Auditing and Assurance Model Test Paper - 8 (Answers) - CA Intermediate PDF Download

 Page 1


ANSWERS OF MODEL TEST PAPER 8 
INTERMEDIATE GROUP – II  
PAPER – 5: AUDITING AND ETHICS
SUGGESTED ANSWERS / HINTS 
PART I – Multiple Choice Questions 
1. (a)
2. (a)
3. (a)
4. (a)
5. (b)
6. (a)
7. (c)
8. (c)
9. (d)
10. (c)
11. (d)
12. (b)
13. (d)
14. (c)
15. (b)
PART II - Descriptive Answers 
1. (a)  Following matters should be considered generally while preparing an
Audit Programme:  
(1) Stay within the scope and limitation of the assignment.
(2) Prepare a written audit programme setting forth the procedures that
are needed to implement the audit plan.
(3) Determine the evidence reasonably available and identify the best
evidence for deriving the necessary satisfaction.
(4) Apply only those steps and procedures which are useful in
accomplishing the verification purpose in the specific situation.
(5) Include the audit objectives for each area and sufficient details
which serve as a set of instructions for the assistants involved in
audit and help in controlling the proper execution of the work.
(6) Consider all possibilities of error.
(7) Co-ordinate the procedures to be applied to related items.
491
Page 2


ANSWERS OF MODEL TEST PAPER 8 
INTERMEDIATE GROUP – II  
PAPER – 5: AUDITING AND ETHICS
SUGGESTED ANSWERS / HINTS 
PART I – Multiple Choice Questions 
1. (a)
2. (a)
3. (a)
4. (a)
5. (b)
6. (a)
7. (c)
8. (c)
9. (d)
10. (c)
11. (d)
12. (b)
13. (d)
14. (c)
15. (b)
PART II - Descriptive Answers 
1. (a)  Following matters should be considered generally while preparing an
Audit Programme:  
(1) Stay within the scope and limitation of the assignment.
(2) Prepare a written audit programme setting forth the procedures that
are needed to implement the audit plan.
(3) Determine the evidence reasonably available and identify the best
evidence for deriving the necessary satisfaction.
(4) Apply only those steps and procedures which are useful in
accomplishing the verification purpose in the specific situation.
(5) Include the audit objectives for each area and sufficient details
which serve as a set of instructions for the assistants involved in
audit and help in controlling the proper execution of the work.
(6) Consider all possibilities of error.
(7) Co-ordinate the procedures to be applied to related items.
491
 Evolving one audit programme- Not Practicable for All businesses: 
Businesses vary in nature, size and composition; work which is suitable 
to one business may not be suitable to others; efficiency and operation 
of internal controls and the exact nature of the service to be rendered by 
the auditor are the other factors that vary from assignment to 
assignment. On account of such variations, evolving one audit 
programme applicable to all business under all circumstances is not 
practicable. 
 In view of above mentioned provisions, CA. P is correct in emphasizing 
for a different audit programme for Time Ltd. 
(b)  Value of Inventory: Inventory to be recognized at the lower of cost and 
net realizable value in accordance with AS 2 - Inventories.  Further, any 
costs that could not be reasonably allocated to the cost of production 
(e.g. general and administrative costs) and any abnormal wastage have 
been excluded from the cost of inventory. An acceptable valuation basis 
(e.g. FIFO, Weighted average etc.) has been used to value inventory as 
at the period-end. 
 In the given situation, ABC & Co. is using FIFO method for valuation of 
its inventories. Further, cost of inventory as on 31.03.2024 is rupees 
25,25,000 which includes material purchase cost of rupees 25,05,000, 
allocated cost of transport of rupees 18,000 and abnormal wastage of 
rupees 2,000. Net realizable value of said inventory is ` 25,24,000.  In 
view of provisions of AS 2, cost allocated to transport for inventory is 
relating to bringing the inventory to the location, thus it will be added in 
cost of material. However, abnormal wastage of rupees 2000 should be 
excluded from cost of inventory.  
