the other hand, documents created or obtained during an audit engagement are called Audit Working
Papers. These documents are created or obtained in whole exercise, i.e. from appointment to completion
of the audit engagement. Working papers comprises all papers created or obtained during engagement,
planning, execution and reporting and include Audit working paper supports that the audit works done is
in order, sufficient and appropriate audit evidences have been obtained and reasonable assurance audit
conclusion can be made in due course.
Question No. 29
What are the key internal control issues concerning the auditor while conducting audit in an EDP
environment? (5 Marks, June 2007, 5 Marks December 2008)
Answer
Following are the key internal control issues which concerns the auditor while conducting audit in an
EDP environment.

a. Authenticity:
The computerized information system should verify the identity of the person or process before
any input is allowed. Passwords and User ID/ personal identification numbers are commonly used
control procedures for this.
b. Accuracy:
Correctness of input data and processes is the important part of internal control.
c. Completeness:
Completeness of data and processing is also very important. Procedures commonly employed to
ensure completeness are edit tests and financial control totals.
d. Non-redundancy:
This implies that data item should be processed only once. There should be no redundant data.
e. Assets Safeguarding:
This implies that all resources of the computer system including data files should be protected
from destruction and corruption. Back up data files should be maintained in back up servers.
f. Existence of Audit Trail:

The source and nature of all data and processes that update database from which the financial
statements are generated should be recorded in the system.
Question No. 30
What do you understand by processing control in a Computerized Information System?
Answer
Processing control is the control over the processing function of application system.
The processing control should ensure that
 Transactions are properly processed by the computer
 Transactions are not lost, added, duplicated or improperly changed
 Processing errors are identified and corrected on a timely basis
The auditor should ensure that the audit trail in respect of processing of data by the computer is adequate.
It is very important for the auditor to understand each process performed on the input data. File controls
and run to run controls are two major components of processing controls. For accuracy of the processing
it is important that correct master files, transaction and programme files are used. In the case of
applications consisting more than one computer run then it should be ensured that each run is
accumulated and agreed with input totals to ensure the prompt detection of any lost, added, changed or
damaged data.

Question No 31
Write short notes on Utility of working paper to auditors (5 Marks December 2007)
Answer
As per NSA 230 on audit working papers are useful for auditors in following:
 Assist in the planning and performance of the audit, working papers are designed and organized to meet
the circumstances and the auditor's needs for each individual audit. The use of standardized working papers
(for example, checklists, specimen letters, and organization of working papers) may improve the efficiency
with which such working papers are prepared and reviewed. They facilitate the delegation of work while
providing a means to control its quality. It provides guidance to the audit staff with regard to the manner of
checking the schedules. It also acts as the process of planning for the auditor so that he can estimate the
time that man be required for checking the schedules.
 Assist in the supervision and review of the audit work and the auditor is able to fix responsibility on the
staff member who signs each schedule checked by him. Further it facilitates review of work done and
works to be done.
 Provide evidence of the audit work performed to support the auditor's opinion. It acts as evidence in
the court of law when a charge of negligence is brought against the auditor.
Question No 32
Adequate audit planning would result in efficient and timely audit. Discuss. (5 Marks, December
2007)
Answer
Audit planning refers to the development of a strategy and detailed approach of the audit in respect of
expected nature, timing and extent of the audit.
Adequate audit planning facilitates the appropriate attentions required for the important areas of audit
and prompt identification of potential problems. The adequate plan expedites the timely completion of
the work with proper utilization of assistants. It also facilitates the coordination of work done by other
auditors and experts.
Adequate audit planning involves:

 development of overall plan for the expected scope and nature of audit, and
 development of audit programme showing the nature, timing and extent of procedure to be
performed with works to be assigned to the audit personnel
The areas which the auditors consider in planning the audit in an attempt to conduct the audit in
most efficient and timely manner are:
 Knowledge of client‟s accounting system, policies and internal control systems/ procedures and
expected degree of reliance to be placed on these

 Assessment of inherent and control risks and the identification significant audit areas
 General economic factors and industry conditions
 His experience of similar kind of clients and the past record of the client and evaluation of
possibility of material misstatement
 The work of internal auditing and expected effect on external audit procedures
 Details of audit procedures to be followed with work to be performed by the assistants/staffs of
the auditor
Question No. 33
Internal evidence and external evidence (5 Marks June 2008)
Answer
Internal evidences are those evidences which are supposed to be generated by or available within the
entity under audit. Examples of internal evidences are bills, receipts, invoices, debit/credit notes, pay
sheets, bank statements etc.
Auditor‟s reliance on the internal evidence depends upon his assessment of the related internal controls.
External evidences are evidences obtained from sources which are independent of the entity under
audit. Examples of external evidences are confirmation from debtors/creditors, confirmation of stock
lying with the third party etc.
External evidences are generally more reliable than internal evidences. Some time it may be difficult to
obtain external evidence in that case the auditor should look for appropriate
Question No 34
Input controls are the important part of overall controls in EDP system. Briefly Explain.
(5 Marks June 2008)
Output in computerized information system largely depends on the input data. Input is the key part of
total processing control. The major areas where there should be adequate controls are as follows:
i) Transactions and input data should be properly authorized before they are processed by the
computer. There should be password and ID control for the input data entry. There should be a set
authorization process for each type of input data. Each type of input data should be approved by a
particular person before they are fed into computer for processing.
ii) The computer should be able to read the transactions and input data so that proper and complete
record is maintained for the processing.
iii) The system should be such that inputs are not lost, added and duplicated. Any duplication of the
data input should be rejected.
iv) No incorrect transaction or input data should be accepted.
v) There should be numbering control. Input data in whatever documented form should be pre-
numbered. The computer should not accept any number twice.

vi) There should be batch total controls. It should be ensured that computer does not accept the
unmatched totals. All debit entries should be matched with credit entries and total of control
accounts and subsidiary accounts are matched
vii) There should be proper control for the editing of the data. The computer should not accept any
correction in the input data without proper authorization.
viii) The computer should be able to accept or reject the prescribed input format.
Question No. 35
After carrying out the routine audit what are the overall tests which an auditor is required to perform?
(5 Marks June 2009)
Answer:
After the routine audit is completed by the junior members of the staff, the same is reviewed by the
principal or the senior assistant with the object of establishing the validity of the accounting data by
conducting the overall assessment of accounts which is an accepted auditing procedure. The technique of
conducting overall tests constitute substantive auditing procedures designed to obtain evidence as to the
completeness, accuracy and validity of the data produced by the accounting system and include analysis
of significant ratios and trends. Such an assessment is necessary in organisation having large volume of
transactions, and in the organisation following mechanised accounting system where it is not possible to
trace and check each and every transaction. The various tests which may be used for overall assessment
of the accounts are as under:
i) Ratio Analysis: The inter-relationship of data is studied to spot variations in the normal
pattern of transaction. Ratios are interpreted and their significance in the light of actual
business circumstances is judged. The various ratios which may be worked out are Gross
Profit Ratio, Return on Investment, Capital Turnover Ratio, Net Profit Ratio, Current Ratio,
Stock Turnover Ratio, ratios of individual expenses to their related income, etc. In ratio
analysis, comparison of the ratios with the corresponding ratios of the previous year is
important. Comparison of ratios with the ratios of similar organisation is also helpful. Overall
study of the various ratios should be made to see disharmony of one ratio in relation to
another related ratio e.g. net profit to sales and gross profit ratio
ii) Quantitative ratios and reconciliation: The analysis of quantitative ratios in physical norms
where practicable is a much better test over analysis of financial ratios because these ratios are
not affected by the changing price levels and thus reveal more stable pattern. The various
quantitative ratios which may be calculated are input-output ratio for a manufacturing
concern, occupancy ratio for hotels etc. The overall reconciliation statement, in case of stocks,
membership fees of club, payroll with number of employees, etc. is also a useful technique in
overall assessment of the accounts.
iii) Trend Analysis: The trend analysis of various ratios and relevant cost and revenues over a
number of years for an organisation is also a useful test employed by the auditor to check the
internal consistency and overall reasonableness of data.

iv) Comparison: Comparison of figures under various significant head of accounts with the
corresponding figures of the previous year constitute a simple but worthwhile approach to
overall assessment.
The overall tests described above help the auditor to confirm his findings on various areas based on other
routine auditing steps. Where confirmation is lacking, it provides with clues for areas needing further
investigation for arriving at his conclusion.
Question No. 36
Describe what are the specific controls over the accounting applications in a Computerised
Information System (CIS) environment? (4 Marks June 2009)
Answer
The specific controls over the accounting applications in an CIS environment are called CIS application
controls. The purpose of CIS application controls is to establish specific control procedures over the
accounting applications in order to provide reasonable assurance that all transactions are authorized and
recorded, and are processed completely, accurately and on a timely basis. CIS application controls
include:
A. Controls over input - designed to provide reasonable assurance that:
 Transactions are properly authorized before being processed by the computer.
 Transactions are accurately converted into machine readable form and recorded in the
computer data files.
 Transactions are not lost, added, duplicated or improperly changed.
B. Controls over processing and computer data files - designed to provide reasonable
assurance that:
 Transactions, including system generated transactions, are properly processed by the
computer.
 Transactions are not lost, added, duplicated or improperly changed.
 Processing errors are identified and corrected on a timely basis.
C. Controls over output - designed to provide reasonable assurance that:
 Results of processing are accurate.
 Access to output is restricted to authorized personnel.
 Output is provided to appropriate authorized personnel on a timely basis.
Question No. 37
Prepare the chart illustrating different audit procedures. Also explain how the auditor obtains
evidence in performing those audit procedures. (4+6 Marks December 2009)

Answer
Chart showing audit procedures
Audit Procedure
Compliance Procedure Substantive Procedure
Test of Detail Analytical Procedure
Test of Transactions Test of Balances

i.e. vouching i.e. verification
The auditor obtains evidence in performing compliance and substantive procedures by one or more of
the following methods:
i) Inspection. It consists of examining records, documents or tangible assets.
ii) Observation. It consists of looking at a process and procedure being performed by others.
iii) Inquiry and Confirmation. Inquiry consists of seeking appropriate information from
knowledgeable person inside or outside the entity. Confirmation consists of the response to
an enquiry to corroborate information in the accounting records.
iv) Computation. It consists of checking the arithmetical accuracy of source documents and
accounting records.
v) Analytical Review. It consists of studying significant ratios and trends and investigating
unusual fluctuation and item.
Question No. 38
During the course of audit, M/s Guess and Guess Associates, an audit firm, has checked 20 percent of
the postings from Cashbook to General Ledger. Some serious questions could be raised about the
representative nature of the sample and about the validity of sample results. What could those serious
concerns be? (5 Marks June 2010)

Answers:
Some of the serious concerns about the representative nature of the sample and about the validity of
sample results could be:
i) Why select, say 20 percent of the posting? Why can it not be 15 or 25 percent? Why check only 2
months?
ii) Can we just state the percentage size of the sample without reference to the total number of
transactions? Are we taking the same amount of risk if we check 2 out of a total of 10 transactions
or 200 out of 2000 transactions?
iii) How can we draw conclusions about the transactions of the whole year by merely checking the
transactions of a few specified months, especially as the level of activity may vary from month to
month?
iv) By not stating the manner in which the 20 percent of the transactions have to be selected, would
not the audit assistants consciously or unconsciously select only those transactions, which are
simpler and easier to audit?
Question No. 39
STU Bank Ltd. appointed you as due diligence auditor to find reason of loss in international Wool Ltd.
The company imports woolen threads and manufactures and exports woolen sweaters to Wall Mart.
Profit margin in such business after input vat refund is 26%. International Wool Ltd. imported woolen
raw materials of Rs. 200 million and sales was 220 million in F/Y 2009/10. Cost of raw materials is
inclusive of all material input. Opening and closing stock remained the same for the year. How would
you plan your audit work and what area would you focus? Give your opinions with reason.
Answer
Based on the information furnished, audit plan of international wool Ltd. is to obtain or update the
knowledge of the business including consideration of the entity‟s organization, accounting systems,
operating characteristics and the nature of its assets, liabilities, revenues and expenses. After initial
assessment and knowledge about the nature of business, areas for special attention can be identified. In
this case following areas need special attention:
1) Whether proper accounting policy is adopted or not.
2) Whether VAT input/VAT refund is excluded from the cost or not
3) Whether process loss is normal and comparable to the industry or not.
4) Whether pilferage and theft of raw material is properly controlled or not.
5) Whether raw material cost and sales value was properly accounted or not.
6) Whether other items of revenue or expenses pertaining to business are properly recorded in the
book of accounts or not.

Question No. 40
Answer the following: (4 marks, June 2010, 5 Marks December 2010)
List out the circumstances, where auditing is done through the computer.
The auditor can use the computer to test the logic and controls prevalent within the system and the
records generated by the system. Depending upon the complexity of the application system being
audited, the approach may be different. It may be fairly simple or may require extensive technical
competence on the part of the auditor. Circumstances that may cause to conduct audit through the
computer are as follows:
a) The application system processes large volume of input and produces large volumes of output that
make extensive direct examination of the validity of input and output difficult.
b) Significant parts of the internal control system are embodied in the computer system.
c) The logic of the system is complex and there are large portions that facilitate use of the system or
efficient processing.
d) Because of cost-benefit considerations, there are substantial gaps in the visible audit trail.
Question No 41
Explain the advantages of working papers. (7 Marks, December 2010)
Answer:
Audit working papers constitute the basic records for the auditor in respect of the audit carried out by
him. They constitute the link between the auditor's report and clients' record.
These include retention of permanent record in the nature of a document to show the actual audit work
executed the nature of the work, the extent of the work and important points, facts, dates and decisions
having bearing on the audit of the accounts audited. The working papers, if properly maintained, can be
used as defense in case of need. The audit working papers are found very useful in the following aspects
as they:
(i) aid in the planning and performance of the audit;
(ii) aid in the supervision and review of the audit work;
(iii) provide evidence of the audit work performed to support the auditor's opinion; and
(iv) act as an evidence in the Court of law when a charge of negligence is brought against
the auditor.
Question No. 42
Justify with reason, whether following statement is true or false.
a) Generally, purpose of misstatement in a financial statement of a medium sized sole
proprietorship business in Nepal is to benefit proprietor himself.
b) Audit plan is substitute for audit program.
(5 Marks each December 2010)

Answer
a) True: Typical medium sized business in Nepal, tend to mispresents their financial statements to
benefit their proprietor by way of lowering or reducing tax liability by understanding income or
over standing the expenses. Typical medium sized business-man tends to lower payment of tax or
do not want to pay any tax. Sometime such business man may mistake his financial statements to
justify his loan application to a bank and financial institutions. In other situations, such financial
statements may be misstated to mislead the various stakeholders or users of such financial
statements so that benefits are derived by proprietor of such business.
b) The statement is false: Audit plan is initial step of audit. Whereas, audit program is setting up of
procedures that are needed to implement the audit plan. Overall audit plan is for expected scope
and conduct of audit. On the other hand, audit program shows nature, time and extend of audit
procedures.
In planning an audit, auditor should consider factor such as complexity of the audit, the
environment in which the client operates, his previous experience with the client and knowledge
of client‟s business. The audit program serves as a set of instructions to the assistants involved in
the audit and a means to control the proper execution of the work. Therefore, audit program
supplements the audit plat for execution and it does not stand out as substitute.
Question No. 43
Answer the following questions
a) „„The concept of evidence is fundamental to auditing. Discuss „management representation‟ as

audit evidence. (5 Marks, December 2010,
December 2017)
b) The concept of „materiality‟ is not always related to financial implications. State your views.
a) Answer
The management representation as audit evidence:
 During the course of an audit, management makes many representations to the auditor, either
unsolicited or in response to some specific enquiries.
 The auditor also should obtain representation from management, where considered appropriate
and necessary.
 The management representation is taken to corroborate audit evidence, but representations by
management cannot be a substitute for other audit evidences that the auditor could reasonably
expect to be reasonably available.
 In certain cases, where knowledge of facts is confined to management, a representation by
management may be the only audit evidence, which can reasonably be expected to be available.

 If a management representation is contradicted by an available other audit evidence, the auditor

should examine the circumstances and, when necessary, reconsider the reliability of other
representations made by management.
b) Answer
The concept of „materiality‟ also depends on:
 Regulatory or law considerations. For example, the appointment of directors is not according to
law; the remuneration paid to them is a material item even if the financial implication is low.
 Materiality is also decided as to the degree of relevance in relation to the overall accounts or in
relation to the group to which it relates or in relation to the classes of transactions to which it
pertains.
 Improper description, for example, of accounting policy in the notes, is a material misstatement
that may affect economic decisions.
 Even insignificant items in terms of quantity may be material in special circumstances. For
example, it is not the quantum of deviation but presence of the deviation itself may be material
factor to determine the correct functioning of logic in a system (computer) driven accounting
areas.
 An item whose impact in present is insignificant but whose effect in future may be significant
may be a material item.
Question No. 44
Terai Bank Limited provided a long-term loan amounting to Rs. 250 Million to Relax Hotel Pvt.
Limited for hotel operation. The hotel is unable to repay installment (principal & interest) as per
repayment schedule. Accordingly, you are appointed by the Bank for special review of the income of
the hotel to ensure whether income procedures are duly complied with and the amount has been fully
accounted for. As a special reviewer how would you plan your review work?
(5 Marks June 2011)
Answer.
An efficient and effective review can only be performed if this has been thoroughly and properly
planned. The planning stage of the review should be used to establish an overall strategy for the
review.
Adequate planning will ensure that appropriate attention is given to crucial areas of the review and that
potential problems are identified on a timely basis. At the planning stage the engagement partner
should assign the necessary staffs who possess the skills and ability required in order to ensure the
review is carried out efficiently and in accordance with the Nepal Standards on Auditing.

Planning Activities
At the planning stage the overall audit strategy is developed. The audit strategy sets the scope, timing
and direction of the review. At this stage the reviewer will develop the detailed review plan which will
help identify problem areas and important review areas.
Once the strategy has been established, then the reviewer is able to develop the more detailed review
plan to address the matters identified in the overall strategy.
Contents of the Plan

The review plan should document the nature, timing and extent of the procedures to be adopted which
should be sufficient and effective enough to be able to assess the risks associated with review
engagements.
The detailed plan should also contain a description of the nature, timing and extent of planned further
audit procedures at the assertion level for each material class of transactions, account balances and
disclosures.
Finally, the review plan should also contain details of other procedures to be adopted so that the review
can be carried out effectively.
Typical contents of the detailed plan are:
 Nature of the business and what it does

 Risk and problematic areas (both business risk and financial statement risk)
 Details of any complexities associated with the assignment
 Specific accounting and auditing standards relevant to the assignment
 Budgets
 Planned review procedures
 Details of sampling techniques
 Key personnel employed at the clients
For the purpose of this review of the income of the hotel and purpose of assignment an audit program
with detailed procedures should also be developed to conduct the review work efficiently and
effectively. Audit procedures inter alia includes amongst the following:
i. Whether rack rates has been maintained for different types of rooms (Suit/Deluxe/Superior etc.),
banquette rates are formalized with recipe and other rates are formalized & approved by
competent authority.
ii. Whether there are formal discount rates. If discount rate is in excess of formal rate, whether this is
approved by the competent authority.

iii. Whether rate agreements has been entered with regular official & individual parties and duly
signed of both parties. If yes agreed rates have been applied or otherwise to ensure how the rate is
formalized in such cases.
iv. Whether complimentary service provided to guests are within the power of approving authority.
v. Whether the billing are made on timely basis and accounted accordingly on departure of guest
with evidence of acceptance by guests. If bill is to be forwarded to customer through mail, is it
forwarded on timely basis?
vi. Whether there is clear cut credit policy and credit facility provided only to eligible guest backing
with deposition of advance.
vii. Whether revenue as per income of auditor`s report, accounting system and VAT return has been
matched. In case of difference, is proper reconciliation has been made.
viii. Whether rates have been reviewed as per formal policy of hotel and approved by the competent
authority.
ix. Whether record of revenue charged has been reflected in the concerned ledger folios of the guest.
x. Whether accounting system (Software/Manual) for revenue is commensurable with volume of

transactions of the hotel.
xi. Check the closing procedures of the hotel during physical presence on sample night audits.
xii. Make the surprise check on different point of sales and observed if any evidences of concealing
the income (by not issuing bill, by providing huge discounts, by undervaluing the bill etc.)
xiii. Check the recovery rate from debtors and utilization of cash.
Question No. 45
Proper audit is not possible without adequate knowledge of client‟s business. Explain it.
(5 Marks June 2011)
Answer
Obtaining an understanding of the entity and its environment is an essential aspect of performing an audit
in accordance with Nepal Standard on Auditing. In particular, that understanding establishes a frame of
reference within which the auditor plans the audit and exercises professional judgment about assessing
risks of material misstatement of the financial statements and responding to those risks throughout the
audit, for example when:
 Establishing materiality and evaluating whether the judgment about materiality remains appropriate
as the audit progresses;
 Considering the appropriateness of the selection and application of accounting policies, and the
adequacy of financial statement disclosures;

 Identifying areas where special audit consideration may be necessary, for example, related party
transactions, the appropriateness of management‟s use of the going concern assumption, or
considering the business purpose of transactions;
 Developing expectations for use when performing analytical procedures;
 Designing and performing further audit procedures to reduce audit risk to an acceptably low level;
and
 Evaluating the sufficiency and appropriateness of audit evidence obtained, such as the
appropriateness of assumptions and of management‟s oral and written representations.
The auditor uses professional judgment to determine the extent of the understanding required of the
entity and its environment, including its internal control. The auditor‟s primary consideration is whether
the understanding that has been obtained is sufficient to assess the risks of material misstatement of the
financial statements and to design and perform further audit procedures. The depth of the overall
understanding that is required by the auditor in performing the audit is less than that possessed by
management in managing the entity.
Question No. 46
Disadvantages of the use of an audit program. (5Marks June 2011)
a) The possible disadvantages of the use of an audit program are:
 The work may become mechanical and particular parts of the programme may be carried out
without any understanding of the object of such parts in the whole audit scheme.
 The programme often tends to become rigid and inflexible following set grooves; the business
may change in its operation of conduct, but the old programme may still be carried on. Changes
in staff or internal control may render precaution necessary at points different from those
originally decided upon.
 Inefficient assistants may take shelter behind the programme i.e. defend deficiencies in their work
on the ground that no instruction in the matter is contained therein.
 A hard & fast audit program may kill the initiative of efficient and enterprising assistants.
 Preparation of audit program without preliminary depth assessment of client‟s business and
without considering scope of work to be carried out by auditor will not provide objectivity of the
audit work.
Question No. 47
Justify with reason, whether following statement is true or false. (5 Marks each June 2011)
a) Reducing assurance engagement risk to zero is very rare.
b) Balance confirmation from debtors/creditors can only be obtained at the end of the financial year.
a) Answer
The statement is true. Reducing assurance engagement risk to zero is very rare because of the
following reasons:

 The use of selective testing;

 The inherent limitations of internal control;
 The fact that much of the evidence available to practitioner is persuasive rather than conclusive;
and
 The use of judgment in gathering and evaluating evidence and framing conclusions based on
that evidence.
b) Answer
The statement is false. Direct confirmation of balances from debtors/creditors in respect of balances
standing in their accounts at end of the financial year end is perhaps the best method of ascertaining
whether the balances are genuine accurately stated and undisputed where internal control system is
relatively weak. The conformation date, methods of obtaining confirmation etc. are to be
determined by the auditor. Debtors/creditors may be requested to confirm balance either as at the
date of balance sheet or any other selected date which reasonably close to the date of balance sheet.
The date should be settled by the auditor in consultation with the entity. Therefore, it is not
necessary that balances of debtors/creditors should be obtained and verified at the end of financial
year.
Question No. 48
a. Audit trail in a computerized accounting environment. (4 Marks December 2005, June
2011, 5 Marks June 2009)
Answer
An audit trail refers to a situation where it is possible to relate “one-to-one” basis, the original
input along with the final output. The work of an auditor would be hardly effected if audit trail is
maintained, i.e. if it were still possible to relate, on a “one-to-one” basis, the original input with
the final output. A simplified representation of the documentation in a manually created audit
trail. The particular credit notes may be located by the auditor at any time s/he may wish to
examine them, even months after the balance sheet date. S/he also has the means, should s/he so
wish, of directly verifying the accuracy of the totals and sub-totals that feature in the control
listing, by reference to individual credit notes. S/he can, of course, check all detailed calculations,
casts and postings in the accounting records, at any time.
In first and early second –generation computer system, such a complete audit trail was generally
available, no doubt, to management‟s own healthy skepticism of what the new machine could be
relied upon to achieve-an attitude obviously shared by the auditor. In such a system:
 The output itself is as complete and as detailed as in any manual system.

 The trail, from the beginning to the end, is complete, so that all documents may be identified
by located for purpose of vouching, totaling and cross referencing.
Any form of audit checking is possible, including depth testing in either direction. In case audit
trail is missing, the auditor employs Computer Assisted Audit Techniques (CAAT) to ensure the
validity of accounting data.
Question No. 49
What is the relationship between materiality and audit risk and how audit risk can be reduced to an
acceptable level? (5 Marks, December 2009, June 2011)
Answer
According to NSA 320 on Audit materiality, there is an inverse relationship between materiality and
degree of audit risk. Higher the materiality level, lower the audit risk and vice-versa. The risk that a
particular account balance or class of transaction would be mis-stated by an extremely large amount
might be very low. But the risk that it could be mis-stated by an extremely small amount might be very
high. The auditor considers this inverse relationship when he determines the nature, timing and extent of
his audit procedures. If after planning for specific audit procedures, he concludes that acceptable
materiality level is lower, audit risk is increased. The auditor should try to reduce the audit risk to an
acceptable level by: -
i. Reducing the assessed degree of control risk by carrying out extended or additional test of
control. or
ii. Reducing detection risk by modifying the nature, timing and extent of his substantive
procedures.
iii. During the audit the auditor may seek to obtain, in conjunction with the client or independently,
audit evidence in the form of reports, opinions, valuations, and statements of an expert.
Examples are:
 Valuations of certain types of assets, for example, land and buildings, plant and machinery,
works of art, and precious stones.
 Determination of quantities or physical condition of assets, for example, minerals stored in
stockpiles, mineral and petroleum reserves, and remaining useful life of plant and machinery.
 Determination of amounts using specialized techniques or methods, for example, an actuarial
valuation.
 The measurement of work completed and to be completed on contracts in progress for the
purpose of revenue recognition.
 Legal opinions concerning interpretations of agreements, statutes, regulations, notifications
circulars, etc.

Question No. 50
Distinguish Between the following
Audit Planning and Audit Program

(5 Marks December 2011, 5 Marks December 2013, 5 Marks December 2016)
As per NSA-300 on Audit Planning, the auditor should plan the audit work so that the audit will be
performed in an effective manner. The "Audit Planning" means developing a general strategy and a
detailed approach for the expected nature, timing and extent of the audit. The auditor plans to perform
the audit in an efficient and timely manner. Audit planning is one of the basic principles of auditing.
Plan should be based on knowledge of the client‟s business. Audit planning is a continuous process
throughout the audit engagement and covers developing an overall plan for the expected scope and
conduct of the audit and developing an audit program showing the nature, timing and extent of audit
procedures. Adequate planning of the audit work helps to ensure that appropriate attention is devoted to
important areas of the audit, those potential problems are identified and that the work is completed
expeditiously. Planning also assists in proper assignment of work to assistants and in coordination of
work done by other auditors and experts. The extent of planning will vary according to the size of the
entity, the complexity of the audit and the auditor's experience with the entity and knowledge of the
business. Matters to be considered by the auditor in developing the overall audit plan include knowledge
of business, understanding the accounting and internal control systems, risk and materiality, nature,
timing and extent of procedures, coordination, direction supervision and review process etc.
The same NSA-300 mentions that the auditor should develop and document an audit program setting
out the nature, timing and extent of planned audit procedures required to implement the overall audit
plan. Hence, audit program is nothing but a list of examination and verification steps to be applied set
out in such a way that the inter-relationship of one step to another in clearly shown and designed,
keeping in view the assertions discernible in the statements of account produced for audit or on the basis
of an appraisal of the accounting records of the client. In other words, an audit program is a detail plan
of applying the audit procedures in the given circumstances with instructions for the appropriate
techniques to be adopted for accomplishing the audit objectives.
The difference between audit plan and audit program is that audit program is a part of audit plan. While
audit plans involve each step of audit from engagement to issuance of final report audit program deals
with only nature, timing and extent of audit procedures.
In summarized form,
The Distinction between Audit Plan and Audit Program are outlined as follows:
Audit plan is the developing a general strategy and a detailed approach for the expected nature,
timing and extent of the audit. The auditor plans to perform the audit in efficient and timely
manner whereas audit program is the step and guidance and works as a tool for
performing/implementing audit at the execution level. The distinctions of those two are:

 Audit plan is prepared before preparing audit program.

 Audit plan is border scope than audit program.
 Audit plan assists acquiring knowledge of client‟s business and concentrating on risk
areas which will help for preparing effective audit program.
 Audit plan generally prepares by senior auditors and program may be prepared by
juniors based on plan and duly approved by seniors.
Question No. 51
Discuss “Audit through the Computer”. (7 Marks December 2011)
Answer
a) Computerization of accounts does not affect the basic objectives of auditing. However, the
auditor would need to modify his audit procedures, approach and technical capabilities so as to be
able to form an opinion on the accounts processed in a computerized environment.
There are two approaches,

i. Audit around the Computer
ii. Audit through the Computer
Audit through the Computer

Audit through the Computer is the audit, with the help of computer technology in the audit of
accounts processed in a computerized environment.
Audit through the computer requires that the auditor submits data to the computer for processing. The
results are then analyzed for the processing reliability and accuracy of the computer program.
Technical and other developments that necessitated this approach include the following;
 On line data entry
 Elimination or reduction of print outs
 Real time files up dating
The auditor can use the computer to test:

 The logic and controls existing within the system, and
 The records produced by the system
Depending upon the complexity of the application system being audited, the approach may be fairly
simple or require extensive technical competence on the part of the auditor.
There are several circumstances where auditing through the computer must be used:
a. The application system processes large volumes of input and produces large volumes of
output that make extensive direct examination of the validity of input and output difficult.
b. Significant parts of the internal control system are embodied in the computer system. For
example, in on line banking system a computer programme may batch transactions for

individual tellers to provide control totals for reconciliation at the end of the day‟s
processing.
c. The logic of the system is complex and there are large portions that facilitate use of the
system for efficient processing.
d. There are substantial gaps in the visible audit trail.
The primary advantage of this approach is that the auditor has increased power to effectively test the
computer system. The range and capability of tests that can be performed increases and the auditor
acquires greater confidence that data processing is correct. By examining the system‟s processing, the
auditor also can assess the system‟s ability to cope with environment change.
The primary disadvantages of the approach are generally high costs and the need for extensive
technical expertise when systems are complex. However, these disadvantages are really not that
important if auditing through the computer is the only viable method of carrying out the audit.
Auditing through computer may be conducted through test data, computer programme, etc.
Question No. 52
List out the analytical procedures that you would adopt in audit of Revenue of an entity. What are the
factors that determine the extent of reliance on such analytical procedures?
Answer.
Analytical procedures are one of many audit processes which help an auditor understand the
client's business and changes in the business, and to identify potential risk areas to plan other
audit procedures. It includes comparison of financial information, relating financial and non-
financial information and consideration of practicable relationship of data.
The analytical procedures that will be adopted in obtaining audit evidence regarding the various
assertions relating to revenue are as follows:
i. Comparison of Gross-profit ratio to sales for the current year with the corresponding figures
of the previous years.
ii. Comparison of ratio of sales returns to sales for the current year with the corresponding
figures for previous years.
iii. Comparison of trade discount to sales for the current year with previous year.
iv. Review of Reconciliation of Excise/VAT booked during the year with Excise/VAT returns
submitted with the total sales booked.
v. Comparison of dividend/interest/royalty for the current year with the corresponding figures
for previous years.

vi. Comparison of ratio of income on investments to average investment for the current year
with corresponding figures for the previous year.
The factors that affect the extent of reliance on analytical procedures are as follows:
i. Materiality: When items are material, the auditor doesn‟t solely rely on the analytical
procedures in forming conclusions but will carry other substantive procedures also.
ii. Other procedures: When other procedures are also directed towards the same objective, it
might confirm or dispel the questions raised from the application of analytical procedures.
iii.Weak controls: When internal controls are weak, greater reliance is placed on tests of
balances and tests of details of transactions rather than on analytical procedures.
iv. Accuracy: The accuracy with which expected results of analytical procedures can be
predicted. For example, greater reliance is place on gross profit ratio compared to previous
year than in comparing discretionary expenses such as donation.
Question No. 53
You are the internal auditor of AB Manufacturing Co. Ltd. The Managing Director has asked you to
enquire into the causes of abnormal wastage of raw materials during the month of Mangsir 2067.
The wastage percentages are as follows:
Bhadra, 2067 1.2%
Ashwin, 2067 1.1%
Kartik, 2067 1.3%
Mangsir, 2067 3.6%
How will you proceed to carry out the Assignment? (8 Marks December 2011)
Answer
Abnormal Wastage of Raw Material: The rate of wastage in Mangsir, 2067 has risen sharply as
compared to previous months. Under the circumstances, before setting for detailed investigation, the
internal auditor needs to understand the manufacturing environment right from the stage of purchase of
materials, the movement of stock flow through the production process while its becomes finished goods.
To locate the reasons for the abnormal wastage, the internal auditor should first of all assess the general
requirements as under:
 Procure a list of raw materials, showing the names and detailed characteristics of each raw
material.
 Obtain the standard consumption figures, and ascertain the basis according to which normal
wastage figures have been worked out. Examine the breakup of a normal wastage into that in
process, storage and handling stages. Also obtain control reports, if any, in respect of
manufacturing costs with reference to predetermined standards.

 Examine the various records maintained for recording separately the various lots purchased and
identification of each lot with actual material consumption and for ascertaining actual wastage
figures therein.
 Obtain reports of Preventive Maintenance Programme of machinery to ensure that the quality of
goods manufacture is not of sub-standard nature or leads to high scrappage work.
 Assess whether personnel employed are properly trained and working efficiently.
 See whether quality control techniques have been consistent or have undergone any change.
 Examine inventory plans and procedures in report of transportation storage efficiency,
deterioration, pilferage and whether the same are audited regularly.
 Examine whether the basis adopted for calculating wastage for September is the same as was
adopted for the other three months.
 Obtain a statement showing break up of wastage figures in storage, handling and process for the
four months under reference and compare the results of the analysis for each of the four months.
Some specific reasons for abnormal wastage in process specific may be considered by the auditor
are as under:
 Examine laboratory reports and inspection reports to find out if raw materials purchased were of a
poor quality or were of sub-standard quality. This will be most useful if it is possible to identify
the wastage out of each lot that has been purchased.
 Machine breakdown, power failure, etc. may also result into loss of materials in process. Check
the machine utilization statements.
 A high rate of rejections in the finished lots may also be responsible for abnormal wastage;
therefore, examine the inspectors‟ reports in respect of inspection carried out on the completion of
each stage of work or process.
 It is possible that the wastage may have occurred because the particular lot out of which issues
were made in Mangsir, 2067 was lying in the store for a long time, leading to deterioration in
quality or because of a change in the weather which may have led to the deterioration. Compare
the wastage figures of Ashwin, 2066 with those of September, 2067.
 Abnormal wastage in storage and handling may arise due to the following reasons:
i) Write offs on account of reconciliation of physical and book stocks: In case of periodical
physical stock taking, such write offs will be reflected only in the month such reconciliation
takes place.
ii) Accidental, theft or fire losses in storage: The auditor should examine the possibility of these
for the purpose.
iii) Examine whether any new production line was taken up during the month in respect of
which standard input-output ratio is yet to be set-up.

Question No. 54
Why are computer assisted audit techniques (CAAT) needed in Computer Information Systems (CIS)
environment and how it helps the auditor in obtaining and evaluating audit evidences?
(5 Marks June 2012)
Answer
Computer Assisted audit techniques (CAAT) may be required in a CIS environment in the following
circumstances:
 The absence of input documents (e.g. order entry in on-line systems) or the generation of
accounting transactions by computer programs (e.g. automatic calculation of discounts) may
preclude the auditor from examining documentary evidence.
 The lack of a visible audit trail will preclude the auditor from visually following
transactions through the computerized accounting system.
 The lack of visible output may necessitate access to data retained on files readable only by
the computer.
The effectiveness and efficiency of auditing procedures may be improved through the use of computer-
assisted audit techniques in obtaining and evaluating audit evidence, for example:
 Some transactions may be tested more effectively for a similar level of cost by using the
computer to examine all or a greater number of transactions than would otherwise be
selected.
 In applying analytical review procedures, transactions or balance details may be reviewed
and reports printed of unusual items more efficiently by using the computer than by manual
methods.
Question No. 55
As a quality control manager of the audit engagement team of D Limited, how can you ensure that
your team has performed the audit works as per the standard maintained by your audit firm along
with the other mandatory compliance of various national and international standards in auditing and
accounting? Points out the review procedures to ensure the quality of the audit work?
Answer
The quality control manager informs the responsibilities of the engagement team and also give some of
the things to be ensured before starting the works as follows;
 understanding the nature of the entity's business
 Possible risk related issues
 Problems that may arise; and
 The detailed approach to the performance of the engagement.

The engagement team's responsibilities include maintaining an objective state of mind and an
appropriate level of professional skepticism, and performing the work delegated to them in accordance
with the ethical principle of due care.
The quality control manager before review the files, will supervise the engagement team and do the
following works:
 Tracking the progress of the audit engagement;

 Considering the capabilities and competence of individual members of the engagement team,
whether they have sufficient time to carry out their work, whether they understand their
instructions, and whether the work is being carried out in accordance with the planned
approach to the audit engagement.
 Addressing significant issues arising during the audit engagement, considering their
significance and modifying the planned approach appropriately.
 Identifying matters for consultation or consideration by more experienced engagement team
member during the audit engagement.
The quality control manager will review the work performed by their team members and consider the
following while reviewing the works and working papers:
 The work has been performed in accordance with professional standards and regulatory and
legal requirements;
 Significant matters have been raised for further consideration;
 Appropriate consultations have taken place and the resulting conclusions have been
documented and implemented.
 There is a need to revise the nature, timing and extent of work performed;
 The work performed supports the conclusions reached and is appropriately documents;
 The evidence obtained is sufficient and appropriate to support the auditor's report;
 The objectives of the engagement procedures have been achieved.
The engagement partner conducts timely reviews at appropriate stages during the engagement. This
allows significant matters to be resolved on a timely basis to the engagement partner‟s satisfaction
before the auditor‟s report is issued. The reviews cover critical areas of judgment, especially those
relating to difficult or contentious matters identified during the course of the engagement, significant
risks, and other areas the engagement partner considers important. The engagement partner need not
review all audit documentation. However, the partner documents the extent and timing of the reviews.
Issues arising from the reviews are resolved to the satisfaction of the engagement partner.
Question No. 56
What are the review areas of an IS Auditor? (5 Marks December 2012)
Answer
The IS auditors may focus on following review areas:

i. Computerized systems and applications: The auditor should verify that systems and applications
are appropriate to the users‟ needs, efficient and adequately controlled to ensure valid, reliable,
timely and secure input, processing and output at current and projected levels of system activity.
ii. Information Processing Facilities: This facility must be controlled to ensure timely, accurate and
efficient processing of applications under normal and potentially disruptive conditions.
iii. Systems Development: An IS auditor should ensure that systems under development meet the
objectives of the organization, satisfy user requirements and provide efficient, accurate and cost-
effective systems and applications. The auditor should also ensure that these systems are written,
tested and installed in accordance with generally accepted standards for systems development.
iv. Management of Information Systems: MIS must develop an organizational structure and
procedures to ensure a controlled and efficient environment for information processing. This plan
should also specify the computers and peripheral equipment required to support all functions in an
economic and timely manner.
v. Client/Server, Telecommunications and Intranets: In a client/server environment, all applications
that can be dedicated to a user are put on the client. All resources that need to be shared are put on
the server. Auditors must ensure that controls are in place on the client as well as on the server and
on the network. Auditors must provide the same level of control assurance in an Internet/Intranet
environment as in a client/server environment, with special emphasis on TCP/IP and HTTP.
Question No. 57
Audit in EDP environment is easier as the Trial Balance always tallies. (5 Marks December 2012)
Answer
In today‟s complex business environment, the importance of trial balance in an audit has to be gauzed not
from the view point of arithmetical accuracy but the nature of transaction to be recorded which in fact
have become very complex. The emergence of new forms of financial instruments like option and
futures, derivatives, off-balance sheet financing, etc. have given rise to further complexities in recording
and disclosure of transactions. A tallied Trial Balance may still contain errors of omissions like omission
of certain entries, compensating errors, duplication of entries, etc. In an audit besides the tallying of a
trial balance, there are also other issues like estimation of depreciation, valuation of inventories, etc.
which still require judgment to be exercised by the auditor. So responsibility of auditor will still remain
even in an EDP environment.
(Further students are advised to mention the difficulties like loss of audit trail, complexities in using
CAAT due to which the given statement does not hold true)
Question No. 58
a) Computerized and manual accounting system (5 Marks June 2013, June 2017)
b) Auditing around computer and Audit through computer (5 Marks June 2009 and June 2017)

a. Answer
Distinction between computerized and Manual Accounting System:
i. Faster and efficient in processing of information in computerized system and no such faster
and efficient in processing of information in manual system
ii. Automatic generation of accounting documents like invoices, cheques and statement of
account which manual system cannot produce.
iii. With the larger reductions in the cost of hardware and software and availability of user-
friendly accounting software package, it is relatively cheaper like maintaining a manual
accounting system;
iv. More timely information can be produced than manual system
v. No more manual processing of the data- all automatically posted to the various
ledgers/accounts and many types of useful reports can be automatically generated for
management to make decisions where as such reports cannot generated on manual system
vi. Power failure, computer viruses and hackers are the inherent problems of using computerized
systems, such risk not remain in manual system
vii. Once data been input into the system, automatically the output are obtained hence the data
being input needs to be validated for accuracy and completeness, we should not forget
concept of GIGO (Garbage In (Input) Garbage out (Output) where validation in manual
system can be checked on inception
viii. Accounting system not properly set up to meet the requirement of the business due to badly
programmed or inappropriate software or hardware or personnel problems can caused more
havoc, where manual system does not have such problem.
ix. Danger of computer fraud if proper level of control and security whether internal and
external
b. Answer
i. Audit Around the Computer: Audit around the computer involves forming of an audit
opinion wherein the existence of computer is not taken into account. Rather the principle of
conventional audit like examination of internal controls and substantive testing is done. The
auditor views the computer as a black box, as the application system processing is not
examined directly. The main advantage of auditing around the computer is its simplicity.
Audit around the computer is applicable in the following situations:
 The system is simple and uses generalized software that is well tested and widely used.
 Processing mainly consists of sorting the input data and updating the master file in
sequence.
 Audit trail is clear. Detailed reports are prepared at key processing points within the
system.
 Control over input transactions can be maintained through normal methods, i.e.
separation of duties, and management supervision.

Generalized software packages, like payroll and provident fund package, accounts receivable and
payable package, etc. are available, developed by software vendors. Though, the auditor may
decide not to go in details of the processing aspects, if there are well tested widely used packages
provided by a reputed vendor. However, he has to ensure that there are adequate controls to
prevent unauthorized modifications of the package. However, it may be noted that all such
generalized packages do not make the system amenable to audit. Some software packages
provide generalized functions that still must be selected and combined to achieve the required
application system. In such a case, instead of simply examining the systems input and output, the
auditor must check the system in depth to satisfy him about such system. The main disadvantages
of the system of auditing around the computer are:
 It is not beneficial for complex systems of large scale in very large multi-unit, multi locational
companies, having various inter unit transactions. It can be used only in case of small
organizations having simple operations.
 It is difficult for the auditor to assess the degradation in the system in case of change in
environment, and whether the system can cope with a changed environment.
(ii) Auditing through the Computer: This approach involves actual use of computer for
processing the information by auditor. The circumstances, where auditing through the computer
is done are as follows:
 The organization has developed either in house or through a reputed vendor, a software
package suitable to its requirement, because of inability of a generalized package to cater to
the complex nature of transactions.
 The system processes very large volumes of output. This makes examination of validity of
input and output difficult.
 The major part of the internal control system in the organization is in the computer system
itself, as the majority of the records is processed through the computer. Examples are
system in bank, insurance companies, online booking in case of Railway, etc.
 The logic of the system is quite complex, and there is virtually no visible audit trail. The
auditor has to use the computer to test the logic and controls existing within the system.
 The auditor has to use the computer system itself for verification, for which he has to be
sufficiently computer literate, and should have adequate technical knowledge and expertise.
The auditor can through the computer, increase his performance, and can rely on the data
processing by carrying out the required tests and applying his skill
Question No. 59
Compliance Procedure and Substantial Procedures (5 Marks June 2010, June 2014)
Or

Explain the compliance procedure and substantial procedures as Audit methods of collecting
evidences for forming an audit opinion. (5 Marks June 2015)
Answer:
Auditor should obtain sufficient and appropriate audit evidences and test them before
framing an opinion about the assertions the financial statements reveal. For this, the auditor
checks evidences through
 Compliance procedure and

 Substantial procedure.
Compliance procedures are tests designed to obtain reasonable assurance that those internal control
on which audit reliance is to be placed are in effect. It seeks to test that
 there exists internal control,
 the existing internal control is effective and
 the internal control is working without break or lacunae during the period under review.
When internal control is found to be to an acceptable level, the accounting entries generated in such a
system is more reliable than in one where the control is weak.
Mere satisfaction about the existence of internal control may not be sufficient for auditors to express
opinion about the assertions the financial data in the form of balances and transactions.
These i.e. transactions and balances need to be tested. This is done by audit procedure called
substantive checking. Substantive procedures are designed to obtain audit evidence as to the
completeness, accuracy and validity of the data produced by the accounting system.
The substantive procedures involve

 checking of transactions and balances and
 analytical review.
The checking of transaction and balances involves vouching of sales, purchases, payments, receipts
and scrutiny of ledgers. The analytical procedure involves critically examining the accounts in an
overall manner and it may entail computation of ratios, trend analysis so as to dwell in length for
examination of unusual or unexplained deviations.
Question No. 60
Raman Mahaseth, the auditor of a company has signed the audit report on 15 Asoj 2071. He has
obtained written representation from the management of the company dated 15 kartik 2071; i.e. the
date of the annual general meeting of the company. Give your opinion on the above.
(5 Marks June 2015)

Answer
Because written representations are necessary audit evidence, the auditor‟s opinion cannot be expressed,
and the auditor‟s report cannot be dated, before the date of the written representations. Furthermore,
because the auditor is concerned with events occurring up to the date of the auditor‟s report that may
require adjustment to or disclosure in the financial statements, the written representations are dated as
near as practicable to, but not after, the date of the auditor‟s report on the financial statements.
In some circumstances, it may be appropriate for the auditor to obtain a written representation about a
specific assertion in the financial statements during the course of the audit. Where this is the case, it may
be necessary to request an updated written representation.
So, in the given case the written representation cannot be considered as appropriate audit evidence
because it was not obtained on or before the audit report date.
Question No. 61
Explain the analytical procedures that an auditor can adopt to verify inventories.
(7 Marks June 2015)
Answer
Analytical procedure for inventories: The auditor can adopt the following analytical procedures to
verify inventories.
 Quantitative reconciliation of opening stock, purchases, production, sales and closing stock
 Comparison of closing stock quantities and values with those of previous year.
 Comparison the inventory turnover ratio with that of the previous year and industry average, if
available.
 Comparison of the current year gross profit ratio with that of previous year.
 Comparison of actual stock, purchase and sales figures with the budgeted one.
 Comparison of raw material yield/wastage with previous year.
Question No. 62
Your CA firm has been allotted with Information Systems Audit of one of the reputed Commercial
Bank of Nepal. How would you assess the reliability of internal control system in computerized
information system? (5 Marks, December 2015)
Answer
For evaluating the reliability of internal control system in CIS, the auditor would consider the followings:
-
 That authorized, correct and complete data is made available for processing.
 That it provides for timely detection and corrections of errors.
 That in case of interruption due to mechanical, power or processing failures, the system restarts
without distorting the completion of entries and records.
 That it ensures the accuracy and completeness of output.

 That it provides security to application software & data files against fraud etc.
 That it prevents unauthorized amendments to programs.
Question No. 63
Quantity of an inventory item as per records was 4 lakhs units as on the year-end date. Auditor was
present during the inventory count at the year-end date and he noticed that only 350,000 units were
there during count. Management explains that there might be counting error because the record was
correct and reconciled with opening stock, purchases and sales.
(5 Marks June 2016)
Certain audit evidences are more reliable than the other audit evidences. Stock quantity as recorded in the
stock ledger was reconciled with opening stock, purchases and sales. But on physical verification, stock
quantity was found to be short. Since the auditor himself has observed that stock quantity as per physical
verification is lower than the quantity as per record, the evidence as per self-verification of the auditor
should be considered as more reliable than the recorded information. The auditor should consider
whether to conclude based on the evidence he/she has in hand or go further corrective evidence.
Question No. 64
Write a short note on; Written representation (2.5 Marks December 2016)
Answer:
This refers to a written statement by management provided to the auditor to confirm certain matters or to
support other audit evidence. Written representations in this context do not include financial statements,
the assertions therein, or supporting books and records. Written representations are necessary information
that the auditor requires in connection with the audit of the entity‟s financial statements. Accordingly,
similar to responses to inquiries, written representations are audit evidence. Although written
representations provide necessary audit evidence, they do not provide sufficient appropriate audit
evidence on their own about any of the matters with which they deal. Furthermore, the fact that
management has provided reliable written representations does not affect the nature or extent of other
audit evidence that the auditor obtains about the fulfillment of management‟s responsibilities, or about
specific assertions.
The auditor shall request written representations from management with appropriate
responsibilities for the financial statements and knowledge of the matters concerned. Written
Representations about management‟s responsibilities include:
 Preparation of the Financial Statements;
 Information Provided and Completeness of Transactions; and
 Other responsibility

Question No. 65
Audit strategy (2.5 Marks June 2013, 2.5 Marks June 2019)
Audit Strategy
Audit planning is the process of gathering information and design audit strategies. The main output of
audit planning is a tailored audit approach supported by appropriate administrative arrangements.
Audit strategy is concerned with designing optimized audit approaches that seeks to achieve the
necessary audit assurance at the lowest cost within the constraints of the information available. Audit
procedures should be relevant to the important assertions, and as cost effective as possible to perform.
Audit strategy generally involves the following steps:
iii) Obtaining knowledge of client‟s business,

iv) Performing analytical procedures at initial stage,
v) Evaluating inherent risks,
vi) Evaluating internal control system for strategy purpose and
vii) Formulating the strategy.
The auditor should also develop the strategy by considering the results of gathering or updating
information about the client, and making preliminary judgment about materiality, inherent risk and
control effectiveness.
The initial assessment of the quality and complexity of the client‟s system will affect the amount of the
information the auditor needs to gather. Sometimes, on a new engagement, the appropriate strategy
may be oblivious from a limited amount of investigation work.
Question No. 66
Distinguish between Test Checking and Routine Checking ( 5 Marks June 2018, June 2013)
Answer:
Criteria Test Checking Routine Checking
Concept Test checking involves selecting a Routine checking involves

few transactions on the basis of checking of books and records on
auditor‟s judgment and examining regular basis.
them.
User Generally, Auditor (Internal/external) Generally, Accountants (Lower &

etc. Middle level).

Objectives The main object of test checking is to The main object of routine
form an opinion on the financial checking is ensuring arithmetical
statements on the basis of accuracy of the entries in the
examination of selected sample. original books and ledgers and
posting to correct ledgers
accounts.
Scope Limited Wide
Time Lesser time consuming Higher time consuming
Reliance Certain reliance can be taken on Reliance cannot be taken on test

routine checking checking
Risk Higher risk of improper result if Lesser risk of improper result if

internal control system is weak. internal control system is strong.
Question No. 67
Write short notes on the following: (2.5 Marks, June 2019)

Contents of Permanent Audit File
Answer
company, this includes the Memorandum and Articles of Association. In the case of a statutory
corporation, this includes the Act and Regulations under which the corporation functions.
This might be in the form of narrative descriptions, questionnaires or flow charts, or some
 Copies of audited financial statements for previous years.
 Copies of management letters issued by the auditor, if any.
 Record of communication with the retiring auditor, if any, before acceptance of the appointment
as auditor.

Chapter 4 Audit Risk and Internal Control

Question No 1
a) What do you understand by Test Checking? (5 Marks June 2001)
Answer
Test checking is a system of sampling employed by auditors for the purpose of reducing the volume of
detail checking involved in an audit. A representative number of transactions, selected at random by the
auditor, are checked in detail and the system of internal check is carefully examined and tested. If this is
found to be satisfactory and the records examined by the auditor are found to be in order, the accuracy of
the records not so checked may reasonably be implied, in the absence of evidence to the contrary, and no
further detailed checking need be carried out.
b) What are its advantages and disadvantages? (4 Marks June 2001)

Answer
The Advantages of Test - Checking are that it reduces the immense volume of work entailed in an audit,
without detracting from the value of the audit, and thus permits the auditor to devote more time to
important matters of principle. It also ensures the periodic examination of the system of internal check.
Any weaknesses in the system or its operation are detected and removed.
The Disadvantages of Test - Checking are that it leaves large record unexamined. If the same routine is
followed at each audit, it will not be possible to detect irregularities. Unless carried our intelligently, test
- checking may become a farce and almost useless as a check on the accounts.
c) What safeguards would you suggest in order to minimize such disadvantages?

(7 Marks June 2001)
Answer
The following safeguards are suggested to minimize the disadvantages of test - checking:
i) The test should be made by the auditor's selecting without regard to the wishes of the client's
staff.
ii) No indication should be given by the auditor in advance as to the portions of the work or
accounts which he proposes to check in detail.
iii) A representative number of transactions or accounts from every book or ledger, covering the
whole of the period under audit, should be checked.
iv) All cash and bank accounts should be balanced and reconciled at the same date, and all cash
balances verified by inspection at the same time.
v) Although, as a general rule, the tests should be of such a nature that different portions of the
work are checked at cash audit, care should be taken at every audit to check certain accounts
which were checked at the previous audit, so that a likely deflator will not feel free from risk
in manipulating the accounts.

vi) Test-Checks should not be applied to the impersonal ledger or to control accounts. These
should be checked in detail at each audit.
Question No. 2
Distinguish between Internal Check and Internal Audit. (4 Marks, June 2003)
Answer
Internal Check has been defined by the Institute of Chartered Accountants of England and Wales, as
the "Checks on day to day transaction which operate continuously as part of the routine system where
by the work of one person is proved independently or complementary to the work of another, the
object being the prevention or earlier detection of error or fraud". The system of internal check in
accounting implies organization of the system of book keeping and arrangement of staff duties in
such a manner that no one person can completely carry through a transaction and record every aspect
thereof.
Internal audit has been defined by the Institute of Internal Auditors, USA as an "Independent
appraisal activity within an organization for the review of operations as a service to the organization.
It is managerial control which functions by measuring and evaluating the effectiveness of other
controls". Traditionally internal auditing was considered to be limited to the examination of the books
of accounts of the organization with a view to ascertaining whether they correctly record the
transaction. Infact, a good internal control system should have internal audit as an integral feature.
The modern concept of internal auditing as enunciated in the aforesaid definition shows that internal
auditing has moved significantly ahead by shouldering greater responsibilities to become one of the
important management control activities.
It can be seen from the foregoing definitions that both internal check and internal audit are parts of
overall control system. Internal check operates as a built-in device as far as staff organization and job
allocation aspect of the control system are concerned. On the other hand, the adequacy and operations
of internal control on a regular basis is to be reviewed by the management through internal audit
system to ensure that all significant control are operating effectively. Thus internal check is merely an
arrangement of book keeping and clerical duties but internal audit involves evaluating the quality and
operation of the various other controls. For example: whether the systems and procedures are well
formulated and adhered to or whether the internal check operating in the organization has any room
for leakage of revenue are matters of internal audit. Internal auditing, therefore, is a control function
which directly contributes to the improvement of the overall control system.
Question No. 3
"The statutory auditor is entitled to rely on the internal auditor". Comment.

Answer
The role of the internal audit function within an entity is determined by management and its prime
objective differs from that of the external auditor who is appointed to report independently on financial
information. By its very nature, the internal audit function cannot be expected to have the same degree of
independence as is essential when the external auditor expresses his opinion on the financial information.
Where the external auditor intends to rely upon the specific internal audit work, he has to carry out the
general evaluation of the internal audit function by considering the organizational status, nature and
depth of coverage of internal auditor, technical competence and whether the audit work was carried out
with due professional care.
Where, following the general evaluation, the external auditor intends to rely upon specific internal audit
work as a basis for modifying the nature, timing and extent of his procedures, he should review the
internal auditors' work, taking into account the following factors:
1. The scope of work and related audit programmes are adequate for the external auditor's
purpose.
2. The work was properly planned and the work of assistants was properly supervised, reviewed
and documented.
3. Sufficient appropriate evidence was obtained to afford a reasonable basis for the conclusions
reached.
4. Conclusions reached are appropriate in the circumstances and any reports prepared are
consistent with the results of the work performed.
5. Any exceptions or unusual matters disclosed by the internal auditor's procedure have been
properly resolved. The external auditor should also test the work of the internal auditor on
which he intends to rely. The nature, timing, and extent of the external auditor's test will depend
upon his judgment
Question No. 4
a. Internal audit evidence and external audit evidence.
(4 Marks June 2002, December2004)
Answer
Internal audit evidence:
Evidence which originates within the organization being audited is internal evidence. Examples: Sales
invoice, copies of sales challan and forwarding notes, goods received note, inspection report, copies of
cash memo, debit and credit notes, etc.

External audit evidence:

Evidence that originate outside the client‟s organization for example purchase invoice, supplier‟s challan
and forwarding note, debit notes and credit notes coming from parties, quotations, confirmations, etc.
The external evidence is generally considered more reliable as they come from third parties who are not
normally interested in manipulation of the accounting information of others. As an ordinary rule the
auditor should try to match internal and external evidence as far as practicable. Where external evidence
is readily available to match, the auditor should see to what extend the various internal evidence
corroborate each other.
b. Internal Control and Internal Auditing (4 Marks December 2004)
Answer
Internal control may be defined as the plan of organization and methods and measures adopted within a
business to safeguard its assets, check the accuracy and reliability of its accounting data, promote
operational efficiency, and encourage adherence to prescribed managerial policies. The phrases
“safeguarding its assets” and “accuracy and reliability of accounting data” are referred to as accounting
controls, whereas the phrases “promote operational efficiency‟s” and “encourage adherence to prescribed
managerial policies are referred to as administrative controls. Administrative controls encompass
operational controls such as quality control, work standards, budgetary controls, periodic reporting,
policy appraisals, quantitative controls, etc. The auditor of financial statements, however, is primarily
concerned with the accounting controls since these have a direct and significant bearing on the reliability
of the financial information.
Internal auditing is an independent appraisal function established within an organization. The objective
of internal auditing is to assist members of the organization in the effective discharge of their
responsibilities. To this end, internal auditing furnishes them with analysis, appraisals, recommendations,
counsel, and information concerning the activities reviewed. After the internal auditor evaluates the
organization‟s internal control system and /or its performance, analysis and recommendation are
provided to the top management. Since it contributes to the effectiveness of an organization‟s system of
internal control, an organization‟s internal audit department can have a substantial impact on the
independent auditor‟s examination of the entity‟s financial statements.
Question No. 5
In auditing, what are the important methods of selecting the sample? (8Marks, June 2004)
Answer
Some of the important methods of selecting the sample are:
I. Random sampling
II. Interval sampling or systematic sampling

I. Random Sampling: This selection ensures that all items in the population or within each stratum
have a known chance of selection. Random sampling includes the following important methods:
(1) Simple random sampling: It is considered that random number tables are simple and easy to
use and also provide assurance that the bias does not affect the selection. Under this method
each unit of the whole population e.g. purchase or sales invoice has an equal chance of being
selected. For example, the population can be considered homogeneous, if say, debtors balance
fall within the range of Rs. 5,000 to Rs. 25,000 and not in the range between Rs. 25 to Rs.
250,000.
(2) Stratified Sampling: This method involves dividing the whole population to be tested in a
few separate groups called strata and taking a sample from each of them. The number of
groups into which the whole population has to be divided is determined on the basis of auditor
judgement. For example: debtor balance of a company is divided into the following four
groups:
 Balance in excess of Rs. 100,000;

 Balance in the range of Rs. 75,000 to Rs. 100,000;
 Balance in the range of Rs. 25,000 to Rs. 75,000; and
 Balance below the range of Rs. 25,000.
II. Interval sampling or systematic sampling: It involves selecting items using a constant interval
between selections, the first interval having a random start. The interval might be a certain number
of items or monetary totals. When using systematic selection, the auditor should determine the
population is not structured in such a manner that the sampling interval corresponds with a
particulars pattern in the population. Systematic sampling includes the following important
methods:
(1) Block sampling: This method involves the selection of a defined block of consecutive items.
For example, take the first 200 sales invoice for the sales day book in the month of July.
(2)Cluster sampling: This method involves dividing the population into group of items known as
clusters. A number of clusters are randomly selected from all the clusters rather than
individual items of the population.
Question No. 6
a. Under what conditions is statistical sampling likely to prove most successful as audit techniques
Answer:
 A large population to be checked.

 The population consists of similar items;

 Items for checking easily selected and located.
 The error rate is reasonably low (e.g. good system of internal control in force)
b. What are the main advantages of statistical sampling properly applied over judgmental sampling?
Answer.
The advantages of statistical techniques, properly applied, over judgment sampling are;
 Conclusions about the total population can be stated with a known confidence and precision;
 Sample size is objectively determined;

 Time and money may be saved by limiting size to that required to achieve a given result.
For the reasons, whenever the size and homogeneity of the group to be checked permits,
statistical sampling is generally to be preferred to judgment sampling.
c. Define audit sampling. Discuss the case where audit sampling is not appropriate.
Answer.
Audit sampling is defined as the application of audit procedures to less than 100% of the items
within an account balance, class of transaction or other population, as representative of that
population, to enable the auditor to obtain and evaluate evidence of characteristics of that
population and to assist in forming a conclusion concerning that characteristic.
In the following situation audit sampling in not appropriate;

 The auditor is “in enquiry” as a result of previous information.
 Populations are too small for valid conclusions to be drawn and, in any event, it is quicker
to test all transactions rather than spend time constructing a sample.
 All the transactions in a particular area of great monetary significance.
 The data may be „sensitive‟ item, such as directors‟ emoluments, which require precise
disclosure in the financial statements.
 The audit area does not consist of items of the same kink i.e. there is a non-homogeneous
population.
Question No. 7
What considerations that should be taken care of by the auditor while evaluating audit evidence.
Answer:
The auditor should consider following while evaluating audit evidence:
i. Sufficiency of evidence
There is no hard and fast rule concerning the precise amount of evidence that the auditor must
collect for each audit area. The auditor uses his own skill and judgment to decide how many items

to test, for example, in his main sales test. The knowledge of the business, the degree of risk
associated with the test, and the reliability of the evidence collected will assist in the decision. For
each client, however, the decision must be made. The consideration here, then is that each client
is different, and that no standard testing quantity can be applied to all clients‟ the auditor must
always use his own skill and judgment to decide the appropriate testing level.
ii. Relevance of audit evidence

The evidence collected should not be use dot draw conclusions about testing objectives not in fact
covered by that test. Thus, merely because a fixed asset register correctly adds up does not mean
that all the individual assets actually exist, or that they are correctly valued. The auditor must
always ensure that the correct tests are used for the audit objective under consideration.
iii. Degree of Knowledge

In some situations, the auditor may have the evidence available to him but he may not be able to
evaluate this properly. For example, at a jewelry store he may not be able to value the stock
correctly. In this case special advice should be sought. Similarly, the auditor may not understand
the evidence as in the case of some legal contracts, and here a solicitor may be needed to explain
fully the effect of the contract on the client.
Write a short note on Audit Risk. (5 Marks December 2006)
Answer:
Audit risk is the risk that an auditor may give an inappropriate opinion on financial information, which is
materially misstated. An auditor may give an unqualified opinion on financial statements without
knowing that they are materially misstated. Such risk may exist at overall level, while verifying various
transactions and balance sheets items. There are three components of audit risk:
i. Inherent risk:
It is a risk that material errors will occur. Inherent risk is the susceptibility of an account
balance or class of transactions to misstatement that could be material, individually or when
aggregated with misstatement in other balances or classes assuming that there were no related
internal controls.
ii. Control risk:
It is the risk that the client's system of internal control will not prevent or correct such errors,
to assess control risk, the auditor should consider the adequacy of control design as well as
test adherence to control procedure.
iii. Detection risk:
It is the risk that an auditor's procedures will not detect a misstatement that exists an account
balance or class of transactions that could be material, individually or when aggregated with
misstatements in other balances or classes. The level of detection risk relates directly to the
auditor's procedures. Some detection risk would always be present.

The inherent and control risks are functions of the entity's business and its environment and the nature of
the account balances or classes of transactions, regardless of whether an audit is conducted. Even though
inherent and control risks cannot be controlled by the auditor, the auditor can assess them and design his
substantive procedures to produce an acceptable level of detection risk, thereby reducing audit risk to an
acceptable low level.
Question No. 8
Explain the advantages of Statistical Sampling in Auditing. (5 Marks, December 2006)
Answer:
The advantages of statistical sampling may be summarized as follows:
1. The amount of testing (sample size) does not increase in proportion to the increase in the size
of the area (universe) tested.
2. The sample selection is more objective and thereby more defensible.
3. The method provides a means of estimating the minimum sample size associated with
specified risk and precision.
4. It provides a means for deriving a "calculated risk" and corresponding precision (sample
error) i.e. the probable difference in result due to the use of a sample in lieu of examining all
the records in the group (universe), using the same audit procedures.
5. It may provide a better description of a large mass of data than a complete examination of all
the data, since non-sampling errors such as processing and clerical mistakes are not as large.
Under some audit circumstances, statistical sampling methods may not be appropriate. The auditor
should not attempt to use statistical sampling when another approach is either necessary or will provide
satisfactory information in less time or with less effort, for instance when exact accuracy is required or in
case of legal requirement etc.
Question No. 9
Distinguish Between
a) Surprise Check and Test Check. (5 Marks December 2006)
Answer:
Surprise Check
The surprise checks constitute an important part of normal audit procedures. Audit procedures cannot
consist merely of any set of rules to be applied to all and every situation but must be allowed to develop
in the light of experience with regard to the circumstances of each audit. An element of surprise can
significantly improve the effectiveness of an audit and therefore, wherever practicable, an element of
surprise should be incorporated into the audit programme.

Surprise checks are mainly intended to ascertain whether the system of internal control is operating
effectively and whether the accounting and other records are prepared concurrently and kept up to date. It
has often been found that manipulations and frauds are facilitated under a system of book keeping, which
does not give proper emphasis to the need to keep the books up to date. Errors in book keeping are often
indicative of weaknesses in internal control, which may be taken advantage of in order to perpetrate
frauds or manipulations. Surprise checks are useful method of determining whether or not such errors
exit and where they exist, of bringing the matter promptly to the attention of the management so that
corrective action is taken immediately. Consequently, surprise visits by the auditor can exercise a good
moral check on the client's staff.
Test Check
The auditor according to his best judgment, having regard to the nature, size and materiality of
transactions, picks up the entries for examination. Normally, entries involving large amounts or relating
to material accounts are seen exhaustively and entries are picked up for verification at random from the
remainder according to certain plan. Sometimes, entries are checked for a few specified months
exhaustively and the rest go unchecked. Though it is state that the technique is an adaptation of the
sampling theory, it is in reality far from it. It lacks any acceptable basis and gives the auditor no idea
about the degree of reliability that can place on the findings for application to the whole set of entries.
The so-called random picking is not random in the statistical sense. To be truly random, the selection
should be free from any bias that is possible only through a statistical process and by reference to the
random under tables. The only quality that this technique can claim lies in its keenness to cover amounts
and material accounts. Even if errors, fraud etc. remain undetected in the part not checked, they‟re not
likely to be too big as to upset the truth and fairness of the financial statement.
b) Sampling and Test checking ( 5 Marks June 2007)

Both of these refer to the selection of less than 100% of the items comprising a population where the
objective is to draw a conclusion about the characteristics of the population.
Selection of items may be done using either statistical or non-statistical techniques.
Statistical techniques are called sampling. These techniques require (i) the units in the population to have
the same chance of being selected (ii) the items for examination to be selected randomly and (iii) the
conclusion to be drawn using tables or formulas based on probability theory. The sample must be large
enough to provide statistically meaningful results.
Test checking is non statistical technique. In test checking the auditor picks up the items for examination
on the basis of nature, size and materiality, Test checking involves judgment.
To be true representative, selection of items should be free from any bias.

Question No. 10
State, in respect of each of the following observations, an internal control procedure that would
prevent the error and a substantive procedure through which the auditor can detect the error: (5
Marks, June 2006)
i. An employee whose services were terminated during the year continued to be paid his
monthly salary.
ii. The foreman of a department punches the time card of an employee of his department on
days when the employee is absent or is late for work.
iii. During the year, there was a reduction in the rate of interest granted to employees. The
person responsible for preparing the payroll continued to deduct interest at the old rates
while entering the interest at revised rates in the advances register and pocketed the
difference.
Answer:
Internal control procedures: Substantive Procedures:
(i) All terminations should be immediately Compare a sample of such advices with
intimated to the payroll department the payroll.
through pre-numbered advices.
(ii) There should be an independent Compare a sample of time cards with the
reconciliation of time cards and job related job cards.
cards.
(iii) Payroll should be thoroughly checked Conduct an in-depth audit of sample
by the supervisor. In this process, entries in the payroll.
deductions shown in payroll should be
verified with reference to the entries in
the advance registers. The person
responsible for preparing payroll
should not be allowed to disburse
wages.
Question No. 11
How an auditor can rely upon the internal control system of inventory accounting?
a) Internal control over inventory accounting plays a vital role in accounting system. An auditor
cannot verify each and every item of inventory purchased and issued for consumption. Thus,
internal control system should be strong to ensure that inventory is properly accounted and
recorded.

Test and sampling audit are based on effective internal control system within the organization. In
case of inventory, it should be ensured that accounting is made as and when it is received.
Inventory items should be procured on receipt of demand from concerned department. Likewise,
issue of inventory items should be made only based on requisition slip. All procurements and
issues should be made on approval of competent authority. It should be ensured that all items are
physically verified and tallied with the store records.
Similarly, accounting is based on the uniform accounting practice using the method specified by
the Nepal Accounting Standard. It should be confirmed that issue of inventory items for capital
works are accounted as work in progress and capitalized thereafter. Items issued for consumption
should be charged to expenses.
Inventory items of semi-finished goods or finished goods should also be valued applying best
accounting practice and provision of NAS. Since, these items has direct impact over the
profitability of the organization, the internal control system to value should be transparent and
justifiable.
Question No. 12

a. Surprise checks (5 Marks December 2007, December 2009 June 2011)
Answer
Surprise check constitutes an important part of normal audit procedures. The audit procedures to be
followed by the auditor cannot always be a set of rules or percept. It should be flexible depending on the
circumstance of each audit. An element of surprise can significantly improve the effectiveness of an audit
and wherever practicable an element of surprise should be incorporated in to the audit programme.
Surprise checks are mainly intended to ascertain whether the system of internal control is operating
effectively and whether the accounting and other records are prepared concurrently and kept up to date.
Surprise checks would generally be appropriate in most cases. In following cases surprise checks would
be effective audit procedures:
 Verification of cash and investments

 Verification of stores and inventories
 Verification of books of prime entry and statutory registers
The auditor should decide the frequency of surprise checks depending on circumstances. The weakness
or any fraud or error observed during the surprise checks should be communicated to the management.
The auditor should satisfy himself that the adequate action is taken by the management on the matters
communicated by him.

b. Reliability of Audit Evidence ( 5 Marks December 2007)

Answer:
The reliability of audit evidence is influenced by its source internal or external and by its visual,
documentary or oral while the reliability of audit evidence is dependent on the circumstances under
which it is obtained the following generalizations as laid down in NSA 500, Audit Evidence, may be
useful in assessing the reliability of audit evidence:
 External evidence (e.g. confirmation received from a third party) is more reliable than internal
evidence.
 Internal evidence is more reliable when related internal control is satisfactory.
 Evidence obtained by the auditor himself is more reliable than that obtained from the entity.
 Evidence in the form of documents and written representations is usually more reliable than oral
representations.
c. Sampling Risks (5 Marks December 2008)

Answer
As per NSA 530, "Sampling risk" arises from the possibility that the auditor's conclusion, based on a
sample may be different from the conclusion reached if the entire population were subjected to the same
audit procedure. There are two types of sampling risk:
a. the risk the auditor will conclude, in the case of a test of control, that control risk is lower than
it actually is, or in the case of a substantive test, that a material error does not exist when in
fact it does. This type of risk affects audit effectiveness and is more likely to lead to an
inappropriate audit opinion; and
b. the risk the auditor will conclude, in the case of a test of control, that control risk is higher
than it actually is, or in the case of a substantive test, that a material error exists when in fact it
does not. This type of risk affects audit efficiency as it would usually lead to additional work
to establish that initial conclusions were incorrect.
The mathematical complements of these risks are termed confidence levels.
Question No. 13
Describe steps involved in the verification of the system of internal control for cash transactions.
Answer
a) The objectives of internal control in cash transactions are as below:
 To give protection against losses though fraud, waste, mistakes, etc.,
 To ensure that the transactions entered into are correctly recorded; and
 To enable the concern to take policy decision as regards cash or fund planning for smooth
operation of the business at the appropriate time.

Steps involved in the verification of the system of internal control:

 Study the system according to which accounting routines are being carried out to ensure that
these do not leave any receipt of cash, material or any other asset remaining unaccounted for,
permit any payment of money being made without relevant goods or services having been
received or tendered or any property being given away without its price having been received
or being accounted for.
 Examine the authority vested in different persons and the conditions under which they can
exercise such authorities.
 Confirm where the supervision over various managerial and accounting functions, exercised
by different members of the staff to whom these duties have been assigned, is adequate.
 Ascertain whether any mechanical aids are being employed to ensure proper accounting of
receipts and prevention of pilferage of cash, stamps, etc.
 Observe the working of the accounting system and routine and determine, by application of
procedural tests, whether checks and counter-checks envisaged by the system of internal
control are being properly applied.
 Confirm that there is a system according to which the physical existence of different forms of
assets is being periodically reconciled with their balance in the books of account and
discrepancies noticed are reported and adjusted; also that balance of customers, creditors,
bankers and persons with whom securities are deposited are reconciled periodically. Further,
that persons who are in custody of valuable assets, have furnished bonds of adequate value
which would protect the company in the event of any misappropriation or misapplication
thereof by such persons or the concern has obtained appropriate insurance coverage.
 Ascertain that the system of internal control is reviewed periodically and, where necessary, a
change in procedures made to plug in any loopholes which might have been observed on such
a review. Also, that policy decisions which are taken from time to time are translated into
actual practice.
 Ascertain that the concern has system of banking all revenues or cash realization and
expenses cannot be made from such realization.
 Ascertain that there is proper segregation of duties, i.e. cash custodian is not allowed to make
accounting entries but records of cash payments and receipts only.
Question No. 14
What is 'Audit Evidence' and how it is obtained? (5Marks, June 2007)
Or
What is an "Audit Evidence"? (5 Marks December 2009, December 2012)
Or
Write short notes on Audit Evidence (4 Marks June 2005, June 2009)

Or
Sufficient Appropriate Audit Evidence (5 Marks December 2010)
Answer
NSA-500 defines audit evidence as "the information obtained by the auditor in arriving at the
conclusions on which the audit opinion is based. “An auditor is called upon to assess effectiveness of
internal control, review the books of accounts and financial statements and provide audit opinion. For
this purpose, auditors are required to obtain sufficient appropriate audit evidence to be able to draw
reasonable conclusions on which to base the audit opinion. In other words, Audit evidence refers to the
necessary information that an auditor gathers in order to form a credible opinion on the assertions by the
client's management that are inherent in the financial statements. Audit evidence comprises source
documents and accounting records underlying the financial statements and corroborating information
from other sources. These evidences, therefore often, include information relating to the completeness,
validity and accuracy of the recorded value of assets, liabilities, equity, income and expenditure of the
client entity. The information, so obtained, may be either in written or oral form. An audit in accordance
with NSA is designed to provide reasonable assurance that the financial statements taken as a whole are
free from material misstatement. Reasonable assurance is a concept relating to the accumulation of the
audit evidence necessary for the auditor to conclude that there are no material misstatements in the
financial statements taken as a whole. Therefore, auditor is expected to make critical assessment, with a
questioning mind, of the validity of audit evidence obtained and is alert to audit evidence that contradicts
or brings into question the reliability of documents or management representation.
Audit evidence is obtained from an appropriate mix of tests of control and substantive procedures. In
some circumstances, evidence may be obtained entirely from substantive procedures. NSA 500 on Audit
Evidence further elaborates this concept. According to it, sufficiency and appropriateness are inter related
and apply to evidence obtained from both compliance and substantive procedures. Sufficiency refers to
the quantum of audit evidence obtained while appropriateness relates to its relevance and reliability. In
fact, the quantum of evidence to be obtained would depend upon the nature of the evidence collected.
More relevant and reliable is the evidence; the lesser quantity would have to be collected. Normally, the
auditor finds it necessary to rely on audit evidence, which is persuasive rather than conclusive. He may
often seek evidence from different sources or of different nature to support the same assertions.
Ordinarily, audit evidence is obtained regarding each financial statement assertion. Audit evidence
regarding one assertion, for example, existence of inventory, will not compensate for failure to obtain
audit evidence regarding another, for example, valuation. The nature, timing and extent of substantive
procedures will vary depending on the assertions. Tests can provide audit evidence about more than one
assertion, for example, collection of receivables may provide audit evidence regarding both existence and
valuation.
While collecting audit evidence, the auditor must remember that the cost of obtaining evidence should
not exceed the benefits to be derived from it.

