Auditing and Assurance revision question and answer

Auditing and Assurance Revision Questions and Answers

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 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 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 the Chief Finance Officer (CFO) was deposited after the fraud was detected 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 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 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.



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