 Thus, cost of inventory will be ` 25,25,000 – ` 2,000 = 25,23,000 rupees 
and Net realizable value of inventory is ` 25,24,000.   
 For valuation in accordance with AS 2, “Inventory”, lower of cost and net 
realizable value will be considered. Accordingly, ` 25,23,000 to be 
considered as value of inventory in the given situation.  
(c)  Internal financial controls as per regulatory requirements: The 
Companies Act, 2013 has placed a greater emphasis on the effective 
implementation and reporting on the internal controls for a company. The 
term “internal financial controls” is used at some places in Companies 
Act, 2013 casting responsibilities as under: - 
Relevant provision of 
Companies Act,2013 
Nature of Responsibility 
Section 134(5)(e)  In case of listed Companies, the 
Directors’ responsibility statement shall 
state that the Directors had laid down 
Internal financial controls to be followed 
by the company and that such Internal 
492
Page 3


ANSWERS OF MODEL TEST PAPER 8 
INTERMEDIATE GROUP – II  
PAPER – 5: AUDITING AND ETHICS
SUGGESTED ANSWERS / HINTS 
PART I – Multiple Choice Questions 
1. (a)
2. (a)
3. (a)
4. (a)
5. (b)
6. (a)
7. (c)
8. (c)
9. (d)
10. (c)
11. (d)
12. (b)
13. (d)
14. (c)
15. (b)
PART II - Descriptive Answers 
1. (a)  Following matters should be considered generally while preparing an
Audit Programme:  
(1) Stay within the scope and limitation of the assignment.
(2) Prepare a written audit programme setting forth the procedures that
are needed to implement the audit plan.
(3) Determine the evidence reasonably available and identify the best
evidence for deriving the necessary satisfaction.
(4) Apply only those steps and procedures which are useful in
accomplishing the verification purpose in the specific situation.
(5) Include the audit objectives for each area and sufficient details
which serve as a set of instructions for the assistants involved in
audit and help in controlling the proper execution of the work.
(6) Consider all possibilities of error.
(7) Co-ordinate the procedures to be applied to related items.
491
 Evolving one audit programme- Not Practicable for All businesses: 
Businesses vary in nature, size and composition; work which is suitable 
to one business may not be suitable to others; efficiency and operation 
of internal controls and the exact nature of the service to be rendered by 
the auditor are the other factors that vary from assignment to 
assignment. On account of such variations, evolving one audit 
programme applicable to all business under all circumstances is not 
practicable. 
 In view of above mentioned provisions, CA. P is correct in emphasizing 
for a different audit programme for Time Ltd. 
(b)  Value of Inventory: Inventory to be recognized at the lower of cost and 
net realizable value in accordance with AS 2 - Inventories.  Further, any 
costs that could not be reasonably allocated to the cost of production 
(e.g. general and administrative costs) and any abnormal wastage have 
been excluded from the cost of inventory. An acceptable valuation basis 
(e.g. FIFO, Weighted average etc.) has been used to value inventory as 
at the period-end. 
 In the given situation, ABC & Co. is using FIFO method for valuation of 
its inventories. Further, cost of inventory as on 31.03.2024 is rupees 
25,25,000 which includes material purchase cost of rupees 25,05,000, 
allocated cost of transport of rupees 18,000 and abnormal wastage of 
rupees 2,000. Net realizable value of said inventory is ` 25,24,000.  In 
view of provisions of AS 2, cost allocated to transport for inventory is 
relating to bringing the inventory to the location, thus it will be added in 
cost of material. However, abnormal wastage of rupees 2000 should be 
excluded from cost of inventory.  
 Thus, cost of inventory will be ` 25,25,000 – ` 2,000 = 25,23,000 rupees 
and Net realizable value of inventory is ` 25,24,000.   
 For valuation in accordance with AS 2, “Inventory”, lower of cost and net 
realizable value will be considered. Accordingly, ` 25,23,000 to be 
considered as value of inventory in the given situation.  