The auditor obtains evidence in performing compliance and substantive procedures by inspection,
observation, inquiry and confirmation computation and analytical review.
Question No. 15
a. Inherent Risk and Control Risk (5 Marks June 2008)

When the internal control system is nonexistent or so weak that a class of transaction or account balances
are susceptible to the material misstatement then the risk associated is known as inherent risk. It is very
important for the auditor to assess the inherent risks associated with all material transactions and should
be considered while developing overall audit plan and drawing up audit programmes.
The assessment of inherent risks is the professional judgements of the auditors However, there are a few
general factors that the auditor can consider while assessing the inherent risk. Some of the examples are
the management experience and knowledge, nature of business, reliability of business partners, level of
engagement of professionals and experts, availability of standard set of policies and rules, etc.
When there is related accounting and internal control system for a class of transaction or accounts
balances but a material misstatement could occur in an individual case as independent of others that
would not normally be prevented or detected by the internal control and accounting system, then there is
existence of control risk.
The auditor should assess whether the accounting and internal control system for a transaction or account
balance are effective and sufficient. It is also important how the control mechanisms relate to each other
in various transactions and account balances.
The audit programme and procedures should be drawn and audit should be performed in light of the
possibility of material misstatement that could occur in any transaction or account as a control risk.
Thus, inherent risk is existence risk whereas control risk is procedural lapses risks. Inherent risks can be
minimized by adopting certain rules and steps whereas control risks can be minimized by way of
continuing assessment of implementation of management rules, procedures and systems.
b. Control Risk and Detection Risk (5 Marks June 2009)

Answer:
Control risk is the risk that misstatement that could occur in an account balance or class of transactions
and that could be material, individually or when aggregated with mis-statements in other balances or
classes, will not be prevented or detected on a timely basis by the system of internal control There will
always be some control risk because of the intrinsic limitation of any system of internal control To assess
control risk, the auditor should consider the adequacy of control design, as well as test adherence to

control procedures. In the absence of such an assessment, the auditor should assume that control risk is
high.
Detection risk is the risk that an auditor's procedures will not detect a misstatement that exists in an
account balance or class of transactions that could be material, individually or when aggregated with
misstatements in other balances or classes. The level of detection risk relates directly to the auditor's
procedures. Some detection risk would always be present even if an auditor were to examine 100 percent
of the account balance or class of transaction because, for example, the auditor may select an
inappropriate audit procedure, misapply an appropriate audit procedure or misinterpret the audit results.
Question No. 16
Briefly describe the components of internal control. (10 Marks December 2008)
Answer
As per NSA 315, the auditor should obtain an understanding of internal control relevant to the audit. The
auditor uses the understanding of internal control to identify types of potential misstatements, consider
factors that affect the risks of material misstatement, and design the nature, timing, and extent of further
audit procedures.
Internal control is the process designed and effected by those charged with governance, management, and
other personnel to provide reasonable assurance about the achievement of the entity‟s objectives with
regard to reliability of financial reporting, effectiveness and efficiency of operations and compliance with
applicable laws and regulations. It follows that internal control is designed and implemented to address
identified business risks that threaten the achievement of any of these objectives.
Internal control, as discussed in this ISA, consists of the following components:
a. The control environment.

b. The entity‟s risk assessment process.
c. The information system, including the related business processes, relevant to financial
reporting, and communication.
d. Control activities.
e. Monitoring of controls.
Let us now discuss in brief about these components:
a) Control Environment
The control environment includes the attitudes, awareness, and actions of management and those
charged with governance concerning the entity‟s internal control and its importance in the entity. The
control environment also includes the governance and management functions and sets the tone of an
organization, influencing the control consciousness of its people. It is the foundation for effective
internal control, providing discipline and structure.
The control environment encompasses the following elements:

 Communication and enforcement of integrity and ethical values.

 Commitment to competence.
 Participation by those charged with governance.
 Management’s philosophy and operating style.
 Organizational structure.
 Assignment of authority and responsibility.
 Human resource policies and practices.
b) Entity’s Risk Assessment Process

An entity‟s risk assessment process is its process for identifying and responding to business risks and
the results thereof. For financial reporting purposes, the entity‟s risk assessment process includes how
management identifies risks relevant to the preparation of financial statements that give a true and
fair view (or are presented fairly, in all material respects) in accordance with the entity‟s applicable
financial reporting framework, estimates their significance, assesses the likelihood of their
occurrence, and decides upon actions to manage them. For example, the entity‟s risk assessment
process may address how the entity considers the possibility of unrecorded transactions or identifies
and analyzes significant estimates recorded in the financial statements. Risks relevant to reliable
financial reporting also relate to specific events or transactions.
Risks relevant to financial reporting include external and internal events and circumstances that may
occur and adversely affect an entity‟s ability to initiate, record, process, and report financial data
consistent with the assertions of management in the financial statements. Once risks are identified,
management considers their significance, the likelihood of their occurrence, and how they should be
managed. Management may initiate plans, programs, or actions to address specific risks or it may
decide to accept a risk because of cost or other considerations. Risks can arise or change due to
circumstances such as the following:
 Changes in operating environment.

 New personnel.
 New or revamped information systems
 Rapid growth.
 New technology.
 New business models, products, or activities.
 Corporate restructurings.
 Expanded foreign operations.
 New accounting pronouncements.
c) Information System, Including the Related Business Processes, Relevant to Financial

Reporting, and Communication

An information system consists of infrastructure (physical and hardware components), software,

people, procedures, and data. Infrastructure and software will be absent, or have less significance, in
systems that are exclusively or primarily manual. Many information systems make extensive use of
information technology (IT).
Accordingly, an information system encompasses methods and records that:
 Identify and record all valid transactions.

 Describe on a timely basis the transactions in sufficient detail to permit proper classification
of transactions for financial reporting.
 Measure the value of transactions in a manner that permits recording their proper monetary
value in the financial statements.
 Determine the time period in which transactions occurred to permit recording of
transactions in the proper accounting period.
 Present properly the transactions and related disclosures in the financial statements.
Communication involves providing an understanding of individual roles and responsibilities

pertaining to internal control over financial reporting. It includes the extent to which personnel
understand how their activities in the financial reporting information system relate to the work of
others and the means of reporting exceptions to an appropriate higher level within the entity. Open
communications channels help ensure that exceptions are reported and acted on. Communication
takes such forms as policy manuals, accounting and financial reporting manuals, and memoranda.
Communication also can be made electronically, orally, and through the actions of management.
d) Control Activities
Control activities are the policies and procedures that help ensure that management directives are
carried out, for example, that necessary actions are taken to address risks that threaten the
achievement of the entity‟s objectives. Control activities, whether within IT or manual systems, have
various objectives and are applied at various organizational and functional levels.
Generally, control activities that may be relevant to an audit may be categorized as policies and
procedures that pertain to the following:
 Performance reviews.
 Information processing.
 Physical controls.
 Segregation of duties.
Certain control activities may depend on the existence of appropriate higher level policies established
by management or those charged with governance. For example, authorization controls may be
delegated under established guidelines, such as investment criteria set by those charged with
governance; alternatively, non-routine transactions such as major acquisitions or divestments may
require specific high-level approval, including in some cases that of shareholders.

e) Monitoring of Controls
An important management responsibility is to establish and maintain internal control on an ongoing
basis. Management‟s monitoring of controls includes considering whether they are operating as
intended and that they are modified as appropriate for changes in conditions. Monitoring of controls
may include activities such as management‟s review of whether bank reconciliations are being
prepared on a timely basis, internal auditors‟ evaluation of sales personnel‟s compliance with the
entity‟s policies on terms of sales contracts, and a legal department‟s oversight of compliance with
the entity‟s ethical or business practice policies.
Monitoring of controls is a process to assess the quality of internal control performance over time. It
involves assessing the design and operation of controls on a timely basis and taking necessary
corrective actions. Monitoring is done to ensure that controls continue to operate effectively. For
example, if the timeliness and accuracy of bank reconciliations are not monitored, personnel are
likely to stop preparing them. Monitoring of controls is accomplished through ongoing monitoring
activities, separate evaluations, or a combination of the two.
Ongoing monitoring activities are built into the normal recurring activities of an entity and include
regular management and supervisory activities. Managers of sales, purchasing, and production at
divisional and corporate levels are in touch with operations and may question reports that differ
significantly from their knowledge of operations.
In many entities, internal auditors or personnel performing similar functions contribute to the
monitoring of an entity‟s controls through separate evaluations. They regularly provide information
about the functioning of internal control, focusing considerable attention on evaluating the design and
operation of internal control. They communicate information about strengths and weaknesses and
recommendations for improving internal control.
Question No. 17
"Internal control questionnaire is a method to collect information about the existence, operation and
efficiency of internal control in an organization" Discuss.
(7 Marks December 2008
Internal control questionnaire is a series of questions concerning internal control. An important
advantage of the questionnaire approach is that oversight or omission of significant internal control
review procedures is likely to occur with this method. With a proper questionnaire, all internal control
evaluation can be completed at one time or in sections. The review can more easily be made on an
interim basis. The questionnaire form also provides an orderly means of disclosing control defects. In the
questionnaire, generally questions are so framed that 'Yes' answer denotes satisfactory position and a 'No'
answer suggests weakness. Provision is made for an explanation or further details of 'No' answer. In
respect of questions not relevant to the business, 'Not Applicable' reply is given.
The questionnaire is usually issued to the client and the client is requested to get it filled by the
concerned executives and employees. If on a perusal of the answer, inconsistencies or apparent

incongruities are noticed, the matter is further discussed by auditor's staff with the client's employees for
a clear picture. The concerned auditor then prepares a report of deficiencies and recommendations for
improvements.
Internal control questionnaire hence facilitates the audit process as a clear picture of the relevant control
weaknesses are traced out immediately which facilitates the entire audit planning as the critical audit
areas are readily identified.
Question No. 18
a) Objectives of Internal Audit (5 Marks June 2009)

The objectives of Internal Audit can be stated as follows:
To verify the accuracy and authenticity of the financial accounting and statistical records presented to the
management.
 To ascertain that the standard accounting practices, as have been decided to be followed by
the organization, are being adhered to.
 To establish that there is a proper authority for every acquisition, retirement and disposal of
assets.
 To confirm that liabilities have been incurred only for the legitimate activities of the
organization.
 To analyze and improve the system of internal check; in particular to see (i) that it is
working; (ii) that it is sound; and (iii) that it is economical.
 To facilitate the prevention and detection of frauds.
 To examine the protection afforded to assets and the uses to which they are put.
 To make special investigations for management.
 To provide a channel whereby new ideas can be brought to the attention of management.
 To review the operation of the overall internal control system and to bring material
departures a non-compliance to the notice of the appropriate level of management; the
review also generally aims at locating unnecessary and weak controls for making the entire
control system effective and economical.
b) Test of Internal Control (5 Marks June 2009)

After assimilating the internal control system, the auditor needs to examine whether and how far the
same is actually in operation. For this, he resorts to actual testing of the system in operation. This he does
on a selective basis: he can plan this testing in such a manner that all the important areas are covered in
period of, say, three years. Selective testing is being done by application of procedural tests and auditing
in depth.

Tests of control are performed to obtain audit evidence about the effectiveness of the:
 Design of the accounting and internal control systems, that is, whether they are suitably designed
to prevent or detect and correct material misstatements; and
 Operation of the internal controls throughout the period.
Tests of control include tests of elements of the control environment where strengths in the control
environment are used by auditor to reduce control risk.
Tests of control may include:
 Inspection of documents supporting transactions and other events to gain audit evidence that
internal controls have operated properly, for example, verifying that a transaction has been
authorised.
 Inquiries about, and observation of, internal controls which leave no audit trail, for example,
determining who actually performs each function and not merely who is supposed to perform it.
 Re-performance of internal controls, for example, reconciliation of bank accounts, to ensure they
were correctly performed by the entity.
 Testing of internal control operating on specific computerised applications or over the overall
information technology function, for example, access or program change controls.
Question No. 19
How would you deal with the following situation?
a) While carrying out the audit of a client you had found that direct confirmation from a major
customer of the company had not been received. The management of the company has explained
that due to a dispute which arose in the recent past, it is not advisable to pursue the customer as
this would further aggravate the relationship. However, the management is willing to provide you
copies of the statements received from the customer along with the reconciliation to verify the
year-end balance, which you may retain in your working papers as audit evidence. (5 Marks
June 2009)
Answer : As per NSA500 " Audit Evidence", the auditor should obtain sufficient appropriate audit
evidence to be able to draw reasonable conclusions on which to base the audit opinion. When obtaining
audit evidence from tests of control, the auditor should consider the sufficiency and appropriateness of
the audit evidence to support the assessed level of control risk. The nature, timing and extent of
substantive procedures will vary depending on the assertions. The reliability of audit evidence is
influenced by its source.
Further, when in substantial doubt as to a material financial statement assertion, the auditor would
attempt to obtain sufficient appropriate audit evidence to remove such doubt. If unable to obtain

sufficient appropriate audit evidence, however, the auditor should express a qualified opinion or a
disclaimer of opinion.
In the given case, there exist some doubt about the balances as the management has agreed that there is a
dispute and hence it is necessary to obtain external confirmation of balances if not the nature of dispute
so that the auditor can reach a conclusion about the appropriateness of the debtors balances in addition to
checking the statements available with the client.
Question No. 20
What are the general considerations in framing a system of internal check?
(7 Marks June 2009)
Answer
The following are the general considerations in framing a system of internal check:
 No single person should have an independent control over any important aspect of the business.
All dealings and acts of every employee should, in the ordinary course, come under the review of
another.
 The duties of members of the staff should be changed from time to time without any previous
notice so that the same officer or subordinate does not, without a break, perform the same
function for a considerable length of time.
 Every member of the staff should be encouraged to go on leave at least once in a year. Experience
has shown that frauds successfully concealed by employees are often unearthed when they are on
leave.
 Persons having physical custody of assets must not be permitted to have access to the books of
account.
 There should exist an accounting control in respect of each important class of assets; in addition,
these should be periodically inspected so as to establish their physical condition.
 To prevent loss or misappropriation of cash, mechanical devices, such as the automatic cash
register, should be employed.
 A majority of business concerns now-a-days work according to some kind of budgetary control. It
enables them to review from time to time the progress of their trading activities. Such business
houses should have a separate staff for the collection of statistical figures which later on should
be checked with corresponding figures from the financial books. If wide discrepancies are
observed, these should be reconciled.
 For stock-taking, at the close of the year, trading activities should, if possible, be suspended. The
task of stock-taking, and evaluation should be done by staff belonging to several sections of the
organisation. It may prove dangerous to depend exclusively on the stock section staff for these
tasks, since they may be tempted to under or over-state the stock.
 The financial and administrative powers should be distributed very judiciously among different
officers and the manner in which these are actually exercised should be reviewed periodically.

 Procedures should be laid down for periodical verification and testing of different sections of
accounting records to ensure that they are accurate.
Accounting procedures should be reviewed periodically, for, even well-designed and carefully
installed procedures, in course of time, cease to be effective.
Question No. 21
a. Test Checking and Statistical Sampling ( 5 Marks June 2009)

Answer
During audit of entries, involving large amounts or relating to material accounts are seen exhaustively
and entries are picked up for verification at random from the remainder according to a certain plan is
known as test checking. The only quality that this technique can claim lies in its keenness to cover
larger amounts and material accounts. Even it errors, frauds etc. remain undetected in the part not
checked, they are not likely to be too big as to upset the truth and fairness of the financial statement.
Statistical sampling is a method of audit testing which is more scientific based entirely on the auditor‟s
own judgment because it involves use of mathematical laws of probability in determining the
appropriate sample size in varying circumstances. Statistical sampling has reasonably wide application
where a population to be tested consists of a large number of similar items and more in the case of
transactions involving compliance testing, debtor‟s confirmation, payroll checking, vouching of
invoices and petty cash vouchers.
b. Internal check and Internal control ( 5 Marks June 2010)

Answer
Internal check is a check on day-to-day transactions which operate continuously as part of the routine
system whereby the work of one person is proved independently or is complementary to the work of
another, the object being the prevention or early detection of errors or fraud. Internal check is a part of the
overall internal control system and operates as built-in device as far as the staff organization and job
allocation aspects of the control system are concerned.
The internal control is a plan of an organization and all the methods and procedures adopted by the
management of an entity to assist in achieving management's objective of ensuring, as far as practicable,
the orderly and efficient conduct of its business, including adherence to management policies, the
safeguarding of assets, prevention and detection of fraud and error, the accuracy and completeness of the
accounting records and the timely preparation of reliable financial information.
Question No. 22
What are the assertions with which an auditor is concerned with while obtaining audit evidence from
substantive procedures? (5 Marks December 2009, 5 Marks June 2010)

Answer
An auditor is concerned with following assertions: -
 Existence: That an asset or liability exists at a given date.
 Rights and obligations: That an asset is a right of the concern and a liability is an obligation at
a given date.
 Occurrence: That a transaction or event which took place pertains to the entity during the
relevant period.
 Completeness: That there are no unrecorded assets, liabilities or transaction.
 Valuation: That an asset or liability is recorded at an appropriate carrying value.
 Measurement: That a transaction is recorded in the proper amount and revenue or expense is
allocated to the proper period.
 Presentation and disclosure: That an item is disclosed classified and described in accordance
with recognized accounting policies and practices and relevant statutory requirements.
Question No. 23
Mention briefly the conditions or events, which increase the risk of fraud or error leading to material
misstatement in financial statements. (5 Marks December 2009)
Answer
In planning and performing his examination, the auditor should take into consideration the risk of
material misstatements of the financial information caused by fraud or error. Weaknesses in the design
of the internal control system and non-compliance with identified control procedures amongst other
conditions or events which increase the risk of fraud or error are:
i) Weaknesses in the design of internal control system and non-compliance with the laid
down control procedures, e.g., a single person is responsible for the receipt of all
information and marking it to the relevant sections or two persons are responsible for
receipt of information but the same is not followed in actual practice, etc.
ii) Doubts about the integrity or competence of the management, e.g., domination by one
person, high turnover rate of employees, frequent change of legal counsels or auditors,
significant and prolonged understaffing of the accounts department, etc.
iii) Unusual pressures within the entity, for example, industry is doing well but the company
is not performing all right, heavy dependence on a single line of product, inadequate
working capital, entity needs raising share prices to support the market price in the wake
of public offer, etc.
iv) Unusual transactions such as transactions with related parties, excessive payment for
certain services to lawyers, etc.
v) Problems in obtaining sufficient and appropriate audit evidence, e.g., inadequate
documentation, significant differences between the figures as per the accounting records
and confirmation received from third parties, etc.

Question No. 24
In a medium size trading organization, the accountant was given additional responsibility of making
recoveries from the debtors. On one occasion, when an insurance claim of Rs. 25,000 was received, he
credited the same to the account of a debtor and misappropriated the cash which he had recovered
from the said debtor. Pinpoint weaknesses in the internal control system which led to this situation.
Give your comments on the above situation.
Answer
Following two essential features of internal control are relevant here :
 Breaking the chain of the work in a manner so that no single person can handle a
transaction from the beginning to the end and
 Segregation of accounting and custodial functions.
Weakness in internal control system in the instant case:
 The accountant is receiving cash and also passing the entries in the books. The
accountant should not have been allowed to effect recoveries.
 It also appears that system for issuing receipts for amount received - whether cash or
cheque is also lacking.
 In a small and to some extent medium size organization, the supervision of the owner
offsets the deficiencies in internal control system. But in this case, it appears, that
supervision and personal control is also lacking.
Thus, in the given case, the main weakness of the system is that it is ignoring the basic requirements of
a good internal control system.
Question No. 25
Write short notes on Flow Chart (5 Marks each December 2009, 5 marks June 2011)
Answer:
It is a graphic presentation of each part of the company's system of internal control. A flow chart is
considered to be the most concise way of recording the auditor's review of the system. It minimizes the
amount of narrative explanation and thereby achieves a consideration or presentation not possible in any
other form. It gives bird's eye view of the system and the flow of transactions and integration and in
documentation, flaws in the system can be easily spotted and improvements can be suggested.
It is also necessary for the auditor to study the significant features of the business carried on by the
concern; the nature of its activities and various channels of goods and materials as well as cash, both
inward and outward; and also a comprehensive study of the entire process of manufacturing, trading and
administration. The flow chart facilitates auditor to understand and evaluate the internal controls in the
correct perspective.

Question No.26
Explain the difference between Internal Control and Internal Check (5 Marks December 2009)
Or
Distinguish between internal control and internal check (4 Marks, December 2003)
Answer:
Internal Control comprises whole system of controls, financial or otherwise established by the
management for the conduct of business. It includes internal check and internal audit besides other
controls. But internal check refers to a system of allocating duties among the staff in such a manner that
every person records a different aspect of a transaction. It is narrower in scope.
A system of internal control strives to achieve objectives such as adherence to policies and procedures
laid down by management, safeguarding of assets, prevention and detection of frauds and errors,
accuracy and completeness of records and timely preparation of reliable financial information. On the
other hand, internal check is designed to prevent frauds and errors and fixing responsibility and
safeguarding the assets. It is a part of Internal Control system.
Internal Control system is reviewed occasionally by the management in the light of changes within the
organization, in the economic environment and suggestions of external and internal auditor. But Internal
Check once introduced in the organization is generally stable for a certain period and, hence, less flexible
as compared to the internal control system.
Question No. 27
a) "Physical presence of the auditor at the time of year end verification of stocks is though not
always possible, it is recommended that he should at least be present as an observer." Signify
the importance of this statement and list out the important aspects which the auditor should
look into to ensure an effective physical verification programme. (5 Marks December 2009)
c. Indicate briefly the purposes for which analytical procedures are applied by the Auditor. (5
Answer:
Physical verification of inventories is the responsibility of the management of the entity. However, as per
NSA 501 "Audit Evidence: Specific consideration for selected items," where the inventories are material
and the auditor are placing reliance upon the physical count by the management, it may be appropriate
for the auditor to attend the stock-taking. The extent of auditor's attendance at stock-taking would depend
upon his assessment of the efficacy of relevant internal control procedures, and the results of his
examination of the stock records maintained by the entity and of the analytical review procedures. The
procedures concerning the auditor's attendance at stock-taking depend upon the method of stock-taking
followed by the entity. There are two principal methods of stock-taking: periodic stock-taking and
continuous stock-taking. Under the first method, physical verification of inventories is carried out at a

single point of time, usually at the year end. Under the second method, physical verification is carried out
throughout the year, with different items of inventory being physically verified at different points of time.
However, the verification programme is normally so designed that each material item is physically
verified at least once in a year and more often in appropriate cases. The continuous stock-taking method
is effective when a perpetual inventory system of record-keeping is also in existence. Some entities use
continuous stock-taking methods for certain stocks and carry out a full count of other stocks at a selected
date. The auditor is expected to examine the adequacy of the methods and procedures of physical
verification followed by the entity.
Before commencement of the verification, the management should issue appropriate instructions to
stock-taking personnel. Such instructions should cover all phases of physical verification and preferably
be in writing. It would be useful if the instructions are formulated by the entity in consultation with the
auditor. The auditor should examine these instructions to assess their efficacy. Where the auditor is
present at the time of stock-taking, he should observe the procedure of physical verification adopted by
the stock-taking personnel to ensure that the instructions issued in this behalf are being actually followed.
The auditor should also perform test-counts to satisfy himself about the effectiveness of the procedures.
a) Analytical procedures are used for the following purposes:
 to assist the auditor in planning the nature, timing and extent of other audit procedures;
 as substantive procedures when theirs use can be more effective or efficient than tests of
details in reducing detection risk for specific financial statement assertions, and
 as an overall review of the financial statements in the final review stage of the audit.
Thus, analytical procedures may be used extensively while conducting an audit to establish authenticity
of information contained in the financial statements. In some cases, analytical procedures can be more
effective than tests of details in reducing detection risk for specific financial statement assertions. This is
particularly true in case volume of information is homogeneous and quite large. For instance, in case of
salaries and wages the volume is generally quite large and only internal evidence is available. In such a
case, performing analytical procedures would provide substantive audit evidence and reduce the extent of
vouching to a large extent.
Question No. 28
Mention briefly the conditions or events, which increase the risk of fraud or error leading to material
misstatement in Financial Statements. (5 Marks June 2010)
Answer
In planning and performing his examination, the auditor should take into consideration th e risk of
material misstatements of the financial information caused by fraud or error. Weaknesses in the
design of the internal control system and non-compliance with identified control procedures
amongst other conditions or events which increase the risk of fraud or error are:

(i) Weaknesses in the design of internal control system and non-compliance with the laid down
control procedures, e.g., a single person is responsible for the receipt of all dak and marking it
to the relevant sections or two persons are responsible for receipt of dak but the same is not
followed in actual practice, etc.
(ii) Doubts about the integrity or competence of the management, e.g., domination by one -person,
high turnover rate of employees, frequent change of legal counsels or auditors, significant and
prolonged understaffing of the accounts department, etc.
(iii) Unusual pressures within the entity, for example, industry is doing well but the company is
not performing all right, heavy dependence on a single line of product, inadequate worki ng
capital, entity needs raising share prices to support the market price in the wake of public
offer, etc.
(iv) Unusual transactions such as transactions with related parties, excessive payment for certain
services to lawyers, etc.
(v) Problems in obtaining sufficient and appropriate audit evidence, e.g., inadequate
documentation, significant differences between the figures as per the accounting records and
confirmation received from third parties, etc.
Question No.29
“Internal control questionnaire is a method to collect information about the existence, operation and
efficiency of internal control in an organization". Discuss. (8 Marks June 2010)
Answer:
Or
Explain briefly the technique of "Internal Control Questionnaire" to facilitate the accumulation of
information necessary for proper evaluation of internal control.
(5 Marks June 2014)
Or
Write short notes on Internal control questionnaire (5 Marks June 2010)
Internal control questionnaire is a series of questions concerning internal control. An important
advantage of the questionnaire approach is that oversight or omission of significant internal control
review procedures is likely to occur with this method. With a proper questionnaire, all internal control
evaluation can be completed at one time or in sections. The review can more easily be made on an
interim basis. The questionnaire form also provides an orderly means of disclosing control defects. In the
questionnaire, generally questions are so framed that 'Yes' answer denotes satisfactory position and a 'No'
answer suggests weakness. Provision is made for an explanation or further details of 'No' answer. In
respect of questions not relevant to the business, 'Not Applicable' reply is given.
The questionnaire is usually issued to the client and the client is requested to get it filled by the
concerned executives and employees. If on a perusal of the answer, inconsistencies or apparent

incongruities are noticed, the matter is further discussed by auditor's staff with the client's employees for
a clear picture. The concerned auditor then prepares a report of deficiencies and recommendations for
improvements.
An important advantage of the questionnaire approach is that oversight or omission of significant internal
control review procedures is less likely to occur with this method. With a proper questionnaire, all
internal control evaluation can be completed at one time or in sections. The review can more easily be
made on an interim basis. The questionnaire form also provides an orderly means of disclosing control
defects. It is the general practice to review the internal control system annually and record the review in
detail.
Question No.30
Giant Ltd. is newly established cement industry and yet to start commercial production. Various
payments, large and small, are being regularly made. You are required to prepare internal control
questionnaire regarding „procedure for authorization‟ for payments.?
(5 Marks June 2010)
Answer
The internal control questionnaire for „procedure for authorization‟ may be drawn as below:
i) Does the enterprise have a formal document showing the various authorities, which can sanction
payments along with the nature of the relevant payments and the limit on sanctioning powers?
ii) Does the system provide for authorization for certain payments by the top management or the
governing body?
iii) Are the financial powers of various sanctioning/disbursing authorities reasonable?
iv) Have the financial powers of various authorities been intimated to various departments of the
enterprise?
v) Is there a system of post facto authorization of payments in exceptional cases where prior sanction
could not be obtained?
Question No.31
So far as the auditor is concerned, the examination and evaluation of the internal control system is an
indispensable part of the overall audit programme. What are the key areas that auditor will enable to
know after reviewing internal controls. (7 Marks June 2010)
Answers:
The review of internal controls will enable the auditor to know:
i) Whether errors and frauds are likely to be located in the ordinary course of operations of the
business.
ii) Whether an adequate internal control system is in use and operating as planned by the
management.
iii) Whether an effective internal auditing department is operating.
iv) Whether the controls adequately safeguards the assets.

v) How far and the how adequately the management is discharging its function in so far as
correct recording of transactions is concerned.
vi) How reliable the reports, records and the certificates to the management can be.
vii) The extent and the depth of the examination that he needs to carry out in the different areas of
auditing.
viii) What would be appropriate audit technique and audit procedure in the given circumstances.
ix) What are the areas where control is weak and where it is excessive.
x) Whether some worthwhile suggestions can be given to improve the control system.
Question No. 32
Torstar‟s Heaven is star level hotel situated at Nagarkot. During the initial discussion it is noticed that
the hotel management is aware of pilferage issues, however due attention is not paid to address the
situation. You are required to express your statement underlying the importance of internal control on
the pilferage issues and the probable consequences of it, if not addressed properly.
(5 Marks June 2010)
Answer:
Pilfering is one of the greatest problems in any hotel and the importance of internal control cannot be
over stressed. It is the responsibility of the management to introduce controls, which will minimize the
leakage as far as possible. If the internal control in the hotel is weak, then a very serious problem exists
for the auditor. Preparing accounts at regular interval for each of the cost/ revenue centers and
investigating the deviation if any could be helpful in this regard. If necessary, scope of audit tests will
have to be increased and in the event of material margin discrepancy being unexplained, the auditor
may consider qualifying his report.
Question No. 33
a. Utility Routine (5 Marks, December 2010)
Answer
Utility Routines are generally supplied by the computer manufacturer and are available for call up by the
operating system. These routines play a key role in an electronic data processing. These are generalized
programs that perform necessary but routine jobs in a computer installation. These routines are
sufficiently flexible to handle needs of all users. They are controlled by parameters to indicate the
particular characteristics of the data or the requirements. Generally, three types of utility routines are
made available by computer vendors-data set utilities, system utilities and independent utilities.
b. Control Risk (5 Marks December 2011)

Answer
Control Risk
Audit risk is the risk that an auditor may give an inappropriate opinion on financial information that is
materially misstated. Audit risk is composed of three components viz. inherent risk, control risk and

detection risk. Control risk is the risk that misstatement that could occur in an account balance or class of
transactions and that could be material, individually or when aggregated with misstatements in other
balances or classes, will not be prevented or detected on a timely basis by the system of internal control.
There will always be some control risk because of the intrinsic limitations of any system of internal
control.
For assessing control risk, the auditor should consider the adequacy of control design, as well as
test adherence to control procedures. In the absence of such assessment, the auditor should
assume that control risk is high. The auditor ordinarily assesses control risk at a high level for
some or all assertions where:
 The entity`s policies and procedures relating to an assertion are not effective or
 Evaluating the effectiveness of the entity`s policies and procedures would be inefficient
 The auditor may make a preliminary assessment of control risk at less than a high level
only when the auditor:
 Is able to identify policies and procedures of the accounting and internal control systems
relevant to specific assertions which are likely to prevent or detect material misstatements
in the financial statements; and
 Plans to perform tests of control or support the assessment.
 It may be noted that nature, timing and extent of substantive audit procedures to be
performed would depend upon the auditor`s assessment of the inter-relationship between
inherent risk, control risk and detection risk.
c. Tagging and Tracing (5 Marks December 2011)

Answer
It is a technique better than Integrated Test Data Facility. It involves tagging the client`s input data in
such a way that relevant information is displayed at key points. It uses the actual data, and so the question
of elimination of special entries test data designed under Integrated Test Data Facility does not arise. The
hard copy, so produced is available only to the auditor and may describe such inputs as hours worked in a
pay period in excess of 60; or sales orders processed in excess of Rs. 200,000 etc. This enables the
auditor to examine transactions at the intermediate steps in processing.
The advantage of tagging and tracing approach lies in the use of actual data and elimination of the need
for reversing journal entries. The disadvantage is that the erroneous data will not necessarily be tagged.
An effective combination approach may be to use the ITF approach (Integrated Test Facility) for a few
hypothetical transactions and the tagging and tracing approach to follow line data through a complex
system.
d. Audit risk in the small business (5 Marks December 2011)

Answer
The auditor needs to obtain the same level of assurance in order to express an unqualified opinion on the
financial statements of both small and large entities. However, many internal controls which would be

relevant to large entities are not practical in the small business. For example, in small businesses,
accounting procedures may be performed by a few persons who may have both operating and custodial
responsibilities, and therefore segregation of duties may be missing or severely limited. Inadequate
segregation of duties may, in some cases, be offset by a strong management control system in which
owner/manager supervisory controls exist because of direct personal knowledge of the entity and
involvement in transactions. In circumstances where segregation of duties is limited and audit evidence
of supervisory controls is lacking, the audit evidence necessary to support the auditor‟s opinion on the
financial statements may have to be obtained entirely through the performance of substantive procedures.
Question No. 34
Define the concept of internal control and explain its inherent limitations.
Answer (5 Marks December 2010)
The concept of internal control may be defined as the plan of organization and all the methods and
procedures adopted by the management of an entity to assist in achieving management‟s objectives of
ensuring the orderly and efficient conduct of its business, including adherence to management policies,
the safeguarding of assets, prevention and detection of fraud and error, the accuracy and completeness of
the accounting records, and the timely preparation of reliable financial information. The system of
system and comprises control environment and control procedures. Internal control is an essential
prerequisite for efficient and effective management of any organization. It is thus, a primary
responsibility of every management to establish and maintain an adequate system of internal control
appropriate to the size and nature of the business of the entity.
An internal control system can provide only reasonable, not absolute, assurance that the management‟s
objectives in establishing the system are achieved. This is because there are some inherent limitations of
internal control. These limitations are mentioned hereunder:
 Controls have to be cost effective. Hence, some control mechanisms may not have been
implemented merely because they are not cost-effective.
 Most control tools are directed at transactions of a usual nature. Therefore, transactions of
unusual nature might have been escaped from such controls.
 The human error potentiality prevails everywhere, even in the control systems.
 Any system of control has its limitations in preventing frauds through collusion between two
or more persons.
 Controls may not change with the pace of changes in conditions.
 Management itself may manipulate transactions or accounting estimates.
 A member of management may himself override the control system.
Question No. 35
Write short notes on the following
a. Management representation as an audit evidence (5 Marks June 2010)

Answer
The management representation as an audit evidence:
 During the course of an audit, management makes many representations to the auditor, either
unsolicited or in response to some specific enquiries.
 The auditor also should obtain representation from management, where considered appropriate
and necessary.
 The management representation is taken to corroborate audit evidence, but representations by
management cannot be a substitute for other audit evidences that the auditor could reasonably
expect to be reasonably available.
 In certain cases, where knowledge of facts is confined to management, a representation by
management may be the only audit evidence, which can reasonably be expected to be available.
 If a management representation is contradicted by an available other audit evidence, the auditor
should examine the circumstances and, when necessary, reconsider the reliability of other
representations made by management.
b. Stratified Sampling (5 Marks, December 2010
Answer
Stratified Sampling is one of the methods of Random Sampling. This method involves dividing the
whole population to be tested in a few groups called strata and taking a sample from each of them. Each
stratum is treated as if it were a separate population and if proportionate items are selected from each of
the stratum. The group into which the whole population is divided is determined by the auditor on the
basis of his judgment, e.g. entire expense vouchers may be divided into:
(i) Vouchers above Rs.100,000
(ii) Vouchers between Rs.25, 000 and Rs.100,000
(iii) Vouchers below Rs.25, 000
The auditor can then decide to check all vouchers above Rs.1, 00,000, 50% between 25,000 and
Rs.100,000 and 25% of those below Rs.25, 000.
The reasoning behind the stratified sampling is that for a highly diversified population, weights should be
allocated to reflect these differences. This is achieved by selecting different proportions from each
stratum. It can be seen that the stratified sampling is simply an extension of simple random sampling.
Question No. 36
PR Sharma & Co. appointed you as an assistant auditor for audit of a business organization. You were
asked to prepare internal control questionnaire for audit of payments of the organization.
Answer
Internal control questionnaire for audit of payment is as given below:
1) Are the duties related to payment segregated and rotated periodically?

2) Are the financial powers properly laid down and reasonable?

3) Have the financial powers of various authorities been intimated to various departments?
4) Whether proper and adequate documents are maintained for each payment?
5) Is the arithmetical accuracy, price, quality, timing and other terms and conditions ( of the contract)
is ensured before approving a payment?
6) Are payments made through account payee cheques except in exceptional cases?
7) Are bills marked as „paid‟ once the payment has been made? Are there adequate controls to
ensure that payment is not made twice against the same bill?
8) Is the person/party, to whom payment is made, properly identified?
9) Is issue of cheque properly controlled? Are all cheques pre numbered? Is each cheque duly
accounted for?
10) Is there a system of sending monthly statement of accounts to suppliers and other parties?
11) Are there adequate controls for safe custody of cheque books?
Question No. 37
Briefly explain five methods of sampling. (5 Marks June 2011)
Answer
Methods of sampling is presented below:
Haphazard Sampling
Haphazard sampling is a technique adopted by the auditor where the sample does not follow a structured
technique. Haphazard sampling is not appropriate when using statistical sampling and the auditor should
always ensure that haphazard sampling is not „doctored‟ in such a way that it deliberately avoids
sampling items which, for example, are difficult to locate. All items in the population should stand a
chance of being sampled.
Stratified Sampling
This is a technique where the auditor will split items in a sample into their various strata‟s. For example,
in a payroll sample the auditor might split the sample between full-time males, full-time females, part-
time males and part-time females and work out the percentage of the strata in the population (the
population being the total amount that makes up a figure). For example if 30% of the population are full-
time males, 40% full-time females, 20% part-time males and 10% part-time females, then the sample will
consist of 30% full-time males, 40% full-time females etc.
Systematic Sampling
Often referred to as „interval‟ sampling this is where the auditor will take the number of sampling units in
the population and divide this into the sample size to give a sampling interval. For example, in a sales
invoice sample where the sampling interval is 20, then the auditor will determine a starting point for
sampling and sample every 20th sales invoice thereafter.

Block Sampling
Block sampling is a technique where the auditor applies procedures to such items that all occur in the
same block of time or sequence. For example, testing amounts received from customers in the month of
September. Alternatively, a „block‟ of remittance advices received in September would be tested in their
entirety. It is to be noted that block sampling should be used with caution because valid references
cannot be made beyond the period or block examined. Where the auditor does use block sampling, then
many blocks should be selected to help minimize sampling risk.
Judgement
Auditors can use their judgement in selecting items for sampling. There are three basic issues which
determine which items are selected:
 The value of items

 The relative risk (items prone to error should be given special attention)
 The representativeness (the sample should be representative of the population)
Question No. 38
On being appointed the auditor of a company for the first time you find that the cashier also handles
the books of account and the cash receipt are not being banked intact but parts of these are being
utilized for cash payments. What would be your reaction? What recommendations would you make to
the company in this connection? (8 Marks, June 2011 )
The internal control system of the company is found very weak and there are the chances of cash being
misappropriated. Recommendations to company for the enhancement of the internal control system of
the company are as follows:
 The cashier should not have access to the books of accounts. The books of account should be
handled by the accountants who should not be directly involved with the cash transaction.
 All the cash collections should be deposited to the bank.
 Cash payments should be made through the Bank.
 Petty expenses should be managed through the Petty cash book, for which purpose the petty
cash, imprest should be provided to the petty cashier through the bank.
Question No. 39
Define the concept of internal control and explain its inherent limitations. (5Marks June 2011)
Answer
The concept of internal control may be defined as the plan of organization and all the methods and
procedures adopted by the management of an entity to assist in achieving management‟s objectives of
ensuring the orderly and efficient conduct of its business, including adherence to management policies,
the safeguarding of assets, prevention and detection of fraud and error, the accuracy and completeness of
the accounting records, and the timely preparation of reliable financial information. The system of

system and comprises control environment and control procedures. Internal control is an essential
prerequisite for efficient and effective management of any organization. It is thus, a primary
responsibility of every management to establish and maintain an adequate system of internal control
appropriate to the size and nature of the business of the entity.
An internal control system can provide only reasonable, not absolute, assurance that the management‟s
objectives in establishing the system are achieved. This is because there are some inherent limitations of
internal control. These limitations are mentioned hereunder:
 Controls have to be cost effective. Hence, some control mechanisms may not have been
implemented merely because they are not cost-effective.
 Most control tools are directed at transactions of a usual nature. Therefore, transactions of
unusual nature might have been escaped from such controls.
 The human error potentiality prevails everywhere, even in the control systems.
 Any system of control has its limitations in preventing frauds through collusion between two or
more persons.
 Controls may not change with the pace of changes in conditions.
 Management itself may manipulate transactions or accounting estimates.
 A member of management may himself override the control system.
Question No. 40
On being appointed, the auditor of a company for the first time you find that the cashier also handles
the books of account and the cash receipt are not being banked intact but parts of these are being
utilized for cash payments. What are the risks involved? What could be your recommendations to
mitigate the risks envisaged? (5 Marks December 2011)
Answer
Since the cashier handles books of accounts and cash is not deposited intact in the bank account the
internal control system of the company is found very weak. There are the risks of cash being
misappropriated. Examples could be:
 Failure to record purchases properly in order to misappropriate cash.
 misappropriation cash from a machine or whilst cash is in transit.
 acceptance or solicitation of money or a benefit to provide cash to a third party.
 acceptance or solicitation of money or a benefit to provide goods or services to a third party
without taking a cash payment from that party.
This may create significant risk to the company that may erupt from the weak internal control system.
Recommendations to company for the enhancement of the internal control system of the company are
as follows:
 The cashier should not have access to the books of accounts. The books of account should be
handled by the accountants who should not be directly involved with the cash transaction.
 All the cash collections should be deposited to the bank.

 Cash payments should be made through the Bank.

 Petty expenses should be managed through the Petty cash book, for which purpose the petty
cash, imprest should be provided to the petty cashier through the bank.
Question No. 41
Distinguish between the following
Compliance Procedures and Substantive Procedure (5 Marks December 2011)
Answer
Compliance procedures are those tests designed to obtain reasonable assurance that those internal
controls on which audit reliance is to be placed are in effect. In obtaining audit evidence from
compliance procedures, the auditor is concerned with assertions that the control exists, the control is
operating effectively and the control has so operated throughout the period of intended reliance.
Whereas substantive procedures are tests designed to obtain evidences as to the completeness, accuracy
and validity of the data produced by accounting system. They are of two types: tests of details of
transactions and balances and analysis of significant ratios and trends. As mentioned in NSA-500 Audit
Evidence, when obtaining audit evidence from substantive procedures, the auditor should consider the
sufficiency and appropriateness of audit evidence from such procedures together with any evidence from
tests of control to support financial statement assertions.
Question No. 42
As an auditor of a small business, how can you assure the internal control system of that company?
(8 Marks June 2013)
Answer
Internal control is a set of internally generated policies and procedures adopted by the management of an
enterprise which is pre requisite for an organization‟s efficient and effective performance. It is thus a
primary responsibility of every management to create and maintained adequate system of internal control
appropriate to the size and nature of the business entity.
The system of internal control as the process designed, implemented and maintained by those charged
with governance, management and other personnel to provide reasonable assurance about the
achievement of an entity‟s objectives with regard to reliability of financial reporting, effectiveness &
efficiency of operations, safeguarding of assets and compliance with applicable laws & regulations.
The auditor needs to obtain the same degree of assurance in order to given an unqualified opinion on the
financial statements of both small & large entities. However many controls which would be relevant to
large entities are not practical in small business. For example, in a small business, accounting procedure
may be performed by a few persons.

Small business is characterized by the lower number of employees, minimum investment of capital,
small capacity of production, difficulty to segregate the owner and the management and there is less use
of technology. It means the business is producing the product (if it is a manufacturing industry) manually
using very less mechanical tools and traditional tools.
Like, another characteristic is the simplicity and local products designed to cover up the local
environment. It is highly labour intensive and less machine oriented in nature. Also the business is
dependent with the skill labour instead of installing high value of machine.
Those persons may have both operating and custodial responsibilities and segregation of function may be
missing or severely limited.
Inadequate segregation of duties, may in some cases, is offset by supervisory controls exercised by the
owner. The supervisory function by the owner becomes possible because of the fact that he has direct
personal knowledge of the business and involvement in the business transactions.
In circumstances where segregation of duties is limited and the evidence of supervisory controls is
lacking the evidence necessary to support the auditors opinion on the financial information may have to
be obtained largely through substantive procedure.
Question No. 42
Batch Processing and On-Line Real Time System (5 Marks June 2013)
Answer
Data processing system in computerized environment is generally Batch Processing or On-Line Real
Time (OLRT) system which can be distinguished as under:
Batch Processing On-Line Real Time (OLRT)
system
 Transactions are accumulated and  Transactions are processed as
processed in group. and when they occur.
 Two types of files are maintained master  Only master file is maintained. It
file is updated when batch processing is keeps updating.
run.
 Updating does not take place as quickly as  Though updating takes place
in On-Line Real time system. immediately the processing
becomes complex.
 Not useful when instant and updated  Useful for immediate reporting
results are required. system.
 Generally, provides Audit trail.  Generally, does not provide
audit trail and hence requires
more attention of auditor.

Question No. 43
a) Detection risk (2.5 Marks June 2013)

b) Tolerable error (2.5 Marks June 2013)
Answer:
a) Detection risk: Detection risk is the risk that the auditor will not detect a misstatement that exists
in an assertion that could be material, either individually or when aggregated with other
misstatements. Detection risk is a function of the effectiveness of an audit procedure and of its
application by the auditor. Detection risk cannot be reduced to zero because the auditor usually
does not examine all of a class of transactions, account balance, or disclosure and because of
other factors. Such other factors include the possibility that an auditor might select an
inappropriate audit procedure, misapply an appropriate audit procedure, or misinterpret the audit
results. These other factors ordinarily can be addressed through adequate planning, proper
assignment of personnel to the engagement team, the application of professional skepticism, and
supervision and review of the audit work performed.
b) Tolerable error: Tolerable error is the maximum error that that the auditor would be willing to
accept and still concludes that the result from the sample has achieved the audit objective.
Tolerable error is considered during the planning stage and for substantive procedures related to
the auditor judgment about materiality. The smaller the tolerable error, the greater the sample size
will need‟s be.
In test of control, the tolerable error is the maximum rate of deviation from a prescribed control
by control procedure that at the auditor would be willing to accept, based on the preliminary
assessment of control risk. In substantive procedure, tolerable error is the maximum monetary
error in an account balance or a class of transactions that the auditor would be willing accept, so
that when the result of all audit procedure is reasonable assurance, that the financial statement are
not materially mis-stated.
Question No. 44
CA. Khari Adhikari heads the internal audit department of Tee limited. The external audit firm
decided to rely on the internal auditor‟s work relevant for external audit because of the professional
competency of the chief of internal audit of Tee Limited. Later it was found that the external auditor
had conducted audit procedures himself instead of relying on internal auditor‟s work; however,
claimed that he should not be made responsible for inappropriate audit opinion because he had relied
on the work of qualified internal auditor. (5 Marks June 2013)

Answer:
The role of internal auditing is determined by management, and its objectives differ from those of the
external auditor who is appointed to report independently on the financial statements. The internal audit
function‟s objectives vary according to management‟s requirements. The external auditor‟s primary
concern is whether the financial statements are free from material misstatements. Nevertheless some of
the means of achieving their respective objectives are often similar and thus certain aspects of internal
auditing may be useful in determining the nature, timing and extent of external audit procedures. Internal
auditing is part of the entity. Irrespective of the degree of autonomy and objectivity of internal auditing, it
cannot achieve the same degree of independence as required of the external auditor when expressing an
opinion on the financial statements. The external auditor has sole responsibility for the audit opinion
expressed, and that responsibility is not reduced by any use made of internal auditing. All judgments
relating to the audit of the financial statements are those of the external auditor.
The external auditor has sole responsibility for the audit opinion expressed, and that responsibility is not
reduced by any use made of internal auditing. All judgments relating to the audit of the financial
statements are those of the external auditor. Hence the external audit firm in the given situation cannot be
relieved of its duty to express opinion on the financial statements by relying on the work of internal
auditor.
Question No. 45
What is audit risk? Explain three components of audit risk and also define their relationship.
(8 Marks December 2013, 5 Marks December 2016)
Answer:
Audit Risk (AR): Audit risk is the risk that the auditor gives an inappropriate audit opinion when
the financial statements are materially misstated. In other words, it is a function of the risk of
material misstatement of the financial statements (or simply, the “risk of material misstatement”)
(i.e., the risk that the financial statements are materially misstated prior to audit) and the risk that
the auditor will not detect such misstatement (“detection risk”).
Three components of audit Risk:

a) Inherent Risk (IR): “Inherent risk” is the susceptibility of an assertion to a misstatement that
could be material, either individually or when aggregated with other misstatements, assuming
that there are no related controls.
b) Control Risk (CR): “Control risk” is the risk that a misstatement that could occur in an
assertion and that could be material, either individually or when aggregated with other
misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity‟s
internal control. That risk is a function of the effectiveness of the design and operation of
internal control in achieving the entity‟s objectives relevant to preparation of the entity‟s

financial statements. Some control risk will always exist because of the inherent limitations of
internal control.
c) Detection Risk (DR): “Detection risk” is the risk that the auditor will not detect a misstatement
that exists in an assertion that could be material, either individually or when aggregated with
other misstatements. Detection risk is a function of the effectiveness of an audit procedure and
of its application by the auditor. Detection risk cannot be reduced to zero because the auditor
usually does not examine all of a class of transactions, account balance, or disclosure and
because of other factors. Such other factors include the possibility that an auditor might select
an inappropriate audit procedure, misapply an appropriate audit procedure, or misinterpret the
audit results. These other factors ordinarily can be addressed through adequate planning, proper
assignment of personnel to the engagement team, the application of professional skepticism,
and supervision and review of the audit work performed.
Relationship of Audit Risk with its components:
The relationship is expressed by the following Equation:
AR=IR*CR*DR
From the definition of various components of audit risk stated above, it is clear that IR and CR
cannot be reduced by the auditor. In other words the auditor has control over DR only. So, to keep
the audit risk at acceptable level based on above equation, if the product of IR and CR is high, the
auditor should reduce DR.
Question No. 46
While conducting the audit of X-ray Limited, Mr. Pratap, the statutory auditor found that the detection
risk relating to certain transactions cannot be reduced to acceptable level. As a Statutory Auditor, how
would you deal in the given situation? (5 Marks June 2013)
Answer
The auditor should use professional judgment to assess audit risk and to design audit procedures to
ensure that it is reduced to an acceptably low level.
“Detection risk” is the risk that an auditor‟s substantive procedures will not detect a misstatement that
exists in an account balance or class of transactions that could be material. The higher the assessment of
inherent and control risks, the more audit evidence the auditor should obtain from the performance of
substantive procedures. When both inherent and control risks are assessed as high, the auditor needs to
consider whether substantive procedures can provide sufficient appropriate audit evidence to reduce
detection risk, and therefore audit risk, to an acceptably low level. The auditor should use his
professional judgments to assess audit risk and to design audit procedures to ensure that it is reduced to
an acceptably low level.
If it cannot be reduced to an acceptable level, the auditor should express a qualified opinion or a
disclaimer of opinion as may be appropriate.

Question No. 47
Explain different methods of obtaining audit evidence. (7 Marks December 2013)
Answer
Different methods of obtaining audit evidence are described below:
i. Inspection of Records or Documents: Inspection consists of examining records or documents,
whether internal or external, in paper form, electronic form, or other media. Inspection of
records and documents provides audit evidence of varying degrees of reliability, depending on
their nature and source and, in the case of internal records and documents, on the effectiveness
of the controls over their production. An example of inspection used as a test of controls is
inspection of records or documents for evidence of authorization.
ii. Inspection of Tangible Assets: Inspection of tangible assets consists of physical examination
of the assets. Inspection of tangible assets may provide reliable audit evidence with respect to
their existence, but not necessarily about the entity‟s rights and obligations or the valuation of
the assets. Inspection of individual inventory items ordinarily accompanies the observation of
inventory counting.
iii. Observation: Observation consists of looking at a process or procedure being performed by

others. Examples include observation of the counting of inventories by the entity‟s personnel
and observation of the performance of control activities. Observation provides audit evidence
about the performance of a process or procedure, but is limited to the point in time at which the
observation takes place and by the fact that the act of being observed may affect how the
process or procedure is performed.
iv. Inquiry: Inquiry consists of seeking information of knowledgeable persons, both financial and
non-financial, throughout the entity or outside the entity. Inquiry is an audit procedure that is
used extensively throughout the audit and often is complementary to performing other audit
procedures. Inquiries may range from formal written inquiries to informal oral inquiries.
Evaluating responses to inquiries is an integral part of the inquiry process.
v. Confirmation: Confirmation, which is a specific type of inquiry, is the process of obtaining a

representation of information or of an existing condition directly from a third party. For
example, the auditor may seek direct confirmation of receivables by communication with
debtors. Confirmations are frequently used in relation to account balances and their
components, but need not be restricted to these items. For example, the auditor may request
confirmation of the terms of agreements or transactions an entity has with third parties; the
confirmation request is designed to ask if any modifications have been made to the agreement
and, if so, what the relevant details are.

vi. Recalculation: Recalculation consists of checking the mathematical accuracy of documents or

records. Recalculation can be performed through the use of information technology, for
example, by obtaining an electronic file from the entity and using CAATs to check the accuracy
of the summarization of the file.
vii. Re-performance: Re-performance is the auditor‟s independent execution of procedures or

controls that were originally performed as part of the entity‟s internal control, either manually
or through the use of CAATs.
viii. Analytical Procedures: Analytical procedures consist of evaluations of financial information

made by a study of plausible relationships among both financial and non-financial data.
Analytical procedures also encompass the investigation of identified fluctuations and
relationships that are inconsistent with other relevant information or deviate significantly from
predicted amounts.
Question No. 48
Explain the limitations of Internal Control. (5 Marks June 2014)
Answer
An Internal Control system can provide only reasonable assurance that the management‟s objectives in
establishing the system are achieved. That is, no internal control system can provide absolute assurance
that the control objectives are achieved. This is due to the fact that any internal control system has certain
internal limitations. The limitations may arise due to:
i. Management‟s usual requirement that the cost of an internal control does not exceed the expected
benefits to be derived.
ii. Most internal controls tend to be directed at routine transactions rather than non-routine
transactions.
iii. The potential for human error due to carelessness, distraction, mistakes of judgment and the
misunderstanding of instructions.
iv. The possibility of circumvention of internal controls through the collusion of a member of
management or an employee with parties outside or inside the entity.
v. The possibility that a person responsible for exercising an internal control could abuse that
responsibility, for example, a member of management overriding an internal control.
vi. The possibility that procedures may become inadequate due to changes in conditions, and
compliance with procedures may deteriorate. Controls has to be cost-effective.
The inherent limitation of internal control system requires the auditor to perform substantive
procedure to be able to express an opinion.

Question No. 49
Distinguish between Internal Control Questionnaire and Internal Control Evaluation
(5 Marks June 2014)
Answer:
Internal Control Questionnaire (ICQ) and Internal Control Evaluation (ICE) : The internal control
questionnaires show the area where weakness occur or likely to occur. They do not give any idea of the
importance of those weaknesses. The Internal Control Evaluation brings to light importance of those
weakness disclosed by ICQ. Main points of distinctions are:
(i) ICQ incorporates a large number of detailed questions but does not attempt to distinguish
their relation in materiality. ICE isolates the main control objectives within the area of review.
(ii) Weaknesses are highlighted by answer “Yes” on ICE compared with „No‟ on ICQ.
(iii) Answer „no‟ in ICQ indicates a weakness real or potential, but its significance is not revealed.
Whereas ICE requires audit personnel to state whether, an apparent weakness may prove to be
material in relation to the accounts as a whole.
(iv) The „Control Checklist‟ in ICE is more than a summary of key control factors, and is no
substitute for ICQ.
Question No. 50
Based on study and evaluation of internal control system, auditor concludes that internal controls are
well designed and functioning effectively. Still auditor performs appropriate substantive audit
procedures to form an opinion on the financial statements before issuance of audit report. Explain
why auditor has to perform appropriate substantive audit procedures in such an ideal situation also.
Answer
An internal control system can provide only reasonable assurance that the management‟s objectives in
establishing the system are achieved. This is due to the fact that internal control system has the following
inherent limitations:
i) Controls have to be cost effective. So, some controls may not be instituted because they
are not cost effective.
ii) Most controls are directed at transactions of usual or routine nature. Therefore transactions
of unusual nature may escape from ambit of internal control.
iii) The potential of human error remains in any system of control.
iv) Controls may not prevent frauds through collusion between two or more persons.
v) Management may override controls.
vi) Controls may not keep pace with changing circumstances.
vii) Management itself may manipulate transactions or accounting estimates.

Above inherent limitations of internal control system makes it necessary for the auditor to perform
substantive procedures to express an appropriate opinion on the financial statements. But if the "Test of
Control" conducted by the auditor concludes that internal control system is in existence, operated
throughout the period and functioning effectively, the auditor may not consider necessary to perform
substantive audit procedure for that particular area. Substantive procedures though cannot be fully
eliminated and the auditor determines the area where substantive procedures should be used.
Question No. 51
a) Self-review threat (2.5 Marks July 2015)
b) Teeming and lading (2.5 Marks July 2015)
c) Audit risk at the financial statement level (5 Marks June 2016)
d) Use of flow chart in evaluation of internal control (2.5 Marks June 2014)
a. Answer
It is the threat that a professional accountant will not appropriately evaluate the results of a previous
judgment made or service performed by the professional accountant, or by another individual
within the professional accountant‟s firm or employing organization, on which the accountant will
rely when forming a judgment as part of providing a current service.
b. Answer
It is a fraud arrangement whereby amount received from a customer being misappropriated; also to
prevent its detection the money received from another customer subsequently being credited to the
account of the customer who has paid earlier. Similarly, moneys received from the customer who
has paid thereafter being credited to the account of the second customer and such a practice is
continued so that no one account is outstanding for payment for any length of time, which may lead
the management to either send out a statement of account to him or communicate with him.
c. Answer
Audit risk is considered at the financial statement level during the audit planning process. At this
time, the auditor should undertake an overall audit risk assessment based on his knowledge of the
client‟s business, industry, management, control environment and operations. Such an assessment
provides preliminary information about the general approach to the engagement, the auditor‟s
staffing needs and the framework within which materiality and audit risk assessments can be made
at the individual account balance or class of transactions level. As part of this overall risk
assessment, the auditor should consider whether there is potential for pervasive problems, for
example, liquidity or going concern problems.

d. Answer
Use of Flow Charts in evaluation of internal control: It is a graphic presentation of each part of the
company‟s system of internal control. A flow chart is considered to be the most concise way of
recording the auditor‟s review of the system. It minimizes the amount of narrative explanation and
thereby achieves a consideration or presentation not possible in any other form. It gives bird‟s eye
view of the system and the flow of transactions and integration and in documentation, can be easily
spotted and improvements can be suggested. It is also necessary for the auditor to study the
significant features of the business carried on by the concern; the nature of its activities and various
channels of goods and materials as well as cash, both inward and outward; and also a
comprehensive study of the entire process of manufacturing, trading and administration. This will
help him to understand and evaluate the internal controls in the correct perspective.
Question No. 52
Write short notes on Detection risk (5 Marks, December 2010, December 2015)
Answer
It is the risk that an auditor‟s procedures will not detect a misstatement that exists in an account balance
or class of transactions that could be material, individually or when aggregated with misstatements in
other balances or classes. The level of detection risk relates directly to the auditor‟s procedures, some
detection risk would always be present. Some detection risk would always be present even if an auditor
were to examine 100 percent of the account balances.
Question No. 53
Hot review & Cold Review in audit ( 5 Marks June 2016)
Answer
Hot file review or hot review is conducted usually conducted during the audit and/or audit work is
completed but before the auditor‟s report is issued. This in nature is a detailed review that is conducted
with an aim to find out if there is any weakness in application of audit procedures or if the results have
been misinterpreted. Hot reviews are usually carried out usually by the senior the audit team or someone
with the same authority who is not connected with the engagement. Such reviews mostly include
meetings with audit team personnel and their individual work so that both work and the skills of
members are improved by pointing out discrepancies and providing recommendations.
The purpose of a hot review is to identify any key areas that need to be addressed prior to signing the
report. The categories for review which may be undertaken can be described as follows:
i. Comfort reviews
ii. High risk reviews
iii. Training reviews
iv. Independence reviews
v. NSQC reviews

To summarize, hot review is conducted during the audit work is conducted but before the auditor‟s report
is issued with a prime objective to ensure compliance with relevant auditing standards and achieving
engagement‟s objectives
Cold file review or cold review is an objective evaluation on the date of auditor‟s report and is performed
by the auditor i.e. partner himself when all the audit work has been concluded and the required sufficient
appropriate audit evidence has been obtained and conclusions drawn and reported. This review usually
takes place when the auditor‟s report is signed off. The purpose of this review is to ensure compliance
with relevant auditing standards and to analyze weaknesses in the way whole audit work is conducted
and how it can be improved for next similar assignments by updating firm‟s quality control standards,
training the staff etc.
Normally the cold file review would aim to:

 Identify whether the disclosure requirements had been properly met - incorrect disclosures are the
largest subject of complaints to the Institute.
 Identify whether the Auditing Standards and Regulations have been properly complied with - each
audit would be "scored" using a comprehensive file review checklist.
 Assess the effectiveness of any independent manager review and the partner review, looking for
any points that should have been picked up by a manager but had not been, and likewise with the
partner.
To summarize, cold review is conducted with a view to check for the weaknesses in the firm‟s quality
control procedures and system, proficiency of audit team members and how they can be improved to
make later audit assignment more effective and efficient.
Question No. 54
Explain the control environment as a part of Internal Control System. ( 5 Marks July 2015)
Answer
Control environment refers to overall attitude, awareness and actions of governance and management
regarding the internal control system and its importance in the entity. The control environment has an
effect on the effectiveness of the specific control procedures. A strong control environment, for example,
one with tight budgetary controls and an effective internal audit function, can significantly complement
specific control procedures. However, a strong environment does not, by itself, ensure the effectiveness
of the internal control system.
Factors reflected in the control environment include:

 The function of the board of directors and its committees.
 Management‟s philosophy and operating style.
 The entity‟s organizational structure and methods of assigning authority and responsibility.

 Management‟s control system including the internal audit function, personnel policies and
procedures and segregation of duties.
Question No. 55
„Doing a statutory audit is full of risk. `Narrate the factors which cause the risk
. (5 Marks December 2015)
Answer
An independent audit whether performed in terms of relevant statutory legislation or in terms of the
engagement, the auditor has to be reasonably satisfied as to whether the information contained in the
underlying accounting records and other source details reliable for the preparation of financial
statements. Since the entire process of auditing is based on the assessment of judgements made by the
management of the entity as well as evaluation of internal controls, the audit suffers certain inherent
risks. Factors which can such risk in conducting an audit are discussed below:
(i) Exercising judgement on the part of the auditor: The auditor‟s work involves exercise of judgement,
for example, in deciding the extent of audit procedures and in assessing the reasonableness of the
judgements and estimates made by management in preparing the financial statements.
(ii) Nature of audit evidence: The auditor normally relies upon persuasive evidence rather than
conclusive evidence. Even in circumstances where conclusive evidence is available, the cost of obtaining
such an evidence may far exceed the benefits.
(iii) Inherent limitations of internal control: Internal control can provide only reasonable, but not
absolute, assurance on account of several inherent limitations such as potential for human error,
possibility of circumstances of control through collusion, etc.
On account of above, it is quite nature that an audit suffers from control risk on account of inherent
limitations of internal control risk and detection risk on account of test nature of audit and judgement and
estimates involved in formulating accounting policies.
Question No. 56
Give your comments on the following situation. ( December 2015)
The management of Sathi Limited suggested for quick completion of the statutory audit that it would
give its representation about the receivables in terms of their recoverability. The management also
acknowledged to the auditors that the management would give their representation after scrutinizing
all accounts diligently and they own responsibility for any errors in these respects. They wanted
auditors to complete the audit checking all other important areas except receivables. The auditor
certified the account clearly indicating in his report the fact of reliance he placed on representation of
the management.
The management of Sathi Limited wants the auditor to carry out audit on all areas, except on area of
receivables. There cannot be any restriction on scope of audit in case of statutory audit.

The management representation, according to NSA 580, cannot substitute another audit evidence that the
auditor could reasonably expect to be available to the auditor.
The audit evidence for checking receivables – say, invoices, debt acknowledgement documents, receipts,
statement of accounts, confirmations etc., are available evidences which auditor is duty bound to verify.
Just because management had owned responsibility for the correctness of its evaluation of receivables,
the auditor cannot shirk his responsibility. This is negligence on his part if he relies on the management
representation without assessing the corroborative available evidences.
Question No. 57
XYZ has trade receivable balance of Rs. 1 crore as on year end date. The cut off procedure indicates
that cheque of Rs 25 lakhs received in the last week of the year was not entered in the books and it
was entered in cheques in hand register. In the history of the company the cheques are never lost or
misappropriated and the cheques are deposited within the first week of receipt. These cheques were
also deposited and trade receivable balances were accordingly reduced in the next year. Give your
comments. (5 Marks June 2016)
Answer
Internal control procedure of the company seems to be appropriate to record all cheques which have not
been deposited on the same date and keep it properly till deposited. However, at the year end all balances
should also reflect the true and fair view. In the given case since no entries are made for cheques in hand,
cash balance is understated and trade receivable balances are overstated by Rs 25 lakhs. So, the company
should deduct the trade receivable balance in the current year itself thereby presenting cheques in hand
under cash and cash equivalents. In the next year when cheques are deposited, cash in hand balance will
be reduced and bank balance should be increased.
Question No. 58
Explain about the factors that influence the reliability of Audit Evidence. (5 Marks June 2017)
Answer:
The reliability of information to be used as audit evidence is influenced by its source, nature, and the
circumstances under which it is obtained, including the controls over its preparation and maintenance.
Even when information to be used as audit evidence is obtained from sources external to the entity,
circumstances may exist that could affect its reliability. For example, information obtained from an
independent external source may not be reliable if the expert may lack objectivity. While recognizing
that exceptions may exist, the following generalizations about the reliability of audit evidence may be
useful:

i. Independent Source - The reliability of audit evidence is increased when it is obtained from
independent sources outside the entity.
ii. Effective internal control system - The reliability of audit evidence that is generated internally is
increased when the related controls, including its preparation and maintenance, imposed by the
entity are effective.
iii. Method of obtaining - Audit evidence obtained directly by the auditor (for example, observation
of the application of a control) is more reliable than audit evidence obtained indirectly or by
inference (for example, inquiry about the application of a control).
iv. Form of Audit Document - Audit evidence in documentary form, whether paper, electronic, or
other medium, is more reliable than evidence obtained orally (for example, a contemporaneously
written record of a meeting is more reliable than a subsequent oral representation of the matters
discussed).
v. Type of Documents - Audit evidence provided by original documents is more reliable than audit
evidence provided by photocopies or facsimiles, or documents that have been filmed, digitized or
otherwise transformed into electronic form, the reliability of which may depend on the controls
over their preparation and maintenance.
Question No. 59
Internal Check and Internal Audit (5 Marks December 2017)
Answer:
Distinction between Internal Check & Internal Audit
SN Internal Check SN Internal Audit

1 Internal check is not a specific check, 1 Internal audit is specifically done to
but the duties of different persons are check that the accounts are properly
so arranged that a person‟s work is maintained and the systems are in
automatically checked by another control.
person while carrying out the normal
duty.
2 Internal check does the preventive job 2 Internal audit does the detective job of
i.e. internal check is derived so that identifying frauds and errors and
frauds and errors are prevented. rectifying them.
3 It is more of process in a day to day 3 It is specific defined job.
functioning of the business.
4 All the persons in the organization are 4 Specific persons are appointed to the
involved to maintain the internal internal audit.
check system.

5 It is required in all organization in 5 Carrying out internal audit is not

formal or informal. compulsory. It is done based on
management decision.
6 It does not include internal audit. 6 It include internal check.
Question No. 60
Write short notes on the following: (2.5 Marks each, June 2019)
a) External confirmation
An external confirmation represents audit evidence obtained by the auditor as a direct written
response to the auditor from a third party (the confirming party), in paper form, or by electronic or
other medium. External confirmation procedures frequently are relevant when addressing assertions
associated with certain account balances and their elements. However, external confirmations need
not be restricted to account balances only. For example, the auditor may request confirmation of the
terms of agreements or transactions an entity has with third parties; the confirmation request may be
designed to ask if any modifications have been made to the agreement and, if so, what the relevant
details are. External confirmation procedures also are used to obtain audit evidence about the absence
of certain conditions, for example, the absence of a “side agreement” that may influence revenue
recognition.
b) Audit Strategy
Audit strategy is concerned with designing optimized audit approaches that seek to achieve the
necessary audit assurances at the lowest cost within the constraints of the information available.
Audit procedures should be relevant to the important assertions, and as cost effective as possible to
perform. Audit strategy generally involves the following steps:
i) Obtaining knowledge of business.
ii) Performing analytical procedures at initial stages.
iii) Evaluating inherent risks.
iv) Evaluating internal control system for strategy purpose.
v) Formulating the strategy – identifying risk areas, development of appropriate audit strategy for
those areas.
Question No. 61
Distinguish between: (5 Marks June 2019)
Test Check & Internal Check
a) Distinction between Test Check & Internal Check
Sn. Particulars Test Check Internal check
1 Meaning It stands for the method of It refers to a system of
auditing when instead of a book-keeping and

complete examination of
arrangement of staff
all the transaction
duties in the organization
recorded in the books of in such a manner that no
account only some of the one person can
transaction is selected
completely carry through a
and verified. transaction and record
every aspect thereof.
2 Instituted It is an audit procedure It is a series of procedures
by performed by the auditor laid down by the
in respect of only selected management.
group of transactions.
3 Objectives The purpose is to aid Its objective is to facilitate
auditors to check and management functions.
draw conclusions about
the voluminous
transactions.
4 Fraud & It helps the auditor to It is instituted to prevent
Errors unearth frauds and errors frauds and errors.
without checking all the
transactions.
5 Management Management has no Internal controls are
Control control over the test subject to review,
checks carried out by the appraisal and changed by
auditors. the management.

Chapter 5 Vouching
Question No 1
How will you vouch the followings?
a. Repairs to assets. (6 Marks, June 2001)
b. Income from investments. (4 Marks, June 2001)
c. Sale proceeds of Scrap. (5 Marks, June 2001)
d. Payment of taxes (3 Marks, June 2001)
e. Royalties received. (4 Marks, June 2001)
a. Answer
Since the line demarcating repairs from renewals is slender, usually it is not a simple matter to
determine the amount of the expenditure, if any, included as charges for repairs, which should be
considered as that incurred for renewal of an asset and added to its cost. It may sometimes be
possible to determine this on a consideration of the nature of repairs carried out. The proportion
of the charges which had the effect of increasing the value of an asset or enhancing its capacity or
life, should be treated as capital expenditure. Where, however, it is not possible to form an option
accurately on the basis of evidence as regards the nature of repairs, a certificate from the engineer
under whose supervision the repairs were carried out, confirming the classification of expenditure
should be obtained.
b. Answer
If the investments are many, the client generally would have an Investment Register. In such a
case, the dividend income is first vouched by reference to the counterfoils of Dividend Warrants
and the interest on securities by reference to the tax - deduction certificates, issued by IRD.
Afterwards the amounts collected are traced into the Investment Register; it is scanned to find out
whether interest or dividend, relating to any investment, has remained unrealized. If so, the
reasons, thereof are ascertained. In order that the gross amount of interest are disclosed in the
Profit and Loss Account, the tax deducted out of interest is debited to the Income-tax Account
and credited to Interest account. The auditor should verify that this has been done.
c. Answer
 Review the internal control on scrap as regards its generation, storage and disposal and see
whether it was properly followed at every stage.
 Ascertain whether the organization is maintaining reasonable records for the sale and disposal
of scrap.
 Review the production and cost records for the determination of the extent of scrap that may
arise in a given period.
 Compare the income from the sale of scrap with the corresponding figures of the preceding
three years.

 Check the rates at which scrap has been sold and compare the same with the rates that
prevailed in the preceding year.
 See that scrap sold has been billed and accounted.
 Make an overall assessment of the value of the realization from the sale of scrap as to its
reasonableness.
d. Answer
Payment on account of income-tax and other taxes consequent upon a regular assessment should
be verified by reference to the copy of the assessment order assessment sheet, demand notice and
the receipted challan. Payments or advance payment of income-tax should also be verified with
the notice of demand and the receipted challan acknowledging the amount paid. The interest
allowed on advance payment of income-tax should be included as income and penal interest
charges for
e. Answer
The auditor should see the relevant contract and examine the important provisions relating to the
conditions of payment of royalty. In particular the rate of royalty, mode of calculation and the due
dates should be noted. The periodical statements received from the payer and the calculation of
the royalty should be checked. If there is any deduction on account of recoupment of royalty for
the past period, the records for earlier royalty receipt should be seen to ensure that the amount of
deduction is as per the contract. Royalties due but not yet received should have been properly
accounted for.
Question No. 2
How will you vouch and/or verify the following? (5 Marks each June 2002)
Advertisement Expenses
Answer
 Ascertain the value if advertisement expenses to ensure that the said expense has been properly
allocated to capital, deferred revenue or revenue as the case may be
 Examine that such expenses relate to the client's business.
 Review and examination of the complete list of media of advertisement indicating that dates,
location, timing etc. along with the amounts paid in respect of each category.
 Examination of the receipts for amounts paid.
 Reviewing the contracts with the different agencies and ensuring the billing conforms to the
term and condition specified therein.
 Ensuring that all such outstanding expenses have been properly accounted for.
Question No. 3
Write short Notes on the Following
a. Depreciation and Fluctuation in Value: (4 Marks June 2002)

Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable
asset arising from use, efflux or time or obsolescence through technology and market changes. It
directly affects the earning capacity of an asset. Hence, it is a charge against the profit of the year.
Fluctuation, on the other hand is a temporary shrinkage or decrease and increase in the value of an
asset usually due to external cause such as rise and fall in market price of an asset. But the fluctuation
does not affect the earning capacity or working life of an asset. Hence, it is not taken into account and
no charge is made against the profit or the year.
Depreciation is only in connection with fixed assets while fluctuation is usually in connection with
current assets. Depreciation generally means fall in the value of faxed asset while fluctuation may
mean may mean either increase or decrease in the value of any asset, current as well as fixed.
b. Floating Charge (4 Marks June 2002)

Floating Charge refers to a general charge on some or all the assets of an enterprise which is not
attached to specific assets and are given as a security against a debt. It has the effect of creating an
immediate charge on the property of the company leaving it (company) to deal with the same in the
ordinary course of business, but subject to the limitations imposed in the instrument creating the
charge. The floating charge however, becomes fixed crystalized and the creditor becomes entitled to
proceed against the assets on which charge was created, on violation of any of the terms of the
instrument of charge.
c. Specific Reserves (4 Marks June 2002, 6 Marks June 2004)

A specific reserve is created for some definite purpose out of the profits of the company. The purpose
may be anything connected with the business which the Article of Association or the directors want
to be provided for, such as dividend equalization, replacement of fixed assets, expansion of the
organization, income - tax liability of the future. Though the concerned amounts are carried under
earmarked heads, these are available for distribution as dividend on the recommendation of the
directors but subject to the approval of shareholders, since these are created by appropriation of
profits.
There may be slight confusion since some of the objects for which specified reserves are created, may
also appear to be covered by a charge against revenue, for example, provision for bad and doubtful
debts as well as reserve for bad and doubtful debts or a provision for repairs and renewals. The only
distinction between the two is based on whether it is a charge against revenue or an appropriation of
profits. To create any specific reserve existence of profit is essential. Any amount which the directors
desire to retain or the Articles require the company to retain over and above provision, necessary for
a true and fair disclosure of profit, is specific reserve unless the same is retained for general purpose,
when it would become a general reserve.

d. Deferred Revenue Expenditure. (4 Marks June 2002)

This is a type of revenue expenditure; whose benefit extends to more than one accounting year during
which it is actually incurred. Accountancy principle requires that only that part of the expenditure
which is pertaining to the accounting period should be debited to profit and loss of the year.
Remaining amount should be carried forward in the balance sheet and it should be written off against
the future income, depending upon the number of years during which the benefit of expenditure is
likely to be enjoyed. This type of expenditure is known as deferred revenue expenditure. Part of such
revenue expenditure is to be treated as asset for the purpose of disclosure in the balance sheet for the
time being till the benefit of such expenditure is fully exhausted.
Some Examples of deferred revenue expenditure are:
 Expenditure on an advertisement campaign to launch a product in the market.

 Discount allowed on subscription to debentures.
 Development expenses in the case of mines and plantation.
e. Outstanding Assets (4 Marks June 2004)

There are two classes of outstanding assets: first; items accruing but not recorded in books
and second, expenditure already incurred, a part or whole of which relates to a period
subsequent to the date of the balance sheet.
Some of the accounts in which adjustment of outstanding assets could be made:
 Rent receivables;
 Interest and dividend
 Insurance charge paid in advance
 Advertisement
f. Casting or totaling (4 Marks June 2004)

Sometimes the totals of a wage bill are inflated by over totaling the column in which the wages
payable are entered. Such fraud can be detected only if the totals of the wage bill are checked.
Similarly, a cashier may misappropriate receipts from customers by under-totaling the receipts
column of the cash book. At times, shortages in cash have been also covered up by over totaling.
Such frauds can be detected only if the totals of the cash book and the ledger are checked.
Sometimes a fraud is committed in the following manner:
 Under casting the receipt side of the cash book;
 Overcasting the payment side of the cash;
 Fictitious entries being made in the cash column to show that amounts have been
deposited in the account when, in fact, no deposit has been made;
 Posting an amount of cash sale to the credit of a party and subsequently withdrawing the
amount; and
 Wrong totals or balances being carried forward in the cash book or in the ledger.

Question No. 4
How would you verify and vouch the following?
a. Remuneration paid to directors. (4 Marks each, June 2003)

b. Research and development expenditure. (5 Marks, June 2002, 4 Marks each, June
2003, 4 marks June 2004, 5 Marks June 2007)
c. Discounted bills receivable dishonored. (4 Marks each, June 2003)
d. Consignment sale. (4 Marks each, June 2003, 4 Marks June 2004,
4 Marks June 2005, 4 Marks December 2005)
Answer
a. Answer
 Refer to General Meeting of Board meeting resolution for the appointment and terms of
appointment and terms of appointment of the director.
 Examine Article of Association and general meeting resolution to determine the mode of
payment monthly, quarterly or by way of commission.
 Check agreement with the director.
 Verify director‟s attendance in the board meetings.
 Ensure compliance with the provision of sections 91 of the Companies Act, 2063, where
appropriate.
 Check computation of the net profits and the commission payable to directors in
accordance with Section 91 of the Companies Act, 2063.
 Verify receipts issued by the directors.
b. Answer
 Ascertain the nature of research and development work at the outset.
 Ascertain accounting policy regarding treatment of research and development of
expenditure.
 Ascertain whether the concerned research activity is authorized by the Board and has
relevance to the objectives of the company.
 See that if the research expenses are for developing products or for inventing a new
product they are treated as deferred revenue expenditure to be written off over a period of
three to five years, if successful. In case it is established that the research effort is not going
to succeed the entire expenses incurred should be written off to the profit and loss account.
 Ensure that if any machinery and equipment have been brought specially for the purpose of
research activity the cost thereof, less the residuals value is appropriately debited to the
Research and Development Account over the years of research.
 See that tax benefit arising on the research and development expenses is taken into account
in creating tax provision.

 Ensure that no expense unrelated to the research and development programme is allowed to
be debited to Research and Development Account.
c. Answer
 Obtain the schedule of discounted bills receivable dishonored.
 Check the entry in bank statement regarding the amount of bills dishonored and see that the
bank has debited the account of client.
 Verify the bills receivable, returned by the bank along with banks advice.
 See that the dishonored bills have been noted and protested by following the proper
procedure and the account of the drawee or the debtor is also debited.
 Check that bank commission, if any changed by the bank has been recovered from the
party.
d. Answer
 Ascertain that credit has been taken only for the profit on the goods sold through the
consignee before the year end. No profit should be taken for the profit on goods remaining
in the hands of the consignee.
 Where it is desired to show the result of each consignment, the goods sent to consignee
should be debited, through consignment day book, to the Consignment Account. All
expenses incurred on this consignment like freight, carriage, insurance, loading etc.
including those incurred by the consignee should also be debited to this account.
 The auditor should check debits in each of the consignment account by reference to the
proforma invoice, consignment day book, goods outward book, transport documents,
acknowledgement of the goods by the consignee and the Account sales etc.
 Credits in the consignment Account should be verified with the help of the account Sales
received from the consignee. The gross sale proceeds should be credited to the
Consignment Accountant and debited to the Consignee's account.
 Verify the terms of agreement between the consignor and the consignee to check the
commission and other expenses debited to the Consignment Account and Credited to the
Consignee's Account. The Account Sales also must be correspondingly checked.
 Ensure that the stock lying with the consignee at the end should be taken in the balance
sheet at cost on a consistent basis and credited to the Consignment Account to arrive at the
result of the Consignment transaction.
 Obtain confirmation of the balance in the account of the consignee from the consignee.
 Sometimes the goods are consigned not at cost but at an inflated price. The auditor should
see that the necessary adjustments to remove the loading are made at the end of the year.
 It is possible that the goods consigned are treated as ordinary sales. The auditor should see
that necessary adjustments are made at the year-end in respect of the unsold goods,
commission and the expense incurred by consignee. The consignee should not be shown at
a debtor for unsold goods and in valuation of stock, these goods should be included in
stock at cost worked out on a consistent basis.

