Practice Questions: Introduction to Auditing
Chapter Sixteen
Syllabus topic 1, 2, "Basics – Financial Statements, Users of Information, Definition of Auditing, Objectives of Auditing, Inherent limitations of Audit, Difference between Accounting and Auditing, Investigation and Auditing."; "Errors & Frauds – Definitions, Reasons and Circumstances, Types of Error, Types of frauds, Risk of fraud and Error in Audit, Auditors Duties and Responsibilities in case of fraud."
Pages 42 to 45 of 98
Question 1 (8 + 7 marks)
(a) "The primary object of an audit is not the detection of fraud." Discuss, and set out the objects of an audit. (8)
(b) State the inherent limitations of an audit, and say why they cannot be removed by doing more work. (7)
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Question 2 (8 + 7 marks)
(a) Distinguish between accounting and auditing on any eight bases. (8)
(b) Distinguish between an audit and an investigation on any seven bases. (7)
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Question 3 (15 marks)
Classify each of the following, giving your reason, and say in each case whether the trial balance would disclose it.
- A credit sale of Rs 40,000 was never entered in the books at all.
- The purchase of a delivery van for Rs 6,00,000 was debited to the repairs account.
- A payment of Rs 5,400 to a supplier was posted as Rs 4,500 in both accounts.
- A sale to Ramesh was posted to Rakesh's account.
- The cashier recorded a customer's payment of Rs 30,000 as a bad debt and kept the money.
- Depreciation was not provided for the year.
- The purchase day book was undercast by Rs 2,000 and the sales day book was undercast by Rs 2,000.
- The storekeeper issued goods on a requisition he had forged.
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Question 4 (10 + 5 marks)
(a) Explain the meaning, advantages and disadvantages of a continuous audit, and state how its chief disadvantage may be met. (10)
(b) Answer in one or two sentences each: (5)
- To whom does a company's auditor report, and under which section?
- Whose responsibility is the prevention of fraud, and which provision says so?
- Above the prescribed amount, to whom must a fraud be reported?
- What is the test of materiality?
- What separates a qualified opinion from an adverse one?
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Answers
Answer 1
(a) The objects of an audit
The statement is correct, and it has not always been correct. Until the early twentieth century the object of an audit was the detection of fraud and error, and the change came with the size of companies: when a business has millions of transactions, examining every one and finding every fraud is not possible, and an audit that promised it would be promising what it could not deliver.
The primary object today is fixed by section 143(2) of the Companies Act 2013, which requires the auditor's report to state whether the accounts and financial statements give a true and fair view of the state of the company's affairs and of its profit or loss and cash flow. Nothing in that sentence mentions fraud.
The objects, gathered.
| Object | |
|---|---|
| Primary | To express an opinion on whether the financial statements give a true and fair view |
| Secondary | To detect errors and frauds that would make them materially misstated |
| Secondary | To prevent errors and frauds by the deterrent effect of the audit |
| Incidental | To confirm compliance with the Companies Act and the accounting standards |
| Incidental | To report weaknesses found in internal control |
| Incidental | To satisfy third parties: lenders, tax authorities, regulators |
Practice Questions: Introduction to Auditing
Detection is secondary because it follows from the primary object rather than standing beside it: the auditor must plan to detect a material fraud because his opinion would otherwise be wrong. Prevention is a by-product: the audit deters because it exists, not because the auditor hunts.
Kingston Cotton Mill Co, 1896, is the case usually cited, for the proposition that an auditor is a watchdog and not a bloodhound: he may rely on the honesty of the company's officers where nothing arouses suspicion. It does not license carelessness, and section 143(12) now puts a positive duty on him once he has reason to believe a fraud has been committed.
(b) The inherent limitations
| Limitation | Why more work cannot remove it | |
|---|---|---|
| 1 | Test checking | Examining every transaction cannot be done in the time and at the cost anybody will pay; selection is part of what an audit is |
| 2 | Evidence is persuasive, not conclusive | A delivery note makes a sale probable and does not prove it; most audit evidence is of that kind |
| 3 | Judgment | What is material and which explanation to accept are judgments, and a judgment can be wrong however carefully made |
| 4 | The accounts contain estimates | A provision or a useful life can be found unreasonable and cannot be found untrue |
| 5 | Concealment and collusion | Segregation of duties assumes people work separately; two who agree to work together produce consistent paperwork |
| 6 | Management override | The controls are operated by people who report to the management they exist to constrain |
They cannot be removed by more work because they are properties of the method, not failings in its execution. Limitations one, two and three follow directly from the primary object: the opinion is on material truth and fairness, formed on evidence, by a professional exercising judgment.
What they do not excuse. Failing to obtain sufficient evidence, accepting an explanation without corroboration where suspicion existed, or failing to plan, are negligence and not limitations. The line is drawn by suspicion: once something arouses it, reliance stops being reasonable.
