What type of circumstances give rise to uncertainty. How auditor should attempt to deal with situation in his report to members?

Following circumstances may give rise to uncertainty
Litigation and claims
Suspicion of fraud
Non compliance with laws and regulations
Going concern problem
Scope limitation
The auditor would deal with the above uncertainties as follows:

Litigation and claims

The auditor will have to determine whether the litigation and claims constitute contingent liabilities or provisions. If the claims represent contingent liabilities, and the client has given adequate disclosure, an emphasis of matter paragraph is required. If no disclosures have been made a qualified or adverse report will issued.
If, in the auditor’s opinion, the claims should be provided and no provision has been made in the accounts, qualified or adverse opinionwill be given.

Suspicion of fraud

If the auditor is precluded by the entity from obtaining sufficient appropriate audit evidence to evaluate whether a fraud has, or is likely to have occurred, the auditor should express a qualified opinion or disclaimer of opinion.

If the auditor is unable to determine whether fraud has occurred because of limitations imposed by the circumstances rather than by entity, the auditor should consider the effect on auditor’s report. Non compliance with laws and regulations If the auditor suspects an non compliance of laws and regulations but adequate information cannot be obtained for the suspected non compliance, the auditor should consider the effect of lack of audit evidence on auditor’s report.

Going concern problem

The auditor should determine if a material uncertainty exists which may cast significant doubt on the entity’s ability to continue as a going concern.
If adequate disclosure is made in the fmancial statements, the auditor should express an unqualified opinion but add a paragraph emphasizing the matter. If adequate disclosure is not made in thefinancial statements the auditor should express a qualified or adverse opinion.

Scope limitation

When in substantial doubt as to a material account balance and the
auditor cannot obtain sufficient appropriate audit evidence, he should express a qualified opinion or disclaimer of opinion.

One of the segments of a company has been incurring losses for last ‘0 years. Equipment of the segment has a book value of Rs. 8 million. e management has made a provision for permanent diminution in the ue of assets amounting to Rs. 2 million. What will be the impact on your audit report?

This is case of significant uncertainty and a paragraph emphasizing the will be in order. However, if the auditor concludes that-the business conditions will not improve in future, a loss of Rs. 6 million needs to be provided. Full disclosure does not justify non recognition of a provision. Accordingly the auditor will have to issue a qualified opinion.

What will be the impact of the following independent cases on auditor’s opinion. Explain with reasons. Year end is December 31

a) Land with a carrying value of Rs. 2.6 million was impaired. The impairment loss is estimated at Rs. 1.2 million. The directors have refused to record the loss on the grounds that the value of other fixed assets is substantially higher than their carrying values.

b) SSO has a subsidiary in the oil industry. The subsidiary is located in a country which has no legislation to clean up contaminated land. The policy of the company is to clean up contaminated land only if required by law. At December 31, 20×5 it is virtually certain that a draft law will be enacted shortly after year end. The subsidiary has disclosed the fact but has made no ,provision.

c) A super market has a policy of returning goods to customers if the) are dissatisfied. The public is generally aware of the policy. The cost of refund at December 31, is estimated at Rs. 850,000 which is considered material. No provision bas been made’ in the accounts.

d) On December 20, 2×5 the Board of directors of a company decide to discontinue a division. The decision has not been communicate to any of those effected and proceedings for close down did not star: in 20×5. No provision has been made for resulting losses.

(e)During 20×5 your client has given a guarantee for certain loans of another enterprise. The financial position at the time of guarantee was given, was sound. During 20×6, the enterprise went bankrupt. The company has disclosed the amount of guarantee as contingencies and commitments, both in 20×5 and 20×6?

a) Increase in the value of other assets is not a justification for not providing impairment loss on land. The audit report will be qualified.

b) Mere disclosure does not justify non-recognition of a provision. In this case a present obligation exists requiring outflow of economic resources. The report will be qualified.

c) A constructive obligation exists as result of past events, requiring outflow of economic resources. A provision is therefore should be recognized. The audit report will be qualified.

d) Provision is not required, as the decision has not yet been communicated to affected parties. An unqualified report will be in order.

(e) Full provision for Rs. 840,000 should be made as this is no longer contingency. Audit report will be qualified.

(f) Present obligation does not exist. An unqualified report will be issued.

g)  At 20×5, disclosure is adequate and an unqualified report will be issued.

 At December 31, 20×6 a provision is required on-the basis of present obligation which will require outflow of economic resources. A qualified report will be issued.

You are the auditor of Stylus Builders for year ended December 31, 20xl Stylus builders acquired materials worth Rs. 12 million for construction of a building in December20xl. The contract provided that the quality of materials used will be approved by the quantity surveyor of the customer. Stylus did not obtain prior approval of the material from the customer. The quantity surveyor visited the site on January 24, 20×2 and rejected the material. The value of this material on December 31, 20xl was Rs. ‘2.5 million and on January 24, 20×2 the net realizable value was Rs. 10 million. The company directors refused to record the loss of Rs. 2 million in 20x 1. They suggested that the loss will be written off in 20×2. How would this situation affect your report?

Draft extracts for the suggested audit report. You need not reproduce full audit report. Only set out opinion paragraph (paragraph regarding true and fair view) of the Standard report which.

IAS 2 requires that inventories should be valued at lower of cost and net realizable value. Since the inventories have not been adjusted to the net realizable value, the opinion will be qualified on the grounds of disagreement with management.
“Inventories include Rs. 12 million stated at cost. Net realizable value of such inventories was Rs. 10 million. No adjustment has been made in the accounts for reducing inventories to net realizable value. As a result, the net profit for the year and ending inventories are overstated by Rs. 2 million.”
Paragraph ( c) of the report will state: “In our opinion and to the best of our information and according to the explanations given to us, the balance sheet, profit and loss account, cash flow statement and statement of changes in equity together with the notes forming part thereof conform with approved accepting standards as applicable in Pakistan, and give the information required by the Companies Ordinance, 1984 in the manner so required and, except for the matter referred to in the preceding paragraph give a true and fair view of the state of the company’s affairs as at December 31, 20xl and of the profit and loss, its cash flow and changes in equity for the year then ended.”
If the error is not considered to be material, the report will not be qualified. However, the auditor should record such misstatement in his list of other immaterial errors found to ascertain aggregate of uncorrected errors.

The company purchased some computers on January 10, 20×8 for Rs. 2 million. The management has depreciated the computers over 10 years. You are of the opinion that due to rapid innovations, the computers may become obsolete after five year.
The company refused to change its workings on the contention that depreciation is to be allocated over the useful life of the asset and no allowance need be made for obsolescence, as it is not predicable.

How would this situation affect your report?

early deprecation charge should have a built in allowance for
bsolescence. The depreciation has been under provided by Rs. 200,000. Assuming that the misstatement is considered to be material, the report will be qualified on the grounds of disagreement with the management. paragraph (c) of the report will state:

In our opinion and to the best of our information and according to the explanations given to us, the balance sheet, profit and loss account, cash flow statement and statement of changes in equity together with the notes forming part thereof conform with approved accepting standards as applicable in Pakistan, and give the information required by the campanies Ordinance, 1984 in the manner so required and, except for understatement of depreciation by Rs. 200,000, give a true and fair view of the state of the company’s affairs as at December 31, 20xl and of the profit and loss, its cash flow and changes in equity for the then ended.