Question No. 5
Distinguish between Capital and Revenue Expenditures
(8 Marks, December 2003, 5 marks December 2006)
Answer
A capital expenditure is that which is incurred for the under mentioned purpose:
a. Acquiring fixed assets

b. Making additions to the existing fixed assets
c. Increasing earning capacity of the business
d. Reducing the cost of production.
e. Acquiring a benefit of enduring nature of a valuable right.
Revenue expenditure is the expenditure, the benefit of which is immediately (within one year) expended
or exhausted in the process of earning revenue. For example, expenditure on purchase of goods for sale,
on their movement from one place to another, on maintaining assets, on keeping a business organization
going etc.
If any expenditure of a revenue nature is treated as capital, it would have the effect of inflating the profit
of the year. If the expenditure of a capital nature is charged to a revenue head, the amount of profit would
be reduced.
Question No. 6
How do you vouch the following?
a. Payment of dividends (4 Marks, December 2003)
Following steps are to be considered, in general, while verifying payments of dividends:

 Examine special provisions, if any, in the memorandum and Articles of Association regarding
payment of dividends.
 See that in declaring dividends, provisions of company's rules have been complied with.
 Examine the Board's minute regarding the payments of dividends.
 Verify the Shareholders' Register and ensure that the names of all shareholders who are entitled
to receive dividends have been included.
 Check the computation of dividends with reference to the rate of dividends and number of
shares held.
 Ensure that the central bank's permission has been obtained in case of remittance of dividends
to non-resident shareholders.
 See counterfoils of cheques for amounts paid to shareholders.
 Verify the amount paid as dividend by cross-reference to challans showing deposit of income
tax deducted at source.

b. Sales proceeds of junk materials (4 Marks, December 2003)

Sales proceeds of junk materials are to be vouched with special attention to the following points:
 Review the internal control on junk materials is as regards its generation, storage and disposal
and see whether it was properly followed at every stage.
 Ascertain whether the organization is maintaining reasonable records for the sale and disposal
of junk materials.
 Review the production and cost records for the determination of extent of junk materials that
may arise in a given period.
 Compare the income from the sale of junk materials with the corresponding figures of the
preceding three years.
 Check the rates at which different types of junk materials have been sold and compare the same
with the rates that prevailed in the preceding years.
 See that all junk materials sold have been billed and check the calculation on the invoices.
 Ensure that there exists a proper procedure to identify the junk material and goods quality
material is not mixed up with it.
 Make an overall assessment of the value of the realization from the sale of junk materials on to
its reasonableness.
c. Assets acquired under hire purchase system (4 Marks, December 2003)

 Verify the hire purchase agreement and note down the relevant points.
 Understand the accounting method followed by the entity under audit with regard to asset under
hire purchase system.
 Ascertain that only the capital portion of the installment has been debited to the asset account
and that the interest included in each installment as well, if any, has been charged off to
revenue.
 Ensure that adequate depreciation has been provided on the full cash purchase price of the asset.
d. Borrowings from bank (4 Marks, December 2003)

This may be either in the form of overdraft limits or firm loans. The verification in each case should be as
follows:
 Reconcile the balances in each type of borrowing as per bank statement.
 Confirm the year-end balance by obtaining relevant certificates from the bank showing balance
in the accounts respectively.
 Verify the authority under which amounts have been borrowed. Since in the case of a company
the authorization from the Board of Director is essential.
 Obtain a certificate from the bank showing particulars of securities deposited with the bank as
security for the borrowings or of the charge created on assets of the concern and confirm
appropriate disclosure and registration thereof with the Registrar of Companies and record in
the Register of Charges.

 Ascertain that the purpose of the borrowings and the manner of utilization is acceptable and that
it has prejudicially affected the concern.
Question No. 7
How do you vouch the following? (4 Marks each, June 2004)
a) Customs and excise duties
Customs duties is usually paid through clearing agents. Their bills duty supported by receipted Bills
of Entry are, therefore, available for verification. If a payment has been made directly, the Bill of
Entry relevant thereto together with the receipt should be inspected.
In the event of dispute where a provisional payment has been made, the amount determined as
payable finally should be ascertained and any additional duty payable or refund of the amount paid
in excess which is recoverable should be brought into account. In certain cases, drawback of
customs duty is allowed, if goods are exported or deemed to be exported. The auditor should see
that on export the refund of duty has been claimed.
Excise duty is levy on manufacture. The Liability for the Duty arises at the point of time at which
manufacture is completed. Normally, excise duty is paid before the issue of excisable goods from
the factory. To verify the payment of excise duties, the amount of duty paid must be checked with
quantity of goods in respect of which the issue permits for the goods have been received. If,
however, a triplicate copy of the challan is available in the file in respect of such payments, it will
serve as an additional evidence of the duty having been paid.
b) Payments for acquisition of assets

The purchase of an asset must be duly supported by the receipt for the amount paid. In case of an
immovable property, verify the title deeds and it passes only on registration. The transfer to sale of
property has to be verified by a solicitor or an advocate. It is necessary for the auditor to satisfy
himself generally as regards existence, value and title of the assets acquired. Verify that the assets
were purchase only by the authorized person. In the case of constructed or a plant or a machinery
manufactured by the concern with its labour and materials, it must be verified that the cost of
labour, materials and other direct expenses incurred has been charged as cost of the asset on a
proper allocation of the total expenditure debited under these heads. It must also be seen that
neither expenses on repairs and maintenance have been capitalized nor the cost of additions to
assets charged off as revenue expenses.
Question No. 8
a) The machinery of M/s J.J Pharmaceutical Ltd. has been maintained in excellent conditions and is
as good as new. Therefore, the company has not provided depreciation for the year. (5 Marks
December 2004)

Answer:
The plea of the management of the company not to provide depreciation on its assets in a particular year
on account of the reason that the company has maintained the machinery in excellent condition during
the year is not acceptable because as per the definition of depreciation given in NAS-6 “Property, Plant
and Machinery and Depreciation” on depreciation is the systematic allocation of the depreciate amount
of an asset over its useful life. Depreciation is a measure of the wearing out, consumption or other loss of
value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and
market changes” thus depreciation also arises due to efflux of time and, therefore, depreciation should be
provided irrespective of whether the assets were maintained very well during the year. Hence, in the
given case, machinery has been maintained in excellent a condition during the year is not acceptable
ground for the management of J.J Pharmaceutical Ltd. not to provide depreciation.
b) In the previous year XYZ Co. Ltd, made a provision of 9% of the contract value on an ongoing
project. The actual loss on completion of the contract in the subsequent year was 10%. The
management adjusted the difference in the previous year‟s account. (5 Marks, December 2004)
Answer:
The provision of loss of 9% of the contract value by XYZ Co. Ltd in the previous year is in the nature of
accounting estimate since due to uncertainties inherent in any business activity; it is difficult to measure
such item in a precise manner. Accordingly, adjusting the difference in the previous years‟ account is not
correct. NAS 8 on Accounting Policies, Change in Accounting Estimates and Error, states that the effect
of a change in an accounting estimate should be included in determination of net profit or loss in the
period of the change, if the change affects the period only. Thus the management should adjust the
difference in the current period only. Alternatively, the auditor should qualify his report.
Question No. 9
How would you vouch and verify the following? (4 Marks each, December 2004)
a) Purchase Returns:
Answer
In part or whole of a consignment of goods found to be defective or of a poor quality, the goods
sometime are returned to the supplier and his account is debited. The debit is raised in the Purchase
Returns Books, on the basis of debit note. The supplier on receiving the debit note, issues credit note
indicating his acceptance of the debit. Thus, on receipt it is attached to debit note. All these entries should
be verified by reference to the record Kept in the goods outwards book or the stores record. The original
invoices through which the purchases were made also should be referred to for confirming that the
nominal account, which was originally debited on the purchases being made, has been subsequently
credited on a part or whole of the goods contained in the consignment having been returned. Where the
purchase returns are large, either at the beginning or at the close of the year, these might be fictitious,
entered to cover bogus purchases recorded earlier. On such a consideration the nature thereof should be

ascertained. The rebate in price and allowances granted by the suppliers should be adjusted through the
journal on the basis credit notes received from the suppliers. These should be verified by reference to the
original invoices.
b) Loans Receivables:
Answer
Audit procedures for vouching and verification of loans receivable:
 Inspect loans deeds for the loan amount, maturity date, periodic installments, interest rate and
security provided.
 Check mortgage deed (registered or otherwise) or guarantee letter or inventory of pledged or
hypothecated merchandise as a security cover for the loan‟s
 Confirm loan balance interest payable and maturity period of loans from the borrower.
 Review minutes meetings of the Board of Directors relating to sanctioning of loans and their
monitoring at periodic intervals.
 Check interest calculations and follow up adjustment of discrepancies.
 Vouch entries to source documentation on selective basis.
 Examine transaction occurring near the year end.
 Examine adequacy of provision for doubtful receivables.
 Inquire if any litigation is ongoing with the borrowers relating to any dispute.
c) Long Term Debts:

Answer
Audit procedures for vouching and verification of long-term debts:
 Vouches issues of debt to authorization in minutes of the Board of Directors.
 Vouch entries to source documentation.
 Ascertain the amount of long-term debt maturing within one year.
 Confirm with the holders of principal amount, maturity date, interest rate, etc.
 Inspect bonds redeemed or retired during the period.
 Recalculate interest expense
 Examine transaction occurring near the year-end.
 Examine classification of obligations as either secured or unsecured.
Question No. 10
How, as an auditor, will you satisfy yourself that all liabilities for expenses have been provided for in
the balance sheet? (8 Marks, June 2005)
Answer.
 Obtain a complete list of outstanding liabilities from a responsible official.
 Scrutinize the list carefully to make sure that expenses for the entire year have been accounted
for.

 Scrutinize list of old advances outstanding on the asset side to make sure that these do not
represent expenses paid but not properly accounted for when bills were received subsequently.
 Check the minutes book to locate any liability undertaken which have not been provided for.
 Compare the list of outstanding liabilities with the previous year.
Obtain a certificate from a competent official that all liabilities for expenses have been provided.
Question No. 11
How would you vouch and\ or verify the following? (4 Marks each, June 2005)
a) Advances given to suppliers
Answer:
 Obtain schedule of debit balances in creditors‟ account and pay particular attention to the age of
the balances. Also scrutinize the purchase ledger.
 Enquiry should be made for long unadjusted outstanding and check as to whether any of them
would require provisioning.
 Examine that the advances have not been shown as deposits in balances sheet.
 Confirmation of balances should be obtained and reconciliation be done in case of any
discrepancies.
b) Cut off arrangement

Answer:
Accounting is a continuous process because the business never comes to halt. It is, therefore,
necessary that transactions of one period would be separate from those in the ensuing period so that
the results of the working of each period can be correctly ascertained. The arrangement that is made
for the purpose is technically known as "Cut-off arrangement". It is essentially forming part of the
internal check of the organization. Accounts, other than sales, purchases and stock are not usually
affected by the continuity of business and, therefore, this arrangement is generally applied only to
the aforesaid accounts. The auditor satisfies by examination and test checks that the cut-off
procedures adequately ensure that:
 Goods purchased, property in which has passed to the client, have in fact been included in the
inventories and that the liability has been provided for in case of credit purchase, and
 Goods sold have been excluded from the inventories and credit has been taken for the sales is to
be received, the concerned party has been debited.
The auditor may examine a sample of documents evidencing the movement of stocks into and out
of stores, including documents pertaining to period shortly before and after the cutoff date and
check whether stocks represented by those documents were included as appropriate during stock
taking.

Question No. 12
Distinguish between Vouching and Verification: (4 Marks, December 2005)
Answer:
The examination of documentary evidence in support of transactions contained in the books of
account is referred to as vouching. It is the technique followed in an audit for establishing
authenticity of the transactions recorded in the primary books of accounts. it essentially consists of
verifying the records of transactions contained in the books of accounts with the relevant
documentary evidence and the authority on the basis of which entries were made, also examining in
the process whether the amount mentioned in the voucher has been posted to an appropriate
account, which would disclose the nature of the transaction on its inclusion in the final statements
of accounts. On these considerations, the essential points to be borne in mind while examining the
voucher are:
 That the date of the voucher falls within the accounting period.
 That the voucher is made out in the client‟s name;
 That the voucher is duly authorized;
 That the voucher comprises all the relevant documents, which would be expected to have
been received or brought into existence on the transactions having been entered into i.e.
the voucher is complete in all respects and
 That the account in which the amount of the voucher is adjusted is the one that would
clearly disclose the character of the receipt or payment posted thereto on its inclusion in
the final accounts.
On the other hand, the term verification usually applies to the process of auditing that examines, by
appropriate manner whether assets and liabilities are properly stated in the balance sheet. The term
verification may also apply to items of profit and loss account for checking of account balance and
their presentation.
Verification in the context of balance sheet items involves an inquiry into ownership, valuation,
existence and presentation of assets and liabilities. Regarding assets the auditor while verifying
whether assets are owned by the client also looks into whether any charge has been created on them
and whether the same has been appropriately disclose, in case of liabilities, the auditor would like
to see that these are owned by the organization. thus, it is clear from the above that vouching deals
with the examination of transactions at their points of origin while verification usually deals with
the balances contained in the Balance Sheet and Profit and Loss Account.
Question No. 13
How would you vouch and verify the following?
a) Capital work in progress (3 Marks December 2007 ,5 Marks June 2010)
b) Advertisement expenses (3 Marks each December 2007)
c) Gratuity to employees (3 Marks each December 2007)

Answer
a) Answer
Capital work in progress generally consists of two accounts namely capital stock and work in
progress. Capital stock is the stock held for the purpose of use or consumption in the construction,
erection or installation of any type in order to create fixed asset.
Work in progress is the part of work completed or uncompleted which will be eventually
capitalized after complying with certain conditions.
The auditor should examine the following to verify the capital work in progress:
 Examine the capitalization policy of the company
 Evaluate the internal control systems relating to the capital stock stores and ensure that the
stores records are separately maintained.
 Examine the process and internal control systems as to the capitalization of fixed assets
 Obtain the capital work in progress sheet and ensures that the total agrees with the capital
work in progress account i.e. control account.
 Test examine the capital stores ledger with receipt and issue notes
 Obtain the physical verification report if the stores have been physically verified otherwise
obtain the stock statement duly certified by the competent personnel of the capital stores
 Ensure that there is underlying policy for valuation of work in progress and it
 Capital work in progress should be certified by the concerned technical staffs of the company.
 Ensure that no depreciation has been charged on the capital work in progress
b) Answer
 Ascertain the nature of advertisement expenses to ensure that the same have been charged
properly.
 Obtain the complete list of advertisement, media wise, i.e., newspapers, slides, hoardings,
magazines, television, radio, etc. showing the dates, exact location, timings, etc., along with
the amounts paid in respect of each category.
 See that advertisement expenses relate to the client‟s business.
 Ascertain whether there is a regular contract with an advertising agency. See that regular
statements are obtained from the agency showing the advertising media and amounts debited
to the client. Discount, if any, should be properly adjusted and disclosed in the bills.
 Check the receipts for amounts paid for the advertising expenses incurred.
 See that outstanding advertising expenses have been properly disclosed on the liabilities side
of the balance sheet.
c) Answer
 Examine the basis on which the gratuity payable to employees is worked out. The liability
for gratuity may either be worked out on actuarial rules or agreement or on the presumption
that all employees retire on the balance sheet date.

 Ensure that the basis of computing gratuity is valid.

 Verify computation of liability of gratuity on the aggregate basis.
 Check the amount of gratuity paid to employees who retired during the year with reference to
number of years of service rendered by them.
 See that the annual payment has been charged to profit and Loss Account in case the concern
has engaged other retirement benefit administrator.
 Ensure that the accounting treatment is in accordance with NAS 26“Accounting and
Reporting by Retirement Benefit Plan”.
Question No. 14
How would you examine the following transactions during statutory audit?
i) Receipt of supplier‟s invoice for goods in transit.
ii) Expenses requiring provision at the year end.
iii) Sales proceeds of scraps.
(9 Marks June 2008)
Answer
i) Answer
Generally, suppliers invoice received for the goods in transit have no effect over the recording
of transaction. Until the goods is received in the store, no accounting of transaction takes
place. However, if the purchase is made on FOB basis (i.e. when risks and rewards are
transferred to buyer once the goods are dispatched by the supplier) and goods have been
dispatched by the suppliers before the date of closing of books of account, it is necessary to
pass an entry for goods in transit.
Thus, the auditor shall pay special attention to the terms of purchases and examine the invoice
for supplied quantity, rate as per contract; total amount etc. The auditor shall also ensure that
goods-in-transit at the balance sheet date has been subsequently received.
ii) Answer
Under accrual basis of accounting, expenses incurred but no payment made at the year-end is
provided in the books of account. An auditor shall compare the provision for expenses made
during the year with that of previous year to ensure that such expenses are not omitted,
periodical and statutory payments are fully booked, either on the basis of invoices or other
evidences or on the best estimate basis if such evidence are not available, for example
expenses on telephone and electricity for the last two months provided based on the average
consumption. The auditor shall ensure that the management has system in place for
identifying such expenses and the estimates made, if any are reasonable. The auditor shall
also verify payments made after the year end of such items specifically and others in general
to ensure that provision for expenses made in the account is just and fair.

iii) Answer
During audit of sales proceeds of scraps, the auditor shall ensure/review that:
 there exists internal control as regards its generation, storage and disposal and the same
has been properly followed at every stage,
 reasonableness of records maintained and proper procedure to segregate scrap with good
quality materials,
 production records to determine extent of scrap production or availability
 sale price is reasonable, authorized by the competent authority and sales proceed is
received,
Question No. 15
How will you vouch and verify the followings?
a) Bills Receivables (2 Marks June 2008)
b) Travelling Expenses (4 Marks June 2008)
c) Salary and Wages (4 Marks June 2008)
Answer
a) Answer
 Obtain the schedule of bills receivables and ensure that the total agrees with the balance in
bills receivable account (control account),
 Check the unpaid bills at year to ensure that bills receivable are correctly accounted for,
 Check the cash collections in respect of bills matured for payment before the balance sheet to
ensure that accounts are correctly presented,
 If any bills are dishonored or are not accepted by the client after the balance sheet date or any
portion of the bills is unrecoverable then the auditor should ensure that the required provision
has been made in the year end accounts,
 Where a new bill is reported to have been taken in lieu of a bill which has matured, the bill
should be inspected,
 Where a number of bills are found to have been discounted before the close of the year, the
auditor should ensure the amount of bills so discounted is shown as contingent liability
b) Answer
 Examine the travelling policy of the company. In most cases employees service
rules/administrative rules have a chapter on travelling by staffs.
 Examine the approval process of travel orders i.e. how the travel orders are approved and
who approves the order
 Establish whether the fixed rates of travelling allowances are paid or travelling expenses are
reimbursed as per actual bills
 Examine the approval process of travel bills/vouchers i.e. who approves the travel bills
/voucher
 Ensure that travel bills/vouchers include approved travel orders with following details and
documents

 Name and designation of the person claiming the amount

— Particular of journey taken
— Original Air ticket (passenger copy)/Bus Ticket/Railway Ticket
— If the lodging and food and any other expenses are on actual reimbursement basis , all
relevant bills in original
 Check the calculation of travel bills payment in case of fixed travelling allowance and ensure
that days are correctly calculated. Any travelling advances taken should be deducted against
the travel bills.
c) Answer
The auditor may carry out the following procedures for the vouching and verification of Salaries
and wages. The records can be examined on sample basis based on the effectiveness of internal
control.
i) Examine the payroll/wage sheets with employees‟ time /attendance record, leave records
and ensure that the payrolls are approved by the competent authority.
ii) Verify the following deductions:
 Absence
 Leave without pay
 Loans and advances
 Income Tax
 Provident fund
 Fines and Penalties
 Welfare schemes/Health schemes/Insurance Charges
 Voluntary contribution to retirement benefits
iii) Examine the legal, regulatory and contractual agreements and confirm their compliances
iv) In case of casual labour, examine approval of competent authority. The auditor can also pay
surprise visits to assess the correctness of attendance.
v) In case of outsourcing of labour, examine the contract with the suppliers
vi) Test the correctness of the amount with reference to the Annual Return of the salaries
submitted to Income Tax Authority
vii) Obtain the list of employees who have retired during the year and verify that they have not
been included in the payroll
viii) Confirm that unpaid or unclaimed salaries and wages are correctly accounted for. Check the
subsequent payments
ix) Compare the following records with those of previous year in order to assess the variation
and to obtain the required assurance
 Total Wage Bill,
 Monthly wages and salaries
 Salaries and wages for each department

 Ratio of salaries and wages to cost of sales/cost of production

 Ratio of P.F/other Contributions (based on fixed percentage) to total salaries and
wages
Question No. 16
How will you vouch and/or verify the following?

a) Personal expenses of directors met by the company (5 Marks June 2009)
b) Preliminary expenses (5 Marks June 2009,5 Marks June 2011, 5 Marks December 2011)
c) Patents (5 Marks June 2009, 5 Marks December 2009)
d) Advances given to suppliers (5 Marks June 2009)
e) Forfeiture of Shares (5 Marks December 2006, 5 Marks June 2009, 4 Marks December 2005)
Answer:
a) Answer
 Check the articles of association, service contract, minutes of general meeting, etc., to check the
authorization for such payment.
 Enquire to ensure that personal expenses are not camouflaged in any other revenue items as
contemplated under the Companies Act.
 Ascertain compliance with disclosure according to requirements of the Companies Act.
 Check documentary evidences to examine the payments reimbursed.
b) Answer
It is the expenditure incurred incidental to the creation, formation and floating of a company. It
consists of stamp duties, registration fees, legal costs, consultants‟ fees, expenses of printing of
memorandum and articles, etc. The following should be checked:
 Check Board‟s minutes book containing the resolution approving the expenses claimed by
promoters as having been spent in formation of the company.
 Examine supporting papers and vouchers, contracts, agreements, etc. to support the
promoters‟ claims. Also check bills and receipts issued by the printer of the memorandum
and articles of association, share certificates, etc.
 Check receipt for the registration fee paid for registration of the company.
 Verify rates of stamp required to be affixed on the memorandum and articles of association.
 Ascertain Boards‟ minutes book for the decision to write off the preliminary expenses over
a period. The quantum thereof which has not yet been written off for these expenses should
be carried forward in the balance sheet under the head miscellaneous expenditure (to the
extent not written off or adjusted) over a period of years.
Check that no expenses other than those what constitutes preliminary expenses are booked under
this head, e.g. underwriting commission and brokerage paid.
c) Answer
 Obtain the schedule containing particulars of the patents owned by the client as on the
balance sheet date. The particulars should contain the dates of registration of the patents
with the related authorities and the dates in respect of the last renewal.

 See that the total of the values of the patent rights shown in each list agree with the values
shown in the respective ledger accounts.
 Examine the cost of patent rights. In case of outright purchase of patent rights, the purchase
consideration, legal fees and registration charges should be included in cost. When they are
developed within the organization, all costs incurred on their development including legal
and registration expenses for registration of the patent should constitute the cost. Capitalized
value should be amortized over the life of the patent.
 See that the renewal fees in respect of the patent rights have been paid and the same has
been treated as a revenue charge.
 Examine the valuation of the patent rights. It should be seen that the patent rights have been
valued at cost less depreciation attributable to the expired legal life of the patent rights.
However, if it is found that the patent rights have already lost substantial part of their
commercial value, it would be proper to value it at their residual commercial value, when it
is less than the book value for their unexpired legal life. In case the product covered by the
patent rights does not have any sale value then patents should be shown at nil valuation
notwithstanding any residual life. Reference to compliance with the provisions of NAS 38
"Intangible Assets” may also be made.
d) Answer
 Obtain schedule of debit balances in creditors‟ account and pay particular attention to the
age of the balances. Also, scrutinize the bought ledger.
 Enquiry should be made for long unadjusted outstanding and check as to whether any of
them would require provisioning.
 Examine that the advances have not been shown as deposits in balance sheet.
discrepancies.
e) Answer
The auditor verifies the forfeiture of shares in following steps:
 ascertain that the Articles authorize the Board of Directors to forfeit shares and that the
power has been exercised by the Board in the best interest of the company;
 verify the amount of call or instalment of calls which was outstanding in respect of each of
the share forfeited.,
 ascertain that the procedure in the Articles has been followed viz., the notice given to the
defaulting shareholders warning them that in the event of non-payment, by a specified date,
of the amount of call already made on the shares standing in their names, together with
interest, if any, the shares shall be forfeited, see that the proper resolutions of Directors, first
as regards issuance of notice and afterwards in respect of forfeiture of shares; and
 verify the entries recorded in the books of account consequent upon forfeiture of shares to
confirm that the premium, if any, received on the issue of shares has not been transferred to
the Forfeited Shares Account.
 Ensure the compliance of Sec. 53(3) of Companies Act 2063

Question No. 17
Write short Notes on the following:
Self-Balancing Ledgers (5 Marks June 2009)
Answer:
When in an organisation a number of ledgers are maintained, it is usual to find the system of self-
balancing or sectional balancing of ledgers in operation. Sectional balancing, as any student of
accountancy knows, is just the system of maintaining a total account in the general ledger in respect of
each sectional ledger like debtors, creditors, nominal accounts. The self-balancing system is a further
improved system which enables the preparation of independent trial balances for each of the separate
ledgers by means of contra-adjustment accounts. This, as part and parcel of the system of internal check,
is of great assistance to the auditors for localising errors. It should however be borne in mind that the
only reliable verification of balances of various adjustment accounts in the general ledger lies in the
thorough verification of balances of various adjustment accounts in the general ledger lies in the
thorough verification of the various personal ledger balances. As regards the routine checking aspects, no
special technique is involved. the posting to the individual ledgers and to general ledger account
maintained for control purpose should be appropriately checked. Also, the castings and balancing should
be tested.
Question No. 18
How would you deal with the following situation?
A company manufacturing pharmaceutical intermediates receives its raw materials in big plastic
containers. These containers are sold or discarded by the company depending upon their condition.
The containers lying in the go-down at the year-end are neither valued nor accounted for. Containers
sold are accounted for on cash basis.
(5 Marks June 2009)
Answer:
The policy of the company to account for containers on cash basis as and when sold is correct in case the
amount in respect of such containers is not material. Where however the amount involved is material, a
disclosure there of should be made under the head "current assets" preferably as separate item, so that
financial statements give a true and fair view and, in such cases, they should be valued at their estimated
net realizable value since their cost cannot be ascertained. Such estimates may be prepared on some
appropriate basis, e.g., the average realizations on containers in a few past years adjusted to changes in
prices. In view of this treatment, the cost of raw materials consumed during the year should be adjusted
accordingly.
Question No. 19
Give your opinions with reason on the following cases: (5 Marks each December 2009)

a) A sum of Rs.10,00,000 is received from an Insurance company in respect of a claim for loss of
goods in transit costing Rs.8,00,000. The amount is credited to the Purchases Account.
b) An auditor of a limited company did not verify the investment and he inserted a note in the balance
sheet "Investment not verified". The shareholders approved and adopted the accounts at the
annual general meeting. Subsequently, it transpired that investments were misappropriated and
the company suffered a loss.
c) BMG Ltd. is a manufacturing company produces durable consumer goods with an annual
turnover of Rs. 100 crores. The company receives orders from its commission agents all over the
country, but goods are dispatched directly to the customers. The documents including transport
bills are sent through the bank for collection. At the end of the 6th year, it is found that documents
covering the dispatch of goods worth Rs. 10 crores were still lying with the banks not cleared by
the customers even though the normal collection period of 15 days from the date of dispatch has
expired. Should revenue be recognized in the above case?
a) Answer
All items of income and expense which are recognized in a period should be included in the
determination of net profit or loss for the period. The claim for loss of goods in transit is arising out
of ordinary activities of the enterprise as a part of its normal course of business. However, the cost of
goods lost in transit is only Rs.8,00,000 while the insurance money received is Rs.10,00,000.
Purchases Account need not be credited since it would distort the purchases done during the year and
as also the gross profit. Therefore, entire amount of Rs.10 lacs needs to be taken to profit and loss
account under an appropriate head. This is an income arising from an ordinary activity of the
enterprise but having regard to amount involved and exceptional nature, a separate disclosure is to be
made in the profit and loss account. Such disclosure would enable the users to understand the
performance of an enterprise for the period.
b) Answer
In case of audit of a limited company, an auditor has to comply with the statutory duties as prescribed
under Companies Act. Verification of investments is an important function of an auditor since, it is
an important asset shown in the balance sheet. The auditor cannot be expected to give a report on the
truth and fairness of the financial statements of the company without verifying its investment. If he
specifically mentions in his audit report, the fact that, he did not verify the investments, he would not
be relieved from his statutory duties. Such statutory duties can never be curbed, though they may be
extended.
c) Answer
According to NAS - 17 on Revenue, revenue from the sale of goods shall be recognized when
 the seller of goods has transferred to the buyer the significant risks and rewards of ownership
of the goods;

 the seller retains neither continuing managerial involvement to the degree usually associated
with ownership nor effective control over the goods sold;
 the amount of revenue can be measured reliably.
 It is probable that the economic benefits associated with the transaction will flow to the entity;
and
 The costs incurred or to be incurred in respect of the transaction can be measured reliably.
Since the transport bills were sent through the bank for collection, it may be said that the seller entity
has retained effective control over the ownership of goods. Further since the documents were not
cleared by the customer even after the expiry of the normal period of collection, there is an
uncertainty in the realization of sale proceeds. Apparently, the amount also appears to be quite
material being 10% of total turnover. Hence, revenue should not be recognized in this case.
Question No. 20
How will you vouch and/or verify the following?
a) Liability towards gratuity (5 Marks December 2009)
b) Rental Receipts (6 Marks, June 2001, 5 Marks December 2009)
c) Sale proceeds of scrap material (5 Marks December 2009)
d) Insurance Claims (6 Marks, June 2001, 5 Marks December 2009,
5 Marks June 2007)
Answer
a) Liability towards gratuity:
(i) The liability towards gratuity payable to the employees at the time of cessation of service
should be ascertained and provided for in the accounts when the employees are in service, it
is an ascertained present liability accruing over the period of service but payable upon
cessation of service.
(ii) The auditor should check the quantification of the gratuity liability. He should ascertain
whether the same had been actuarially determined.
(iii) The auditor should treat the actuary as an expert and conduct procedures relevant to
checking the opinion of an expert in accordance with NSA 620.
(iv) The auditor should check the technical competence of actuary, the input fed to the actuary,
the assumptions made by the actuary, the methodology adopted by the actuary, opinion
given etc.
(v) The auditor should bear in mind the relevant pronouncements of NAS 26 “Accounting and
Reporting By Retirement Benefit Plans” in this regard. He should check whether the
expenses of provision for gratuity are towards a defined benefit plan or contribution plan.
(vi) If the contributions are made to outside agency, says the insurance company, he should
check the premium paid, the acknowledgement receipts issued by the insurance company,
the coverage of policy etc. Premium due but not paid, prepaid premium etc. should be
appropriately accounted.

(vii) If the company maintains its trust for gratuity, the auditor may peruse whether the trust is an
approved one under income tax law, whether the trust accounts are audited, copy of the
latest accounts etc.
b) Rental Receipts
(i) Check copies of bills or rent receipt issued to the tenant with reference to tenancy agreement
and bills of charges paid by the landlord on behalf of tenants.
(ii) The entries in the rental register in respect of rent accrued should be traced with reference to
copies of rental bills.
(iii) Scrutinize the account of collecting agent when the rent is collected by such agent.
(iv) Vouch the entries for rent received in advance and ensure proper adjustment is made.
(v) Investigate into abnormal rent outstanding.
(vi) Reconcile the outstanding rent and see that proper provision is made if unrecoverable.
(vii) If rent is received net of TDS, see that rent income is shown at gross and TDS is shown in
Balance Sheet as advance Tax.
c) Sale Proceeds of Scrap Material
(i) Review the internal control on scrap materials, as regards its generation, storage and
disposal and see whether it was properly followed at every stage.
(ii) Ascertain whether the organization is maintaining reasonable records for the sale and
disposal of scrap materials.
(iii) Review the production and cost records for determination of the extent of scrap materials
that may arise in a given period.
(iv) Compare the income from the sale of scrap materials with the corresponding figures of the
preceding three years.
(v) Check the rates at which different types of scrap materials have been sold and compare the
same with the rates that prevailed in the preceding year.
(vi) See that scrap materials sold have been billed and check the calculations on the invoices.
(vii) Ensure that there exists a proper procedure to identify the scrap material and good quality
material is not mixed up with it.
(viii) Make an overall assessment of the value of the realisation from the sale of scrap materials as
to its reasonableness
d) Insurance Claims
Insurance claims may be in respect of fixed assets or current assets. While vouching the receipts
of insurance claims, the auditor should examine a copy of the insurance claim lodged with the
insurance company correspondence with the insurance company and with the insurance agent
should also be seen Counterfoils of the receipts issued to the insurance company should also be

seen. The auditor should also determine the adjustment of the amount received in excess or short
of the value of the actual loss as per the insurance policy. The copy of certificate/report
containing full particulars of the amount of loss should also be verified. The accounting treatment
of the amount received should be seen particularly to ensure that revenue is credited with the
appropriate amount and that in respect of claim against asset, the profit and loss account is
debited with the short fall of the claim admitted against book value, if the claim was lodged in the
previous year but no entries were passed, entries in the profit and loss account should be
appropriately described.
Question No 21
Metro Developers Pvt. Ltd is Bharatpur based Real Estate Company. It has invested heavily on the
apartments and commercial complexes on and around Narayangarh. Recently, audit of the
transaction for rental receipts was hastily completed by taking monthly average figure and multiplying
it by 12. You are required to suggest appropriate way of conducting of audit for the above said
transaction of rental receipts.
(5 Marks June 2010)
Answer
To vouch for rental receipts, various documents need to be seen. To start with, copies of bills issued to
tenants should be test checked by reference to copies of tenancy agreements and bills of charges paid by
the landlord on behalf of the tenants e.g., house tax, water tax etc. The amounts collected from tenants on
account of rent should be checked by reference to receipts issued by them. The entries in the Rental
Register in respect of rents accrued afterwards should be verified. The register should also be scrutinized
for finding out the rent amount, which have not been recovered and are considered bad or irrecoverable,
for deciding whether these should be written off or provision against the same should be made.
Question No 22
How would you vouch and verify the following? (5 Marks each December 2010)
a) Recovery of Bad-debts written off
b) WIP
c) legal Charges
d) Rental Receipts
Answer
a) Recovery of Bad-debts written off
 The total amount of bad debts to be ascertained.
 All recoveries of bad debts have been properly recorded in the books of account to be ensured.
 Notification from the Court or from bankruptcy trustee, letters from collecting agencies or from
debtors should also be seen.
 Credit Manager‟s file for the amount received and deposit of the said amount into the bank promptly
to be verified.

b) WIP
The auditor has to carefully assess the stage of completion of the work-in-progress for assessing the
appropriateness of its valuation. For this purpose, the auditor may examine the production/costing
records (i.e., cost sheets), hold discussions with the personnel concerned, and obtain expert opinion,
where necessary. Cost sheets of work-in-progress should be verified as follows:
 The cost sheets are to be duly attested by the works engineer and works manager.
 The correctness of the cost as disclosed by the cost records to be verified with respect to quantities
and cost of materials, wages and other charges included in the cost sheets by reference to the
records maintained in respect thereof.
 The unit cost or job cost as shown by the cost sheet to be compared with the standard cost or the
estimated cost.
 The allocation of overhead expenses should be made on a rational basis.
 The cost sheet should be compared in detail with that of the previous year. If they vary materially
the cause has to be investigated.
c) Legal charges
 Examine the bills received from lawyer and the receipt for payment made.
 Ensure that advances given earlier, if any has been adjusted against the bills.
 Determine the nature of expenses to consider whether the same should be capitalized or charged to
revenue.
 Ensure that applicable tax deductions have been made before the payment is made.
 Consider whether these charges can be recovered from anybody else and if yes, examine whether
efforts have been made to do so.
 See that the related files containing case statements or other matters forwarded to the lawyer.
 Check the Register for law suits if any, maintained by the entity.
d) Rental receipts
 The copies of bills issued to tenants should be verified against the tenancy/rental agreements.
 Examine that charges pertaining to electricity, security, water have been charged in accordance
with agreed terms and conditions.
 If these are on reimbursement basis of actual expense, the actual expense should be compared to the
proportionate charges made to all applicable tenants.
 Check the tax deducted by tenants on rent has been appropriately booked.
 The rental income has been appropriately booked covering the total period as per the agreements
with each tenant.
 Rental Register should be scrutinized for deciding whether unduly long outstanding should be
written off or provision against the same should be made.
 Ensure whether any of the rental agreements have expired and that these are timely renewed or if
remained vacant, a certificate in respect thereof should be obtained from the client.

Question No. 23
As an auditor how would you vouch/verify the following (Any Four):
a) Receipt of capital subsidy
b) Purchase of quoted investment
c) Retirement gratuity to employees
d) Sales commission expenditure
e) Purchase return
a) Answer:
 Refer to application made for the claim of subsidy to ascertain the purpose and the scheme under
which the subsidy has been made available.
 Examine documents for the grant of subsidy and note the conditions attached with the same relating
to its use, etc.
 See that conditions to be fulfilled and other terms especially whether the same is for a specific asset
or is for setting up a factory at a specific location.
 Check relevant entries for receipt of subsidy.
 Check compliance with requirements of NAS 20 on “Accounting for Government Grants and
Disclosure of Government Assistance” i.e. whether it relates to specific amount or in the form of
promoters‟ contribution and accordingly accounted for as also compliance with the disclosure
requirements.
b) Answer:
 Ascertain the date of purchase, rate of purchase, nature of investments purchased and nature of
transaction, i.e., error cum-dividend/interest/right/bonus.
 Compare the rate of purchase with quotation available. Obtain suitable explanations in case of
significant variations.
 Verify the amount paid towards purchase of investments.
 Trace the amount in the cheque book counterfoils and bank statements.
 Obtain a schedule of investment from Management for physical verification at the year end.
 Verify the investment certificate to confirm title.
 Verify whether investments are duly disclosed in financial statements in accordance with recognized
accounting policies and practices and relevant statutory requirements.
c) Answer:
 Examine the basis on which the gratuity payable to employees is worked out. The liability for
gratuity may either be worked out on actuarial rules or agreement or on the presumption that all
employees retire on the balance sheet date.

 Check the amount of gratuity paid to employees who retired during the year with reference to number
of years of service rendered by them.
 See that the annual premium has been charged to Profit and Loss account.
 Ensure that the accounting treatment is in accordance with NAS 26, “Accounting and Reporting by
Retirement Benefit Plans”.
d) Answer:
 Ascertain agreement, if any, in respect of sales transaction actually occurred during the year carried
out by authorized parties on its behalf. If yes, the commission should be in accordance with the terms
and conditions as specified.
 Check evidence of services rendered by the party to whom commission is paid with reference to
correspondence etc.
 Ensure that the sales in fact have taken place and the same has been charged to profit and loss
account.
 Compare the amount incurred in previous years with reference to total turnover.
e) Answer:
 Examine debit note issued to the supplier which in turn may be confirmed by corresponding credit
note issued by the supplier acknowledging the same. The relevant correspondence may also be
examined.
 Verify by reference to relevant corresponding record in goods outward book or the stores records.
Further, the figures in these documentary evidence should be compared with the supplier‟s original
invoices for rates and other charges and calculation should also be checked.
 Examine in depth to eliminate the possibility of fictitious purchase returns for covering bogus
purchases recorded earlier when such returns outwards are in substantial figure either at the
beginning or end of the accounting year.
 Cross-check with reference to original invoices any rebates in price or allowances if any given by
suppliers on strength of their Credit Notes.
Question No. 24
State briefly the duty of the auditor with regard to:
A sum of Rs.10,00,000 is received from an Insurance Company in respect of a claim for loss of goods
in transit costing Rs.8,00,000. The amount is credited to purchases account.
(7 Marks June 2011)
Answer
All items of income and expenses which are recognized in a period should be included in the
determination of net profit or loss for the period.

The loss of goods in transit costing Rs.8,00,000 should be therefore, charged to profit and loss account of
present financial year and insurance claim of Rs.10,00,000 should be credited to profit and loss account
under an appropriate head. It should not have been credited to purchases account. If done so, the
purchases would be overstated.
Insurance claim (excess) is profit from ordinary activities. when items of income (and expense) within
profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant
to explain the performance of the entity for the period, the nature and amount of such items should be
disclosed separately.
Thus, a separate disclosure of insurance claim received is necessary and it should not be credited to
purchases account.
Question No. 25
How would you safeguard your client against the payment for fictitious purchases?
(7 Marks June 2013)
Answer:
The auditor has to be very cautious while verifying the purchases that no payments have been made for
the fictitious purchases. For this purpose, he may have to take the following actions:
i) He should examine first the internal control system in connection with purchases and satisfy
himself with regard to its effectiveness.
ii) He should ensure that before passing the invoices for payment, they are checked with the
original order, with goods received book and the stock records.
iii) He should inspect the invoices and see that the authorities responsible for passing them for
payment have duly checked them and initialed.
iv) He should test check the invoices to see that dates given in the invoices are for the period
concerned and they have been addressed in the name of the client.
v) He should also compare a number of invoices with the records in the goods received book and
stock records.
vi) He can make physical verification of the goods purchased, if a part of it is still in the stock.
vii) He should also compare the supplier‟s statement with the supplier‟s account.
viii) Postings in the various suppliers‟ accounts should also be checked and compared with the
statement received from them.
Question No. 26
Distinguish Between Vouching and Verification. (5 Marks December 2006, June 2007, July 2015,
December 2017)
Answer:
Vouching:
Vouching and a substantive audit procedure, which broadly deals with examination of profit and loss
account transactions while 'verification' is also a substantive audit procedure, which deals with balance
sheet items. Vouching involves examination of relevant documentary evidence and authorization

therefore is support of transactions or events occurring and affecting a particular period of an entity
recorded essentially in primary books of account. It also consists of examining the process whether the
amount mentioned in the voucher has been posted to an appropriate account, which would disclose the
nature of the transaction on its ultimate inclusion in the final statements of account viz. Profit and Loss
Account and Balance Sheet respectively. On these considerations, the essential points to be borne in
mind while examining the voucher are:
 that the date of the voucher falls within the accounting period.
 that the voucher is made out the client's name;
 that the voucher is duly authorized;
 that the voucher comprises all the relevant documents, which would be expected have been
received or brought into existence on the transactions having been entered into i.e. the voucher is
complete in all respects; and
 that the account in which the amount of the voucher is adjusted is the one that would clearly
disclose the character of the receipt or payment posted thereto on its inclusion in the final
accounts.
Verification:
On the other hand, the term 'verification' usually applies to the process of auditing that examines and
reviews by appropriate manner, whether assets and liabilities are properly stated in the balance sheet
essentially. The term may also apply and extend to the components or items of profit and loss account for
checking the account balances and their presentation (i.e. revenue). It involves an enquiry into
ownership, valuation, existence and presentation (including charge, if any) of assets and liabilities in the
context of Balance Sheet items as on a particular date. In case of assets, these are the rights of the
enterprise while liabilities shown in the balance sheet are owned by the entity.
Thus, vouching deals with the examination of transactions at their points of origin whereas verification
usually deals with the final balances contained in the final accounts i.e. Profit and Loss Account and
Balance Sheet.
Question No. 27
Describe substantive procedures you should perform in audit to confirm the completeness and
accuracy of payroll expense. (5 Marks December 2016)
Answers:
 Agree the total wages and salaries expense per the payroll system to the trial balance, investigate
any differences.
 Cast a sample of payroll records to confirm completeness and accuracy of the payroll expense.
 For a sample of employees, recalculate the gross and net pay and agree to the payroll records to
confirm accuracy.

 Re-perform the calculation of statutory deductions to confirm whether correct deductions for this
year have been made in the payroll.
 Compare the total payroll expense to the prior year and investigate any significant differences.
 Review monthly payroll charges, compare this to the prior month and budgets and discuss with
management for any significant variances.
 Perform a proof in total of total wages and salaries, incorporating joiners and leavers and the
annual pay increase.
 Compare this to the actual wages and salaries in the financial statements and investigate any
significant differences.
 Select a sample of joiners and leavers, agree their start/leaving date to supporting documentation,
recalculate that their first/last pay packet was accurately calculated and recorded.
 Agree the total net as pay per the payroll records to the bank transfer listing of payments and to
the cashbook.
 Agree the individual wages and salaries as per the payroll to the personnel records for a sample.
 Select a sample of weekly overtime sheets and trace to overtime payment in payroll records to
confirm completeness of overtime paid.
Question No. 28
Write short notes on Vouching of Advances to the Suppliers (2.5 Marks December 2017)
Answer
Vouching of Advances to suppliers can be done as follows:
 Obtain schedule of debit balances in trade payables‟ account and pay particular attention to the
age of the balances. Also scrutinize the bought ledger.
 Enquiry should be made for long unadjusted outstanding and check as to whether any of them
would require provisioning.
 Examine that the advances have not been shown as deposits in balance sheet.
discrepancies.

Chapter 6 Verification of Assets and liabilities
Question No 1
As an auditor comment on the following situations:
a. A company had lost a legal action, which had been pending for the last three years and in
consequence had to pay Rs. 75,000 as duty for import of machinery and Rs. 10,000 towards costs.
No provision appeared in the previous year's accounts. (5 Marks June 2001)
Answer
The subject matter of the case relates to a dispute on import duty on machinery imported. The
amount of Rs. 75,000/- paid in terms of the court order should be debited to the appropriate
Machinery Account and the amount of Rs. 10,000/- paid as costs should be charged off to revenue,
as a separate item. The auditor should ensure that depreciation in respect of the Machinery has been
recomputed on the increased cost and should be provided prospectively over the residual useful life
of the asset. Since the liability for payment has arisen during the year on account of court order, it
cannot be called as a prior period. Item.
b. A company has given a guarantee to the court for payment of Income-tax dues of Rs. 5 lakhs by
one of its subsidiaries. (5 Marks June 2001)
Answer
By giving the guarantee, the company has incurred a contingent liability. If the subsidiary fails to
make the payment, the Company would be obliged to honor the guarantee. Therefore, this should
be disclosed as a contingent liability in the notes to accounts of the company.
c. A company is depreciating its fixed assets on WDV method at a rate higher than the rate
prescribed by the Income-tax rules. (5 Marks June 2001)
Answer
As per NAS-16, the company must consider the useful life of the fixed assets i.e. the rate which is
adequate to write off the assets over its normal life. If the rate so arrived at is higher than the
corresponding rate under the Income Tax rules, the Company should provide depreciation at such
higher rate.
The determination of the commercial life of an asset is a technical matter and the decision of the
board of directors should ordinarily be accepted by the auditor unless he has reasons to believe that
such decision is grossly incorrect. The charging of depreciation at a higher rate than the rate
prescribed by the I.T. Rules, will not impair the true and fair view of the financial statements,
unless the rate chosen by the directors is considered grossly incorrect by the auditor.

d. One of the godowns of the company was destroyed in the earthquake in respect of which a claim
of Rs. 4 lakhs was received from the insurance company including claim for the stock destroyed,
the book value whereof was Rs. 1,50,000. The cost of rebuilding the godown amounted to Rs. 5
lakhs. It has been debited to Building Repairs Account.
Answer (5 Marks June 2001)
Since the insurance company has paid a claim of Rs. 4,00,00/- out of which Rs. 1,50,000/- can be
assumed to be for stock destroyed, the amount recoverable against the godown would be Rs.
2,50,000/-. The cost of re-building the godown being Rs. 5,00,000/- (against which Rs. 2,50,000/-
has been recovered from the insurance company), Rs. 2,50,000/- only needs to be debited to
Building Repairs Account. If it is assumed that the excess amount spent is for extension of the
godown; this amount should be capitalized.
Question No. 2
Describe the manner of checking the following schedules prepared by the management at the end of
the year and indicate in detail, how such verification would assist the auditor in his work:
a. Schedule of Outstanding Liabilities (8 Marks, December 2001)

b. Schedule of Advances Recoverable (8 Marks, December 2001)
a. Answer
i) Manner of checking:
 Compare the outstanding liabilities of the current year with those of the previous year.
 Scrutinize the outstanding liabilities list of the previous year to determine whether all items
appearing therein have been paid or otherwise adjusted;
 In respect of recurring expenses, ensure that expenses for the full period of the account have been
provided for.
 Verify subsequent payments from the cash book for the next few weeks and see whether any
payment relates to the period under checking.
 Refer to the minute books, contracts, legal correspondences etc. as these may give a clue as to the
possible existence of outstanding liabilities, including those for goods-in-transit.
 Refer to goods inward book, R/R register etc. towards the end of the year for determining liabilities
on account of purchases. The auditor should examine the cut-off arrangements and the system of
internal control in respect of expenditure incurred and payments made.

A certificate from a responsible official to the effect that all outstanding liabilities have been provided
should be obtained.
ii) Importance of verification to the auditor:

The incorrect provision for outstanding liabilities would vitiate the results of the company's operations
in as much as the expenses would not have been properly accounted for and accordingly, the
verification of outstanding liabilities is important. An examination of old outstanding items may reveal
that excessive provisions exist which require adjustment and, in the absence of such an adjustment,
liabilities would needlessly stand over-stated and profits under-stated. With a view to ascertaining a
true and fair view of the profit or loss or of liabilities, the correct recording of the outstanding liabilities
is essential. Verification of outstanding liabilities list may also corroborate the capital asset acquisition
programme undertaken by the directors.
b. Manner of checking:
First of all, the auditor should ascertain the system of internal control in respect of advances,
particularly the system of authorizing the payment of the advance and its subsequent recovery or
adjustment, the security that there may be for the purpose etc. The following further steps should then
be undertaken:
 Verify the purpose of advances and whether the purpose is such for which an advance is
legitimate.
 Determine the manner in which the advance is to be recovered and/or adjusted.
 Where it is to be recovered in cash, ensure that recoveries are being promptly made.
 Where the advances have been given against goods or services to be received, ensure that the
necessary adjustments are made as soon as goods or services have been received.
 Consider the security obtained, if any, and whether it is good and adequate.
 In case of slow recovery, inquire into the reasons and ascertain whether the amount can be
considered as fully recoverable.
 In case of advances to staff, consider whether the persons to whom advances are given are still in
the employment of the concern.

 In the case of advances given by the company to concerns in which it is Directors are interested
or to companies under the same management, ensure that all legal formalities have been properly
complied with and the necessary disclosures have been made in the accounts.
 Ensure that the provision for doubtful debts is adequate and at the same time is not excessive.
iii) Importance of verification to Auditor:

Advances constitute an important item on the assets side of the balance sheet and its verification is,
therefore, of considerable importance. Furthermore, if advances have been given against goods or
services to be supplied, it is essential that adjustments are made on receipt of such goods or services
as, otherwise, the assets and profits would stand inflated.
The verification of the legal formalities is also important to ensure that there is no violation of the
Companies Act. The verification of provision for doubtful debts ensures that the accounts show a true
and fair view in respect of this item. It is also necessary from the balance sheet point of view that
advances and book debts are not mixed up. Further, for the same purpose, particulars as regards
advances have to be given for advances that are considered good (secured and unsecured) and those
that are doubtful, advances including to companies under the same management, advances due from
directors or other officers of the company etc.
Question No. 3
How would an auditor verify and deal with the following? (June 2002)
a. Foreign traveling expenses of a directors in connection with a trip for exports and import of
machinery for a new project.
b. Interest paid for plant machinery purchased on deferred credit.
c. Receipt of compensation from the insurance company in respect of a motor accident claim.
d. Loose tools manufactured in a factory for internal use.
Answer
a. The expense, in the instant case is on composite purpose of exports and of a new project.
Verification:
 Examine the Board's minutes for the sanction of the foreign trip of the director, the amount of
expense allowed and the purpose of the trip.
 Verify the sanction of foreign exchange by the bank regulating foreign exchange.
 Peruse the report, if any, submitted by the director on return.
 Examine correspondence with foreign parties in connection with the trip.
 Examine statement if expenses submitted by the director after return
 See that the expenses are in accordance with the Board's sanction.
 Verify supporting vouchers (e.g. counterfoil of plane ticket, hotel bills etc.
 If the director is entitled to a daily allowance, in lieu of or in addition to the cost of stay, verify
that the daily allowance has been paid in accordance with the rules.

How to deal:
Since the travel cost is of a composite nature, the same should be apportioned on same reasonable
basis, say, in proportion to time spent abroad for the above two purposes, the part attributable to export
should be charged to revenue and the part attributable to Export should be charged to revenue and the
part attributable to import of machinery for a new project may be capitalized and debited to the
machinery if the same is imported in the relevant financial year. Alternatively, such expenses on
foreign trip for import of machinery may be accounted to an account called expenditure during
construction of the project and capitalized at the time of completion of the project.
b. Answer
Verification:
 Examine the deferred credit agreement and ascertain the rate of interest payable, and the periodicity
of payment.
 Check the calculation of interest
 Verify the acknowledgement of the machinery supplier for the payment made.
 In case the amount is paid outside the country, the permission of the Reserve Bank regulating
foreign exchange should be verified.
 In case the amount of interest paid is not separately stated in the agreement but is paid in lump sum,
installment of the deferred credit payment determine the amount of interest included in each
installment separately and see that the same has been debited to interest account.
How to deal:
Interest being a period cost for finance/ credit, it should be debited to revenue account of the respective
year for which the same is paid, computed on the principle sum outstanding. It should be seen that the
interest or any part of it is not capitalized even though the interest might have been paid in the
installment payment under the deferred credit arrangement. it is assumed that plants machinery
purchased on deferred credit is ready for use immediately after purchase.
c. Receipt of a sum from the insurance company in respect of a mother accident claim: Further
enquiries to be made are the following:
 Whether the motor car involved in the accident was covered by the insurance policy taken by
the client and the extent of the coverage of the risks;
 Computation of the claim in terms of the policy and scrutiny of the claim lodged with the
insurer together with the survey report, if any, as also correspondence exchanged with the
insurer;
 Examination of the basis on which the claim was finally settled and the communication from
the insurer of the amount at which the claim was settled;

 Whether the amount has actually been received and deposited in the bank.
 Whether any further amount is expected to be received.
Treatment in Accounts:
The amount received as claim for the accident loss should be credited to motor vehicles account, if the
case is of a total loss. The difference, between the written down value of the motor car and the amount of
the claim, should be appropriately adjusted in the accounts. If the written down value is higher, the
difference being loss should be debited to the profit and loss account. In the converse the capital gain i.e.
the excess, if any, over the original cost of the vehicle should be credited to profit and loss account.
Appropriate entry should be made in the Motor Vehicles Register also.
If the claim was for a partial loss, the amount of the claim should be credited to a separate account and
amount required to carry out the necessary repairs should be debited to that account. The difference, if
any, should be credited or debited to the profit and loss account.
Any debit or credit to the profit and loss account in either of the cases mentioned above should be
separately shown, as it is an unusual item.
d. Answer
For verification of loose tools manufactured for own use, it would be useful to acquaint oneself with
the management policy in this regard to ascertain the circumstances in which tools are made by the
factory itself and in which they are bought from outside. Departures from the principle should be
enquired into it should be seen that the departure was specially authorized by a competent person.
The steps necessary for verification of loose tools manufactured for internal use are given hereunder: -
 Ascertain the name of the official who is vested with the power to order such manufacture.
 Examining the orders for manufacture with reference to stores requisitions and observing the
time limits specified for the completion of the jobs. Undue delays in execution of the jobs
should be brought to the notice of the management.
 Examining the production records to find out the quantities and types of tools manufactured
and to ensure that these are backed by production order of the appropriate authority and the
stores requisition.
 Enquiring whether the factory has the predetermined material schedule and labor hours for
these productions.
 Examination of the costing records, if any, that are maintained and comparison of the same
with the pre-determined materials schedule and labor hours. In the absence of aforesaid
records, examination of the cost build-up with reference to available information.
 Reviewing whether the costs incurred are significantly higher than the prices at which the same
could be obtained from external sources.

 Considering the accounting entries for transfer of loose tools from the production account to
the loose tools account, it should, however, be ensured that, except appropriate burned of
overhead, the pricing should not include any profit element.
 If scrapped damaged and/or obsolete machines, tools, etc., are being melted to have the
requisite raw material for the production of these loose tools, it should be seen that costing of
the tools is based on the valuation placed by the company on such scarp materials, etc.
 For year-end valuation, these tools in stores should be valued at cost or market price,
whichever is lower; and those which have been issued to the operating departments and still
have unexpired life, can be valued on the basis of a consistent policy of revaluation or can as
well be charged off to production, if the management's policy is such.
Question No. 4
How will you vouch and/or verify the following? (5 Marks each June 2002)
a. Sundry Creditors for goods supplied:

Answer
For verifying sundry creditors for goods supplied, the under mentioned steps are recommended:
 Evaluate the system of internal control on purchases of goods and payments therefore.
 Obtain a list of sundry creditors and check it with the creditor‟s ledger.
 Scan the creditor's accounts and judge the nature of the balance by its age, nature of supplies,
and disputes regarding admissibility of the balances.
 Test check stock records supplier's invoices and challans, cheques paid and credit notes and
trace them to the creditor ledger.
 Seek confirmation of selected balance (including nil balance) by asking the client to write to
the creditors with the request that they should write directly to the auditor.
 Check credits raised on account of supplies towards the end of the year to ensure that they are
normal and not for manipulation of an account.
 Enquire about the reasons, if any, for changes remaining unpresented for a long time.
 Balance due to the companies under the same management, subsidiaries and companies in
which directors are interested must be screened carefully.
 Ensure that the total of the amount in the sundry creditors list agrees with the balance in the
control accounts.
 Go through the goods Inwards Book for two or three weeks before the close of the year and for
a week or so after the close and see that for all goods received before the close, invoices have
been passed through the books and that goods were actually received for all invoices entered in
the books. Similarly, the goods Outward Book should be seen to ascertain whether there are
instances of goods returned to the suppliers without there being an appropriation debit Note.
 Compare the total amount outstanding at the end of the year with the figure at the end of the
previous year and, having regard to the scale of operations during the year, see that any
material deviation is properly explained.

b. Purchase of an Office Building:

Answer
 Examination of the Board resolution sanctioning the purchase of the office building.
 Ensuring that proper steps have been taken to examine the validity of the seller's title to the
property and that the property is free from encumbrances.
 Ensuring that proper steps have been taken to ascertain the reasonableness of the price at which
the building was purchased.
 Examination of the receipt for the consideration money paid.
 Verification of the solicitor's statement of completion and the title deed.
 Seeing that expenses incurred on stamp duty and solicitor's fees have been included in the cost
of the building property.
 Verifying that the building property purchased has been entered in the fixed assets records of
the company.
Question No. 5
Write short notes on Stock taking (8 Marks, December 2003)
Answer
Physical verification of inventories is the responsibility of management of the entity. However, where the
inventories are material and the auditor are placing reliance upon the physical count by the management,
it may be appropriate for the auditor to attend the stock taking. The extent of auditor's attendance at stock
taking would depend upon his assessment of efficacy of relevant internal control procedures, and the
result of his examination of the stock records maintained by the entity and of the analytical review
procedures. There are two principal methods of stock taking; periodic stock taking and continuous stock
taking. Under the first method, physical verifications of inventories are carried out at a single point of
time, usually at the year end. Under the second method, physical verification is carried out throughout the
year with different items of inventory being physically verified at different points of time. The
continuous stock taking method is effective when a perpetual inventory system of record keeping is also
in existence.
Question No. 6
How would you verify the following? (4 Marks each, June 2004)
a. Redemption of debentures at a premium.

Answer
The auditors should verify the provision for the premium payable on redemption of debentures.
Such provision is made in either of the following two ways:
 The amount of premium payable on redemption may be debited to an account denominated as
'Loss on Issue of Debentures' and credited to 'Premium payable on Redemption of Debentures

Account' or subsequently, the debit balance in the first mentioned account should be carried
forward till it is written off, while the latter account would be closed on payment of the
premium, on redemption of debentures.
 The fact that the debentures will have to be redeemed at premium may be disclosed by way of
a note in the Balance sheet along with the date of redemption and, as and when redemption is
made, the amount paid as a premium should be debited to the Premium on Redemption of
Debentures Accounts.
b. Declaration of interim dividends.

Answer
The auditor should consider some matters, which were to be taken into account by the management
before such dividend is declared:
 Whether the directors are authorized to pay such a dividend under the Articles of the
company.
 Whether interim accounts have been reared after making the provisions required for bad
debts, annual depreciation, etc.
 Whether there are sufficient profits available for distribution as a dividend.
 The rate of interim dividend should be such does not raise and undue hope in minds of
shareholders, as regards the amount of the final dividend, larger than that justified by the
financial position of the company, in that case prices of the share will fluctuate unduly.
c. Issue of Bonus shares.

The following steps should be taken:
 Whether the Articles permit capitalization of profits;
 Whether the company had a sufficient number of unissued shares for allotment as bonus
shares;
 Inspect the Minute book of shareholders for the resolution authorizing declaration of the
Bonus and Director's Minute for the resolution appropriating profits for being applied in
payment of shares to be allotted to shareholders as bonus shares;
 Trace the allotment of shares as per particulars contained in the Allotment Book or sheets in
to the register or Members;
 Confirm that all the statutory requirements relevant to the issue of shares have been
complied with;
 Ensure the Security Exchange Board Guidelines relating to issue of bonus shares have been
complied with.
d. Forfeitures and reissue of forfeited shares.

For forfeiture of shares, the auditor should:
 Ascertain that the articles authorize the board of directors to forfeit shares and that the
power has been exercised by the board in the best interest of the company;

 Verify the amount of call or installment of calls which was outstanding in respect of each of
the share forfeited;
 Ascertain that the procedure in the articles has been followed;
 Verify that the premium, if any received on the issue of shares has not been transferred to
the Forfeited Share Account.
For reissue of forfeited shares, the auditor should:
 Ascertain that the articles authorize the board of directors to reissue forfeited shares;
 Refer to the resolution of board of directors, re-allotting forfeited shares;
 Vouch the amounts collected from person to whom the shares have been allotted and verify
the entries recorded from re-allotment and see that the total amount received on the share,
including that received prior to forfeiture, is not less than the par value; and
 Verify that computation of the amount of surplus resulting on the reissue of shares credited
to the Capital Reserve Account.
Question No. 7
Give your views on the following issue:
The management of Agrawal Garments (P) Ltd. insists that as a part of statutory audit, the auditors
must carry out physical verification of fixed assets and inventories as a means of collection the
necessary audit evidence as also to detect any frauds. (5 Marks, December 2004)
Answer
The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions
on which to base the audit opinion. Audit evidence is obtained from a mix of tests of control and
substantive procedures as the auditor considers appropriate. With regards to the inventory, which is
material to the financial statements, the auditor should obtain sufficient appropriate audit evidence
regarding its existence and condition by attendance at physical inventory counting unless impracticable.
Such attendance will enable the auditor to inspect the inventory, to observe effective compliance with the
operation of management‟s procedures for recording and controlling the results of the count and to
provide evidence as to the reliability of management‟s procedures. It is not the duty of auditors to carry
out physical verification of inventories on their own as insisted by the management of Agrawal Garments
(P) Ltd. with a view to collect necessary audit evidence as also to detect any frauds. Because of the test
nature and other inherent limitations of an audit, together with the inherent limitation of any accounting
and internal control system, there is an unavoidable risk than even some material misstatements and
frauds may remain undetected.
Question No. 8
Explain the main procedures to be adopted for verifying the investments.
(6 Marks, December 2004, 5 Marks June 2006)

Answer
Main procedures to be adopted for verifying the investment:
 Obtain schedule of securities and share in hand at the beginning of the audit period containing
description, date of purchase, face value, book value, market value rate of interest, date of
payment of interest, date around which dividend is normally declared etc.
 Verify the securities and share purchased and sold during the year, if any.
 Compare the balance of investment with the control account in the general ledger.
 Ascertain whether the investment made by entity is within its authority.
 Proper authority and documentation for the purchase and sale of investments.
 Sale and purchase of investment cum-dividend, ex-dividend, cum interest, ex-interest.
 Physical verification of the investment at the last date of the accounting year. Inspection of
investments by the auditor during course of audit.
 Market value of the investments; in the case of quoted investments are in accordance with the
authentic market reports; and unquoted investments the basis of the valuation adopted by it for the
purpose of disclosure in the balance sheet.
 in the case of immovable properties, title deed of the properties.
 Valuation and disclosure of the valuation of investment in the financial statements are in
accordance with the recognized accounting policies.
Cost incurred on account of acquisition of the investment, if any, are included in the cost of
investments
Question No. 9
Write a note on the audit of Impersonal Ledger? (8 Marks, June 2005)
Answer
The impersonal ledger contains the whole of the accounts affecting the composition of the Trading and
Profits and Loss. Account and all accounts representing assets and liabilities, other than those contained
in the personal ledgers. The impersonal ledger is variously known in common usage as the private ledger
general ledger or nominal ledger, these terms generally being interchangeable although in many
businesses a private ledger is utilized to contain only accounts of an essentially private nature. The term
impersonal ledger is here employed to cover all those accounts not included in the personal ledgers.
Except in a very larger business, the amount of detail in the impersonal ledger is not excessive, and the
auditor will be able to check the whole of the entries therein. This is important, because, if the auditor is
able to verify the correctness of the impersonal accounts, this fact in itself will go a long way towards
providing the accuracy of the personal accounts, at any rate in total; one of the commonest methods of
concealing manipulations in personal accounts being to make a corresponding fictitious entry in an
impersonal account.

The entries in the impersonal ledger will come either from the totals of books of prime entry or their
equivalents, the Journal or from the Cash Book. The casts of the various books of prime entry or machine
lists, having been verified, the totals thereof should be checked to the accounts in the Impersonal Ledger
to which they relate. Where the totals have been subjected to analysis, the analysis should be cast and
proved, and the individual items checked to their respective accounts in the impersonal ledger.
The auditor should be particularly careful with entries coming from the Journal since many important
transactions are recorded through the Journal.
It should also be ascertained that balances in all income and expense accounts have been adjusted (i)
According to standard accounting practices; and (ii) on a consideration of the legal provisions which are
applicable to the organization. Each ledger balance finally should be examined on a consideration of its
position in the Final Accounts to see how the financial position of the concern would be affected by
inaccuracy in the balance.
Wherever practicable, the balances in the Impersonal Ledger should be traced simultaneously into the
trial balance, the grouping schedule and the Final Accounts. At the same time, by way of comparison, the
corresponding balances in the previous year‟s Final Account in the balance.
It should be confirmed that the accounts have been kept according to accepted principles and Balance
Sheet and the Profit and Loss Account have been drawn upon the same basis as in the previous year.
Special attention should be given for the scrutiny of the Impersonal Ledger to cut –off transactions. Such
adjustments which affect the Impersonal Ledger are:
(a) Pre-payments like insurance, taxes, etc. By scanning the account, it should be ascertained
that the charge only for the full year has been included in the account.
(b) Provision for liability in respect of purchases, rent and taxes, freight charges and salary
etc. Thus, if account payable at the close of the year has been paid in the succeeding
period, a provision therefore should be made.
(c) Accrual of income adjustments should be checked. For instance, all rent receivable due or
accrued to the date of the Balance Sheet should be calculated and brought into account
after a provision has been made for doubtful or irrecoverable arrears of rent allowances
etc. similarly interest, dividends and payment of insurance premium should also be
examined.
(d) Adjustment of advances should be scrutinized. Amount paid as advances should be

included as an asset.

The relevant expenses and income should be thoroughly scrutinized to make sure that only such costs
and revenue which relate to the period under audit have been carried to the Profit and Loss Account.
The Scrutiny of their impersonal ledger also should cover the review of valuation of assets. The auditor
should make sure that generally accepted accounting principles have been followed for charging
depreciation and the current assets been valued at lower of cost or net realizable value. The ascertainment
of cost should be done consistently from year to year.
Question
How would you vouch and verify the followings? (4 Marks each December 2005)
a) Preliminary Expenses.
Answer.
Following procedures will be followed:
 Ensure that appropriate costs have been included in the preliminary expenses, such as
expenditure incurred incident to the creation, formation and floating of a company.
 Check board‟s minute book containing the resolution approving the expenses claimed by the
promoters as having been spend in the formation of the company.
 Examine supporting papers and vouchers, contracts, agreements etc. to support the promoters‟
claim. Also check bills and receipts issued by the printer of the memorandum and articles of
association, share certificates etc.
 Check receipt for the registrations fee paid from registration of the company.
 Verify rates of stamp required to be fixed on the memorandum and articles of association.
 Ascertain board‟s minutes book for the decision to write off the preliminary expenses over a
period. The quantum of thereof, which has not yet been written off for these expenses should
be carried forward in the balance sheet under the head miscellaneous expenditure (to the
extent not written off or adjusted) over a period of year.
 Check that no expenses other than those what constitutes preliminary expenses are booked
under this head.
b) Recovery of bad debts written off two years ago.

Answer.
Following procedures will be followed:

 Ensure that recovery pertains to bad debts properly written off in earlier years and the
decision for writing off of bad debts was recorded properly.
 Ascertain total bad debts and see whether all recovery of bad debts is recorded properly in the
books of account and deposited into bank.
 Check all notifications from court or bankruptcy trustee and all correspondence from debtors
and collecting agencies.
 Check credit manger‟s files for amount recovered and confirm acknowledgment receipts
issued to trustees/ debtors.
 If amount recovered is material, ensure that proper disclosure has been made in the financial
statements.
Question No. 13
How will you vouch/ verify the following?
a) Transactions with the directors (5 Marks December 2006)
Answer:
 It is the special item for review by an auditor as it involves checking of compliance as well as
poses high risk due to influence from top.
 Review relevant laws and regulations and ensure compliance with those provisions by the
company.
 Scrutinize the accounts related to directors' expenses and ensure that the expenses claimed are
reasonable and equitable.
 Enquired of transactions related to relative of the directors and system of documentation.
 Ensure that information with respect to directors are sent to relevant authorities as required.
b) Stock lying with third parties (4 Marks December 2006)
Answer:
 Obtain confirmations from the third party including the time period and reasons thereof.
 Evaluate condition of gods and see whether adequate provision has been made.
 Check whether subsequently the goods lying with third party were sold or received back after
expiry of stipulated time period.
 Ensure that the goods have been included in the closing stock through lying with third party.

c) Contingent liabilities (6 Marks December 2006, 4 marks December 2005, 4 Marks June 2005)
Or
Forward Looking Co Ltd is dealing with various transactions that could be well termed as
contingent liability. As an auditor, suggest some of the procedures for verifying contingent
liabilities?
(5 Marks June 2010)
Answer:
A contingent liability will be known or determined only on the occurrence or non-occurrence of one or
more uncertain future events. The uncertainty as to whether there will be any legal obligation
distinguishes a contingent liability from an actual liability. An obligation may be a contingent liability
when the very basis of the obligation is contested. For example, when a claim is made against a company
in respect of infringement of a patent and the suing company does not possess a legitimate title.
Contingent liabilities should be disclosed as a foot note to the balance sheet. Some examples of
contingent liabilities include claims against the company not acknowledge as debts, arrears of fixed
cumulative dividends etc. In case there is a probability that a loss may be incurred and a reasonable
estimate of the amount can be made, then such contingent liability must be adjusted in the financial
statements. Otherwise, disclosure will have to be made describing nature of the event, uncertainties
affecting the event and estimate of the financial effect or a statement that such an estimate cannot be
made. In such circumstances, the auditor may take following steps.
i. Inspect the minute books of the company to ascertain all contingent liabilities known to the
company.
ii. Examine the contracts entered into by the company and the likelihood of contingent liabilities
emanating there from.
iii. Scrutinize the lawyers' bill to track unreported contingent liabilities.
iv. Examine bank letters in respect of bills discounted and not matured.
v. Examine bank letters to ascertain guarantees on behalf of other companies or individuals.
vi. Discuss with various functional officers of the company about the possibility of contingent
liability existing in their respective field.
vii. Obtain a certificate from the management that all known contingent liabilities have been
included in the accounts and they have been properly disclosed.
viii. Ensure that proper disclosure has been made as per the law.
Question No. 14
How would you verify the following items in the books of account of a company?
(5 Marks, each June 2007)
a) Retirement gratuity to employees
b) Bills payable

a) Answer
 Examine the basis on which the gratuity payable to employees is worked out. The liability for
gratuity may either be worked out on actuarial rules or agreement or on the presumption that all
employees retire on the balance sheet date.
 Verify computation of gratuity on the aggregate basis.
number of years of service rendered by them.
 See that the annual premium has been charged to Profit and Loss Account in the case the concern
has taken a policy from the Insurance Company.
 Ensure that the accounting treatment is in accordance with the generally accepted accounting
principles.
b) Answer
These are acknowledgements of debts payable. For their verification, it is necessary to see that bills
paid have been cancelled and the liability in respect of those outstanding has been correctly
ascertained and disclosed.
The steps involved in their verification are:

 Vouch payments made to retire bills on their maturity or earlier and confirm that the relevant bills
have been duly cancelled.
 Trace all the entries in the Bills Payable Book into the Bills Payable Account to confirm that the
liability in respect of the bills has been correctly recorded.
 Reconcile the total of the schedule of bills payable outstanding at the end of the year with the
balance in the Bills Payable Account.
 Obtain confirmation from the drawers or holders of the bills in respect of amount due on the bills
accepted by the client that are held by them.
 Verify that the charge, if any, created on any asset for the due payment of bills has been
appropriately disclosed.
Question No. 15
Express your opinion in the following cases: (5 Marks June 2008)
M/s Trade Link Ltd. incurred a heavy loss of finished stock of goods due to heavy rain in its store. The
management treated the loss as cost of goods and charged it to the cost of goods sold on the ground
that ultimately it is cost for the company. Give your opinion as a financial auditor for the treatment
made by the company for such loss.

Answer
The loss incurred by heavy rain seems to be the nature of abnormal loss. The accounting treatment made
by management to treat such loss as cost of goods and disclosing under cost of goods sold is not correct.
The disclosure of the nature and amount of such abnormal item may be made on the face of the income
statement, or when this disclosure is made in the notes to the financial statements, the total amount of all
abnormal loss is disclosed on the face of the income statement.
Question No. 16
A manufacturing company includes depreciation consistently in its valuation of inventories of

manufactured goods. In the year 2066-67, the company decided not to provide depreciation in the
books of account mainly because of lack of profits. The company however included depreciation in
stock valuation for the annual accounts even though depreciation was not charged to Profit and Loss
account during the year. Discuss. (4 Marks June 2009)
Answer
In the present case as depreciation is not debited to the profit and loss account, it means that it is not
recognised as cost by the management and hence cannot be recognised as an item of cost for the purpose
of inventory valuation. Therefore, the company cannot include the depreciation for the purpose of
valuation of manufactured inventories. The auditor should qualify the main report as the depreciation has
not been provided as per NAS and also report that the valuation of the said inventories is not fair and
proper as per the generally accepted accounting principles and that the valuation of the inventories is not
carried on the same basis as in the earlier years. The auditor should also report the effect of the said
deviation, if material.
Question No. 17
What are the basic procedures an auditor should follow while examining the records to verify the
debtors of a company?
(6 Marks June 2009)
Answer
a) The auditor should carry out an examination of the relevant records himself about the validity,
accuracy and recoverability of the debtor balances. The extent of such examination would depend
on the auditor's evaluation of the efficacy of internal controls.
Following basic procedures should be followed while examining the records to verify the debtors of
the company.
i) The auditor should check the agreement of balances as shown in the schedules of debtors with those
in the ledger accounts. He should also check the agreement of the total of debtor balances with
related control account. Any differences in this regard should be examined.

ii) Verification of subsequent realizations is a widely used procedure, even in cases where direct
confirmation procedure is followed. In the case of significant debtors, the auditor should also
examine the correspondence or other documentary evidence to satisfy himself about their validity
and accuracy.
iii) While examining the schedules of debtors with reference to the debtors' ledger accounts, the auditor
should pay special attention to the following aspects:
 Where the schedules show the age of the debtors, the auditor should examine whether the age
of the debts has been properly determined.
 Where the amounts outstanding are made up of items which are not overdue, having regard to
the credit terms of the entity.
 Whether transfers from one account to another are properly evidenced.
 Whether provisions for allowances, discounts and doubtful debts should recognise that even
though a debtor may have confirmed the balance due by him, he may still not pay the same.
iv) Bad debts written off or excessive discounts or unusual allowances should be verified with the
relevant correspondence. Proper authorization should be inspected.
v) In the case of claims made against insurance companies, shipping companies, railways etc., the
auditor should examine the correspondence or other available evidence to ascertain whether the
claims have been acknowledged as debts and there is a reasonable possibility of their being
realized. If it appears that they are not collectible, they should be shown as doubtful. Similar
considerations apply in respect of claims for export incentives, claims for price escalation in case of
construction contracts, claims for interest on delayed payments, etc.
vi) The auditor should examine whether contingent liability, if any, in respect of bills accepted by
customers and discounted with the banks is properly disclosed. He should also examine whether
adequate provision on this account has been made, where required.
Question No. 18
Write short Notes on Balance Sheet Audit (5 Marks June 2009)
Answer
Balance Sheet Audit consists of the verification of all the balance sheet items together with the
examination of expense and income accounts which are closely related to these items. The Balance sheet
Audit as against the conventional vouch and post audit has developed along with the development of
internal control system and phenomenal growth in the activities of business entities. Balance Sheet Audit
encompasses the following:
 Examining the existence and ownership of assets included in the balance sheet.
 Satisfying that all assets owned on the balance sheet date have been included.
 Verifying the inclusion of assets in the balance sheet in accordance with the generally accepted
accounting principles.
 Ascertaining inclusion of all liabilities in the balance sheet and at proper amounts.

 Examining all opening, closing and adjustment entries.

 Satisfying that distinction between capital and revenue has been properly maintained.
 Satisfying that the capital amount has been properly reflected.
 Analyzing the charges and credits to revenue accounts and inclusion of the resultant balance
sheet.
 Reviewing that internal controls on all material areas are satisfactory.
Question No. 19
As an auditor, how would you justify that all assets are reflected in the financial statement of an
organization? (5 Marks June 2009)
Answer
a) Financial statement is prepared on periodic basis. Commonly, it is prepared on yearly basis as per the
requirement of the law into force. As an auditor, it should be ensured that all assets are accounted and
shown into the financial statement. The assets that requires specific recognition may be as:
 Interest earned but not received.