(c)  Internal financial controls as per regulatory requirements: The 
Companies Act, 2013 has placed a greater emphasis on the effective 
implementation and reporting on the internal controls for a company. The 
term “internal financial controls” is used at some places in Companies 
Act, 2013 casting responsibilities as under: - 
Relevant provision of 
Companies Act,2013 
Nature of Responsibility 
Section 134(5)(e)  In case of listed Companies, the 
Directors’ responsibility statement shall 
state that the Directors had laid down 
Internal financial controls to be followed 
by the company and that such Internal 
492
financial controls are adequate and 
were operating effectively. 
As per Section 149(8) of the 
Act 
The company and independent 
directors shall abide by the provisions 
specified in Schedule IV which lays 
down the Code for independent 
Directors. As per this code, the role and 
functions of independent directors 
include that they shall satisfy 
themselves on the integrity of financial 
information and that financial controls 
and the systems of risk management 
are robust and defensible.   
Section 177(4)(vii) of the 
Act 
Every audit Committee shall act in 
accordance with the terms of reference 
specified in writing by the Board which 
shall, inter alia, include - evaluation of 
internal financial controls and risk 
management systems. 
(d)  Assembly of the Final Audit File:  
 Audit documentation may be recorded on paper or on electronic or other 
media. Audit file may be defined as one or more folders or other storage 
media, in physical or electronic form, containing the records that 
comprise the audit documentation for a specific engagement. Hence the 
views of CA B that audit documentation should be maintained 
mandatorily in paper form is not correct. 
 The auditor shall prepare audit documentation on timely basis. Preparing 
sufficient and appropriate audit documentation on a timely basis helps 
to enhance the quality of the audit and facilitates the effective review and 
evaluation of the audit evidence obtained and conclusions reached 
before the auditor’s report is finalized. Documentation prepared after the 
audit work has been performed is likely to be less accurate than 
documentation prepared at the time such work is performed. Completing 
the audit Documentation by CA B not on timely basis is not proper.  
 An appropriate time limit within which to complete the assembly of the 
?nal audit ?le is ordinarily not more than 60 days after the date of the 
auditor’s report. In the given situation, CA. B, after completion of audit 
season, is completing the audit file as well as assembling of final audit 
files of his client after three months of the date of audit report which is 
not valid as per SQC 1.  
 SQC 1 “Quality Control for Firms that perform Audits and Review of 
Historical Financial Information, and other Assurance and Related 
Services”, requires ?rms to establish policies and procedures for the 
493
Page 4


ANSWERS OF MODEL TEST PAPER 8 
INTERMEDIATE GROUP – II  
PAPER – 5: AUDITING AND ETHICS
SUGGESTED ANSWERS / HINTS 
PART I – Multiple Choice Questions 
1. (a)
2. (a)
3. (a)
4. (a)
5. (b)
6. (a)
7. (c)
8. (c)
9. (d)
10. (c)
11. (d)
12. (b)
13. (d)
14. (c)
15. (b)
PART II - Descriptive Answers 
1. (a)  Following matters should be considered generally while preparing an
Audit Programme:  
(1) Stay within the scope and limitation of the assignment.
(2) Prepare a written audit programme setting forth the procedures that
are needed to implement the audit plan.
(3) Determine the evidence reasonably available and identify the best
evidence for deriving the necessary satisfaction.
(4) Apply only those steps and procedures which are useful in
accomplishing the verification purpose in the specific situation.
(5) Include the audit objectives for each area and sufficient details
which serve as a set of instructions for the assistants involved in
audit and help in controlling the proper execution of the work.
(6) Consider all possibilities of error.
(7) Co-ordinate the procedures to be applied to related items.
491
 Evolving one audit programme- Not Practicable for All businesses: 
Businesses vary in nature, size and composition; work which is suitable 
to one business may not be suitable to others; efficiency and operation 
of internal controls and the exact nature of the service to be rendered by 
the auditor are the other factors that vary from assignment to 
assignment. On account of such variations, evolving one audit 
programme applicable to all business under all circumstances is not 
practicable. 
