Audit Evidence, Completion and Review — Case Studies — Practice

Question 1

An auditor obtains a positive external confirmation from a customer stating an outstanding balance of ₹12 lakh, while the company's own accounts receivable ledger shows this same customer owing ₹18 lakh. Explain how the auditor should approach this discrepancy, and why the external confirmation should not simply be assumed to be correct without further work.

Accepted Answer

The auditor should not simply defer to the external confirmation's ₹12 lakh figure purely because external evidence is generally more reliable than internally generated evidence; instead, the auditor must investigate the specific discrepancy of ₹6 lakh to understand its cause before concluding whether it represents a genuine misstatement, and if so, on which side. Possible explanations include a timing difference, such as goods dispatched and invoiced by the company but not yet received or recorded by the customer at the confirmation date, which would not represent a genuine misstatement at all but simply a reconciling item; a disputed amount the customer is deliberately declining to acknowledge for reasons unrelated to the company's own recording accuracy; or a genuine error in the company's own ledger, overstating the receivable. The reliability hierarchy provides a general guide, external evidence is ordinarily more reliable than internally generated evidence, but it is not an automatic or unconditional rule that resolves every specific discrepancy without further investigation; the auditor must obtain sufficient appropriate evidence to actually explain this specific ₹6 lakh gap, for instance by examining shipping and invoicing documentation around the confirmation date, before concluding whether the company's recorded receivable is genuinely misstated, and by how much, rather than mechanically substituting the confirmed amount for the recorded amount without understanding why the two figures actually differ.

Question 2

An auditor sends confirmation requests to five of the company's largest customers, representing a significant portion of total receivables. Three respond confirming the balances; two do not respond despite follow-up requests. Explain the auditor's next steps regarding the two non-responses, and the circumstance under which this could ultimately affect the audit opinion.

Accepted Answer

For the two non-responding customers, SA 505 requires the auditor to perform alternative audit procedures to obtain sufficient appropriate audit evidence about the existence and valuation assertions the confirmation was intended to address, such as examining subsequent cash receipts from these customers after the reporting date and matching them against the specific outstanding invoices, or examining shipping documentation and sales invoices supporting the recorded balance directly. If these alternative procedures provide sufficient appropriate evidence supporting the recorded balances for these two customers, the non-response itself does not present a further problem, since the audit evidence need has still been satisfied, simply through an alternative route rather than direct confirmation. However, if these two customers represent a sufficiently significant portion of total receivables, and the alternative procedures performed do not, in fact, provide sufficient appropriate evidence, perhaps because subsequent cash receipts are incomplete or the underlying documentation itself is unavailable or unpersuasive, this could constitute a scope limitation: the auditor has been unable to obtain sufficient appropriate audit evidence about a potentially material item, which, if this evidentiary gap cannot be resolved through any other means, could ultimately require the auditor to modify the audit opinion, either qualifying it or, if the matter is both material and pervasive, disclaiming an opinion altogether, precisely the reporting consequence that follows directly from an unresolved scope limitation on a material item.

Question 3

During the audit, the auditor notices that the company sold a significant piece of machinery to an entity called 'Sunrise Trading Co.' at a price 40% above independently assessed fair value, with payment terms far more generous than the company extends to any other customer, and Sunrise Trading Co. was previously unknown to the auditor. Explain the specific indicators here that should prompt the auditor to investigate a possible undisclosed related party relationship, and the audit procedures that would help uncover it.

Accepted Answer

The specific indicators prompting investigation are: a transaction priced significantly above independently assessed fair value (40% above), which has no obvious commercial rationale for why an unrelated arm's-length buyer would agree to pay a substantial premium over fair value, unless some other, undisclosed relationship or motivation exists; unusually generous payment terms extended to this specific customer, materially more favourable than terms offered to any other customer, again inconsistent with ordinary, arm's-length commercial dealing where a company would not typically extend uniquely favourable terms without a specific reason; and the counterparty being a previously unknown entity to the auditor, with no established prior business relationship or documented rationale for this specific transaction having emerged from the ordinary course of business relationships already known and understood. Audit procedures to investigate this include reviewing the company's register of related parties and inquiring specifically of management and those charged with governance whether Sunrise Trading Co. or its owners have any relationship with the company's own directors, key management personnel, or their close family members; examining company registration records or ownership filings for Sunrise Trading Co. itself to identify its beneficial owners; reviewing board and shareholder meeting minutes for any discussion of this transaction or of Sunrise Trading Co. specifically; and if a related party relationship is confirmed, evaluating whether the transaction and relationship have been appropriately identified, accounted for, and disclosed under the applicable financial reporting framework and Ind AS 24, given SA 550's specific concern that related party transactions are inherently susceptible to concealment by management precisely because of the kind of non-arm's-length pricing this transaction exhibits.