 Receivable created due to credit sales
 Prepaid expenses
 Inventory/closing stock
 Fixed assets
 Cash and bank etc.
The item that has to be recognized as assets should be carefully scrutinized. Sales if made in credit
should be verified with invoices and inventory record, interest receivable should be examined with
the bank balance at the year end and interest income recognized in the books of account. Similarly,
prepaid expenses should be verified with the payment voucher of particular expenses with period for
which the payment is made. Likewise, inventory that should be shown as per valuation can be
examined with the production and sales report, which ensures the actual position of inventory items.
Fixed assets created should be separately shown instead of stock or work in progress. The cash and
bank balances should be examined with cash book records and bank statement respectively. It should
be ensured that bank reconciliation statement has been prepared and tallied with the bank balance as
per books. Cash balance should be as per physical verification at the year end.
Question No. 20
Smart Telecom is one of the leading companies dealing with various tele-communication services,
wireless networking and internet related services. It receives huge collection of cash daily from its
customer on various accounts. Everything looked well, until one day it was noticed that large amount
was missing in the bank account. In fact, that said amount was not credited in the bank account at all

and it was missing since last few years. When the case was revealed, probably it was too late and all
the said money was lost.
Considering the above case, what are the likely documents you would like to examine as an auditor of
the company? (5 Marks December 2009)
Answer
According to the case given in question, the following mention document should be checked as an
auditor:
 Cash receipt register
 Security arrangement in the counter area.
 Procedures followed to deposit the amount in the bank
 Bank account opening procedure
 Special arrangements with bank for transferring funds, if any
 Bank reconciliation statement
 Duty rotation of the personnel, directly handling cash collection
 Reporting arrangement to central office
 Fidelity Insurance etc.
Question No. 21
As an auditor, how you will vouch/ verify following transactions? (5 Marks each June 2010)
a) Bankruptcy Dividends
b) Royalties received
c) Calls in arrears
Answers:
a) Bankruptcy Dividends
Correspondence with the official receiver or liquidator to find particular of part amounts already collected
and the balance outstanding at the beginning of the year. The advice, if any, received from the same
authority along with the payment should be referred to.
b) Royalties received
The auditor should see the relevant contract and examine the important provisions relating to the
conditions of payment of royalty. The rate of royalty, mode of calculation, due dates, periodical
statements received, royalty already received and royalty due but not yet received should also be seen.
c) Calls in arrears
The amounts due from shareholders in respect of calls in arrears should be verified by reference to the
Share Register. If any calls are due from directors, they should be shown separately in the balance sheet.
Often the articles provide that interest be charged on calls in arrears. The adjustment of interest in such a
case should be verified.

Question No. 22
How will you vouch and verify the followings: (5 Marks each, June 2010)
a) Provision for income tax
b) Bank Borrowings
c) Premium paid for insurance of a Motor car.
Answer:
a) Provision for income tax

 Obtain the computation of income prepared by the auditee and verify whether it is as per the
Income-tax Act, 2058 and Rules made there under.
 Review adjustments, expenses, disallowed special rebates, etc. with particular reference to the last
available completed assessment.
 Examine relevant records and documents pertaining to advance tax, self-assessment tax and other
demands.
 Compute tax payable as per the latest applicable rates in the Finance Act.
 Ensure that overall provisions on the date of the balance sheet is adequate having regard to current
year provision, advance tax paid, assessment orders, etc.
b) Bank Borrowings
Borrowings from the banks may be either in the form of overdraft limit or fixed loans.
In each case, borrowings should be verified as follows:
 Reconcile the balances in the overdraft or loan account with that shown in the pass books and
confirm the last-mentioned balance by obtaining balance confirmation certificate from the bank.
 Obtain certificate from the bank showing particulars of securities deposited with the bank as
security for the loans or of the charge created on an asset / asset of the concern and confirm the
same has been correctly disclosed and duly registered with the Registrar of Companies and
recorded in the Register of Charges.
 Verify the authority under which the loan or overdraft has been raised. In case of the company, only
the Board of Directors is authorized to raise a loan or borrow from a bank.
 In case of company, confirm restraint of Company Act regarding the maximum amount of loan that
the company can raise has not been contravened.
 Ascertain the purpose for which the loan has been raised and the manner in which it has been
utilized and that this has not prejudicially affected the concern.
c) Premium paid on Insurance of a Motor Car
 Check insurance cover note issued by Insurance Company. Verify car no., period of Insurance etc.
 See that “No claim Bonus” is given, where entitled, by the Insurance Company.
 Ensure that proper adjustment is made for pre-paid insurance premium.

Question No. 24
XYZ Hotels Ltd. has incurred loss and one of its illiterate directors wants your assistance to find out
exactly what happened in the company. He suspects that the company has paid excessive interest on its
borrowing. He has found average of 12-month end borrowing balance was Rs. 120 million and
prevailing interest rate was 10% for the year. Interest paid for 12 months was Rs. 12 million. Suggest
to the director on this matter how he can verify this matter. Give your opinions with reason.
Answer
Average interest cost on the average borrowing by XYZ Hotels Ltd. is matching with prevailing interest
rate. However, detailed verification of borrowing and interest expenses booked need to be carried out as
following:
1) Examine the date, rate and amount of borrowing with reference to borrowing documents.
2) Verify booking date of the balances in individual accounts and total of borrowing balance.
3) Examine whether there is a procedure for obtaining confirmation of balance periodically.
4) Check calculations of interest and examine whether interest expenses have been accurately provided
for with reference to the duration of borrowing.
5) Trace the amount of borrowing in to bank account and interest and loan repayment from bank
account.
6) Examine whether borrowing is properly authorized and whether internal control procedures have
been followed.
7) Examine that other items of liability are not booked as borrowing.
Question No. 25
As an auditor, express your comments/views on the following situations:
a) Trade and Trust Limited Company has a policy of writing back unclaimed balances
(creditors/sundry payables etc.) as income if it remained for more than 3 years. During the year
2066-67, it has written back Rs.14,050 out of Rs.55,000 balance in dividend payable as the
Rs.14,050 was more than 5 years old.
b) You are auditor of Exim Limited which exports Pashmina Goods to M/s. ImexInc, of USA for the
financial Year 2066-67. The Company‟s around 75% sale constitutes export to Imex Inc. and there
is outstanding balance of Rs. 17 Crore in Sundry Debtors which covers around 85% of the total
debtors as at 32 Ashad, 2067. Due to global recession, the Imex Inc. has filed bankruptcy in USA
on 15 Ashwin, 2067 which came to your notice during the audit.
a) Answer
Write back of unclaimed balances unilaterally without consent of the party involved is not in line with
Nepal Accounting Standards. Therefore, the policy adopted by the Company is not consistent with
Accounting Standards. In case of Dividends, Section 182 of company Act 2063 requires that the amount

of dividend not claimed/received by any Shareholder even after the expiry of a period of five years after
the date of resolution adopted by the company in its general meeting to distribute dividend shall be
credited to the investors protection fund to be established under Section 183 of the same Act. Before
crediting the amount to the fund, it shall publish a notice in a national daily newspaper inviting the
concerned to receive the dividend, within the time limit of at least one month.
Therefore, the writing back of dividend by Trade and Trust Company is violation of provisions of
Company Act and shall be liable.
b) The filing of bankruptcy of the company during the course of audit but after the balance sheet date is
subsequent event or events occurring after balance sheet date. It is seen that the debtor covers the major
portion of debtors, the debtors shown in the balance sheet may no longer be appropriate and hence
adequate provision should be made. Since, the party is major customer and covers major portion of the
debtor, the going concern assumption of the company may no longer be appropriate. In such
circumstances, the auditor should ask the management for necessary adjustment/provisioning in the
financial statement regarding the debtor balances and necessary disclosure thereof.
Further, the auditor should also:

 Review management's plans for future actions based on its going concern assessment;
 gather sufficient appropriate audit evidence to confirm or dispel whether or not a material
uncertainty exists through carrying out procedures considered necessary, including considering
the effect of any plans of management and other mitigating factors; and
 Seek written representations from management regarding its plans for future action.
Based upon further assessment and actions of management, the auditor shall issue his opinion.
Question No. 26
Babarmahal Trading Ltd (BTL) is a wholesaler of Chinese goods and all accounting information is
stored on BTL‟s computer. You are the audit senior in charge of the audit of the receivables balance.
Explain the audit procedures that should be carried out on the receivables balance at BTL. (5Marks
June 2011)
Answer
Procedures for verification of receivable balance of BTL are prescribed below:
 Cast the receivables ledger to ensure it agrees with the total on the receivables control account.
 Compare the balance on each receivable account with its credit limit to ensure this has not been
exceeded.
 Review the balances in the receivables ledger to ensure no balance exceeds total sales to that
customer.

 Calculate receivables days for each month end to monitor control of receivables over the year.
 Stratify receivables balances to show all material items and select appropriate sample for testing.
 Produce an aged receivables analysis to assist with the identification of irrecoverable receivables.
 Obtaining the external confirmations as per NSA 505 and evaluating whether the results of the
external confirmation process together with the results from any other audit procedures performed,
provide sufficient appropriate audit evidence regarding the assertion being audited. In conducting
this evaluation, the auditor considers the guidance provided by NSA 330 and NSA 530, “Audit
Sampling and Other Selective Procedures.”
Question No. 27
State how you would verify the following:
a) Intangible assets (5Marks each June 2011)
b) Sale of Investments (5Marks each June 2011)
c) Leasehold property (5Marks each June 2011, 5 Marks June 2010)
Answer
c) Intangible Asset:
An intangible asset is an identifiable non-monetary asset, without physical substance held for use
in the production or supply of goods or services, for rental to others or for administrative
purposes. Enterprises frequently expand resources, or incur liabilities, on the acquisition,
development, maintenance or enhancement of intangible resources such as scientific or technical
knowledge, design and implementation of new processes or systems, licenses, intellectual
property, market knowledge and trademarks (including brand names and publishing titles).
Common is another example of an item of intangible nature which either arises on acquisition or
is internally generated. If an item covered does not meet the definition of an intangible asset
expenditure to acquire it or generate it internally is recognized as an expense when it is incurred.
However, if the item is acquired in an amalgamation in the nature of purchase, it forms parts of
the goodwill recognized at the date of the amalgamation.
Some intangible assets may be contained in or on a physical substance such as a compact disk
(in the case of computer software), legal documentation (in the case of a license or patent), or
film (in the case of motion pictures). The cost of the physical substance containing the intangible
assets is usually not significant. Accordingly, the physical substance containing intangible assets,
though tangible in nature, is commonly treated as a part of the intangible asset contained in or on
it.
In some cases, an asset may incorporate both intangible and tangible elements that are, in
practice, inseparable. In determining whether such an asset should be treated under NAS 16, or
as an intangible asset under NAS 38, Judgment is required to assess as to which element is
predominant. For example, computer software for a computer-controlled machine tool that

cannot operate without that specific software is an integral part of the related hardware and it is
treated as a fixed asset. The same applies to the operating system of a computer, where the
software is not an integral part of the related hardware, computer software is treated as an
intangible asset.
d) Sale of investment:
 See that sale of investment has been made on the proper authorization of Board or other
competent authority.
 Ascertain the method of selling investments. It may be either through broker, directly or
through a bank. See the broker‟s sold note.
 See that the difference between the carrying amount and the sales proceeds, net of expenses,
is recognized in the Profit & Loss Account. Ensure that when only a part of the holding of an
individual investment is sold, the carrying amount is allocated on the basis of average
carrying amount of the total holding of the investments.
 Interest, dividends, rentals on investments are to be shown in P& L A/c at Gross Value and
TDS as advance tax paid.
 Showing separately profit & Loss on disposal and changes in carrying amount of current and
long-term investments.
The auditor should verify that contingent liabilities do not include any items which require an
adjustment of relevant assets or liabilities.
d) Leasehold property
Various steps involved in the verification of leasehold properties are stated below:
1. Inspect the lease or assignment thereof to ascertain the amount of premium, if any, for
securing the lease, and its terms and conditions; and that the lease has been duly registered.
2. Ascertain that all the conditions, the failure to comply with which might result in the
forfeiture or cancellation of the lease, e.g. payment of rent in due dates, insurance of property,
maintenance of property etc. as prescribed by lease agreement are being duly complied with.
3. Examine the counterpart of the lease agreements, if part of the leasehold property has been
sublet.
4. Make certain that due provisions for any claim that might arise under the dilapidation clause
on the expiry of the lease has been made, and, if no such provision has been made, draw the
client‟s attention to the matter.
5. Ensure that the outlay as well as any legal expense incurred to acquire the lease which are
shown as an asset in the Balance Sheet are being written off at a rate which could completely
wipe off the assets over the unexpired term of the lease.
A leasehold property, even where no premium has been paid for its acquisition, may sometime
can have a considerable value. In such a case, it may not be advisable to continue to show the
assets as if it has no value. Nevertheless, where the leasehold rights have been revalued that fact
should be clearly shown on the Balance Sheet till the account has been completely written off.

Question No. 28
Give your comments on the following:
Xylocaine Communications Company is one of the leading companies dealing with various
telecommunication services, wireless networking and internet related services. It receives huge
collection of cash daily from its customer on various accounts. Everything looked well, until one day it
was noticed that large amount was missing in the bank account. In fact that said amount was not
credited in the bank account at all and it was missing since last few years. When the case was
revealed, probably it was too late to recover the money. Considering the above case, what are the likely
documents you would like to examine as an auditor of the company? (5 Marks
December 2011)
Answer.
Considering the case presented the auditor of Xylocaine Communications Company should check all the
books of accounts and documents related with the cash and bank transactions. Hence, the likely
documents the auditor should examine in the circumstances presented are mentioned hereunder:
 Separate Cash receipt register for different services like tele-communication, wireless
networking and internet related services
 Prenumbered Receipt pad for collecting cash.
 Security arrangement in the counter area.
 Procedures followed to deposit the amount in the bank
 Special arrangements with bank for transferring funds, if any
 Bank reconciliation statement
 Duty rotation of the personnel, directly handling cash collection
 Reporting arrangement to central office
 Fidelity Insurance etc.
 Bank deposit slips
Question No. 29
How would you vouch and verify the following? (5 Marks each December 2011)
a) Personal expenses of directors met by the company
b) Redemption of debentures at a premium
c) Impairment of assets
Answer
a) Answer
Personal Expenses of Directors:
(i) Check the articles of association, service contract, minutes of general meeting, etc., to check
the authorization for such payment.
(ii) Enquire to ensure that personal expenses are not camouflaged in any other revenue items.

(iii) Check the invoices and relevant documents to support the claim made.
(iv) Check documentary evidences to examine the payments reimbursed.
b) Answer
The auditors should verify the provisions for the premium payable on redemption of debentures.
Such provisions are made in either of the following two ways:
a. The amount of premium payable on redemption may be debited to an account
denominated as „Loss on Issue of Debentures‟ and credited to „Premium payable on
redemption of debentures Account‟ or subsequently, the debit balance in the first
mentioned account should be carried forward till it is written off, while the later account
would be closed on payment of the premium, on redemption of debentures.
b. The fact that the debentures will have to be redeemed at premium may be disclosed by a
note in the Balance sheet along with the date of redemption and , as and when redemption
is made, the amount paid as a premium should be debited to the Premium on Redemption
of Debentures accounts.
c) Answer
An asset is impaired when its carrying amount exceeds its recoverable amount.
The difference between the carrying amount of an assets and recoverable amount is termed as
impairment loss.
Besides charging annual depreciation on assets by the reason of normal wear and tear, effluxion
of time and obsolescence to re-instate the correct value of the assets considering the future cash
flows that the assets can generate, impairment loss needs to be provided.
The treatment of impairment loss is similar to depreciation except the fact that it can be re-
instated in future, if the recoverable amount of the assets exceeds the carrying amount.
The auditor must ensure that provisions of NAS 36 “Impairment of Assets” are followed.
Question No. 30
Highlight the Audit approach for the "Assets Abroad". (3 Marks December 2011)
Answer
The auditor should follow various audit approaches stated as under:
 The auditor should review the internal control to confirm the accountability of each asset has been
established by maintaining appropriate records and has been accounted and depreciated properly.
 Where documents of title relating to assets held abroad are not available for inspection, a certificate
should be obtained from the agent or any other party holding the document. Such a certificate must
disclose unequivocally that they are free from any charge or encumbrance.

 The auditor should obtain sufficient evidence to satisfy that the assts are physically verified and exists
at the specified location.
 The auditor should obtain third party confirmation for any assets that are in possession of other
parties like bank balance, debtors etc.
Question No. 31
You have taken up the assignment for Due Diligence Review of the financial statement as of 31 Asadh
2069 of Das Dhunga Bank Ltd for facilitating the merger process with Lucky Finance Co. Ltd. Write
down any seven points you have to pay due consideration on carrying out the review on assets side
(covering each asset category) of the financial statement.
Answer:
b) Upon taking up the assignment for due diligence review of the Das Dhunga Bank Ltd; i have to
pay due following due consideration on review assets side of the financial statement:
i. Loan & Advances: The due consideration to be paid on loan and advances is whether the adequate
loan loss provision has been made in line with Nepal Rastra Banks Directive applicable to the bank.
ii. Investment: The due consideration to be paid on investment is that whether the investment has been
made in line with Nepal Rastra Banks Directive in eligible portfolio. If investment is doubtful of
recovery to see whether necessary provision has been set aside or otherwise. Further in
applicable cases have to see whether required reserves/funds against the investment been set aside.
iii. Fixed Assets: The due consideration to be paid on fixed assets is that whether all the fixed assets
appearing in financial statement legally owned by the entity, physically available and are in working
condition. The major fixed assets should be revalued with the help of expert for the purposes of DDA.
iv. Advance Tax: The due consideration to be paid on Advance Tax is to see whether the amount shown
as advance tax are really an existed asset representing the cash deposits made and advance tax made
by parties and are not time barred for claiming for assessment of tax purposes.
v. Non-Banking Assets (NBA): To see whether the NBA are on the possession and ownership of the
bank. See whether disposal (sales) process of NBA has not been suffered any hindrances like NBA is
insufficient for covering dues recoverable, NBA is subject to lien of others, NBA is under legal cases.
Further should be ensured that NBA is adequately provisioned as per NRB Directives.
vi. Advances: To see the recoverability of advances. If advances are doubtful of recoverability, ensure
that whether adequate provision against possible loss has been made.
vii. Deposits: To see the existence of various deposits. If deposits are doubtful of refund and are not
backed up with sufficient documents, ensure that whether adequate provision against possible loss has
been made.
Question No. 32

While auditing the books of account of Manang Ltd., Chief Accountant did not produce the records of
debtors saying that all the debtors are paying all their dues in due date and insisted that the auditor
need not verify the debtor‟s balance, as the debtors are considered good by the management.
Answer:
While In this case auditor fails to obtain sufficient information to form an overall opinion by the matters
contained in the financial statements, he may than issue a disclaimer of opinion.
In this case, auditor is unable to verify the debtors‟ ledger it amounts to restriction on the scope of the
duties of an auditor. Therefore auditor may state that he is unable to express an opinion because he has
not been able to obtain sufficient audit evidence to form an opinion.
Question No. 33
How will you verify the retirement gratuity to employees? (5 Marks December 2012)
Verification of retirement gratuity
Answer
 Examine the basis on which payable to employees is worked out. The liability for gratuity may
either be worked on actuarial rules or agreement or the presumption that all employees retire on the
balance sheet date.
number of years of services rendered by them.
 See that the annual premium has been charged to profit and loss account in cash the concern has
taken a policy from the insurance companies.
 Ensure that the accounting treatment is in accordance with NSA 26 " Accounting and Reporting by
Retirement Benefits Plans"
Question No. 34
The Company has sent semi-finished goods to third parties for further processing, which is laying with
them at the end of the year. Comment? (5 Marks December 2012)
Answer
Semi-finished goods being composite part of the inventories, normally, constitute significant item in case
of any entity. It is the duty of the auditor to ensure that entire inventories which are owned by the
enterprise exist on that date and valuation thereof is also proper. Since the semi-finished goods belong to
the company, it is necessary to ensure that the same have been included for in valuation of inventories.
The auditor should also obtain direct confirmation about the quantity of inventories lying with the
processors at the end of the year. Also, the auditor should see that the valuation has been made properly

with reference to the stage of completion in respect of work-in-process inclusive of expenses incurred in
sending the goods for processing. In case, the amount happens to be material, such stock may be
disclosed separately as stocks with processors.
Question No. 35
Write down any five audit steps for the audit of Debtors. (5 Marks December 2013)
Answer
Five audit steps for the audit of Debtors out of various possible steps are presented below:
i. Verify the opening balances with last year closing audited balances
ii. Obtain a schedule of receivables and determine whether the total agrees with the trial balance.
iii. Obtain and consider explanations of significant variations in Debtor‟s turnover ratio of current
period and prior period and anticipated debtor turnover ratio.
iv. Select a sample of debtors and obtain direct confirmation from the parties concerned.
v. Obtain an aged analysis of the debtors. Inquire about the reason for unusually large accounts,
credit balances on accounts or any other unusual balances and inquire about the collectability
of receivables.
Question No. 36
Cash book of an entity showed huge debit balances throughout the year. Comment
Answer
Cash balance is maintained to meet the day to day operational needs of the organization. So, the auditor
has to perform audit procedures particularly having regard to the fact that maintaining such huge
balance is highly prone to misappropriation and other forms of fraud. Accordingly, since the entity is
maintaining consistently huge cash balance which is not required for its operational needs, the auditor
should carry out the surprise verification of cash more frequently to ascertain whether the actual cash in
hand agrees with the balance as per cash book. If the actual cash balance is not in agreement with the
book balance, he should seek explanations from senior official of the entity. In case any material
difference is not satisfactorily explained, the auditor should state this fact appropriately in his audit
report. In any case, he should satisfy himself regarding the necessity for such huge cash balance having
regard to the normal working requirements of the entity. The entity may also be advised to deposit the
whole or major part of the cash balance in the bank at reasonable interval.
Material cash on hand if found during the audit in relation to the financial statements taken as a whole,
or if there are significant negotiable securities in the custody of the client, consider performing the
following additional procedures:

 Count the cash fund or observe and list the securities in the presence of a client
representative.
 Tie amount counted to general ledger balances.
 In most of small businesses, cash on hand is immaterial and should not be counted,
unless it is at the clients' request.
Question No. 37
As an auditor, how will you verify application and allotment money received on shares issued for
cash? (5 Marks June 2014)
Answer
Verification of application and allotment money received on Shares Issued for Cash shall be carried out
as under:
On Application
Verify the amount received along with the applications for shares in the following manner:
 Check entries in the Application and Allotment Book (or Sheets) with the original
applications;
 Check entries in the Application and the Allotment Book as regards deposits of money,
received with the applications, with those in the Cash Book;
 Vouch amounts refunded to the unsuccessful applicants with copies of Letters of Regret;
 Check the totals columns in the Application and Allotment Book and confirm the journal entry
debiting Share Application Account and crediting Share Capital Account.
On Allotment
 Examine Director‟s Minutes Book to verify approval of allotments.
 Compare copies of letters of allotment with entries in the Application and Allotment Book.
 Trace entries in the Cash book into the Application and Allotment Book for the verification
of amounts collected on allotment.
 Trace the amount collected on application as well as those on allotment from the Application
and Allotment Book into the Share Register.
 Check totals of amounts payable on allotment and verify the journal entry debiting Share
Allotment Account and crediting Share Capital Account.
Question No. 38
Revaluation of Fixed Assets (2.5 Marks December 2014)
Answer
Revaluation of fixed assets is the process of increasing or decreasing their carrying value in case of
major changes in fair market value of the fixed asset. NAS-16, Property, Plant and Equipment requires
fixed assets to be initially recorded at cost but they allow two models for subsequent accounting for
fixed assets, namely the cost model and the revaluation model. Under the Revaluation model, the asset

is carried at a revalued amount, being its fair value at the date of revaluation less subsequent
depreciation and impairment, provided that fair value can be measured reliably. Revaluations should be
carried out regularly, so that the carrying amount of an asset does not differ materially from its fair
value at the balance sheet date. If an item is revalued, the entire class of assets to which that asset
belongs should be revalued. Revalued assets are depreciated in the same way as under the cost model.
If a revaluation results in an increase in value, it should be credited to other comprehensive income and
accumulated in equity under the heading "revaluation surplus" unless it represents the reversal of a
revaluation decrease of the same asset previously recognized as an expense, in which case it should be
recognized in profit or loss. A decrease arising as a result of a revaluation should be recognized as an
expense to the extent that it exceeds any amount previously credited to the revaluation surplus relating
to the same asset. When a revalued asset is disposed of, any revaluation surplus may be transferred
directly to retained earnings, or it may be left in equity under the heading revaluation surplus. The
transfer to retained earnings should not be made through profit or loss.
Question No. 39
Write short note on
a) Audit of contingent liabilities ( 2.5 Marks June 2015)
The auditor may take following steps to verify the contingent liabilities:
ii. Inspect the minute books of the company to ascertain all contingent liabilities known to the
company.
iii. Examine the contracts entered into by the company and the likelihood of contingent liabilities
iv. Scrutinize the lawyer‟s bills to track unreported contingent liabilities.
v. Examine bank letters in respect of bills discounted and not matured.
vi. Examine bank letters to ascertain guarantees on behalf of other companies or individuals.
vii. Discuss with various functional officers of the company about the possibility of contingent
viii. Obtain a certificate from the management that all known contingent liabilities have been
included in the accounts and they have been properly disclosed.
ix. Ensure that proper disclosure has been made as per NAS 37, Provisions, Contingent
Liabilities and Contingent Assets.
Question No 40
Write short note on
b) Audit of contingent liabilities ( 2.5 Marks June 2015)
The auditor may take following steps to verify the contingent liabilities:
i. Inspect the minute books of the company to ascertain all contingent liabilities known to the
company.

ii. Examine the contracts entered into by the company and the likelihood of contingent liabilities
iii. Scrutinize the lawyer‟s bills to track unreported contingent liabilities.
iv. Examine bank letters in respect of bills discounted and not matured.
v. Examine bank letters to ascertain guarantees on behalf of other companies or individuals.
vi. Discuss with various functional officers of the company about the possibility of contingent
vii. Obtain a certificate from the management that all known contingent liabilities have been included
in the accounts and they have been properly disclosed.
viii. Ensure that proper disclosure has been made as per NAS 37, Provisions, Contingent Liabilities and
Contingent Assets.

Chapter 7 Company Audit

Question No. 1
C& Z co. was a statutory auditor of CTZ Ltd. for the FY 2059/60. he submitted the audit report to the
co. on Poush 15,2060. the company called the annual general meetings on 30 poush,2060. To the date
of annual general meeting C & Z Co. holds the office of the auditor of the Co. But the co. secretary
did not notice the auditors to attend the general meeting saying that the auditors‟ job is completed
before the annual general meeting. (5 Marks- December 2004)
Answer
Right to attend general meeting :The auditors of a company are entitled to attend any general meeting
of the company ; also to receive all the notices and other communications relating to the general
meetings, which members are entitled to receive and to be heard at any general meeting in any part of the
business of the meeting which concerns them as auditors.
Question No. 2
a. Briefly explain the steps to be considered necessary for carrying out the audit of “Share Transfer”?
Answer
1. Ascertain whether notices were sent in every case to the transferors and in case of join holders to
each of the holders and the objections, if and, raised by them were taken into considerations before
the transfers were registered.
2. Verify that in the case of partly paid shares where the application for registration was made by the
transferor a notice invariably was sent to the transferee and the transfer was registered only when
“no objection” has been received from him, within two weeks, from service of notice on him.
3. Scrutinize transfer forms, noting specially; transfer form in on prescribed form and duly stamped,
cash transfer form bears stamp duty, the name of the company, in inadequate consideration an
enquiry for the reasons therefore, alterations in the name and address of the transferee, etc.
4. Compare the signature of each transferor or on the transfer form with his signature on the original
application for shares or on the transfer form.
5. Ascertain that none of the transform is disqualified from holding shares in the company.
6. Vouch the entries in the transfer journal by reference to transfer forms.
7. The transfer forms, after they have been checked, should be marked and the transferors share
certificate cancelled to prevent the same being presented once again in support of another transfer.

8. Verify by reference to the minute book of the Board of Directors that all the transfers recorded in
the transfer journal have been approved by the board.
9. Confirm that every clerk who was entrusted with certain duties as regards the registration of
transfers has initialed the documents verified by him.
10. Check the postings of distinctive numbers of shares transferred and the name of transferors and
transferees into the register of members from the share transfer journal.
11. Verify the particulars entered on counterfoils of shares certificate issued to the transferees.
12. Verify that every duplicate share certificate in lieu of one loss of destroyed has been issued under
the consent of the Board and on the conditions prescribed by the board as regards production of
evidence or execution of a bond of indemnity.
13. Ascertain in cases where shares certificates have been issued in replacement of old certificates
whether such a fact was entered on the stub of the counter foil and the word “Duplicate” was
punched or stamped in bold letters across the face of the share certificates.
14. Confirm that the forms of share certificates are printed only under the authority of the board.
Question No. 3
Answer the following
a) Describe the stages in the issue of shares for cash? (4 Marks December 2005)
Answer:
Usually there are three stages in the issue of shares of cash, viz:
i. Receipt of applications for shares along with application money;
ii. Allotment of shares and receipt of allotment; and
iii. Making calls and receipt of call money.
Question No. 4
Option on share capital (4 Marks June 2008)

Answers
a) Para 79(a) (vii) of NAS-1 requires disclosure of the particulars of any option on unissued share
capital either in the face of the balance sheet or in notes. An option on shares arises when a
person has acquired a right under an agreement with the company to subscribe for share in the
company if he so chooses. Such options generally arise under the following circumstances:
i) Under the promoter‟s agreements subsequently ratified by the company;

ii) Collaboration agreement;

iii) Loan agreements, debenture deeds;
iv) Agreements to convert preference shares into equity share; and
Other contracts, such as for supply of capital goods and/or merchandise.
Question No. 5
Comment on the following:
The Members of Board of Directors of M/s Kantipur Bank Ltd. could not meet for meeting to decide
on an important issue that required immediate decision. The chairman of the Board of Director
instructed Company Secretary to draft the minute and circulate it to sign by all the members as he had
already talked the issue with other members and they had agreed to sign even there was not meeting.
Examine the validity of the decision taken by the Board of Directors in view of Companies Act, 2063.
Answer:
Company Act, 2063 section 97 deals with the meeting and decision of Board of Directors. Sub section
(4) of section 97 states that there would be no meeting if at least 51% of total members are not self-
present in the meeting. Likewise sub section (7) of same section specifies that a minute should be
prepared for such meeting mentioning the name of members present, the agenda and decision of the
meeting and such minute should be signed at least by 51% members present in that meeting.
However, sub section (9) of section 97 gives the board members full right to decide on agenda if all
members agree in writing without holding the meeting. In given case, the decision of the Board of
Directors is as per sub section (9) of section 97 so it is valid from the point of view of this section.
However, if any of the members is not ready to sign on proposed minute by the Chairman of the board,
the decision shall not be valid.
Question No. 6
Veri Ltd. is the Public Ltd. Company. It has not appointed Company Secretary. As an internal auditor
of the Company suggest whether the company has to appoint the Company Secretary including for the
required qualification of the Company Secretary. (5 Marks June 2014)
Answer
Section 185 of the company act deals with the provision for appointment of company secretary: Section
185 (1) states that public company with the paid –up capital of ten million rupees or more shall appoint
the company secretary a Nepalese citizen who has the qualification mentioned in Sub-section (2) .

Section (2) states that a Nepalese citizen who has worked in the related field for at least two years after
obtaining the professional certificate of company secretary issued by a native or foreign body authorized
to issue the professional certificate of company secretary pursuant to the prevailing law or who has
worked in the related field or in the field of company management for at least three years after doing at
least bachelor degree in law, management ,commerce or economics may be appointed to the post of
company secretary. Provided, however, that this provision shall not apply to the company secretary who
is incumbent at the time of commencement of this Act for three years after the date of commencement of
this Act.
In the light of above provision of company act, I have to suggest the applicability of aforesaid provision
for Veri Ltd. if it‟s paid up capital is Rs. 10 million or more.
Question No. 7
Answer/Comment on the following: (25=10 June 2019)

a) Explain the disqualifications of auditors as per Section 64 of Banks and Financial
Institutions Act, 2073.
b) RGS & Co. a firm of Chartered Accountants has three partners, namely, R, G & S. The firm is
allotted the audit of BY Ltd. Mr. R, partner in the firm subsequently holds 100 shares in BY
Ltd. Comment.
Answer:
a) Disqualifications for appointment as auditor:
Following persons or any firm or company in which such person is a promoter or partner shall not be
eligible to be appointed as an auditor of a licensed institution and shall in de facto cease to hold office
of auditor even though such person is already appointed:
i) A promoter, director, chief executive officer of bank or financial institution or his or her family
member;
ii) An officer, employee, or internal auditor of the bank or financial institution;
iii) A person working as a partner of any director or employee or chief executive officer of the
bank of financial institution;
iv) A borrower, substantial shareholder or associated person or any person with financial interest of
the bank or financial institution;
v) A person who has been punished in an offense relating to audit, and a period of five years has
not elapsed after he or she has served the punishment;
vi) A person who is insolvent in Nepal or foreign country;
vii) A person, firm, company or institution having subscribed one percent or more of the shares in
the concerned bank of financial institution;
viii) A person who has been punished by the court for a criminal offense involving moral turpitude,
and a period of five years has not elapsed after he or she has served the punishment; and

ix) A person who is disqualified to be appointed as an auditor as per relevant laws.
b) As per section 112(1)(g) of the Companies act, a substantial shareholder of the company or a
shareholder holding one percent or more of the paid-up capital of the company or his close relative
is disqualified from being an auditor.
In the given case, Mr. R is a partner of RGS & Co, Chartered Accountants and RGS & Co. has been
allotted the auditor of the BY Ltd. Mr. R partner of the firm has 100 shares of By Ltd. As per the
company act, a substantial shareholder of the company or his close relative is disqualified from
being an auditor. Mr. R holds only 100 shares which is not substantial shareholder of the company.
So, RGS & Co. can be auditor of the company.

Chapter 8 Audit of special sectors

Question. No. 1
Which special points you as an auditor would consider in auditing the accounts of a Charitable
Educational Institution? (16 Marks, JUNE 2001)
Or
What are the special steps involved in conducting the audit of an Educational Institution?
(14 Marks, June 2009, 7 Marks December 2011)
Answer
Special steps to be taken by the auditor while auditing the accounts of a Charitable Educational
Institution are as under:
(1) The Trust Deed of the Charitable Educational Institution should be inspected to ascertain the
provisions affecting accounts and the financial powers of the management.
(2) The auditor should go through the minutes of the meetings of the managing Committee in
order to see that the resolution affecting accounts have been duly complied with.
(3) Examine receipts of donations etc. All donations received as shown in the Cash Book should
be vouched with the corresponding counterfoil of receipts as also with the subscription and
donations lists periodically published.
(4) Fees recovered should be verified with the Register of Students and also check from
counterfoil of receipts into the Cash Book. Fees unrecovered, if any, have been written - off
after due authorization by the Managing Committee.
(5) Proper authority should be sent for free enrolment or those at reduced fees.
(6) Enquire into the system of recording of extra charges for diplomas, examination fees,
laboratory fees etc. payable by the students.
(7) Any failure of records to control adequately the collection of tuition fees, dormitory rents,
boarding and other charges should be brought to the notice of the committee. Income from
landed properties, if any, should be duly verified with the relevant records.
(8) Investments should be verified by actual inspection or with banker's certificate.
(9) All establishment expenses should be vouched in the usual way and if there is any unduly
heavy expenditure under any head, the same should be properly enquired into.

(10) Any increase in the staff salaries should be duly sanctioned and minuted.
(11) Any capital expenditure, incurred during the period under audit, should be verified with the
minutes of the Committee.
(12) Enquiry should be made into the system of buying of provision, food-stuffs, clothing and
other equipment‟s for boarders and it should be seen whether there is proper internal check
on the payment of such bills.
(13) Donation should be carefully verified with the announcements in the annual report, and in
case of funds endowed for any specified purpose, the auditor should see that the income there
from has been applied towards the purpose as required by the donors. If the income from the
finds endowed for specific purpose is not being applied towards the objects designated by
donors, the auditor must disclose the fact in his report.
(14) Properly certified inventories should be obtained in respect of furniture and other equipment
and stocks of stationery, provision, etc.
(15) See that the accrued income in respect of outstanding fees and accrued interest on
investments has been included as also outstanding liabilities for expenses incurred but not
paid, in the annual accounts instead of the latter being presented on the cash basis.
(16) Income from properties, if any, should be duly verified from the relevant records.
(17) Grants from Government and other authorities, if any, should be verified and their utilization
should be checked by reference to the terms of the grant. Any money remaining unutilized
within the period for which it was sanctioned or for a project which was not taken up should
be separately disclosed as a liability.
(18) See that all outstanding assets and liabilities are duly brought into accounts and shown in the
balance sheet.
(19) Building and other depreciable assets have been properly depreciated.
(20) Repayments of library or laboratory deposits should be properly checked to ensure that
deduction in respect of loss of books, damage of books a breakage of laboratory equipment
have been made.
(21) Whether the income of the Institution is exempt form income tax under Section 11 of the
Income-Tax Act and, if so, whether the tax deducted at source from the dividend or interest
income has been claimed from the taxation authorities.

Question No. 2
What special considerations will you keep in mind while auditing the Income and Expenditure of
Club? (16 Marks, December 2001)
Or
You are appointed as auditor of Big Star Club. State special consideration for audit of a club?
Answer
Clubs are social associations meant only for the members who are their main source of income and they
generally manage the affairs of the clubs. The main objectives before an auditor are to see compliance
with rules framed and proper accounting of the income and expenditures. Accordingly, he must carefully
study the rules of the club. He shall also acquaint himself with the general activities of the club and
current organizational set up including the present office bearers. Mainly, he must take up the following
steps:
1. Vouch the membership fee or/and the entrance fee on the basis of the charter or Constitution
and the Register of Members.
2. Vouch the annual subscription received by comparing receipts with list of members.
 Subscription-in-arrears must be shown separately and properly treated.
 Subscription received in advance must be properly recorded.
 Check whether regular defaulters are allowed to enjoy all the facilities offered by the
club. He should also take note of steps taken to recover the arrears from the defaulters.
3. Vouch and verify that special donations are meant for specified purposes only.
4. Vouch in the usual way the income from canteen, if any, maintained by the club.
5. Vouch specially the income from sales of liquor, cigars, snacks or refreshments or facilities
like swimming or billiards.
6. If the club premises are let out for sports activities or social functions like marriages, income
from rent or other charges must be vouched.
7. Check that a proper distinction is made between Capital and Revenue Expenditure.
8. See that heavy expenditure is spread over a number of years.
9. See that a proper system of charging depreciation is adopted by the club.
10. See that all purchases are duly sanctioned by the office bearers and that proper stock records
are maintained for all the items.
11. Verify that all expenditures are made in connection with the general activities of the club
only.
12. Verify assets like cash and bank balance, investments and stocks.
13. Verify liabilities such as outstanding expenses or loans taken.

Question No. 3
What are the special steps involved in carrying out the audit of Hospital? (June 2002)
Or
Mention special points which you as an auditor would look into while auditing the books of account
of Hospital. (7 Marks June 2012)
Or
What are the special issues involved in an audit of a hospital? (10 Marks, December 2006)
The special steps involved in carrying out the audit of a Hospital are stated below:
1. Vouch the Register of patients with copies of bills issued to them. Verify bills for a selected
period with the patient‟s attendance record to see that the bills have been correctly prepared.
Also see that bills have been issued to all patients from whom an amount was recoverable
according to the rules of the hospital.
2. Check cash collections as entered in the Cash Book with the receipts, counterfoils and other
evidence for example, copies of patients bill counterfoils of dividend and other interest
warrants, copies rent bills, etc.
3. See by reference to the property and investment Register that all income that should have been
received by way of rent of properties, dividends, and interest on securities settled on the
hospital, has been collected.
4. Ascertain that legacies and donations received for a specific purpose have been applied in the
manner agreed upon.
5. Trace all collections of subscription and donations from the Cash Book to the respective
Registers. Reconcile the total; subscriptions due as shown by the Subscription Register and the
amount collected and that still outstanding.
6. Vouch all purchases and expenses and verify that the capital expenditure was incurred only
with the prior sanction of the Trustees or the Managing Committee and that appointments and
increments to staff have been duly authorized.
7. Verify that grants, if any, received from Government or local authority have been duly
accounted for. Also, that refund in respect of taxes deducted at source has been claimed.

8. Compare the totals of various items of expenditure and income with the amount budgeted for
them and report to the trustees or the Managing Committee significant variations which have
taken place.
9. Examine the internal check as regards the receipt and issue of stores: medicines, linen,
apparatus, clothing, property, instruments, etc. So as to ensure that purchases have been
properly recorded in the stock Register and that issued have been made only against proper
authorization.
10. See that deprecation has been written off against all the assets at the appropriate rates.
11. Inspect the bonds, share scrips, title deeds of properties and compare their particulars with
those entered in the property and investment Registers.
12. Obtain inventories, specially of stocks and stores as at the end of the year and check a
percentage of the items physically; also compare their total values with respective ledger
balances.
Question No. 4
Mention the points to be considered in the audit of a leasing company?

Answer
A lease is a contract between the "Lessor' who is the legal owner of the asset and the "Lessee" who
acquires the right to use the specific asset on payment of fixed rentals Lessor retains ownership of assets
and only grants the exclusive right to the party (lessee) to use the asset, for an agreed period of time, in
return for payment of specified rental. Thus, lease finance is as alternative whereby project costs could be
met by taking in assets and equipment on hire rather than buying.
In respect of leasing transactions entered into by a leasing company involved in the leasing capital goods,
the auditor should check/verify the following:
a. The object clause of the leasing company to see that the company can undertake financing
activities or not.
b. Whether there exists. a procedure to ascertain the credit analysis of lessee like lessee's ability
to meet the commitment under lease, past credit record, capital strength, availability of
collateral security etc.
c. The lease agreement should be examined and the following points may be noted:

i. The description of the lessor, the lessee the equipment and the location where the
equipment is to be installed (The stipulation that the equipment shall not be removed from
the described location except for repairs. For the sake of identification, the lessor may also
require plates or markings to be attached to the equipment.)
ii. The tenure of lease, dates of payment lease charges, deposits or advance etc. should be
noted.
iii. Whether the equipment shall be returned to the lessor on termination of the agreement and
the cost shall be borne by the lessee.
iv. Whether the agreement prohibits the lessee from assigning or subletting the equipment
and authorises the lessor to do so.
d. Examine the lease proposal form submitted by the lessee requesting the lessor to provide him
on lease the equipment.
e. Ensure that the invoice is retained safely as the lease is a long-term contract.
f. Examine the acceptance letter detained from the lessee indicating that the equipment has been
received in order and is acceptable to the lessee.
g. See the Board resolution authorizing a particular director to execute the lease agreement has
been passed by the lessee.
h. See that the copies of the insurance policies have been obtained by the lessor for his records
Question No. 5
Discuss special points involved in carrying out the audit of Hire Purchase and Leasing companies.
Answer.
Hire purchase agreement means an agreement under which goods are let on hire and under which the
hirer has an option to purchase them in accordance with the terms of the agreement and includes an
agreement under which:
i. Possession of goods is delivered by the owner thereof to a person on condition that such
person pays the agreed amount in periodical installments, and
ii. The property in the goods is to pass to such person on the payment of the last of such
installments, and
iii. Such person has a right to terminate the agreement at any time before the property so passes.
Thus hirer means the person who obtains or has obtained possession of goods from an owner under a
hire-purchase agreement and owner means the person who lets or has let, delivers or has delivered

possession of goods to a hirer under a hire-purchase agreement in order to complete the purchase of ,or
the acquisition or property in, the goods of which the agreement relates, and includes any sum payable
by the hirer under the hire purchase agreement by way of a deposit or other initial payment. While
checking the hire-purchase transaction, the auditor may examine the following:
i. Hire purchase agreement is in writing and is signed by all parties.
ii. Hire purchase agreement specifies clearly;
a. The hire-purchase price of the goods to which the agreement relates;

b. The cash price of the goods, that is to say, the price at which the goods may be purchase by
the hirer for cash;
c. The date on which the agreement shall be deemed to have commenced;
d. The number of installments by which the hire-purchase price is to be paid, the amount of
each of those installments, and the date, or the mode of determining the date, upon which it
is payable, and the person to whom the place where it is payable: and
e. The goods to which the agreement relates, in manner sufficient to identify them.
iii. Ensure that payments are being received regularly as per the agreement.
In a lease agreement, a party (called „lessee‟) acquires the right to use an asset for an agreed period of
time in consideration of payments of rent to another party (called lessor). In certain lease agreement,
the legal ownership of the asset remains with the lessor (the leasing company), but in substance, all the
risks and rewards of ownership of the assets are transferred to the lessee. In other words, the lease, in
effect, a financing arrangement. Such leases are termed as finance leases. An operating lease, on the
other, is a simple arrangement where, in return for rent, the lessor allows the lessee to use the asset for
a certain period.
A normal financial lease transaction usually goes through the following modality:
The lessee selects the equipment, and satisfy himself about its functional fitness and specifications, the
lessor has no participation at this stage.
Having chosen the equipment, the lessee approaches a lessor, either directly or through a lease broking
agency.
The lease agreement is broadly negotiated and rates are finalized. The lessor places an order on the
manufacturer as chosen by lessee.
The manufacturer delivers the equipment at the site of the lessee, and the latter gives notice of
acceptance to the lessor. The lease agreement giving detailed terms of contract is signed between the
parties. Leases will normally be full pay out, with term varying as per requirements.

During the lease period, the lessee:
 Pays rentals regularly at periods agreed-upon, which are usually each calendar month.
 Keeps the equipment in good repair and working condition, etc.
 Will be entitled to manufacturer‟s warranties or after-sales services.
In respect of leasing transaction entered into by the leasing company, the following procedures may be
adopted by the auditor.
i. The object clause of leasing company to see that the goods like capital goods, consumer
durables etc. in respect of which the company can undertake such activities. Further, whether
company can undertake financing activities or not.
ii. Whether there exists a procedure to ascertain the credit analysis of lessee like lessee‟s ability to
meet the commitment under lease, past credit track, recorded capital strength, availability of
collateral security etc.
iii. The lease agreement should be examined and the following points may be noted:
a. The description of the lessor, the lessee, the equipment and the location where the equipment
shall not be removed from the described location except for repairs. For the sake of
identification, the lessor may also require plates or makings to be attached to the equipment
b. The amount of tenure of lease, dates of payment, late charges, deposits advances etc. should be
noted.
c. Whether the equipment shall be returned to the lessor on termination of the agreement and cost
shall be borne by the lessee.
d. Whether the agreement prohibits the lessee from assigning the subletting the equipment and
authorizes the lessor to do so.
iv. Examine the lease proposal form submitted by the lessee requesting the lessor to provide him
on lease the equipment.
v. Ensure that the invoice is retained safely as the lease is a long-term contract.
vi. Examine the acceptance letter obtained from the lessee indicating that the equipment is received
in order and is acceptable to the lessee.

vii. Check the Board resolution authorizing a particular director to execute the lease agreement has
been passed by the lessee.
See that the copies of the insurance policies have been obtained by the lessor for his records.
Question No. 6
What is the ideal approach while carrying out an audit of incomplete records?
Answer:
An auditor may face the situation of incomplete records under the following circumstances:
a. Where records are kept on a single-entry book-keeping system; or

b. Where records are kept on a double entry basis but some of the records are destroyed accidentally
or are seized by authorities or are otherwise not available for the auditors‟ examination due to
similar reasons.
Under the second circumstances, an ideal approach for carrying out the audit would be that the auditor
may direct the management of the enterprise to complete or reconstruct the accounting records, e.g. if
vouchers are available but the cash book, journal and the ledger are not maintained, then cash book,
journal and ledger should be written up. However, if vouchers are also not available, then cash book,
journal and ledger will have to be prepared correlating the evidence available, e.g. memorandum
records, bank statements, statements from outside parties, etc. even though such books, which are
prepared may not be complete, but may still contain useful information for the auditor.
On the other hand, when books are maintained on single entry basis, then management of the entity
would be asked to write up the books, to the extent possible, as they would have been written up under
the double entry book keeping system. In any case, the following steps would be required to conduct
the audit under such circumstances:
i. Ascertain that the balance sheet or statement of affairs as the beginning of the year should be
prepared and all the relevant accounts should be opened in the ledger. Normally, under the single-
entry system, cash, bank and personal ledgers accounts are maintained.
ii. Confirming that all entries on receipt side of the cashbook are posted on the ledger accounts.
iii. Check that all entries on the payments side of the cash book are also posted in the ledger
accounts.

iv. Confirming that all entries appearing in the bank account are posted in the necessary ledger
accounts.
v. To analyze creditors account and post entries related to credit purchases made, purchase returns,
discount received, bills payable issue to suppliers, bills payable dishonored to relevant accounts.
vi. Apply analytical review procedures in depth and notice deviations to investigate in detail. Obtain
direct indirect evidence to verify the existence of fixed assets e.g. payment of local taxes,
electrical bills, etc.
vii. Formulate an appropriate audit opinion based on above findings. A disclaimer of opinion may be
appropriate in case there is any restriction on the scope of audit.
Question No. 7
Discuss the important points in the audit of an educational institution. (9 Marks, June 2006)
Answer:
1) Knowledge of the Institution

a) Ascertain the legal status of the institution.
b) Note the important provisions of regulating Act.
c) Examine the bye-laws and note the relevant provisions.
d) Examine the minutes of the meetings of the board/governing body/managing committee/finance

committee etc.
e) Obtain a list of functionaries who are authorized to sanction or execute financial transactions.
f) Obtain a list of books of account and that of other registers and records.
g) Examine the previous years' audit reports, internal audit reports and note the important
observations.
2) Income
1. Examine copies of the bills raised for fees. Examine whether the bills are based on the fees
applicable to different categories of students and whether they contain details of fees structure.

Also verify that the fee structure conforms to the rules and limits prescribed by the government/
other authorities.
2. Examine whether fee concession have been granted as per the rules.
3. Examine whether the bills have been entered properly in the fee register/other records.
4. Examine the entries in the cash book/ fee register with reference to the counterfoils of receipt
issued.
5. Examine the statement of reconciliation of fees i.e. total fees received during the year and the
total fees receivable as per the applicable fees structure.
6. Verify interest/ dividend receipt during the year with the total interest/ dividend that should have
been received as per investment register. Examine whether interest accrued but not received has
been duly recognized.
3) Expenditure
1. Examine whether salaries and allowance paid are in accordance with the terms and conditions of
appointment of each category of staff.
2. Check the computation of gross remuneration payable and deductions.
3. Vouch payment of salaries and allowances with reference to the acknowledgements from the
employees and entries in the bank statement.
4. Verify the deposits of amounts relating to income tax, provident fund etc. Examine whether the
amounts have been deposited within the prescribed time limits.
5. Examine whether payments of scholarships to students are properly authorized and conform to
the terms stipulated. Vouch payments of scholarship with reference to the acknowledgment from
the students.
6. Examine the payments on account of expenditures in the usual manner. Similarly, examine the
payments relating to purchases.

4) Assets and Liabilities
1. Verify payments made on account of refund of security and other deposits to students leaving the
institution with reference to acknowledgement given by them.
2. Verify payments made on account of purchase of fixed assets and recording of it.
3. Examine the charge of depreciation.
4. Carry out physical verification of fixed assets and investments. Examine whether the applicable
legal requirements regarding acquisition of investments have been complied with.
5. Examine the transactions of loans, advances as also of purchases, sales etc. between the
institution and any member of the governing body. Examine whether these transactions are prima
facie detrimental to the interest of the institution.
Question No. 7
Briefly state the important matters to be considered by the auditor in audit of a charitable institution.
Or
Discuss the special steps involved in carrying out the audit of a Charitable Institution.
Answer:
The following are the important matters on which the attention of the auditor should be made in the
audit of Charitable Institutions.
1. General:
a) Study the constitution under which the charitable institution has been set up whether under the
Society Registration Act, as a trust or as a company limited by guarantee.
b) Verify whether it is managed as contemplated by the law under which it has been set up.
c) Examine the system of internal check mainly relating to amounts collected.

d) Verify the income in detail and confirm that the amounts received have been deposited in the
bank regularly and promptly.

2. Subscription and donations:

a) Ascertain the changes, if any, regarding the annual or life membership subscription fees
during the year.
b) Ascertain that there is adequate internal control over the issue of official receipts, custody of
unused receipt books, printing of receipt books etc.
c) Examine the system of internal check regarding money received from box collection, flag
days, etc.
d) Ensure that there is proper system of control over collection and all collections are properly
accounted.
e) Verify the total subscriptions and donation received with the published figures in the reports
issued by the charitable institution.
3. Legacies: Verify the amount received with the correspondence in this regard and other available
information.
4. Grants: Verify the amount received with the relevant correspondence receipts and minute books
and obtain a certificate from a responsible official showing the amount of grants received.
5. Investments Income: Vouch the amount received with the dividend and interest counterfoils and
calculation of interest on securities. In case of sale or purchase of investment, ensure appropriate
dividend is received. Also, compare the dividend received with the list of investments to ensure
that dividend has been received in respect of all investments.
6. Rents: Examine the rent roll and tenancy agreement in respect of amount of rent and due dates.
Also, vouch the rent receipts with rent roll cash book and counterfoils of receipt book.
7. Special Functions etc.: Vouch gross receipts and payments in respect of any special functions
and ensure that the proceeds of all tickets issued have been accounted for after making the
allowance of return.
8. Income Tax refunds: Verify the refund of tax deducted at source on dividend/interest form the
Income Tax Authorities as charitable institutions are exempted from Income Tax.
9. Expenditure:
a) Vouch payment of grants and it is paid only for charitable purpose.
b) Verify the schedules of securities held and also inventories of properties held.

c) Ensure that the Trustees or any official are not benefited out of the institution
d) Conduct physical verification of securities and title deeds and movable properties.
e) Verify the cash and bank balances.
f) Ensure that any fund contributed for a special purpose has been utilized for the purpose.
Question No. 8
What are the special steps involved in audit of incomplete records?

(5Marks, June 2007, 6 Marks June 2010)
Answer
Normally, the auditor of incomplete records may be necessitated under two circumstances viz. (i) when
the accounts have been maintained on single entry basis of (ii) accounting records may be destroyed by
fire, flood, etc. or seized by government authorities. Under either of circumstances the audit objective
would remain the same and, thus, auditor would have to follow extensive audit procedure before
expression of an opinion on such financial statements. Steps, which may be followed in this regard, are
as under:
1. Ascertain the exact status of accounting records available including memoranda records, if any.
Also obtain a list of records i.e. accounting, memoranda, statistical etc.
2. Ensure that the management compiles/ reconstructs accounting records to the extent practicable.
In case of single entry, the accounts may be converted to double entry basis.
3. Perform compliance procedure to assess whether any control system is in operation. Generally, it
is difficult rather almost impracticable that any control worth the name would be in existence.
4. Vouch transaction recorded in books of account with reference to appropriate audit evidence.
Check posting, casting etc. in depth. Auditor may also obtain external evidence as far as possible
like confirmation from third parties. Bank reconciliation should also be examined in detail.
5. Examine the system in operation in respect of custody managed cash memos, receipts, cheque-
books etc.
6. Conduct surprise checks to verify cash in hand, inventory, etc.
7. Verify fixed assets by observing physical verification.
8. Obtain indirect evidence to verify the existence of fixed assets e.g. payment of local taxes to
municipal authorities, electrical bills, etc. in case of building.
9. Check veracity of memoranda records and obtain further evidence to confirm the same.
10. Apply analytical review procedures in depth and notice deviations to investigate in detail. Ratio
analysis shall be of particular importance since it would provide substantive audit evidence.
Formulate an appropriate audit opinion based on above findings. A disclaimer of opinion may be
appropriate in case there is any restriction on the scope of an audit.

Question No. 9
Describe the procedures to conduct audit of sales under hire purchase agreement.
Answer
Hire purchase agreement means an agreement under which goods are let on hire where the hirer has an
option to purchase them in accordance with the terms of the agreement, such as possession of the goods
is delivered by the owner and the user agrees to pay an agreed amount in various instalments. While
conducting audit of sale under hire purchase agreement, the following points are suggested:
 Hire purchase agreement is in writing and is signed by all parties.
 The hire purchase agreement specifies clearly:
— the hire purchase price of the goods,
— the cash price of the goods,
— the date on which the agreement shall be deemed to have commenced,
— the number of installments by which the hire purchase price is to be paid, the amount of
each those installments, and the date,
 Ensure that payments are being received regularly as per the agreement.
 Ensure that correct accounting entries are made for interest and towards the principal amounts.
 Obtain balance confirmation from the parties of the outstanding balances on regular basis.
Question No. 10
What are the special issues that should be covered during conducting audit of educational
institutions? (8 Marks June 2008)
Answer
a) The special issues that should be covered during conducting audit of educational institutions are as
under:
Education Act 2028 (Revised) and Education Rules 2029 (Revised) contain following provisions
with respect to audit of an educational institute. The requirements differ in the case of types of school
registered under Trust Act or Company Act.
Section 13 A of Education Act stipulates that the audit of the educational institution shall be done as
prescribed. Rules 171 of Education Rules provides following with respect to auditing:
1. The headmaster (HM) shall require annual audit of school from the auditors appointed by the
District Education Office.
2. The HM shall make available all books of accounts, records and information asked by the auditor.
3. The auditors shall report to School Management Committee, District Education Office and
Regional Education Directorate mentioning specified comments.

As an auditor, s/he should consider following steps in carrying out the audit of an educational
institute:
1. Review of trust deed, registration documents with special attention to requirement for
finance/account and audit
2. Review of minutes of the meeting of the School Management Committee or Governing Body,
noting resolutions affecting accounts to see that these have been duly complied with, specially the
decisions as regards the operations of bank accounts and sanctioning of expenditures.
3. Cross check names entered in the Students‟ Fee Register for each month with the respective class
register and verify amount of fees and internal control system in place.
4. Check fees received by comparing counterfoils of receipts granted with entries in the cash book
and tracing the collections in the Fee Register.
5. Total up the various columns of the Fees Register for each month or term to ascertain that fees
paid in advance have been carried forward and the arrears that are irrecoverable have been written
off under the sanction of the appropriate authority.
6. Check admission fees with admission slips signed by the head of the institution and confirm that
the amount had been credited to capital fund, unless SMC has taken a decision in contrary.
7. See that free studentship/scholarship and concessions have been granted by appropriate
authorized person, having regard to standard rules.
8. Confirm that fines for late fee payments or absence, etc. have either been collected or written off
under proper authority.
9. Confirm that hostel dues are recovered before student accounts were closed and their deposits
have been refunded.
10. Verify rental income, if any from agreements, etc. and interest and other dividends incomes.
11. Verify government and other local authority grants with the relevant papers.
12. Identify the reasons for any expenses disallowed by the authorities and future compliance thereof.
13. Assess internal control system adopted for review and realization of dues.
14. Ensure proper accounting and disclosure of deposits and other liabilities, income, reserves,
expenses, etc.
15. Vouch expenses as per school rules, SMC‟s decision and Financial Administration Policies.
16. Ensure compliance with respect of disclosure of accounting policies and notes to account for any
material transactions and requirement of legislations.
Question No. 11
Association for Backward Communities (ABC) is one of the NGOs working in the Midwest part of the
country. There seems to be confusion regarding total receipt of the NGO as what could be the
probable revenue sources and how they should be vouched. The chief of the NGO is mostly on the
foreign tour and the accountant of the NGO simply says „boss knows everything and he is just clerk‟.
What documents you will insist to check to deal with the situation?
(5 Marks June 2010)

Answer
The receipt of income of NGO may be checked on the following lines:
i) Contribution and grants for projects and programmes: Check agreements with donors and
grants letters to ensure that funds received have been accounted for. Check that all foreign
contributions receipts are deposited into bank accounts and proper disclosure is made.
ii) Receipts from fund raising programmes: Verify in detail the internal control system and
ascertain who are the persons responsible for collection of funds and mode of receipt.
iii) Interest and dividends: Check the interest and dividends received and receivable with
investments held during the year.
iv) Miscellaneous receipts: Check sale of scrap, rental receipts etc., if any.
Question No. 12
A Donor has appointed you as an auditor for ensuring financial management capacity of the NGO
before funding made to the NGO to rely on the fund operating capability of the NGO. What would be
your special focus area for such assignment? (5 Marks June 2011)
Answer
For ensuring financial management capacity of the NGO my special focus area would be:
i. To ensure whether adequate internal control system for accounting administration has been
existed within the organization.
ii. To ensure the required experiences & academic qualification of accounting staff.
iii. To ensure the volume of donors‟ fund previously operated by the NGO.
iv. To ensure the adequacy of policies etc. (like accounting manual, chart of account, financial &
administrative regulation, software is in place & adequate).
v. To see the annual audit report, internal audit report & other types of audit report for ensuring
serious and risky areas if any to pay due attention.
vi. To ensure the basic accounting concept of non-accounting staff for handling the advances.
vii. To see overall account of the NGO, whether there is any diversion of project fund to institutional
fund through any unfair means.
viii. To see the composition of program cost & office running cost for ensuring whether office
running cost mainly salary is excessively high than program cost.
ix. To the composition of common cost (cost shared by different donors) in past period to ensure that
whether same cost has been borne by different donors in books of accounts.
x. To ensure whether periodical reconciliation (bank/cash/fund etc.) system are in place.

xi. To ensure whether budgetary control system is in place.

xii. To ensure whether there is excessive turnover of the accounting staff.
xiii. To ensure whether proper & adequate delegation of authority has been made and properly
exercised in practice.
Question No. 13
Mention any ten special points to be examined by you in the audit of Income and Expenditure of a
charitable institution running a hospital. (10 Marks June 2011)
Answer
a) While auditing the Income and Expenditure Account of a charitable institution running a hospital,
following special points may be examined:
(i) Verify the register of patients with duplicate copy of bills and patient‟s admission record to see that
bills have been properly and correctly prepared for all the services, tests and treatments.
(ii) Check cash collections from patients by tracing the receipt issued into cash book.
(iii) Check receipt of interest, rent, dividend etc., with receipt counterfoil into cash book and bank
book and ensure that all such income has been duly accounted for.
(iv) Check collection of subscription, donations from the receipt issued, correspondence etc., into cash
book.
(v) Verify that all grants from government and other bodies have been duly accounted for and have
been applied in the manner as specified.
(vi) Verify all recurring nature of revenue expenditure, with necessary evidence like bill, authority,
period etc.
(vii) Examine the internal check as regards the receipt and issue of stores, medicines, linen etc., to
ensure that these have been properly recorded and issued/consumed only on proper authorization.
(viii) See that depreciation has been written off in respect of all the assets at appropriate rate and
method as in the earlier year.
(ix) Verify the receipts from supply of food and canteen receipts and compare the same with previous
year as regards number of patients.

(x) Ensure that all outstanding liabilities have been adequately provided for and similarly all accrued
incomes and receipts have been duly accounted for.
(xi) Obtain inventory of stock and stores as at the end of the year and physically check a percentage of
items.
Question No. 14
What are the steps followed while conducting audit of incomplete records? (5 Marks December 2011)
Answer
Incomplete records emanate risk of misstatement of financial statement due to omission and wrong
recording of transactions. Therefore, the auditor should be careful in this regard. Steps that are followed
in audit of incomplete records are as below:
a) Ascertain the exact status of accounting records available including memoranda records.
b) Ensure that the management compiles / reconstructs accounting records to the extent practicable.
c) Perform compliance procedure to assess whether any control system is in operation.
d) Vouch transactions recorded in books of account with reference to appropriate audit evidence.
Check posting, casting etc.
e) Examine the system in operation in respect of custody managed cash memos, receipts, check
books etc.
f) Verify fixed assets by observing physical verification.
g) Conduct surprise checks to verify cash in hand, inventory etc.
h) Apply analytical review procedures in depth and notice deviations to investigate in detail.
i) Formulate an appropriate audit opinion based on above findings.
Question No. 15
Nepal Engineers Association organized a three three-day national Conference of Engineers in Kathmandu.
You are asked to audit the accounts of the conference. Draft the audit program for audit of receipt of
participation fees from delegates to the conference. Mention any six point, peculiar to the situation, which you
will like to include in your audit program.
Answer
The organization of three-day International conference of Engineers in Kathmandu by Nepal Engineers
Association is a one- time event. Normally, in view of mega-size of the event, organizing committee is
formed in the organization to handle the entire event. Since few people would be handling the event, the

internal control may not be that strong and, thus, more emphasis is required to be given on substantive
procedure.
Following are the areas for consideration:
i. Internal Control System

a. Examine the organization structure of organizing committee formed for the
International conference if any, and division of responsibilities amongst persons and
control custody over receipt books.
b. Verify the internal control system for restricting the participation of unregistered
delegates.
ii. Rate of Participation Fees

a. Verify with reference to resolution passed by the organizing committee/Nepal
Engineers Association.
b. Also verify the rate from the literature/registration form circulated for promotion of
conference.
iii. Receipts of Participation Fees

a. Verify counterfoil of the receipts issued for individual registration.
b. Ensure that receipts are issued for all the registration received in cash.
c. Trace the receipts in bank statement or cash book as the case may be.
d. Verify Bank Reconciliation statement and list out dishonored cheques.
e. Verify subsequent recovery in respect of dishonored cheques.
iv. Overall checking

a. Verify the total receipt of participation fees shown in the financial statements with
reference to total number of receipts issued to participants.
b. Cross check the total number of delegates with reference to the following:
1. Kits distributed to participants.
2. Bills of Hotel/caterer for providing meals during conference.
3. Capacity of the Hall
4. Participation Certificate if any issued.
v. Foreign Delegates
In case of foreign delegates – if registration fees are higher – ensure that they are
registered at higher fees.
vi. Special Issues

a. Take out list of absentees and in case of nil absentees, probe the issue further.

b. If certain participants are exempted from payment of fees – obtain the list along with
proper authorization in this regard.
Question No. 16
Mention the special points in case of an audit of the entity from incomplete records.
(8 Marks June 2012)
Answer
Audit of the entity from incomplete records:
The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions
on which to base the audit opinion. As mentioned in Nepal Standard on Auditing on Audit Evidence
NSA 04,
audit evidence is obtained from an appropriate mix of tests of control and substantive procedures. In
some circumstances, evidence may be obtained entirely from substantive procedures. "Audit evidence"
means the information obtained by the auditor in arriving at the conclusions on which the audit opinion is
based. Audit evidence will comprise source documents and accounting records underlying the financial
statements and corroborating information from other sources. The examination of records and
documents is one of the most important techniques through which an auditor collects evidence.
Therefore, in case the records and documents maintained by an enterprise are incomplete, it would prove
to be a great handicap to the auditor. Hence the auditor needs to take special care while auditing in the
circumstance of incomplete records.
An auditor may face the situation of incomplete records under the following circumstances:
i. Where records are kept on single entry basis; or
ii. Where records are kept on double entry basis, but some of the records are destroyed
accidentally, or are seized by authorities or are otherwise not available for the
auditors' examination due to similar reasons.
Under the second circumstance, an ideal approach for carrying out audit would be that the auditor
may direct the management of the enterprise to complete or reconstruct the accounting records,
e.g., if the vouchers are available but the cash book, journal and the ledger are not maintained, then
the cash book, journal and ledger should be written up. However, if vouchers are also not
available, then cashbook / journal / ledger will have to be prepared by correlating the evidence
available, e.g., memoranda records, bank statements, statements from outside parties, etc. Even
though such books which are prepared may not be complete, but may still contain useful
information for the auditor.
On the other hand, when books are maintained on single entry basis, the management of the
enterprise would be asked to write up the books, to the extent possible, as they would have been
written up under double entry system.

In any case, the following steps would be required to conduct an audit;
i. Ascertain that the balance sheet or statement of affairs as at the beginning of the
year should be prepared and all the relevant accounts should be opened in the
ledger. Normally, under the single-entry system, cash, bank and personal accounts
are maintained.
ii. Confirming that all entries on receipt side of the cash book are posted in the ledger,
even by opening new account(s) wherever necessary.
iii. Check that all entries on the payment side of cash book are posted in the ledger.
iv. Confirming that all entries appearing in bank account are posted in ledger.
v. Analyze personal accounts of debtors. This will provide vital information regarding
credit sales, sales returns, discount allowed, and bills received, and bills dishonored
etc. It would be necessary to post such items to relevant accounts to complete the
double entry from the debtors‟ accounts.
vi. Similarly, it would be necessary to analyze the creditors‟ accounts and post entries
relating to credit purchase made, discounts earned, purchase returns, bills payable
issued to suppliers, bills payable dishonored etc. to relevant accounts.
From an auditor‟s view point, the supervisory controls exercised by the owners are generally
less reliable and hence while auditing incomplete records, auditor will largely depend on
extensive substantive procedures and obtain external evidence, physical examination /
observation, management representation and perform analytical procedures. The auditor
should also pay due attention towards the provisions made in NSA04 Audit Evidence.
Question No. 17
District Education Office has appointed you as an auditor for some community schools of Humla
District. What special points do you consider while doing audit of such schools? Explain.
(5 Marks June 2013)
Answer
Audit of Education Institutions i.e. Community Schools of Humla District:
The special steps involved in their audit are the following:
 Examine the Education Act and Education Rules in these cases as these are the Community
Schools which are under the control of the District Education Office and note all the provisions
affecting accounts.
 Read through the minutes of the meeting of the School Management Committee, noting
resolutions affecting account to see that these have been duly complied with, specially the
decisions as regards the operation of bank account and sanctioning of expenditure.

 Check names entered in the Students Fee Register for each month or term, with the respective
Class Registers, showing names of student on rolls and test amount of fees and extra charged; and
verify that there operates a system of internal check which ensures that demands against the
student are properly raised.
 Check fees received by comparing counterfoils or receipts granted with entries in the Cash Book
and tracing the collections in the Fee Register to confirm that the revenue from this source has
been duly accounted for.
 Total up the various columns of the Fees Register for each month or term to ascertain that fees
paid in advance have been carried forward and that the arrears that are irrecoverable have been
written off under the sanction of an appropriate authority.
 Check admissions fees with admissions slips signed by the head of the institution and confirm
that the amount has been credited to a Capital Fund, unless the School Management Committee
has taken a decision to the contrary.
 See the free studentship and concessions have been granted by a person authorized to do so,
having regard to the Rules prepared by the Management Committee.
 Confirm that fines for late payment or absence, etc. have been either collected or remitted under
proper authority.
 Confirm that hostel dues were recovered before student's accounts were closed and their deposits
of caution money refunded.
 Verify rental income from landed property with the rent rolls, etc.
 Verify any government or local authority grant with the memo of grant. If any expense has been
disallowed for purposes for grant, ascertain the reasons thereof.
 Report any old heavy arrears on account of fees, dormitory rents, etc. to the Management
Committee.
 Confirm that caution moneys and other deposits paid by students on admission, have been shown
as liability in the balance sheet and not transferred to revenue, unless they are not refundable.
 See that the investments representing endowment funds for prizes are kept separate and any
income in excess of the prizes has been accumulated and inappropriate securities.
 Check the distribution of scholarship to the students and ensure the same with the receipts of the
students.
 Check the distribution sheet of textbooks, payroll of the PCF teachers with the number of
students.
Question No. 18
Help- SIPA, an NGO registered in Nepal raises funds from members, donors or contributors to
support victims of Earthquake of Sindhupalchok. Explain the points which you will consider in
preparing the Audit Programme of this NGO. (5 Marks July 2015)
Answer
The audit programme should include in a sequential order all assets, liabilities, receipts and expenditures
ensuring that no material item is omitted.

(a) Corpus Fund: The contributions / grants received towards corpus be vouched with special
reference to the letters from the donor(s). The interest income be checked with Investment
Register and Physical Investments in hand.
(b) Reserves: Vouch transfers from projects / programmes with donors‟ letters and board resolutions
of NGO. Also check transfer of gross value of asset sold from capital reserve to general reserve
and adjustments during the year.
(c) Ear-marked Funds: Check requirements of donor‟s institutions, board resolution of NGO, rules
and regulations of the schemes of the ear-marked funds.
(d) Project / Agency Balances: Vouch disbursements and expenditure as per agreements with donors
for each of the balances.
(e) Loans: Vouch loans with loan agreements, receipt counter-foil issued.
(f) Fixed Assets: Vouch all acquisitions / sale or disposal of assets including depreciation and the
authorizations for the same. Also check donor's letters/agreements for the grant. In the case of
immovable property check title, etc.
(g) Investments: Check Investment Register and the investments physically ensuring that
investments are in the name of the NGO. Verify further investments and disinvestments for
approval by the appropriate authority and reference in the bank accounts for the principal
amount and interest.
(h) Cash in Hand: Physically verify the cash in hand and impress balances, at the close of the year
and whether it tallies with the books of account.
(i) Bank Balance: Check the bank reconciliation statements and ascertain details for old outstanding
and unadjusted amounts.
(j) Stock in Hand: Verify stock in hand and obtain certificate from the management for the
quantities and valuation of the same.
(k) Programme and Project Expenses: Verify agreement with donor/contributor(s) supporting the
particular programme or project to ascertain the conditions with respect to undertaking the
programme / project and accordingly, in the case of programmes/projects involving contracts,
ensure that income tax is deducted, deposited and returns filed and verify the terms of the
contract.
(l) Establishment Expenses: Verify that provident fund, life insurance premium, employee‟s
insurance and their administrative charges are deducted, contributed and deposited within the
prescribed time. Also check other office and administrative expenses such as postage, stationery,
travelling, etc.
Question No. 19
Mr. Abhyudaya has been appointed as an Auditor of Kashvi Enterprises. After appointment, the
books of Kashvi Enterprises have been destroyed by earthquake. State the extensive procedures to be
followed for audit in such scenario. (December 2015)

Answer
The scenario is guided by the audit of incomplete records. Audit of incomplete records are generally
required under the following two circumstances.
(i) When accounts have been maintained on single entry basis or

(ii) Accounting record may be destroyed by fire, flood etc. or seized by government authorities.
The auditor may be required to follow extensive procedures, which include:
(a) obtain list of records available

(b) Ensure that management reconstructs/compile records to the extent possible.
(c) Perform compliance procedure to assess whether internal control system is in operation.
(d) Vouch transactions in books of accounts with appropriate evidence.
(e) Examine system of custody of cash receipts, cheque book etc.
(f) Conduct surprise verification of cash & inventory.
(g) Verify fixed assets by physical verification.
(h) Formulate appropriate audit opinion.
A disclaimer of opinion may be necessary if any restriction on scope of audit is enforced.

Chapter 9 Government Audit
Question No. 1
What are the special features if the audit of Public Sector undertakings? (JUNE 2002)
Answer
Following are the special features if the audit of public sector undertakings:
Public sector undertakings have certain special features of audit as working and organization of
such enterprises have distinctive feature. Generally, most of the public sector undertakings are
run as Government companies registered under the Companies Acts or as statutory corporation
set up under special act of the legislature.
As per Section 10 of Audit Act 2075, Audit of corporate body fully owned by Government of
Nepal, State Government or Local Government
a) The audit of the corporate bodies wholly owned by Government of Nepal State Government or
Local Government shall be audited by the Auditor General and Auditor General may appoint
license holder auditors under the prevailing laws an assistant. While appointing auditor as such,
he/she shall give priority to the Nepali citizen.
c) The auditor appointed pursuant to above shall act under the direction, supervision and control
of the Auditor General.
d) The powers, functions, duties and responsibilities of the auditors appointed by Auditor General
and the procedures to be followed by them in course audit and provisions relating to their
report shall be as prescribed by the Auditor General.
e) The remuneration to be paid by the concerned organization to the auditors appointed shall be
fixed by the Auditor General keeping in view the volume of financial transactions, status of
accounts, number of branches and sub-branches, work load and work progress of the concerned
organization.
Question No. 2
What do you understand by the term "Government Auditing”? (8 Marks, June 2003)
Answer
Government auditing is the objective, systematic, professional and independent examination of financial
administrative and other operations of a public entity made subsequently to their execution for the
purpose of evaluating and verifying them, presenting a report containing explanatory comments on audit
findings together with conclusions and recommendations for future actions by the responsible officials
and in the case of examination of financial statements, expressing the appropriate professional opinion.