 In view of above mentioned provisions, CA. P is correct in emphasizing 
for a different audit programme for Time Ltd. 
(b)  Value of Inventory: Inventory to be recognized at the lower of cost and 
net realizable value in accordance with AS 2 - Inventories.  Further, any 
costs that could not be reasonably allocated to the cost of production 
(e.g. general and administrative costs) and any abnormal wastage have 
been excluded from the cost of inventory. An acceptable valuation basis 
(e.g. FIFO, Weighted average etc.) has been used to value inventory as 
at the period-end. 
 In the given situation, ABC & Co. is using FIFO method for valuation of 
its inventories. Further, cost of inventory as on 31.03.2024 is rupees 
25,25,000 which includes material purchase cost of rupees 25,05,000, 
allocated cost of transport of rupees 18,000 and abnormal wastage of 
rupees 2,000. Net realizable value of said inventory is ` 25,24,000.  In 
view of provisions of AS 2, cost allocated to transport for inventory is 
relating to bringing the inventory to the location, thus it will be added in 
cost of material. However, abnormal wastage of rupees 2000 should be 
excluded from cost of inventory.  
 Thus, cost of inventory will be ` 25,25,000 – ` 2,000 = 25,23,000 rupees 
and Net realizable value of inventory is ` 25,24,000.   
 For valuation in accordance with AS 2, “Inventory”, lower of cost and net 
realizable value will be considered. Accordingly, ` 25,23,000 to be 
considered as value of inventory in the given situation.  
(c)  Internal financial controls as per regulatory requirements: The 
Companies Act, 2013 has placed a greater emphasis on the effective 
implementation and reporting on the internal controls for a company. The 
term “internal financial controls” is used at some places in Companies 
Act, 2013 casting responsibilities as under: - 
Relevant provision of 
Companies Act,2013 
Nature of Responsibility 
Section 134(5)(e)  In case of listed Companies, the 
Directors’ responsibility statement shall 
state that the Directors had laid down 
Internal financial controls to be followed 
by the company and that such Internal 
492
financial controls are adequate and 
were operating effectively. 
As per Section 149(8) of the 
Act 
The company and independent 
directors shall abide by the provisions 
specified in Schedule IV which lays 
down the Code for independent 
Directors. As per this code, the role and 
functions of independent directors 
include that they shall satisfy 
themselves on the integrity of financial 
information and that financial controls 
and the systems of risk management 
are robust and defensible.   
Section 177(4)(vii) of the 
Act 
Every audit Committee shall act in 
accordance with the terms of reference 
specified in writing by the Board which 
shall, inter alia, include - evaluation of 
internal financial controls and risk 
management systems. 
(d)  Assembly of the Final Audit File:  
 Audit documentation may be recorded on paper or on electronic or other 
media. Audit file may be defined as one or more folders or other storage 
media, in physical or electronic form, containing the records that 
comprise the audit documentation for a specific engagement. Hence the 
views of CA B that audit documentation should be maintained 
mandatorily in paper form is not correct. 
 The auditor shall prepare audit documentation on timely basis. Preparing 
sufficient and appropriate audit documentation on a timely basis helps 
to enhance the quality of the audit and facilitates the effective review and 
evaluation of the audit evidence obtained and conclusions reached 
before the auditor’s report is finalized. Documentation prepared after the 
audit work has been performed is likely to be less accurate than 
documentation prepared at the time such work is performed. Completing 
the audit Documentation by CA B not on timely basis is not proper.  
 An appropriate time limit within which to complete the assembly of the 
?nal audit ?le is ordinarily not more than 60 days after the date of the 
auditor’s report. In the given situation, CA. B, after completion of audit 
season, is completing the audit file as well as assembling of final audit 
files of his client after three months of the date of audit report which is 
not valid as per SQC 1.  