Arabian. Sea Trading Company has submitted its financial statements for the year ended December 31, 20×8 for audit any has the company not made any provision relating to following, but. has disclosed the facts as contingent liabilities:
(a) Two law suits have been filed against the company during the yearfor Rs. 2 million and Rs. 3.5 million respectively. The Company’s legal  counsel is of the view that an unfavorable decision is unlikely in the case of claim of Rs 3.5 million; however the court verdict against the company of Rs l.5 million is probable in the suit of Rs. 2 million.

(b) In September 20×8, 1998, the company was identified as one of the potentially responsible parties to an oil spell into the sea from an oil tanker on which the oil of the company was being imported. The company’s management believes that it is not probable the company would be responsible for these damages. A reasonable estimate of damages is Rs. 2.5 million.

(c) A damages claim of Rs. 15 million for breach of contract has been served on the company. The company’s legal counsel is of the view that it is possible that the damages will be awarded to the plaintiff. – However, the amount of damages cannot be reasonably estimated. Indicate how would you treat the effect of above in your audit report. None of the above has been provided.

(a) For the law suit of Rs. 2 million, there is a present obligation and an outflow of resources embodying economic benefits in settlement probable.

A provision is required for Rs. 1.5 million. The report will have to be qualified.

For the law suit of Rs. 3.5 million, there is no obligation as a result of past events. No provision is required.

(b) There is no obligation as a result of past events. No provision is required. The matter is rightly disclosed as contingent liability.

(c) The outflow of economic resources is possible. However since: the amount cannot be measured with sufficient reliability, a disclosure of  contingent liability will be in order.

What types of audit opmions should be expressed in the fo110
circumstances: (You are not required to draft the opinion paragraphs)

(a) The management of the company has not allowed the auditors to send request letters to the legal advisors. Accordingly, the auditors could not become aware of the status of all the litigations against the company. On account of their prior experience, the auditors believe that there are significant claims against the Company.

a) This is a non adjusting event. Since the company has disclosed the event, an unqualified report will be issued. However the auditor should consider possible impact on going concern.

b) If management refuses to give the auditor permission to communicate with the legal advisors, the report will be qualified on the grounds of scope limitation.

Discuss different type of limitations of scope that may results in a modified opinion giving suitable examples of each (you are not required to draft opinion)

1 Computer break down destroying substantial accounting records.
2 Client did not allow direct verification with customers.
3 Client did not allow confirmation from company lawyers
4 Auditor could not attend physical inventory at year end
5 Books of accounts are not auditable.
6 Missing audit trails
7 Client did not provide letter of representation.

What types of audit opinion should be expressed in the following curcumstances:

(a) A listed company has accounted for a finance lease as an operating lease and accordingly has not recognized the asset and liability in this respect. The impact of this accounting treatment is significant to the financial statements.

(b) The appointment of auditors was such that they have not been able to observe the physical stock count. However, they have satisfied themselves through alternative audit procedures.

(c) The management has not accounted for the full liability in respect of gratuity. The management is of the view that it is a
deferred liability and not a current one. The impact is material but not pervasive in relation to the financial statements.

(a) Qualified opinion on the grounds of disagreement with management.

(b) Unqualified opinion as the auditor has satisfied himself with alternative procedures.

(c) Qualified opinion on the grounds of disagreement.

What will be responsibility of the auditor in the following situations:

(a) Company changes policy for revenue recognition but the new policy is not in accordance with the requirements of International Accounting Standards. Effect is material but not pervasive.

(b) There are doubts about the ability of the company to continue operating as a going concern but this issue is properly disclosed in the financial statements.

(a) Qualified opinion on the grounds of disagreement.

(b) If adequate disclosure is made in the financial statements, the auditor should express an unqualified opinion but modify the auditor’s report by adding an emphasis of matter paragraph that
highlights the existence of a material uncertainty relating to the event or condition that may cast significant doubt on the entity’s ability to continue as a going concern and draws attention to the note in the financial statements that discloses uncertainties. In assessing the adequacy of the financial statement disclosure, the
auditor considers whether the information explicitly draws the reader’s attention to the possibility that the entity may be unable to continue realizing its assets and discharging its liabilities in the normal course of business.

Due to major computer breakdown during the year, the accounting records of the company are no more verifiable. The company does not have proper manual records. Although the integrity of the management is not in doubt, the auditor is not in a position to substantiate management’s assertions contained in the financial statements. What type of opinion should be expressed in these circumstances?

This is the case where effect of a limitation of scope is so material and pervasive that the auditor has not been able to obtain sufficient appropriate audit evidences and accordingly is unable to express an opinion. A disclaimer of opinion is therefore required. You are the auditor of certain companies audits of which have been finalized and audit opinions are expected to be shortly issued. Significant issues concerning these audits are as follows:

• Company A

Subsequent to the year end, a debtor from whom a significant balance is due initiated winding up proceedings. Accounts were not adjusted.

Company B

The company is a shipping line with more than 6 ships as its assets. Subsequent to the year-end, one of its high value ship, carrying huge stock for other parties, sank in high seas.

Company C

udit of the year ended December 31, 2003, would need to be iinalized by Jan 4, 2004.

The credit period for trade receivables is 3 months. You noted that significant sales were made in late December 2003. You have requested the company to provide the evidences of such sales, which request has been sent by them to its field office. However, the company considers that these evidences may not be timely available by January 4, 2004 due to law and order situation in the area where the field office is situated.

As an audit engagement partner of above companies, what would be your suggestions to the companies management regarding the above circumstances on the financial statements of the companies? Also explain the type of opinion you would issue, if the companies management do not agree with your suggestions.

Company A

This is a non adjusting event. Financial statements need not be adjusted.

Company B

Disclosure is required in the financial statements. If the management refuses to disclose the fact, a qualified or adverse opinion is required.

Company C

An unqualified report cannot be issued without obtaining sufficient appropriate audit evidences. In such case the audit opinion has to be delayed to avoid qualification on the grounds of scope limitation. An alternative could be to issue a review report by January 4, and carry out detailed audit subsequently.

Masoom & Co. Chartered Accountants have audited the financial statements of Cunning Limited. The financial statements have been issued after getting proper approval of the Board of Directors and audit report singed by the auditors. After some time, the auditor came to know that a major law suit was decided against the company subsequent to year end but before the audit report was singed by the auditors. The issue existed at the balance sheet date. The outcome of the law suit was not brought to the knowledge of the auditors. Had it been known to the auditors, the financial statements would have required proper adjustments in this respect. State auditor’s responsibilities in this situation. Also analyze the situation, if the issue of the financial statements for the following period is imminent.

This case relates to facts discovered after the financial statements have been issued. ISA 560, Subsequent events, provides that when after the financial statements have been issued, the auditor becomes aware of a fact which existed at the date of the auditor’s report and which, if known at that date, may have caused the auditor to modify the auditor’s report, the auditor should consider whether the financial statements need revision, should discuss the matter with management and should take action appropriate in the circumstances. If the management revises the financial statements, the auditor would carry out the audit procedures necessary in the circumstances, would review the steps taken by management to ensure that anyone in receipt of previously issued financial statements is informed of the situation and would issue a new report on revised financial statements. The new auditor’s report should include an emphasis of a matter paragraph, referring to a note to the financial statements that more extensively discusses the reasons for the revision of financial statements. If the management does not revise financial statements, the auditor vould notify the Board and audit committee that action will be taken to prevent reliance on the auditor’s report. The action taken will depend pon auditor’s legal rights and obligations and the recommendations of the auditor’s lawyers may not be necessary to revise the financial statements and issue a new auditor’s report when issue of financial statements of the following period is imminent, provided appropriated disclosures are made in such financial statements.

