CA Inter P5 · Chapter 5
Audit of Items of Financial Statements MCQs with Answers
12 multiple-choice questions on Audit of Items of Financial Statements for CA Inter P5 Auditing and Ethics. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
While verifying share capital issued during the year by Pranav Textiles Ltd., the auditor should examine:
- A) Board and general meeting minutes, the register of members, and the return of allotment filed with the Registrar
- B) The fixed asset register and depreciation schedule
- C) Only the cash book entries showing receipt of application money
- D) The sales register and dispatch notes
Show answer & explanation
Answer: A) Board and general meeting minutes, the register of members, and the return of allotment filed with the Registrar
Verification of share capital involves checking authorisation in the memorandum and resolutions, minutes approving allotment, the register of members, receipt of money in the bank, and filings such as the return of allotment with the Registrar. The cash book alone does not show that shares were properly authorised and allotted.
Question 2
Goods were dispatched to a customer of Lavanya Ceramics Ltd. on 31 March (the year-end) with control passing on dispatch, but the invoice was raised on 2 April. Which procedure best detects such an error?
- A) Recomputing the GST payable for the month of March
- B) Reviewing the minutes of the annual general meeting
- C) Examining dispatch records for a few days before and after the year-end and matching them with the period in which sales were recorded
- D) Obtaining a confirmation of the bank balance as on 31 March
Show answer & explanation
Answer: C) Examining dispatch records for a few days before and after the year-end and matching them with the period in which sales were recorded
This is a sales cut-off issue. Revenue should be recognised in the period in which control passed, i.e. March. Cut-off testing involves matching dispatch documents around the year-end with the period of recording to ensure sales are recorded in the correct period. Bank confirmations and AGM minutes do not address this.
Question 3
The auditor of Bhoomi Engineering Ltd. selects assets physically present on the factory floor and traces them to the fixed asset register. This procedure primarily provides evidence about:
- A) Valuation of property, plant and equipment
- B) Occurrence of depreciation expense
- C) Existence of property, plant and equipment
- D) Completeness of property, plant and equipment
Show answer & explanation
Answer: D) Completeness of property, plant and equipment
Tracing from physical assets to the register checks whether assets that exist are recorded, which tests completeness. Selecting items from the register and verifying them physically tests existence. Neither procedure on its own tests valuation.
Question 4
Title deeds of a factory building owned by Yatin Polymers Ltd. are lodged with a bank as security for a term loan. To verify title, the auditor should:
- A) Obtain a certificate directly from the bank confirming that it holds the title deeds on behalf of the company
- B) Accept a photocopy of the title deed certified by the company secretary
- C) Disregard verification because the bank has already checked the title
- D) Accept the company's own register of immovable properties as sufficient
Show answer & explanation
Answer: A) Obtain a certificate directly from the bank confirming that it holds the title deeds on behalf of the company
When title deeds are held by a lender as security, the auditor should obtain a confirmation directly from the bank that it holds the deeds, and examine the deeds where possible. The auditor should also check whether the property stands in the company's name and whether the charge is disclosed. Internal copies or registers are less reliable.
Question 5
Ekam Packaging Ltd. bought a machine on 1 October for Rs. 48 lakh. Its estimated residual value is Rs. 3 lakh and useful life 9 years. The company uses the straight-line method and charged Rs. 5 lakh as depreciation for the year ending 31 March. What should the depreciation for the year be?
- A) Rs. 5.33 lakh
- B) Rs. 2.5 lakh
- C) Rs. 5 lakh
- D) Rs. 2.67 lakh
Show answer & explanation
Answer: B) Rs. 2.5 lakh
Annual depreciation = (Rs. 48 lakh - Rs. 3 lakh) / 9 = Rs. 5 lakh. The machine was used for 6 months (October to March), so depreciation = Rs. 5 lakh x 6/12 = Rs. 2.5 lakh. The company has overstated depreciation by Rs. 2.5 lakh. Rs. 2.67 lakh ignores residual value (48/9 x 6/12), and Rs. 5.33 lakh ignores both residual value and the time factor.
Question 6
The auditor of Garima Distributors Ltd. examines cash received from customers in the six weeks after the year-end and matches it to year-end receivable balances. This procedure provides evidence mainly about:
- A) Existence and valuation (recoverability) of trade receivables
- B) Classification of share capital
- C) Occurrence of purchases
- D) Completeness of trade payables
Show answer & explanation
Answer: A) Existence and valuation (recoverability) of trade receivables
Subsequent receipts against year-end balances show that the debts existed and were recoverable, supporting existence and valuation. Balances that remain unpaid long after the year-end may need an allowance for expected credit losses. The procedure says nothing about payables, purchases or share capital.
Question 7
Ritam Chemicals Ltd. holds 1,000 units of a product at a cost of Rs. 600 per unit. The expected selling price is Rs. 650 per unit and estimated costs necessary to make the sale are Rs. 80 per unit. At what amount should this inventory be carried?