 SQC 1 “Quality Control for Firms that perform Audits and Review of 
Historical Financial Information, and other Assurance and Related 
Services”, requires ?rms to establish policies and procedures for the 
493
retention of engagement documentation. The retention period for audit 
engagements ordinarily is no shorter than seven years from the date of 
the auditor’s report, or, if later, the date of the group auditor’s report. He 
retains audit file of the client for 4 years from the date of audit report is 
also non-compliance of SQC 1.  
2. (a)  Inquiries of Management and Others Within the Entity: 
(i) Inquiries directed toward internal audit personnel may provide 
information about internal audit procedures performed during the 
year relating to the design and effectiveness of the entity’s internal 
control and whether management has satisfactorily responded to 
findings from those procedures. 
(ii) Inquiries directed toward in-house legal counsel may provide 
information about such matters as litigation, compliance with laws 
and regulations, knowledge of fraud or suspected fraud affecting 
the entity, warranties, post-sales obligations, arrangements (such 
as joint ventures) with business partners and the meaning of 
contract.  
(iii) Inquiries directed towards marketing or sales personnel may 
provide information about changes in the entity’s marketing 
strategies, sales trends, or contractual arrangements with its 
customers.  
(iv) Inquiries directed to information systems personnel may 
provide information about system changes, system or control 
failures, or other information system-related risks.  
(b)  A letter of specific inquiry includes: 
(i) A list of litigation and claims; 
(ii) Where available, management’s assessment of the outcome of 
each of the identified litigation and claims and its estimate of the 
financial implications, including costs involved; and 
(iii) A request that the entity’s external legal counsel confirm the 
reasonableness of management’s assessments and provide the 
auditor with further information if the list is considered by the 
entity’s external legal counsel to be incomplete or incorrect.   
 In certain circumstances, the auditor also may judge it necessary to meet 
with the entity’s external legal counsel to discuss the likely outcome of 
the litigation or claims. Further, if management refuses to give the auditor 
permission to communicate or meet with the entity’s external legal 
counsel, or the entity’s external legal counsel refuses to respond 
appropriately to the letter of inquiry, or is prohibited from responding, 
and the auditor is unable to obtain sufficient appropriate evidence by 
performing alternate audit procedures, the auditor shall modify the 
opinion in the auditor’s report in accordance with SA 705.  
494
Page 5


ANSWERS OF MODEL TEST PAPER 8 
INTERMEDIATE GROUP – II  
PAPER – 5: AUDITING AND ETHICS
SUGGESTED ANSWERS / HINTS 
PART I – Multiple Choice Questions 
1. (a)
2. (a)
3. (a)
4. (a)
5. (b)
6. (a)
7. (c)
8. (c)
9. (d)
10. (c)
11. (d)
12. (b)
13. (d)
14. (c)
15. (b)
PART II - Descriptive Answers 
1. (a)  Following matters should be considered generally while preparing an
Audit Programme:  
(1) Stay within the scope and limitation of the assignment.
(2) Prepare a written audit programme setting forth the procedures that
are needed to implement the audit plan.
(3) Determine the evidence reasonably available and identify the best
evidence for deriving the necessary satisfaction.
(4) Apply only those steps and procedures which are useful in
accomplishing the verification purpose in the specific situation.
(5) Include the audit objectives for each area and sufficient details
which serve as a set of instructions for the assistants involved in
audit and help in controlling the proper execution of the work.
(6) Consider all possibilities of error.
(7) Co-ordinate the procedures to be applied to related items.
491
 Evolving one audit programme- Not Practicable for All businesses: 
Businesses vary in nature, size and composition; work which is suitable 
to one business may not be suitable to others; efficiency and operation 
of internal controls and the exact nature of the service to be rendered by 
the auditor are the other factors that vary from assignment to 
assignment. On account of such variations, evolving one audit 
programme applicable to all business under all circumstances is not 
practicable. 
 In view of above mentioned provisions, CA. P is correct in emphasizing 
for a different audit programme for Time Ltd. 
(b)  Value of Inventory: Inventory to be recognized at the lower of cost and 
net realizable value in accordance with AS 2 - Inventories.  Further, any 
costs that could not be reasonably allocated to the cost of production 
(e.g. general and administrative costs) and any abnormal wastage have 
been excluded from the cost of inventory. An acceptable valuation basis 
(e.g. FIFO, Weighted average etc.) has been used to value inventory as 
at the period-end. 