Government audit serves as a mechanism or process for public accounting of Government funds. It also
provides public accounting of the operational, management programme and policy aspects of public
administration as well as accountability of the officials administering them. Audit observations based on
factual data collection also serve to highlight the lapses of the lower hierarchy, thus helping supervisory
level officers to take corrective measures.
Question No. 3
Write short notes on Propriety audit (4 Marks December 2003, 4 Marks June 2005)
Answer
Property audit stand for verification of transactions on the test of public interest, company accepted
customs and standards of conduct. Propriety audit requires the transactions and more particularly
expenditure to confirm to certain general principles. These principles are:
i. that the expenditure is not prima facie more than the occasion demands and that every official
exercise the same degree of vigilance in respect of expenditure as a person of ordinary
prudence would exercise in respect of his own money.
ii. that funds are not utilized for the benefit of a particular person or group of persons and
iii. that apart from the agreed remuneration or reward, no other avenue is kept open to indirectly
benefit the management personnel, employees and others.
Question No. 4
Explain propriety audit in the context of Audit Act, 2048. (5 Marks July 2015)
Answer
(As per section 5 of) the Audit Act, 2048 requires that the Auditor General shall audit following matters
considering the propriety thereof-
i. On the propriety of any expenditure and its authorization, if in the opinion of the Auditor General
such expenditure is a reckless one or is an abuse of national property, whether movable or
immovable, despite that the expenditure confirms to the authorization, and
ii. On the propriety of all authorizations issued in respect of any grant of national property whether
movable or immovable, fixed or current, or underwriting of any revenue, or any contract, license
or permits relating to mining, forest, water resources, etc. and any other act of abandoning
movable or immovable, assets of the nation.
The Auditor General may not include in the report minor items of discrepancy and other items
deemed as insignificant in view of their property which were observed during the audit of income
and expenditure.
(Note: Prevailing Act for Government Audit is Audit Act 2075, the provisions mentioned are similar to
the new Act)

Question No. 5
What are the matters to be audited in view of propriety as per Audit Act, 2048 as amended in 2075?
Answer
Section 5 of the Audit Act 2048 (As amended in 2075) states that; the Auditor General shall audit
following matters considering the propriety thereof:
(i) On the propriety of any expenditure and its authorization, if in the opinion of the Auditor General
such expenditure is a reckless one or is an abuse of national property, whether fixed or current,
despite that the expenditure conforms to the authorization, and
(ii) On the propriety of all authorizations issued in respect of any grant of national property whether
fixed or current, or underwriting of any revenue, or any contract, license or permits relating to
mining, forest, water resources, etc. and any other act of abandoning fixed or current assets of the
nation.
Though the Auditor General may not include in his report minor items of discrepancy and other items
deemed by him as insignificant in view of their propriety which were observed during the audit of
income and expenditures.
Question No. 6
Short Notes On:
a. Performance Audit
Answer (5 Marks June 2002, June 2004, December 2010)
The scope of audit has been extended to cover efficiency, economy and effectiveness audit or
performance audit, or full scope audit. Efficiency audit look into whether the various schemes /
projects are executed and their operations conducted economically and whether they are yielding
the results expected of them, i.e. the relationship between goods and services produced and
resources used to produce them; and examination aimed to find out the extent to which operations
are carried out in an economical and efficient manner. Economy audit looks into whether the entity
has acquired the financial, human and physical resources in an economical manner, and whether the
sanctioning and spending authorities have observed economy. Effectiveness audit is an appraisal of
the performance of programmes, schemes, projects with reference to the overall targeted objectives
as well efficiency of the means adopted for the attainment of the objectives. Efficiency cum-
performance audit, wherever used, is an objective examination of the financial and operational
performance of an organization, programme, authority or function and is oriented towards
identifying opportunities for greater economy and effectiveness. The procedure for conducting
performance audit covers identification of topics, preliminary study, planning and execution of
audit, and reporting. Normally speaking, the performance audit is conducted by the government in
respect of various expenditure incurred.

b. Features of government audit (2.5 Marks June 2013)

Answer
Citizen of the country are more concern on issues concerning public accountability, including the
misuse of public funds, evaluation of the effectiveness and outcomes of government programs,
information disclosure based on the “right-to-know,” and requests for disclosure of government
financial data through financial statements. To meet these challenges, each government has one
Supreme Audit Institution that is responsible for the public auditing whereas Financial Comptroller
General is responsible to maintain public accounting.
Supreme Audit Institution in Nepal is called the office of the Auditor General (OAGN) who conduct
public audit of the government budget and expenditure. Regarding the aim of auditing, public audits
are carried out as comprehensive audits that include financial auditing and performance auditing or
value-for-money (VFM) auditing.
The aim of audit of government auditing has some audit areas that are completely different from
those concerning the auditing of corporate accounts. In government auditing, the scope of financial
auditing includes audit areas other than the audit of accounts, and performance auditing includes the
evaluation of economy, efficiency, and effectiveness. OAGN also performs the audit of regularity
and propriety.
Government auditing was initially conducted as compliance audits, which means accurate account
auditing or financial auditing. Subsequently, government organizations were required to provide
effective public services by efficient management in the performance of their trusteeship obligations,
which in turn necessitated performance auditing.
As a feature of performance auditing, the Auditing Standards of the International Organization of

Supreme Audit Institutions (INTOSAI) point out that “performance audits should not concentrate
solely on criticism of the past but should be constructive.
c. Government audit in Nepal (2.5 Marks December 2015)

Answer
Government audit is as old as history of states. The concept and scope of government audit has
developed in tune with political, social and economic development of the countries. Government
audit aims to promote good governance through an independent, efficient and effective audit services.
To carry out audit in an independent manner, some independent institutions are set up through
constitutional or legal provisions. Such institution is empowered to carry out audits of all receipts,
expenditure and other matters as specified in mandate from various aspects such as regularity,
economy, efficiency, and effectiveness, and propriety.
In Nepal, government audit is performed by an independent constitutional body, i.e. Office of
Auditor General (OAG). The Constitution of Nepal (2072) provides power to the auditor General,
who is appointed on the recommendation of the Constitutional Council, of conducting audit of all

public sector entities with due regards to regularity, economy, efficiency, effectiveness and
proprietary.
As per the Audit Act, 2048, the Auditor General may conduct final audit of the financial activities
and other activities relating thereto of the offices, bodies or organization under its jurisdiction, either
in detail or sporadically or a random basis and present the facts obtained there from make critical
comments thereon and submit its reports.
The Auditor General submits his/her annual report to the president and which is caused by the
president to be tabled at parliament for discussion through prime minister.
Question No. 7
Propriety Audit and Performance Audit (5 Marks June 2006, June 2007)
Answer
Propriety Audit Performance Audit
Under this audit, it is required to be seen that This involves that the various programs,
the expenditure is incurred with due regard to schemes and projects where large financial
broad and general principles of financial expenditure has been incurred are being run
propriety. The auditor aims to bring out cases economically and are yielding results
of improper, avoidable expenditure even expected of them. Efficiency-cum-
though the expenditure has been incurred in performance audit, wherever used, is an
conformity with the existing rules and objective examination of the financial and
regulations. Audit aims to secure a reasonably operational performance of an organization,
high standard of public financial morality by program, authority or function and is oriented
looking into the wisdom, faithfulness and towards identifying opportunities for greater
economy of transactions. economy and effectiveness.
Question No. 8
Powers to issue Directives by the Auditor General (2.5 Marks June 2017)
The Auditor General may, subject to the Constitution of Nepal and the prevailing laws, issue directives to
the concerned Government Offices, and Corporate Bodies wholly or substantially owned by Government
of Nepal, from time to time to make proper arrangements on matters of accounts and to maintain
regularity therein. It shall be the duty of the concerned offices or organizations to abide by such
directives.

Question No. 9
Pandit & Associates is the firm of practicing chartered accountants. The firm accept the audit of
Siddhartha Ltd. where Government of Nepal (GoN) holds 60 % ownership. What is the responsibility
of Pandit & Associates before accepting such audit? Comment (5 Marks December 2017)
Answer
As per the provision of section 11 of Audit Act 2075, the auditor of companies where GoN holds
majorities of share should be done in consultation with the Office of Auditor General of Nepal.
Further the practicing-chartered accountant as per section 34 (13) of ICAN Act 2053 should not accept
his appointment as an auditor of an organization without ascertaining that all required procedures for
appointment as the auditor under the prevailing law has been duly fulfilled.
In the light of aforesaid provisions of Audit Act 2075, Pandit & Associates before accepting
appointment, should ensure that whether Siddhartha Ltd. has consulted with the Office of Auditor
General of Nepal for their appointment.

Chapter 10 Completing and reporting on an

assurance engagement
Question No. 1
How would you react as an Auditor to the following accounting practices being followed by a Limited
Company?
a. Provision for Income-tax is made as and when tax assessment is made. (5 Marks, December 2001)
b. Excise duty paid is treated as pre-paid expenses. (4 Marks, December 2001)
c. Bank Account opened at construction site in the name of the site manager to facilitate bank
operations is shown in the Balance Sheet as staff advance. (4 Marks, December 2001)
d. Machinery bought on deferred payment guarantee scheme is capitalized only to the extent bills
drawn under the scheme have fallen due for payment. (5 Marks, December 2001)
Answer
a. Answer
The accounting practice of making provision for income tax as and when tax assessment is made is not
correct. The liability to pay tax arises immediately with the end of the accounting year. Even where
assessee having profits have paid advance tax, unless the liability for the taxation payment is made in
the form of a provision, the profits shown in the balance sheet will be misleading. This might also lead
to excessive declaration of dividend. Provision for taxation must be made at the tax rates applicable at
that point of time. Non-provision for taxation in the accounts of the relevant year would amount to
contravention of the provisions of Sections 209 and 211 of the Companies Act and as such would
require qualification in the auditor's report. It has further recommended that where taxation provision is
not necessary in view of brought forward losses, availment of various tax benefits, these facts should be
disclosed by way of a note explaining the reasons why the provisions for taxation has not been made.
b. Answer
Excise duty is relevant to items of inventory and cannot be considered as prepaid expenses. Excise duty
should be considered as a manufacturing expenses and should be treated as an element of cost for
inventory valuation. It is not considered as a prepaid expense for the reason that it is not a period cost.
Hence, the excise duty paid cannot be treated as a pre-paid expense.
c. Answer
This accounting practice is not correct. The asset represented by the balance in bank belongs to the
company and not to the employee concerned. Therefore, this item should be disclosed as a bank
balance and not as a staff advance.

However, a suitable note may be given in the balance sheet explaining that this asset of the company is
not held in the company's name.
d. Answer
This practice also cannot be recommended as the liability to pay for the entire value of the machinery
has been incurred when the plant was purchased. Deferred payment guarantee scheme enables the
buyer of the machinery to pay the entire sum at agreed installments together with interest. Therefore,
showing the machinery at a value representing payments made under the scheme is not an acceptable
accounting practice. This will distort the true & fair view of the balance sheet. The auditors will be
required to appropriately qualify his report.
Question No. 2
Distinguish between Clean Audit Report and Qualified Audit Report. (4 Marks, June 2003)
Answer
Clean Report: A clean Report which is otherwise known as unconditional opinion is issued by the auditor
when he does not have any reservation with regard to the matters contained in the financial statement. In
such a case the audit report may state that the financial statements give a true and fair view of the state of
affairs and profit and loss account for the period.
Qualified Report: Qualified Audit Report is one which does not give a clear chit about the truth and
fairness of the financial statements but makes certain reservations. The gravity of such reservations will
vary depending upon the circumstances. In majority of cases, items which are the subject matter of
qualification are not so material as to affect the truth and fairness of the whole accounts but merely creates
uncertainty about a particular item. In such cases it is possible for the auditors to report that in their opinion
but subject to specific qualifications mentioned, the accounts present a true and fair view. Thus, an auditor
may give his particular objection or reservation in the audit report and state "subject to the above, we report
that balance sheet show a true and fair view .....". The auditor must clearly express the nature of
qualification in the report. The auditor should also give reasons for qualification.
Question No. 3
Express your view as an auditor in the following case:
The Directors of D Ltd. want to transfer to the Profit and Loss Account a large sum of amount lying in
unclaimed dividends account. The dividends were remained unclaimed over the last three years. (5
Marks, December, 2003)
Answer
As per Sec 182 (9) of the Companies Act 2063, The amount of dividend not claimed/received by any
shareholder even after the empery of a period of five years after the date of resolution adopted by the
company in its general meeting to distribute dividend shall be credited to the investor protection fund to be

established under Section 183 of the Companies Act. Hence the auditor should advise the Board not to
transfer the amount to profit and loss account. Alternatively, the Auditor would be required to state this
qualification in his report
Question No. 4
Write short notes on Disclaimer of Opinion and Adverse Opinion(4 Marks, December, 2003, 4 Marks
June 2007)
A disclaimer of opinion is issued by the auditor when the possible effect of a limitation of scope on his
work or of an uncertainty is so significant that the auditor is unable to express an opinion on the financial
statements.
For instance, the Income Tax authorities seize the books of account of a company. Under such
circumstances, the auditor is unable to conduct an audit of the same. A situation may also arise when an
auditor is not permitted to verify inventory at location outside the city is which the company's office is
located. In such situation the auditor may state that he is unable to express an opinion because he has not
been able to obtain sufficient audit evidence to form an opinion.
An adverse opinion is one where the auditor states that the accounting statements do not show a true and
fair view of state of affairs or of the operating results. Such an opinion is issued when the effect of
disagreement is so material and pervasive to financial statements that the auditor concludes that a
qualification of his report is not adequate to disclose the misleading or incomplete picture of the financial
statements. This conclusion can be reached by the auditor in an extreme case when there had been flagrant
violation of the accounting principles or evidence is not available for material transactions or within the
knowledge of the auditor there exists material concealment or misstatement about financial affairs
Question No. 5
How do you express your view as an auditor in the following case? (5 Marks each June 2004)
a. ABC Ltd. has earned a lower profit during the finance year 200X and its assets were idle for more
than Seven months during the period. During the finance year it has a profit of Rs. 400 thousand,
before providing depreciation, and the board of directors decided for not to provide depreciation on
assets, amounting to Rs. 500 thousand, during the finance year.
Answer
As per Section 182(6) of the Companies Act 2063, before paying or declaring a dividend out of the profits
for any financial year, a company shall have fully deducted the pre operation expenses, the amount
required to be depreciated in accordance with the accounting standards fixed by the competent authority
under the prevailing law, any amount required to be paid or
set aside out of the profits under the prevailing law or the amount or accumulated loss in previous financial
years.

Also, for a prudent accounting to arrive at the fair value of assets, depreciation needs to be charged once
the asset is ready for use. It is irrelevant whether or not the assets were used during the reporting period. In
this case no depreciation has been provided in the financial statements. This is in contrary to Accounting
norms.
In such case, the auditors should report in their opinion in the financial statements stating 'had this
depreciation on assets was provided in the financial statements, during the financial year 200X, the
company would have a loss of Rs. 100 thousand (Rs. 400 thousand profit-Rs. 500 thousand depreciation).
Similarly, the closing balance of the fixed assets is also overstated to that extent. Accordingly, the auditor
has to issue a qualifies opinion on the same.
b. C Company did not produce the records of the debtors to the auditor saying that all the debtors of the
company are paying all their liabilities in due date. And the chief accountant of the company insisted
that the auditor need not verify the debtor's balance, as the debtors are considered good by the
management.
Answer
In this case the auditor fails to obtain sufficient information to form an overall opinion by the matters
contained in the financial statements he may then issue a disclaimer of opinion. In this case, the auditor is
unable to verify the debtors' ledger it may amount to restriction on the scope of the duties of an auditor.
Therefore, the auditor may state that he/she is unable to express an opinion because he/she has not been
able to obtain sufficient audit evidence to form an opinion.
c. XYZ Ltd.‟s total turnover for the Finance Year 200X is Rs. 100 lacs and it includes Rs. 1.50 lacs of
By-Product sales. Whereas, the by-product sales are included under the miscellaneous income of the
financial statements and is not separately disclosed in the income head.
Answer
NAS- 01 defines materiality items as relatively important and relevant items, i.e. "items the knowledge of
which would the decisions of the users of the financial statements". Materiality is a relative term and what
may be material in one circumstance may not be material in another. The decision to judge the materiality
of the item whether the aggregation of items, presentation and classification of items shall depend upon the
judgement of prepares of the account on the circumstances of the particular case.
In this case, income from sale of by-product shall be disclosed separately in the revenue item as the income
from by-product is considered material items since it is more than one percent of total turnover of the
company. Similarly, the auditor has to ensure that a material item is disclosed separately and distinctly or
at least clear information about the item is available in the accounting statements. In this case, he is

required to make qualification in his audit report, as the income from by-product is material in giving or
distorting a true and fair view of financial statements.
d. J Ltd. is a very famous and 50 years old company and is operating through its own premises which
is situated in a costlier locality of the city. During the finance year 200X the auditor observed the
following information from the financial statement of the company:
Share Capital (Issued, Called and Paid up) Rs. 100 Lacs
Reserve and Surplus (including undistributed profit) Rs. 50 Lacs
Term Loan and Current Liability Rs. 200 Lacs
Fixed Assets at Book value Rs. 150 Lacs
Current Assets Rs. 50 Lacs
Current Years Profit (Loss) (Rs. 150 Lacs)
Answer
Here, the auditor has made the following analysis:
Total assets of the company:

(Fixed Assets Rs. 150 Lacs + Current Assets Rs. 50 Lacs) Rs. 200 Lacs
Less: Unabsorbed Losses Rs. 150 Lacs
Balance of assets to discharge its liabilities Rs. 50 Lacs
Less: (Liabilities) Term Loan and Current Liabilities Rs. 200 Lacs
Net worth of the company: (Rs. 150 lacs)
In this case, the auditor observes that an adequate disclosure is made in the financial statements and the
auditor need not express and qualified opinion as all the above information are drawn up from the financial
statements. However, he should, in his report, add a paragraph that highlights the going concern problem
by drawing attention to the note in the financial statement that discloses:
i. adequately, describe the principal conditions that raise substantial doubt about the entity's ability to
continue in operation for the foreseeable future;
ii. state that there is significant uncertainty that the entity will be able to continue as a going concern and,
therefore, may be unable to realize its assets and discharge its liabilities in the normal course of
businesses.
Question No. 6
As an independent financial auditor, how would you deal with the following situations?
(4 Marks each, June 2004)

a. An enterprise changes the method of depreciation from written down value method to straight line
method.
Answer
In this case, I will first evaluate whether this change has been done due to any of the following reasons:
i. as required by status, or
ii. as required by Accounting Standard/ Financial Reporting Standards, or
iii. if the change will result in a more appropriate presentation of transactions in the financial
statements
If change has been done due to above reason, depreciation should be recalculated in accordance with the
use. The deficiency or surplus of depreciation arising from the change of method should be taken to the
profit & loss account. Suitable disclosure about the change in the depreciation method should be made in
the financial statement.
b. Dividend @10% for the year 2059/60 has been proposed by the company on Shrawan 30, 2060
(i.e. after the balance sheet date) and therefore not adjusted in the financial statement of 2059/60.
Answer
If dividend is proposed or declared after the balance sheet date, the enterprise should not recognize it as a
liability at the balance sheet date (NAS. 10). For this only disclosure should be made either on the face of
the balance sheet or in the notes to the financial statements.
c. A company has borrowed substantial funds for construction of a new plant. The work on the plant is
completed and the plant is ready to be put to use on 28th February 2003. The company capitalizes
the interest on borrowed fund for the period up to 31st March, 2003.
Answer
Financial costs should act be capitalized to the extent that they relate to periods after the relevant fixed
assets are ready to be put to use. Qualification should be made in audit report and amount an interest for
the month of March which should not be capitalized should be quantified. It should also be stated that fixed
assets as well as profits and reserves have been overstated to that extent.
An enterprise has made addition to the existing fixed assets which is an integral part of that assets.
Question No. 7
State with reasons your opinion in regard to treatment of the following transactions appearing in the
books of account. (4 Marks each, June 2004)
i. Travelling expenses incurred by directors for acquisition of plant & machinery.

Travelling expenses incurred by directors for acquisition of plant & machinery which is directly
attributable costs of bringing the assets to working condition for its intended use is part of cost of that
plant & machinery.
ii. Non-technical staff's salary during the period of installation of plant & machinery.
Non-technical staff's salary during the installation of plant & machinery should be capitalized as part
of construction cost if it is indirectly related to construction or incidental thereto. If it is not related,
then such expenditures should be treated as deferred revenue expenditure to be written off within a
reasonable period offer the commencement of production.
iii. Major repairs to assets.
Cost of major repairs to assets should be added to its cost only if it increases the future benefits from
the existing assets beyond its previously assessed standard of performance.
Question No. 8
State with reasons your views on the following :(5 Marks each, December 2004)
a. The Nepal Stock Exchange suspended trading in shares of Kasthmandap Ceramics (P) Ltd.
(KCPL) after it was de-listed on 15 Ashadh 2061 due to non- payment if listing fees. On 14 Ashadh
2061 the shares of the company, with the face value of Rs.100, were traded at Rs.90per share.
Alpha Beta co. (P) Ltd. (ABCPL) held 1500 shares of KCPL as its current investment. The shares
were acquired at a price equal to the face value of shares. In the financial statements of 31stAshad
2061, ABCPL stated the value of investment in shares of KCPL at the cost price.
Answer
The carrying amount of current investment is lower of cost and fair value on the date of the balance sheet.
In respect of investments for which an active market exists, market value generally provides the best
evidence of fair value. The lower of cost and fair value provides a prudent method of determining the
carrying amount to be stated in the financial statements. In the case given, the shares of KCPL were
actively traded in the Nepal Stock Exchange before the company was de-listed with effect from 15 Ashadh
2061. the price of share on 14 Ashadh 2061, therefore, provides an indicative fair value of shares which
may be considered vis-à-vis the cost of shares for the purpose of determining the carrying value of
investment. The price at which KCPL shares were traded on 14 Ashadh 2061, therefore, should be
considered for determination of the carrying value of investment, being lower of the cost or the considered
fair value on the balance sheet date ABCPL‟s valuation or investment in shares of KCPL at the cost price,
therefore is not appropriate.
b. In the financial statements for FY 2059/60, Makalu Finance Co. Ltd. (MFCL) had provided Rs.45
lacs towards provision for income tax. The advance tax paid that year was Rs.60 lacs. Internal
Revenue Office assessed Rs.55 lacs as tax for FY 2059/60. In the financial statements of FY
2060/61, MFCL showed the amount of tax short provided in FY 2059/60 and paid in FY 2060/61
amounting to Rs.10 lacs as appropriations from the distributable profits for FY 2060/61.

Answer
Provision for tax being a charge on the profit & loss account of the company has to be shown above the
line. Provision for tax which falls short of the tax amount assessed by the Internal Revenue Office and paid
in the subsequent year should, therefore, be added to the provision for tax made in the subsequent year as
amount short provided in the previous year. The provision for tax made by Makalu Finance Co. ltd. In FY
2059/60, which fell short of Rs. 10 lacs vis-à-vis the tax amount assessed and paid in the subsequent year
should, therefore, be added to the provision for tax made in FY 2060/61. it is not correct to show the
amount of tax short provided in FY 2059/60 as appropriation from the distributable profit of FY 2061/61.
c. In connection with the audit of Gamma Delta & Co. (P) Ltd. (GDCPL) for the year ended
31stAshadh 2060, the audit staff found that as a result of an improper cut-off of inventory
shipments at the end of the year, approximately Rs.50, 000 of sale applicable to the subsequent
year was recorded in the current year. The management of GDCPL refuses to adjust the financial
statements for the Rs.50, 000 errors.)
Answer
The profit and loss account of a business enterprise should include only income and expenses relating to
the relevant financial year. Inclusion of any income and / or expenses pertaining to the previous or the
subsequent year in the profit and loss account of the current year will inhibit presentation of a true and fair
view of the working results of the enterprise. In the books of Gamma Delta & Co. (P) Ltd. The auditors
found appx Rs. 50, 000 of sales applicable to the subsequent year recorded as sales in the current year due
to improper cut – off of inventory shipments at the year-end. Having detected overstatement of sales in the
financial statements the auditor should explain to the management that overstatement of sales will
artificially inflate the net profit, thereby, not presenting a true and fair view of the operating results of the
company. Should the management refuse to take heed of the suggestions, the auditor should express
qualified opinion in his audit report.
d. CD Co. Ltd. a fully subsidiary Co. of AB Co. ltd. was sold by AB Ltd. to ER Ltd. on Bhadra 15 of
FY 2061/62 and on 15 Aswin 2061 the Board of Directors of AB Co. Ltd. approved the Financial
Statements of FY 2060/61. Is it necessary to disclose the transaction in the financial statements of
FY 2060/61?
Answer
Accounting Standards for Events after the Balance Sheet Date:

This category of event which although take place after the balance sheet date are required to be reflected in
the financial statements because of statutory, requirements or because of their special nature.
Disclosure on Non-adjusting Events After the Balance Sheet Date: -
Where non-adjusting events after the balance sheet date are of such importance that non-disclosure would
affect the ability of the users of the financial statements to make proper evaluations and decisions, an

enterprise should disclose the following information for each significant category of non-adjusting event
after the balance sheet date:
 the nature of the events; and
 an estimate of its financial effect, or a statement that such an estimate cannot be made.
As per the NAS 10 Events after the Reporting Period : announcing a plan to discontinue an operation,
disposing of assets or setting liabilities attributable to a discontinuing operation or entering into binding
agreements to sell such assets or settle such liabilities is a transaction as non-adjusting events after the
balance sheet date but that may be of such importance that non-disclosure would affect the ability of the
users of the financial statements to make proper evaluation and decisions. The company is required to
disclose such transaction of sale of investment to ER Ltd. on its financial statement of finance year
2060/61.
Question No. 9
State with reasons your opinion regarding accounting treatment of the following transactions appearing
in the books of account of Valley Finance & Savings Co. Ltd. (one-year old company) for financial year
2060/61: (4 Marks each, December 2004)
a. Rs.10 lacs were paid to Info-Tech Solutions (P) Ltd. for supply and installation of accounting
software.
Answer
Rs.10 lacs paid by Valley Finance & Saving Co. Ltd. to Info-Tech Solutions (P) Ltd. for supply and
installation of an accounting software in the first year of operation can be treated in the books of account in
the following manner:
(a) As the benefit from the use of accounting software is likely to extend for several years, the company
can adopt an accounting policy to treat it as deferred revenue expenditure and write – off the total
amount during say five years in equal annual installments.
Or,
(b) Rs.10 lacs spent on acquisition and installation of accounting software may be treated as expenses for
the year and charged to the profit & loss account in the first year of its operation.
b. Share underwriting charges of Rs.6 lacs was paid to the issue manager‟s Venture capital Markets
Ltd.
Answer
Share underwriting charges of Rs.6 lacs paid by Valley Finance & Savings Co. Ltd. to the issue managers
Venture Capital Markets Ltd. may be included in the preliminary expenses and written – off during the
specified number of years as per accounting policy adopted by the company.

c. Company registration charges, legal charges, administration and other expenses totaling Rs12 lacs
was incurred during the first six months prior to commencement of business by the company.
Answer
Company registration charges, legal charges, administration and other expenses totaling Rs.12 lacs
incurred by the company during the first six months prior to commencement of business should be treated
as preliminary expenses and written- off during the specified number of years as per accounting policy of
the company.
d. Rs. 4 lacs remained unclaimed by several applicants who were not allotted any shares by the
company.
Answer
Applicants for shares of Valley Finance & Saving Co Ltd. who were not allotted any shares should make
their claim for refund as soon as possible. Where the applicants fail to claim refund of their application
deposit within a reasonable time the company should take steps to refund the deposits to the unsuccessful
applicants. Nevertheless, so long as the application deposits remain in custody of the company, pending
their refund to the concerned persons/parties, the unclaimed amount should be reflected under the head of
current liabilities in the balance sheet.
Question No. 10
Distinguish between Qualified Opinion and Adverse Opinion (4 Marks, December 2004)
Answer
A qualified opinion is expressed by the auditor when he concludes that an unqualified opinion cannot be
expressed but that the effect of any disagreement with management or limitation on scope is not as material
and pervasive as to require an adverse opinion or a disclaimer of opinion. Where an auditor has to give a
qualified opinion, he should express clearly the nature of the qualification on the report. The reasons for
the qualification should also be stated. A qualified opinion should be expressed as being “except for” the
matter to which the qualification relates.
An adverse opinion is expressed when the effect of a disagreement is so material and pervasive to the
financial statements that the auditor concludes that a qualification of the report is not adequate to disclose
the misleading or incomplete nature of the financial statements. The auditor gives an adverse opinion when
he states that the financial statements do not present a true and fair view of the financial position of the
company and the results of its operations and its cash flows.
Question No. 11
Express your views as an auditor in the following cases: (5x4 = 20 Marks, June 2005)
a. Mr. Ram Singh Kathayat, FCA has been doing audit of ABC Co. Ltd for the past few years. His
experience as auditor of the company for the past few years shows that accounts of the company are

always in order. The managing director of ABC Co. Ltd. requested him to issue an unqualified audit
report without conducting the audit for the year since the audit for the year since the audit report is
positively required the next day if the company is to secure a very good contract.
Answer.
Mr. Ram Singh Kathayat, FCA should conduct the audit of ABC Co. Ltd. in accordance with Nepalese
Standards on Auditing having regard to the requirements of NSA, relevant professional bodies, legislation,
regulations and where appropriate, the terms of the audit engagement and reporting requirement. For this
he needs to obtain sufficient evidence and information to verify the transaction of ABC Co. Ltd for the
year. The auditor should not only rely on the past tract records of the company and agree to the request of
his client to issue unqualified audit report.
b. As at the beginning of the year, M/s ABC Ltd. has a capital of Rs. 250 Lakhs, free reserves of Rs.50
Lakhs and Revaluation Reserves of Rs.450 Lakhs. In the relevant year under the audit, ABC Ltd. has
incurred a loss of Rs.400 lakhs. The company proposes to adjust the loss with the revaluation
Reserve.
Answer.
An increase in net value of assets is normally credited to owner‟s interest and under the heading
Revaluation Reserve except that, to the extent that such increase is related to and not greater than a
decrease arising on revaluation previously recorded as a charge to the profit and loss statement, it may be
credited to the profit and loss statement. A decrease in net book value arising on revaluation of fixed asset
should be charged directly to the profit and loss statement except that the extend such a decrease is related
to an increase which was previously records as, credit to revaluation reserve and which has not been
subsequently reversed or utilized, it may be charged directly to that account the treatment of reserve
created on Revaluation of Fixed Assets states that where the value of fixed assets is written up in the
books of account of a company, the corresponding credit appearing as revaluation reserve does not
represent a realized gain and is therefore, not available for distributions as dividend. Similarly,
accumulated losses and the depreciation on the acquisition cost (including arrears of depreciation) should
not be adjusted against revaluation reserve since this would amount to setting off actual losses against
unrealized gains.
The auditor should explain to the management that accumulated losses cannot be adjusted against the
revaluation reserve created on revaluation of the fixed assets. In case the company in question does so, the
balance sheet of the company will not reflect a true and fair view of the state of affairs of the company
keeping in view the magnitude of the amounts involved, i.e. accumulated amounted to Rs.400 Lakhs and
share capital and free reserves amounted to Rs.300 Lakhs(excluding revaluation reserve). If the
management does not agree with the opinion of the auditor, the auditor may even issue an adverse report.
c. XYZ Company Ltd. did not manage their closing stock of finished product and raw material properly,
as a result of which physical verification of such items could not be carried out properly by the

management. However, management certified the list of stock as true and correct balance of the stock
as on the Asadh end 2061.
Answer:
The physical verification of stock is the primary responsibility of the management. The auditor however, is
required to examine the verification programme adopted by the management. As per NSA 501, the auditor
must satisfy himself about the existence, ownership and valuation of such stock. In the given case, the
auditor could not able to obtain sufficient information relating to closing stock of the XYZ Company Ltd.
to form an overall opinion contained in the financial statements. The certification made by the management
cannot be a substitute for other audit evidence that the auditor could reasonably expect to be available. If
the auditor is unable to obtain sufficient appropriate audit evidence that he believes would be available
regarding a matter, which has or may have material effect on the financial information, this will constitute
a limitation on the scope of his examination even if he has obtained a certificate from the management on
the matter. Therefore, in the given case, auditor should take further audit evidence to satisfy as mentioned
above, otherwise, the auditor may issue a disclaimer of opinion by stating his/her unable to express an
opinion for the reason that he has not been able to obtain sufficient audit evidence to form an opinion.
d. Alex Co. Ltd. wants to provide for non-moving stock during the financial year ending 2060/61 based
on technical evaluation:
Total Value of Stock Rs.2 Crore.
Provision required based on one-year issue Rs.4 Lakhs.
Provision required on the basis of technical evaluation Rs.3 Lakhs.
Give your view as an auditor of Alex Co. Ltd.

i. Does this amount to change in Accounting Policy?
ii. Can the company change the method of provision?
Answer:
The decision of making provision for non-moving stocks on technical evaluation basis does not amount
to change in accounting policy. Accounting policy of a company may require that provision for non-
moving stocks should be made. The method of estimating the amount of provision may be changed in
case a more prudent estimate is required to be made.
In the given case, considering the total value of stock, the change in the amount of required provision of
non-moving stock form 4 lakhs to 3 lakhs is also not material. The disclosure can be made for such
change in the following lines by way of notes to accounts in the annual accounts of Alex Co. Ltd. for the
year 20600/61

“The company has also provided for non-moving stock on the basis of technical evaluation unlike the
preceding years. Had the same method been followed as in the previous year, the profit and the
corresponding effect on the year-end net assets would have been higher by Rs.1 lakh.”
Question No. 12
Distinguish between
a. Explanatory Notes and Qualificatory Notes. (4 marks December 2005)
Answer:
An explanatory is meant to explain or supplement a matter contained in or related to financial statements.
The matter on which an explanatory note is given is one on which the auditor has not taken adverse view,
e.g. note on regrouping of figures of previous year or an information on the basis of allocation of a
common expense. Explanatory notes are given by the directors of the company and are usually shown
under “Notes to accounts”. Such notes may also appear elsewhere in the statements of account. All notes to
account, wherever shown, constitute an integral part of the accounting statements.
Qualificatory notes also refer to the matters stated in the statements of accounts and usually are included
under “Notes to account” along with the explanatory notes. Qualificatory notes are such notes on which the
auditor has taken and adverse view e.g. payment of managing director‟s remuneration when the
government‟s approval is awaited. In view of their impact on the statements of account and on the resulting
audit report, the auditors refer to the qualificatory notes in the audit report itself in a specific manner by
identifying the notes on which they have taken an adverse view and drawing attention of the shareholders
thereto. The auditors usually refer to the qualificatory notes by the use of the prefix “subject to” in their
report. One important point to be noted in this connection. Qualificatory notes are put by the directors as
they are also equally obliged to make the disclosure of the adverse position. Since, both the directors and
the auditors require to make the qualificatory notes to accounts with mutual agreement, thereby dispensing
with the necessity of repeating the same note twice, one under the notes to accounts and again under the
audit report.
b. Disclaimer of Opinion and Adverse Opinion. (4 marks December 2005)

Answer.
A disclaimer of Opinion: Such opinion has to be necessarily issued when the auditor is unable to express
an opinion on the financial statements because he fails to obtain sufficient information to form an opinion.
This may arise when certain limitations are imposed on the scope of audit by the management or because
of significant uncertainty in determination of various figures appearing in the financial statements. For
instance, non-availability of records either because they are destroyed in fire or seized by the government
authorities or they are not accessible for any other reasons. Such an opinion is appropriate when an auditor
fails to obtain sufficient evidence to express an opinion because in the absence of records, he cannot
conclude that the accounts do not reflect a true and fair view. The auditor must also state the reasons
whenever disclaimer of opinion is given.

An adverse opinion: An adverse opinion is issued by the auditor when the financial statements do not show
a true and fair view of the state of affairs or of the operating results. At times when the effect of
disagreement is so material and pervasive on financial statements that the auditor concludes that the
qualification in the audit report is not adequate to disclose the misleading picture of the financial
statements. An adverse opinion is given when there is flagrant violation of accounting principles or
evidence is not available for material transactions or where there exists material misstatement or
concealment about financial affairs. The auditor must have sufficient evidence in favor of his conclusions.
It should be appreciated that this opinion is also on “overall” opinion on the entire financial statements and
owes direct relationship to the portrayal of the financial position in the financial statements. Where the
auditor gives an adverse opinion, he must disclose all material reasons therefore and clearly state that the
financial statements do not reflect a true and fair view.
Question No. 13
What will be your views on the following issues/statements? (4 Marks each December 2005)
a) Mr. RJ Thapa, Chief Accountant booked the expenses of Rs.5,00,000/- incurred in structural
modification in the construction of building of factory premises. He charged this expense in building
repairs account.
Answer.
Any subsequent expenditure on fixed assets, which increases future benefits arising from them beyond
their previously assessed standards of performance amounts to capital expenditure and thus, must form part
of the cost of the asset. The words “structural alteration” would generally signify that some significant
changes have been taken place in the design of building to provide more strength to the building or
expansion in the capacity of the building. Therefore, cost of Rs.5,00,000/- represents the cost of expansion
or may increase the life span of premises, it is hence a capital expenditure, and an adjustment entry by
debiting building Account and crediting Building Repair Account should be made and depreciation should
be provided accordingly.
b) M/s ABC Ltd. sold a plot of land at Rs. 15,00,000/- as the same is not required for use whose cost to
the company is Rs.8,00,000/- resulting thereby a profit of Rs.7,00,000/- on this sale. M/s ABC Ltd.
credited entire profit of Rs.7,00,000/- to the profit and Loss Account. The boards of directors are
planning to propose a dividend out of profit made from this sale.
Answer.
Profit of Rs.7,00,000/- on the sale of plot of land is a capital profit i.e. it represents the excess of sale value
over the original cost of the asset. The question whether such a profit can be distributed as dividend has

been considered in legal cases viz. Lubbock v. The British Bank of South America Ltd. and foster v. the
News Trinidad Lake Asphalte Co. Ltd. Based on the court Judgments, it is argued that capital profits can
be distributed by a company only if certain conditions are fulfilled. However,
As per NAS 16 on " Property, Plant and Equipment", the gain or loss arising from the derecognition of an
item of property, plant and equipment shall be included in the profit or loss when the item is derecognized.
Thus, all profits, which can properly be taken to the profit and loss account are distributable profits.
Therefore, in the given case, the directors can declare dividend out of the above profit.
c) A company commenced production on Magh 1, 2061 after a construction period of 3 years. No profit
and loss were drawn-up during the construction period. Now, the company proposes to capitalize all
the expenditure incurred during that period. Just before the end of the construction period, some
scrap was sold. The sale proceeds are proposed to be credited to miscellaneous income.
Answer:
The entire expenditure cannot be capitalized. The expenditure should be properly analyzed and classified
into capital, deferred revenue and revenue expenditure. The proceeds from sale of scrap may be deducted
from the related expenditure or shown as miscellaneous income.
Question No. 14
State with reasons your opinion in regard to treatment of the following transactions appearing in the
books of account. (7 Marks, June 2006)
i. Travelling expense incurred by directors for acquisition of plant and machineries.
ii. Non-technical staffs' salary during the period of installation of plant and machinery.
Answer:
i. This is indirect cost directly related to that plant & machinery acquired. Thus, these expenses
should be capitalized as part of the cost.
ii. Such expenses incidental to installation should be apportioned over related plant & machinery in an
equitable manner. If such expenses are not related to the installation, such expenses should be
treated as deferred revenue expenses to be written off within a reasonable period after the
commencement of production.
Question No. 15
Give your opinion on the following issues: (5Marks, each December 2006)

a) While auditing the financial statements of M/s Sita Ram Ltd. for the year ended on Ashadh 32,
2063, the statutory auditor came across the case where there has been an error in the valuation of
inventory, which affects the financial statements materially. As a statutory auditor of the said company
how would you deal in such situation? Comment in line with NSA 240.
Answer:
Errors in Valuation of Inventories and Auditor's Responsibilities: NSA 240, "The Auditor's responsibility
relating fraud in an Audit of Financial Statements", required that if circumstances indicate the possible
existence of fraud or error, the auditor should consider the potential effect of the possible existence of fraud
or error, the auditor should consider the potential effect of the suspected fraud or error on the financial
information. If the auditor believes the suspected fraud or error could have a material effect on the financial
information, he should perform such modified or additional procedures as he determines to be appropriate.
NSA 5 also requires that the auditor should consider the implications of the misstatement in relation to
other aspect of the audit, particularly, the reliability of management representations. Further NSA 320
"Audit Materiality" also requires that in such circumstances, the auditor should consider requesting the
management to adjust the financial information or consider extending his audit procedures. If the
management refuses to adjust the financial information and the results of extended audit procedures do not
enable the auditor to conclude that the aggregate of uncorrected misstatements is not material, the auditor
should express a qualified or adverse opinion, as appropriate. In the instance case, the auditor has detected
the material errors affecting the financial statements, the auditor should communicate his findings to
management on timely basis, consider the implications on true and fair view and also ensure that
appropriate disclosures have been made.
b) M/s ABC Company Ltd. has scrapped a semi-automatic part of a machine (not entirely written
off) and replaced with a more expensive fully automatic part. As a result, it has doubled the output of
the machine. The machine so scrapped was moved to a more suitable place in the factory. This
involved the construction of a new foundation in addition to the cost of dismantling and re-erection.
The company wants to charge the whole expenditure to revenue. Give your comment as the statutory
auditor of M/s ABC Company Ltd.
Answer:
M/s ABC Company Ltd. is required to write off the written down value of the semi-automatic part to the
revenue as the company has scrapped such part of the machine. The whole expenditure incurred in
purchasing the fully automatic part and repositioning the machine is required to be treated as capital
expenditure since the amount incurred has increased the earning capacity of the machine. A clear
distinction shall have to be made as to the nature of expenditure, which leads to benefits in the future
period by increasing the earning capacity of the machine. In the given case, it is clear that such an
expenditure cannot be treated as revenue at any cost because of the enhanced earning capacity of the
machine in the future. In fact, the output of the machine has almost doubled and the machine has been

removed to a more suitable place. Therefore, the company's contention to charge whole expenditure to
revenue is not justifiable.
c) A fraud was detected in M/s Thompson Finance Company Ltd. The Chief Finance Officer of the
company was found to be involved in the fraud. The amount involved was subsequently deposited by
the Chief Finance Officer who insists that it need not be reported upon. As a statutory auditor of the
said company how would you deal in such situation?
Answer:
The management's request that the amount defalcated by the Chief Finance Officer (CFO) was deposited
after the fraud was detected by the auditors and, therefore, no reporting is necessary is not tenable. It will
be necessary for the auditor to bring to the notice of the shareholders about the fraud since the same had
been committed by the CFO. Such an event shows that internal control systems are quite weak in the
organization and the top management is in a position to abuse its authority.
The mere fact that no loss to the company has occurred would not preclude the auditor from bringing it to
the notice of the shareholders. A suitable disclosure is called for, particularly, in view of the fact that the
fraud has been committed by the Chief Finance Officer. Even NSA 240 requires specifically, the auditor
to assess the likelihood of senior management involvement. Further, the auditor should also consider the
implications of the circumstance on the true and fair view which the financial statements ought to convey
and frame his report accordingly.
Question No. 16
As an independent financial auditor, how would you deal with the enterprise which has invested a
substantial amount in the shares of another company under the same management. The market price of
the shares of the aforesaid company is about half of that at which these shares were acquired by the
enterprise. The management is not prepared to provide for the fall in the value of shares on the ground
that the loss is only notional till the time the shares are actually sold. (5 Marks December 2006)
Answer Hint:
It is necessary to provide for the fall in the value of shares if it is other than temporary auditor's report
would be necessary since the amount involved is substantial.
Question No. 17
Express your views as an auditor in the following cases: (5Marks, each June 2007)
a) A company has received a final assessment order from the Inland Revenue Office for the FY
2058/059. The assessment order has provided a tax credit of Rs. 15 lakhs being the advance tax paid

in the FY 2058/059. On review of the books of the Company, you came to note that the credit granted
was erroneously charged to the Profit and loss account in the year it was paid. The management
seeks your opinion on the mode of presentation of the tax credit in its financial statements.
b) M/s M & N Company Ltd. is an exporter of Nepali handicrafts. During the FY 2062/63 it sold the
handicrafts amounting to US $ 500,000 out of which US $ 100,000 was on credit which was
outstanding and included in debtors account at the year end. The sales were booked at US $ 1 =
NPR. 70.00, which was exchange rate on the date of sales. However, on the closing day of the year
the US $ became costlier the exchange rate being US $ 1 = NPR 74.00.
The company does not want to account for profit arising out of change in exchange rates for the FY
2062/63 on the ground that this is notional and no settlement of debtors was done during the year.
Answer
a) It is evident that the advance paid for income tax in the year 2058/059 was erroneously charged to
the profit and loss account as expense. Since the amount is material, financial statements of
2058/059 cannot be considered as reliable. Therefore, the error that relates to prior period should be
reported by adjusting the opening balance of retained earnings. Comparative information should be
restated. Alternatively, the amount may be included in the determination of net profit or loss for the
current period and comparative information should be presented as reported in the financial
statements of the prior period. If this alternative treatment is adopted the company will be required
to present the prior period adjustment through additional information, in the financial statement.
b) Exchange differences arising on reporting an enterprise's monetary items at rates different from
those at which they were initially recorded during the period, or reported in previous financial
statements, should be recognized as income or as expenses in the period in which they arise, with
the exception of exchange differences dealt with in accordance with of NAS 21. When the
transaction is settled within the same accounting period as that in which it occurred, all the
exchange difference is recognized in that period. However, when the transaction is settled in a
subsequent accounting period, the exchange difference recognized in each intervening period up to
the period of settlement is determined by the change in exchange rates during that period. Since the
exchange rate of transaction is different from the date of settlement, there is a resulting exchange
difference. Therefore, the company should recognize the exchange difference in each period till the
settlement is made.
In the given case, the company must account for exchange profit of NPR 4,00,000 by writing up the
value of debtors by the same amount for the FY 2062/063.

Question No. 18
A and B are Chartered Accountants. They have a partnership firm named AB & Co. AB & Co is the
auditor of X limited of which B is engagement partner. S, a shareholder of the company has filed
complaints against AB & Co in the Institute of Chartered Accountants of Nepal for following faults.
You are requested to advise the Institute whether the points raised in the complaints are valid. The
points raised in the complaints are given below:
a) The company increased sales price of the products from 1stShrawan 2064. To gain profit, the
salesman of the company raised invoice on 31stAshadh 2064 for some goods. The goods were
adjusted in invoices raised on or after 1stSharwan 2064. The company has neither a policy of
physical verification of stock nor certification of ending number of invoices at the year end. The
auditors are of the view that it is not a material internal control weakness and did not report the
same.
b) A, the partner of the AB & Co purchased goods worth Rs. 5,000 from the company on 1stAshadh
2064 on credit. The company has a policy of normal credit period of 15 days to regular customers.
The amount of credit purchase was paid while finalizing the audit report for the year 2063/064
during Aswin 2064. Auditors are of the opinion that the transaction is of personal nature. Therefore,
it does not apply to the firm.
c) The company purchased a motor car valued at Rs. 6,00,000 on hire purchase basis on 1 stBaishakh
2064. The payment is to be made in 60 Equal Monthly Installments of Rs 15,000. The company
debited Vehicle account and created liability to the bank by crediting Rs. 9,00,000. The amount of
installment is debited to the financing bank account as and when paid. The auditors have not
mentioned anything in the report about this.
d) The company does not include selling and distribution cost while valuing inventory. The auditors
have certified inventory at value without taking selling and distribution cost as cost of inventory.
Answer
a) Since the company has neither policy of physical verification of stock nor certification of ending
number of invoices, there is a serious lapse in internal control in the company. Therefore, the
auditors should have planned their work in the light of possibility of fraud involving removal of
stocks from the company's stores without the same being accounted for. Similarly, in absence of
certification of ending number of invoices there is a possibility of raising back dated invoices as
well. The company increased sales price from the beginning date of next financial year. Therefore,
possibility of this type of fraud gains more strength.
Considering possibility of fraud due to weaknesses in the internal control, the auditor should have
increased the coverage of his substantive tests regarding dispatches of stocks and correlation of
such dispatches with invoices raised. This would have been further supplemented by surprise
physical verifications and stock reconciliations. It seems these substantial tests were not carried out

and the fraud remained undetected. This suggests serious lapses on the part of auditor in adopting
appropriate technique of audit and failure of reporting the fraud. The auditor has committed
professional misconduct.
b) Section 112(b) of the Companies Act 2063, provides that a person indebted to the company or does
not pay amount payable to the company within the due date is not qualified for appointment as
auditor of the company. In a partnership all partners work for each other and there is no separate
existence of the partnership from the partners. Therefore, if a partner is indebted to the company,
the firm is also not qualified for appointment as auditor. Hence the argument that the transaction is
of personal nature and it does not apply to the firm is not tenable. Since the debt was outstanding
for the period more than normal credit period, it has crossed the due date and the auditors seized to
be qualifying for continuation as auditor of the company.
c) Where a movable asset, such as motor car or machinery has been acquired on hire-purchase basis, it
should be adjusted in accounts at its cash value by raising a liability for the amount payable to the
financing company. The interest payable along with each installment, whether separately or
included therein should be debited to the interest account.
In the cited case the cash value of the car is only Rs. 600,000. Therefore, vehicle account should be
debited by Rs 600,000 only and the financing bank should be credited by the same amount. While
paying installment the interest portion from the installment should be debited to interest account and
balance should only be debited to financing bank account. It is clear from the above that the
company has not given proper treatment while acquiring the car and while paying installments.
Therefore, auditors have failed to point out the incorrect accounting treatment given.
d) As per NAS 02, the cost of inventories should comprise all costs of purchase, costs of conversion
and other costs incurred in bringing the inventories to their present location and condition. Costs,
other than bringing the inventories to their present location and condition, are not included in the
cost of inventories. NAS 02, while giving examples of costs excluded from the cost of inventories
and recognized as expenses in the period in which they are incurred specifically excludes selling
costs from inclusion in the cost of inventories. Hence, auditors have certified inventory in
accordance with the Nepal Accounting Standards and cannot be termed as failed in performing
duty.
Question No. 19
Just before the year end, a fire broke out in the warehouse of M/s RM Manufacturing Ltd. thereby
destroying the huge chunk of raw materials which forms major part of company‟s current assets.

The management was unable to ascertain the value of the raw materials destroyed in the fire. Insurance
claim was lodged for the book value of whole inventory. The claim is pending at the time of finalization
of accounts and the company does not want to make provision for losses and wants to show whole
amount as insurance claim receivable. Give your comments.
Answer
In the given case, the company has to make provision for losses mainly for two reasons, firstly the
event resulting in the loss of assets has actually been happened and secondly the insurance claim
receivable is uncertain.
Since company has lodged claim for the loss of whole inventory as per the book value, it has
acknowledged the whole inventory has been destroyed in the fire not withstanding whether any
inventory was still safe and usable. Hence, provision equal to the insurance claim lodged should be
made in the accounts of the company. After the claim is received in part or whole, the provision equal
to the claim received can be written back and shown as the income of the company. A proper
disclosure of the events and its status shall be made in the accounts.
Question No. 20
You are the audit manager on the audit of Hindus Limited. The audit senior has completed the audit of
the company for the year ended Ashad 31, 2065 and submitted a draft audit report for your review. The
following paragraphs have been extracted from the draft audit report:
'We conducted our audit in accordance with the auditing standards as applicable in Nepal. These
standards require that we plan and perform the audit to obtain………. We believe that our audit
provides a reasonable basis for our opinion and, after due verification, we report that:
We did not observe the counting of the physical inventories as of Ashad 31, 2065, since that date was
prior to the time we were initially engaged as auditors of the Company. Owing to the nature of the
Company's records, we were unable to satisfy ourselves as to the quantities of inventory by other audit
procedures.
In our opinion and to the best of our information and according to the explanations given to us, the
balance sheet --------------------so required and respectively give a true and fair view of the view of the
state of the Company's affairs as at Ashad 31, 2065 and of the loss, its cash flows and changes in equity
for the year then ended.
The Company's liabilities exceed its assets at Ashad 31, 2065 creating an adverse situation which
management believes is reversible over the coming twelve months. Management further believes that the
Company is capable of continuing in operation for twelve months from the date of this report"
Identify the shortcomings in the above paragraphs extracted from the audit report.

Answer
There are three issues related to draft report prepared by the audit senior, as given below:
1. Limitation on the audit scope shall have been added as except as noted below we conducted our
audit in accordance ….,
2. Opinion paragraph states true and fair view without mentioning the qualification of limitation on
audit scope, and
3. The emphasis of matter has not been properly added.
It should be written as follows:
Except as discussed in the following paragraph, we conducted our audit in accordance with Nepal
Standards on Auditing or relevant practices. Those Standards or relevant practices require that we plan and
perform the audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion.
"We did not observe the counting of the physical inventories as of Ashad 31, 2065, since that date was
prior to the time we were initially engaged as auditors for the Company. Owing to the nature of the
Company's records, we were unable to satisfy ourselves as to inventory quantities by other audit
procedures."
In our opinion, except for the effects of such adjustments, if any, as might have been determined to be
necessary had we been able to satisfy ourselves as to physical inventory quantities, the financial statements
give a true and fair view of (or „are presented fairly, in all material respects,‟) the financial position of
Hindus Ltd as of Ashad 31, 2065, and of the results of its operations and its cash flows for the year then
ended in accordance with Nepal Accounting Standards or relevant practices and comply with Company
Act, 2063.
Without qualifying our opinion, we draw attention to Note X to the financial statements, we further state
that the Company‟s liabilities exceed its assets at Ashad 31, 2065 creating an adverse situation which
management believes is reversible over the coming twelve months. Management further believes that the
Company is capable of continuing in operation for twelve months from the date of this report.”
Question No. 21
What does qualified opinion mean? What are the situations in which the auditor should qualify the
assurance report? (4 Marks June 2009)

Answer
A qualified opinion is issued when the auditor concludes that he cannot issue an unqualified opinion but
that the effect of any disagreement, uncertainty or limitations on scope is not so material as to require an
adverse or a disclaimer of an opinion. It is given in respect of a part of the information reflected in the
financial statements and that the auditor is not in agreement with that part. Moreover, the part with
reference to which he is not in agreement does not materially affect the view portrayed by the financial
statements. Thus, the need for a qualified opinion arises where the auditor is satisfied with the truth and
fairness of the financial statements; yet because of certain transactions he is not fully satisfied so as to issue
a clean or unqualified report.
The auditor should qualify their Assurance Reports in case -
 accounting policies have not been properly disclosed, or

 accounts have not been prepared on accrual basis
 the fundamental accounting assumption of going concern has not been followed and this fact has
not been disclosed in the financial statements, or
 proper disclosures regarding changes in the accounting policies have not been made.
Question No. 22
Write short notes on Modified Auditor's Report: (5 Marks December 2009)
An Auditor's report is considered to be modified if either an emphasis of matter paragraph(s) added to the
report or if the opinion is other than unqualified. It includes matters that do not affect the auditor's opinion
by emphasis of matter or matters that do affect the auditor's opinion by issuing qualified opinion,
disclaimer of opinion or adverse opinion.
Uniformity in the form and content of each type of modified report will enhance the user's understanding
of such reports.
In certain circumstance, an auditor's report may be modified by adding an emphasis of matter paragraph to
highlight a matter affecting the financial statements which is included in a note to the financial statements
that more extensively discusses the matter. The addition of such an emphasis of matter paragraph does not
affect the auditor's opinion. The paragraph would preferably be included preceding the opinion paragraph
and would ordinarily refer to the fact that the auditor's opinion is not qualified in this respect.
An auditor may not be able to express an unqualified opinion when either of the following circumstances
exists and, in the auditor's judgment, the effect of the matter is or may be material to the financial
statements:
 there is a limitation on the scope of the auditor's work; or

 there is a disagreement with management regarding the acceptability of the accounting policies
selected, the method of their application or the adequacy of financial statement disclosures.

The circumstances described in (a) could lead to a qualified opinion or a disclaimer of opinion. The
circumstances described in (b) could lead to a qualified opinion or an adverse opinion.
Question No. 23
Write short notes on Disclaimer of opinion (5 Marks June 2010)

Answer
Depending upon the circumstances, an auditor expresses an opinion on the financial statement. A
disclaimer of opinion should be expressed when the possible effect of a limitation on scope is so material
and pervasive that the auditor has not been able to obtain sufficient appropriate audit evidence and
accordingly is unable to express an opinion on the financial statements.
Question No. 24
An auditor of New Nepal Ltd. audited and signed the accompanying financial statement of the company
as of July 15, 2010 (Corresponding to 31stAshad, 2067). Date of the signature of the audit report was
August 16, 2010. Give your opinion with reasons (5 Marks December 2010)
Answer
Audit of financial statement is normally carried out for a full financial year. Financial year as per the
prevailing law is first of Shrawan to the end of Ashad month as per Nepali calendar. Date of the audit
report should be after the date of financial year end and after completion of audit functions. However, in
above mentioned case, date of financial statements is July 15,2010, which is 1 day short of actual financial
year end i.e. July 16,2010 (corresponding to 32 Ashad 2067). This may happen in following situations:
a) An assurance assignment was for audit of financial statements of that date.

b) Company ended its operation from that date.
c) Company is merged to another company from that date.
d) Company went in to liquidation from that date.
e) Auditor signed wrong dated financial statement.
Therefore, the auditor should check out the relevant date of financial statements under audit before signing
the report.
Question No. 25
What are the basic elements of the Auditor‟s Report? (10 Marks June 2011)
Answer
The auditor‟s report includes the following basic elements, ordinarily, in the following layout:
Title  The auditor‟s report shall have a title that clearly indicates that it is the report
of an independent auditor.

(“INDEPENDENT AUDTORS REPORT")

Addressee  The auditor‟s report shall be addressed, as appropriate, based on the
circumstances of the engagement.
 Law, regulation or the terms of the engagement may specify to whom the
auditor‟s report is to be addressed in that particular jurisdiction.
 The auditor‟s report is normally addressed to those for whom the report is
prepared, often either to the shareholders or to TCWG of the entity whose
financial statements are being audited.
Auditor’s Opinion  The first section of the auditor‟s report shall include the auditor‟s opinion,
and shall have the heading “Opinion.”
 The Opinion section of the auditor‟s report shall also:
a. Identify the entity whose financial statements have been audited;
b. State that the financial statements have been audited;
c. Identify the title of each statement comprising the financial statements;
d. Refer to the notes, including the summary of significant accounting
policies; and
e. Specify the date of, or period covered by, each financial statement
comprising the financial statements.
 The auditor‟s opinion Modified opinion or Unmodified opinion, as the case
may be, shall be expressed in this paragraph
Basis for Opinion  The auditor‟s report shall include a section, directly following the Opinion
section, with the heading “Basis for Opinion”, that:
a. States that the audit was conducted in accordance with NSAs
b. Refers to the section of the auditor‟s report that describes the auditor‟s
responsibilities under the NSAs;
c. Includes a statement that the auditor is independent of the entity in
accordance with the relevant ethical requirements relating to the audit,
and has fulfilled the auditor‟s other ethical responsibilities in
accordance with these requirements.
d. States whether the auditor believes that the audit evidence the auditor
has obtained is sufficient and appropriate to provide a basis for the
auditor‟s opinion.
Going Concern  Where applicable, the auditor shall report in accordance with NSA 570
(Revised)- Going Concern.
Key Audit Matters  For audits of complete sets of general-purpose financial statements of listed
entities, the auditor shall communicate key audit matters in the auditor‟s
report in accordance with NSA 701 (Key Audit Matters).
 When the auditor is otherwise required by law or regulation or decides to
communicate key audit matters in the auditor‟s report, the auditor shall do so
in accordance with NSA 701.
Other Information  Where applicable, the auditor shall report in accordance with NSA 720
(Revised).
Responsibilities for the  The auditor‟s report shall include a section with a heading “Responsibilities
Financial Statements of Management for the Financial Statements.”
 This section of the auditor‟s report shall describe management‟s
responsibility for:
a. Preparing the financial statements in accordance with the applicable
FRF and for such internal control as management determines is

necessary to enable the preparation of financial statements that are free

from material misstatement, whether due to fraud or error; and
b. Assessing the entity‟s ability to continue as a going concern15 and

whether the use of the going concern basis of accounting is appropriate.
Auditor’s Responsibilities  The auditor‟s report shall include a section with the heading “Auditor‟s
for the Audit of the Responsibilities for the Audit of the Financial Statements.”
Financial Statements  This section of the auditor‟s report shall:
a. State that the objectives of the auditor are to:
1. Obtain reasonable assurance about whether the financial statements
as a whole are free from material misstatement, whether due to
fraud or error; and
2. Issue an auditor‟s report that includes the auditor‟s opinion.
b. State that reasonable assurance is a high level of assurance, but is not a
guarantee that an audit conducted in accordance with NSAs will always
detect a material misstatement when it exists; and
c. State that misstatements can arise from fraud or error and explain
under what circumstances they are considered material
In this section the auditor also states his responsibilities for:
a. Assessing the risk of material misstatements
b. Understanding the internal control system
c. Evaluating the appropriateness of accounting policies
d. Concluding the appropriateness of the managements use of going
concern basis
e. Communication with TCWG etc.
Other Reporting  For other matters to be reported as per the requirements of other laws and
Responsibilities regulations the other reporting responsibilities shall be addressed in a
separate section in the auditor‟s report with a heading titled “Report on Other
Legal and Regulatory Requirements” or otherwise as appropriate
Name of Engagement  The name of the engagement partner shall be included in the auditor‟s report
Partner on financial statements of listed entities unless, in rare circumstances, such
disclosure is reasonably expected to lead to a significant personal security
threat.
 Naming the engagement partner in the auditor‟s report is intended to provide
further transparency to the users of the auditor‟s report on financial
statements of a listed entity.
Signature of the Auditor  The auditor‟s report shall be signed. The auditor‟s signature is either in the
name of the audit firm, the personal name of the auditor or both, as
appropriate for the particular jurisdiction.
Auditor’s Address  The auditor‟s report shall name the location in the jurisdiction where the
auditor practices.
Date of the Auditor’s Report  The auditor‟s report shall be dated no earlier than the date on which the
auditor has obtained sufficient appropriate audit evidence on which to base
the auditor‟s opinion on the financial statements

Question No. 26
TIGS & Company is the appointed auditors of RACE Ltd. After completing the audit but before issuing
report, the auditor has come to the conclusion that an unqualified opinion cannot be expressed but that
the effect of the disagreement with the management is not so material and pervasive as would require an
adverse opinion. Advice in detail how should he reports? (5 Marks December 2012)
Answer
A qualified opinion should be expressed when the auditor concludes that an unqualified opinion cannot be
expressed but that the effect of any disagreement with management is not so material and pervasive as to
require an adverse opinion, or limitation on scope is not so material and pervasive as to require a
disclaimer of opinion. A qualified opinion should be expressed as being 'subject to' or 'except for' the
effects of the matter to which the qualification relates.
An adverse opinion should be expressed when the effect of a disagreement is so material and pervasive to
the financial statements that the auditor concludes that a qualification of the report is not adequate to
disclose the misleading or incomplete nature of the financial statements.
Whenever the auditor expresses an opinion that is other than unqualified, a clear description of all the
substantive reasons should be included in the report and unless impracticable, a qualification of the
possible effect(s), individually and in aggregate, on the financial statements should be mentioned in the
auditor's report. In circumstances where it is not practicable to quantify the effect of modifications made in
the audit report accurately, the auditor may do so, on the basis of estimates made by the management after
carrying out such audit tests as are possible and clearly indicate the fact that the figures are based on
management estimates.
Ordinarily, this information would be set out in a separate paragraph preceding the opinion or disclaimer of
opinion and may include a reference to a more extensive discussion, if any, in a note to the financial
statements.
Question No. 27
Under what circumstances an independent auditor can issue comfort letter to his/her client?
(5 Marks June 2013)
A letter from independent auditor including in a preliminary prospectus stating that, while a full audit has
not undertaken, the auditor has done a review sufficient to assure that financial statement information in
the preliminary prospectus is correctly prepared to the best of the auditor knowledge. The auditor in effort
states that, had a full audit been done, they are comfortable that the audited financial statements would not
be materially different from the ones presented in the preliminary prospectus.
Before or during a new issue, a statement by an auditor stating that, while a full audit has not been done, a
review of the issue's prospectus has revealed nothing inaccurate or misleading. The comfort letter also

states that the auditor is confident that a full audit would not uncover anything unusual that would
negatively affect the issue.
In other word, a letter is given to organizations or persons of interest by external auditors regarding
statutory audits, statements and reports used in a prospectus. The comfort letter will be attached to the
preliminary statements as assurance that it will not be materially different from the final version.
Question No. 28
Explain the situations of modifying the auditor‟s report as per NSA. (8 Marks July 2015)
Answer
There are the following situations of modifying the auditor‟s report wording:
I. Matters that Do Not Affect the Auditor’s Opinion

i. Emphasis of matter: In certain circumstances, an auditor‟s report may be modified by adding an
emphasis of matter paragraph to highlight a matter affecting the financial statements which is
included in a note to the financial statements that more extensively discusses the matter. The
addition of such an emphasis of matter paragraph does not affect the auditor‟s opinion. The
paragraph would preferably be included after the paragraph containing the auditor‟s opinion but
before the section on any other reporting responsibilities, if any. The emphasis of matter paragraph
would ordinarily refer to the fact that the auditor‟s opinion is not qualified in this respect.
II. Matters that Do Affect the Auditor’s Opinion
i. Qualified opinion: A qualified opinion should be expressed when the auditor concludes that an
unqualified opinion cannot be expressed but that the effect of any disagreement with management,
or limitation on scope is not so material and pervasive as to require an adverse opinion or a
disclaimer of opinion. A qualified opinion should be expressed as being „except for‟ the effects of
the matter to which the qualification relates.
ii. Disclaimer of opinion: A disclaimer of opinion should be expressed when the possible effect of a
limitation on scope is so material and pervasive that the auditor has not been able to obtain
sufficient appropriate audit evidence and accordingly is unable to express an opinion on the
iii. Adverse opinion: An adverse opinion should be expressed when the effect of a disagreement is so
material and pervasive to the financial statements that the auditor concludes that a qualification of
the report is not adequate to disclose the misleading or incomplete nature of the financial
statements.
Question No. 29
Explain the Process of judgment formation by Auditor (5 Marks June 2009)

Answer:
After the audit, the opinion that the auditor expresses are the result of exercise of judgement on facts,
evidence and circumstances which he comes across in the course of audit. The judgement is formed on the
following basis: -
 Identification of the assertions to be examined.
 Evaluation of the assertion as to relative importance.
 Collection of the information or evidence about the assertions to enable him to give an
informed opinion.
 Evaluation of evidence as valid or invalid, pertinent or not pertinent, sufficient or
insufficient.
 Formulation of judgement as to the fairness of the assertions under consideration.
Question No. 30
Present the illustrative auditor's report for an audit of financial statements prepared in accordance with
NAS expressing an unqualified opinion. (8 Marks December 2009)
Answer
INDEPENDENT AUDITOR’S REPORT
To the Shareholders,
ABC Company
Report on the Audit of the Financial Statements1
Opinion
We have audited the financial statements of ABC Company (the Company), which comprise the statement of financial position
as at Ashadh 32, 20XX, and the statement of comprehensive income, statement of changes in equity and statement of cash flows
for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.
In our opinion, the accompanying financial statements present fairly, in all material respects, (or give a true and fair view of) the
financial position of the Company as at Ashadh 32, 20XX, and (of) its financial performance and its cash flows for the year then
ended in accordance with Nepal Financial Reporting Standards (NFRSs).
Basis for Opinion

We conducted our audit in accordance with Nepal Standards on Auditing (NSAs). Our responsibilities under those standards are
further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are
independent of the Company in accordance with the ICAN‟s Handbook of Code of Ethics for Professional Accountants together
with the ethical requirements that are relevant to our audit of the financial statements in [jurisdiction], and we have fulfilled our
other ethical responsibilities in accordance with these requirements and the ICAN‟s Handbook of The Code of Ethics For
Professional Accountants. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis
for our opinion.
Key Audit Matters

Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the financial
statements of the current period. These matters were addressed in the context of our audit of the financial statements as a whole,
and in forming our opinion thereon, and we do not provide a separate opinion on these matters.
[Description of each key audit matter in accordance with NSA 701.]
Other Information [or another title if appropriate such as “Information Other than the Financial Statements and
Auditor’s Report Thereon”]
[Reporting in accordance with the reporting requirements in NSA 720 (Revised)]
Management is responsible for the other information. The other information comprises the [information included in the “Annual
Report” (as defined in NSA 720), but does not include the financial statements and our auditor‟s report thereon.] Our opinion on
the financial statements does not cover the other information and we do not express any form of assurance conclusion thereon.
In connection with our audit of the financial statements, our responsibility is to read the other information, and in doing so,
consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the
audit or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a
material misstatement of this other information; we are required to report that fact. [We have nothing to report in this regard [or
a statement that describes any material misstatement of the other information].
Responsibilities of Management and Those Charged with Governance for the Financial Statements.
Management is responsible for the preparation and fair presentation of the financial statements in accordance with NFRSs, and
for such internal control as management determines is necessary to enable the preparation of financial statements that are free
from material misstatement, whether due to fraud or error.
In preparing the financial statements, management is responsible for assessing the Company‟s ability to continue as a going
concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless
management either intends to liquidate the Company or to cease operations, or has no realistic alternative but to do so.
Those charged with governance are responsible for overseeing the Company‟s financial reporting process.
Auditor’s Responsibilities for the Audit of the Financial Statements
Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material
misstatement, whether due to fraud or error, and to issue an auditor‟s report that includes our opinion. Reasonable assurance is a
high level of assurance, but is not a guarantee that an audit conducted in accordance with NSAs will always detect a material
misstatement when it exists.
Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could
reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.
As part of an audit in accordance with NSAs, we exercise professional judgment and maintain professional skepticism
throughout the audit. We also:
 Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or
error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and
appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is
higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions,
misrepresentations, or the override of internal control.
 Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate
in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Group‟s internal
control.
 Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related
disclosures made by management.
 Conclude on the appropriateness of management‟s use of the going concern basis of accounting and, based on the audit
evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt
on the Group‟s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required

to draw attention in our auditor‟s report to the related disclosures in the consolidated financial statements or, if such
disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the
date of our auditor‟s report. However, future events or conditions may cause the Group to cease to continue as a going
concern.
 Evaluate the overall presentation, structure, and content of the consolidated financial statements, including the
disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a
manner that achieves fair presentation.
 Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities
within the Group to express an opinion on the consolidated financial statements. We are responsible for the direction,
supervision and performance of the group audit. We remain solely responsible for our audit opinion.
 We communicate with those charged with governance regarding, among other matters, the planned scope and timing of
the audit and significant audit findings, including any significant deficiencies in internal control that we identify during
our audit.
 (For listed entities) We also provide those charged with governance with a statement that we have complied with
relevant ethical requirements regarding independence, and to communicate with them all relationships and other
matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards.
Report on Other Legal and Regulatory Requirements

(Example: For entities covered by application of Companies Act)
As per the requirements of Section 115 of the Companies Act, 2063 (First Amendment 2074), we further report that:
a) We have obtained all the information and explanations, which to the best of our knowledge and belief were
necessary for the purpose of our audit.
b) In our opinion the Company has kept proper books of account as required by law so far, as appears from our
examinations of those Books.
c) The financial statements are in agreement with the books of account.
d) In our opinion and to the best of our information and according to the explanation given to us, the financial
statement the said Balance Sheet, Income Statement and Cash Flow Statement, read together with the notes
forming part of the accounts give the information required by the Companies Act 2063 (First Amendment 2074) in
the manner so required and give a true and fair view:
i. In the case of Balance Sheet, of the state of affairs of the Company as at 32 nd Ashadh, 20XX; and
ii. In the case of Income Statement, of the results of operations of the Company for the year ended on 32nd
Ashadh, 20XX; and
iii. In the case of the Cash Flow Statement, of Cash inflow and outflow of Company for the year ended on that
date.
e) Neither we have come across any of the information about the misappropriation of fund by the directors or any of
the representative or company's staffs during the course of our audit nor have we received any such information
from the management.
f) No accounting fraud has been observed during the course of our audit.
Place for XYZ & Associates

Chartered Accountants
Date Signature
Name of Member
Designation
Membership No.

Question No. 31
a) Unqualified Audit Report and Qualified Audit Report. (5 Marks December 2006, December 2009,
June 2008, December 2015)
Answer:
An unqualified report, which is otherwise known as unconditional opinion is issued by the auditor when he
does not have any reservation with regard to the matters contained in the financial statements. In such a
case, the audit report may state that the financial statements give a true and fair view of the state of affairs
and profit and loss account for the period. Under the following circumstances an auditor is justified in
issuing an unqualified report.
i. The financial information has been prepared using acceptable accounting policies, which have been
consistently applied.
ii. The financial information complies with relevant regulations and statutory requirements, and
iii. There is adequate disclosure of all material relevant to the proper presentation of the financial
information, subject to statutory requirements, where applicable.
Qualified audit report, on the other hand, is one, which does not give a clear chit about the truth and
fairness of the financial statements but makes certain reservations. The gravity of such reservation will
vary depending upon the circumstances. In majority of cases, items, which are the subject matter of
qualification, are not so materials as to affect the truth and fairness of the whole accounts but merely create
uncertainty about a particular item. In such cases, it is possible for the auditors to report that in their
opinion but subject to specific qualifications mentioned, the accounts present a true and fair view. Thus, an
auditor may give his particular objection or reservation in the audit report and state "subject to the above,
we report that balance sheet shows a true and fair view …………." The auditor should also give reasons
for qualification. The words "subject to" are essential to state any qualification. It is also necessary that the
auditors should quantify, whenever possible the effect of these qualifications on the financial statements in
clear and unambiguous manner if the same is material and state aggregate impact of qualifications.
Thus, it is clear from the above that in case of clean report, the auditor has no reservation in respect of
various matters contained in the financial statements but a qualified report may involve certain matters
involving difference of opinion between the auditor and the management.
b) Audit report and certificate (5 Marks December 2013, June 2018)

Answer:
Audit Report and Certificate
i. The term „report‟ is used where an expression of opinion is involved. The term „certificate‟ is
preferable where the auditor comments on or verifies facts
ii. The Auditor Report is based on facts, estimates and assumptions whereas Auditor's Certificate is
based on actual facts

iii. Auditor Report is not a guarantee of the absolute correctness & accuracy of the books of
accounts. But the auditor certificate serves as a guarantee of the absolute correctness & accuracy
of the books of accounts
iv. If the Auditor Report is later on found to be wrong, he cannot be held responsible since he has
given merely his opinion on the state of affairs of the company. But if the duly signed
certificate is found as wrong, he will be held responsible
Basis Audit Report Audit Certificate
Meaning An Audit Report is an expression of Certificate is a written confirmation

opinion on the true and fair view of the accuracy of the fact stated
presented by financial statements therein and does not involve any
estimate of opinion.
Utility The term audit report is used when the The term certificate is used when
auditor expresses his opinion on the the auditor verifies certain exact
financial statements fact e.g. Royalty payment made to
foreign collaborators, value of
import/exports of a company during
a financial year.
Implication Audit report implies that the auditor A certificate implies that the
Auditor
- Has examined relevant records in
accordance with generally accepted- Has verified certain precise
auditing standards; and figures; and
- Is expressing an opinion whether or- Is in a position to vouch their
not the financial statements accuracy as per the examination of
representing a true and fair view of documents and books of account
the state of affairs and of the working produced before him.
results of the enterprise.
Accuracy The Auditor is responsible for ensuring The Auditor is responsible for the
that the report is based on factual data factual accuracy of what is stated
that his opinion is in accordance with therein.
facts, and that it is arrived at by
application of due care & Skill.
Question No. 32

a) Date of auditor‟s report (December 2015)

b) Competence and objectivity of the expert engaged by auditor

(5 Marks June 2016)
Answer
a) Answer
Date of Auditor’s Report: The auditor should date the audit report no earlier than the date on
which the auditor has obtained sufficient appropriate audit evidence on which to base the opinion
on the financial statements. Sufficient appropriate audit evidence should include evidence that the
entity‟s complete set of financial statements has been prepared and that those with the recognized
authority have asserted that they have taken responsibility for them.
b) Answer
When planning to use the work of an expert, the auditor should assess the professional competence
of the expert which will involve considering the expert‟s:
a. Professional certification or licensing by, or membership in, an appropriate professional body;
b. Experience and reputation in the field in which the auditor is seeking audit evidence.
The auditor should assess the objectivity of the expert. The risk that an expert‟s objectivity will be
impaired increases when the expert is:
a. Employed by the entity; or
b. Related in some other manner to the entity, for example, by being financially dependent upon
or having an investment in the entity. If the auditor is concerned regarding the competence or
objectivity of the expert, the auditor needs to discuss any reservations with management and
consider whether sufficient appropriate audit evidence can be obtained concerning the work of an
expert.
The auditor may need to undertake additional audit procedures or seek audit evidence from another
expert.
Question No. 33
Write short notes on the following: (2.5 Marks, June 2019)
Limited Assurance Engagement
Answer
A limited assurance engagement is an assurance engagement in which the practitioner reduces engagement
risk to a level that is acceptable in the circumstances of the engagement but in which the risk is greater than
for a reasonable assurance engagement. For a limited assurance engagement, the team must understand the
subject matter sufficiently to identify areas where a significant deviation is most likely to arise. Further,
obtaining an understanding of internal control relevant to the engagement is usually not required. The
evidence needed in a limited assurance engagement would normally be limited to that obtained by inquiry,
analytical procedures, and discussion, to enable the practitioner to conclude that the subject matter is
plausible in the circumstances. In contrast to reasonable assurance engagements, the practitioner in a

limited assurance engagement would not normally seek to corroborate evidence obtained as long as the
information obtained from carrying out the audit procedures appears plausible in the circumstances to the
practitioner. The conclusion for a limited assurance engagement is in the negative form, i.e. “based on the
procedures performed and evidence obtained, nothing has come to our attention (…).”

Chapter 11-Nepal Standards on Auditing

s
Question No. 1
“Company Auditor uses the work of Branch Auditor." Explain the relationship between the two. (16
Marks June 2001)
Answer
Relationship between Company Auditor and Branch Auditor:
The following points are relevant may be noted in this regard:

1. The company auditor would normally be entitled to rely upon the work of the branch auditor unless
there are special circumstances to make it essential for him to visit the branch and/or examine the
books of account and other records of the branch.
2. The company auditor is not normally required to evaluate the professional competence or
independence of the branch auditor unless there are circumstances which create doubt in this
regard.
3. There should be proper liaison between the company auditor and the branch auditor. For this
purpose, the company auditor may issue a written communication to the latter. The branch auditor
should co-operate with the company auditor and assist him actively. Both should communicate to
each other significant matters which come to their attention and which may have an important
bearing on each other's work.
4. The company auditor may ordinarily follow the following procedures:
a. Advise the branch auditor of the use that is to be made of his work and report and inform him
of related matters such as time - table for completion of audit, arrangements for co-ordination
and areas required for special consideration.
b. Advise the branch auditor of significant accounting, auditing and reporting requirements and
obtain representation as to compliance with them.
c. Ascertain from the branch auditor whether there are any limitations on the scope of his work.
d. Consider the significant audit findings of the branch auditor. These findings may be discussed
with the branch auditor and the management of the branch. Where considered necessary, the
company auditor may decide to conduct supplementary tests of the records of the branch or
may request the branch auditor to do so. It may be noted on that the ultimate responsibility
for the auditor report on the financial statements of the company is that of the company
auditor. Therefore, it is for him to decide whether any of the significant findings of the branch
auditor need to be included in the company auditors report or not.
5. Where considered necessary the company auditor may require the branch auditor to answer a
detailed questionnaire regarding matters on which the company auditor requires information for
discharging his duties. The branch auditor should respond to such questionnaire on a timely basis.
6. The company auditor should keep proper working papers showing the particulars of branches
audited by branch auditor, significance of the financial statements of each branch in relation to the

company as a whole, name of the branch auditors and the conclusions of the company auditor
regarding the reports of the branch auditors. Where the branch auditor's report is qualified of
contains a disclaimer or an adverse opinion, the company auditor should also document how he
dealt with those qualifications or adverse remarks while framing his own report. In doing so, he
should consider whether the qualifications made by the branch auditor are of such nature and
significance in relation to the financial statements of the entity as a whole that they require
qualification in his report.
7. The company auditor would not be responsible in respect of the work entrusted to the branch
auditors, except in circumstances giving rise to suspicion about the reliability of the work
performed by the branch auditors. However, the report of the company auditor should clearly state
the division of responsibility for the financial statements of the entity, by indicating the extent to
which the financial statement of branches audited by branch auditors have been included in the
financial statements of entity e.g. the number of branches audited by branch auditors.
It may be noted that the statement on Qualifications in Auditors Report also requires that the
company auditor should normally incorporate the qualifications made in the branch auditors report
in his own report, unless he is satisfied. that:
 the objections of the branch auditor have been met while preparing the accounts of the
company or during the conduct of the company's audit; or
 the subject matter of the qualification is not material in the context of the accounts of the
company as a whole; or
 in the light of information and explanations given to him, which were not available to the
branch auditor, he is satisfied that the qualification is not called for.
Question No. 2
a. Inherent limitations of an audit (4 Marks, December 2003)

The Inherent Limitations are as follows
 The test nature of an audit of financial information involves judgment as to the areas to be
tested and number of transactions to be examined. Furthermore, much audit evidence is
persuasive rather than conclusive in nature. Hence auditor's examination is subject to the
inherent limitation that some material misstatements of the financial information resulting from
fraud or error, if either, exists, may not be detected.
 The risk of not detecting material misstatement resulting from fraud is greater than the risk of
not detecting a material misstatement resulting from error. Unless the auditor's examination
reveals evidence to the contrary, he is entitled to accept representations as truthful and records
and documents as genuine.
 While the existence of an effective system of internal control reduces the probability of
misstatement of financial information resulting from fraud or error, there will always be some

risk of internal control failing to operate as designed. Hence even the auditor's judgment about
internal control and his test procedures based on internal control procedure does not guarantee
that fraud and error does not exist.
b. Balance confirmation procedures (4 Marks, December 2003)

NSA 505 defines confirmation as a method of collecting audit evidence, which consists of the
response to an inquiry to corroborate information contained in the accounting records. For example,
the auditor requests confirmation of receivables by direct confirmation with debtors. Balance in
bank account at the year-end is verified by obtaining balance confirmation from bankers. Balance
confirmation procedure is an important audit tool, which provides more reliable audit evidence to
the auditor, as it is the evidence obtained from the external source
.
Question No. 3
Give your opinion on the following issues/ statements. (4 Marks each, December 2005)
a) Mr. Ram Gopal Sharma, Chief Accountants of M/s Lucky finance Co. Ltd. produced the
photocopies of fixed deposit receipts of Rs. 10,00,000/- to the auditor during the course of audit
period as the managing director who kept original receipts in safe vault was presently out of the
country to attend the seminar abroad.
Answer.
An auditor should obtain sufficient appropriate audit evidence, evaluate the same and draw
reasonable conclusions there from as required by NSA 500 on Audit Evidence. In the given case,
photocopies of fixed deposit receipts were made available by Mr. Ram Gopal Sharma, Chief
Accountant to the auditors as the original receipts could not be verified, which were kept in the safe
vault.
The auditor is generally required to inspect and physically verify the fixed deposit receipts
representing the assets on the last day of the accounting period. Such verification is necessary to
ensure that no unauthorized charge has been created or the fixed deposits receipts have been lodged
with a bank to secure a loan or an overdraft. Thus, the photocopies of FDRs cannot serve the desired
purpose. Alternatively, reliance can be placed by the auditor on such evidence provided photocopies
are certified as true copies by the management as also backed by a letter of representation. Managing
director may also be asked to confirm in writing from abroad that no unauthorized charge has been
created on the fixed deposits receipts and same shall be produced to auditors as soon as he returns
from seminar abroad. The auditor may also obtain independent confirmation from the respective bank
that not charge has been created on such fixed deposit receipts.
The auditor should consider the materiality of the amount involved and its overall impact on the
financial statement forming an opinion. In case the auditor is satisfied after extending the substantive
audit procedure and if amount involve is reasonable in his opinion, he need not state anything in his

report after getting suitable confirmation in writing from managing director about the status of fixed
deposits receipts.
b) While carrying out the audit of M/s Laxmanpur Sugar Factory Ltd. for the year 2061/62, you as
an auditor of this organization found out an error in the valuation of inventory. The error affects
the financial statements of above company materially. Give your comment in line with Auditing
and Assurance Standards.
Answer:
The Auditor‟s responsibility to consider Fraud and Error in an Audit of Financial Statements under
NSA 240 requires that if circumstances indicate the possible existence of fraud or error, the auditor
should consider the potential effect of the suspected fraud or error on the financial information. If the
auditor believes that suspected fraud or error could have a material effect on the financial
information, he should perform such modified or additional procedures as he determines to be
appropriate. NSA 240 also requires that the auditor should consider the effects of the misstatement in
relation to other aspects of the audit, particularly, the reliability of management representations.
Further NSA 320 “Audit Materiality" also requires that in such circumstances, the auditor should
request the management to adjust the financial information or consider extending his audit
procedures. If the management refuses to adjust the financial information and the results of extended
audit procedures do not enable the auditor to conclude that the aggregate of uncorrected misstatement
is not material, the auditor should express a qualified or adverse opinion, as appropriate.
In view of the above, in the given case the auditor has detected the material errors affecting the
financial statements; the auditor should communicate his findings to the management on timely basis,
consider the effect on the true and fair view and also ensure that appropriate disclosures have been
made.
Question No. 4
There is no need of issuing Audit Engagement Letter once you are appointed by the proprietor of a
proprietorship trading firm to do Statutory and Tax Audits by sending an appointment letter.
Comment. (5 Marks, December 2006)
Answer:
As per NSA 210: Agreeing the Terms of Audit Engagements "The auditor and the client should agree
on the terms of the engagement". The agreed terms would need to be recorded in an audit engagement
letter or other suitable form of contract. It is in the interest of both client and auditor that the auditor
sends an engagement letter, preferably before the commencement of the engagement, to help in avoiding
misunderstandings with respect to the engagement. The engagement letter documents and confirms the
auditor's acceptance of the appointment, the objective and scope of the audit, the extent of the auditor's
responsibilities to the client and form of any reports.
Thus, an engagement letter should be issued by the auditor upon receipt of appointment as an auditor to
do statutory as well as tax audits.