You are the auditor of Central Chemical Company Limited, a public listed company which is engaged in the manufacture and sale of chemicals. The production is carried out at five different locations throughout Pakistan. The customers include a number of local as well as foreign buyers.

You are required to explain the action you would take in each of the following independent situations with respect to audit for the year ended  june 30,2004.

(a) On August 10, 2004, a competitor introduced a low cost product which was very good replacement of one of the company’s products being marketed under the brand name “Dellow”. The marketing manager was of the view that the company would not be able to sell “Dellow”, unless the price is reduced to Rs. 40 per kg, i.e., 20% below its present cost. While the management was considering how to reduce the costs, it was decided to sell all production after the year end. The stock of that product as on August 10, 2004 was 100,000 kg, out of which 5000 kgs, had been produced after the year end. You became aware of the situation on August 11, 2004, when the accounts have already been finalized but prior to signing of the audit report. The management is of the view that the matter need not be disclosed in the financial statements nor any adjustment is needed.

(b) After the auditor’s report has been issued you came to know that one of the factories have caught fire causing loss of machinery worth Rs. 250 million. On inquiry you are informed that the loss is covered by insurance policy but the factory will have to remain closed till the new machinery is installed. The installation may take six to eight months. The financial statements have not yet been published or circulated to shareholders.

(c) After the financial statements have been issued, there was a
significant decline in the market value of investments.

(a) IAS 10 requires that if non adjusting events after the balance sheet are material, a disclosure is required in the financial statements. Accordingly, abnormally large decline after the balance sheet date in, inventory prices needs disclosure. If management refuses to give required.
Disclosures, the audit opinion will have to be qualified on grounds of disagreement with management.

(b) ISA 560, subsequent events provides that when after the date of the auditor’s report but before the financial statements are issued the auditor becomes aware of a fact which may materially affect the financial statements the auditor should consider whether.the financial statements need amendment.

(c) The auditor should request management to revise the financial statements. If the management revises the financial statements, the auditor will issue a new report which will include an emphasis of a matter paragraph. If the management does not revise financial statements, the auditor would notify the Board and audit committee that action will be taken to prevent reliance on the auditor’s report.

Analyze the following situations and state under which condition auditor ould most likely issue a disclaimer of opinion:

(i) Presentation of short tenn investments as long term

(ii) There are certain indications that a company may not be a going concern. However management has adequate plans to mitigate such problems.

(iii) Management’s refusal to furnish written representations in respect of items for which no other evidences are reasonably expected to exist.

(i) Presentation of short term investments as long tem represents disagreement with management and therefore, a qualified opinion will be issued.

(ii) If the management has disclosed the problem, emphasis of a matter is required. If no disclosures are made qualified or adverse opinion will be appropriated.
(iii) If management refuses to give representation letter the auditor will issue a qualified opinion. However if the effect is considered material and pervasive a disclaimer of opinion will be issued.

You an external auditor, have received direct confirmation from the
company legal advisor about a claim of significant amount which was provider for and included in the sundry claims payable account last year. unication states that the relevant court of law has, subsequent  to the year end, issued judgment in favor of the company. The matter was discussed with the management but they are not willing to reverse the provision on the ground that the decision of the court was delivered after the financial year end. What will be the impact on your audit opinion on management’s reluctance to reverse the above provision?

IAS 37 provides that caution is needed in making judgments under
conditions of uncertainty, so that income and assets are not overstated and expenses or liabilities are not understated. However, uncertainty does not justify the creation of excessive provision or deliberate overstatement of liabilities.

In this case if the management refuses to reverse the provision, the audit opinion will be qualified on the grounds of disagreement with

IAS 37 provides that caution is needed in making judgments under conditions of uncertainty, so that income and assets are not overstated and expenses or liabilities are not understated. However, uncertainty does not justify the creation of excessive provision or deliberate overstatement of liabilities.
In this case if the management refuses to reverse the provision, the audit opinion will be qualified on the grounds of disagreement with management.


(a) Exercising your professional judgment, state whether the a matter affects the auditor’s opinion or not. Support your answer reasons.

(b) If the ebove matter affects auditor’s opinion, should this be regarded as limitation of scope or disagreement with management:

Give reasons to support your answer.

(c) Assuming your are not satisfied with the adequacy of disclosure made by the management of the company in a note to its accounts:

(i) theauditor’s reservation
(ii) opinion paragraph of the auditor’s report

(a) The auditor cannot issue an unmodified opinion as the allowance for doubtful accounts and net profit for year are overstated. A mere disclosure in notes to the accounts does not rectify misstatements in the financial statements.

(b) The report will be qualified on the grounds of disagreement with management. The disagreement arises due to material misstatement in financial statements.

(c) (i) Unsecured advances include Rs. 504 million due from an associated company. The amount is outstanding for a few years. The customer is at the verge of bankruptcy and likelihood of any recovery is virtually minimal. No allowance has been made in the accounts against the debt.
(ii) In our opinion, and to the best of our information and according to the explanations given to us, the balance sheet, profit and loss account, cash flow statement and statement of changes in equity together with the notes forming part thereof confirm with approved accounting standards as applicable in Pakistan, and give the information required by the Companies Ordinance, 1984, in
he manner so required and, except for the matter referred to in the preceding paragraph, give a true and fair view of the state. of the company’s affairs at ‘” ….. and of the profit / loss, its cash flows and changes in equity for the year then ended.

rou are the auditor of an airline company. The airline is required by law to overhaul its aircraft once every five years. The company has not carried out overhauling after five years and the cost is expected to be material in relation to financial statements. The client has not made any provision for the cost of overhauling.

How the fact that a provision has not been made for cost of overhauling will affect your audit opinion in view of the requirements of IAS 37 Provisions, Contingent liabilities and Contingent Assets?

The cost of overhauling· the aircraft should not be recognized as a provision because, at the balance sheet date, no obligation to pay cost of overhauling exist. Even a legal requirement to overhaul does not make the cost of overhaul a liability, because no obligation exists to overhaul the aircraft independently of entity’s future action as the company could avoid the future expenditure by its future actions, for example by selling the aircraft.

However, the authorities might impose substantial fines, against which a provision need be made. They might place restrictions in the operations of the aircraft and the auditor should consider going concern problem.

A company has a portfolio of long term of investment. Value of one of the investments has permanently fallen by Rs. 350,000. The company did not record impairment in the value on the grounds that increase in market value of other investments is far in excess of Rs. 350,000. Net profit for year amounted to Rs. 5,000,000. What sort of audit opinion would you recommend?

Unless the effect is pervasive, qualified (except for) opinion should be issued on the grounds of disagreement with management.

Increase in the value of one asset cannot be offset against decrease in the value of other assets

An oil company has a legal obligation to remove oil rigs at the end of production (l~ars from now) and restore seabed. Estimated cost of restoration is Rs. 20 million. The company has made annual provision of Rs. ,2;million.