Question 4

A company's reporting date is 31 March. The auditor's report is signed on 20 May. The financial statements are actually issued to shareholders on 5 June. On 15 June, the auditor learns of a major customer's bankruptcy, a customer whose receivable balance was material and was assessed as fully collectible at the report date, with no indication of financial distress evident to the auditor before 20 May. Identify which subsequent events window this fact falls within, and the specific duty this triggers.

Accepted Answer

This fact came to the auditor's attention on 15 June, which is after the financial statements were issued (5 June), placing it within the third subsequent events window, facts discovered after the financial statements have been issued. Under SA 560, the auditor has no obligation to actively search for such facts after issuance, but once the auditor becomes aware, through whatever means, of a fact that existed at the reporting date (or, more precisely here, a fact indicating conditions relevant to collectibility that may have existed, at least in part, at or before the report date, though the specific bankruptcy event itself occurred later) that, had it been known at the report date, might have caused the auditor to modify the audit report, the auditor has a duty to discuss the matter with management and those charged with governance, and to consider whether the financial statements need amendment. If management agrees to amend the financial statements, the auditor performs the necessary procedures on the amendment and issues a new report; if management does not agree to amend the financial statements despite the auditor believing they should be amended, and the auditor is unable to prevent continued use of the previously issued financial statements and audit report, the auditor may need to take further action, such as notifying those charged with governance and, depending on the circumstances and applicable legal requirements, seeking legal advice about further steps, given the financial statements have already been issued and relied upon by users.

Question 5

A company has incurred operating losses for the past two years, has a current working capital deficiency, and lost its largest customer six months before the reporting date. However, management has a signed, binding agreement to sell a non-core division for a substantial sum shortly after the reporting date, with the proceeds specifically earmarked to eliminate the working capital deficiency and fund operations for the next 18 months, and has disclosed this plan and its expected effect clearly in the notes to the financial statements. Explain how the auditor should weigh these facts together in evaluating going concern, rather than concluding automatically that a material uncertainty exists purely because multiple negative indicators are present.

Accepted Answer

The auditor's task under SA 570 is not to mechanically conclude that a material uncertainty related to going concern exists purely because several negative indicators, recurring operating losses, a working capital deficiency, and loss of a major customer, are simultaneously present, but to genuinely weigh these indicators against management's identified mitigating factor, the signed, binding sale agreement for the non-core division. The auditor should evaluate the credibility and reliability of this specific mitigating plan: is the sale agreement genuinely binding and unconditional, or subject to conditions that could yet fail to be satisfied; is the counterparty's own ability to complete and fund the purchase genuinely credible; is the timing of the expected proceeds (shortly after the reporting date) sufficiently certain and prompt to actually address the near-term working capital deficiency before it causes genuine operational difficulty; and does the amount of proceeds expected genuinely appear sufficient, as management claims, to fund operations for the stated 18-month period given the company's other ongoing cash needs. If, having evaluated this evidence, the auditor concludes the mitigating plan is genuinely credible, sufficiently certain, and adequately disclosed, along with its expected effect, in the notes to the financial statements, the auditor may conclude the going concern basis of preparation remains appropriate without a material uncertainty requiring separate emphasis, or, if some genuine residual uncertainty remains even after considering the mitigating plan, the auditor may conclude a material uncertainty does exist but is adequately disclosed, warranting an unmodified opinion with an Emphasis of Matter paragraph drawing attention to the disclosure, rather than a modified opinion; the specific conclusion reached depends entirely on the auditor's professional judgement about the credibility and adequacy of this specific mitigating evidence, not on a mechanical count of negative indicators present.

Question 6

A company's management provides a written representation confirming that a specific piece of litigation is not expected to result in any material liability, based on management's own assessment. The auditor has no other corroborating evidence on this matter beyond this written representation. Explain why the auditor cannot rely on this representation alone to conclude the litigation provision (or lack thereof) is appropriate.

