Auditing and EthicsQuestion 5669 of 212
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Question 3 (a) ABC & Co., a Chartered Accountant firm, has been appointed as the statutory auditors of Pen Private Limited for the F.Y. 2023-24. During audit, one of the team members, Mr. R noticed that Pen Private Limited has purchased software amounting to ` 2.00 crore and the said software is not an integral part of the related hardware. Mr. R further observed that Pen Private Limited has conducted some research of an internal project work amounting to ` 1.00 crore. Pen Private Limited, following Indian GAAP, has presented the aforesaid details in the Balance Sheet as on 31st March, 2024 as follows: Property, Plant, and Equipment ` - Software 2.00 crore - Research 1.00 crore Mr. R approached the engagement partner with above details and enquired about the correctness of the presentation made by Pen Private Limited in terms of Schedule III to the Companies Act, 2013. Mr. R further wanted to ensure that all additions to Intangible assets during the year 2023-24 have been recorded appropriately in the financial statements of Pen Private Limited. Guide Mr. R. (5 Marks) (b) Projects India Limited (PIL) is engaged in manufacturing and trading of disposable glasses and plates used in social gatherings/functions. XYZ & Co., Chartered Accountants, is the statutory auditor of PIL for the F.Y. 2023-24. Analytical procedures carried out by the audit team, headed by CA Z, indicate that company's business is going downward and PIL could achieve only 50% of total revenue of F.Y. 2022-23. Management has not taken any steps to increase the revenue or add new products or customers to stabilize the revenue and profitability. Also the suppliers are demanding cash payment at the time of purchase of raw material. Before finalizing the audit report, audit in charge asked for a cash flow forecast from management for the next AUDITING AND ETHICS 12 months from the end date of financial statements. Keeping in view the above facts, answer the following: (i) What can be the likely purpose of CA Z in the above situation? (3 Marks) (ii) State any two audit procedures in relation to the cash flow forecast likely to be performed by CA Z. (2 Marks) (c) Singh & Associates, while carrying out statutory audit of Rubber Industries Limited, observed that debtors are not making payments invoice wise. As the debtors constitute sixty percent of the total assets, so auditors requested management to provide external confirmations of all the debtors outstanding for an amount exceeding ` 1.00 Lac. However, management resisted and no external confirmations were made available. Auditor firm has decided to disclaim an opinion on the financial statements and seek your guidance on amendments that should be made in the "Basis for Opinion" section and elements required by SA 700 (Revised) which need not to be included in the auditor's report. Guide them suitably. (4 Marks)

Options

A
B
C
D
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Correct Answer

✅ Option descriptive — Correct Option

All Options:

  • A
  • B
  • C
  • D

Detailed Solution & Explanation

**(a) Review of Accounting Presentation and Intangible Asset Audit Procedures:**
**Correctness of Presentation:**
1. **Software (` 2.00` crore)**: Since the software is not an integral part of the related hardware, it should be treated as an intangible asset under Indian GAAP (AS 26). Pen Private Limited's presentation of this software under Property, Plant, and Equipment is incorrect. It must be presented under the head **"Intangible Assets"** on the face of the Balance Sheet in terms of Schedule III to the Companies Act, 2013.
2. **Research (` 1.00` crore)**: Under AS 26, expenditure on research (or on the research phase of an internal project) must be recognized as an expense when it is incurred. It cannot be capitalized. Therefore, presenting it under Property, Plant, and Equipment is incorrect. It should be charged to the Statement of Profit and Loss as an expense.

**Audit Procedures for Additions to Intangible Assets:**
To ensure that all additions to intangible assets have been recorded appropriately, CA R should perform the following:
- For all material additions, verify whether the expenditure meets the recognition criteria for an intangible asset as per AS 26.
- Ensure that no intangible asset arising from research is recognized, and that all research phase costs have been expensed in the period of occurrence.
- Examine supporting documentation (such as certificates, completion reports, or agreements) to verify the date the intangible asset was put to use, linking it to the date of commercial production or economic use.
- Verify that all additions and acquisitions have been approved by the appropriate authorized management of the entity.
- Test the procurement process on a sample basis, checking whether internal procedures (such as inviting competitive quotations or tenders) were followed before selecting the vendor.

**(b) Cash Flow Forecast Assessment (SA 570):**
**(i) Likely Purpose of CA Z:**
In this situation, the company's business is declining, revenue is down by 50%, no stabilization plans have been implemented, and suppliers are demanding cash. CA Z requested a cash flow forecast for the next 12 months for the following purposes:
1. To obtain sufficient appropriate audit evidence regarding, and conclude on, the appropriateness of management's use of the going concern basis of accounting in the preparation of the financial statements.
2. To determine whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern.
3. To determine the appropriate reporting format as per SA 570 (Revised).

**(ii) Audit Procedures on Cash Flow Forecast:**
1. Evaluate the reliability of the underlying data generated by management to prepare the forecast.
2. Determine whether there is adequate support and realistic basis for the assumptions underlying the forecast.

**(c) Disclaimer of Opinion - Basis for Disclaimer & Excluded Elements:**
When management refuses to allow external confirmations for debtors (which constitute 60% of total assets) and no alternative evidence is available, the auditor has a scope limitation that is both material and pervasive. The auditor has correctly decided to disclaim an opinion. Under SA 705 (Revised), the reporting adjustments are:

**Amendments in the "Basis for Opinion" Section:**
1. Modify the heading of the section to **"Basis for Disclaimer of Opinion"**.
2. Describe the details of the limitation (the management's refusal to allow external confirmations and the auditor's inability to obtain alternative audit evidence) within this section.

**Elements of SA 700 (Revised) to be Excluded:**
When disclaiming an opinion, the auditor's report must NOT include:
1. A reference to the section of the auditor’s report where the auditor’s responsibilities are described.
2. A statement about whether the audit evidence obtained is sufficient and appropriate to provide a basis for the auditor’s opinion.

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