Question No. 5
Briefly explain the concept of Materiality. (3 Marks June 2008)
As per NSA 320: Audit Materiality, the auditor should consider materiality and its relationship with audit
risk when conducting an audit.
"Materiality" is defined in the Nepal Accounting Standards Board's "Framework for the Preparation and
Presentation of Financial Statements" in the following terms:
"Information is material if its omission or misstatement could influence the economic decisions of users
taken on the basis of the financial statements. Materiality depends on the size of the item or error judged
in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or
cut-off point rather than being a primary qualitative characteristic which information must have if it is to
be useful."
The objective of an audit of financial statements is to enable the auditor to express an opinion whether
the financial statements are prepared, in all material respects, in accordance with an identified financial
reporting framework. The assessment of what is material is a matter of professional judgement.
In designing the audit plan, the auditor establishes an acceptable materiality level so as to detect
quantitatively material misstatements. However, both the amount (quantity) and nature (quality) of
misstatements need to be considered. Examples of qualitative misstatements would be the inadequate or
improper description of an accounting policy when it is likely that a user of the financial statements
would be misled by the description, and failure to disclose the breach of regulatory requirements when it
is likely that the consequent imposition of regulatory restrictions will significantly impair operating
capability.
The auditor needs to consider the possibility of misstatements of relatively small amounts that,
cumulatively, could have a material effect on the financial statements. For example, an error in a month
end procedure could be an indication of a potential material misstatement if that error is repeated each
month.
The auditor considers materiality at both the overall financial statement level and in relation to individual
account balances, classes of transactions and disclosures. Materiality may be influenced by
considerations such as legal and regulatory requirements and considerations relating to individual
financial statement account balances and relationships. This process may result in different materiality
levels depending on the aspect of the financial statements being considered.
Materiality should be considered by the auditor when:
(a) determining the nature, timing and extent of audit procedures; and
(b) evaluating the effect of misstatements.

Question No. 6
Express your opinion in the following cases: (5 Marks each June 2008)
a) As an auditor of M/s Clean Kathmandu Valley Company Ltd. you noticed that the company has
not adjusted its closing stock with the actual stock after physical verification. Total 10 items
amounting to Rs. 500,000 was short during verification out of 100 items amounting to Rs.
5,000,000. The management refuses to adjust such short in its books of account arguing that it will
have no material effect over the financial statement. Can you rely upon the management or what
will be your steps to overcome this situation?
Answers
As per of Nepal Standard on Auditing –320, Audit Materiality, the auditor needs to consider whether
the aggregate of uncorrected misstatements is material. If the auditor concludes that the
misstatements may be material, the auditor needs to consider reducing audit risk by extending audit
procedures or requesting management to adjust the financial statements. In the given case,
management has refused to adjust the misstatement in the financial statement, the auditor should
consider the appropriate modification to the auditor's report on financial statement if the extended
audit procedures do not enable the auditor to conclude that the aggregate of uncorrected misstatement
in not material.
b) While reporting on the consolidated financial statements the principal auditor has to evaluate the
financial statements of the subsidiary company also. At times, such financial statements are
audited by other auditors. The principal auditor relied on the audit reports submitted by such
company without further audit procedures.
Answer
As per NSA 600, when the principal auditor uses the work of another auditor, the principal auditor
should determine how the work of the other auditor will affect the audit. The principal auditor should
perform procedures to obtain sufficient appropriate audit evidence, that the work of the other auditor
is adequate for the principal auditor‟s purposes, in the context of the specific assignment.
The principal auditor may conclude that it is not necessary to apply any substantive or quality check
procedures because sufficient appropriate audit evidence previously obtained that acceptable quality
control policies and procedures are complied with in the conduct of the other auditor‟s practice.
Thus, from above it can be concluded that the principal auditor has not complied with the provisions
of said NSA and has not done his job with professional competence.

Question No 7
Write short notes on the Following

a. Peer Review (5 Marks December 2008)
As per Statement on Peer Review approved by the Council of the Institute, Peer Review means an
examination and review of the systems and procedures to determine whether they have been put in place
by the practice unit for ensuring the quality of attestation services as envisaged and implied/mandated by
the Technical Standards and whether these were effective or not during the period under review.
Peer Review is directed towards maintenance as well as enhancement of quality of attestation services
and to provide guidance to members to improve their performance and adhere to various statutory and
other regulatory requirements. Essentially, through a review of attestation services engagement records,
peer review identifies the areas where a practicing member may require guidance in improving the
quality of his/her performance and adherence to various requirements as per applicable Technical
Standards.
The main objective of Peer Review is to ensure that in carrying out their attestation services assignments;
the members of the Institute (a) comply with the Technical Standards made mandatory for application by
the Institute and (b) have in place proper systems (including documentation systems) for maintaining the
quality of the attestation services work they perform. The Council has specified in this Statement on Peer
Review, the Technical Standards in relation to which peer reviews are to be carried out. Peer review does
not seek to redefine the scope and authority of the Technical Standards promulgated by the respective
Standards Boards but seeks to ensure their implementation both in letter and spirit.
b. Consultation in quality audit (2.5 Marks July 2015)

NSQC 1 and NSA 220 provides that the engagement partner should:
 Be responsible for the engagement team undertaking appropriate consultation on difficult or

contentious/controversial matters;
 Be satisfied that members of the engagement team have undertaken appropriate consultation
during the course of the engagement
 Be satisfied that the nature and scope of, and conclusions resulting from, such consultations are
documented and agreed with the party consulted; and
 Determine that conclusions resulting from consultations have been implemented
c. Benefits of implementing IFRS or equivalent national standards (2.5 Marks December 2015)
There are many benefits of implementing IFRS or its national equivalent financial reporting standards
which can be broadly divided into 3 main parts – Economy, Investors and the Industry.
Benefits to the Economy - As the market expands globally, the need for a global standard is also
increasing. Implementation of IFRS or equivalent standards facilitates the maintenance of orderly and
efficient capital markets and also helps to increase the capital formation and thereby economic growth.

Benefits to the Investors - Investors who are willing to invest abroad want information which is more
relevant, reliable, timely and comparable across various jurisdictions. Financial statements prepared
using a common set of accounting standards help investors better understand, at a little cost, the
investment opportunities as opposed to financial statements prepared using a different set of national
accounting standards.
Benefits to the Industry - the Industry would be able to raise capital from foreign markets at a lower cost
if it can create confidence in the minds of the foreign investor that their financial statements comply with
globally accepted accounting standards.
Question No. 8
Audit documentation facilitates understanding of the nature, timing and extent of audit procedures;
the results of audit procedures and significant matters arising during the audit.
Discuss briefly:
i) What are the "significant matters" which are required to be documented?

ii) In how many days after the date of auditor's report, the auditor is required to complete the
assembly of his final audit file as per NSQC 1?
Answer
(i) “Significant matters” required to be documented:
As per NSA 230, the auditor should document matters which are important in providing evidence
to support the audit opinion and evidence that the audit was carried out in accordance with Nepal
Standards on Auditing (NSA). All significant matters, which require the exercise of judgment,
together with the auditor's conclusion thereon, should be included in the working paper as
follows:
 information concerning the legal and organizational structure of the client,

 extracts or copies of important legal documents, agreements and minutes,
 information concerning the industry, economic environment and legislative environment
within which the client operates,
 evidence of the planning process including audit programs and any changes thereto,
 evidence of the auditor's understanding of the accounting and internal control systems,
 evidence of inherent and control risk assessments and any revisions thereof,
 evidence of the auditor's consideration of the work of internal auditing and conclusions
reached,
 analysis of transactions and balances,
 analysis of significant ratios and trends,
 a record of the nature, timing and extent of audit procedures performed and the results of
such procedures,

 evidence that the work performed by assistants was supervised and reviewed,
 an indication as to who performed the audit procedures and when they were performed,
 details of procedures applied regarding components whose financial statements are audited
by another auditor,
 copies of communications with other auditors, experts and other third parties,
 copies of letters or notes concerning audit matters communicated to or discussed with the
client, including the terms of the engagement and material weaknesses in internal control,
 letters of representation received from the client,
 conclusions reached by the auditor concerning significant aspects of the audit, including
how exceptions and unusual matters, if any, disclosed by the auditor's procedures were
resolved or treated and
 copies of the financial statements and auditor‟s report.
(ii) Requirement of auditor to complete the assembly of his final audit files as per NSQC 1:
As per NSQC 1, the firm should establish policies and procedures for engagement teams to
complete the assembly of final engagement files on a timely basis after the engagement reports
have been finalized.
Law or regulation may prescribe the time limits by which the assembly of final engagement files
for specific types of engagement should be completed. Where no such time limits are prescribed
in law or regulation, the firm establishes time limits appropriate to the nature of the engagements
that reflect the need to complete the assembly of final engagement files on a timely basis. In the
case of an audit, for example, such a time limit is ordinarily not more than 60 days after the date
of the auditor‟s report.
Where two or more different reports are issued in respect of the same subject matter information
of an entity, the firm‟s policies and procedures relating to time limits for the assembly of final
engagement files address each report as if it were for a separate engagement. This may, for
example, be the case when the firm issues an auditor‟s report on a component‟s financial
information for group consolidation purposes and, at a subsequent date, an auditor‟s report on the
same financial information for statutory purposes.
Question No. 9
How would you determine the aggregate of uncorrected misstatements? (5 Marks December 2008)
Answer
As per NSA 240, when planning and performing audit procedures and evaluating and reporting the
results thereof, the auditor should consider the risk of material misstatements in the financial statements
resulting from fraud or error.

When the auditor encounters circumstances that may indicate that there is a material misstatement in the
financial statements resulting from fraud or error, the auditor should perform procedures to determine
whether the financial statements are materially misstated.
When the auditor encounters such circumstances, the nature, timing and extent of the procedures to be
performed depends on the auditor‟s judgement as to the type of fraud or error indicated, the likelihood of
its occurrence, and the likelihood that a particular type of fraud or error could have a material effect on
the financial statements. Ordinarily, the auditor is able to perform sufficient procedures to confirm or
dispel a suspicion that the financial statements are materially misstated resulting from fraud or error.
When the auditor confirms that, or is unable to conclude whether, the financial statements are materially
misstated as a result of fraud or error, the auditor should consider the implications for the audit.
As per NSA 320 "Audit Materiality" Planning the audit solely to detect individually material
misstatements overlooks the fact that the aggregate of individually immaterial misstatements may cause
the financial statements to be materially misstated, and leaves no margin for possible undetected
misstatements.
Performance materiality (which, as defined, is one or more amounts) is set to reduce to an appropriately
low level the probability that the aggregate of uncorrected and undetected misstatements in the financial
statements exceeds materiality for the financial statements as a whole. Similarly, performance materiality
relating to a materiality level determined for a particular class of transactions, account balance or
disclosure is set to reduce to an appropriately low level the probability that the aggregate of uncorrected
and undetected misstatements in that particular class of transactions, account balance or disclosure
exceeds the materiality level for that particular class of transactions, account balance or disclosure.
Question No. 10
Comment and give your views as auditor with reasons on each of the following case:
a) Mr. Bhandari & Associates, Chartered Accountants was appointed as an auditor of the company.
Subsequently, Mr. Sharma & Associates, Chartered Accountants was offered appointment as an
auditor of the company replacing Mr. Bhandari & Associates, Chartered Accountants. Mr.
Sharma & Associates, Chartered Accountants for whom this is an initial audit engagement accepts
the appointment and starts the audit without communicating with anyone.
Answer:
a) Mr. Sharma & Associates has started the audit in violation with NSA 300 "Planning the Audit".
According to NSA 300 "Planning an Audit", the auditor should communicate with previous
auditor where there has been a change of auditors, in relevance to ethical requirements.

And again, since it is initial audit, the auditor may need to expand the planning activities because
the auditor does not ordinarily have previous experience with the entity that is considered when
planning recurring engagements. The auditor should consider the following in developing overall
audit strategy and plan.
 Unless prohibited by the law, arrangement to be made with previous auditor to review the
previous auditor's working papers;
 Any major issues discussed with management in connection with the initial selection as
auditors.
 Other procedures required by the firm's system of quality control for initial audit
engagements
Question No. 11
Briefly discuss the basis of disclosure of accounting policies according to NAS-1 on “Presentation of
Financial Statements". (4 Marks June 2009)
Answer:
According to NAS-1, an entity shall disclose in the summary of significant policies:
 measurement basis used for preparing the financial statements;
 the other accounting policy used that are relevant to an understanding of the financial statements.
In addition to the specific accounting policies used in the financial statements, it is important for the
users to be aware of the measurement basis used (historical cost, current cost, realizable value, fair value
or present value) because they form the basis on which the financial statements are prepared. When more
than one measurement basis is used in the financial statements, for an example, when certain non-current
assets are revalued, it is sufficient to provide an indication of the categories of assets and liabilities to
which each measurement basis is applied.
In deciding whether a particular policy shall be disclosed, management considers whether disclosure
would assist users in understanding the way in which transactions and events are reflected in the reported
financial performance and financial position. The accounting policies that an entity might consider
presenting include revenue recognition, recognition and depreciation/ amortization of tangible and
intangible assets, capitalization of borrowing costs and other expenditure, financial instruments and
investments, leases, research and development costs, inventories, taxes, provisions, employee benefit
costs, foreign currency transaction, definition of cash and cash equivalent and government grants.
Question No. 12
Briefly state the circumstances when the audit report is modified without affecting the auditor‟s
opinion (10 Marks June 2009

Answer:
As per NSA 706, in certain circumstances, an auditor's report may be modified by adding an emphasis
of matter paragraph to highlight a matter affecting the financial statements which is included in a note
to the financial statements that more extensively discusses the matter. The addition of such an emphasis
of matter paragraph does not affect the auditor's opinion. The paragraph would preferably be included
after the opinion paragraph and would ordinarily refer to the fact that the auditor's opinion is not
qualified in this respect.
The addition of a paragraph emphasizing a going concern problem or significant uncertainty is
ordinarily adequate to meet the auditor's reporting responsibilities regarding such matters. However, in
extreme cases, such as situations involving multiple uncertainties that are significant to the financial
statements, the auditor may consider it appropriate to express a disclaimer of opinion instead of adding
an emphasis of matter paragraph.
In addition to the use of an emphasis of matter paragraph for matters that affect the financial
statements, the auditor may also modify the auditor's report by using an emphasis of matter paragraph,
preferably after the opinion paragraph, to report on matters other than those affecting the financial
statements.
Question No. 13
List down the principal contents of an audit engagement letter. (6 Marks June 2009)
Answer
As per NSA 210, the form and content of audit engagement letters may vary for each client, but they
would generally include reference to:
 The scope of the audit, including reference to applicable legislation, regulations or pronouncements
of the Institute of Chartered Accountants of Nepal (ICAN).
inherent limitations of any accounting and internal control system, there is an unavoidable risk that
even some material misstatement may remain undiscovered.
The auditor may also wish to include in the letter:

 Arrangements regarding the planning of audit.
 Expectation of receiving from management written confirmation concerning representations made
in connection with the audit.

 Request for the client to confirm the terms of the engagement by acknowledging receipt of the
engagement letter.
 Description of any other letters or reports the auditor expects to issue to the client.
 Basis on which fees are computed and any billing arrangement.
When relevant, the following points could also be made:

 Arrangements concerning the involvement of other auditors and experts in some aspects of the
audit.
 Arrangements concerning the involvement of internal auditors and other client staff.
 Arrangements to be made with the predecessor auditor, if any, in the case of an initial audit.
 Any restriction of the auditor's liability when such possibility exists.
 A reference to any further agreements between the auditor and the client.
Question No. 14
As an auditor, comment on the following situations: (5 Marks each December 2009)
a) CS & Co. and DS & Co. were appointed as joint auditors of XYZ Bank Ltd. What would be their
professional responsibilities in a case where the company has cleverly concealed certain
transactions that escaped the notice of both the auditors?
b) Mr. Rohan Sharma is a sales executive of M/s Duo Electric Company. He is involved in sales,
collection of payments and stock supervision. Managing Director of the company found that Rs. 2
lakhs were embezzled by the sales executive by overstating the receivables. How would you deal
with the situation as a statutory auditor?
Answer:
a) Answer
Responsibilities of Joint Auditors: In conducting a joint audit, the auditor(s) should bear in
mind the possibility of existence of any fraud or error or any other irregularities in the accounts
under audit. The principle of joint audit involves that each auditor is entitled to assume that other
joint auditor has carried out his part of work properly. However, in this case, if it can be assumed
that the joint auditors CS & Co. and DS & Co. have exercised reasonable care and skill in
auditing the accounts of XYZ Bank Ltd. and yet the concealment of transaction has taken place,
both joint auditors cannot be held responsible for professional negligence. However, if such
concealment could have been discovered by the exercise of reasonable care and skill, the auditors
would be responsible for professional negligence. Therefore, it has to be seen that while dividing
the work, the joint auditors have not left any area unattended and exercised reasonable care and
skill while doing their work
b) Answer
The overstating of receivable by the employee needs close examination of transaction with the
debtors. Taking conformation from debtors is the key tool to verify the embezzlement. Once the

conformation is received, the actual receivable can be confirmed and deviation if any, with the
books of account will lead the embezzlement by the concerned staff. As per Nepal Standard on
Auditing (NSA) 240, “The Auditor‟s Responsibility to Consider Fraud in an Audit of Financial
Statements,” the auditor should consider the risks of material misstatements in the financial
statements due to fraud while planning and performing the audit to reduce audit risk to an
acceptably low level.
Question No. 15
What is agreed upon procedures? (5 Marks June 2010)
Answer
According to the NSRS 4400, “Engagement Agreed upon Procedures Regarding Financial Information”
the objective of an agreed-upon procedures engagement is for the auditor to carry out procedures of an
audit nature to which the auditor and the entity and any appropriate third parties have agreed and to
report on factual findings.
As the auditor simply provides a report of the factual findings of agreed-upon procedures, no assurance is
expressed by him in his report. Instead, users of the report assess for themselves the procedures and the
findings reported by the auditor and draw their own conclusions from the work done by the auditor.
The report is restricted to those parties that have agreed to the procedures to be performed since others,
unaware of the reasons for the procedures, may misinterpret the results. However, it is possible in certain
circumstances that the report of the engagement may not be restricted only to those parties that have
agreed to the procedures to be performed, but made available to a wider range of entities or individuals,
e.g., in case of Government organizations.
The auditor should conduct an agreed-upon procedure engagement in accordance with this NSA and the
terms of the engagement. The auditor should ensure with representatives of the entity and, ordinarily,
other specified parties who will receive copies of the report of factual findings, that there is a clear
understanding regarding the agreed procedures and the conditions of the agreement.
Matters to be agreed include the following:

 Nature of the engagement including the fact that the procedures performed will not constitute an
audit or a review and that accordingly no assurance will be expressed.
 Stated purpose for the engagement.
 Identification of the financial information to which the agreed-upon procedures will be applied.
 Nature, timing and extent of the specific procedures to be applied.
 Limitations on distribution of the report of factual findings. When such limitation would be in
conflict with the legal requirements, if any, the auditor would not accept the engagement.
In certain circumstances, for example, when the procedures have been agreed to between the regulator,
industry representatives and representatives of the accounting profession, the auditor may not be able to
discuss the procedures with all the parties who will receive the report. In such cases, the auditor may

consider, for example, discussing the procedures to be applied with appropriate representatives of the
parties involved, reviewing relevant correspondence from such parties.
Matters that would be included in the engagement letter include:

 A listing of the procedures to be performed as agreed-upon between the parties.
 A statement that the distribution of the report of factual findings would be restricted to the specified
parties who have agreed to the procedures to be performed.
Question No. 16
How the work of an expert should be evaluated before accepting the same as Audit evidence?
(5 Marks June 2010)
Answer:
Using the work of an expert: As per the NSA 620, when the auditor intends to use the work of an
expert, he should evaluate the following before accepting the same as audit evidence:
 Professional qualification of the expert;
 Experience and reputation of expert in related field;
 Independence and objectivity of the expert;
 The objectives and scope of the expert‟s work;
 Expert‟s relationship with the client, if any;
 The source data used;
 Assumptions and method used;
 The results of the expert‟s work in the light of auditor‟s overall knowledge of the business and of
the result of his audit procedures.
Question No. 17
The auditor may encounter circumstances that, individually or in combination, indicate the possibility
that the financial statements may contain a material misstatement resulting from fraud or error. List
down some of those (at least 8) circumstances that indicate a possible misstatement.
(8 Marks June 2010)
Answer
Some of the circumstances that, individually or in combination, indicate the possibility that the financial
statements may contain the material misstatement:
 Unrealistic time deadlines for audit completion imposed by management.
 Reluctance by management to engage in frank communication with appropriate third parties, such
as regulators or bankers.
 Limitation of audit scope imposed by management.
 Identification of important matters not previously disclosed by management.
 Significant difficult-to-audit figures in the accounts.
 Aggressive application of accounting principles.

 Conflicting or unsatisfactory evidence provided by management or employees.

 Unusual documentary evidence such as handwritten alterations to documentations
 Information provided unwillingly or after unreasonable delay.
 Seriously incomplete or inadequate accounting records.
Question No. 18
What are the major responsibilities of the Auditor for detecting material misstatement due to fraud?
Answer
Nepal Standard on Auditing (NSA) 240, “The Auditor‟s Responsibility to Consider Fraud in an Audit of
Financial Statements” deals with the responsibility of an auditor conducting an audit in accordance with
NSAs. The auditor should obtain reasonable assurance that the financial statements taken as a whole are
free from material misstatement, whether caused by fraud or error. An auditor cannot obtain absolute
assurance that material misstatements in the financial statements will be detected because of such factors
as the use of judgment, the use of testing, the inherent limitations of internal control and the fact that
much of the audit evidence available to the auditor is persuasive rather than conclusive in nature. When
obtaining reasonable assurance, an auditor maintains an attitude of professional skepticism throughout
the audit and considers the potential for management override of controls and recognizes the fact that
audit procedures that are effective for detecting error may not be appropriate in the context of an
identified risk of material misstatement due to fraud. The remainder of this NSA provides additional
guidance on considering the risks of fraud in an audit and designing procedures to detect material
misstatements due to fraud.
As per NSA 240, the auditor should maintain an attitude of professional skepticism throughout the audit,
recognizing the possibility that a material misstatement due to fraud could exist, notwithstanding the
auditor‟s past experience with the entity about the honesty and integrity of management and those
charged with governance.
Question No. 19
Shareholder of ABC Ltd. appointed Goddar & Co. as statutory auditor for last financial year. During
the audit, auditor found that previous auditor had issued qualified audit report in respect of assets
which was overstated by Rs.15 Million and a director‟s capital account was credited by that amount.
After series of discussion, current auditor reached in to conclusion that he was appointed for the
current financial year and he is not responsible for the misstatement in previous year which is already
reported by previous auditor. Give your opinions with reason.
Answer
As per NSA 510 Initial Engagements- Opening Balances, for initial audit engagements, the auditor
should obtain sufficient appropriate audit evidence that (a)the opening balance do not contain

misstatements that materially affect the current period‟s financial statements; (b) the prior period‟s
closing balances have been correctly brought forward to the current period or, when appropriate, have
been restated. If the effect of the misstatement is not properly accounted for and adequately disclosed, the
auditor should express a qualified opinion or an adverse opinion, as appropriate. Since the misstatement is
carried forward during the current year, it has affected current year position as well and accordingly the,
auditor‟s contention is not valid. Goddar &Co. should qualify his report quantifying the misstatements
unless management is ready to correct the statements.
Question No. 20
A statutory auditor of a commercial Bank is requested to report about frauds. The management
suspects that in two loan files there could be fraud. The auditor has already found a case of misuse of
authority relating to a loan amount of Rs. 2500000 resulting into loss to the Bank to the extent of that
amount. However, the auditor was unable to find fraud in any other loan transactions. Suggest the
auditor about his course of action.
Answer.
The primary responsibly for the prevention and detection of fraud and error rests with both those charged
with the governance and the management of an entity. The auditor should obtain evidence that
management acknowledges its responsibility for the fair presentation of the financial statements in
accordance with the relevant financial reporting framework, and has approved the financial statements.
Objective of an audit of financial statements is to enable an auditor to express an opinion on such
financial statements and not the detection and prevention of fraud and error. Audit involves exercise of
judgement. Also, the nature of the audit evidence enables the auditor to draw only reasonable conclusions
therefrom. Because of the inherent limitation of an audit, there is an unavoidable risk that some material
misstatements may remain undiscovered. While in many situations, the discovery is not the main
objective of audit nor is the auditor‟s program of work specifically designed for such discovery. The audit
cannot, therefore be relied upon to ensure the discovery of all frauds or errors but where the auditor has
such indication, he should extend his procedures to confirm or dispel his suspicions.
Question No. 21
Give your comments on the following: (5 Marks December 2010)
Management of MNO production House argues that the auditor should accept the figure of stock
verification conducted by internal audit. The management is willing to certify this figure. The
engagement partner, however, insists that stock verification should be carried out again by
management in presence of his assistants on 25% of locations.
Answer
The auditor should obtain sufficient and appropriate audit evidence from compliance and substantive
procedures to form his opinion. Accordingly, the auditor can demand the physical verification be done in

the presence of his assistants to obtain a level assurance of the inventory system in place. However,
auditor should also consider the reliance that may be placed in the report of internal audit in accordance
with NSA 610 considering the work of Internal Auditing. Where such reliance may be placed in the work
of an internal audit, the physical verification is not necessary.
Question No. 22

a) What is accounting estimates? Provide eight examples of accounting estimates.
b) What is the importance of working papers to the auditor? List out the documents to be kept in
permanent audit files.
Answer
a) Accounting estimate means an approximation of the amount of an item in the absence of a precise
means of measurement. On this ICAN has issued NSA 540. The examples are:
i. Allowances to reduce inventory and accounts receivable to their estimated realizable
value.
ii. Provisions to allocate the cost of fixed assets over their estimated useful life.
iii. Accrued Revenue.
iv. Provision for taxation.
v. Provision for a loss from lawsuit.
vi. Insurer`s liability for outstanding claim.
vii. Losses on construction contracts in progress.
viii. Amortization of certain items like goodwill and deferred revenue expenditure.
b) Working papers are the property of the auditor. In view of the importance of working papers to
the auditor, ICAN has issued NSA 230 "Documentation". The importance of working papers are:
i.) to assist in the planning and performance of the audit, ii.) to assist in the supervision and review
of the audit work and iii.) to provide evidence of the audit work performed to support the auditor`s
opinion.
Working paper files are generally divided in to two types as per nature of documents; namely
permanent working paper files (permanent audit files) and current working paper files (current
audit files). The contents of permanent audit files are:
i. information concerning the legal and organizational structure of the client. In the case of a
company, this includes the Memorandum and Articles of Association. In case of a
statutory corporation, this includes the Act and Regulations, under which the corporation
functions,
ii. extracts or copies of important legal documents, agreements and minutes relevant to the
audit,

iii. a record of the study and evaluation of the internal controls related to the accounting
system. This might be in the form of narrative descriptions, questionnaires or flow charts,
or some combination thereof,
iv. copies of audited financial statements of previous years,
v. analysis of significant ratios and trends,
vi. copies of management letters issued by the auditor, if any,
vii. record of communication with the retiring auditor, if any before acceptance of the
appointment as auditor,
viii. notes regarding significant accounting policies and
ix. significant audit observations of earlier years.
Question No. 23
Give your opinions with reasons on the following case

Paudel Provident Fund (PPF) is an approved retirement fund, which manages retirement benefits of
employees of group of companies relating to "Poudel Group". PPF has entered into an agreement
with a commercial bank for maintenance and operation of the retirement‟s accounts relating to its
beneficiaries. Under the agreement, PPF is required to open a deposit account in the bank and
maintain the entire fund only with the bank. During the audit of PPF, auditor finds that bank has
credited its account with excess interest by 4,32,000. All the interest income in the account is
distributed on pro-rata basis to the individual employees through accounts maintained in the bank
itself.
(5 Marks June 2011)
Answer
As per NSA 200 "Overall Objective of the Independent Auditor and Conduct of Audit In Accordance
with Nepal Standards on Auditing", The objective of an audit of financial statements is to enable the
auditor to express an opinion whether the financial statements are prepared, in all material respects, in
accordance with an identified financial reporting framework.
Once the financial statements are misstated, auditor is required to report on the matter by quantifying
its impact on the financial statements. Therefore, auditor should look in to the matter by verifying the
fact about how PPF has treated the excess credit by the bank in its account. Even if bank cannot recover
from PPF's employee, and the PPF has not given any effect to this item in its account, auditor should
ask management to disclose the fact in notes to the account of financial statements and of require,
should modify the audit report accordingly.
Question No. 24
What are the auditor‟s responsibilities for detection of frauds and errors? (10 Marks June 2011)
Answer
It has been explicitly mentioned in the NSA 240 that the primary responsibility for the prevention and
detection of fraud rests with both those charged with governance of the entity and with management.

The respective responsibilities of those charged with governance and of management may vary by
entity to entity. It is important that management, with the oversight of those charged with governance,
place a strong emphasis on fraud prevention, which may reduce opportunities for fraud to take place,
and fraud deterrence, which could persuade individuals not to commit fraud because of the likelihood
of detection and punishment. It is the responsibility of those charged with governance of the entity to
ensure, through oversight of management, that the entity establishes and maintains internal control to
provide reasonable assurance with regard to reliability of financial reporting, effectiveness and
efficiency of operations and compliance with applicable laws and regulations. This responsibility
includes establishing and maintaining controls pertaining to the entity‟s objective of preparing financial
statements that give a true and fair view (or are presented fairly in all material respects) in accordance
with the applicable financial reporting framework and managing risks that may give rise to material
misstatements in those financial statements. Such controls reduce but do not eliminate the risks of
misstatement.
An auditor conducting an audit in accordance with NSAs obtains reasonable assurance that the
financial statements taken as a whole are free from material misstatement, whether caused by fraud or
error. An auditor cannot obtain absolute assurance that material misstatements in the financial
statements will be detected because of such factors as the use of judgment, the use of testing, the
inherent limitations of internal control and the fact that much of the audit evidence available to the
auditor is persuasive rather than conclusive in nature.
The primary objective of an auditor is to express an opinion on the financial statements. However, the
auditor while conducting the audit is required to consider the risk of material misstatements in the
financial statements resulting from fraud or error. An audit conducted in accordance with the auditing
standards generally accepted in Nepal is designed to provide reasonable assurance that the financial
statements taken as a whole are free from material misstatement, whether caused by fraud or error. The
fact that an audit is carried out may act as a deterrent, but the auditor is not and cannot be held
responsible for the prevention of fraud and error.
The auditor's opinion on the financial statements is based on the concept of obtaining reasonable
assurance; hence, in an audit, the auditor does not guarantee that material misstatements, whether from
fraud or error, will be detected.
Question No. 25
You have attended physical verification of Supreme Garments Limited and noted no discrepancies
between the physical quantity and the Store Register for the year ending the management provides a
statement of value of stocks but refuses to provide with the cost sheet and calculations regarding how
the value has been arrived. The company discloses that the value of stocks is as “certified by the
management” in the Financial Statement. The management is ready to disclose the same in the
Management Representation letter. (5Marks June 2011)

Answer
As per NSA-500 “Audit Evidence”, Audit evidence regarding an assertion of existence of inventory
will not compensate for failure to obtain assertion regarding valuation. The auditor should satisfy
himself that the valuation of inventories is in accordance with the Nepal Accounting Standard -02
“Inventories”. The auditor should examine the methods of applying the basis of inventory valuation
which include examination of stock sheets, costing records and treatment of overhead expenses as a
part of cost of inventories. In the given case, it will be construed as limitation on the scope of auditors.
Accordingly, the auditor will have to issue a qualified opinion.
Certification by Management of Supreme Garments Ltd. cannot be taken as conclusive evidence and it
cannot relieve the duty of auditors when there are other procedures and means of gathering audit
evidence. Just because management had owned responsibility for the correctness of its valuation of
Stock/inventory, the auditor cannot shirk his responsibility. This is negligence on his part if he relies on
the management representation without assessing the corroborative available evidences.
Question No. 26
Nepal Standards on Auditing relating to "Management Representation" provides guidance on the use
of management representation as audit evidence. Enumerate five items that could be included in a
management representation letter. (5Marks June 2011)
Answer
Following matters form part of the management representation letter as per NSA 580 „Management
Representations‟:
 It is management's responsibility for the fair presentation of the financial statements in accordance
with Nepal Accounting Standards or relevant practices.
 No irregularities involving management or employees that could have a material effect on the
financial statements
 All books of account and supporting documentation have been made available to the auditors
 Information and disclosures with reference to related parties is complete
 Financial statements are free from material misstatements including omissions
 No non-compliance with any statute or regulatory authority requirements.
 No plans that will materially alter the carrying value or classification of assets or liabilities in the
financial statements
 No events, unless already disclosed, after the end of the reporting period that needs disclosure in
the financial statements.
Question No. 27
Mr. Lee Wee, partner of M/s Himal & Associates, a Chartered Accountant firm was appointed as an
auditor of Xian Commercial Bank Ltd. One of the shareholders of the bank lodged a complaint
against the auditor for not assuming the responsibilities to consider laws and regulations with

regards to lending to a business house in an audit of financial statements of the bank. You are asked
to identify the auditors „responsibilities to consider laws and regulations in an audit of financial
statements of bank with regards to complaint lodged against the auditor?
Answer
In accordance with NSA 200: "Overall Objective of the Independent Auditor and Conduct of Audit In
Accordance with Nepal Standards on Auditing" the auditor should plan and perform the audit with an
attitude of professional skepticism recognizing that the audit may reveal conditions or events that would
lead to questioning whether an entity is complying with laws and regulations.
In accordance with specific statutory requirements, the auditor may be specifically required to report as
part of the audit of the financial statements whether the entity complies with certain provisions of laws or
regulations. In these circumstances, the auditor would plan to test for compliance with these provisions of
the laws and regulations.
Further, the auditor should obtain sufficient appropriate audit evidence about compliance with those
laws and regulations generally recognized by the auditor to have an effect on the determination of
material amounts and disclosures in financial statements. The auditor should have a sufficient
understanding of these laws and regulations in order to consider them when auditing the assertions
related to the determination of the amounts to be recorded and the disclosures to be made.
Here, in given situation, the auditor should plan his audit and report for lending to a business house in
accordance with the prevailing banking rules and regulations. He should have sufficient knowledge of
statutory provisions of lending and its reporting in prescribed format.
Question No. 28
What are the points to be considered while using the work of an expert? (5 Marks, June 2011)
Answer
As per NSA 620, following points are relevant for using the work of an expert.
When determining whether to use the work of an expert or not, the auditor should consider:
 the materiality of the item being examined in relation to the financial information as a whole.
 the nature and complexity of the item including the risk of error therein, and
 the other audit evidence available with respect to the item.
Skills and competence of the expert:
When the auditor plans to use the expert‟s work as audit evidence, he should satisfy himself as to the
expert‟s skills and competence by
considering the expert‟s:
 professional certification, license or membership in an appropriate professional body.

 experience and reputation in the field in which the auditor is seeking evidence.
However, when the auditor uses the work of an expert employed by him, lie will not need to inquire into
his skills and competence.
Objectivity of the expert: The auditor should also consider the objectivity of the expert.
The risk that an expert‟s objectivity will be impaired increases when the expert is:
 employed by the client, or

 related in some other manner to the client.
Accordingly, in these circumstances, the auditor should (after taking into account the
factors stated above) consider performing more extensive procedures than would
otherwise have been planned, or lie might consider engaging another expert.
Question No. 29
Audit of the Sagarmatha Byapar Co. Pvt. Ltd. is in final stage and the audit report is being drafted.
Management of the company, including Chief Executive Officer, is of the view that auditors are
primarily responsible for preparation and fair presentation of financial statements. Management of
the company is of the view that they are free to prepare accounts in their own way and it is the duty of
the auditor to satisfy about financial statements to government and other regulatory agencies.
Comment (5 Marks, December 2011)
Answer
Nepal Standard on Auditing (NSA 200) mentions that while the auditor is responsible for forming and
expressing an opinion on the financial statements, the responsibility for preparing and presenting the
financial statements is that of the management of the entity. The audit of the financial statements does
not relieve management of its responsibility. Management rather than the auditor is responsible for the
preparation and fair presentation of financial statements. This responsibility includes designing,
implementing and maintaining internal control relevant to the preparation and fair presentation of
financial statements that are free from material misstatements, whether due to fraud or error, selecting
and applying appropriate accounting policies, and making accounting estimates that are reasonable in the
circumstances. Thus, the contention of the management is not correct.
Question No. 30
a) What is the relationship between materiality and audit risk and how audit risk can be reduced to
an acceptable level? (5 Marks December 2011)
b) What are the points to be considered while using the work of an expert? (5 Marks December
2011)

Answer
a. Answer
The auditor is concerned with expressing opinion on true and fairness of the financial statements.
Similarly, as per NSA-240 Nepal Standards on Auditing, the auditors' responsibility to consider
fraud and error in an audit of financial statements. Audit Risk is the risk that the auditor gives an
inappropriate audit opinion when the financial statements are materially misstated or the frauds and
errors are not reported. Due to nature of audit evidence and the characteristics of fraud, the auditor
is not able to obtain absolute assurance of detecting misstatements and frauds. Thus, the auditor
gives only reasonable assurance that material misstatements are detected.
The concept of materiality recognizes that some matters, either individually or in the aggregate, are
important for fair presentation of ﬁnancial statements in conformity with generally accepted
accounting principles, while other matters are not important. As per NSA-320 on Audit Materiality
the auditor should consider materiality and its relationship with audit risk when conducting an
audit. "Materiality" is defined in the Nepal Accounting Standards Board's "Framework for the
Preparation and Presentation of Financial Statements" in the following terms: "Information is
material if its omission or misstatement could influence the economic decisions of users taken on
the basis of the financial statements. Materiality depends on the size of the item or error judged in
the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold
or cut-off point rather than being a primary qualitative characteristic which information must have
if it is to be useful."
According to NSA-320 on Audit materiality, there is an inverse relationship between materiality
and degree of audit risk. Higher the materiality level, lower the audit risk and vice-versa. The risk
that a particular account balance or class of transaction would be mis-stated by an extremely large
amount might be very low. But the risk that it could be mis-stated by an extremely small amount
might be very high. The auditor considers this inverse relationship when he determines the nature,
timing and extent of his audit procedures. If after planning for specific audit procedures, he
concludes that acceptable materiality level is lower, audit risk is increased. The auditor should try
to reduce the audit risk to an acceptable level by:-
i. Reducing the assessed degree of control risk by carrying out extended or additional test of
control, or
ii. Reducing detection risk by modifying the nature, timing and extent of his substantive
procedures.
b) Answer
NSA 620 "Using the work of an expert" prescribes that when using the work performed by an
expert, the auditor should obtain sufficient appropriate audit evidence that such work is adequate
for the purposes of the audit. During the audit, the auditor may seek to obtain, in conjunction with
the client or independently, audit evidence in the form of reports, opinions, valuations, and
statements of an expert. Examples are:

a. Valuations of certain types of assets, for example, land and buildings, plant and machinery,
works of art, and precious stones.
b. Determination of quantities or physical condition of assets, for example, minerals stored in
stockpiles, mineral and petroleum reserves, and remaining useful life of plant and
machinery.
c. Determination of amounts using specialized techniques or methods, for example, an
actuarial valuation.
d. The measurement of work completed and to be completed on contracts in progress for the
purpose of revenue recognition.
e. Legal opinions concerning interpretations of agreements, statutes, regulations, notifications
circulars, etc.
When determining whether to use the work of an expert or not, the auditor should consider:
a) The materiality of the item being examined in relation to the financial information as a
whole.
b) the nature and complexity of the item including the risk of error therein, and
c) the other audit evidence available with respect to the item.
When the auditor plans to use the expert‟s work as audit evidence, he should satisfy himself as to the
expert‟s skills and competence by considering the expert‟s professional certification, license or
membership in an appropriate professional body and experience and reputation in the field in which the
auditor is seeking evidence.
However, when the auditor uses the work of an expert employed by him, he will not need to inquire
into his skills and competence.
The auditor should also consider the objectivity of the expert. The risk that an expert‟s objectivity will
be impaired increases when the expert is employed by the client, or related in some other manner to the
client.
Accordingly, in these circumstances, the auditor should (after taking into account the factors stated
above) consider performing more extensive procedures than would otherwise have been planned, or lie
might consider engaging another expert.
Question No 31
Mr. Alex Pitt, partner of M/s Pitt Marwick & Associates, a Chartered Accountant firm was appointed
as an auditor of Cosmopolitan Commercial Bank Ltd. One of the shareholders of the bank lodged a
complaint against the auditor for not assuming the responsibilities to consider laws and regulations
with regards to lending to a business house in an audit of financial statements of the bank. You are
asked to identify the auditors „responsibilities to consider laws and regulations in an audit of financial
statements of bank with regards to complaint lodged against the auditor? (5 Marks
December 2011)

Answer
with Nepal Standards on Auditing" the auditor should plan and perform the audit with an attitude of
professional skepticism recognizing that the audit may reveal conditions or events that would lead to
questioning whether an entity is complying with laws and regulations. In accordance with specific
statutory requirements, the auditor may be specifically required to report as part of the audit of the
financial statements whether the entity complies with certain provisions of laws or regulations. In these
circumstances, the auditor would plan to test for compliance with these provisions of the laws and
regulations.
Further, the auditor should obtain sufficient appropriate audit evidence about compliance with those laws
and regulations generally recognized by the auditor to have an effect on the determination of material
amounts and disclosures in financial statements. The auditor should have a sufficient understanding of
these laws and regulations in order to consider them when auditing the assertions related to the
determination of the amounts to be recorded and the disclosures to be made. Section 115(3) (e) of the
Nepal Company Act, 2063 specially states that the auditor should report any non-compliance of
prevailing laws. Further, Banks and financial Institutions Act 2063 also requires report of auditors on
certain matters. Thus, Here, in given situation, the auditor should plan his audit and report for lending to
a business house in accordance with the prevailing banking rules and regulations. He should have
sufficient knowledge of statutory provisions of lending and its reporting in prescribed format.
Question No. 32
One of the debtors of M/s General Trading Company Limited had filed a case in the court against the
company after the balance sheet date (financial statements for the year 2067/68) seeking that he
should be compensated with Rs. 500,000 for damage of goodwill due to the company's negligence
during the year 2067/68. The court decided the case in debtor's favor on before issuing the financial
statements for that year. The Chief Accountant wants to simply disclose this issue in the notes to the
account for the year 2067/68 without adjusting the compensation amount in the financial statement.
Express your view on Chief Accountant's move in accordance with relevant Accounting Standard.
(7 Marks December 2011

Answer
In accordance with NAS 10: “Events After the Reporting Period” an entity shall adjust the amounts
recognised in its financial statements to reflect adjusting events after the balance sheet date. However,
an entity shall not adjust the amounts recognised in its financial statements to reflect non-adjusting
events after the balance sheet date. In the given case, It seems that any contingent amount toward
compensation has not been accounted for as the debtor has filed a case in court after the balance sheet
date and the court has decided before issuing the financial statement. It shows that the receipt of
information about payment of compensation to the debtor after the balance sheet date was not into

existence at the balance sheet date. Therefore, the court decision in debtors‟ favour can be treated as
non-adjusting events as there was no existence of any event on balance sheet date and hence, only
disclosure in this regard including nature of the event and estimate of its financial effect would be
sufficient. The move of Chief Accountant in this case is as per the provision of Nepal Accounting
Standard 5.
Question No. 33
Enumerate, in brief, the important aspects to be evaluated by the external auditor in determining the
efficiency and extent of reliance to be placed on the work and function of an Internal Auditor.
Answer
Evaluation of Internal Audit Function: The external auditor should as a part of his audit, carryout
general evaluation of the internal audit function to determine the extent to which he can place reliance
upon the work of the internal auditor. As per NSA 610 "Relying Upon the Work of an Internal Auditor",
the important aspects to be considered by external auditor are:
i. Organizational Status: An important aspect is whether the audit is being carried out by outside
agency or by departmental team. Another related aspect is level in the organization to whom the
report is addressed and whether he is free to communicate with the external auditor.
ii. Scope of Function: Nature and depth of coverage of the internal audit and to what extent the
management considers and where appropriate, act upon the recommendations of the internal
auditor.
iii. Technical competence: Internal audit work is performed by persons having adequate technical
training and proficiency. Professional qualification and experience of the persons carrying out
internal audit function also need to be considered.
iv. Due Professional care: It should be ascertained that the internal audit appears to be properly
planned, supervised, reviewed and documented. Existence of proper internal audit manual,
programmes and working papers will lead to the establishment of due professional care.
The external auditor should document his evaluation and conclusion of all the above factors.
Question No. 34
Write Short Notes on the following

Analytical review procedures (5 Marks, June 2009, June 2011)
According to NSA 520 Analytical procedures, Analytical procedures mean the evaluations of financial
information made by a study of plausible relationships among both financial and non-financial data.

Analytical procedures also encompass the investigation of identified fluctuations and relationship that
are inconsistent with other relevant information or deviate significantly from predicted amounts.
Analytical review procedures include the consideration of comparisons of the entity‟s

financial information with, for example:
 Comparable information for prior periods

 Anticipated results of the entity, such as budgets or forecasts, or expectation of the auditor,
such as an estimation of depreciation.
 Similar industry information, such as a comparison of the entity‟s ratio of sales to account
receivable with industry averages, or with other entities of comparable size in the same
industry.
Analytical procedures also include consideration of relationships:
 Among elements of financial information that would be expected to confirm to a predictable

pattern based on the entity‟s experience, such as gross margin percentages.
 Between financial information and relevant non-financial information, such as payroll costs
to number of employees.
Analytical procedures are used for the following purposes:

a) As risk assessment procedures to obtain an understanding of the entity and its environment.
b) as substantive procedures when their use can be more effective or efficient than tests of
details in reducing the risk of material misstatement at the assertion level to an acceptably
low level
c) as an overall review of the financial statements at the end of the audit.
Question No. 35
Write Short Notes on the following

a) Management representation (5 Marks December 2011, June 2008)
NSA 580 “Written Representations”, establishes standards and provide guidance on the use of
management representations as audit evidence, the procedures to be applied in evaluating and
documenting management representations, and the action to be taken if management refuses to
provide appropriate representations.
The Auditor should obtain appropriate representations from management.
 That management acknowledges its responsibility for the fair presentation of the
financial statements in accordance with the applicable financial reporting framework,
and has approved the financial statements.

 Written representation from management on matters material to the financial

statements when another sufficient appropriate audit evidence cannot reasonably be
expected to exist.
 Management acknowledge its responsibility for the design and implementation of
internal control to prevent and detect error,
 Management believes the effects of those uncorrected financial statement
misstatements aggregated by the auditor during the audit are immaterial, both
individually and in the aggregate, to the financial statements taken as a whole.
Management representation constitutes audit evidence furnished by management to auditor in

respect of any transaction entered into by the entity. Management Representation is of great use
to the auditor when other sufficient appropriate audit evidence cannot reasonably be expected to
exist. In certain instances, such as where matter is principally of intention, a representation by
management may be the only audit evidence which can reasonably be expected to be available
for example intention of management to hold a specific investment for long term.
However, it cannot be a substitute for other audit evidences expected to be available.
b) Going concern concept (5 Marks December 2011)

Answer
The Framework for the preparation and presentation of Financial Statements states
The Financial statements are normally prepared on the assumption that an entity is going
entity has neither the intention nor the need to liquidate or curtail materially the scale of
operation, if such an intention or need exists, the financial statements may have to be prepared
on a different basis and if so, the basis used is disclosed.
This Going Concern concept envisages that the entity will continue for the foreseeable future.
Accounts are prepared on this concept unless there are indications that going concern
concept is not holding good for a particular entity. On account of this basic concept of going
concern, assets and liabilities are recorded on the basis that the entity will be able to realize its
assets and discharge its liabilities in the normal course of business. If this assumption is
unjustified, the entity may not be able to realize its assets at the recorded amounts and there may
be changes in the amounts and maturity dates of liabilities. NAS 1, „Nepal Accounting Standard
on Presentation of Financial Statements” requires that when financial statements are not
prepared on a going concern basis, that fact shall be disclosed, together with the basis on which
the financial statements are prepared and the reason why the entity is not considered as a going
concern.
NSA 570, “Going Concern”, establish standards and provide guidance on the auditor‟s
responsibility in the audit of financial statements with respect to the going concern assumption

used in the preparation of the financial statements, including considering management‟s

assessment of the entity‟s ability to continue as a going concern.
Question No. 36
As an auditor, give your opinions with reasons on the following cases:
a. Surya, a Chartered Accountant was engaged by Terai Company Pvt. Ltd. for auditing their
accounts. He sent his letter of engagement to the Board of Directors, which was accepted by the
company. In the course of audit of the company, the auditor was unable to obtain appropriate
sufficient audit evidence regarding inventories. The client requested for a change in the terms of
engagement. (5 Marks June 2012)
b. During the course of audit of M/s Grow Company Limited, you, as an auditor found huge
difference between the control accounts and subsidiary records. The chief finance controller
informed that this is common due to huge volume of business conducted by the company during
the year. How would you deal in this situation? (5 Marks June 2012)
Answer
a.) Answer
Nepal Standard on Auditing (NSA-210) states about the “Agreeing Terms of Audit Engagements”.
Auditor should consider following matters:
 An auditor who is required to change the engagement which requires lower level of assurance
before the completion of engagement should consider the appropriateness of doing so.
 But when the terms of engagement are changed, both the auditor and the client should agree on
the new terms.
 However, the auditor should not agree to a change in terms where there is no reasonable
justification for doing so.
In the instant case, the auditor was unable to obtain sufficient evidence regarding inventories. The
client requested him for a change in the terms of the agreement to avoid qualified/adverse opinion.
Hence there is no reasonable justification for change in the terms of engagement.
Thus, the auditor should not agree for change in the terms of engagement letter.
b.) Answer
The finding of huge difference between the control accounts and subsidiary records of M/s Grow
Company Limited indicates that there may be material misstatements requiring detailed examination
of the books and records so as to ascertain the reason for the difference. The contention of the chief
financial controller cannot be acceptable simply because the company has conducted huge volume of
business during the year. Such finding indicates recording of business transactions is not being done
properly or the accounting system in the company fails to capture all transactions in time. The auditor
would rather check whether it is a recurring phenomenon or not. He would also verify why such
reconciliation could not be done at a subsequent date. Considering all these facts, it may indicate the
possibility of some kind of material misstatements in the financial statements. As per NSA 240, “The
Auditor‟s Responsibility to Consider Fraud and Error in an audit of Financial Statements” the auditor

should perform procedures to determine whether the financial statements are materially misstated
when the auditor encounters the situation that there is material misstatement in the financial
statements. The auditor is required to report appropriately if he came across any material information
involving fraud or gross irregularity.
Question No. 37
While compiling the financial statements of a concern, you observed that the input information
supplied by the concern is incomplete, incorrect and few of the Accounting Standards have not been
followed. Describe, in brief, the procedure you will follow in the given circumstances.
(8 Marks June 2012)
Answer
According to para 32 NSRS 4410 “Engagements to Compile Financial Information”, an accountant
would normally have to rely upon the management for information to compile the financial statements in
a compilation engagement. If in the course of compilation of financial statements, it is observed that the
information supplied by the entity is incorrect, incomplete or otherwise unsatisfactory, the accountant
should perform following procedures:
i. Make any enquiries of management to assess the reliability and completeness of the information
provided;
ii. Assess internal controls prevailing in the entity; and
iii. Verify any matters or explanations.
The accountant may also request the management to provide additional information. This may be asked
in the form of management representation letter. If the management refuses to provide additional
information, the accountant should withdraw from the engagement, informing the entity of the reasons
for such withdrawal.
If one or more accounting standards are not complied with, the same should be brought to the notice of
the management and if the same is not rectified by the management, the accountant should include the
same in notes to the accounts and the compilation report to the management.
Question No. 38
Describe the policies to be considered by an auditor regarding quality control as prescribed in
quality control standard. (7 Marks June 2012)
Answer:
The policies to be considered by an auditor regarding quality control as prescribed in quality control
standard (NSQC) are given below:

 Professional requirements as mentioned in Code of Ethics,

Personnel in the firm are to adhere to the principles of independence, integrity, objectivity,
confidentiality and personal behaviors.
 Skills and competence,

Staffing should be arranged to maintain the technical and professional competence required to
enable them to fulfil their responsibilities with due care.
 Assignment,
Audit work to be assigned to personnel who have the degree of technical training and proficiency
required in the circumstances.
 Delegation,
There is to sufficient direction, supervision and review of work at all levels to provide reasonable
assurance that the work performed meets appropriate standards of quality.
 Consultation,
Whenever necessary, consultation within or outside the firm is to occur with those who have
appropriate expertise.
 Acceptance and Retention of Clients,

An evaluation of prospective clients and review, on an ongoing basis, of existing clients is to be
conducted. In making a decision to accept or retain a client, the firm's independence and ability to
serve the client properly are to be considered.
 Monitoring,
The continued adequacy and operational effectiveness of quality control policies and procedures
is to be monitored.
Question No. 39
"The auditors should communicate audit matters of governance interest arising from the audit of
financial statements with those charged with the governance of an entity". Briefly state the five major
matters to be included in such Communication. (5 Marks June 2012)
Answer
NSA 260 “Communication with Those Charged with Governance" deals with communications of audit
matters with those charged with governance.
The following are the audit matters of governance interest which are to be communicated.
 The general approach and overall scope of audit including expected limitations.

 The selection of or change in significant accounting policies and practices that have
a material effect on the entity‟s financial statements.
 The potential effect on the financial statements of any significant risks and exposures.
 Adjustment to financial statements arising out of audit which have a significant effect on the
financial statement.
 Material uncertainties that may cast significant doubt on the entity‟s ability to continue as a
going concern.
 Disagreement with management on matters which could have significant impact to the
financial statements and to audit report.
 Expected modifications to the audit report.
 Others matters like material weakness in internal control measures, questions on
management integrity and fraud involving management.
 Other matters agreed in terms of audit engagement., etc.
Question No. 40
Comment on the following situation.
On final audit of Hattiban Limited, the physical verification of fixed assets was conducted. However,
the auditor was not able to confirm the existence of valuable items and costly equipment. Though, the
auditor received a certificate from the management to prove its existence and value and accepted the
same blindly without applying any further procedures. (5Marks June 2012)
Answer:
The physical verification of fixed assets is the primary responsibility of the management. The auditor,
however, is required to examine the verification programme. Further, he must satisfy himself about the
existence, ownership, procession and valuation of fixed assets. It appears from the facts of the case that
the auditor has not been able to verify either existence or valuation of significant fixed assets despite
conducting physical verification audit procedure himself. Ultimately, he accepted the certificate from the
management without performing further procedures. As per NSA 580, “Written Representations”,
representation by management cannot be a substitute for other audit evidence that the auditor could
reasonably expect to be available. Thus, a representation by management as to the existence of valuables
and machinery is no substitute for adopting normal audit procedures regarding verification of valuable
and important machinery. If the auditor is unable to obtain sufficient appropriate audit evidence that he
believes will be available, this will constitute a limitation on the scope of his examination even if he has
obtained a representation from management on the matter.
Question No. 41
As an auditor, express your comments/views on the following situation:
You are appointed as an auditor of film distributing company. Besides acting as distributors of film, it
produces films under its own banner, owns a studio, which is also let out to other producers and also

owns a number of exhibiting halls showing exclusively the films under its distribution. Enumerate the
special points that you will include in your audit programme.
(7 Marks June 2012)
Answer
As mentioned in the Nepal Standard -300 on "Audit Planning”, the auditor should develop and document
an audit program setting out the nature, timing and extent of planned audit procedures required to
implement the overall audit plan. The audit program serves as a set of instructions to assistants involved
in the audit and as a means to control and record the proper execution of the work. The audit program
may also contain the audit objectives for each area and a time budget in which hours are budgeted for
various audit areas or procedures. In preparing the audit program, the auditor would consider the specific
assessments of inherent and control risks and the required level of assurance to be provided by
substantive procedures. The auditor would also consider the timing of tests of controls and substantive
procedures, the coordination of any assistance expected from the entity, the availability of assistants and
the involvement of other auditors or experts.
The following special matters deserve the auditors' attention in the audit of accounts in such case
industry:
Aspect Points to be consider on audit programme
Inter-  See whether separate records are kept for each different
departmental economic activity carried on by the company, viz.., (a)
services Distribution of films, (b) Production of films, (c) Ownership of
studio, and (d) Exhibition of films.
 When inter-departmental services are rendered, verify the basis
on which the expenditure and charges for services have been
adjusted in the account, i.e. Whether it has been done at cost or
the amounts charged included an element of profit.
Film  Ascertain the basis of valuation of pictures- the exhibition rights
Distribution wherein had not expired until the end of the year, and verify the
activity values placed on them.
 Scrutinize the advance or loans paid to producers to acquire
exhibition rights for pictures under production, to confirm that
these are good and realizable.
 Verify that adequate provision is made in respect of doubtful or
irrecoverable balances.
 Verify the receipts arising on exhibition of pictures both at the
theaters owned by the company and at other theaters by
reference to agreements entered in to with them.
Own  Verify the classification of expenditure for the purpose of
production adjustment, as capital and revenue expenses.

 Examine the basis on which the artists are remunerated and that
their remuneration is adjusted as cost of production of picture.
 Verify the basis on which the pictures have been transferred to
the distribution department and confirm that unrealized profit
on the inter-departmental transfer has been eliminated.
Studio hire  Verify whether income from hire of studio has been properly
Activity accounted by referring to Hall/ Shift booking diary.
 See whether proper cost adjustment has been made in respect of
studio used for the company's own film production. See
whether the rate charged is the same as that charged from
outsiders or only a proportion of the cost has been debited.
Exhibition  Test check the box-office collections for selected period by
activity reference to the record of tickets and for different shows, and
the free passes issued.
 Verify that the box office collections have been duly received
and deposited in the bank.
 Verify the copies of returns of box-office collections submitted
to distributors, by reference to copies of agreements entered
with them.
 Verify the receipts from exhibition of slides and the recovery of
contract monies from parties who run a canteen, a restaurant or
sell food and other articles to the public inside the theatre.
 Vouch the expenditure on advertisement, verifying specially
that the part thereof recovered from the distributors, on the basis
of exhibition contracts, has been recovered.
General  Verify the fixed assets and ensure that adequate deprecation is
Aspects provided.
 Scrutinize the accounts of sundry creditors for goods, creditors
for services and analyze whether there are any abnormal
movements.
 Verify whether the form and manner of presentation of financial
information conforms to accounting standards and applicable
legal requirements.
 Compare the financial statements of the current year with that
of the previous years, compute significant accounting ratio and
see whether there are whether there are any significant
unexplained deviations.
 Obtain appropriate management representation and certificates,
in respect of the various aspects covered during the course of
audit.

Question No. 42
As statutory Auditor of XYZ Pvt. Ltd. you requested your client for sending letter for balance
confirmations from certain debtors, the client argue that since the said balances with debtors are
under dispute and the matter is pending in the court it is not necessary to ask balance confirmation.
Answer:
NSA 505, “External Confirmations”, establishes standards on the debtor‟s use of external confirmation as
a means of obtaining audit evidence. It requires that the auditor should employ external confirmation
procedures in consultation with the management. The auditor may come across certain situations in
which the management may request him not to seek external confirmation from certain parties because of
dispute with the debtors, etc. The management, for example, might make such a request on the grounds
that due to a dispute with the particular debtor, the request for confirmation might aggravate the sensitive
negotiations between the entity and the debtor. In such cases, when an auditor agrees to management‟s
request not to seek external confirmation regarding a particular debtor, the auditor should consider
validity of grounds for such a request and assess management‟s integrity and obtain evidence to support
the same. The auditor should also ask the management to submit its request in a written form, dealing
therein the reasons for such a request. The auditor agrees to management‟s request not to seek external
confirmation regarding a particular matter, the auditor should document the reasons for accepting to the
management‟s request and should apply alternative procedures to obtain sufficient appropriate evidence
regarding that matter. While considering the validity of request, in case the auditor reaches at a
conclusion that the same was not valid, he may appropriately modify the report.
Question No. 43
As an auditor, give your opinions with reasons on the following case:
During the course of audit of a limited company, the auditor detected that the managing director had
committed a fraud involving a loss to the company. And the managing director has also fully
compensated the loss as committed by him to the company immediately after the detection of fraud.
(5 Marks June 2013)
Answer:
The detection of a fraud committed by the Managing Director involving a loss to the company is a
serious matter irrespective of the fact that the Managing Director has fully compensated the company
before the end of the fiscal year. In this context, NSA-240 on “the Auditor responsibility to consider
fraud and error in an audit of financial statements” enumerates responsibilities of the auditor in case
fraud and error to exist while conducting the audit. It requires, first of all that auditor should consider the
implications of the circumstances on the true and fair view which the financial statements ought to
convey and secondly, where the significant fraud has occurred, that auditor should consider the necessary
for a disclosure of fraud in the financial statements and if adequate disclosure is not made, the necessity
for a suitable disclosure in his report.

NSA 240 further defined the duties of the auditor to communicate these matters to the appropriate level
of management on a timely basis, and consider the need to report such matters to those charged with
governance in such case.
When the auditor has obtained evidence that fraud exists or may exist, it is important that the matter be
brought to the attention of an appropriate level of management. This is so even if the matter might be
considered inconsequential (for example, a minor defalcation by an employee at a low level in the
entity‟s organization). The determination of which level of management is the appropriate one is also
affected in these circumstances by the likelihood of collusion or the involvement of a member of
management. If the auditor has determined that the misstatement is, or may be, the result of fraud, and
either has determined that the effect could be material to the financial statements or has been unable to
evaluate whether the effect is material, the auditor: (a) discusses the matter and the approach to further
investigation with an appropriate level of management that is at least one level above those involved, and
with management at the highest level; and (b) if appropriate, suggests that management consult with
legal counsel.
Also, Sec 115(3) of Companies Act 2063 specifically requires the auditor to communicate the matters of
fraud identified during the course of audit.
Question No. 44
a) The chief executive officer of a client company has returned your draft representation letter stating
that the directors fail to see why such a letter is necessary and declaiming to issue the letter. (5
Marks June 2013)
b) The management of Shri Ram Pvt. Ltd. argued that auditor has not carried out the work properly
citing reason that certain fraud and error were revealed after issuing audit report, whereas audit
report was silent on such fraud & error. (5 Marks June 2013)
Answer
a) Answer
NSA 580 has defined the management representations while conducting the audit. The auditor
should obtain written representations from management on matters material to the financial
statements when other sufficient appropriate audit evidence cannot reasonably be expected to
exist. The possibility of misunderstandings between the auditor and management is reduced when
oral representations are confirmed by management in writing. Written representations requested
from management may be limited to matters that are considered either individually or collectively
material to the financial statements. Regarding certain items it may be necessary to inform
management of the auditor‟s understanding of materiality.

If management refuses to provide a representation that the auditor considers necessary, this
constitutes a scope limitation and the auditor should express a qualified opinion or a disclaimer of
opinion. In such circumstances, the auditor would evaluate any reliance placed on other
representations made by management during the course of the audit and consider if the other
implications of the refusal may have any additional effect on the auditor‟s report.
b) Answer
Nepal Standards on Auditing (NSA) 240 on „The Auditor's Responsibility to Consider Fraud and
Error in an Audit of Financial Statements‟ deals the matter on auditor responsibility. NSA 01 has
defined the objective of an audit of financial statements and as per this standard, the auditor
should express an opinion whether the financial statements are prepared, in all material respects,
in accordance with an identified financial reporting framework or relevant practices. An audit
conducted in accordance with NSAs or relevant practices is designed to provide reasonable
assurance that the financial statements taken as a whole are free from material misstatement,
whether caused by fraud or error. The fact that an audit is carried out may act as a deterrent, but
the auditor is not and cannot be held responsible for detection of fraud and error.
The management connotation on charge to auditor will be tenable only if the auditor fails to carry
out his duty under following parameters:
 Using professional skepticism for understanding the risk of material misstatements

resulting from the errors and frauds in financial statements.
 Audit preliminaries for gaining knowledge about any susceptibility of
misstatements arising from fraud; Audit planning with audit team, audit enquiry of
management; discussion with charge of corporate governance; identification of
fraud risk factors etc.
 Audit Response when fraud risk factors are identified to be present -Considering
modifying substantive procedures to reduce detection risk.
 Circumstances indicative of presence of misstatement resulting from fraud,
identification of misstatement.
 Determining the effect of misstatement in financial statements, tagging it with
fraud, documentation, communication and reporting.
 Awareness of auditor‟s responsibility in addition with the responsibility of that
charge of governance.
Question No. 45
a) An audit firm was requested to perform the audit of a trading company for the year 2068/69 where
all records relating to sales transactions were seized by Inland Revenue Department for
investigation. The company requested the auditor to accept the appointment saying that audit

report with qualification on sales is acceptable.

b) The auditor of G-Mall had completed the audit of the financial statements for the year 2069/70.
The date of the audit report was 8 Kartik 2070 whereas financial statements were approved by the
management of the company on 10 Kartik 2070.
a) Answer
In a given case the client is imposing the limitation on scope of audit. The term scope of an audit
refers to the audit procedures deemed necessary in the circumstances to achieve the objective of
the audit. The procedures required to conduct an audit in accordance with NSA should be
determined by the auditor having regard to the requirements of NSA, relevant professional bodies,
legislation, regulations and, where appropriate, the terms of the audit engagement and reporting
requirements.
An audit in accordance with NSA is designed to provide reasonable assurance that the financial
statements taken as a whole are free from material misstatement. Reasonable assurance is a concept
relating to the accumulation of the audit evidence necessary for the auditor to conclude that there are
no material misstatements in the financial statements taken as a whole. Reasonable assurance relates
to the whole audit process. However, there are inherent limitations in an audit that affect the
auditor's ability to detect material misstatements. These limitations result from factors such as:
a) The use of testing
b) The inherent limitations of any accounting and internal control system (e.g. the possibility of
collusion)
c) The fact that most audit evidence is persuasive rather than conclusive
Also the work undertaken by the auditor to form an opinion is permeated by judgment, in particular
regarding the gathering of audit evidence, e.g. in deciding the nature, timing and extent of audit
procedures; and the drawing of conclusion based on audit evidence gathered, e.g. assessing the
reasonableness of the estimates made by management in preparing the financial statements.
Other limitations may affect the persuasiveness of evidence available to draw conclusions on
particular financial statement assertions (e.g. transactions between related parties). In these cases
certain NSA(s) identify specified procedures which will, because of the nature of the particular
assertions provide sufficient appropriate audit evidence in the absence of unusual circumstances
which increase the risk of material misstatement beyond that which would ordinarily be expected; or
any indication that a material misstatement has occurred.
In the given situation the client is imposing a limitation on the scope of audit. Since all the records
relating to sales are not available for audit, the auditor is not in the position to perform alternate
audit procedures for audit of sales. Further, sales is the most important item of profit or loss

account (being a trading company) and hence without auditing sales an opinion on profit or loss
account cannot be provided. That is the auditor has no option but to provide disclaimer of opinion.
Since this situation is known to auditor before acceptance of engagement, it is advisable not to
accept such limited scope engagement unless required by statute.
b) Answer
NSA 700 "Forming an opinion and Reporting on Financial Statements" has defined the date of
report. As per this para the auditor should date the report as of the completion date of the audit.
This informs the reader that the auditor has considered the effect on the financial statements and
on the report of events and transactions of which the auditor became aware and that occurred up to
that date. Since the auditor's responsibility is to report on the financial statements as prepared and
presented by management, the auditor should not date the report earlier than the date on which the
financial statements are signed or approved by management.
The auditor should date the report on the financial statements no earlier than the date on which the
auditor has obtained sufficient appropriate audit evidence on which to base the opinion on the
financial statements. Sufficient appropriate audit evidence should include evidence that the entity‟s
complete set of financial statements has been prepared and that those with the recognized authority
have asserted that they have taken responsibility for them. Since the management has approved the
complete set of the financial statements on 10 Kartik 2070, it cannot be considered that the
management has taken the responsibility of the financial statements before 10 Kartik 2070. So, the
auditor should not have dated his report before 10 Kartik 2070.
Question No. 46
Write a short note on:
Guiding factors of materiality concept (2.5 Marks December 2013)

NSA 320 “Audit Materiality”, establishes standards on the concept of materiality and the relationship
with audit risk while conducting an audit. Guiding factors for determining the materiality are:
i. Item of materiality may be determined individually or in aggregate.

ii. The materiality depends on the regulatory or legal considerations.
iii. Materiality is not often reckoned with respect to quantitative details above. It has
qualitative dimensions as well.
A qualifying insurance policy (2.5 Marks December 2013)

A qualifying insurance policy is an insurance policy issued by an insurer that is not a related party (as
defined in NAS 24 Related Party Disclosures) of the reporting entity, if the proceeds of the policy:
a. can be used only to pay or fund employee benefits under a defined benefit plan; and

b. are not available to the reporting entity‟s own creditors (even in bankruptcy) and cannot be paid
to the reporting entity, unless either:
i. the proceeds represent surplus assets that are not needed for the policy to meet all the related
employee benefit obligations; or
ii. the proceeds are returned to the reporting entity to reimburse it for employee benefits already
paid.
Question No. 47
Answer the following: (5 marks each December 2013)
a) What are the elements that an auditor has to be considered while evaluating the design of the
entity‟s control environment?
b) State the reporting responsibilities of an auditor in the context of non-compliance of laws and
regulations in an audit of financial statements
c) Mention briefly the conditions or events, which increase the risk of fraud or error leading to
material misstatement in financial statements.
a) Answer
As per NSA 315 on Identifying and Assessing the Risk of Material Misstatement through
Understanding the Entity and Its Environment, the auditor should obtain an understanding of the
control environment. The control environment includes the governance and management
functions and the attitudes, awareness, and actions of those charged with governance and
management concerning the entity‟s internal control and its importance in the entity. The control
environment sets the tone of an organization, influencing the control consciousness of its people.
It is the foundation for effective internal control, providing discipline and structure.
The primary responsibility for the prevention and detection of fraud and error rests with both
those charged with governance and the management of an entity. In evaluating the design of the
control environment and determining whether it has been implemented, the auditor understands
how management, with the oversight of those charged with governance, has created and
maintained a culture of honesty and ethical behavior, and established appropriate controls to
prevent and detect fraud and error within the entity.
In evaluating the design of the entity‟s control environment, the auditor considers the following
elements and how they have been incorporated into the entity‟s processes:
i. Communication and enforcement of integrity and ethical values – essential elements

which influence the effectiveness of the design, administration and monitoring of controls.
ii. Commitment to competence – management‟s consideration of the competence levels for
particular jobs and how those levels translate into requisite skills and knowledge.

iii. Participation by those charged with governance – independence from management, their
experience and stature, the extent of their involvement and scrutiny of activities, the
information they receive, the degree to which difficult questions are raised and pursued with
management and their interaction with internal and external auditors.
iv. Management’s philosophy and operating style – management‟s approach to taking and
managing business risks, and management‟s attitudes and actions toward financial reporting,
information processing and accounting functions and personnel.
v. Organizational structure – the framework within which an entity‟s activities for achieving
its objectives are planned, executed, controlled and reviewed.
vi. Assignment of authority and responsibility – how authority and responsibility for
operating activities are assigned and how reporting relationships and authorization
hierarchies are established.
vii. Human resource policies and practices – recruitment, orientation, training, evaluating,
counseling, promoting, compensating and remedial actions.
b) Answer
NSA 250 “Consideration of Laws and Regulations In an Audit of Financial Statements” has
defined the reporting responsibilities of an auditor in the context of non-compliance of laws and
regulations in an audit of financial statements.
The auditor should as soon as practicable, either communicate with the audit committee, the
Board of Directors and senior management or obtain evidence that they are appropriately
informed regarding non-compliance that comes to the auditor‟s attention.
If in the auditor‟s Judgment, the non-compliance is believed to be intentional and/ or material, the
auditor should communicate the findings without delay.
If the auditor suspects that members of senior management, including members of the Board of
Directors, are involved in non-compliance, the auditor should communicate the matter to the next
higher level of authority at the entity, such as, the audit committee or Board of Directors, to the
users of the auditors‟ report or financial statements.
If the auditor concludes that the non-compliance has a material effect on the financial statements
and has not been properly reflected in the financial statements the auditor should express a
qualified or an adverse opinion.
If the auditor is precluded by the entity from obtaining sufficient and appropriate audit evidence
to evaluate whether non-compliance is, or is likely to have occurred that have or may have
material impact on the financial statements, the auditor should express a qualified opinion or a
disclaimer of opinion on the financial statements on the basis of a limitation on the scope of the
audit.

If the auditor is unable to determine whether non-compliance has occurred because of limitations
imposed by the circumstances rather than by the entity, the auditor should consider the effect on
the auditor‟s report.
The auditor‟s duty of confidentiality would ordinarily preclude reporting non-compliance to a

third party. However, in certain circumstances, that duty of confidentiality is overridden by
statement, law or by courts of laws.
c) Answer
NSA 240 "The Auditors Responsibilities Relating to Fraud in and Audit of Financial Statements"
has defined the risk of fraud and error in the entity. In planning and performing his examination,
the auditor should take into consideration the risk of material misstatements of the financial
information caused by fraud or error. Weaknesses in the design of the internal control system and
non-compliance with identified control procedures amongst other conditions or events which
increase the risk of fraud or errors are:
 Weaknesses in the design of the internal control system and non-compliance with the laid
down control procedures.
 Doubts about the integrity or competence of the management.
 Unusual pressures within the entity
 Unusual transactions
 Problem in obtaining sufficient and appropriate audit evidence.
Question No. 48

a) Auditor of Elephant Ltd. was unable to confirm the existence and valuation of stock lying at the
remote project site and accepted a certificate from the management without obtaining other audit
evidence.
b) P.G. & Company is the auditors of Professional Systems Company Ltd. The Managing Director of
the Company demands copies of the working papers from the auditors. Are the auditors bound to
oblige the Managing Director?
a) Answer
As per NSA 580 on “Written Representation” in the course of audit, an auditor comes across
various matters in respect of which he is not able to obtain sufficient appropriate audit evidence.
In such a situation he may rely on the submission by the management but he should seek
corroborative audit evidence from sources inside or outside the entity and evaluate the
representation made by management.

Management representation is not a substitute for other audit evidence. The auditor should seek
and apply normal audit procedure. Mere possession of a certificate does not absolve the auditor
from his liability. He should not seek or accept certificates when subject matter is such that it is
capable of verification from internal and/or external evidences.
In the instant case, the stock site material lying with the remote project site can be easily verified
with purchase order, invoice, bill of entry, custom document, physical verification report from
independent authority, visual means for observing stock etc.
Therefore, the auditor in this instant case has not used available evidences. He should not have
rested with the certificate obtained from the management and could have evaluated other
evidences. He may be held liable for negligence and professional misjudgment. But, if the stock
is not material to the financial statement because of low value, the auditor can accept
management representation as evidence if there are no reasons to question the authenticity of
representation made by the management.
b) Answer
As per principle of Audit Documentation, the working papers are the property of the auditor, the
auditor may, at his discretion make portion of or extracts from his working papers available to the
client. In the instant case the managing director of the company has demanded copies of the
working papers from the auditor. He has no right to obtain copies of the working papers from the
auditor because they are the property of the auditor. However, the auditor may at his discretion
make portions of or extracts from the working paper to the managing director of Professional
Systems Company Ltd.
Conclusion:
The auditor is not bound to oblige the managing director by supplying copies of the audit working
papers.
Question No. 49
What are the factors that are to be considered while designing a confirmation request? (5 Marks June
2014)
As per NSA -505 “External Confirmations”, the design of a confirmation request may directly affect the
confirmation response rate, and the reliability and the nature of the audit evidence obtained from
responses. The following factors should be considered while designing a confirmation request: -
 The assertions being addressed.

 Specific identified risks of material misstatement, including fraud risks.

 The layout and presentation of the confirmation request.