Accepted Answer

SA 580 explicitly establishes that written representations, while necessary audit evidence the auditor must obtain, do not on their own constitute sufficient appropriate audit evidence about any of the specific matters to which they relate; a written representation from management is, in substance, management's own assertion restated in writing, and using it as the sole evidence to support a conclusion about that same assertion would mean the auditor has obtained no genuinely independent corroboration at all, relying entirely on management's own, potentially biased or overly optimistic, self-assessment of a matter (litigation exposure) in which management has an obvious incentive to understate the likely liability. The auditor should instead obtain independent corroborating evidence, such as directly corresponding with the company's external legal counsel handling the litigation (a standard, specifically prescribed procedure precisely for this type of matter), to obtain the lawyer's own independent, professional assessment of the likely outcome and any resulting exposure, and only with this kind of genuinely independent evidence, considered alongside, rather than instead of, the written representation, can the auditor reach a properly supported conclusion about whether the litigation provision, or the absence of one, is appropriate; the written representation remains a necessary, required piece of evidence confirming management's own position and acknowledging management's responsibility for that position, but it cannot substitute for the independent corroboration a matter of this significance genuinely requires.

Question 7

A firm is appointed as auditor for the first time, replacing a previous auditor whose engagement ended after a dispute with the client over an accounting treatment. The new auditor requests access to the predecessor auditor's working papers but the client refuses permission. Explain what the new auditor must do instead to obtain sufficient appropriate evidence about the opening balances under SA 510.

Accepted Answer

Where access to the predecessor auditor's working papers is not available, whether due to the client's refusal of permission or any other reason, SA 510 requires the new auditor to obtain sufficient appropriate audit evidence about whether the opening balances contain misstatements that materially affect the current period's financial statements through other means; this typically involves performing specific audit procedures directly on the opening balances themselves, such as verifying that the closing balances from the prior period have been correctly brought forward, or, where appropriate, restated as the opening balances of the current period, and performing specific procedures depending on the nature of the accounts, for instance obtaining external confirmations for significant asset and liability balances existing at the opening date directly, or, for inventory, potentially performing procedures to gather evidence about the quantities and condition of opening inventory that could not have been directly observed at that past date, such as reviewing the prior period's inventory count records and testing the roll-forward through the current period's transactions. Given the added context that the predecessor auditor's engagement ended following a dispute over an accounting treatment specifically, the new auditor should treat this as a heightened risk indicator, prompting particular scepticism and more extensive direct procedures on the opening balances relevant to that specific disputed area, rather than relying on standard, routine opening balance procedures alone, since the circumstances of the predecessor's departure themselves suggest a specific area warranting closer scrutiny.

Question 8

An auditor performs a test of controls using audit sampling and concludes the control is operating effectively based on the sample tested, when in fact the control is not operating effectively across the full population. Separately, in a test of details, the auditor concludes a balance is materially misstated based on the sample, when in fact it is not. Identify which sampling risk each error represents, and explain why the first is generally considered more serious from an audit effectiveness perspective.

Accepted Answer

The first error, concluding a control is operating effectively when it is not, represents the risk of assessing control risk too low (or, in a test of details context, the risk of incorrect acceptance), the sampling risk that the sample leads the auditor to a conclusion more favourable than the true state of the population actually warrants. The second error, concluding a balance is materially misstated when it is not, represents the risk of incorrect rejection, the sampling risk that the sample leads the auditor to a conclusion less favourable than the true state of the population actually warrants. The first type of error, incorrect acceptance or assessing control risk too low, is generally considered more serious from an audit effectiveness perspective because it directly undermines the audit's fundamental purpose: the auditor proceeds with an unwarranted degree of reliance on a control that is not, in fact, functioning correctly, potentially resulting in insufficient substantive testing being performed and a genuine material misstatement going undetected, whereas the second type of error, incorrect rejection, while inefficient (requiring the auditor to perform additional, ultimately unnecessary work to resolve an apparent problem that does not genuinely exist), does not itself result in an incorrect audit opinion being issued, since it prompts further investigation rather than false reassurance.

Question 9

In a company's first year being audited by a new firm, a customer that was included in the opening receivables balance as fully collectible is declared bankrupt one month into the current audit period, with clear evidence the customer had already been in serious financial difficulty well before the prior reporting date. Explain how this should affect the new auditor's evaluation of the opening balances under SA 510, connecting it to the adjusting event concept.

Accepted Answer

Since there is clear evidence the customer was already in serious financial difficulty well before the prior reporting date, this bankruptcy, although only formally declared during the current period, provides evidence of a condition that existed at the prior reporting date, precisely the kind of adjusting event concept familiar from Ind AS 10 and from the Intermediate-level Auditing syllabus's own treatment of subsequent events; the bankruptcy declaration merely confirms, rather than creates, a doubtful-collectibility condition that genuinely existed at the opening balance date. Under SA 510, the new auditor evaluating the opening balances must consider this evidence directly: if the opening receivable balance was carried as fully collectible without any allowance despite this pre-existing financial difficulty, the opening balance itself may have been materially misstated, and this misstatement, having originated in the opening balance, would need to be evaluated for its effect on the current period's financial statements, potentially requiring a prior period adjustment or, depending on the applicable framework and the materiality of the effect, at minimum requiring the auditor to consider whether this affects the auditor's ability to conclude the opening balances are free from material misstatement, illustrating precisely why SA 510 requires the new auditor to perform genuine, direct procedures on opening balances rather than simply accepting them as presented, particularly where subsequent evidence like this specific bankruptcy casts direct doubt on their original accuracy.