How would the above treatment affect your audit report?

The correct treatment is to discount the provision of Rs. 20 million to its present value, using appropriate discount rate. The discounted amount will be debited to fixed assets.
If the company refuses to adjust the accounts, a qualified report will be issued, on the grounds of disagreement with management, provided the misstatement is material and not pervasive.

The opinion paragraph of audit report of a company states:
The company has not valued inventories at lower of cost and NRV. The management has explained that it is difficult to compute NRV. We concur with management’s reasoning.
In our opinion, and to the best of our information and according to the explanations given to us, the balance sheet, profit and loss account and cash flow statement together with notes forming part thereof, give the information required by the Companies Ordinance, 1984, in the manner so required, and except for inventory valuation at cost, respectively give a true and fair view of the state of the Company’s affairs as at – and of
profits and cash flows for the year then ended. 

Comment on the above report.

The report is contradicting. On the one hand the auditor has concurred with management representation. On the other hand he has qualified the report. Also nothing has been mentioned regarding possible adjustments that might have been necessary had the inventory been valued at net realizable value. The mere fact that it is difficult to estimate net realizable value is not a justification for departure from IAS 2 Abbreviation which are not commonly understood should be avoided for example instead ofNRV, the full description, net realizable value should have been used.

In case of departure of a particular requirement of any IFRS what matters the auditor should consider?

In case of departure of a particular requirement of any IFRS the auditor should consider following matters.
• If management concludes that compliance with requirement in a Standard would be so misleading that it would conflict with true and fair view, and if the relevant regulatory framework requires or does not prohibit such departure, the auditor may concur with the departure from the Standard.

• If the management departs from a requirement of a Standard or an
interpretation it shall disclose

(a) that management has concluded that the financial statements present fairly the entity’s financial position, financial performance and cash flows.

(b) that it has complied with applicable Standards and Interpretations, except that it has departed from a particular requirement to achieve a fair presentation:

(c) the title of the Standard and interpretation from which the entity has departed, the nature of departure, including the treatment that the Standard or Interpretation would require, the reason why the treatment would be so misleading in the circumstances that it would conflict with the true and fair view.

(d) for each period presented, the financial impact>of the departure of each item in the financial statements that would have been reported in complying with the requirements.

• A wrong accounting policy is not rectified by disclosure
• As a general rule a departure from IFRS requires qualification of the auditors opinion.

You have been appointed as auditors of Lime Enterprises, a partnership firm, which trades in cement bags, for year ended December 31, 20×8.

You have noted that perpetual inventory records have been maintained and integrated with general ledger. The client counts 100% inventories at year end.
For some reasons, your appointment was made on January 10, 20×9 and accordingly you did not attend physical inventory at December 31, 20×8.
Your analytical review does not indicate any major fluctuation in gross profit ratio and inventory turnover ratio. The previous auditors have provided you list of inventories at December 31, 20×7.

 What would you do in such circumstances?

We can apply alternative procedures to ascertain inventory quantities at December 31, 20×8. If the alternative procedures enable us to estimate inventory quantities reliably, unqualified opinion will be issued.

‘ou are that auditor of a jewelry shop. The inventories of the jewelry op largely consists of- gold and silver. You have noted that the inventory of gold and silver has been carried at market value.what will be the impact on audit report?

Valuation of inventory at market is a departure from the requirement of LAS 2. However, IAS 1 provides that If management concludes that liance with requirement in a Standard would be so misleading that uld conflict with true and fair view, and if the relevant regulatory work requires or does not prohibit such departure, alternative ting policy may be used, It is not uncommon to value commodities at market value as it is ded that this practice gives more true and fair view accordengly, an unqualified opinion will be issued.

Your client purchased a piece of land on March 20, 20×7 for Rs. 12 millions The land was revalued on January 1, 20×8 at Rs. 17 million.

On june 30, 20×8 the land was sold for Rs. 19 million.

The amounts involved are material in the context of total assets and net profit. What audit adjustment will be suggest?

The first entry is correct

IAS 16 (paragraph’ 68) requires that the gain or loss arising from de recognition of fixed assets shall be included in the profit and loss when the item is de recognized.

Paragraph 71 of IAS 16 states that the gain or loss is the differences between sale proceeds and the carrying value.

Second entry has to be adjusted. While revaluation surplus has been correctly debited the credit should be to retained earnings.

Paragraph 41 of IAS 16 requires that revaluation surplus in respect of an item of property plant and equipment is to be transferred directly to the retained earnings when the asset is de recognized.

Bella Enterprises started manufacturing of home room air conditioners in September 20×7. The company sells air conditioners with a warranty of eight months after purchase. Sales for the accounting period ended December 31, 20×7 amounted to Rs. 8,935,140.

The productionmanager estimates that

If compressorsdefects are found in all products
the warrantieswould cost Rs.                                     2,400,000
If other defects are found in all products
the warrantieswould cost Rs.                                     1,300,000

The production manager also estimates that:

60% of air conditioners sold will have no defects
15% of air conditioners sold will have compressor defects
25% of air conditioners sold will have other defects

The company has disclosed a contingent liability of Rs. 750,000

What will be the impact on your audit opinion for year ended Dec. 31, 20×7

IAS 37 Provisions, contingent liabilities and contingent assets requires that the amount recognized as provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date.

The estimates of outcome and financial effect are determined by the judgment of the management of the entity.

In this case a provision of Rs. 685,000 is required as reflected by the following computations.

Required provision    Provision

16% of          Rs              0                       0
15% of                           2,400,000           360,000
25% of                           1,300,000          325,000                                                                                                 685,000

One of your clients Jumbo Petroleum Company causes contamination and is, subject to environment legislation, The company is under obligation to rectify the damage at the end of the contract which expires 6 years. Estimated cost of clean up to be incurred at end of 6th year million. The company has made a provision of Rs. 9 million. 

What will be the impact on your audit opinion?

The accounting treatment followed by Jumbo is not in accordance with IAS 37, Provisions, contingent liabilities and contingent assets. IAS 37 (Paragraph 45) require that when the effect of time value of money is material, the amount of provision should be the present value of the expenditure expected to be required to settle the obligation.

Using an appropriate discount rate.

Assume that the discount rate is 12% the relevant factor is 0.50663.
The accounting entry should be

Land                                               4,559,670
Provision for dis contamination                                           4,559,670

If Jumbo refuses to make full provision equal to the present value of
obligation, the report will be qualified

Vital Enterprises deals in motor cars.

The cars are received on consignment from the manufacturer with a clause that unsold cars will be returned to” the manufacturer after a specified period.

The past practice reflects that Vital never returns any cars. The dealer bears the risk of slow moving and obsolescence.

Vital in its books has included the cost of unsold cars in the inventories.

What will be the impact of above treatment on your audit report assuming that the amounts involved are a material.

Although the legal form of the transaction is a consignment, in substance it is sale by manufacturer to Vital. The client, Vital should include unsold cars in the inventory. Unqualified report will be in order.