Answer 2
(a) Accounting and auditing
| Basis | Accounting | Auditing | |
|---|---|---|---|
| 1 | Meaning | Recording, classifying and summarising transactions and preparing the statements | Examining those statements and the records behind them to express an opinion |
| 2 | When it begins | With the transaction | Where accounting ends |
| 3 | Object | To ascertain the profit and the position | To report whether the statements are true and fair |
| 4 | Qualification | None required | A chartered accountant, section 141 |
| 5 | Status | Usually an employee | Independent, appointed by the members |
| 6 | Nature | Constructive | Analytical |
| 7 | Period | Continuous through the year | After the year end |
| 8 | Reports to | Management | The members, section 143(2) |
Practice Questions: Introduction to Auditing
Section 144 forbids the auditor of a company to provide it with accounting and book keeping services, which is the statutory expression of row five.
(b) Audit and investigation
| Basis | Audit | Investigation | |
|---|---|---|---|
| 1 | Object | An opinion on truth and fairness | To establish a specific fact |
| 2 | Compulsion | Compulsory for a company | Voluntary, unless ordered under the Act |
| 3 | Ordered by | The members | The client, or the Central Government |
| 4 | Period | One financial year | Any period the purpose requires |
| 5 | Depth | Test checking | Often exhaustive |
| 6 | Who may do it | A chartered accountant | Anybody the client appoints |
| 7 | Output | An opinion | A finding, often with recommendations |
Answer 3
| The item | Classification | Trial balance | |
|---|---|---|---|
| 1 | Credit sale never entered | Error of complete omission | Agrees; both sides are equally short |
| 2 | Van debited to repairs | Error of principle; capital expenditure charged to revenue | Agrees |
| 3 | Rs 5,400 posted as Rs 4,500 in both accounts | Error of commission, wrong amount in both | Agrees |
| 4 | Sale posted to the wrong customer | Error of commission, wrong account of the same class | Agrees |
| 5 | Payment taken and written off as a bad debt | Fraud: misappropriation of cash | Agrees; the entry was made to conceal it |
| 6 | Depreciation not provided | Error of principle | Agrees |
| 7 | Both day books undercast by Rs 2,000 | Compensating errors | Agrees |
| 8 | Goods issued on a forged requisition | Fraud: misappropriation of goods | Agrees; the paperwork was complete |
All eight leave the trial balance agreeing, which is the point of the question. An agreed trial balance proves that the debit and credit postings are equal, and nothing else.
Two further observations that carry marks. Item 2 understates the profit and the fixed assets; item 6 overstates both. And items 5 and 8 differ from the rest in intention, which is the whole of the difference between an error and a fraud.
Answer 4
(a) The continuous audit
Meaning. An audit in which the auditor's staff attend the client's premises at regular intervals throughout the financial year, examining the records as they are made, the work being completed after the year end. It suits large concerns, those with weak internal control, and those needing early accounts.
| Advantages | Disadvantages |
|---|---|
| Errors and frauds are found early | Figures already checked may be altered |
| A moral check on the staff | The auditor's presence dislocates the client's work |
| Final accounts are ready quickly | Expensive |
| The audit is thorough | The thread is lost between visits |
| The audit staff's work is spread over the year | Queries raised at one visit may be forgotten by the next |
| Better knowledge of the business | Familiarity can weaken independence |
Practice Questions: Introduction to Auditing
Meeting the chief disadvantage. The risk is that a figure the auditor has examined is altered after he leaves.
- Rule off and initial each portion of the work as it is completed.
- Use distinctive audit ticks and coloured pencils that the client's staff do not use.
- Note the balances of important accounts at the end of each visit and compare them at the next.
- Instruct that no alteration is to be made to a checked figure without the auditor's knowledge, and that corrections be made by a fresh entry rather than by amendment.
- Test check the period already examined at a later visit.
(b) Answers in one or two sentences
1. To the members, under section 143(2) of the Companies Act 2013.
2. Management's, and section 134(5)(c) requires the Directors' Responsibility Statement to state that the directors took proper and sufficient care for the maintenance of adequate accounting records for safeguarding the assets and for preventing and detecting fraud and other irregularities.
3. To the Central Government, under section 143(12); below the prescribed amount, to the audit committee under section 177 or to the Board.
4. Whether the omission or misstatement of the item could influence the economic decisions of a person relying on the financial statements.
5. Whether the misstatement is pervasive: a material but confined misstatement gives a qualified opinion, and one that makes the statements as a whole unreliable gives an adverse one.
Marking yourself
| If your answer | Then |
|---|---|
| Said the object of an audit is to detect fraud | It was, until the early twentieth century; the primary object is now the opinion under section 143(2) |
| Listed limitations without saying why they are inherent | The marks are in "why more work cannot remove them" |
| Answered a distinction in prose | Use a table in matching order; the marks are for pairs |
| Said the trial balance would disclose an error of principle | It never does; both entries are of the right amount on the right sides |
| Called item 5 an error | It was intentional, and intention is the whole difference |
| Gave the continuous audit's disadvantages without the remedies | MU's own topic line asks for overcoming them |
The rest of this subject
These notes are cut from the University's printed syllabus. Open the syllabus itself, or the past papers, for the same subject.