 Prior experience on the audit or similar engagements.
 Management‟s authorization to the confirming parties to respond to the auditor. Confirming
parties may only be willing to respond to a confirmation request containing management‟s
authorization.
 The ability of the confirming party to provide the requested information
Question No. 50
Comment on the following situations/statements: (5 Marks each June 2014)
a) Auditor of Makalu Ltd. is of the opinion that “Nepal Standards of Auditing” are meant only for
references and it is not mandatory to adhere such Standards.
b) Explain Principal Auditor in line with NSA 600. What are the factors to be considered by auditor
to act as Principal Auditor?
Answer:
a) Answer
Contention of the auditor is totally wrong and is against the fundamental assumptions and
guidelines governing Nepal Standards on Auditing.
NSA 200 "Objectives and General Principles Governing an Audit of Financial Statements" stated
that the auditor should conduct an audit in accordance with the Nepal Standards on Auditing.
These contain basic principles and essential procedures together with related guidance in the form
of explanatory and other material.
As per ICAN, while discharging their attest function, it will be the duty of the members of the
Institute to ensure that the NSAs are followed. The NSAs will apply whenever an independent
financial audit is carried out to express an opinion thereon.
The member of the Institute must follow the NSAs. The auditors must draw attention to the
material departures from NSAs in their audit report along with the reasons for such departure.
Auditors in their report has to mention that audit was conducted in accordance with “Nepal
Standards on Auditing” in Nepalese context.
Hence the auditor is duty bound to follow the NSAs.
b) Answer
As per NSA 600 Principal auditor means the auditor with responsibility for reporting on the
financial statements of an entity when those financial statements include financial information of
one or more components audited by another auditor.

The auditor should consider whether the auditor‟s own participation is sufficient to be able to act
as the principal auditor. For this purpose, the principal auditor would consider:
(a) the materiality of the portion of the financial statements which the principal auditor audits;
(b) the principal auditor‟s degree of knowledge regarding the business of the components;
(c) the risk of material misstatements in the financial statements of the components audited by the
other auditor; and
(d) the performance of additional procedures as set out in this NSA regarding the components
audited by the other auditor resulting in the principal auditor having significant participation
in such audit.
Question No. 51
a) Professional skepticism (2.5 Marks June 2014)
b) Use of positive confirmations (2.5 Marks June 2014)
a) Answer
It is a requirement of NSA 200 and NSA 240 that, when planning and performing an audit, the
auditor should adopt an attitude of professional skepticism. Professional skepticism is defined by
NSA 200 as an attitude that includes a questioning mind, being alert to conditions which may
indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.
This does not mean that the auditors should disbelieve everything they are told, but they should
view what they are told with a skeptical attitude, and consider whether it appears reasonable and
whether it conflicts with any other evidence. In other words, they must not simply believe
everything management tells them.
b) Answer
A positive external confirmation request asks the respondent to reply to the auditor in all cases
either by indicating the respondent‟s agreement with the given information, or by asking the
respondent to fill in information. A response to a positive confirmation request is ordinarily
expected to provide reliable audit evidence. There is a risk; however, that a respondent may reply
to the confirmation request without verifying that the information is correct. The auditor is not
ordinarily able to detect whether this has occurred. The auditor may reduce this risk, however, by
using positive confirmation requests that do not state the amount (or other information) on the
confirmation request, but ask the respondent to fill in the amount or furnish other information. On
the other hand, use of this type of “blank” confirmation request may result in lower response rates
because additional effort is required of the respondents.

Question No. 52
Answer the following (5 Marks each December 2014)
a) Explain „Audit Sampling‟ and „Sampling Risk‟ in the light of NSA - 530 Audit Sampling and
Other Selective Testing Procedures.
Answer
Audit sampling involves the application of audit procedures to less than 100% of items within an
account balance or class of transactions such that all sampling units have a chance of selection. This
will enable the auditor to obtain and evaluate audit evidence about some characteristic of the items
selected in order to form or assist in forming a conclusion concerning the population from which the
sample is drawn. Audit sampling can use either a statistical or a non-statistical approach.
Sampling risk arises from the possibility that the auditor's conclusion, based on a sample may be
different from the conclusion reached if the entire population were subjected to the same audit
procedure. There are two types of sampling risk:
i. the risk the auditor will conclude, in the case of a test of control, that control risk is lower
than it actually is, or in the case of a substantive test, that a material error does not exist when
in fact it does. This type of risk affects audit effectiveness and is more likely to lead to an
inappropriate audit opinion; and
ii. the risk the auditor will conclude, in the case of a test of control, that control risk is higher
than it actually is, or in the case of a substantive test, that a material error exists when in fact
it does not. This type of risk affects audit efficiency as it would usually lead to additional
work to establish that initial conclusions were incorrect.
Question No. 53
“Responsibility for properly determining the quantity and value of inventories rests with the
management of the entity”. Comment (5 Marks December 2014)
Answer
with Nepal Standards on Auditing" the responsibility for preparing and presenting the financial
statements is that of the management of the entity. Accordingly, the responsibility for properly
determining the quantity and value of inventories rests with the management of the entity. Therefore, it is
the responsibility of the management of the entity to ensure that inventories included in the financial
information are physically in existence and represent all owned by the entity.
The management can satisfy this responsibility by carrying out appropriate procedures such as
verification of all items of inventory at least once in every financial year. The auditor is expected to

examine the adequacy of the methods and procedures of physical verification followed by the entity. He
is also required to determine whether the procedures for identifying defective, damaged, obsolete, excess
and slow-moving items are well-designed and operate properly.
This responsibility of the management is not reduced even where the auditor attends any physical count
of inventories in order to obtain audit evidence. The entities usually maintain detailed stock records in the
form of Stores/Stock ledgers showing in respect of each major item the receipts, issues and balances. The
extent of examination of these records by an auditor with reference to the relevant basic documents (e.g.,
goods received notes, inspection reports, material issue notes, bin cards, etc.) depends upon the facts and
circumstances of each case. In valuation aspects, compliance with NAS 02 should also be ensured.
Question No. 54
What are the principal contents of Terms of Audit Engagement as per NSA 210?
Answer
The form and content of audit engagement letters may vary for each client, but they would generally
include reference to:

pronouncements of the Institute of Chartered Accountants of Nepal (ICAN).
inherent limitations of any accounting and internal control system, there is an unavoidable risk that
even some material misstatement may remain undiscovered.
 Management's responsibility for establishing and maintaining effective internal control.
Other matters that may be included are:

 Description of the basis for fees.
 Ownership and accessibility of the auditor‟s files to external parties.
 Interactions with specialists, internal auditors, and the predecessor auditor needed to conduct the
audit
 Restrictions to the auditor's liability.

Question No. 55
Explain the circumstances when work of the internal audit function cannot be used by External
Auditor. (December 2015)
Answer
The external auditor‟s evaluation of whether the internal audit function of organizational status and
relevant policies and procedures adequately support the objectivity of the internal auditors, the level of
competence of the internal audit function, and whether it applies a systematic and disciplined approach
may indicate that the risks to the quality of the work of the function are too significant and therefore it is
not appropriate to use any of the work of the function as audit evidence.
Consideration of the factors of NSA 610 individually and in aggregate is important because an individual
factor is often not sufficient to conclude that the work of the internal audit function cannot be used for
purposes of the audit. For example, the internal audit function‟s organizational status is particularly
important in evaluating threats to the objectivity of the internal auditors.
If the internal audit function reports to management, this would be considered a significant threat to the
function‟s objectivity.
This is because of the possibility that the engagement team will use the results of the internal audit
service without properly evaluating those results or without exercising the same level of professional
skepticism as would be exercised when the internal audit work is performed by individuals who are not
members of the firm.
Question No. 56
The financial statement of Sagarmatha Ltd. for the fiscal year 2070/71 has been approved by its Board
of Directors on 1 Kartik 2071; auditor has issued his audit report on 25 Aswin 2071. Give your
comments (December 2015)
Answer
As Per NSA 700 , the auditor should date the report as of the completion date of the audit. This informs
the reader that the auditor has considered the effect on the financial statements and on the reports of
events and transactions of which the auditor become aware and that occurred up to that date. Since the
auditor`s responsibility is to report on the financial statements as prepared and presented by management,
the auditor should not date the report earlier than the date on which the financial statements are signed or
approved by Board of Directors.
Question No. 57
What do you mean by the term 'Sufficient Appropriate Audit Evidence'? State various factors that
help the auditor to ascertain as to what is sufficient appropriate audit evidence.
(December 2015)

Answer
The auditor shall design and perform audit procedures that are appropriate in the circumstances for the
purpose of obtaining sufficient appropriate audit evidence. NSA 500 on „Audit Evidence‟ further
expounds this concept. According to it, the sufficiency and appropriateness of audit evidence are
interrelated.
Sufficiency is the measure of the quantity of audit evidence. The quantity of audit evidence needed is
affected by the auditor‟s assessment of the risks of misstatement (the higher the assessed risks, the more
audit evidence is likely to be required) and also by the quality of such audit evidence (the higher the
quality, the less may be required). Obtaining more audit evidence, however, may not compensate for its
poor quality.
Appropriateness is the measure of the quality of audit evidence; that is, its relevance and its reliability in
providing support for the conclusions on which the auditor‟s opinion is based. The reliability of evidence
is influenced by its source and by its nature, and is dependent on the individual circumstances under
which it is obtained.
NSA 330 requires the auditor to conclude whether sufficient appropriate audit evidence has been
obtained. Whether sufficient appropriate audit evidence has been obtained to reduce audit risk to an
acceptably low level, and thereby enable the auditor to draw reasonable conclusions on which to base the
auditor‟s opinion, is a matter of professional judgment. Further, NSA 200 contains discussion of such
matters as the nature of audit procedures, the timeliness of financial reporting, and the balance between
benefit and cost, which are relevant factors when the auditor exercises professional judgment regarding
whether sufficient appropriate audit evidence has been obtained.
In general the various factors which may influence the auditor‟s judgment as to what is sufficient and
appropriate audit evidence are as under:
 Degree of risk of misstatements which may be affected by factors such as the nature of items,
adequacy of internal control, nature and size of businesses carried out by the entity, situations
which may exert an unusual influence on management and the financial position of the entity.
 The materiality of the item.
 The experience gained during previous audits.
 The results of auditing procedures, including fraud and errors which may have been found.
 The type of information available.
 The trend indicated by accounting ratios and analysis.
Question No. 58
The auditor of a company is unable to obtain audit evidence relating to business promotion
expenditures of Rs. 1 lakh. The company has earned net profit of Rs. 1 billion and has net asset base
of Rs. 10 billion. The management explains that the expenditure is genuine although the said invoices
are misplaced. However, auditor requests the management either not to charge the said promotional

expenditure to profit or loss statement or he will qualify his audit report. The auditor does not have
any issue raising question on the faithful presentation and preparation of the financial statements. (5
Marks June 2016)
Answer
As per NSA 705, "Modification to the opinion in the independent Auditor's Report', the auditor shall
express a qualified opinion when:
i) The auditor, having obtained sufficient appropriate audit evidence, concludes that
misstatements, individually or in the aggregate, are material, but not pervasive, to the
financial statements; or
ii) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the
opinion, but the auditor concludes that the possible effects on the financial statements of
undetected misstatements, if any, could be material but not pervasive.
Rs 1 lakh expenses for a company which earns net profit of Rs 1 billion and having net assets
base of Rs 10 billion seems to be immaterial/insignificant because omission or misstatement
of expenditure by Rs 1 lakh in this case is unlikely to affect the decision of the users due to
this omission/misstatement. Since the auditor does not have any other issue on faithful
preparation and presentation of the financial statements, qualifying audit opinion for
immaterial impact does not seem to be appropriate. The auditor should however communicate
the finding through management letter with the recommendation to strengthen the system of
proper maintenance and retention of supporting evidence.
Question No. 59
a) Knowledge of client business is important for effective and efficient conduct of the audit. Please
explain the various sources from which the auditor can obtain such knowledge.
b) Audit evidences collected from different sources and of different nature are not equally reliable.
Please explain.
c) It is not necessary to sign audit engagement letter every year in case of recurring/ongoing
audits. Please explain the statement as per provisions of NSA 210.
Answer
a) Sources for obtaining Knowledge of the client business:
The various sources from which the auditor can obtain knowledge of the client business are:
 General economic factors and industry conditions affecting the client‟s business.
 Important characteristics of the client, its business, its financial performance and its reporting
requirements including changes since the date of the prior audit.
 The general level of competence of the management.

 The clients annual report to shareholders.

 Minutes of meetings of shareholders, board of directors and important committees.
 Internal financial management reports for current and previous periods, including budgets.
 The previous year audit working papers and other relevant files.
 Firm personnel responsible for non-audit services to the client who may be able to provide
information on matters that may affect audit.
 Discussions with the client.
 The client‟s policy and procedures manual.
 Relevant publications of ICAN and other professional bodies, industry publications, trade
journals, magazines, newspapers etc.
 Consideration of state of economy and its effect on the client‟s business and
 Visits to the client‟s premises and plant facilities.
b) Reliability of audit evidences: The reliability of audit evidence is influenced by its source and by
its nature and is dependent on the individual circumstances under which it is obtained.
Generalizations about the reliability of various kinds of audit evidence can be made; however,
such generalizations are subject to important exceptions.
While recognizing that exceptions may exist, the following generalizations about the reliability of
audit evidence may be useful:
 Audit evidence is more reliable when it is obtained from independent sources outside the
entity.
 Audit evidence that is generated internally is more reliable when the related controls
imposed by the entity are effective.
 Audit evidence obtained directly by the auditor (for example, observation of the application
of a control) is more reliable than audit evidence obtained indirectly or by inference (for
example, inquiry about the application of a control).
 Audit evidence is more reliable when it exists in documentary form, whether paper,
electronic, or other medium (for example, a contemporaneously written record of a meeting
is more reliable than a subsequent oral representation of the matters discussed).
 Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles.
c) Audit Engagement Letter in Recurring Audit: As per NSA 210, on recurring audits, the auditor
shall assess whether circumstances require the terms of the audit engagement to be revised and
whether there is a need to remind the entity of the existing terms of the audit engagement. The
auditor may decide not to send a new audit engagement letter or other written agreement each
period.

However, the following factors may make it appropriate to revise the terms of the audit
engagement or to remind the entity of existing terms:
 Any indication that the entity misunderstands the objective and scope of the audit.
 Any revised or special terms of the audit engagement.
 A recent change of senior management.
 A significant change in ownership.
 A significant change in nature or size of the entity‟s business.
 A change in legal or regulatory requirements.
 A change in the financial reporting framework adopted in the preparation of the financial
statements.
 A change in other reporting requirements.
Question No. 60
LMN Ltd. deals in electronic goods and has 4 warehouses at different locations in Nepal out of
which2 warehouses at Birgunj Custom borders. The major stocks are generally supplied from
warehouse at Birgunj. LMN Ltd. appointed M/s OPQ & Co. to conduct its audit for the financial year
2072/73. Due to earthquake and subsequent strike for 3-4 months, the warehouse at Birgunj was
inaccessible and the auditors were not able to conduct physical verification.
(5
Answer
In some cases, attendance at physical inventory counting may be impracticable. This may be due to
factors such as the nature and location of the inventory, for example, where inventory is held in a
location that may pose threats to the safety of the auditor. The matter of general inconvenience to the
auditor, however, is not sufficient to support a decision by the auditor that attendance is impracticable.
Further, as explained in NSA 200 “Overall Objectives of the Independent Auditor and the Conduct of
an Audit in Accordance with Nepal Standards on Auditing”, the matter of difficulty, time, or cost
involved is not in itself a valid basis for the auditor to omit an audit procedure for which there is no
alternative or to be satisfied with audit evidence that is less than persuasive. Further, where attendance
is impracticable, alternative audit procedures, for example, inspection of documentation of the
subsequent sale of specific inventory items acquired or purchased prior to the physical inventory
counting, may provide sufficient appropriate audit evidence about the existence and condition of
inventory.
In some cases, though, it may not be possible to obtain sufficient appropriate audit evidence regarding
the existence and condition of inventory by performing alternative audit procedures. In such cases,
NSA 705 on Modifications to the Opinion in the Independent Auditor‟s Report, requires the auditor to
modify the opinion in the auditor's report as a result of the scope limitation.

Question No. 61
NSA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the
Entity and Its Environment describes the five components of an entity‟s internal control. Briefly
explain the five components of an entity‟s internal control.
Answer
NSA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the
Entity and Its Environment considers the components of an entity‟s internal control. It identifies the
following components:
 Control environment
The control environment includes the governance and management functions and the attitudes,
awareness, and actions of those charged with governance and management concerning the entity‟s
internal control and its importance in the entity. The control environment sets the tone of an
organization, influencing the control consciousness of its people.
The control environment has many elements such as communication and enforcement of integrity and
ethical values, commitment to competence, participation of those charged with governance,
management‟s philosophy and operating style, organizational structure, assignment of authority and
responsibility and human resource policies and practices.
 Entity’s risk assessment process
For financial reporting purposes, the entity‟s risk assessment process includes how management
identifies business risks relevant to the preparation of financial statements in accordance with the
entity‟s applicable financial reporting framework. It estimates their significance, assesses the
likelihood of their occurrence, and decides upon actions to respond to and manage them and the
results thereof.
 Information system, including the related business processes, relevant to financial
reporting, and communication
The information system relevant to financial reporting objectives, which includes the accounting
system, consists of the procedures and records designed and established to initiate, record, process,
and report entity transactions (as well as events and conditions) and to maintain accountability for the
related assets, liabilities, and equity.
 Control activities relevant to the audit
Control activities are the policies and procedures which help ensure that management directives are
carried out. Control activities, whether within information technology or manual systems, have
various objectives and are applied at various organizational and functional levels.

 Monitoring of controls
Monitoring of controls is a process to assess the effectiveness of internal control performance over
time. It involves assessing the effectiveness of controls on a timely basis and taking necessary
remedial actions. Management accomplishes the monitoring of controls through ongoing activities,
separate evaluations, or a combination of the two. Ongoing monitoring activities are often built into
the normal recurring activities of an entity and include regular management and supervisory
activities.
Question No. 62
a) NSA 300 Planning an Audit of Financial Statements provides guidance to assist auditors in
planning an audit. Explain the benefits of audit planning.
b) NSA 210 Agreeing the Terms of Audit Engagements requires auditors to agree the terms of an
engagement with those charged with governance and formalize these in an engagement letter.
Identify and explain the factors which would indicate that an engagement letter for an existing
audit client should be revised.
c) Verisk Limited has employed an Independent Actuary (Dansk & Co.) for actuarial valuation of its
employees‟ long-term liabilities for the year end 31st Ashadh 2073. This was the first year of
actuarial valuation. CA Mangesh was statutory auditor for the company. He was satisfied with the
appropriateness and reasonableness of the assumptions and methods used along with financial
data reflected in the financial statement and decided to issue an unmodified report. He also added
following in his report for more clarity on the subject “The employees‟ long-term liabilities are
based on actuarial valuation by Dansk & C0.”
Answer:(a)
Benefits of audit planning
Audit planning is addressed by NSA 300 Planning an Audit of Financial Statements. It states that
adequate planning benefits the audit of financial statements in several ways:
 Helping the auditor to devote appropriate attention to important areas of the audit.
 Helping the auditor to identify and resolve potential problems on a timely basis.
 Helping the auditor to properly organize and manage the audit engagement so that it is
performed in an effective and efficient manner.
 Assisting in the selection of engagement team members with appropriate levels of capabilities
and competence to respond to anticipated risks and the proper assignment of work to them.
 Facilitating the direction and supervision of engagement team members and the review of
their work.
 Assisting, where applicable, in coordination of work done by experts.

Answer:(b)
Engagement letters for recurring/existing clients should be revised if any of the following factors are
present:
 Any indication that the entity misunderstands the objective and scope of the audit, as this
misunderstanding would need to be clarified.
 Any revised or special terms of the audit engagement, as these would require inclusion in
the engagement letter.
 A recent change of senior management or significant change in ownership. The letter is
signed by a director on behalf of those charged with governance; if there have been
significant changes in management, they need to be made aware of what the audit
engagement letter includes.
 A significant change in nature or size of the entity‟s business. The approach taken by the
auditor may need to change to reflect the change in the entity and this should be clarified in
the engagement letter.
 A change in legal or regulatory requirements. The engagement letter is a contract; hence if
legal or regulatory changes occur, then the contract could be out of date.
 A change in the financial reporting framework adopted in the preparation of the financial
statements. The engagement letter clarifies the role of auditors and those charged with
governance, it identifies the reporting framework of the financial statements and if these
changes, then the letter requires updating.
 A change in other reporting requirements. Other reporting requirements may be stipulated in
the engagement letter; hence if these changes, the letter should be updated.
Answer:(c)
 NSA 620 “Using the work of an expert” requires that “when issuing an unmodified
auditor‟s report, the auditor should not refer to the work of an expert”. Such reference might
be misunderstood to be a qualification of the auditor‟s opinion or diversion of responsibility,
neither of which is intended.
 In the given context, the reporting by CA Mangesh is more inclined to “emphasis of matter”
under modified reports (matters that do not affect the auditor‟s opinion). Hence, CA
Mangesh should not refer the actuarial valuation in his audit report. However, he must
ensure that adequate disclosures about the actuarial valuation and the related figures have
been reflected by the Management in the Financial Statement.
Question No. 63
a) Competence of the audit engagement team (5 Marks June 2016)

b) Financial indicators of going concern issue (5 Marks June 2016)

c) Subsequent Events (2.5 Marks December 2017)
Answer
a) The appropriate capabilities and competence expected of the engagement team as a whole
include the following:
 An understanding of, and practical experience with, audit engagements of a similar

nature and complexity through appropriate training and participation.
 An understanding of professional standards and regulatory and legal requirements.
 Appropriate technical knowledge, including knowledge of relevant information
technology.
 Knowledge of relevant industries in which the client operates.
 Ability to apply professional judgment.
 An understanding of the firm‟s quality control policies and procedures.
b) Financial Indicators
 Net liability or net current liability position.
 Fixed‐term borrowings approaching maturity without realistic prospects of renewal or
repayment; or excessive reliance on short‐term borrowings to finance long‐term assets.
 Indications of withdrawal of financial support by debtors and other creditors.
 Negative operating cash flows indicated by historical or prospective financial statements.
 Adverse key financial ratios.
 Substantial operating losses or significant deterioration in the value of assets used to
generate cash flows.
 Arrears or discontinuance of dividends.
 Inability to pay creditors on due dates.
 Inability to comply with the terms of loan agreements.
 Change from credit to cash‐on‐delivery transactions with suppliers.
 Inability to obtain financing for essential new product development or other essential
investments.
c) Subsequent Events: NSA 560 on “Subsequent Events”, defines the term “subsequent events” as
events occurring between the date of the financial statements and the date of the auditor‟s
report, and facts that become known to the auditor after the date of the auditor‟s report.,
“subsequent events” also refer to significant events which occurred up to the date of report of
the auditor of that component. Thus, subsequent events are those events which occur after the
date of the balance sheet till the audit report is signed by the auditor.

Question No. 64
a) Uses of Negative External Confirmation Requests (2.5 Marks June 2017)
b) Use of assertion in an Audit of financial statements (2.5 Marks June 2017)
c) Key Audit Matters (2.5 Marks June 2017)
Answer:
a) Uses of Negative External Confirmation Requests
A negative external confirmation request asks the respondent to reply only in the event of
disagreement with the information provided in the request. However, when no response has been
received to a negative confirmation request, the auditor remains aware that there will be no explicit
evidence that intended third parties have received the confirmation requests and verified that the
information contained therein is correct. Accordingly, the use of negative confirmation requests
ordinarily provides less reliable evidence than the use of positive confirmation requests, and the
auditor considers performing other substantive procedures to supplement the use of negative
confirmations.
Negative confirmation requests may be used to reduce audit risk to an acceptable level when: (a) the
assessed level of inherent and control risk is low; (b) a large number of small balances is involved;
(c) a substantial number of errors is not expected; and (d) the auditor has no reason to believe that
respondents will disregard these requests.
b) Use of Assertion in an Audit of Financial Statements

Assertions are the implicit or explicit claims and representations made by the management
responsible for the preparation of financial statements regarding the appropriateness of the
various elements of financial statements and disclosures.
Auditor may use those assertions for audit examination during audit of Financial Statements. In
preparing financial statements, management is making implicit or explicit claims (i.e. assertions)
regarding the recognition, measurement and presentation of assets, liabilities, equity, income,
expenses and disclosures in accordance with the applicable financial reporting framework (e.g.
NAS/NFRS)
Following Assertions for class of transaction, account balance and disclosures can be used.
 Occurrence,
 Completeness,
 Accuracy cut-off,
 Classification and understandability
 Existence,

 Rights and Obligations

 Valuation and allocation
c) Key Audit Matters

Those matters that, in auditor's professional judgment, are of most significant in the audit of
financial statements of the current period are referred as key audit matters. Such key audit
matters are selected from matters communicated with those charged with governance. The
auditor is required to communicate such matters to those charged with governance and include in
audit report in the Key Audit Matters Section.
The purpose of communicating key audit matters is to enhance the communicative value of
auditor's report by providing greater transparency about the audit that was performed.
Communicating key audit matters provides additional information to intended users of the
financial statements to assist them in understanding those matters which are of most significance
in the audit of the financial statements. Communicating key audit matters is not a substitute for
disclosure in the financial statements or the substitute for the auditor expressing a modified
opinion. In determining key audit matters, auditor may take into account the areas of higher
assessed risks and areas requiring significant management judgment.
Question No. 65
Answer the following (5 Marks each December 2017)
a) The auditor of H Ltd. wanted to obtain confirmation from its creditors. But the management made
a request to the auditor not to seek confirmation from certain creditors citing disputes. Can the
auditor of H Ltd. accept to this request?
b) M/s KBC Associates, a Chartered Accountant was engaged by Hanuman& Co. Ltd. for auditing
their accounts. He sent his letter of engagement to the Board of Directors, which was accepted by
the company. In the course of audit of the company, the auditor was unable to obtain appropriate
sufficient audit evidence regarding receivables. The client requested for a change in the terms of
engagement. Offer your comments in this regard for acceptance of changes in terms of
engagement.
a) Answer
NSA 505, “External Confirmations”, establishes standards on the auditor‟s use of external
confirmation as a means of obtaining audit evidence. It requires that the auditor should employ
external confirmation procedures in consultation with the management.

The auditor may come across certain situations in which the management may request him not to
seek external confirmation from certain parties because of some reasons, for example, due to a
dispute with the particular creditor or debtor.
If the management refuses to allow the auditor to a send a confirmation request, the auditor shall
 Inquire as to Management‟s reasons for the refusal, and seek audit evidence as to their
validity and reasonableness,
 Evaluate the implications of management‟s refusal on the auditor‟s assessment of the relevant
risks of material misstatement, including the risk of fraud, and on the nature, timing and
extent of other audit procedures, and
 Perform alternative audit procedures designed to obtain relevant and reliable audit evidence.
If the auditor concludes that management‟s refusal to allow the auditor to send a confirmation request
is unreasonable or the auditor is unable to obtain relevant and reliable audit evidence from alternative
audit procedures, the auditor shall communicate with Those Charged with Governance (TCWG) and
also determine its implication for the audit and his opinion.
b) Answer
NSA 210 “Agreeing the Terms of Audit Engagement” deals with the auditor‟s responsibilities in
agreeing the terms of the audit engagement with management. As per NSA 210, if prior to
completing the audit engagement, the auditor is requested to change the audit engagement to an
engagement that conveys a lower level of assurance, the auditor shall determine whether there is
reasonable justification for doing so.
The auditor shall not agree to a change in the terms of the audit engagement where there is no
reasonable justification for doing so. If the terms of the audit engagement are changed, the auditor
and management shall agree on and record the new terms of the engagement in an engagement
letter or other suitable form of written agreement.
If the auditor is unable to agree to a change of the terms of the audit engagement and is not permitted
by management to continue the original audit engagement, the auditor shall:
 Withdraw from the audit engagement where possible under applicable law or regulation; and
 Determine whether there is any obligation, either contractual or otherwise, to report the
circumstances to other parties, such as Those Charged with Governance (TCWG), owners or
regulators.
Question No. 66
Write down examples of situations where external confirmations may be used by the auditor.

Answer:
a) As per provision sated in NSA 505 (External Confirmations); external confirmations are frequently
used in relation to account balances and their components, but need not be restricted to these items.
Accordingly examples of situations where external confirmations may be used by the auditor are:
 bank balances and other information from bankers,
 accounts receivable balances,
 stocks held by third parties at bonded warehouses for processing or on consignment,
 property title deeds held by lawyers or financiers for safe custody or as security,
 investments purchased from stockbrokers but not delivered at the balance sheet date,
 loans from lenders, and
 accounts payable balances.
Question No. 67
a) Impairment of Assets (2.5 Marks each December 2017)
Answer:
Impairment of Assets: Besides charging annual depreciation on assets by the reason of normal wear
and tear, effluxion of time and obsolescence to re-instate the correct value of the assets considering
the future cash flows that the assets can generate, impairment loss needs to be provided. The
difference between the carrying amount of an asset and recoverable amount is termed as
impairment loss. The treatment of impairment loss is similar to depreciation except the fact that it
can be re-instated in future, if the recoverable amount of the asset exceeds the carrying amount.
The auditor must ensure that the provisions of NAS 36 “Impairment of Assets” are followed.
b) External Confirmation Process to obtain audit evidence at the assertion level

External Confirmation Process:
As per NSA 505 on External Confirmations: When confirming confirmation procedures, the
auditor should maintain control over the process of selecting those to whom a request will be sent, the
preparation and sending of confirmation requests and the responses to those requests. Control is
maintained over communications between the intended recipients and the auditor to minimize the
possibility that the results of the confirmation process will be biased because of the interception and
alteration of confirmation requests or responses. The auditor ensures that it is the auditor who sends
out the confirmation requests, that the requests are properly addressed, and that it is requested that all
replies are sent directly to the auditor. The auditor considers whether replies have come from the
purported senders.

Question No. 68
a) Your firm has been appointed as the statutory auditor of Super Express Bank Ltd. for the financial
year 2074/75. You, as the engagement partner, are in the process of drafting audit plan of the said
audit. When obtaining an understanding and performing a preliminary assessment of the internal
audit function for drafting your audit plan, what are the important criteria to be considered.
b) While auditing accounts of a public limited company for the year ended 31 st Ashadh 2074, an
auditor found out an error in the valuation of inventory, which affects the financial statement
materially.
c) Auditor of Maya Limited was unable to confirm the existence and valuation of imported inventory
lying with the transporter and accepted a certificate from the management without obtaining audit
evidence. The inventory lying with the transporter is material to the financial statements.
a) Answer:
As per NSA 610; "Using the work of internal auditors" the statutory auditor should consider the
activities of internal auditors and their effect, if any, on statutory audit procedures. In the light of
aforesaid provision of NSA, the following aspects should be considered for drafting the audit plan of
Super Express Bank Ltd. for the financial year 2074/75:
1. Organizational Status: specific status of internal auditing in the entity and the effect this has on
its ability to be objective. In the ideal situation, internal auditing will report to the highest level of
management and be free of any other operating responsibility. Any constraints or restrictions
placed on internal auditing by management would need to be carefully considered. In particular,
the internal auditors should be free to communicate fully with the external auditor.
2. Scope of Function: the nature and extent of internal auditing assignments performed. The
external auditor would also need to consider whether management acts on internal audit
recommendations and how this is evidenced.
3. Technical Competence: whether internal auditing is performed by persons having adequate

technical training and proficiency as internal auditors. The external auditor may, for example,
review the policies for hiring and training the internal auditing staff and their experience and
professional qualifications.
4. Due Professional Care: whether internal auditing is properly planned, supervised, reviewed and
documented. The existence of adequate audit manuals, work programs and working papers would
be considered.

b) Answer:
NSA 450 “Evaluation of Misstatements identified during the audit” deals with the auditor‟s
responsibility to evaluate the effect of identified misstatements on the audit and of uncorrected
misstatements, if any, on the financial statements. The auditor should consider requesting the
management to adjust the financial information or consider extending his audit procedures. If the
management refuses to adjust the financial information and the results of extended audit procedures
do not enable the auditor to conclude that the aggregate of uncorrected misstatements is not material,
the auditor should express a qualified or adverse opinion, as appropriate.
In the instant case, the auditor has detected the material errors affecting the financial statements; the
auditor should communicate his findings to the management on a timely basis, consider the
implications on true and fair view and think about modifying the report.
c) Answer:
As per NSA 580 “Written Representations” auditor may rely on the representation by the
management but he should seek corroborative audit evidence. The management representation
cannot substitute other evidence that the auditor could reasonably expect to be available to the
auditors.
Also, NSA 501 “Audit Evidence: Specific Consideration for Selected items” requires obtaining
sufficient and appropriate evidence regarding the existence and condition of inventory lying with
third party if material to the financial statement.
Supporting evidences can be obtained from inside or outside sources. The audit evidence for
verification of inventory lying with the transporter - say purchase order, invoice, custom clearance
certificate, inspection, confirmation from transporter etc. are available evidences which auditor
should verify.
Just because the management had confirmed the existence and valuation of imported inventory lying
with the transporter the auditor cannot shrink his responsibility. This is negligence on his part.
Question No. 69
a) What are the provisions on „Timing of Liaison and Coordination‟ amongst internal audit and
external audit in NSA 610?
b) Mr. Shyam was appointed as the auditor of M/s Himalayan Ltd. and intends to apply the concept
of materiality for the financial statements as a whole. Please guide him as to the factors that may
affect the identification of an appropriate benchmark for this purpose.
c) Explain the concept of True and Fair View.

a) Answer:
When planning to use the work of internal auditing, the external auditor will need to consider
internal auditing‟s tentative plan for the period and discuss it at as early a stage as possible.
Where the work of internal auditing is to be a factor in determining the nature, timing and extent of
the external auditor‟s procedures, it is desirable to agree in advance the timing of such work, the
extent of audit coverage, test levels and proposed methods of sample selection, documentation of
the work performed and review and reporting procedures.
Liaison with internal auditing is more effective when meetings are held at appropriate intervals
during the period. The external auditor would need to be advised of and have access to relevant
internal auditing reports and be kept informed of any significant matter that comes to the internal
auditor‟s attention which may affect the work of the external auditor. Similarly, the external auditor
would ordinarily inform the internal auditor of any significant matters which may affect internal
auditing.
b) Answer:
Use of benchmark in determining Materiality: NSA 320 Materiality in planning and performing an
audit prescribes the use of benchmarks in determining materiality for the Financial Statements as a
Whole. Accordingly determining materiality involves the exercise of professional judgment. A
percentage is often applied to a chosen benchmark as a starting point in determining materiality for
the financial statements as a whole.
Factors that may affect the identification of an appropriate benchmark include the following:
i. The elements of the financial statements (for example, assets, liabilities, equity, revenue,
expenses);
ii. Whether there are items on which the attention of the users of the particular entity‟s financial
statements tends to be focused (for example, for the purpose of evaluating financial performance
users may tend to focus on profit, revenue or net assets);
iii. The nature of the entity, where the entity is at in its life cycle, and the industry and economic
environment in which the entity operates;
iv. The entity‟s ownership structure and the way it is financed (for example, if an entity is financed
solely by debt rather than equity, users may put more emphasis on assets, and claims on them,
than on the entity‟s earnings); and
v. The relative volatility of the benchmark.
c) Answer:
'True and fair view' is a phrase usually auditors use to express audit opinion on the financial
statements of an entity. It implies that the financial statements are presented fairly in all materials
respect; the position, performance, cash flows and changes in equity of the entity. The auditor
expresses such opinion upon assessment of the internal control system of the entity and test
checking the financial transactions carried out during the fiscal year. The auditor's act is guided by

the provisions set forth in the Nepal Standards on Auditing together with the Code of Ethics
applicable to the professional accountants.
As per NSA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in
accordance with NSA”, the auditor‟s expression of true and fair view is supposed to be received as
only the “reasonable assurance and not the absolute assurance” of the state of the financial
statements. This implies that the users are not supposed to absolutely rely on auditor‟s judgment for
making their financial decisions relating to the entity. This is because the auditor is not expected to,
and cannot, reduce audit risk to zero and cannot therefore obtain absolute assurance that the financial
statements are free from material misstatement due to fraud or error. This is because there are
inherent limitations of an audit, which result in most of the audit evidence on which the auditor draws
conclusions and bases the auditor‟s opinion being persuasive rather than conclusive.
Broadly speaking, the financial statements are considered as presenting to true and fair view if:
 The information contained in them are not materially misstated;
 There is an appropriate application of Nepal Accounting Standards, with additional disclosure in
the case of companies registered under Companies Act. In the case of other entities there is an
appropriate application of generally accepted accounting principles as is applicable; and
 They comply with the provisions of applicable laws and regulations of the company.
Question No. 70
a) National Company Limited had definite plan of its business being closed within a short period
from the close of the accounting year ended on 32ndAshadh, 2075. The Financial Statements for
the year ended 32ndAshadh, 2075 had been prepared on the same basis as it had been in earlier
periods with an additional note that the business of the Company shall cease in near future and
the assets shall be disposed of in accordance with a plan of disposal as decided by the
management. The Statutory Auditors of the Company indicated this aspect in "Key Audit Matters"
only by a reference as to a possible cessation of business and making of adjustments, if any,
thereto to be made at the time of cessation only. Comment on the reporting by the Statutory
Auditor as above.
b) You are the auditor of Special Mart Ltd. for FY 2074/75. Your audit team has approached to you
on how to judge whether the particular risk is significant or not. As a principal auditor how do you
guide your audit team?
Answer:
a) As per NSA 570 “Going Concern”, management intentions to liquidate the entity or to cease
operations is one of the event or condition that may cast significant doubt on the entity‟s ability

to continue as going concern. If events or conditions have been identified that may cast
significant doubt on the entity‟s ability to continue as a going concern but, based on the audit
evidence obtained the auditor concludes that no material uncertainty exists, the auditor shall
evaluate whether, in view of the requirements of the applicable financial reporting framework,
the financial statements provide adequate disclosures about these events or conditions
Further, as per NSA 701 “Communicating Key Audit Matters in the Independent Auditor‟s
Report”, when matters relating to going concern may be determined to be key audit matters, and
explains that a material uncertainty related to events or conditions that may cast significant
doubt on the entity‟s ability to continue as a going concern is, by its nature, a key audit matter.
NSA 701 also emphasizes on auditor‟s responsibility to communicate key audit matters in the
auditor‟s report.
As per the facts given in the case, intention of the National Company Limited had definite plan
of its business being closed down within short period from 32ndAshad, 2075. However,
financial statements for the year ended 32ndAshad, 2075 had been prepared on the same basis as
it had been in earlier periods with an additional note. Thus, management intentions to liquidate
the entity or to cease operations is one of the event or condition that may cast significant doubt
on the entity‟s ability to continue as going concern is a key audit matter. Therefore, the auditor
is required to communicate the Key Audit Matters in accordance with NSA 570 in above stated
manner. Simple reference as to a possible cessation of business and making of adjustments, if
any, be made at the time of cessation only by the auditor in his report is not sufficient.
b) Answer
As per NSA 315 (Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and Its Environment), in exercising judgment as to which risks are
significant risks, the auditor shall consider at least the following:
 Whether the risk is a risk of fraud;
 Whether the risk is related to recent significant economic, accounting or other
developments and, therefore, requires specific attention;
 The complexity of transactions;
 Whether the risk involves significant transactions with related parties;
 The degree of subjectivity in the measurement of financial information related to the
risk, especially those measurements involving a wide range of measurement uncertainty;
and
 Whether the risk involves significant transactions that are outside the normal course of
business for the entity, or that otherwise appear to be unusual.
In the light of the aforesaid provision of NSA 315, I will guide my audit team to ensure the
risk identified by them are significant risk or otherwise.

Question No. 71
a) In the light of NSA 315, explain understanding the entity and its environment.
b) “The auditor shall exercise professional judgment in planning and performing an audit of
financial statements”. Comment.
c) What are the assertions with which an auditor is concerned with while obtaining audit evidence
from substantive procedures?
Answer:
a) Answer
The auditor‟s understanding of the entity and its environment consists of an understanding of
the following aspects:
 Industry, regulatory, and other external factors, including the applicable financial reporting
framework.
 Nature of the entity, including the entity‟s selection and application of accounting policies.
 Objectives and strategies and the related business risks that may result in a material
misstatement of the financial statements.
 Measurement and review of the entity‟s financial performance.
 Internal control.
b) Answer
Nepal Standard on Auditing 300 (Planning an audit of financial statements) stated that the
manner in which the auditor emphasizes to engagement team members the need to maintain a
questioning mind and to exercise professional skepticism in gathering and evaluating audit
evidence.
Professional Judgment is the application of relevant training, knowledge and experience, within the
context provided by auditing, accounting and ethical standards, in making informed decisions about
the courses of action that are appropriate in the circumstances of the audit engagement. That the
auditor shall exercise professional judgment in planning and performing an audit of financial
statements. Exercise of professional judgment depends on facts & circumstances known to the
auditor. It is to be exercised throughout the audit and to be appropriately documented. It is
important when deciding about:
 Materiality & audit risk.

 Nature, time and extent of audit procedures.
 Evaluating sufficiency & appropriateness of audit procedures.
 Evaluating management judgment in applying applicable Financial Reporting Framework.
 Drawing conclusions based on audit evidence.

c) Answer
Nepal Standard on Auditing 500 "Audit Evidence” prescribes audit procedures for obtaining audit
evidences. Accordingly, an auditor is concerned with following assertions while obtaining audit
evidences from substantive procedures:
 Existence: That an asset or liability exists at a given date.

 Rights and obligations: That an asset is a right of the concern and a liability is an
obligation at a given date.
 Occurrence: That a transaction or event which took place pertains to the entity during the
relevant period.
 Completeness: That there are no unrecorded assets, liabilities or transaction.
 Valuation: That an asset or liability is recorded at an appropriate carrying value.
 Measurement: That a transaction is recorded in the proper amount and revenue or expense
is allocated to the proper period.
 Presentation and disclosure: That an item is disclosed classified and described in
accordance with recognized accounting policies and practices and relevant statutory
Question No. 72
As an auditor, give your opinion with explanations on the following cases: (5 Marks, June 2019)
At the year-end (2075-03-31), Chitwan Biscuits P. Ltd. revealed an inventory of Rs. 3.5 crores at its
godown. Due to a fire on 2075-04-01, inventory worth Rs. 2 crores were destroyed. The salvage
value and insurance claim were estimated at Rs. 1.25 crores before the commencement of audit.
No provision was made in the books of company for the year ended 2075-03-31 for Rs. 0.75 crore.
Answer:
NSA 560 "Subsequent events" requires that the auditor should consider the effects of subsequent
events on the financial statements and the auditor's report. However, the exact manner and treatment
would depend upon whether the event falls in the category of adjusting event or non-adjusting event as
mentioned in NAS 10 Events after Reporting Date. The event took place after the close of accounting
year and does not relate to conditions existing at the Balance Sheet Date. Thus, it is a non-adjusting
event after the reporting period as per NAS 10. Therefore, an entity shall not adjust the amounts in
Financial Statements for this case. However, an entity shall disclose for each material category of non-
adjusting events the nature of event and its financial effect.
In this case, as the company has correctly accounted by not providing provision, the auditor is required
to ensure whether the proper disclosure of the event has been made in financial statements.
Question No. 73
Binaya Bhandari & Co. is appointed as statutory auditor of Sagarmatha Development Bank Ltd. by
an Annual General Meeting. As a partner at Binaya Bhandari & Co., describe the process Binaya

Bhandari & Co. should undertake to assess whether the preconditions for an audit are present when
accepting the audit of Sagarmatha Development Bank Ltd. (5 Marks June 2019)
Answer
NSA 210 prescribes the procedures to establish whether the pre-conditions for an audit are present in
order to accept or continue an audit engagement. Following steps have to be followed by partner of
Binaya Bhandari & Co. to ascertain the same:
(a) Determine whether the financial reporting framework to be applied in the preparation of the
financial statements is acceptable;
(b) Obtain the agreement of management that it acknowledges and understands its responsibility:
(i) for the preparation of the financial statements in accordance with the applicable financial
reporting framework, including where relevant their fair presentation;
(ii) for such internal control as management determines is necessary to enable the preparation of
financial statements that are free from material misstatement, whether due to fraud or error;
and
(iii) to provide Binaya Bhandari & Co. with:
a. Access to all information of which management is aware that is relevant to the preparation
of the financial statements such as records, documentation and other matters;
b. Additional information that Binaya Bhandari & Co. may request from management for the
purpose of the audit; and
c. Unrestricted access to persons within the entity from whom Binaya Bhandari & Co
determines it necessary to obtain audit evidence.
Question No 74
Answer the following: (35=15, June 2019)
a) Mr. Ashish Basnet is a partner at Basnet & Shrestha Associates which is the external auditor
of PQR Ltd., public company. During the audit, he identified a regulatory non-compliance. He
is considering reporting it to the audit committee. Suggest him in the light of NSA 250, what
should be taken into consideration for reporting the same to the audit committee.
b) What are the factors auditors need to consider while evaluating the adequacy of the auditor‟s
expert‟s work?
c) Explain what is meant by “Written Representations” and indicate to what extent an auditor
can place reliance on such representations.
Answer:
a) Mr. Basnet should follow the procedures prescribed by NSA 250 Consideration of Laws and
Regulations in the Audit of Financial Statements.
If Mr. Basnet becomes aware of information concerning an instance of non-compliance or suspected
non-compliance with laws and regulations, he shall obtain:

a. An understanding of the nature of the act and the circumstances in which it has occurred; and
b. Further information to evaluate the possible effect on the financial statements.
Following points should be considered for reporting identified non-compliance to audit committee: -
 Mr. Basnet should evaluate the implications of non-compliance in relation to other aspects of the
audit, including the auditor‟s risk assessment and the reliability of written representations, and
take appropriate action.
 Unless all the members of audit committee are aware of such non-compliance, Mr. Basnet should
communicate non-compliance with laws and regulation that come to his attention during the
course of audit.
 If in Mr. Basnet‟s judgment, the non-compliance is believed to be intentional and material, he
should communicate the matter to the audit committee as soon as practicable.
 If the Mr. Basnet suspects that members of the audit committee are involved in non-compliance,
he should communicate the non-compliance to other members of the Board of Directors. Where
he suspects that everyone in position of governance including Board of Directors are involved or
the communication may not be acted upon, he should consider the need to obtain legal advice.
b) As per NSA 620, the auditor should evaluate the adequacy of auditor‟s expert‟s work as audit
evidence regarding the assertions being considered. This will involve evaluation of whether the
substance of the expert‟s finding is properly reflected in the financial statements or supports the
assertions, and consideration of:
 The relevance and reasonableness of expert‟s findings and conclusions and their consistency with
other audit evidence,
 If expert‟s work involves use of significant assumptions and methods, the relevance and
reasonableness of those assumptions and methods in the circumstances,
 Source data used,
 Results of expert‟s work in the light of the r auditors‟ overall knowledge of the business and of
the result of other audit procedures.
 While considering whether the expert has used source data which is appropriate in the
circumstances, the auditor consider the following procedure
 Making inquiries regarding any procedures undertaken by the expert to establish whether the
source data is relevant and reliable.
 Reviewing or testing the data used by the expert.
The auditor needs to obtain an understanding of the assumptions and methods used and to consider
whether they are appropriate and reasonable based on the auditors‟ knowledge of the business and the
results of other audit procedures. If the result of the expert‟s work does not provide sufficient
appropriate audit evidence or if the results are not consistent with other audit evidence the auditor
should resolve the matter by applying additional audit procedures including possibly engaging another
expert or modifying the auditor‟s report.

c) Written Representation: The management is responsible for the preparation and presentation of
financial statements. Thus, it is quite natural that during the course of audit, management would be
required to make several representations on various matters relating to financial statements. The
representation by management constitutes acknowledgement by the management about its
responsibility for the preparation and approval of the financial information. A written representation
may either take the form of a letter from the management or letter by auditor outlining auditor‟s
understanding and confirmation of the same by the management.
Extent of Reliance: Written representations are necessary information that auditor requires in
connection with the audit of the entity‟s financial statements. Accordingly, this is similar to responses
to inquiries, hence, written representation is audit evidence.
Although they provide necessary audit evidence, they do not provide sufficient appropriate audit
evidence on their own about any of the matter with which they deal. Furthermore, the fact that
management has provided reliable written representation does not affect the nature or extent of other
audit evidence that the auditor obtains about the fulfillment of management‟s responsibilities, or about
specific assertions.
Therefore, the auditor should:
(a) seek corroborative evidence from sources inside or outside the entity,
(b) evaluate whether the representations made by the management appear reasonable and
consistent with other audit evidence obtained, including other representations; and
(c) consider whether the individuals making the representations are expected to be well
informed on the matter.
It must be noted that representations by the management cannot be the substitute for other audit
evidence that the auditor could reasonably expected to be available. For example, a representation by
the management as to existence, quantity and cost of inventories is not substitute for adopting audit
procedures regarding verification and valuation of inventories. If a representation by management is
contradicted by other evidence, the auditor should examine the circumstances and, when necessary,
reconsider the reliability of other representations made by the management as well.

Chapter 12-Nepal Accounting Standard/ Nepal

Financial Reporting Standard
s
Question No 1
Express your view as an auditor in the following cases:

a) M. Ltd. was a 100% export-oriented ply board manufacturing company. During the year 2002-03
the own manufactured board of Rs. 1,000,000/- (cost) was used by the company for its interior
decoration. The VAT authority made assessment of Rs. 200,000/- being the VAT credit claimed on
the raw material of boards used for interior decoration. The Accountant debited Rs. 200,000/- only
under the head "furniture and fixtures”. (5 Marks, December, 2003)
Answer
As per the Nepal Accounting Standard (NAS-16) on property, plant and equipment the cost of an
item of equipment comprises its purchase price including import duties and non-refundable purchase
taxes and any directly attributable cost of bringing the asset to working condition for its intended use.
The cost of self – constructed asset is determined using the same principles as for an acquired asset. If
an enterprise makes similar assets for sale in the normal course of business, the cost of the asset is
usually the same as the cost of producing the assets for sale.
In the given case since own manufactured board of Rs. 10 Lacs was used by N Ltd. for interior
decoration the cost of its manufacture has to be capitalized apart from the VAT penalty that was
imposed for violation of VAT Act.
b) N. Ltd. was the 100% export-oriented undertaking situated at Simara, Nepal. It was operating Pass
Book System with the customs authority and Credit of Rs. 5 Million was given in the pass book by
the customs authority, Birgunj for the Year 2002-03. But the Accountant booked the entire
customs payment of Rs. 6 million as the cost of materials. (5 Marks, December, 2003)
Answer
According to Nepal Accounting Standard (NAS - 2) on "inventories" the cost of purchase of
inventories comprises the purchase price, import duties and other taxes (other than those subsequently
recoverable by the enterprise from the taxing authority) and other cost directly attributable to the
acquisition of materials.
In the given case since the import duties of Rs. 6 million has been recovered from the custom
authority, this cannot be the part of cost of raw materials and should not be included in the valuation
of inventory of raw materials. Hence N Ltd. is suggested to reduce the cost of raw materials by Rs. 6

million credited in pass book and show it as the customs deposits to be shown under Loans and
Advances in the balance sheet.
c) E Ltd. a Sugar manufacturing Company incurred Rs. 9 million under repairs and overhauling of
sugar machinery for the year 2002-03. Since the repairs and overhauling cost was coming more,
the Board of Directors instructed Accounts Manager to capitalize Rs. 6 million and show only the
Rs. 3 million as the expenses for the year. (5 Marks, December, 2003)
Answer
As per the Nepal Accounting Standard (NAS - 16) on property, plant and equipment subsequent
expenditure relating to an item of property, plant and equipment that has already been recognized
should be added to the carrying amount of the asset when it is probable that future economic benefits,
in excess of the originally assessed standard of performance of the existing asset will flow to the
enterprises. All other subsequent expenditure should be recognized as an expense in the period in
which it is incurred.
Expenditure on repairs or maintenance of plant is to restore or maintain the future economic benefits
that an enterprise can expect from the originally assessed standard of performance of the asset.
Since repair and overhauling cost was incurred by E Ltd. to maintain and restore the original
capacity, entire expenditure of Rs. 9 million can be recognized as an expense for the financial year
2002-03 and the capitalization of Rs. 6 million by the accountant is against the norms of Nepal
Accounting Standards. Alternatively, Rs. 6 million may be treated as deferred revenue expenditure
with notes and proper discloser in the balance sheet.
Question No. 2
Mr. Shyam Shivakoti, Finance Manager of M/s ABC Manufacturing Co. Ltd. of received
Rs.9,00,000/- from M/s Apurva Insurance Company Ltd. against the loss of goods in transit Rs.
7,50,000/-. Mr. Shivakoti credited the amount so received from Insurance Company to the Purchase
Account. (4
Marks, December 2005)
Answer:
NAS- 8 on “Accounting Policies, Change in Accounting Estimates and Error " requires that all items of
income and expenses, which are recognized in period should be included in the determination of net
profit or loss for the period .The claim for loss of goods in transit is arising out of ordinary activities of
the enterprise as a part of its normal course of business. However, the cost of goods lost in transit is only
Rs.7,50,000/- while the insurance money received from M/s Apurva Insurance Company Ltd. is Rs.
9,00,000/-. Purchase Account need not be credited as it would distort the purchase done during the year
and also distorts the gross profit. Therefore, entire amount of Rs.9,00,000/- needs to be taken to profit

and loss account under an appropriate head. This is an income arising from an ordinary activity of the
enterprise but having regards to amount involved and exceptional nature, a separate disclosure be made
in the profit and loss account. Such disclosure would enable the users to understand the performance of a
company for the period.
Question No. 3
Kasthamandap Bank Ltd. wants to change its depreciation policy from Straight Line Method to
Written Down Value from the current year 2061/62.
Answer:
As per NAS 16: Property, Plant & Equipment and Depreciation, the depreciable amount of an item of
property, plant and equipment should be allocated on systematic basis over its useful life. The
depreciation method used should reflect the pattern in which the asset‟s economic benefit are consumed
by the enterprises. The depreciation charge for each period should be recognized as an expense unless it
is included in the carrying amount of another asset. Also, the depreciation method applied to property,
plant and equipment should be reviewed periodically and, if there has been a significant change in the
expected pattern of economic benefits form those assets, the method should be changed to reflect the
changed pattern. When such a change in depreciation method is necessary the change should be
accounted for as a change in accounting estimate and depreciation charge for the current and future
periods should be adjusted.
On the basis of above, it is clear that a change in depreciation method is made only if adoption of the new
method is required by any statute or for compliance with an accounting standard or it is considered that
the change would result in a more appropriate preparation and presentation of the financial statements of
the enterprise. Thus, the auditor must ensure that the change in method of depreciation form SLM to
WDV was made on account of the above.
Also, when such a change in the method takes place, changed depreciation amount is charged in the
income statement from the date of change, i.e. F/Y 2060/61 and such a change in depreciation method
should be disclosed in the accounting policies with the effect of change quantified.
Question No. 4
One of the sundry debtors of Kaushala Iron Ltd. owing Rs.25 lacs have been declared bankrupt on 3 rd
of Shrawan 2062. the books of account for the year 2061/62 are yet to be finalized.
Answer.
As per NAS 10: Events after the Reporting Date, Events after the balance sheet date are those events,
both favorable and unfavorable, that occur between the balance sheet date and the date when the financial
statement are authorized for issue. Two types of events can be identified:

a) Those that provide evidence of conditions that existed at the balance sheet date (adjusting
events after the balance sheet date); and
b) Those that are indicative of conditions that arose after the balance sheet date (non-adjusting
events after the balance sheet date).
An enterprise should adjust the amounts recognized in its financial statements to reflect adjusting events
after the balance sheet date.
One of the examples of adjusting events after the balance sheet date that require an enterprise to adjust
the amounts recognized in its financial statements, or to recognize items that were not previously
recognized is the receipts of information after the balance sheet date indicating that an asset was impaired
at the balance sheet date, or that the amount of a previously recognized impairment loss for that asset
needs to be adjusted. For example; the bankruptcy of a customer, which occurs after the balance sheet
date usually confirms that a loss already existed at the balance sheet on a trade receivable account and
that the enterprise needs to adjust the carrying amount of the trade receivable account.
On the basis of above, it is clear that conditions existed on the date of balance sheet in respect of which
additional evidence has been provided by the insolvency of the debtors and hence suitable adjustment is
to be made on the debtor balance by way of making additional provision, if provision already made is not
adequate to cover the loss due to declaration of bankruptcy of the debtors considered.
Question No. 5
Give your opinion on the following issues: (5 Marks each, June 2006)
a) An enterprise under your audit has taken a loan of Rs. 10 million against security of certain
shares. Due to sharp fall in shares prices, the market value of these shares as on the date of the
balance sheet is only Rs. 9.5 million. However, by the time of finalization of accounts, the market
value has recovered to Rs. 10.5 million. The management wants to show the loan as fully secured.
Answer Hint:
The loan should be shown as secured only to the extent of Rs. 9.5 million. Changes in the market value
of the securities subsequent to the balance sheet date are not relevant.
b) Leather Development Corporation (LDC) has installed advanced machinery, costing Rs. 50
Million, which was provided by the government through DANIDA's grant in FY 2061/62 and is
put to use from the date of installation. LDC is providing depreciation at 15% p.a. as per Income
Tax Act 2058 in a consistent basis. Whereas, such depreciation during the first year amounting to
Rs. 7.50 Million was charged to Profit and Loss Account.
Answer:
As per Accounting Standard NAS - 20 for Accounting for government grants and disclosure of
government assistance: Government grants related to assets, including non-monetary grants at fair value,

should be presented in the balance sheet either by setting up the grant as deferred income or by deducting
the grant in arriving at the carrying amount of the asset.
In this case, the cost of machinery should be presented under government grants in the balance sheet and
depreciation on such asset should be charged on such grant accounts. As per above information, LDC has
charged the depreciation on these assets to profit and loss account. So, the auditor has to qualify his
report stating that profit has been understated by 7.50 Million for non-compliance of applicable
accounting standards.
Question No. 6
Express your views as an auditor in the following cases: (5Marks, June 2007)
ABC Company, a multinational, has recently opened its branch office in Nepal. It had received
equipment from the parent company after its incorporation. However, the value has not been received
till the date of finalization of the audit. The management expresses the view that since the value of the
equipment is not available the same will not be brought to the books and the same will be accounted
for once advice from parent company regarding the value is received.
Answer
According to Nepal Accounting Standard -16 assets needs to be capitalized when they are ready for use
or put to use. In the cited case it may be noted that the asset has been put to use in current financial year.
Hence, even though the value has not been received from the parent company, the equipment received
should be capitalized and brought to the books of account at estimated or provisional value. The fact that
the asset is stated at estimated value and the value shall be adjusted after receiving invoice along with
reason thereof should be disclosed. The assertion of the management that the capitalization of the
equipment will be done only after the value against the same is received may not be justified as it will
lead to understatement of the fixed assets and corresponding understatement of the depreciation charge
for the related financial year.
Question No. 7
After review of books of account of M/s Mega Power Company, auditor came to know that Rs. 340,000
was incurred for replacement of roof of newly constructed building due to water leakage. Company
wants to charge this expense as revenue expenditure. Is this treatment justifiable? (4 Marks, June
2008)
Answer
Any subsequent expenditure relating to an item of property, plant and equipment is only recognized as an
asset when the expenditure improves the condition of the assets beyond its originally assessed standard of
performance.
However, if the subsequent expenditure is in the nature of repair and maintenance, it is charged as
expenses for the period. The replacement of roof of newly constructed building is merely a change not
meant for improving the condition as originally assessed standard of performance but maintenance of the

same. Thus, M/s Mega Power Company is justifiable in view of Nepal Accounting Standard 16:
Property, Plant and Equipment.
Question No. 8
Express your opinion in the following cases: (5 Marks June 2008)
M/s Reliable Hospital Ltd. received a cash grant of Rs. 2.5 Million from the Government of Japan in
FY 2063/64 under the agreement that the grant amount will be used to organize 3 free health camps in
the eastern Nepal.
In the FY 2063/64 it organized 2 free health camps and spent Rs. 1.5 Million in total.
The company treated Rs. 2.5 Million as miscellaneous income and Rs. 1.5 Million as charity expenses
for the year. Comment in line with applicable accounting standards.
In the given case, M/s Reliable Hospital Ltd. received the grant to organize 3 free health camps but it
organized only 2 free health camps in the FY 2063/64 and incurred expenses of Rs.1.5 million out of
Rs.2.5 million it received.
As per NAS 20: Accounting for Government Grants and Disclosure of Government Assistance, since the
grant was received with a condition, whole of the amount received cannot be considered as income of the
year without fulfilling the condition and hence balance amount of Rs.1 million shall be considered as
liability for the year. Thus, the treatment given by the hospital is incorrect. Balance amount of grant i.e.
Rs. 1 million should be deferred to set off against the expenses that will be incurred for organizing 3rd
free health camp.
The disclosures regarding the receipt and use of the grant and accounting policy for recognition of grant
received as income should be made in the financial statements.
Question No. 9
Express your opinion in the following cases: (5 Marks each December 2008)
a) M/s Quality Garment Pvt. Ltd. a garment manufacturing company calculated cost of finished
goods at USD 6,300 per 1000 Pcs. Due to crisis in the export market, the company could not
export the expected quantity and huge chunk of stock was lying in the company‟s inventory at
year end. Before the year end, to clear the inventory and to manage the cash shortage,
company collected price bids from the international parties. It received the best offer of USD
5,750 per 1000 pcs. The company decided to wait for some time for better price offers.
The company valued its inventory at cost price of USD 6,300 per 1000 Pcs. citing the reason that
company has not sold its stock as yet and the question of market/selling price does not arise. Give
your comment.

Answer
In the given case, irrespective of whether the company has sold its inventory or not, selling price at year
end should have been decreased as the price offers from the international parties indicate.
The inventory of the company should be valued at lower of the cost or net realizable value (NAS 02).
Further net realizable value is estimated based on the most reliable evidence available at the time
estimates are made. In the given case since the company received the best price offer of USD 5750 per
1000 Pcs. this should be taken as selling price of the products at the year end. As the net realizable value
of the inventory is less than cost price at the year end, the company should value its inventory at net
realizable value.
b) The company you are auditing, which is a listed company manufacturing automotive parts and
air-conditioners for motor vehicle assemblers, is facing a potential legal claim from Reliable
Motors Limited (RML) in respect of defective air conditioners supplied to them. Annual sale of
the company is Rs. 850 million and profit before tax is Rs. 60 million. A claim for Rs.25 million
being the cost of replacement of air conditioners and lost production time has been lodged with
the Company by RML. The management is of the view that the claim is not justified, as the air
conditioners were properly functioning and had been tested for quality and that the defects
have arisen because of the negligence of RML and its technicians. However, a provision of Rs.
2 million has been made in the financial statements in this respect.
Answer:
As per NAS 37: a provision should be recognized when:
a. an enterprise has a present obligation (legal or constructive) as a result of a past event;
b. it is probable that on outflow of resources embodying economic benefits will be required to settle
the obligation; and
c. a reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision should be recognized. Further, an enterprise should not
recognize a contingent liability but a contingent liability is disclosed, unless the possibility of an outflow
of resources embodying economic benefits is remote.
Thus, it is necessary to identify whether it requires making provisions or disclose it as a contingent

liability.
Firstly, it is not clear from the question that whether there is warranty provision for the supplies supplied
by the Company. But since a provision of Rs.2 million has been made by the company, it is assumed that
there exists provision of warranty claim. If so, a best estimate of warranty claim shall be calculated and
see whether provision made is adequate against Rs.25 million's claim lodged against the clause.

If there exists no warranty clause in sales, it is not necessary to make provision of Rs.2 million and a
disclosure of claim will be sufficient until it is resolved.
c) M/s Giant Manufacturing Company Ltd. found that one of its debtors was declared insolvent
by the court. The company came to know this fact before finalizing its accounts but after the
end of the year. Your view is sought during finalizing the financial statement.
Answer
An enterprise should adjust the amounts recognized in its financial statements to reflect adjusting events
after the balance sheet date. The receipt of information after the balance sheet date indicating that the
assets was impaired at the balance sheet date is sufficient to adjust the amount of impaired assets (debtor)
in the financial statement as per of Nepal Accounting Standard 10 " Events after the Reporting Date".
Hence, the effect of the same needs to be adjusted in the account balance on finalizing the books of
account same.
Question No. 10
How would you vouch and verify the following? (5 Marks each June 2009)
a) Opening balances carried over
b) Erection of fixed assets using own labor and materials in a manufacturing company.
a) Answer
 In the case of recurring audit, verify the opening balances from the audited file of the previous
year and ensure that the same are tallied with published account, if.
 In the case of audit of a company by the auditor for the first time, obtained signed account of the
previous year and verify the opening balance from the same.
 Check whether any adjustment required to be made in the opening balance as per the instruction
of the regulating body or correction of mistake is done and the presentation and disclosure
requirement of NAS-08 " Accounting Policies, Change in Accounting Estimates and Errors" is
fulfilled.
 Ensure that opening balances are carried over and disclosed in appropriate heads.
b) Answer
 As per NAS 16: Property, Plant and Equipment and Depreciation, Administration and other
general overhead costs are not a component of the cost of property, plant and equipment unless
they can be directly attributed to the acquisition of the asset or bringing the asset to its working
condition. Generally, materials and labour expenses are of revenue nature and hence charged off

to income statement and not capitalized. However, such expenses are capitalized when these are
incurred for the purpose of creation of fixed assets.
 As per NAS 16: Property, Plant and Equipment and Depreciation, the cost of an item of property,
plant and equipment comprises its purchase price, including import duties and non-refundable
purchase taxes, and any directly attributable costs of bringing the asset to working condition for
its intended use; any trade discounts and rebates are deducted in arriving at the purchase price.
 The cost of a self-constructed asset is determined using the same principles as for an acquired
asset.
 Therefore, any internal profits are eliminated in arriving at such costs. Similarly, the cost of
abnormal amounts of wasted material, labor or other resources incurred in the production of a
self-constructed asset is not included in the cost of the asset.
Question No. 11
a) The entire liability for interest on deferred payment terms is treated as part of capital cost of the
asset as such liability was incurred at the time of acquisition of the asset itself.
Answer
According to NAS - 23 on "Borrowing Costs", under allowed alternative treatment, borrowing costs that
are directly attributable to the acquisition, construction or production of a qualifying asset shall be
capitalised as part of the costs of that asset. The interest on deferred payment terms are borrowing costs
directly attributable to the acquisition of the asset and can be treated as part of the capital cost. However,
under NAS - 23, the capitalisation of borrowing cost shall cease when substantially all the activities
necessary to prepare the qualifying asset for its intended use are complete. Hence, the interest on deferred
payment related to the period after the assets are ready to put to use shall not be capitalised.
b) Fire Ltd. purchased equipment for its power plant from Urja Ltd. during the year 2006-07 at a cost
of Rs.100 lacs. Out of this they paid only 90% and balance 10% was to be paid after one year on
satisfactory performance of the equipment. During the Financial year 2007-08, Urja Ltd. waived
off the balance 10% amount which was credited to Profit and Loss account by Fire Ltd. as
discount received.
Answer
According to NAS-16 on Property, Plant and Equipment, the cost of an asset may undergo changes
subsequent to its acquisition on account of exchange fluctuation, price adjustment, changes in duty or
similar factors. Such changes in price /cost needs to be adjusted with the cost of the asset.
In the give case, Fire Ltd., initially accounted for 100% amount i.e., Rs.100 lacs as cost of fixed asset
although they paid only Rs.90 lacs and kept Rs.10 lacs as payable to the credit of Urja Ltd. Now since the

supplier has waived off the balance amount of Rs.10 lacs, this should be treated as change in price and
needs to be adjusted with the cost of asset.
Therefore, the treatment given by Fire Ltd., in crediting Rs.10. Lacs as discount to Profit & Loss Account
is completely wrong and needs to be corrected. It will have effect on depreciation also and needs
adjustment.
The auditor should report the matter if suitable changes are not made in the accounts.
Question No. 12
Depreciation on certain equipment has been charged at 10% per annum on reducing balance method.
This rate is consistent with prior years and the same rate is being used by most other companies, in the
automobile industry. However, significant losses have recently been recorded on the disposal of
similar equipment. Discuss (5 Marks June 2009)
Answer
As per NAS 16, subsequent to initial recognition as an asset, an item of property, plant and equipment
should be carried at its cost less any accumulated depreciation and any accumulated impairment losses. It
is evident from the question that there is no problem in case of depreciation but there is evidence of
material impairment losses as significant losses being recorded on the disposal of similar equipment. The
fair value of items of plant and equipment is usually their market value, determined by appraisal.
Thus, the company shall determine accumulated impairment losses and deduct the same from the book
value to arrive at carrying value of equipment.
Question No. 13
The management tells you that the work in process is not valued since it is difficult to ascertain the
same in view of the multiple processes involved and in any case the value of opening and closing work
in process would be more or less the same.
Answer
According to NAS-02 on "Inventories", the inventories also include those assets which are in the process
of production for sale in the ordinary course of business apart from finished goods and those materials or
supplies to be consumed in the production process or in the rendering of services. It is, thus, necessary
for a company to ensure that each and every component of inventory is valued properly. The argument
advanced by the company that it is difficult to ascertain the same in view of the multiple processes
involved is not acceptable. In general, the audit procedures regarding work-in-process are similar to those
used for raw materials and finished goods. the auditor has to carefully assess the stage of completion of
the work-in-process for assessing the appropriateness of its valuation.

The argument that the opening and closing work-in-process would be more or less the same is also not
justified because the omission of those would lead to distortion of true and fair view. Further, costs
incurred for raw materials and the overheads would normally different and would give rise to different
value of opening and closing stock. In view of the above, the auditor shall have to qualify the Assurance
Report in case work-in-process is not valued and shown in the financial statements.
Question No. 14
M/s ABC & Co. has decided to change policy of inventory valuation from LIFO to Weighted average
method from the current year 2062/063. What are your duties as an auditor while carrying out the
audit to ascertain the valuation and presentation is fair? (5 Marks June 2009)
Answer:
The presentation and classification of items in the financial statements should be retained from one
period to the next unless the change will result in a more appropriate presentation or is required by the
Nepal Accounting Standard. If the inventory valuation method has been changed due to the above reason,
M/s ABC & Co. should reclassify its comparative information in accordance with of Nepal Accounting
Standard 01, "Presentation of Financial Statements" and disclose accordingly. However, if the
reclassification is not possible, the reason should be disclosed.
Question No. 15
As an auditor, comment on the following situations: (5 Marks each December 2009)
c) Amico International Limited, a public company seeks your opinion regarding the accounting
treatment of interest on loan amount taken to acquire machinery during the financial year
2064/065 in view of NAS.
d) Auto Gear Ltd. is engaged in manufacturing and supply of gear boxes to Hulas Automobile Ltd.
As per terms of supply, full price of the goods is not released by Hulas Automobile Ltd. but 10%
thereof is retained and paid after one year, if there is satisfactory performance of the parts
supplied. Auto Gear Ltd. accounts for only 90% of the invoice value as sale at the time of supply
and balance 10% is accounted as sale in the year of receipt of payment.
Answer:
c) Interest on loan taken to acquire machine can be termed as borrowing cost. Nepal Accounting
Standard – 23 deals with the accounting of borrowing cost. It states that borrowing costs
should be recognized as an expense in the period in which they are incurred. Likewise, under
the benchmark treatment borrowing costs should be recognized as an expense in the period in
which they are incurred regardless of how the borrowings are applied. However, as per
alternative treatment, borrowing costs that are directly attributable to the acquisition should be
capitalized as part of the cost of that asset.

Further, Commencement date for capitalization of borrowing costs regarding qualifying assets is
a date when an entity fulfils all of the following conditions:
 Borrowing cost is being incurred

 Expenditure have been incurred and
 Active development taking places
d) According to NAS-18 on Revenue, revenue recognition from sale of goods should be

recognized when the seller has transferred to the buyer, the property in the goods for a price
or when the seller has transferred all significant risk and rewards and the seller repairs no
effective control over goods and no significant uncertainty exists regarding the amount of
consideration and its collectability. In the given case the goods as well as the risk and
ownership has been transferred by Auto Gear Ltd., to Hulas Automobile Ltd., on the basis of
invoice and delivery of material. In the instant case, therefore, Auto Gear Ltd., should
recognize sale at full 100% of the invoice value in spite of the fact that 10% payment will be
released after one year. However, depending upon the past experience regarding collectability
of 10% amount, they can make a provision for the amount that is not likely to be realized.
Hence, the treatment given by the company is not correct and if they do not correct it, the
auditor should qualify his report.
Question No. 16
Give your comments on the following: (5 Marks each December 2009)
a) Gear Ltd. is engaged in manufacturing and supply of gear boxes to Kathmandu Automobile Ltd.
As per terms of supply, full price of the goods is not released by Kathmandu Automobile Ltd. but
10% thereof is retained and paid after one year, if there is satisfactory performance of the parts
supplied. Gear Ltd. accounts for only 90% of the invoice value as sale at the time of supply and
balance 10% is accounted as sale in the year of receipt of payment.
b) Inventories of a car manufacturing company include the value of items required for the
manufacture of a model which was removed from the production line five years back, at cost price.
Answer:
a) Answer
b) According to NAS 18 on Revenue, revenue from sale of goods should be recognized when the
seller has transferred to the buyer, the property in the goods for a price or when the seller has
transferred all significant risk and rewards and the sel ler repairs no effective control over
goods and no significant uncertainty exists regarding the amount of consideration and its
collectability.
In the given case the goods as well as the risk and ownership has been transferred by Gear Ltd., to
Kathmandu Automobile Ltd., on the basis of invoice and delivery of material.

In the instant case, therefore, Gear Ltd., should recognize sale at full 100% of the invoice value in spite
of the fact that 10% payment will be released after one year. However, depending upon the past
experience regarding collectability of 10% amount, they can make a provision for the amount that is not
likely to be realized.
Hence, the treatment given by the company is not correct and if they do not correct it, the auditor should
qualify his report.
c) Answer
Inventory valuation: NAS 2 on “Inventories” provides that the cost of inventories may not be
recoverable if those inventories are damaged, have become wholly or partially obsolete, or if
their selling prices have declined.
Accordingly, the auditor should examine whether appropriate allowance has been made for the defective,
damaged, obsolete and slow-moving inventories in determining the net realizable value.
In this case, items required for the manufacture of a model which has been withdrawn from the
production line five years ago are included in the stock at cost price resulting in overstatement of
inventory and profit. As it appears from the facts given that the net realizable value of these items is
likely to much lower than the cost at which these are being shown in the books of account.
Accordingly, it becomes necessary to write down the inventory to „net realizable value‟ if the items of
inventories become wholly or partially obsolete. Under the circumstance, the auditor should qualify the
report appropriately.
Question No 17
Write short note on

Impairment of assets. (5 Marks, December 2009, December 2010)
Answer
As per NAS 36 on Impairment of Assets, an asset is impaired when the carrying amount of the asset
exceeds its recoverable amount. The difference between the carrying amount of an asset and recoverable
amount is termed as impairment loss. Besides charging annual depreciation on assets by the reason of
normal wear and tear, afflux ion of time and obsolescence to reinstate the correct value of the assets
considering the future cash flows that the asset can generate, impairment loss needs to be provided. Some
indications that an asset might have been impaired are mentioned as follows:
(a) Significant changes with an adverse effect on the entity have taken place during the period, or will
take place in the near future, in the technological, market, economic or legal environment in
which the entity operates or in the market to which an asset is dedicated.
(b) The carrying amount of the net assets of the entity is more than its market capitalization.
(c) Evidence is available of obsolescence or physical damage of an asset.

(d) Evidence is available from internal reporting that indicates that the economic performance of an
asset is, or will be, worse than expected.
If any of the above indications is present, an entity is required to make a formal estimate of recoverable
amount and impairment loss need to be provided.
Question No.18
Care Limited purchased machinery on 1.4.2065 from a foreign country at a price of $ 200 thousands
upon terms of credit that the price should be settled within six months from the date of purchase. The
company capitalized the asset and created liability for the capital goods converting the foreign
currency liability to Nepalese Rupees at a rate of exchange prevailing as on 1.4.2065. When the
company settled the liability on 30 Poush 2065, it had to incur an additional amount of Rs. 5,00,000
due to change in foreign exchange rate on the date of settlement. It added this additional amount of
exchange variation in the capital cost of the asset and charged depreciation upon the enhanced
amount of asset value from 1 Magh 2065. Give your opinion. (5 Marks June 2010)
Answer
Effects of Changes in Foreign Exchange rates: According to NAS 21-, the foreign currency
transactions should be initially recognized at the exchange rate prevailing on the date of transaction.
Accordingly, the asset and liability should be accounted at exchange rate prevailing on the date of
purchase. The monetary items should be reported at the exchange rate prevailing on the close of the
accounting period. The liability for capital goods purchased is a monetary item.
If during the accounting period, if a monetary liability is settled at a rate different from the rate at which
it was initially recognized the exchange difference should be charged to P&L account in the year of
settlement.
According to NAS 21, hence, it is necessary to write off Rs, 500 thousand being exchange differences at
the date of settlement. It cannot be added to the cost of the capital. Hence, the company is wrong in
capitalizing foreign exchange differences between the amounts of initial recognition and settlement and
computing depreciation on the wrongly capitalized portion of the asset. This needs correction by the
company. Else, the auditor may qualify his report upon relevant considerations.
Question No.19
Kathmandu Boarding School was established in year 2010. It recently constructed swimming pool of
2020-meter size behind its main building. Due to Vastusastra problem, the swimming pool was
reconstructed toward 5-meter west side of the building. Relocation of the pool incurred additional cost
of 20%. Suggest, how this cost be booked in account.
Answer Hint
According to NAS 16 Property, Plant and Equipment, the expenditure for relocation of swimming pool
should be capitalized.

Question 20
M/s Zahira& Co. engaged in manufacturing pharmaceutical products has invested in shares of M/s
Enforce Ltd. The company, after balance sheet date, finds that the share value was declining and thus,
seeking your opinion regarding recording the losses in financial statement to comply the Nepal
Accounting Standard 10, "Event after the Reporting Period". What would be your suggestion in this
regard?
Answer
Nepal Accounting Standard – 10, "Events after the Reporting Period" requires an entity to adjust the
amounts recognized in its financial statements to reflect adjusting events after the balance sheet date.
However, Para 10 of the said NAS states that an entity shall not adjust the amounts recognized in its
financial statements to reflect non-adjusting events after the balance sheet date. In the given case, the
decline in market value does not normally relate to the condition of the investments at the balance sheet
date, but reflects circumstances that have arisen subsequently.
Therefore, M/s Zahira& Co. should not adjust the amounts recognized in its financial statements for the
investments. Similarly, the company should not update the amounts disclosed for the investments as at
the balance sheet date, although it may need to give additional disclosure if non-adjusting events after the
balance sheet date are material, nondisclosure could influence the economic decisions of users taken on
the basis of the financial statements. Accordingly, an entity shall disclose for each material category of
non-adjusting event after the balance sheet date:
 the nature of the event; and
Question No. 21
During the audit of current year, while obtaining confirmation from the debtors, it was found that the
revenue amounting to Rs. 150 million of M/s Mahalaxmi Manufacturing Company Limited for the
previous year was not booked. The management of the company wants to recognize the revenue in
current year income statement as prior period items. As an auditor, you are required to give your
opinion for accounting of such revenue based on relevant Nepal Accounting Standard.
Answer
Errors can arise in respect of the recognition, measurement, presentation or disclosure of elements of
financial statements. Financial statements do not comply with NAS if they contain either material errors
or immaterial errors made intentionally to achieve a particular presentation of an entity‟s financial
position, financial performance or cash flows. Potential current period errors discovered in that period are
corrected before the financial statements are authorized for issue. However, material errors are
sometimes not discovered until a subsequent period, and these prior period errors are corrected in the
comparative information presented in the financial statements for that subsequent period.