Calico Enterprises had acquired an equipment on January 1, 2005 for Rs. 30 million with a useful life of 6 years. The company has been using straight line method.
On January 1,2009, the remaining useful life was estimated to be 6 years You are the auditor of Calico for year ended December 31, 2009 You have noted that the company has passed following entry on January 1,2009

Equipment                              8
Retained earnings                                          8

Rs. in millions
Cost                                                                                              30
Accumulated depreciation to 31112/08 (4 years)                     20

Depreciation to 31112/08 on the basis of 10 years life            12
Excess depreciation                                                                     8

The amount involved are considered to be material

During 2009, the company charged depreciation Rs. 3 million

What will be the impact on your audit opinion?

lAS 16 provides that a change in useful life is change in accounting estimate. The change of accounting estimate is to be accounted for in the current and future periods. Opening retained earnings should not be adjusted.

Depreciation for 2009 and future year should be Rs. 1.67 million (Rs. 10 million 1 6)

If the management does not adjust the accounts qualified opinion should e issued.

You are the auditors of Kerr Corporation for year ended December 31, 20×8. On December 10, 20×8, the management decided for restructuring and closing down a division. The decision was communicated to those affected on January 15, 20×9 and no other steps were taken to implement the decision. Kerr has made provision of Rs. 5 million representing approximate costs for closure of division. Your independent estimate of cost works out to Rs. 9 million.

What will be the impact on audit report?

At December 31, 20×8 there was no obligating event and no provision should have been made.

IAS 37, Provision, contingent assets and contingent liabilities provides that a provision is recognized only when there is present obligation as a result of past events.

A Provision for restructuring may be made only when an entity has announced the main features to those affected by it.

If the management does not reverse the provision, a qualified opinion will be issued.

Year end of one of your client is December 31, 20×8. In February 20×9, before the accounts were approved, the Government announced increase in tax rates by 10% . The liability for deferred tax has been adjusted by the increase in tax rates. The amount involved is material. What will be the impact on your audit report for year ended December 31,20×8?

One of the examples of non adjusting events per IAS 10 states: “Changes in tax rates or tax laws enacted or announced after the balance sheet date and has a significant effect on current and deferred tax assets and liabilities. “

Since there is no present obligation at year end, no provision should have been made. The report will be qualified if the client does not reverse the provision.

You are the auditors of Good Dealers Limited for year ended December 31, 20×8. The Company was defendant in a law suit alleging infringement of certain patent rights. Preliminary hearing was in progress and at year end. The ultimate outcome of the matter could not be determined at year end.

The case was decided against the company on February 27, 20×9 before the accounts were approved.

The company has made a disclosure in notes to accounts What type of audit report will you issue?

This is an adjusting event under lAS 10. A mere disclosure is not adequate. Provision should have been made in the accounts. If the amount is material, a qualified report should be issued.

Give an example of a matter which has material and pervasive effect on financial statements.

An error, correction of which converts reported significant profits into
significant loss

You are the auditor of Matz Pharmaceutical for year ended December 31, 2009. You have already signed the audit report on March 20,2010. On March 21, you have read a report of a Government agency for quality control that Matz Pharmaceutical is in breach of the regulatory requirements for quality control and a fine of Rs. 27 million (which is material to the financial statements) has been levied. The breach of the law took place in a production batch commenced on January 23,2010.

How would you deal with the matter in audit report.

The event occurred after year end and does not provide further evidence as to the conditions existed at the balance sheet date. However a disclosure of the penalty should be made in the financial statements.

You have competed the audit of financial statements of Pride Limited showing profit before tax .and total assets of Rs. 74 million and Rs. 582 million respectively. Following issues are still unresolved: 

(i) Subsequent to year end, an employee left the company without settling a loan of Rs. 0.5 million. Management has refused to make provision but ready to give a disclosure.

(ii) The company imported a plant on deferred payment management. No forward exchange cover was taken by the company. At year end the liability was valued at Rs. 83.0 million and reported accordingly. However, it was finally settled for Rs. 88.5 million.

(iii) The revenue recognition policy is not consistent with the relevant International Accounting Standard (lAS). Had it been in accordance with the lAS, the profit before tax would have been Rs. 79.2 million.

(iv) The contract with a major customer is about to expire after three years. Certain internal documents show that the company might have to face a very difficult situation thereafter.
(v) Personal files of many senior executives do not contain any
documentary evidence of their qualification. Salaries paid to such executives are Rs. 24 million.


Discuss the impact of each of the above matters on your audit report.

(i) Amount involved Rs. 0.5 million is immaterial and would not have any impact on audit report.

(iii) Subsequent change in foreign exchange rate is not an adjusting event. The decision to take or not to take forward cover is based on management’s understanding and assessment of the underlying business environment and the auditor has no right to interfere unless the matter is very material and involves an unduly high degree of risk as regards the viability of entity.

(iv) Non compliance with IFRS is one of the causes of disagreement with the client. Since the effect of the error is 7% of net profit before tax, the impact is material. A qualified report is required.

(v) Currently the company is profitable. Three – year period is substantial time available with the company to improve the situation. An unqualified report is to be issued.

(vi) Non availability of personnel files does not require a modification in the report.

You are manager incharge for the audit of Sehwan Marbles Limited. During audi you noticed that the company was sued for breach of contract by a customer claiming damages of Rs. 200 million. Based on the lawyer’s opinion (received through management), the management asserted that there would be no significant liability at the balance sheet date in respect of the said breach and accordingly, no provision was made in the financial statements. However, while studying the case file you found a memorandum from the head of the legal department addressed to the managing director in which he had opined that the company will have to pay at least 50% of the damages claimed. You concluded that this note was a strong evidence indicating the existence of this liability, which should be provided for. Management considers that such note was nullified by the opinion of the company’s legal advisor and as such there was no need to make any provision in respect of this contingent liability that was considered to be remote. Therefore, the CFO advises you that at the most there may be a disclosure of this contingent liability in the financial statement of perhaps an emphasis of matter paragraph in the auditor’s report without qualification.


Write a memorandum containing your conclusion and recommendation for the decision of the partner as to the type of opinion that should be issued and why.

From                Manager in charge – Shewans Marbles Limited

To                     Partner

Subject            Breach of contract by a customer claiming damages                          Rs. 200,000

Date                  xxx

Kindly refer to attached detailed note on the subject.

My conclusions and recommendations are:

1. A provision is required under the circumstances as outflow of economic resources is probable and the amount can be estimated reliably.

2. A qualified opinion is required on the grounds of disagreement with management.

Under what circumstances the effect on audit opinion is considered to be pervasive? Explain with examples.

A matter is considered to be pervasive· if:

(a) the effect of misstatement or inability to obtain audit evidence

(b) the effect of misstatement or inability to obtain audit evidence is material, affects only specific elements.of financial statements but represents a substantial proportion of financial statements

(c) inadequate or misleading disclosures are fundamental to the understanding of financial statements.


(1) Receivables a count for 8% of tofal assets. The client restricte the auditor to send confirmation- letters. No alternative procedures could be used to verify the year end balances of receivables. There were no problems in the rest of financial statement accounts

The effect is not considered to be pervasive.

(2) Inventories account for 85% of total assets, Physical inventory could not be carried out at year end. No alternative procedures could be used to verify the year end balances of inventories. There were no problems in the rest of financial statement accounts.

The effect is considered to be pervasive

Explain the circumstances when audit opinion is modified on the grounds of material misstatement.

The audit report is modified on the grounds of material misstatement under following circumstances:

1. Inappropriate accounting policies, that is adoption of policies, that is adoption of policies in contradiction to IFRS.

2. Misapplication of accounting policy resulting in incorrect amounts. This also includes violation of consistency principle.

