Question 4
(a) PQR & Co., Chartered Accountants, has been appointed as statutory
auditor of MGM Ltd. The financial statements of the company have
material amount outstanding as debtors. Ageing of debtors is being done by
the internal auditors and is given by them in their monthly report. This
issue was also discussed with the management. The engagement partner
from PQR & Co. decided to give the age wise debtors as per the report of
internal auditor due to shortage of time. After the audit report was released,
the engagement partner realized that the disclosure of the debtors is
misleading and the ageing was not done by the internal auditor on correct
principles due to which the provision made against old debtors was wrong.
The engagement partner held the internal auditor responsible for this. Is he
correct in making statement that the internal auditor is responsible for
false provisioning? What considerations PQR & Co. should have
undertaken before relying on the work of internal auditor?
(5 Marks)
(b) Identify and explain the assertions that the auditor will check by performing
the following audit procedures-
(i) Employee benefit expenses do not include the cost of any unauthorised
personnel.
22
**(a) Responsibility of External Auditor and Considerations Before Relying on Internal Auditor:** **Responsibility:** The engagement partner's contention holding the internal auditor responsible for the false provisioning is **incorrect**. The external auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the external auditor’s use of the work of the internal audit function. The external auditor cannot delegate their professional responsibility to the internal auditor.
**Considerations before relying on the work of the internal auditor (SA 610):** Before using the work of the internal audit function, PQR & Co. should have evaluated: 1. **Objectivity**: The extent to which the internal audit function’s organizational status and policies/procedures support the objectivity of the internal auditors. 2. **Competence**: The level of professional competence of the internal audit function (e.g., qualifications, experience). 3. **Systematic and Disciplined Approach**: Whether the internal audit function applies a systematic and disciplined approach, including quality control processes. 4. **Adequacy of Work**: If using the work, the external auditor must perform audit procedures on that work to determine its adequacy for the audit's purposes (e.g., verifying sample selection, re-performing tests).
**(b) Identification and Explanation of Assertions:** 1. **Procedure (i)**: Employee benefit expenses do not include the cost of any unauthorized personnel. - **Assertion**: **Occurrence** (ensuring that recorded transactions actually occurred and pertain to the entity). 2. **Procedure (ii)**: All the items of inventory pertaining to the relevant year shall be included regardless of the location. - **Assertion**: **Completeness** (ensuring all assets that should have been recorded are included) and **Cut-off** (ensuring transactions are recorded in the correct accounting period). 3. **Procedure (iii)**: Sales are recorded correctly in the books based on the invoices. Discounts have been properly adjusted or accounted for. - **Assertion**: **Accuracy / Measurement** (ensuring transactions have been recorded accurately at their appropriate amounts in the financial statements). 4. **Procedure (iv)**: The entity owns or controls the inventory recorded in the financial statements (purchase invoices in client's name). - **Assertion**: **Rights and Obligations** (ensuring the entity has legal title/ownership of assets and liabilities represent actual obligations). 5. **Procedure (v)**: Inventory recognized at the lower of cost and net realizable value as per AS 2. - **Assertion**: **Valuation and Allocation** (ensuring assets are recorded at appropriate carrying values and valuation adjustments are properly made).
**(c) Reporting of Pending Litigations (SA 501 and SA 706):** In the given case, BPL is in litigation with the regulator and the appeal is pending. The company has disclosed this in the financial statements. The auditor should report this as follows: 1. **Emphasis of Matter Paragraph**: Under SA 706 (Revised), since the litigation represents an uncertainty regarding the future outcome of an exceptional regulatory action, the auditor must draw attention to it by including an **Emphasis of Matter (EOM)** paragraph. This paragraph must: - Have a separate section in the auditor's report with the heading "Emphasis of Matter". - Provide a clear reference to the litigation and the specific note in the financial statements where the details are disclosed. - State clearly that the auditor's opinion is not modified in respect of this matter. 2. **Reporting under Section 143(3)**: Under Section 143(3) of the Companies Act, 2013, the auditor's report must state whether the company has disclosed the impact of pending litigations on its financial position in its financial statements. 3. **Materiality and Provisioning Review**: The auditor must evaluate whether the litigation requires a provision under AS 29. If a provision was required but only a disclosure was made, the auditor should request management to adjust the financial statements. If management refuses, the auditor must modify the opinion accordingly.