NAS – 08, Nepal Accounting Standards on Accounting Policies, Changes in Accounting Estimates &
Errors, Para 42 states that an entity shall correct material prior period errors retrospectively in the first set
of financial statements authorized for issue after their discovery by:
(a) Restating the comparative amounts for the prior period(s) presented in which the error occurred; or
(b) If the error occurred before the earliest prior period presented, restating the opening balances of
assets, liabilities and equity for the earliest prior period presented.
Likewise, Para 43 and 44 state that a prior period error shall be corrected by retrospective restatement
except to the extent that it is impracticable to determine either the period – specific effects or the
cumulative effect of the error. When it is impracticable to determine the period – specific effects of an
error on comparative information for one or more prior periods presented, the entity shall restate the
opening balances of assets, liabilities and equity for the earliest period for which retrospective
restatement is practicable (which may be the current period).
In given case, it seems that the revenue not recognized into account is material and hence, it requires
retrospective restatement in the comparative amounts for the prior period.
Question No. 22
Fire Ltd. purchased equipment for its power plant from Urja Ltd. during the year 2064-065 at a cost of
Rs.100 lacs. Out of this, they paid only 90% and balance 10% was to be paid after one year on
satisfactory performance of the equipment. During the Financial year 2065-066, Urja Ltd. waived off
the balance 10% amount which was credited to Profit and Loss account by Fire Ltd. as discount
received.
Answer
According to NAS-16 on Property, Plant and Equipment, the cost of an asset may undergo changes
subsequent to its acquisition on account of exchange fluctuation, price adjustment, changes in duty or
similar factors. Such change in price /cost needs to be adjusted with the cost of the asset.
In the given case, Fire Ltd., initially accounted for 100% amount i.e., Rs.100 lacs as cost of fixed asset
although they paid only Rs.90 lacs and kept Rs.10 lacs as payable to the credit of Urja Ltd. Now since the
supplier has waived off the balance amount of Rs.10 lacs, this should be treated as change in price and
needs to be adjusted with the cost of asset as per NAS-16.
Therefore, the treatment given by Fire Ltd., in crediting Rs.10. Lacs as discount to Profit & Loss Account
is completely wrong and needs to be corrected. It will have effect on depreciation also and needs
adjustment.
The auditor should report the matter if suitable changes are not made in the accounts.

Question 23

a. Deferred tax arising from a business combination (5 Marks December 2010, December 2011)
Answer
As per NAS 12, "Income Taxes", temporary differences in deferred tax may arise in a business
combination that is an acquisition. In accordance with, an entity recognizes any resulting deferred tax
assets or deferred tax liabilities as identifiable assets and liabilities at the date of the acquisition.
Consequently, those deferred tax assets and liabilities affect goodwill or negative goodwill. However, an
entity does not recognize deferred tax liabilities arising from goodwill itself and deferred tax assets
arising from non- taxable negative goodwill which is treated as deferred income.
As a result of a business combination, an acquirer may consider it probable that it will recover its own
deferred tax asset that was not recognized prior to the business combination. For example, the acquirer
may be able to utilize the benefit of its unused tax losses against the future taxable profit of the acquiree.
In such cases, the acquirer recognizes a deferred tax asset and takes this into account in determining the
goodwill or negative goodwill arising on the acquisition.
Question No. 24
The Critical Pollution Extinction Company Limited procured a pollution controlling machine for
which the government has 50% rebate in customs duty upon the precondition that the machine should
be used for at least 5 years. During the course of audit, you found that the company has credited 50%
rebate provided to income for the year by disclosing the same in the Notes to Accounts in the
Financial Statement. What is your opinion as regarding the accounting treatment by the company?
(5Marks June
2011)
Answer
As mentioned in NAS 20 Accounting for Government Grants and Disclosure of Government Assistance,
a government grant is not recognized until there is reasonable assurance that the entity will comply with
the conditions attaching to it, and that the grant will be received. Receipt of a grant does not of itself
provide conclusive evidence that the conditions attaching to the grant have been or will be fulfilled.
Government grants shall be recognized as income over the periods necessary to match them with the
related costs which they are intended to compensate, on a systematic basis. They shall not be credited
directly to shareholders‟ interests. It is fundamental to the income approach that government grants be
recognized as income on a systematic and rational basis over the periods necessary to match them with
the related costs. Income recognition of government grants on a receipts basis is not in accordance with
the accrual accounting assumption. Government grants related to assets, including non- monetary grants
at fair value, shall be presented in the balance sheet either by setting up the grant as deferred income or
by deducting the grant in arriving at the carrying amount of the asset. Hence the NAS has provided two
acceptable alternative methods of presentation in financial statements of grants related to assets.

According to the first method, the grant amount is accounted for as deferred income which is recognized
as income on a systematic and rational basis over the useful life of the asset. Under the other alternative
method, government grant is deducted in arriving at the carrying cost of the asset and the grant is
recognized as income over the depreciable asset by way of a reduced depreciation charge.
Hence, as mentioned here above, the treatment to credit whole of the credit rebate amount in the year of
purchase of the machine by Critical Pollution Extinction Company is not appropriate since it is bound by
the precondition that the machine should be used for at least 5 years. The 50% rebate received on
customs duty should be credited to income for at least over a period of 5 years.
Question No. 25
(5 marks June 2011)
b) A firm of a father and a son is receiving Rs. 2 lakhs towards job work done for XYZ Ltd. during
the year ended on 15 July 2007. The total job work charges paid by XYZ Ltd. during the year are
over Rs. 50 lakhs. The father is a Managing Director of XYZ Ltd. having substantial holding. The
Managing Director told the auditor that since he is not involved in the activities of the firm and
since the amount paid to it is insignificant; there is no need to disclose the transaction. He further
contended that such a payment made in the last year was not disclosed. Is Managing Director right
in his approach?
c) ABC Construction Company Ltd. is financed loan from bank to acquire Loader (i.e. heavy
equipment). Initially the loan was scheduled to repay within five years but due to sound financial
condition, company pre-paid the balance of loan installments before maturity. Bank instead
charged pre-payment fee for such early payment. The company has opted the allowed alternative
treatment for borrowing costs that directly attributes to the acquisition, construction or production
of an asset to include in the cost of that asset. Here, in given case, the company seeks your opinion
whether to include such pre-payment fee in the cost of Loader or recognize as an expense for that
period.
d) Your client in FY 2064/65 had made a provision of Rs. 25,000 for the payment of a claim on
account of enhancement in the price of goods supplied to him. While auditing the amount for the
year 2066/67 you find that the claim during this year has been settled for Rs. 35,000 and the
amount has been debited to the Purchases Account of the year.
Answers
a) NAS 24, “Related Parties” establishes standards on auditor‟s responsibilities and audit procedures
regarding related party transactions. In this case, the related party relationship is absolutely clear
and accordingly the auditor must examine that the disclosure requirements as laid down in NAS 24,
“Related Party Disclosures” has been followed, as Managing Director.
Further auditor is to require to comply with the provisions of NSA 550 regarding Related Parties.

b) The borrowing costs that are directly attributable to the acquisition, construction or production of a
qualifying asset are those borrowing costs that would have been avoided if the expenditure on the
qualifying asset had not been made. As per Nepal Accounting Standard on Borrowing Costs – 23,
amortisation of discounts or premiums relating to borrowings also consists borrowing cost. Here in
given case the company has paid premium to redeem the loan in advance and such pre-payment fee
is simply a borrowing cost for the company. Therefore, the company should include pre-payment
fee in the cost of that assets i.e. Loader as the company is applying the allowed alternative
treatment for borrowing costs.
c) As per the NAS 8- Nepal Accounting Standard on Accounting Policies, Change in Accounting
Estimates & Errors “the correction of a prior period error is excluded from the profit or loss for the
period in which the error is discovered. So, the action of debiting the purchase account is not
justified.
Question No. 26
M/s Skyline Industry Ltd. had adopted weighted average method of accounting policy for valuation of
inventory used for segment A business and FIFO method of accounting policy for valuation of
inventory used for segment B business. Segment A business was not into operation till the second year.
On third year, segment A business was started and Industry thought that it would be worthwhile to
adopt FIFO method of accounting policy for valuation of inventory in segment A business too. The
chief accountant of the Industry wants to treat the change in method of valuation as change in
accounting policy. Is his opinion justified?
Answer
Nepal Accounting Standard 08, "Accounting Policies, Changes in Accounting Estimates & Errors" states
that the application of new accounting policy for transactions, other events or conditions that did not
occur previously or were immaterial are not changes in accounting policies. Here, in given case, the
Industry had adopted weighted average method of accounting policy for valuation of inventory used for
segment A business and FIFO method of accounting policy for valuation of inventory used for segment
B business. Segment A business was not into operation till the second year. On third year, segment A
business was started and accounting policy for valuation of inventory in segment A business was
changed to FIFO method. It shows that the Industry never applied the weighted average method of
inventory valuation method as there was no business operation before. Therefore, the chief accountant of
the Industry has no valid reason to treat the change in method of valuation as change in accounting
policy. His opinion can't be justified.
Question No. 27
Give your opinions with reasons on the following cases: (5 Marks each, December 2011))

a) Grand Industries Ltd. is engaged in manufacturing and supply of gear boxes to Suzaki Vehicles
Ltd. As per terms of supply, full price of the goods is not released by Suzaki Vehicles Ltd. but 15%
thereof is retained and paid after one year, if there is satisfactory performance of the parts
supplied. Grand Industries Ltd. accounts for only 85% of the invoice value as sale at the time of
supply and balance 15% is accounted as sale in the year of receipt of payment. Comment
b) The Company`s plant & machinery was Rs. 200 million as on 1stShrawan 2067. It provided
depreciation at 15% per annum under WDV method. However, it noticed that about Rs. 20 million
worth of imported asset, which is component of above plant & machinery acquired on 1stShrawan
2067, would be obsolete in 2 years. Company wants to write off this asset over 2 years. Can
Company do so? Give Comments.
Answer
a) According to NAS-18 on Revenue, revenue recognition from sale of goods should be recognized
when the seller has transferred to the buyer, the property or the goods for a price or when the seller
has transferred all significant risk and rewards and the seller has no effective control over goods and
no significant uncertainty exists regarding the amount of consideration and its collectability. In the
given case the goods as well as the risk and ownership has been transferred by Grand Industries Ltd.,
to Suzaki Vehicles Ltd., on the basis of invoice and delivery of material. In the instant case, therefore,
Grand Industries Ltd. should recognize sale at full 100% of the invoice value in spite of the fact that
15% payment will be released after one year. However, depending upon the past experience
regarding collectability of 15% amount, they can make a provision for the amount that is not likely to
be realized. Hence, the treatment given by the company is not correct and if they do not correct it, the
auditor should qualify his report.
b) As per Nepal Accounting Standard 16 (Property, Plant and Equipment), where the addition or
extension retains a separate identity and is capable being used after the existing asset is disposed of,
depreciation should be provided independently on the basis of an estimate of its own useful life. As it
appears that imported assets of Rs. 20 million, which is component of plant and machinery, is having
independent useful life. Therefore, the company`s policy to write off over two years is correct.
Question No. 28
As an auditor, express your comments/views on the following situations: (4×5=20Marks December
2011)
a) ABC Ltd.‟s total turnover for the FY 2067/68 is Rs. 1 Crore and it includes Rs. 2.1 lakhs from sale
of by-product. Whereas, the by-product sales are included under the miscellaneous income of the
financial statements and is not separately disclosed in the income head.
b) Shakti Pan Masala (P) Ltd. was incurring heavy losses in the last several years since it could not
withstand the competition in the market. The Constituent Assembly in the meantime has passed a
bill to ban manufacture and sale of all kinds of Pan Masalas in the country. While finalizing the
accounts for the year ended 31-03-2067, the CFO of the company created a Deferred Tax Asset for

the tax benefits that would arise in future years from the earlier years losses that had remained
unabsorbed in Income Tax.
c) Salony Airlines Ltd. received confirmation that a foreign governmental authority will grant
permission to remit the consideration from a sale in a foreign country. The Airlines recognized
revenue based on the permission granted. It was noted that some changes in regulation happened
and a part of the consideration from the sale was not eligible to remit in that foreign country. The
Airlines adjusted that much of consideration from the sale not eligible to remit in the revenue that
was originally recognized. As an auditor, you are required to examine the action of the Airlines is
correct?
d) A firm of a father and a son is receiving Rs. 2 lakhs towards job work done for XYZ Ltd. during
the year ended on 31.03.07. The total job work charges paid by XYZ Ltd. during the year are over
Rs. 50 lakhs. The father is a Managing Director of XYZ Ltd. having substantial holding. The
in his approach?
Answer
a) As per NAS-01 “Presentation of Financial Statements” States that, Information is material if its
omission or misstatement could influence the economic decisions of users taken on the basis of the
financial statements. Materiality depends on size of the item or error judged in the particular
circumstances of its omission or misstatement. Thus, materiality provides a threshold or cut-off
point rather than being a primary qualitative characteristic which information must have if it is to be
useful.
As per Nepal Accounting Standard 1 Each material item shall be presented separately in the
financial statements. Immaterial amounts shall be aggregated with amounts of a similar nature or
function and need not be presented separately.
In this case, income from sale of by-product shall be disclosed separately in the revenue item as the
income from by-product is considered material items since it is more than two percent of total
turnover of the company. Similarly, the auditor has to ensure that a material item is disclosed
separately and distinctly or at least clear information about the item is available in the accounting
statements. In this case, he is required to make qualification in his audit report, as the income from
by-product is material in giving or distorting a true and fair view of financial statements.
b) Creation of Deferred Tax Asset: Accounting Standard 12 on “Accounting for Taxes” requires that
Deferred Tax Asset (DTA) should be recognized for all timing differences, subject to the
considerations of prudence. The Standard further states that unabsorbed losses of the business can be
considered for creation of DTA provided there is virtual certainty supported by convincing evidence
that sufficient future taxable income will be available against which such DTA can be realized. In
view of this, the DTA created by the CFO of Shakti Pan Masala (P) Ltd. is not in order. Since the

company which is in the business of manufacturing of pan masala has been incurring heavy losses
and in addition to this the State in which the company is having its major sales is proposing the ban
on sale and manufacture of pan masala, the statutory auditor would, therefore, have to qualify his
report and mention the extent of amounts of loss and reserves which are under and overstated
respectively.
c) Revenue is recognised only when it is probable that the economic benefits associated with the
transaction will flow to the entity. In some cases, this may not be probable until the consideration is
received or until an uncertainty is removed. Here in given case the Salon Airlines Ltd. which
recognised revenue on the ground of permission granted to remit the consideration from a sale in a
foreign country. It seems that the uncertainty to receive the sales consideration is removed and
revenue is recognised. NAS 18, Nepal Accounting Standard on Revenue states that however, when
an uncertainty arises about collectability of an amount already included in revenue, the uncollectable
amount or the amount in respect of which recovery has ceased to be probable is recognised as an
expense, rather than as an adjustment of the amount of revenue originally recognised. Therefore, the
treatment of the Airlines to adjust that much of consideration from the sale not eligible to remit in
the revenue that was originally recognised is not justified.
d) Related Party Transactions: Accounting Standard 24 and NSA 550, “Related Party Disclosures”
applies to the facts of the case. NAS 24 requires disclosure of party relationship and transactions
between a reporting enterprise and its related parties. The parties are considered to be related if at
any time during the reporting period, one party has the ability to control the other party or exercise
significant influence over the other party in making decisions. As per the explanation given in NAS
24, significant influence is said to exist in case the investing party has 20% or more voting power in
the enterprise. In the instant case, the managing director of XYZ Ltd. is a partner in the firm with his
son, which has been paid Rs. 2 lakhs as job work charges. Since, the partner (Managing Director in
this case) is member of the Board of Directors, he is capable to influence economic decision of the
company. Thus, the partnership firm is a related party. Further, the managing director has a
substantial holding in the firm. Therefore, the case is squarely covered by NAS 24 and the approach
of the managing director is not tenable under the law and accordingly all disclosure requirements
relating to related party have to be complied. Under the circumstances, the auditor shall have to
modify his report.
Question No. 29
a) Howard Ltd., as part of overall cost cutting measure announced voluntary retirement scheme
(VRS) to its employees, to reduce the employee strength. During the year ended 32.03.2068 the
company paid a compensation of Rs.10 million to those who availed the scheme. The chief
accountant has reflected this payment as part of regular salaries and wages paid by the company.
(5 Marks June 2012)

b) Reena Ltd. received Rs. 50 lakhs as grant from the Nepal Government towards the part cost of a
specific machinery. The company credited the above sum of Rs. 50 lakhs as income in its profit &
loss account for the year. (5 Marks June 2012))
Answer
d) NAS 1, “Presentation of Financial Statements” clearly states that when the items of income and
expenses are material, their nature and amount shall be disclosed separately. Such a disclosure shall
assist in understanding the financial performance achieved and in assessing future results. In the
instant case the payment made to the employees on account of VRS as an overall cost cutting
measure would fall under the domain of material item. Accordingly, it is eligible to be shown
separately in the income statement of Howard Ltd., so that the effect of it on the operating results of
the Company during the previous year can be perceived. Therefore, clubbing of Rs. 10 million with
the regular salaries and wages of the company by the Chief Accountant is not appropriate.
e) NAS 20: Accounting for government grants recognized two methods of presentation of grants related
to specific fixed assets in financial statements as acceptable alternatives:
 Under first alternative, the grant is shown in the Balance Sheet as a deduction from the gross value
of a machinery. The grant is recognized in P& L A/c over the useful life of a depreciable asset by
way of a reduced depreciation charges.
 Under second alternative, it can be treated as deferred income which should be recognized in P &
L A/c over useful life of asset in proportion in which depreciation on machinery will be charged.
The deferred income pending its apportionment to P & L A/c should be disclosed in Balance Sheet
with a suitable description e.g. Deferred Government Grants.
In the given case, Reena Ltd. received Rs.50 lakhs as grant towards part cost of specific machinery. The
company has credited the said sum as income in its Profit and Loss account which is incorrect as per the
above provisions.
Question No. 30
a) A firm of a father and a son is receiving Rs. 2 lakhs towards job work done for XYZ Ltd. during
the year ended on 32.03.2068. The total job work charges paid by XYZ Ltd. during the year are
in his approach? (5 Marks June 2012)

b) Shree Ltd. has 2 divisions X and Y. The finished products of division X are transferred to division
Y where further processing is carried out before sale to customers. To achieve transparency and
accountability between the divisions, division X raises an invoice on division Y at cost plus normal
margins. At the year end the unrealized profits on inter-division stocks are eliminated. However,
the transfers are recorded at the invoice value as sales and purchases in the respective divisions for
the purpose of preparing the Profit & Loss Account. Suitable disclosures, for this are given in the
„Notes to Accounts‟. (5 Marks June 2012)
Answer:
a) Nepal Accounting Standard 24, “Related Party Disclosures” applies to the facts of the case. NAS 24
requires disclosure of party relationship and transactions between a reporting enterprise and its related
parties. The parties are considered to be related if at any time during the reporting period, one party
has the ability to control the other party or exercise significant influence over the other party in
making decisions. As per the explanation given in NAS 24, significant influence is said to exist in case
the investing party has 20% or more voting power in the enterprise. In the instant case, the managing
director of XYZ Ltd. is a partner in the firm with his son, which has been paid Rs. 2 lakhs as job work
charges. The managing director is having a substantial holding in the firm. The case is covered by
NAS 24. The approach of the managing director is not tenable under the law and accordingly all
disclosure requirements have to be complied. Since there is related party transaction the contention of
managing Director is not correct and the auditor should advise him to make proper disclosure as
required by NAS and if the management refuses, the auditor shall express a qualified report. The
auditor shall suitably ensure the compliance with NSA 550 regarding the reporting of related party
disclosures
b) As per the definition of the term “Revenue” in NAS 18, revenue is the gross inflow of cash,
receivables or other consideration arising in the course of the ordinary activities of an enterprise from
the sale of goods, from the rendering of services, and from the use by others of enterprise resources
yielding interest, royalties and dividends. Revenue is measured by the charges made to customers or
clients for goods supplied and services rendered to them and by the charges and rewards arising from
the use of resources by them.
The definition clearly implies that the transfers within the enterprise cannot be considered as fulfilling
the definition of the term “revenue”. Thus, the recognition of inter-divisional transfers as sales is an
inappropriate accounting treatment and is inconsistent with NAS 18. Further, in case of inter-
divisional transfers, risks and rewards remain within the enterprise and also there is no consideration
from the point of view of the enterprise as a whole. Thus, the recognition criteria for revenue
recognition are also not fulfilled in respect of inter-divisional transfers. In the instant case, therefore,
Shree Ltd cannot recognize inter-division transfers from X to Y as sales and the same will have to be
eliminated during finalization. If management does not agree to do so, the auditor shall qualify his
report.

Question No. 31
Treatment of foreign currency monetary items on balance sheet date. (5 Marks June 2012)
Answer
Foreign Currency Monetary Items and its Treatment on Balance Sheet date: As per NAS- 21 on
“Accounting for the Effects of Changes in Foreign Exchange Rates” monetary items are money held and
assets and liabilities to be received or paid in fixed or determinable amounts of money, e.g., cash,
receivable, payables, etc. Regarding foreign currency transactions, NAS 21 requires that while reporting
effects of changes in exchange rates subsequent to initial recognition, at each balance sheet date,
monetary items denominated in a foreign currency, (e.g., foreign currency notes, balances in bank
accounts denominated in a foreign currency, and receivables, payables and loans denominated in a
foreign currency) should be reported using the closing rate prevailing on balance sheet date. However, in
certain circumstances the closing rate may not reflect, with reasonable accuracy, the amount in reporting
currency that is likely to be realized from or required to be disbursed to because the rate is unrealistic. In
such circumstances, the relevant monetary item should be reported in the reporting currency at the
amount which is likely to be realized from or required to be disbursed to at the balance sheet date.
Question No. 32
Your client has computed the deferred tax assets or liabilities on: i. Fixed assets as per financial base
Rs. 500,000, as per tax base Rs. 600,000; ii. Other assets as per financial base 300,000 as per tax base
Rs. 200,000 and other liabilities as per financial base Rs. 100,000 as per tax base Rs. 50,000. Consider
applicable tax rate 5% and opening balance of deferred tax asset is Rs.5,000. As an Auditor how
would be check the accounting treatment made on deferred tax by your client (show your computation
as well)?
Answer:
Nepal Accounting Standard 12 (NAS) defined on deferred tax assets and liabilities. The NAS suggested
for computing deferred tax assets or liabilities on temporary differences on tax base and financial base
and booking corresponding income or expenses. The computation of deferred tax has been as follows:
Particulars Financia Tax Base Deferred Applica Deferred Tax

l Base (B) (Assets) ble (Assets) /Liabilities
(A) /Liabilities C= @ 5% D= C*5%
(A-B)
1.Fixed Assets (100,000) Yes (5,000)
500,000 600,000
2.Other Assets 100,000 Yes 5,000
300,000 200,000

3. Liabilities (50,000) Yes (2,500)

100,000 50,000
Net Asset (2,500)
Previous year Asset (5,000)
Balance
Decrease in Asset (50,000) (2,500)
(Charged to PL) 900,000 850,000
Accordingly closing balance of deferred tax should be Rs. 2,500 and deferred tax asset should be credited
by Rs. 2,500 by charging corresponding amount to profit & loss account as deferred tax expenses.
Question No. 33
Comment on the following situations/statements.
a) M/s Bulbul Ltd. has taken a Group Gratuity Policy from Insurance Company. During accounting
year 2011-12 it received a communication from the said Insurance Company informing that
premium amount for the accounting year 2010-11 was less charged by Rs. 35 lacs on account of
arithmetical error on the part of Insurance Company. M/s Bulbul Ltd. paid the sum of Rs. 35 lacs
during the accounting year 2011-12 by debiting the same to prior period expenses.
b) Grow Ltd. gave a guarantee to the Court for payment of excise dues of Rs.10 lacs for one of its
Subsidiary. According to the Company, since the guarantee was given on behalf of its subsidiary,
no disclosure was required.
c) Financial Controller of Druk Investment Company Limited noted that the interest recoverable for
the year 2066-67 from one of the debtors was wrongly accounted under the head loan receivable.
During audit of the year 2067-68, Financial Controller of the Company requested the auditor to
rectify the error by recognizing the income in current year as prior period item and adjust the loan
amount accordingly. State your view whether the Financial Controller's request can be accepted?
Answer:
a) Answer
Nepal Accounting Standard 8 “Accounting Policies, Change in Accounting Estimates and Error"
defines the prior period items as income or expenses which arise in the current period as a result
errors or omission in the preparation of financial statements of one or more prior period. Errors may
occur as a result of mathematical mistakes, mistakes in applying accounting policies,
misinterpretation of fact or oversight. In this case, there have been arithmetical mistakes in
computing the amount of premium.

Though in this case there was no omission on the part of M/s Bulbul Ltd. and the error was on the
part of the Insurance Company. But it is the management which is responsible for preparation of
financial statements. Thus, the expenditure pertains to prior period and to be debited to prior Period
Expenses. Therefore, the accounting treatment accorded by the management is appropriate. The
auditor should, however, ensure that the nature of mistake i.e. Insurance premium has been disclosed
separately in such a manner that its impact on current profit or loss can be perceived.
b) Answer
Grow Ltd., in its books of account is required to record a contingent liability of Rs.10 lacs for the
guarantee given by it for payment of excise dues of its subsidiary, to the Court. In the event, the
subsidiary failed to meet its obligation, Grow Ltd. would be required to pay Rs.10 lacs to the
authorities concerned.
Nepal Accounting Standard also states that the existence and amount of guarantees undertaken by an
enterprise are generally disclosed in financial statements by way of a note, even though the
possibility that the loss will occur, is remote. Thus, the amount of any guarantee given by a company
on behalf of its subsidiary is required to be stated and where practicable, the general nature of such
contingent liability, if material, be specified. Accordingly, the views expressed by the company
cannot be accepted.
c) Errors can arise in respect of the recognition, measurement, presentation or disclosure of elements of
financial statements. Financial statements do not comply with NAS if they contain either material
errors or immaterial errors made intentionally to achieve a particular presentation of an entity‟s
financial position, financial performance or cash flows. However, material errors are sometimes not
discovered until a subsequent period, and these prior period errors are corrected in the comparative
information presented in the financial statements for that subsequent period.
NAS 08 "Accounting Policies, Changes in Accounting Estimates & Errors" states that an entity shall
correct material prior period errors retrospectively in the first set of financial statements authorized
for issue after their discovery by:
 restating the comparative amounts for the prior period(s) presented in which the error
occurred; or
 if the error occurred before the earliest prior period presented, restating the opening balances
of assets, liabilities and equity for the earliest prior period presented.
Hence, in given case the opinion of Financial Controller is not acceptable as such errors in prior
period can't be accounted in the current period rather it should be corrected by restating the
comparative accounts of income and loan of the year 2066/67.
Question No. 34
Comment on the following:

Chief Financial Officer of M/s Subizon Industries Limited prepared financial statements of the
Company without considering the effect of market value of major equipment‟s which is drastically
below the book value. As an auditor, how would you deal with such situation?
As specified in Nepal Accounting Standard on Impairment of Assets (NAS – 36) in assessing whether
there is any indication that an asset may be impaired, as a minimum, the following indications shall be
considered:
External sources of information
a. during the period, an asset‟s market value has declined significantly more than would be expected
as a result of the passage of time or normal use.
b. significant changes with an adverse effect on the entity have taken place during the period, or will
take place in the near future, in the technological, market, economic or legal environment in
which the entity operates or in the market to which an asset is dedicated.
c. market interest rates or other market rates of return on investments have increased during the
period, and those increases are likely to affect the discount rate used in calculating an asset‟s
value in use and decrease the asset‟s recoverable amount materially.
d. the carrying amount of the net assets of the entity is more than its market capitalization.
Internal sources of information
a) evidence is available of obsolescence or physical damage of an asset.
b) significant changes with an adverse effect on the entity have taken place during the period, or are
expected to take place in the near future, in the extent to which, or manner in which, an asset is
used or is expected to be used. These changes include the asset becoming idle, plans to
discontinue or restructure the operation to which an asset belongs, plans to dispose of an asset
before the previously expected date, and reassessing the useful life of an asset as finite rather than
indefinite.
c) evidence is available from internal reporting that indicates that the economic performance of an
asset is, or will be, worse than expected.
d) cash flows for acquiring the asset, or subsequent cash needs for operating or maintaining it, that
are significantly higher than those originally budgeted;
e) actual net cash flows or operating profit or loss flowing from the asset that are significantly worse
than those budgeted;
f) a significant decline in budgeted net cash flows or operating profit, or a
g) significant increase in budgeted loss, flowing from the asset; or
h) Operating losses or net cash outflows for the asset, when current period amounts are aggregated
with budgeted amounts for the future.
An entity may identify other indications that an asset may be impaired and these would also require the
entity to determine the asset‟s recoverable amount or, in the case of goodwill, perform an impairment test
in accordance with the specified provision in NAS.

Here, in given case, the book value of the assets is higher than market value which needs to be provided
for and an entity shall disclose the amount of impairment losses recognized in profit or loss during the
period and the line item(s) of the income statement in which those impairment losses are included for
each class of assets. If the company fails to disclose the fact, the auditor should qualify the audit report.
Question No. 35
Write down ten areas where different accounting policies are applied on accounting the financial
transactions based on the nature of entities. (5 Marks June 2013)
Answer:
Various Nepal Accounting Standards (NAS) are issued by the Accounting Standard Board of Nepal
which are mandatory in nature and few are recommendatory as well. For prudent accounting practices;
application of NAS should be made on accounting of financial transactions. Some areas where
accounting policies suggested by NAS/NFRS are:
i) Method of depreciation, depletion and amortization-Straight Line Method, Written Down

Value method.
ii) Accounting Concept: Historical cost convention is to be defined.
iii) Fluctuation of foreign currency and its treatment should be defined.
iv) Valuation of inventories – FIFO, LIFO, weighted average etc.
v) Treatment of goodwill – write off, retain.
vi) Valuation of investment –at cost, market or net realizable value etc.
vii) Treatment of retirement benefits-Actuarial, funded through trust, insurance policy etc.
viii) Recognition of Revenue either on mercantile or accrual basis is defined.
ix) Revaluation of fixed assets and write-off of fixed assets having certain value say Rs. 1,000
or less.
x) Treatment of contingent liabilities.
Question No. 36
a) Satya Limited is company listed in Recognized Stock Exchange of Nepal. During normal course of
operation, a fire broke out on 15thAshoj, 2070, in which material worth 50 lakhs which was lying
in stock since 1stAshadh, 2070 was totally destroyed. The financial statements of the company have
not been adopted till the date of fire. The management of the company argues that since the loss
occurred in the year, 2070-71, no provision for the loss needs to be made in the financial
statements for 2069-70. State whether argument of management is in accordance with applicable
provision.
b) Dhaulagiri Ltd. is an associate of Sagarmatha Ltd. How do you ensure whether Sagarmatha Ltd.
has significance influence in Dhaulagiri Ltd. or otherwise?

a) Answer:
Event occurring after the balance sheet date: This case requires attention to NSA 560 “Subsequent
Events” and NAS 10 “Events After the Reporting Period”. As per NAS 10 “Events After the Reporting
Period”, adjustments to assets and liabilities are required for events occurring after the balance sheet date
that provide additional information materially affecting the determination of the amounts relating to
conditions existing at the balance sheet date or that indicate that the fundamental accounting assumption
of going concern (i.e., the continuance of existence or substratum of the enterprise) is not appropriate.
NAS – 10 also requires disclosure of the non-adjusting event, in the report of the approving authority.
Further, as per NSA 560 “Subsequent Events”, the auditor should assure that all events occurring
subsequent to the date of the financial statements and for which the applicable financial reporting
framework requires adjustment or disclosure have been adjusted or disclosed. The event took place after
the close of the accounting year and does not relate to conditions existing at the balance sheet date. Thus,
it will have no effect on items appearing at the balance sheet date because as per NAS – 10 have to be
adjusted that provide evidence of conditions existing as at the balance sheet date. However, the auditor
has to ensure that this loss will not materially affect the substratum of the enterprises as per its size,
nature and complexity of operations.
Thus, subject to satisfaction in respect of non-violation of going concern concept, the company has
correctly accounted by not providing provision. However, the auditor is required to ensure the proper
disclosure of abovementioned event.
b) Answer
As per NAS 28, investment in associates; if an investor holds, directly or indirectly (e.g. through
subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the investor has
significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if the
investor holds, directly or indirectly (e.g. through subsidiaries), less than 20 per cent of the voting power
of the investee, it is presumed that the investor does not have significant influence, unless such influence
can be clearly demonstrated. A substantial or majority ownership by another investor does not
necessarily preclude an investor from having significant influence.
Further Para 6 of NAS 28 stated that the existence of significant influence by an investor is usually
evidenced in one or more of the following ways: (a) representation on the board of directors or equivalent
governing body of the investee;(b) participation in policy-making processes, including participation in
decisions about dividends or other distributions; (c) material transactions between the investor and the
investee; (d) interchange of managerial personnel; or (e) provision of essential technical information.
Accordingly, in the light of aforesaid provision of NAS 28, for ensuring whether Sagarmatha Ltd. have
significance influence over Dhaulagiri Ltd; first of all, have to ensure percentage of voting power of
Sagarmatha Ltd. in Dhaulagiri Ltd. or evidencing factor as mentioned in above Para, existence of any one
evidence is deemed to have significant influence.

Question No. 37
a) On the basis of approval accounting policy, Bee Limited has revalued its property and charged Rs.
5 crores revaluation loss in profit and loss account in 2067/68 whereas transferred Rs. 10 crores
the revaluation gain to revaluation reserve in 2068/69.
(5 Marks June 2013)

b) A company wants to adjust the bank balance on the balance sheet date by reversing the entry for a
cheque issued in the normal course of business and cancelled after the year end but before the
finalization of accounts. The cheque was returned on the ground that the signature differs.
(5 Marks June 2013)

c) ABC Hydropower Pvt. Ltd. has purchased equipment worth of Rs. 4 million which is kept stand by
for urgent usage on need basis for repairing the heavy equipment as and when default is reported
in functioning of heavy equipment. The accountant has treated it as recurring inventory item and
charged to profit and loss account at the end of each financial year based on consumption pattern
calculated on reasonable basis. Is the accounting treatment made by accountant is correct?
Comment.
a) Answer
NAS 16 states about the treatment of revaluation of fixed assets. As per this NSA, if an asset‟s carrying
amount is increased as a result of a revaluation, the increase shall be credited directly to equity under the
heading of revaluation surplus. However, it reverses a revaluation decrease of the same asset previously
recognized in profit or loss.
If an asset‟s carrying amount is decreased as a result of a revaluation, the decrease shall be recognized in
profit or loss. However, the decrease shall be debited directly to equity under heading of revaluation
surplus to the extent of any credit balance existing in the revaluation surplus in respect of that asset.
The revaluation surplus included in equity in respect of an item of property, plant and equipment may be
transferred directly to retained earnings when the asset is derecognized. This may involve transferring the
whole of the surplus when the asset is retired or disposed of. However, some of the surplus may be
transferred as the asset is used by an entity. In such a case, the amount of the surplus transferred would
be the difference between depreciation based on the revalued carrying amount of the asset and
depreciation based on the asset‟s original cost. Transfers from revaluation surplus to retained earnings are
not made through profit or loss.
Hence in a given case, the revaluation profit of Rs 5 crores is to be credited to profit or loss account of
the year 2068/69, the amount equivalent to revaluation loss which was charged to profit or loss account

in earlier years and Rs 5 crores is to be credited to equity directly (i.e. revaluation reserve). So, the
accounting treatment on revaluation of property, plant and equipment provided by the company for the
year 2068/69 is not in accordance with the requirement of NAS.
b) Answer
According to the NAS-10 “Events After the Reporting Period”, assets and liabilities should be
adjusted for significant events occurring after the balance sheet date that provide additional evidence
to assess estimation of amounts relating to conditions existing at the balance sheet date. Since the
phenomenon of difference in signature existed on the balance sheet due (though known afterwards);
the reversal of the entry can be made as on the balance sheet date if the amount is material.
c) Answer
As per NAS 16- Property, Plant and Equipment, spare parts and servicing equipment are usually carried
as inventory and recognized in profit or loss as consumed. However, major spare parts and stand-by
equipment qualify as property, plant and equipment when an entity expects to use them during more than
one period. Similarly, if the spare parts and servicing equipment can be used only in connection with an
item of property, plant and equipment, they are accounted for as property, plant and equipment.
In view of the above provision made in NAS 16, the equipment purchased by ABC Hydropower Pvt. Ltd.
should be treated as property, plant and equipment. Though it is servicing equipment used on repairing
heavy equipment; it has to be kept stand-by and can be used only in connection with heavy equipment
and usable for more than one accounting period, it should be treated as property, plant and equipment
instead of treating it as inventory.
Question No. 38
Give your comments on the following: (5 Marks December 2013)
Chitale Limited has declared dividend of 12% for FY 2069/70 in the month of Ashoj 2070. The
company has booked this as Interim Dividend in Financial Statement of 2069/70.
Answer
Dividend has been declared at year end so this should be final dividend.
Further, Nepal Accounting Standards 10 on Events after the Reporting Period provides that if an entity
declares dividends to holders of equity instruments after the balance sheet date, the entity shall not
recognize those dividends as a liability at the balance sheet date.
If dividends are declared after the balance sheet date but before the financial statements are authorized
for issue, the dividends are not recognized as a liability at the balance sheet date because they do not

meet the criteria of a present obligation. Such dividends are disclosed in the notes in accordance with
NAS 01 Presentation of Financial Statements.
Thus, the treatment followed by Chitale limited is not in line with NAS.
Question No. 39
a) M/s Merita Impex is engaged in the business of manufacturing and trading of musical instruments.
A sum of Rs. 5 lakhs, received from an insurance company as an insurance claim for loss of goods
in transit costing Rs. 4 lakhs, is credited to the purchase account.
b) Alpha Limited purchased a high value plant from Beta Limited in exchange of 10,000 units of its
finished products. The plant was in use in Beta Limited for last 3 years and expert expects that its
useful life could be further 17 years (i.e. 20 years in total). Alpha limited sells its finished products
in the market at Rs 1,000 per unit whereas there is no specific market for the used plant but the
expert valuation of the used plant indicates the value of the plant as Rs. 1.2 crores. Hence, Alpha
Limited has recorded the cost price of the plant at Rs. 1.2 crores.
c) Normal waste of material in production process is 2 % of input. 10,000 kg. of input was made in
process with resultant wastage of 500 kg. Cost per kg of input is Rs. 100. The entire quantity of
waste is in stock at the year end. As an auditor how do you ensure the proper valuation of
inventory?
d) Z Ltd. paid Rs. 100,000 income tax for disposal of capital assets during fiscal year 2069/070 and
showed as deduction from cash flow from operating activities. Is this treatment in compliance with
NAS 03? Suggest correct treatment in cash flow statement.
Answer:
a) All items of income and expense which are recognized in a period should be included in the
determination of net profit or loss for the period. The claim for loss of goods in transit is arising out of
ordinary activities of the impex as a part of its normal course of business. However, the cost of goods
lost in transit is only Rs.4,00,000 while the insurance money received is Rs.5,00,000. Purchases
Account need not be credited since it would distort the purchases done during the year and as also the
gross profit. Therefore, entire amount of 5 lakhs needs to be taken to profit and loss account under an
appropriate head. This is an income arising from an ordinary activity of the enterprise but having
regard to amount involved and exceptional nature, a separate disclosure be made in the profit and loss
account. Such disclosure would enable the users to understand the performance of an enterprise for the
period.
As per NAS 18 Revenue is the gross inflow of economic benefits during the period arising in the
course of the ordinary activities of an entity when those inflows result in increases in equity, other

than increases relating to contributions from equity participants. In a given case it has been shown
after deducting in the purchase which is not as per this standard and it should be disclosed in gross as
per this NAS.
b) The fair value of the asset given up by Alpha Limited is Rs 10,000,000 (i.e. 10,000 units * Rs 1,000).
As per NAS 16 on property plant and equipment, if an entity is able to determine reliably the fair
value of either the asset received or the asset given up, then the fair value of the asset given up is used
to measure the cost of the asset received unless the fair value of the asset received is more clearly
evident. In the present case, the fair value of the used plan is not clearly evident because there is no
specific market for the used plant.
Hence the plant should be recorded at the fair value of finished stock of Alpha Limited given up to
purchase the used plant; i.e. Rs 1 crore. So, the accounting treatment on measurement of cost of used
plant purchased from Beta Limited by Alpha Limited is not in accordance with the requirement of
NAS.
c) As per Para 16 of NAS-2, abnormal amounts of waste materials, labor or other production costs,
storage costs, unless those costs are necessary in the production process before a further production
stage; administrative overheads that do not contribute to bringing inventories to their present location
and condition; and selling costs are excluded from cost of inventories and such costs are recognized as
expenses in the period in which they are incurred.
In this case, normal waste is 200 kg and abnormal waste is 300 kg. The cost of 200 kg will be included
in determining the cost of inventories (Finished Products) at the year end. The cost of abnormal waste
amounting to Rs. 30,000 (300 kg *Rs. 100) will be charged in the profit and loss statement.
d) As per NAS-07, cash flows arising from taxes on income shall be separately disclosed and shall be
classified as cash flows from operating activities unless they can be specifically identified with
financing and investing activities.
Further Para 35 added that taxes paid are usually classified as cash flows from operating activities.
However, when it is practicable to identify the tax cash flow with an individual transaction that gives
rise to cash flows that are classified as investing or financing activities, the tax cash flow is classified
as an investing or financing activity as appropriate.
In view of the above provision in NAS -07, the treatment for income tax (capital gain tax) on disposal
of capital asset is not in compliance with NAS 07, accordingly it should be shown under cash flow
from investing activities.

Question No. 40
a) Smart Pvt. Limited sold a Television worth of Rs. 500,000 (exclusive of all taxes) on 32 Ashadh
2071 which includes Rs. 100,000 for servicing fees of the Television for 5 years from the date of
sales. The servicing fee is estimated equal amount for each guaranteed service years. Smart Pvt.
Limited booked entire Rs. 500,000 as revenue for financial year 2070/71.
b) A company purchased a plant for Rs. 20 crores on 1 Shrawan 2070. The company has the policy to
charge depreciation at the rate of 10% on such plants on straight line basis. Due to long dispute
between the management and the labour of the company, the factory was closed from Kartik 1,
2070 to Chaitra end 2070. Management has charged depreciation of Rs. 1 crore on the said plant
to the income statement for the year because the newly purchased plant was not used for 6 months
in the year.
c) XYZ is a manufacturing company. There was huge fire in the factory of XYZ on 1 Ashoj 2071 and
fixed assets of written down value Rs. 10 crores were lost out of total fixed assets of Rs. 20 crores
of the company. The financial statements of the company for the year 2070/71 was approved by the
Board on 30 Ashoj 2071 in which fixed assets have been presented at WDV of Rs. 20 crores despite
the severe loss due to fire and the information about the loss due to fire is properly explained in the
Notes to the financial statements.
Answer
a) As per NAS 18 "Revenue" when the selling price of a product includes an identifiable amount for
subsequent servicing (for example, after sales support and product enhancement on the sale of
software), that amount is deferred and recognized as revenue over the period during which the
service is performed. The amount deferred is that which will cover the expected costs of the
services under the agreement, together with a reasonable profit on those services. Accordingly, in
the light of aforesaid provision of NAS 18; the accounting treatment made by Smart Pvt. Limited
is not correct. Smart should book Rs. 400,000 as revenue for FY 2070/71 and Rs. 100,000 should
be deferred. For each coming year Rs. 20,000 should be recognized as revenue to match its
services cost.
b) Depreciation of an asset begins when it is available for use, i.e. when it is in the location and
condition necessary for it to be capable of operating in the manner intended by management.
Depreciation of an asset ceases at the earlier of the date that the asset is classified as held for sale
(or included in a disposal group that is classified as held for sale) in accordance with NAS 16 and
the date that the asset is derecognized. Therefore, depreciation does not cease when the asset
becomes idle or is retired from active use unless the asset is fully depreciated. So, in the given
case, depreciation expenses to be charged to the income statement for the year 2070/71 should be
Rs 2 crores (i.e. for full year) instead of Rs 1 crore.

c) As per NAS-10, Events After the Reporting Period, events after the reporting period are those
events, favorable and unfavorable, that occur between the end of the reporting period and the date
when the financial statements are authorized for issue. Two types of events can be identified:
 those that provide evidence of conditions that existed at the end of the reporting period
(adjusting events after the reporting period); and
 those that are indicative of conditions that arose after the reporting period (non-adjusting
events after the reporting period)
So, the event in the given case (fire after reporting period) is a non-adjusting event. An entity shall
not adjust the amounts recognized in its financial statements to reflect non-adjusting events after the
reporting period.
If events after the balance sheet date impacts going concern status of the entity, the entity is required
to prepare its financial statement on break-up value basis. This does not seem to be the case here.
If non-adjusting events after the reporting period are material, non-disclosure could influence the
economic decisions that users make on the basis of the financial statements. Accordingly, an entity
shall disclose the following for each material category of non-adjusting event after the reporting
period:
 the nature of the event; and

So, presenting fixed assets at Rs 20 crores in the balance sheet with appropriate disclosure in the
Notes to Accounts seems to be appropriate.
Question 41

(5 Marks each July 2015)
a) The following information pertains to the trading stock of a company:
Product Historical cost (Rs.) Net Realizable

value (Rs.)
Color TVs 200,000 270,000
Black & White TVs 115,000 150,000
Ordinary Bikes 200,000 185,000
Sport bikes 110,000 115,000
Computers 80,000 100,000
Total 705,000 820,000

The company has a policy to value stock at lower of cost or net realizable value and accordingly
trading stock has been valued at Rs. 705,000 in the balance sheet of the company.
b) A company purchased machinery on 1stAsoj 2071 for Rs. 10 crores on credit for 6 months. The
seller normally does not sell such machineries on credit and cash price of the machinery is Rs 9.5
crores. The buying company recognizes machinery at Rs. 10 crores in the books on 1stAsoj and the
liability is fully paid on Falgun Masant.
c) Total trade receivable of a company is Rs. 20 crores. It includes receivables from Maheswary
Limited amounting to Rs 2 Crores. Maheswary Limited was declared bankrupt on 15 thAsoj 2071;
i.e. after the reporting period of Ashad end 2071 and before the date when financial statements
were authorized for issue; i.e. Asoj Masant 2071. The company management claims that the
carrying amount of trade receivable does not need to be adjusted because the information about
bankruptcy was known after the reporting period.
a) Answer
Inventories are usually written down to net realizable value (NRV) item by item. In the given case, cost
of all the items on total basis is lower than their NRV. However, if we compare NRV with cost product-
wise, we can note that NRV of ordinary bikes (i.e. Rs 185,000) is lower than its cost (i.e. Rs. 200,000).
The following comparative table may be useful for valuation of inventories
Product Historical cost Rs Net Realizable Presentable

value (Rs.) value (Rs.)
ClourTvs 200,000 270,000 200,000
Black & White TVs 115,000 150,000 115,000
Ordinary Bikes 200,000 185,000 185,000
Sport bikes 110,000 115,000 110,000
Computers 80,000 100,000 80,000
Total 705,000 820,000 690,000
So, inventory should be presented at Rs. 690,000 in the balance sheet rather than at Rs. 705,000.
b) Answer
As per NAS 16, the cost of an item of property, plant and equipment is the cash price equivalent at the
recognition date. If payment is deferred beyond normal credit terms, the difference between the cash
price equivalent and the total payment is recognized as interest over the period of credit unless such
interest is capitalized in accordance with NAS 23.

So, in the given case, the machinery should be recognized at Rs. 9.5 crores in the books and 0.5
crores should be recognized as interest over the 6 months period (Asoj-Falgun)
c) Answer
Events after the reporting period are those events, favorable and unfavorable, that occur between the
end of the reporting period and the date when the financial statements are authorized for issue. Two
types of events can be identified:
i. those that provide evidence of conditions that existed at the end of the reporting period
(adjusting events after the reporting period); and
ii. those that are indicative of conditions that arose after the reporting period (non-adjusting
events after the reporting period)
So, the event in the given case (knowing information about bankruptcy of the debtor after balance sheet
date) seems to be an adjusting event because the debtor was bankrupt on the balance sheet date which
was declared by the court later on. Hence the carrying amount of the trade receivable should be presented
at Rs. 18 crores instead of Rs. 20 crores in the balance sheet.
Question No. 42
Give your comments on the following: (5 Marks each July 2015)
Financial Statements for the year 2069/70 was issued in Paush 2070. While preparing the financial
statements of 2070/71, it was known that the financial statements of 2069/70 included error. The
auditor advises the management to correct and revise the financial statements of 2069/70 and circulate
the revised financial statements with all the authorities where original financial statements were
submitted.
Answer
As per NAS 8, prior period errors are corrected in the comparative information presented in the financial
statements. Unless it is impracticable, an entity shall correct material prior period errors retrospectively
in the first set of financial statements authorized for issue after their discovery by: (a) restating the
comparative amounts for the prior period(s) presented in which the error occurred; or (b) if the error
occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and
equity for the earliest prior period presented.
So, in the given case, the error in the financial statements of 2069/70 can be rectified in the comparative
information of the financial statements of 2070/71. The financial statements of 2069/70 which was
already issued need not be revised.

Question No. 43
As an auditor, give your opinion with explanations on the following cases: (December 2015)
a) A company has 10 vehicles with carrying amount of 5 crores. The company has purchased a new
machinery worth Rs 8 crore by exchanging with its 10 used vehicles and making further payment
of Rs 2 crores in cash. The company management derecognizes vehicles from its financial
statements and recognizes machinery at Rs 7 crores (5 crores plus 2 crores).
b) A company‟s financial year ends on 31 March 2015 for group accounting purpose. Due to
devastating earthquake in the month of April 2015, the company‟s factory building with carrying
amount of Rs 5 crores was totally destroyed. The board of director authorized the financial
statements for issue on 30June 2015. The financial statements include the destroyed building at Rs
5 crore although the Notes to account makes appropriate disclosure about the earthquake and the
destruction of the factory building.
c) PQR limited has computed the cost of the inventory using last in fast out (LIFO) method and the
value comes to Rs 2 crores (if the cost of the inventory is computed as per first in first out formula,
its cost will be Rs 2.5 crores). Net realizable Value of the stock is Rs 2.25 crores. Since the policy of
the company is to present inventory at lower of cost or NRV, the company has presented inventory
in the financial statement at Rs 2 crores, being the lowest.
d) A company purchased a plant at the cost of Rs 10 crores on 1 Srawan 2066 and the company is
charging depreciation on straight line basis over 10 years useful life assuming there will be no
scrap. In the year 2071/72 the company decides to charge depreciation as per written down value
method @ 10%. The company management considers this as the change in accounting estimate
and accordingly considers the effect due to the change prospectively; i.e. depreciation charged in
the year 2071/72 is Rs 50 lakh and no adjustment in retained earnings and carrying amount of
machinery.
Answer
a) The company has acquired new machinery by exchanging with used vehicles and making further
payment of Rs 2 crores in cash. As per NAS 16, the assets acquired in such case shall be recognized
at the fair which is Rs 8 crore in this case. So, Machinery should be recognized at Rs 8 crores. Since
2 Crores has been paid in cash, disposal of vehicle should be recognized at Rs 6 crore thereby
resulting into gain of Rs 1 crore on disposal of vehicle because the carrying amount of vehicle in the
books of the company is Rs 5 crore. Hence the treatment of recognizing new machinery at Rs 7 crore
and not recognizing gain of Rs 1 crore on disposal of vehicle by the management does not seem to be
appropriate in accordance with NAS 16.
b) Earthquake occurred in the month of April 2015 which is after the end of the accounting year (31
March 2015) and before the date when the financial statements are authorized for issue (30 June
2015). Hence it is an event after reporting period. Since this event does not provide further evidence
of the condition existed at the end of reporting period (31 March 2015) and it indicates the condition

that arose after the reporting period, it is a non-adjusting event. So, the carrying value of the
destroyed factory building need not be adjusted in the financial statements and appropriate disclosure
in the Notes to account seems to be in line with NAS 10.
c) As per NAS 2, cost of inventories should be assigned as per first in first out or weighted average
formula. Determining the cost as per last in first out is not allowed. So, despite the fact the cost of
inventories of PQR will be more if FIFO is used than if LIFO is used, the cost should be determined
as per FIFO. Hence the cost of inventory shall be taken as 2.5 crore in the given case instead of 2
crores as per LIFO. Since NRV of the inventory is 2.25 crores, lower than the cost, inventory shall be
presented at Rs 2.25 crores in the financial statements.
d) As per NAS 8, Accounting policies are the specific principles, bases, conventions, rules and practices
applied by an entity in preparing and presenting financial statements.
A change in accounting estimate is an adjustment of the carrying amount of an asset or a liability, or

the amount of the periodic consumption of an asset, that results from the assessment of the present
status of, and expected future benefits and obligations associated with, assets and liabilities.
Examples of estimate provided in the standard includes the useful lives of, or expected pattern of
consumption of future economic benefits embodied in depreciable assets.
Straight line method or written down value method of depreciation reflects the estimate of useful life
and expected pattern of consumption of future economic benefits from depreciable assets. Hence
change of depreciation method from straight line to WDV is the change in accounting estimate and
not the change in accounting policy. So, the effect of the change considered by the management in
the preparation of the financial statements seems to be appropriate.
Question No. 44
As an auditor, give your opinion with explanations on the following cases: (December 2015)
Organo Pvt. Ltd., manufacturing noodles, has valued at the year end its closing stock of packed
finished goods for which firm sales contracts have been received, at realizable value inclusive of profit
and cash incentive. As at the year end, the ownership of the goods has not been transferred to the
buyers.
Answer
Valuation of Inventories: NAS 02 requires that inventories should be valued as lower of cost and Net
realizable value (NRV). A departure from the general principle can be made if the NAS is not applicable
or having regard to the nature of industry. NAS 2 also states that (a) work in progress arising under
construction contracts, including directly related service contracts (b) work in progress arising in the

ordinary course of business of service providers;(c) shares, debentures and other financial instruments
held as stock-in-trade; and (d) producers‟ inventories of livestock, agricultural and forest products are
measured as NRV based on established practices. In the given case the sale is assumed under a forward
contract but the goods are not of a nature covered by the above exceptions taking into account the facts
the closing stock of finished goods should have been valued at cost, as it is lower than the realizable
value (as it includes profit). Further, sale cash incentives should not be included for valuation purposes.
The policy adopted by the Organo Pvt. Ltd. for valuing its closing stock of inventory of finished goods
on selling price plus sale incentives is not correct. The statutory auditor should give a qualified report.
Question No. 45
As an auditor, give your opinion with explanations on the following cases:
(5 Marks June 2016)
a) M/s DC Limited signed an agreement with workers for increase in wages with retrospective effect.
The outflow on account of arrears was for 2011-12 Rs. 10.00 lakhs, for 2012-13 Rs. 12.00 lakhs
and for 2013-14 Rs. 12.00 lakhs. This amount is payable in September, 2014. The accountant
wants to charge Rs. 22.00 lakhs as prior period charges in financial statement for 2014-15.
b) X Ltd. sold the apartment to M Ltd. for Rs. 60 lakhs on 30.09.2014 and gave possession of the
property to M Ltd. However, Malpot documentation and legal formalities are pending. Due to this,
the company has not recorded the sale and has shown the amount received as an advance. The
book value of the building is Rs. 25 lakhs as on March 31, 2014.
c) Manu Manufacturing Limited acquired an asset which has been declared by municipality as not
meeting the requirements of environment laws which have been recently enacted. The asset has to
be destroyed as per the law. The asset is carried in the Balance Sheet at the year end at Rs.
6,00,000. The estimated cost of destroying the asset is Rs. 70,000. The accountant wishes to charge
off net balance of Rs.5,30,000 in next 5 years.
a) Answer
The term prior period item refers only to income or expenses which arise in the current period as a result
of errors or omission in the preparation of the financial statements of one or more prior periods. The
term does not include other adjustments necessitated by circumstances, which though related to prior
periods are determined in the current period. The full amount of wage arrears paid to workers will be
treated as an expense of current year and it will be charged to profit and loss account as current expenses
and not as prior period expenses. It may be mentioned that additional wages are an expense arising from
the ordinary activities of the company.
Although abnormal in amount, such an expense does not qualify as an extraordinary item. However, as
per NAS, when items of income and expense within profit or loss from ordinary activities are of such
size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for
the period, the nature and amount of such items should be disclosed separately.

b) Answer
Principles of prudence, substance over form and materiality should be looked into, to ensure true and
fair consideration in a transaction. In the given case, the economic reality and substance of the
transaction is that the rights and beneficial interest in the property has been transferred although legal
title has not been transferred. Hence, X Ltd. should record the sale and recognize the profit of Rs. 35
lakhs in its financial statements for the year ended 31st March, 2015; value of building should be
removed from the balance sheet.
Therefore, the treatment given by the company is not correct.
c) Answer
As per NAS on Impairment of Assets, impairment loss is the amount by which the carrying amount of
an asset exceeds its recoverable amount, where, recoverable amount is the higher of an asset‟s net
selling price and its value in use·. In the given case, recoverable amount will be nil [higher of value in
use (nil) and net selling price is also nil. Thus, impairment loss will be the sum of Rs. 670,000 including
the cost of disposable of the fixed assets.
Therefore, asset is to be fully impaired and impairment loss of Rs. 6,70,000 has to be recognized as an
expense immediately in the statement of income as per NAS.
Question No. 46
a) X Ltd. owns five motors that it uses in its business as property, plant, and equipment. The entity
intends to carry three motors under the cost model and the remaining two under the revaluation
model.
b) A Ltd. company has been valuing its closing inventories under the weighted-average cost method.
In 2072/73, management decided to change its accounting policy relating to the valuation of
inventories to first-in, first-out (FIFO) method since it was considered to more accurately reflect
the usage and flow of inventories in the economic cycle. Is the change in accounting policy
justified?
c) M/s MeritaImpex is engaged in the business of manufacturing and trading of musical instruments.
A sum of Rs. 5 lakhs, received from an insurance company as an insurance claim for loss of goods
in transit costing Rs. 4 lakhs, is credited to the purchase account.
Answer:
a) NAS 16 permits an entity to choose between either the cost model or the revaluation model. It does
not allow an entity to apply two different models for the same class of property, plant, and
equipment. Therefore, the company is not allowed to carry three motors under the cost model while
carrying two under the revaluation model, since the standard categorically prohibits such an
accounting treatment.

b) As per NAS 8, an entity shall change an accounting policy only if the change
 Is required by a NFRS; or
 Results in the financial statements providing reliable and more relevant information about
the effects of transactions, other events, or conditions on the entity‟s financial position,
financial performance, or cash flows.
 Reflect the economic substance of transactions, other events and conditions, and not
merely the legal form;
 are neutral, i.e. free from bias;
 are prudent and are complete in all material respect.
In this case, the company has changed its accounting policy in order to accurately reflect the usage
and flow of inventories in the economic cycle. The change in accounting policy is justified.
c) All items of income and expense which are recognized in a period should be included in the
determination of net profit or loss for the period. The claim for loss of goods in transit is arising
out of ordinary activities of the Impex as a part of its normal course of business.
Since the company received Rs. 5 lakhs against goods lost in transit costing Rs. 4 lakhs, there is
profit of Rs. 1 lakh from insurance claim which should be separately recognized in P/L.
Further cost of goods sold should be reduced by Rs. 4 lakhs (i.e. goods lost in transit) so that gross
profit figure is not affected as sales revenue did not arise for these goods.
Question No. 47
a) Nice Guy Ltd. sells goods with a cost of Rs. 100,000 to Start-up Co. for Rs. 140,000 and a credit
period of six months. Nice Guy‟s normal cash price would have been Rs. 125,000 with a credit
period of one month or with a Rs. 5,000 discounts for cash on delivery. The company wishes to
book the revenue as Rs. 140,000.
b) AA Ltd. provided Rs 64 lakhs for Inventory obsolescence in 2072/73. In the subsequent year, it was
determined that 50% of such inventory was usable. The Board of Directors wants to adjust the
same through prior period adjustment.
c) A firm of a father and a son is receiving Rs. 2 lakhs towards job work done for XYZ Ltd. during
the year ended on 32.03.2072. The total job work charges paid by XYZ Ltd. during the year are

in his approach?
a) Answer
Effectively, Nice Guy Ltd is financing Start-up Co. for a period of six months. The normal price would
have been Rs. 125,000 as the goods sold with a credit period of six months. Therefore, cash discount
should not be applicable for the goods sold on credit settlement. Sales revenue should be accounted for
Rs. 125000 being the fair value of consideration receivable. The difference between the nominal amount
of Rs. 140,000 and the normal price of goods Rs. 125000 i.e. Rs. 15,000 would be recognized as interest
income over the period of finance of six months.
As per NAS 18, Revenue is the gross inflow of economic benefits during the period arising in the course
of the ordinary activities of an entity when those inflows result in increases in equity, other than increases
relating to contributions from equity participants. In a given case it has been shown after deducting in the
purchase which is not as per this standard and it should be disclosed in gross as per this NAS.
b) Answer
As per NAS 10 on "Events after the Reporting Date ", prior period items are income or expenses which
arise in the current period as a result of errors or omissions in the preparation of the financial statements
of one or more prior periods. The write-back of provision made in respect of inventories in the earlier
year does not constitute prior period adjustment since it neither constitutes error nor omission but it
merely involves making estimates based on prevailing circumstances when financial statements were
being prepared. It is a mere estimate process involving judgment based on the latest information
available.
An estimate may have to be revised if changes occur regarding the circumstances on which the estimate
was based, or as a result of new information, more experience or subsequent developments. The revision
of the estimate, by its nature, does not bring the adjustment within the definitions of an extraordinary
item or a prior period item.
In this case, AA Ltd. provided Rs 64 lakhs for inventory obsolescence in 2072-73. In the subsequent year
due to change in circumstances, it was determined that 50% of such inventory was usable. Revision of
such an estimate does not bring the resulting amount of Rs.32 lakhs within the definition either of a prior
period item or of an extraordinary item. The amount, however, involved is material and requires separate
disclosure to understand the financial position and performance of an enterprise. Accordingly, adjustment
in the value of the inventory through prior period item would not be appropriate.
c) Answer
Nepal Accounting Standard 24, “Related Party Disclosures” applies to the facts of the case. NAS 24
requires disclosure of party relationship and transactions between a reporting enterprise and its related
parties. The parties are considered to be related if at any time during the reporting period, one party has

the ability to control the other party or exercise significant influence over the other party in making
decisions.
In the given case, the managing director of XYZ Ltd. is a partner in the firm with his son, which has been
paid Rs. 2 lakhs as job work charges. The managing director is having a substantial holding in the firm.
The case is covered by NAS 24. The approach of the managing director is not tenable under the standard
and accordingly all disclosure requirements have to be complied. Since there is related party transaction
the contention of managing Director is not correct and the auditor should advise him to make proper
disclosure as required by NAS and if the management refuses, the auditor shall express a qualified report.
Question No. 49
Sagar International Ltd. has acquired a solar power system on 01.04.2072 for Rs. 100 lakhs. On
02.04.2072, it applied to Alternative Energy Promotion Board of Nepal for a 50% subsidy. The subsidy
application was finally approved on 01.06.2073. While finalizing the accounts, the company has
accounted the subsidy as adjusting event after reporting period. The board of directors has not yet
authorized the financials for issue. (5 Marks each June 2017)
Answer:
NAS 10 on “events after reporting period” requires the value of assets and liabilities to be adjusted for
events occurring after the balance sheet date which occur up to the date of approval of accounts by the
Board of Directors ( authorized for issue) if they provide evidence of the conditions existing at the end of
the reporting period. Since, in this case books of account have not been approved, grant of subsidy will
be considered as an adjusting event. Hence, the accounts should be adjusted for the subsidy in 2072-73.
Hence, the subsidy should be either credited to the cost of the system or alternatively may be treated as
deferred income to be written off over the useful life in proportion in which depreciation is written off.
Question No. 50
a) M/s Radisson Hotel on 15.4.2073 imported two Mercedes Benz from Germany at a price Euro 200
thousand each upon terms of credit that price should be settled within three months from the date
of purchase. The company capitalized the asset and created a liability for the capital goods
converting the foreign currency liability to Nepalese Rupees at a rate of exchange prevailing as on
15.4.2073. When the company settled the liability on 30.8.2073, it had to incur an additional
amount of Rs.15,00,000 due to foreign exchange rate on the date of settlement. It added this
additional amount of exchange variation in the capital cost of the asset and charged depreciation
upon an enhanced amount of asset value from 30.8.2073.

b) Mr. Rajaram is a director in M/s P Ltd. and also in M/s Q Ltd. M/s Q Ltd. purchases goods from
M/s P Ltd. The two companies reported the transaction as transaction with related party as on
Ashadh 31, 2074 under NAS-24.
Answer:
a) Nepal Accounting Standards (NAS) 21 states that the exchange differences on the settlement of
monetary items at a rate different from those at which they were translated on initial recognition
during the period or in previous financial statements shall be recognized in profit or loss in the
period in which they arise. Therefore, in view of the above, the M/s Radisson Hotel should charge
the additional amount of Rs.15,00,000 to profit and loss account in accordance with the said
standard and not to capitalize.
b) According to the Provisions of NAS-24, the given transaction between P Ltd. and Q Ltd. is not a
related party transaction. According to the standard, related party relationship includes enterprises
owned by directors or major shareholders of the reporting enterprise and enterprises that have a
member of key management in common with the reporting enterprise. In the given case, none of
the enterprises is owned by Rajaram. He is only a director in both the enterprises not a Key
Management Personnel (Such as Managing Director, Whole time Director, etc.). Therefore, P Ltd
should not report the transaction as related party transaction.
Question No. 51

a) AJ Limited has an investment worth NPR 1,000,000 in its financial statements at 31 stAshadh
2074. Due to the continuing recession, the investment reduced in value to NPR 900,000 by
15thShrawan 2074.
b) MNS Ltd. (The Company) is engaged in manufacturing business. The book value of plant &
machinery of the company was Rs. 900 million as on Ashadh end 2073 (purchased at Rs. 1,000
million on 1stShrawan 2072). It provided depreciation on straight line basis at 10% per annum
based on useful life of the plant & machinery. Imported asset of Rs. 100 million, the
component of above plant & machinery was acquired on 1stShrawan 2073 that would be
obsolete in 2 years. The company wants to write off this asset over 2 years. Can the company do
so?
c) X Ltd. entered into an agreement with Y Ltd. to dispatch goods valuing Rs. one lakh every
month for six months upon receipt of entire payments. Y Ltd. accordingly made the payment.

In third month due to a natural calamity Y Ltd. requested X Ltd. not to dispatch until further
notice.
d) During the financial year 2073/74, Y & R Private Limited, a service providing company
purchased generator of Rs. 2 million for smooth functioning of its office. The accountant
claims that there is no necessity to provide for depreciation in respect of generator as it was
kept standby but not used at all during the financial year.
Answer:
a) NAS 10 Events after the Reporting Period provides guidance whether an entity should adjust its
financial statements or shall disclose for the events after reporting period.
Since reduction in investment value occurred only after the reporting period, it is indicative of
condition that arose after the reporting period which is a non-adjusting event as per para 3 of NAS 10.
An entity shall not adjust the amounts recognized in financial statement to reflect non-adjusting
events after the reporting period. The decline in fair value does not normally relate to the condition of
the investments at the end of the reporting period, but reflects circumstances that have arisen
subsequently.
Therefore, the entity does not update the amounts disclosed for the investments as at the end of the
reporting period, however it may need to give additional disclosure about the nature of event and an
estimate of its financial effect, or a statement that such an estimate cannot be made.
b) As per Nepal Accounting Standard 16 (Property, Plant and Equipment), each part of an item of
property, plant and equipment with a cost that is significant in relation to the total cost of the item
shall be depreciated separately.
An entity shall allocate the amount initially recognized in respect of an item of property, plant and
equipment to its significant parts and depreciate separately each such part. To the extent that an entity
depreciates separately some parts of an item of PPE it also can depreciate separately the remainder of
the item. As it appears that imported assets of Rs. 100 million, which is component of plant and
machinery, is having independent useful life.
Therefore, the company can choose to depreciate the significant parts at 10% p.a. and remainder
imported assets over two years.
c) NAS 18 “Revenue” specifies that revenue from sale of goods should be recognized when following
conditions have been fulfilled:
i) The seller of the goods has transferred all significant risks and rewards of ownership to the
buyer.
ii) the seller retains no effective control of the goods sold usually associated with ownership;
iii) The amount of revenue can be measured reliably.
iv) It is probable that the economic benefits associated with the transaction will flow to the entity
and
v) The cost in respect of the transaction can be measured reliably.

In this case X Ltd had transferred the significant risk and rewards of the property at an agreed price.
As such sale has been fully completed because upon receipt of the entire payment. X Ltd was
required to dispatch goods valuing Rs 100,000 for six months out of its inventory. However, in the
third month, Y Ltd requested to stop dispatch until further intimation due to a natural calamity. X Ltd
had transferred the goods at an agreed price and all significant risks and rewards. The delivery was to
be affected as per the schedules indicated by Y Ltd. As per NAS 18, Revenue, mere postponement of
delivery at buyer‟s request does not alter the period in which revenue should be recognized.
Accordingly, X Ltd should recognize the entire 600,000 as Sales.
d) As per para 55 of NAS 16 "Property, Plant and Equipment", depreciation of an assets begins when it
is available for use, i.e. when it is in the location and condition necessary for it to be capable of
operating in the manner intended by the management.
Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable
asset arising from use, efflux of time or obsolescence through technology and market changes. Thus,
depreciation has to be charged even in case of these assets which are not used at all during the year
but by mere efflux of time provided such assets qualify as depreciable assets.
When the generator was kept ready for use as stand-by, it means it was intended to be used for the
purpose of business. Depreciation in respect of this generator would have been provided in the
accounts for the year ended 31st Ashadh 2074. If there is an intention to use an asset, though it may
not have actually been used, it is a 'constructive' or 'passive' use and eligible for charging
depreciation.
Question No. 52
a) The total assets of Rs. 250 million of Y & Z Limited includes inventory amounting to Rs. 50
million. The inventories were valued at cost. The market price of the inventories was Rs. 42
million. The company has disclosed this fact in the notes to accounts.
b) A Co. Ltd. has not included in the Balance Sheet as on 32-03-2075 a sum of Rs. 1,500,000 being
amount in the arrears of salaries and wages payable to the staff for the last 2 years because the
negotiations were going since last 18 months which concluded on 30-04-2075. The auditor wants
to sign the said financial statement and give the audit report on 31-05-2075. The auditor came to
know the result of the negotiations on 15-05-2075.
Answer:
a) As per Nepal Accounting Standards (NAS) 2, Inventories should be measured at lower of cost
and net realizable value. In the present case the cost price of the inventories is Rs. 50 million and
net realizable value is Rs. 42 million and hence the inventories should be presented at Rs. 42

million in the balance sheet. However, the company has presented the inventories at Rs. 50
million and disclosed in the notes to accounts that the inventories have been presented at cost
although its net realizable value is lower than the cost. Mere disclosure of this fact in the notes
however does not result into compliance with the accounting standard.
Hence as an auditor, I will qualify my audit report because inventory in the present case
represents material item of the assets of the company and it has been materially misstated in the
balance sheet.
b) As per NAS 10 “Events after the reporting period”, adjustments to assets and liabilities are
required for events after the reporting date that provide additional information materially
affecting the determination of the amounts relating to conditions existing at the reporting date.
Similarly, as per NAS 37 "Provisions, Contingent liabilities and Contingent Assets", future events
that may affect the amount required to settle an obligation should be reflected in the amount of a
provision where there is sufficient objective evidence that will occur.
The amount of Rs 1,500,000 is a material amount and it is the result of an event, which has
occurred after the reporting date. The facts have become known to the auditor before the date of
issue of the Audit Report and Financial Statements. The auditor has to perform the procedure to
obtain sufficient, appropriate evidence about the events occurring from the date of the financial
statements i.e. 32-3-2075 to the date of Auditors Report i.e. 31-05-2075. It is observed that as a
result of long pending negotiations a sum of Rs. 1,500,000 representing arrears of salaries of last
two years have not been included in the financial statements. It is quite clear that the obligation
requires provision for outstanding expenses. So, the auditor should request the management to
adjust the sum of Rs. 1,500,000 by making provision for expenses. If the management does not
accept the request the auditor should qualify the audit report.
Question No. 53
As an auditor, give your opinion with explanations on the following cases: (5 Marks each June
2019
a) Surendra Clothing Pvt. Ltd. has been assessed to Income-tax, in which a demand of Rs. 10
lakhs have been made. The company has gone in appeal. The company has deposited Rs. 6
lakhs against the demand, on being pursued by the department. The company has been advised
by its counsel that there is 80% chance of losing in respect of one of the grounds which may
end up confirming the demand of rest Rs. 4 lakhs. How the company should treat the same
while preparing the final accounts for the year ending Asadh end, 2076?
b) During the previous year ABC Limited has followed the straight-line method of depreciation.
During the current year it has been changed to written down value method.
c) The ABC Ltd., while valuing its finished inventory at the year-end wants to include interest on
Bank Overdraft as an element of cost, for the reason that overdraft has been taken specifically

for the purpose of financing current assets like inventory and for meeting day to day working
expenses.
a) Answer
As per paragraph 14 of NAS 37, an entity shall recognize a provision if and only if:
 a present obligation (legal or constructive) has arisen as a result of past event (the obligating
event),
 payment is probable („more likely than not‟)
 the amount can be estimated reliably
Here, the obligating event is an event that creates a legal or constructive obligation and therefore
results in an entity having no realistic alternative but to settle the obligation.
Contingent liability is a possible obligation depending on whether some uncertain future event
occurs or a present obligation but payment is not probable or the amount cannot be measured
reliably. Contingent liability is not recognized; rather it is disclosed in the notes to accounts in
In the given case, there is an assessment by income tax authority of Rs. 10 lakhs. This situation has
arisen as a result of past event resulting in present obligation of the entity and there is an 80% chance
of losing the case. This extent of probability is substantial. The amount of obligation can also be
estimated reliably. Therefore, the company shall make provision for Rs. 10 lakhs. If the provision of
Rs. 6 lakhs already deposited has been accounted for as provision, additional provision of Rs. 4
lakhs should be made and presented in financial statements accordingly.
b) Answer
As per NAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors” defines
accounting policy and a change in accounting estimates.
An entity shall change the accounting policy only if the change:
 is required by Standards; or
 results in the financial statements providing reliable and more relevant information about the
effects of transactions, other events or conditions on the entity‟s financial position, financial
performance or cash flows.
A change in accounting estimate is an adjustment of carrying amount of an asset or liability, or an
amount of the periodic consumption of assets, which results from the assessment of present status of,
and expected future benefits and obligations associated with, assets and liabilities.
As per NAS 16 Property, Plant and Equipment para 5, the residual value and the useful life of an
assets shall be reviewed at least at each financial year-end, if expectation differs from previous
estimates, the changes shall be accounted for as a change in an accounting estimate in accordance
with NAS 8. Para 60 and 61 further describe that depreciation method used shall reflect the pattern in
which the asset‟s future economic benefits are expected to be consumed by the entity and shall be

reviewed at least at each financial year-end, if there has been a significant change in the expected
pattern of consumption of the future economic benefits embodied in the assets, the method shall be
changed to reflect the changed pattern. Such a change shall be accounted for as a change in
accounting estimate in accordance with NAS 8.
In light of provisions laid down in NASs as discussed above, the change in depreciation method by
the entity is a change in accounting estimate, not the changes in accounting policy. Therefore, as per
NAS 8, effect of such changes in accounting estimate shall be recognized prospectively by including
it in profit or loss in the period of the change or in the period of change and future periods, if such
change affects both. The entity shall disclose the nature and amount of such change in an accounting
estimate that has an effect in current period or is expected to have an effect in future periods.
c) Answer
As per NAS 2 “Inventories”, cost of inventories comprises all costs of purchase, costs of conversion
and other costs incurred in bringing the inventories to their present location and condition. NAS 23
borrowing costs identifies circumstance where borrowing costs can be included in the cost of
inventories. Such borrowing cost shall be directly attributable to the inventories and would have been
avoided if the expenditure on inventory had not been made. In light of these provisions, in given case,
overdraft was taken for financing current assets and meeting day to day working expenses, not
necessarily directly for inventory only. Therefore, the proposal of ABC Ltd. to include interest on
bank overdraft as an element of cost of inventory is not acceptable because it does not form part of
cost of production.

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CHARTERED ACCOUNTANCY PROFESSIONAL II

Compilation of Suggested Answers

Paper 2: Audit and Assurance

© The Institute of Chartered Accountants of Nepal

This compilation of suggested answers is prepared by the Institute of Chartered Accountants of

Chapter 1 Principles and Concept of Assurance

© The Institute of Chartered Accountants of Nepal 1

© The Institute of Chartered Accountants of Nepal 2

b) Errors and Fraud (4 Marks, December 2003)

Fraud may involve:

Error refers to unintentional mistakes in financial information such as:

© The Institute of Chartered Accountants of Nepal 3

© The Institute of Chartered Accountants of Nepal 4

 Copies of audited financial statement for previous years.

 Analysis of significant ratios and trends.

 Copes of management letters issued by the auditor, if any.

© The Institute of Chartered Accountants of Nepal 5

 Notes regarding significant accounting policies.

 Significant audit observations of earlier years.

The current files normally include:

 Correspondence relating to acceptance of annual reappointment.

 Evidence of the planning process of the audit and audit programme.

 Analysis of transactions and balances.

 Copies of letters or notes concerning audit matters communicated to or discussed with

 Letters of representation or confirmation received from the client.

Importance of Working Papers:

© The Institute of Chartered Accountants of Nepal 6

 To ascertain cost accurately: Unless a proper charge on account of depreciation is

 To charge initial costs against earnings: The objective of depreciation accounting is to

© The Institute of Chartered Accountants of Nepal 7

Whereas, provisions are amounts charged against revenue to provide for:

Differences are summarized as below:

1. Reserve is an appropriation of profit whereas provision is a charge against Profit.

© The Institute of Chartered Accountants of Nepal 8

© The Institute of Chartered Accountants of Nepal 9

b) Disclosures of accounting Policies. (4 Marks December 2004)

i. a relevant to the decision- making needs of users; and

© The Institute of Chartered Accountants of Nepal 10

i. Auditing and Accounting.

ii. Auditing and Law.

iii. Auditing and Economics

iv. Auditing and Behavioral Science

© The Institute of Chartered Accountants of Nepal 11

v. Auditing and Statistics & Mathematics

vi. Auditing and Data Processing

vii. Auditing and Financial Management

viii. Auditing and Production

© The Institute of Chartered Accountants of Nepal 12

Write short notes on the followings:

Fundamental accounting assumptions. (4 Marks December 2005, 4 Marks June 2008)

© The Institute of Chartered Accountants of Nepal 13

© The Institute of Chartered Accountants of Nepal 14

© The Institute of Chartered Accountants of Nepal 15

b) Independence of auditor (5 Marks June 2006)

c) Fundamental Accounting Assumption (5 Marks June 2006)

© The Institute of Chartered Accountants of Nepal 16

e) Management Representation Letter (5 Marks June 2006, 5 Marks December 2009)

If a representation by management is contradicted by other audit evidence, the auditor should

© The Institute of Chartered Accountants of Nepal 17