3. Inadequate disclosure or presentation of disclosures in contradiction with the requirements of IFRS.

Discuss the nature of inability to obtain audit evidence

Inalability to obtain audit evidence is also referred to as scope limitation. Such limitation arises from following matters:
1 Circumstances beyond the control of entity, for example, entity’s accounting records have been destroyed.

2  Nature and timings of the auditor’s work; for example the auditor’s appointment was made after year end. As a result the auditor could not observe physical inventory and no alternative procedures could be applied. Also, in an IT environment, if an entity’s controls are ineffective and substantive procedures alone cannot provide sufficient appropriate audit evidences.

3 Limitations imposed by management

For example, management does not allow the auditor to send confirmation letters to debtors.

State circumstances when a modified opinion is issued.

Audit opinion is modified if the opinion is:

(a) Qualified opinion

Qualified opinion is issued when the effect of misstatement or inability to obtain audit evidence is material but not pervasive.

(b) Adverse opinion

Adverse opinion is issued when the effect misstatement to obtain audit evidence is material and pervasive.

(c) Disclaimer

Disclaimer is issued when the effect of inability to obtain evidences material and pervasive.

The auditor has accepted an audit engagement. Subsequent to acceptance the management has imposed some restriction on the work of the auditor. Discuss possible consequences in such a case.

If after acceptance- of audit, the management has imposed some
restrictions the auditor should:

(a) Carry out alternative audit procedures. For example, if the management has prevented auditor to count inventories at year end, carry out physical count at an alternative date, and work back with verification of transactions in intervening period.

(b) If due to the nature of records, alternative procedures could not be applied, and the matter is not pervasive issue a qualified opinion.

(c) If the matter is pervasive, consider withdrawal from engagement or issue a disclaimer of opinion. Withdrawal may not be appropriate if the audit is substantially complete or the auditor has statutory duty to complete the audit.

A company has acquired a piece of land on 99 years lease. The company classifies the lease as operating lease. How would it affect your audit opinion?

In the case of leasehold land the risk and rewards are not transferred to the lessee. Accordingly, IAS 17 classifies leasehold land as operating lease. However For the schedule of the Companies Ordinance, 1984 requires that leasehold land should be classified under fixed assets.’ As the Companies Ordinance, 1984 prevails over IFRS, the leasehold is accounted for as part of fixed assets and not as operating lease. If the financial statements are not amended, a qualified opinion will be issued on the grounds of disagreement with management.

You are the manager in charge on the audit of Hexa Garments Limited HGL). The company is listed on the Karachi Stock Exchange and has nine directors. It is engaged in the manufacture and sale of fancy garments through its own retail outlets. You are considering the ollowing matters in respect of the audit for the year ended December 31, 2009:

a) The diluted earnings per share of Rs. 36.60 has been calculated without taking into account the share options held by three directors. To justify the above calculations, these directors haw confirmed in writing that they do not intend to exercise the share option. Had the share options been considered, the diluted earnings per share would have been Rs. 35.60. The review of subsequent events revealed that four of the remaining directors had exercised their share options following the balance sheet date. The share options are available upto December 31, 2010.

(b) According to the draft financial statements the total assets of the company are valued at Rs. 375 million. These include value of ten retail outlets amounting to Rs. 175 million. The valuation is based on historical cost less accumulated depreciation. During the year ended December 31, 2009, the management had decided to revalue all the retail outlets. The valuer appointed by the management has not been able to complete the assignment to date. However, he has submitted two interim reports as described below:

(c) During the year HGL has developed two new brands “Deebal” and “Kalachi” and has launched an aggressive marketing campaign for their promotion. The company has recognized the cost incurred on the campaign amounting to Rs. 10 million as an intangible asset. It is being written off over the estimated useful life of the brands i.e. four years.


Discuss the matters that may be of significance to you as an auditor,in respect of the above issues. Also explain their implications on the audit report.

(a) Significant audit matters

In the calculation of diluted EPS, the entity has to consider shared option. A disclosure is also required for exercise of such option impacton audit opinion If the fmancial statements are not amended, a qualified report should be issued on the grounds of material misstatement.

(b) Significant audit matters

IAS 16 requires that if an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which the asset belongs shall be revalues. Impact on audit opinion If only selective revaluation is made, a qualified report should be issued on the grounds of material misstatement.

(c) Significant audit matters

IAS 38 prohibits recognition of internally brands as intangible assets.

Impact on audit opinion

If internally generated brands are recognized as intangible assets, a qualified report should be issued on the grounds of material misstatement.

You are the auditor of Blue Sky Limited (BSL). The draft consolidated .financial statements of BSL and its subsidiary Sea Green Limited (SGL) for the year ended September 30, 2009 show a profit before taxation of Rs. 10.5 million (2008: Rs. 9.4 million) and net assets of Rs. 55.2 million’ 2008: Rs. 50.7 million). You have performed the audit procedures you considered necessary for the year ended September 30, 2009 and are satisfied with the results of those procedures. However, your firm is also the auditor of Sea Green Limited (SGL). You were appointed as SGL’s auditors for the year ended September 30, 2009 after BSL acquired 90% shares of SGL on June 30,2008. SGL’s draft financial statements for the year ended September 30, 2009 show profit before taxation of Rs. 0.7 million (2008~ Rs. 1.7 million) and net assets of Rs. 16.1 million (2008: Rs. 16.6 million). Both the companies ate exempt from tax.

The previous auditors’ report on SGL’ statements, for the year ended September 30, 2008 was unmodified. However, during the audit of SGL it was discovered that due to an error, the inventory as appearing in the audited financial statements for the year ended September 30, 2007 was overvalued by Rs. 5.7 million. This amount is now being adjusted by SGL over a period of three years i.e. over the years ended September 2008 to 2010.

You have approached the management advising them to adjust the full amount in the current year. However, the management is not willing to accept your point of view.


Draft the modification paragraph of the report which you would issue on the consolidated financial statements, in the above situation. (A full report is not required).

Basis for qualified opinion

On September 30, 2007, the inventory of a subsidiary was overstated by Rs. 5.7 million. The overvaluation was adjusted to the extent of Rs. 1.9 million during each years ended September 30, 2008 and 2009 Overstatement of inventory requires correction by adjusting opening retained earnings. According:

The inventory should be reduced by Rs. 1.9 million in 2009 and by Rs. 3.8 million in the year 2009. Profit for year should be increased by Rs. 1.9 million in 200″ and by Rs. 0.475 million in 2008. Retained earnings should be increased by Rs. 2.1375 million 2009 and by Rs. 0.4275 million in 2008. Non controlling interest should be reduced by Rs. 0.19 million the year 2009 and by Rs. 0.38 rnil!ion in 2008. In our opinion, except for the effect on the consolidation financ statements 0l the matter referred to in the preceding paragraph, consolidated fUI!i7’cialstatements fairly present the financial position Blue Sky LImited and its subsidiary at September 30, 2009, and’ results of operan ons for the year then ended.

The financial statements of Modem Equipment (Pvt) Limited reveal that the company has paid a donation of Rs. 15 million to a charitable organization where one of the directors of the company is a trustee. The company has earned a gross profit of Rs. 40 million. The selling and administration expenses including the donation amount to Rs. 60 million and as a result the company has incurred a net loss of Rs. 20 million. 