Question 10

Near the completion of an audit, management refuses to provide a specific written representation the auditor has requested, relating to management's assessment of a significant accounting estimate, though management verbally confirms it agrees with the estimate. Explain the significance of this refusal under SA 580, and the auditor's likely course of action.

Accepted Answer

SA 580 treats a refusal by management to provide a requested written representation as a significant matter, since written representations are necessary audit evidence the auditor requires as part of forming the audit opinion, and a refusal to provide a specific written representation, even where management verbally confirms the same position, raises a genuine concern about management's willingness to formally, and therefore more accountably, stand behind a position it is apparently willing to state only informally and without the same level of commitment a written representation carries; this discrepancy between a verbal assurance and a refusal to commit that same assurance to writing can itself be an indicator of doubt about the reliability of other representations and audit evidence obtained from management more generally. Where management refuses to provide a requested written representation, SA 580 requires the auditor to discuss the matter with management, re-evaluate the integrity of management, and consider the effect this refusal may have on the reliability of other representations (oral or written) obtained during the audit, and to take appropriate action, which may include a possible effect on the audit opinion; since written representations of this kind are considered necessary audit evidence, a refusal that cannot be resolved may ultimately result in the auditor being unable to obtain sufficient appropriate audit evidence, potentially leading to a disclaimer of opinion or a qualified opinion, depending on the significance of the specific matter the refused representation related to and the availability of any alternative corroborating evidence the auditor might otherwise be able to obtain.

Question 11

An auditor is appointed after the company's year-end physical inventory count has already taken place, with the auditor unable to have observed the count. Explain the alternative procedures SA 501 requires in this situation to obtain sufficient appropriate audit evidence about the existence and condition of inventory.

Accepted Answer

Where attendance at the physical inventory count was impracticable due to the timing of the auditor's appointment, SA 501 requires the auditor to perform alternative audit procedures to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory; this typically involves inspecting records of the physical count that was actually performed, such as count sheets and reconciliation records, and, where feasible, performing test counts of inventory currently on hand and tracing these back through purchase and sales records to the quantities recorded at the count date, effectively reconstructing and verifying the roll-forward of inventory quantities from the count date to the present. The auditor may also perform procedures on the intervening transactions, examining purchase and sales documentation for the period between the count date and the current inspection date, to gain assurance that the roll-forward computation is reliable and that the recorded opening inventory quantities at the count date, as reflected in the count records now being relied upon, genuinely appear reasonable and consistent with other evidence; if these alternative procedures cannot provide sufficient appropriate evidence, the auditor must consider the effect on the audit opinion, potentially a scope limitation if inventory is material and no adequate alternative evidence can be obtained.

Question 12

In two separate audits, both companies face a genuine material uncertainty related to going concern. In Company A, management has adequately disclosed the material uncertainty, the events or conditions giving rise to it, and its plans to address it, in the notes to the financial statements. In Company B, management refuses to include any disclosure about the uncertainty at all, believing it would alarm investors unnecessarily. Explain the different audit report outcomes for each company.

Accepted Answer

For Company A, since management has adequately disclosed the material uncertainty related to going concern, the auditor generally issues an unmodified opinion, but includes a separate section in the audit report, headed 'Material Uncertainty Related to Going Concern,' drawing attention to the relevant note in the financial statements that discloses the events or conditions giving rise to the uncertainty and management's plans to address it, and stating that the auditor's opinion is not modified in respect of this matter; the disclosure itself is what management has done correctly, and the auditor's report specifically highlights this adequate disclosure for users' attention without qualifying the opinion, since the underlying accounting (the going concern basis of preparation) remains appropriate given the adequate disclosure. For Company B, since management refuses to include any disclosure about the genuine material uncertainty at all, the financial statements themselves fail to adequately disclose a matter the auditor has independently concluded is material and genuinely warrants disclosure under the applicable financial reporting framework; this is a disclosure inadequacy, and under SA 570 and SA 705, the auditor should express a qualified opinion or an adverse opinion, depending on the materiality and pervasiveness of the missing disclosure's effect on the financial statements' overall fairness, describing in the basis for the modified opinion the material uncertainty that exists and explaining that this uncertainty has not been adequately disclosed, precisely the kind of disclosure-inadequacy modification distinct from the unmodified-opinion-with-separate-section outcome that Company A's adequate disclosure earns instead.