- A) Rs. 6,50,000
- B) Rs. 5,70,000
- C) Rs. 5,20,000
- D) Rs. 6,00,000
Show answer & explanation
Answer: B) Rs. 5,70,000
Net realisable value = Rs. 650 - Rs. 80 = Rs. 570 per unit. Inventory is valued at the lower of cost (Rs. 600) and NRV (Rs. 570), so Rs. 570 x 1,000 = Rs. 5,70,000. A write-down of Rs. 30,000 is required. Rs. 6,00,000 is cost, Rs. 6,50,000 is selling price, and Rs. 5,20,000 wrongly deducts costs to sell from cost.
Question 8
In verifying cash in hand of Uday Hotels Ltd. at several counters, which of the following is NOT good audit practice?
- A) Counting cash at all locations simultaneously, or sealing cash not counted immediately
- B) Allowing each cashier to count the cash in the auditor's absence and later obtaining a signed certificate of the amount
- C) Carrying out surprise counts in addition to the count at the year-end
- D) Conducting counts in the presence of the cashier and obtaining the cashier's signature on the count sheet
Show answer & explanation
Answer: B) Allowing each cashier to count the cash in the auditor's absence and later obtaining a signed certificate of the amount
The auditor should personally count or observe the count, in the cashier's presence, with simultaneous counts or sealing to prevent shifting of cash between locations, and should consider surprise counts. Relying on a cashier's certificate prepared without the auditor's observation provides weak evidence and defeats the purpose of physical verification.
Question 9
At year-end, Tejas Builders Ltd. recorded cheques of Rs. 60 lakh as issued to suppliers, reducing both the bank balance and trade payables. The auditor finds the cheques were actually handed over to suppliers only in the third week of the next month. The appropriate audit view is that:
- A) The amount should be shown as a contingent liability in the notes
- B) Only the bank balance should be increased by Rs. 60 lakh, with no change in payables
- C) The cheques were not issued at the year-end; the payments should be reversed, increasing both the bank balance and trade payables by Rs. 60 lakh
- D) The entries are correct because the cheques were written before the year-end
Show answer & explanation
Answer: C) The cheques were not issued at the year-end; the payments should be reversed, increasing both the bank balance and trade payables by Rs. 60 lakh
A payment by cheque occurs when the cheque is delivered to the payee. Writing cheques but holding them back is a form of window dressing that reduces reported liabilities and improves ratios. The entries should be reversed so that both cash at bank and trade payables increase by Rs. 60 lakh; the auditor should also consider the implications for management integrity.
Question 10
Saakshi Steels Ltd. has breached a covenant in its long-term loan agreement on or before the year-end, making the loan repayable on demand, and has not obtained a waiver by the year-end. This primarily affects which aspect of the borrowing that the auditor must verify?
- A) Occurrence of interest expense
- B) Completeness of share capital
- C) Classification of the loan as a current liability
- D) Existence of the lender
Show answer & explanation
Answer: C) Classification of the loan as a current liability
Where a covenant breach on or before the reporting date makes a long-term liability payable on demand and no waiver exists at the reporting date, the liability is generally required to be classified as current. The auditor should review loan agreements, compliance with covenants and lender confirmations to ensure correct classification and disclosure.
Question 11
The auditor of Nandan Security Services Ltd. suspects that the payroll includes 'ghost' employees. Which procedure is most effective in addressing this risk?
- A) Comparing the payroll with personnel records and attendance, and checking for duplicate bank account numbers of employees
- B) Comparing total salary cost with the previous year
- C) Checking that salary is debited to the correct expense account
- D) Recomputing the total of the payroll register
Show answer & explanation
Answer: A) Comparing the payroll with personnel records and attendance, and checking for duplicate bank account numbers of employees
Ghost employees are fictitious names on the payroll. Matching payroll to independent HR records and attendance, and looking for several employees paid into the same bank account, directly addresses this risk. Casting the register, overall comparisons and posting checks would not identify fictitious individuals.
Question 12
Which procedure is most effective in identifying unrecorded contingent liabilities of Arjun Logistics Ltd.?
- A) Reviewing minutes of board meetings, correspondence with lawyers and legal expense ledgers, and sending letters of inquiry to the company's external legal counsel
- B) Vouching recorded provisions to supporting calculations
- C) Obtaining confirmations from trade receivables
- D) Recomputing the balance of the provisions account
Show answer & explanation
Answer: A) Reviewing minutes of board meetings, correspondence with lawyers and legal expense ledgers, and sending letters of inquiry to the company's external legal counsel
Contingent liabilities, by their nature, are often not recorded, so the auditor must look for evidence of them in sources such as minutes, legal correspondence, legal fees and letters to external counsel (SA 501). Vouching or recomputing recorded provisions tests existence or accuracy of recorded items, not completeness of unrecorded ones.