(a) Discuss the significance of the above donation, to the auditor and design appropriate audit procedures to address the issue.

(b) Discuss the-possible impact of the above issue on the auditor’s 

(a) Significant issues:

Substantial amount of donations have been given although the entity has incurred losses Donations have been made to’ an organizations where one of the directors of the client is trustee.

Audit procedures: 

Obtain details of the organization.

Consider whether the organization exists only on paper Obtain registration documents of the organization and its by laws

Determine mode of payment, i.e., through cash or crossed cheque Ascertain who approved the donation Consider relationship of entity’s business to the donee. Impact on audit opinion: Expenditure does not seem to be made for the purpose of business

You have recently completed the audit of Rubi Limited (RL), a
multinational company, for the year ended December 31, 2005. The Chief Financial Officer (CFO) of the company has now approached you for a report on book value per share, as of December 31, 2008 for submission to the regulatory authorities. Following is an extract from the audited balance sheet of RL as at December 31, 2008: 

The auditor’s opinion on the financial statements for the year ended December 31, 2008 was qualified as deferred tax asset amounting to Rs. 5 million was not recognized in the fmancial statements.


Draft a report for submission to the client. Show necessary calculations related to the figures disclosed in the report.

The Board of Directors

Dear Sir,

We have examined the annexed Statement of Book value per Share 0: the Company at December 31, 2008 duly initialed by us for identificatio purposes.
The book value per share has been determined on the basis of audite balance sheet of the Company at December 31,2008 in accordance wi the directives of the institute of Chartered Accountants of Pakistar contained in t he Technical Release 22 “Book Value per Share” (TR Zand we report that:

The Statement is the r~sponsibility of the management of the company. Our responsibility is to examine the Statement and report thereon. In our opinion, the Statement is presented fairly in all material respects in accordance with TR 22 of the institute of Chartered Accountants of Pakistan.

The book value per share of the face value of Rs. 10 share each, taking into consideration, surplus on revaluation of fixed assets, works out to Rs. 30.25 per share.
The book value per share of the face value of Rs. 10 share each, without taking into consideration, surplus on revaluation of fixed assets, works out to Rs. 28.75 per share. ‘

This report is being issued’ at the specific request of the Company to meet regulatory requirements and it should not be used for any other purpose or circulated to anyone else without our prior written consent.

You are the senior in charge on the external audit of Brown Limited (BL), a company dealing in consumer products. The draft financial statements for the year ended December 31, 2008 show profit before tax of Rs. 30.1 million and total assets of Rs. 242.4 million. The following issues have been identified during the course of the audit: 

(i) On January lO;2009, a liquidator has been appointed at Express Pakistan Limited (EPL), a major customer of the company. Sales to EPL during the year under review amounted to 35% of BL’s revenue and the balance due from EPL at December 31, 2008 was Rs. 5.89 million.

(ii) On January 25, 2009, a direct confirmation was received from BL’s lawyers. He had informed that because of the complexity of the issues involved in one of the litigation faced by the company, which was initiated in October 2008, it is not possible to forecast its outcome. However, he has advised that the possible impact of an unfavorable decision (if any), ranges between zero to Rs. 10 million. The draft financial statements do not contain any disclosure in respect of this uncertainty:

(iii) During the year the company incurred costs of Rs. 1.1 million in respect of repairs and maintenance of its machinery. These costs have been capitalized and included in the carrying value of property, plant and equipment. The management has refused to make any adjustments in the financial statement in respect of this matter.

(iv) During the year, the company has commercially imported certain branded products amounting to Rs. 200 million, which are subject to FTR at import stage. The final tax paid at import stage amounted to Rs. 4 million and the entire amount has been recognized as expense, in the current period. However, goods costing Rs. 50 million remained unsold and are included in the stock -in-trade.


Explain the possible effects of the situations described above, on BL’s financial statements for the year ended December 31, 2008 and discuss the implication thereof, if any, on the audit report.

(i) Effect on financial statements

The amount due from Express represents 19.5% of profit and is therefore material. Allowance for ‘doubtful debts should be set up to the extent the debt is not recoverable.

Implication on audit report

If the management refuses to make an allowance where the auditor deems it necessary, the report should be qualified on the grounds of material misstatement. The auditor should also consider the validity of going concern assumption as BLP is a of major customer of Express

 (ii) Effect on financial statements

The amount involved is materia}, 33% of profits. The matter should be disclosed in notes to the accounts. Implication on audit report If the management di~closes the matter in notes to the accounts, an emphasis of matter paragraph is required If management refuses to make pertinent disclosures, qualified report is to be issued on the grounds of material misstatement.

iii) Effect on financial statements

Repairs and maintenance c”o~tscannot be capitalized Implication on audit repprt The amount capitalized is not material, 3.6% of profit before tax and 0.45% of total assts. An unqualified report may be issued. Effect on financial statements Tax paid at import stage under FR should be recognized as expense in which the related goods are sold. An appropriate portion may be included in the cost.
Implication on audit report Amount involved is not material and therefore an unqualified may be issued.

Platinum Limited (PL) is a key supplier of raw materials to Zinc Limited (ZL). PL has filed a suit against zr, for breach of terms of an agreement. The amount claimed by PL is RS. 10 million. ZL has disclosed it as a contingent liability in the draft financial statements for the year ended 31 December 2011. However, ZL is striving for an out 01 court settlement and recent correspondence indicates that PL is likely to agree and settle the dispute for 50% of the amount claimed by them.


Describe the audit procedures that ZL’s auditor should perform in the above situation. Also discuss the impact, if any, of the above procedures on the audit report.

Perform following audit procedures to conclude whether a provision is required:

1. Inspect correspondence with PL to ascertain probability of settlement of claim.

2. Seek opinion of entity’s lawyers for the estimated amount involved.

3. Obtain written representation from management, If the management refuses to make approt>iiate provision as the auditor considers necessary the repbrt should be qualified.

The following situations have arisen on diffe’refitdients being audited b.
your form. The year end in each instance is j 1 December 2011:
(a) The management of Dir Limited itItenas- to present certaiz;
unaudited supplementary information, with the audited financi
statements, in order to comply with the requirements of
parent company. Before signing the audit- report, it has be
determined that some of the information is inconsistent with .
information in the draft financial Statements.

(b) Malakand Industries Limited (MIL) is engaged in the supply of customized machinery to textile manufacturers. On 18 February 2012 one of its customers, who owed Rs. 9.6 million, went into voluntary liquidation. In addition to the above amount, a job was in progress on behalf of that customer and on -which MIL had already spent Rs. 13.9 million.

The directors have refused to make a provision against the debt on the grounds that the liquidator was appointed after the balancesheet date. They have also refused to make any provision -in respect of th~ work in process as they,palaning to sell the machinery bemg manufactured to another cusfctmer for Rs. 15.7 million.

The profit after tax of MIL is Rs. 85 million. The- materiality level is 10% of profit after tax. 

(c) Swat Limited has invested Rs. 150 million ina business which is not mentioned in the object clause of its- Memorandum of Association. However, the object clause was amended a week before the signing of the audit report.


In the light of the relevant requirements, discuss how should the auditor deal with the above situations and describe the impact thereof on the audit report.