Question 13

During an audit, a factory manager verbally tells the auditor that a specific batch of inventory, physically present at the count, is obsolete and unsellable, though this is not reflected in any of the company's own inventory records or write-off documentation. Explain why the auditor should treat this oral statement carefully, and what additional evidence the auditor should seek before relying on it.

Accepted Answer

This oral statement from the factory manager is a form of audit evidence, but oral evidence is generally less reliable than written or documented evidence, and here the statement is not corroborated by any of the company's own formal records or write-off documentation at all, meaning the auditor has, at this point, only an unverified verbal assertion from a single individual, whose own possible motivations (perhaps understating inventory obsolescence has previously been discouraged by more senior management, or perhaps the manager has a specific reason to flag this batch now) the auditor cannot yet assess. Before relying on this statement to conclude the batch should be written down or written off, the auditor should seek corroborating evidence, such as physically inspecting the batch itself for visible signs of damage, obsolescence, or deterioration consistent with the manager's claim; inquiring of other relevant personnel, such as the sales or quality control function, about this specific batch; reviewing any correspondence, quality reports, or sales history suggesting this inventory has genuinely become unsellable; and, if the amount is material, raising the matter formally with management to obtain their own assessment and, where appropriate, incorporate a specific written representation addressing this matter, since a single unverified oral statement from one individual, however seemingly credible, does not on its own constitute sufficient appropriate audit evidence for a potentially material inventory write-down.

Question 14

Between the reporting date and the date of the auditor's report, the auditor learns that a major fire destroyed one of the company's warehouses, with no indication the warehouse had any pre-existing structural issue. Explain what the auditor's active duty under SA 560 requires in this window, and how the auditor should treat this specific event once identified.

Accepted Answer

Under SA 560, between the reporting date and the date of the auditor's report, the auditor has an active duty to perform audit procedures designed to identify events that may require adjustment of, or disclosure in, the financial statements, such as reviewing management's own procedures for identifying subsequent events, reading minutes of meetings held after the reporting date, and inquiring of management about any subsequent events that may affect the financial statements. Having identified this specific fire through such procedures, the auditor must then classify it: since there is no indication the warehouse had any pre-existing structural issue at the reporting date, this event arose from conditions occurring entirely after the reporting date, making it a non-adjusting event under the same Ind AS 10 framework covered in the Financial Reporting paper's own subsequent events chapter, meaning the financial statements are not adjusted to reflect the loss, but if the fire and resulting loss are material, the auditor should verify that the nature of the event and an estimate of its financial effect (or a statement that such an estimate cannot be made) are adequately disclosed in the notes to the financial statements as a non-adjusting event, and should evaluate whether this disclosure has genuinely been made adequately before concluding the financial statements are not misstated in this respect.

Question 15

An auditor obtains a large volume of documentation, invoices, delivery notes, and payment records, relating to a related party transaction, but none of this documentation independently addresses whether the transaction's pricing genuinely reflected arm's-length terms. Explain why this documentation, despite its volume, may still fail to constitute sufficient appropriate audit evidence.

Accepted Answer

Sufficiency and appropriateness are two distinct dimensions of audit evidence quality, and a large volume of documentation addresses only the sufficiency dimension, the quantity of evidence obtained, without necessarily satisfying the appropriateness dimension, the quality of that evidence, specifically its relevance to the particular assertion the auditor actually needs evidence about. Here, the invoices, delivery notes, and payment records may well be highly persuasive evidence that the transaction genuinely occurred (existence) and that the recorded amounts were actually paid (in that narrow sense, accuracy of recording), but none of this documentation, however voluminous, directly addresses the specific concern relevant to a related party transaction: whether the pricing itself was genuinely conducted on arm's-length terms, or whether the price was instead influenced by the related party relationship in a way that misrepresents the transaction's true economic substance. Obtaining more of the same type of evidence, additional invoices or delivery notes, would increase sufficiency (quantity) without improving appropriateness (relevance to the actual question at hand), illustrating precisely why audit evidence must be assessed on both dimensions together; the auditor here would need genuinely different evidence, such as independent market pricing data for comparable transactions, or evidence of the process by which this specific price was negotiated and agreed, to obtain appropriate evidence addressing the actual arm's-length pricing concern this related party transaction raises.

Practice — Audit Evidence, Completion and Review — Case Studies

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