 In the given situation, ABC & Co. is using FIFO method for valuation of 
its inventories. Further, cost of inventory as on 31.03.2024 is rupees 
25,25,000 which includes material purchase cost of rupees 25,05,000, 
allocated cost of transport of rupees 18,000 and abnormal wastage of 
rupees 2,000. Net realizable value of said inventory is ` 25,24,000.  In 
view of provisions of AS 2, cost allocated to transport for inventory is 
relating to bringing the inventory to the location, thus it will be added in 
cost of material. However, abnormal wastage of rupees 2000 should be 
excluded from cost of inventory.  
 Thus, cost of inventory will be ` 25,25,000 – ` 2,000 = 25,23,000 rupees 
and Net realizable value of inventory is ` 25,24,000.   
 For valuation in accordance with AS 2, “Inventory”, lower of cost and net 
realizable value will be considered. Accordingly, ` 25,23,000 to be 
considered as value of inventory in the given situation.  
(c)  Internal financial controls as per regulatory requirements: The 
Companies Act, 2013 has placed a greater emphasis on the effective 
implementation and reporting on the internal controls for a company. The 
term “internal financial controls” is used at some places in Companies 
Act, 2013 casting responsibilities as under: - 
Relevant provision of 
Companies Act,2013 
Nature of Responsibility 
Section 134(5)(e)  In case of listed Companies, the 
Directors’ responsibility statement shall 
state that the Directors had laid down 
Internal financial controls to be followed 
by the company and that such Internal 
492
financial controls are adequate and 
were operating effectively. 
As per Section 149(8) of the 
Act 
The company and independent 
directors shall abide by the provisions 
specified in Schedule IV which lays 
down the Code for independent 
Directors. As per this code, the role and 
functions of independent directors 
include that they shall satisfy 
themselves on the integrity of financial 
information and that financial controls 
and the systems of risk management 
are robust and defensible.   
Section 177(4)(vii) of the 
Act 
Every audit Committee shall act in 
accordance with the terms of reference 
specified in writing by the Board which 
shall, inter alia, include - evaluation of 
internal financial controls and risk 
management systems. 
(d)  Assembly of the Final Audit File:  
 Audit documentation may be recorded on paper or on electronic or other 
media. Audit file may be defined as one or more folders or other storage 
media, in physical or electronic form, containing the records that 
comprise the audit documentation for a specific engagement. Hence the 
views of CA B that audit documentation should be maintained 
mandatorily in paper form is not correct. 
 The auditor shall prepare audit documentation on timely basis. Preparing 
sufficient and appropriate audit documentation on a timely basis helps 
to enhance the quality of the audit and facilitates the effective review and 
evaluation of the audit evidence obtained and conclusions reached 
before the auditor’s report is finalized. Documentation prepared after the 
audit work has been performed is likely to be less accurate than 
documentation prepared at the time such work is performed. Completing 
the audit Documentation by CA B not on timely basis is not proper.  
 An appropriate time limit within which to complete the assembly of the 
?nal audit ?le is ordinarily not more than 60 days after the date of the 
auditor’s report. In the given situation, CA. B, after completion of audit 
season, is completing the audit file as well as assembling of final audit 
files of his client after three months of the date of audit report which is 
not valid as per SQC 1.  
 SQC 1 “Quality Control for Firms that perform Audits and Review of 
Historical Financial Information, and other Assurance and Related 
Services”, requires ?rms to establish policies and procedures for the 
493
retention of engagement documentation. The retention period for audit 
engagements ordinarily is no shorter than seven years from the date of 
the auditor’s report, or, if later, the date of the group auditor’s report. He 
retains audit file of the client for 4 years from the date of audit report is 
also non-compliance of SQC 1.  