(a) (i) If there are material inconsistencies in the additional disclosures the auditor should discuss the reasons thereof with the management and ask them to revise the other information or the
financial statements, as may be appropriate.

ii) If the revision of other information is necessary and the management refuses to revise the same, the auditor shall communicate the matter to those charged with governance and;

iii) Include in the auditor’s report an ‘other matter paragraph’ describing the material inconsistencies, if they persist.

(IV)  If the revision of the draft fmancial statements is necessary and
management refuses to make the revision, the auditor shall consider giving a qualified opinion or adverse opinion as may be appropriate.

(v) The auditor should also consider that whether the supplementary
information that is not required by the applicable financial reporting framework, is clearly differentiated from the audited financial statements.

(vi) If it is not clearly differentiated, he shall ask the management to
change the way in which the unaudited supplementary information has been presented.

(vii) In case of disagreement in respect of the above, the auditor shall explain in the auditor’s report that such supplementary information has not been audited.

(b) (i) The amount ofRs. 9.6 million which is due from MIL is material to the financial statements.

(ii) With respect to job in progress, if the auditor can satisfy himself that management .would be able to recover the cost of work in process from another customer, he may conclude that a provision
is not required in this respect.

(iii) In making the above decision the auditor should also consider the expenses that are required to be incurred on the job, subsequent to year end.

(iv) The auditor should ask the management to provide for the loss of Rs. 9.6 million or any part thereof depending upon the estimated amount of default, plus any further provision that may be necessary in respect of the work in process .. In case of management’s refusal, the auditor shall qualify his report.

(c) The auditor shall qualify the audit by mentioning that investment of Rs. ISO million was not in accordance with the objects of the company with a clarification that the object clause was amended a week before the issuance of audit report, to include the said objective.

You are the audit manager of MM Electronics (Private) Limited. The company markets its products through retail outlets in nine major cities The draft financial statements for the year ended 30 June 2011 show profit after tax of Rs. 20 million and net assets of Rs. 150 million. Tl audit team has noted the following matters for your consideration

(a) During the year the company has changed its policy of valuation of property, plant and equipment from historical cost to revalued amount. For this purpose, the services of Professional Valuers (Private) Limited were hired. They have issued valuation reports of three out lets indicating a revaluation surplus of Rs. 10 million, which has been recognized in the fmancial statements.

The management has informed you that the valuation reports  f
the remaining properties are expected to be issued in December 2011.

(b) The company was sued for breach of contract by a customer claiming damages of Rs. 10 million. The legal advisor has confirmed the management’s assertion that no liability existed at the balance sheet date. However, while reviewing the customers’ files, you found an email from the Manager (Legal Department) addressed to the Chief Executive in which he has opined that the company will have to pay atleast 50% of the damages claimed.

c) With effect from 01 July 2010, the company has introduced a
policy of providing one year warranty on its television sets. No
warranty is provided on the other products. Sales of television
sets aggregated Rs. 20 million, whereas the total sales for the
year amounted to Rs. 80 million.
The company has a customer support department which provides after sales services on all products. For defects not covered under the warranty, the company bills the customers at 25% above cost. The management has included a note in the draft financial statements stating that no provision has been made in respect of the warranty, as the amount cannot be measured reliably. The directors have decided not to disclose earnings per share as the same had reduced significantly on account of 100% bonus shares. The disclosure was however made in all previous financial statements.


Express your views on each of the above situations and discuss the act thereof on the audit report

(a) Revaluation of Properties

(i) In accordance with IAS 16, Property, Plant and Equipment, if a policy of revaluation is to be applied, it should be applied to allthe non-current assets in a particular class of assets.

(ii) Since compliance with
(i) above is not possible, the auditor should advise the client to not to change the accounting policy and state the values of the property at cost.

(iii) In case of disagreement the auditor may consider issuing a qualified report.
(b) Suit for damages:
(i) The reliability of audit evidence provided by the legal advisor high because it has been obtained from an independent soure outside the entity. As management is also of the view that liability exists at the balance sheet date, therefore in the presentof legal advisor’s confirmation a conclusion should not be on the basis of manager’s legal email.

(ii) However, since there is inconsistency in audit evidence obtain and the auditor is unaware of the context in which the management (legal) sent the email, he shall investigate the reasons thereof may need modification or addition to the audit procedures.

(iii) The auditor should analyze the situation, in the light of IAS Provisions. Contingent Liabilities and Contingent Assets. assess whether a disclosure of the event as a contingent lia
is required or not.

(iv) If disclosure of contingent liability is required, and the disagrees the audit report may be qualified.

(c) Warranty Provision:

(i) The management’s claim that the amount cannot be me – reliably is not correct because they were charging the cus at 25% above cost prior to July 01,2010 i.e. when there warranty on the sale of television sets and hence they mus: a position to make a reliable estimate based on the experience and records available with them.

(ii) If a provision is not made for the warranty then if the amount of provision is material to the financial statements then the audit report should be qualified.

(d) on-Disclosure of Earnings per share in the financial statements: International Accounting Standards 33, Earnings per share does not apply to non-listed entities; therefore there is no requirement of disclosing earnings per share in the financial statements

a) Briefly explain the term ‘pervasive effects on the financial
statements’ .

b) As the engagement partner, you have reviewed the audit working papers of Apricot Engineering Limited (AEL). The audit team has highlighted the following matters in the working papers:

The company has issued a bank guarantee to one of its related
parties after the balance sheet date. No disclosure in this regard has been made in the draft financial statements. AEL has paid a dividend after many years. Zakat has been appropriately deducted and deposited in the Central Zakat Fund.

Subsequent to the year end, a major debtor has declared bankruptcy. The company expects to recover only 20% of the outstanding amount. The management has refused to make a provision but is ready to disclose the fact by way of a note. 

With effect from January 1,2010, AEL has:

• changed the method of charging depreciation on its fixed assets from the ‘straight line’ to the ‘diminishing balance’;
• revised its estimate of useful lives of vehicles from 6 years to 4 years


Discuss the impact of each of the above matters on your audit report

a) Pervasive is a term used to describe the effects of misstatement on the financial statements or the possible effects thereon if any misstatement remains undetected due to the auditor’s inability to obtain sufficient audit evidence.

Pervasive effects on the fmancial statements are those that, in the auditor’s judgments:

(i) are not confined to specific elements, account or items of the financial statements,

(ii) if so confined, .represent or could represent a substantial proportion of the financial statements or

(iii) in relation to disclosures, the fundamental to user’s understanding of the financial statements.

(b) (i) Issuance of bank guarantee after the year end does not require any adjustment or disclosure. Therefore, there will be no effecton the audit report on this issue.

(ii) the audit report shall state that “Zakat deductible at source under the Zakat & Ushr Ordinance, 1980, was deducted and deposited in the Central Zakat Fund established under section 7 of tha Ordinance”.

(iii) The auditor should consider the materiality of the amount. If the amount is material, the. auditor should express a qualified or adverse opinion.

(iv)    • The audit report shall mention the exception to the consiste:: application of accounting policies and whether the audit concurs with it or not.

• The financial statements shall be adjusted accordingly and effect of change in estimate shall be adjusted accordingly and effect of change in estimate shall be disclosed in the notes to financial statements unless the differences are material auditor has reasons to differ with the reviewed estimate. The would be no impact on the audit report on this issue.

Posted on November 2, 2015 in ModificationTo TheOpinion Th Independence Auditers Report

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