2. (a)  Inquiries of Management and Others Within the Entity: 
(i) Inquiries directed toward internal audit personnel may provide 
information about internal audit procedures performed during the 
year relating to the design and effectiveness of the entity’s internal 
control and whether management has satisfactorily responded to 
findings from those procedures. 
(ii) Inquiries directed toward in-house legal counsel may provide 
information about such matters as litigation, compliance with laws 
and regulations, knowledge of fraud or suspected fraud affecting 
the entity, warranties, post-sales obligations, arrangements (such 
as joint ventures) with business partners and the meaning of 
contract.  
(iii) Inquiries directed towards marketing or sales personnel may 
provide information about changes in the entity’s marketing 
strategies, sales trends, or contractual arrangements with its 
customers.  
(iv) Inquiries directed to information systems personnel may 
provide information about system changes, system or control 
failures, or other information system-related risks.  
(b)  A letter of specific inquiry includes: 
(i) A list of litigation and claims; 
(ii) Where available, management’s assessment of the outcome of 
each of the identified litigation and claims and its estimate of the 
financial implications, including costs involved; and 
(iii) A request that the entity’s external legal counsel confirm the 
reasonableness of management’s assessments and provide the 
auditor with further information if the list is considered by the 
entity’s external legal counsel to be incomplete or incorrect.   
 In certain circumstances, the auditor also may judge it necessary to meet 
with the entity’s external legal counsel to discuss the likely outcome of 
the litigation or claims. Further, if management refuses to give the auditor 
permission to communicate or meet with the entity’s external legal 
counsel, or the entity’s external legal counsel refuses to respond 
appropriately to the letter of inquiry, or is prohibited from responding, 
and the auditor is unable to obtain sufficient appropriate evidence by 
performing alternate audit procedures, the auditor shall modify the 
opinion in the auditor’s report in accordance with SA 705.  
494
 Alternatively, if the auditor is able to perform alternate audit procedures 
and can obtain sufficient and appropriate audit evidence to resolve the 
issue, then he can give an unmodified opinion. 
(c)  Inherent limitations of audit: The process of audit suffers from certain 
inbuilt limitations due to which an auditor cannot obtain an absolute 
assurance that financial statements are free from misstatement due to 
fraud or error. These fundamental limitations arise due to the following 
factors: - 
(1) Nature of financial reporting: Preparation of financial statements 
involves making many judgments by management. These 
judgments may involve subjective decisions or a degree of 
uncertainty. Therefore, auditor may not be able to obtain absolute 
assurance that financial statements are free from material 
misstatements due to frauds or errors. 
(2) Nature of Audit procedures: The auditor carries out his work by 
obtaining audit evidence through performance of audit procedures. 
However, there are practical and legal limitations on ability of 
auditor to obtain audit evidence. For example, an auditor does not 
test all transactions and balances. He forms his opinion only by 
testing samples.  It is an example of practical limitation on auditor’s 
ability to obtain audit evidence. 
 Management may not provide complete information as requested 
by auditor. There is no way by which auditor can force management 
to provide complete information as may be requested by auditor. In 
case he is not provided with required information, he can only 
report.  It is an example of legal limitation on auditor’s ability to 
obtain audit evidence. Further, fraud may involve sophisticated and 
carefully organized schemes. 
(3)  Not in nature of investigation: Audit is not an official 
investigation. Hence, auditor cannot obtain absolute assurance that 
financial statements are free from material misstatements due to 
frauds or errors. 
(4) Timeliness of financial reporting and decrease in relevance of 
information over time: The relevance of information decreases 
over time and auditor cannot verify each and every matter. 
Therefore, a balance has to be struck between reliability of 
information and cost of obtaining it.  
(5)  Future events: Future events or conditions may affect an entity 
adversely. Adverse events may seriously affect ability of an entity 
to continue its business. The business may cease to exist in future 
due to change in market conditions, emergence of new business 
models or products or due to onset of some adverse events.   
(d) Consider the factors that, in the auditor’s professional judgment, 
are significant in directing the engagement team’s efforts: The 
auditor needs to direct efforts of engagement team towards matters that 
495