PART A

“GENERAL
CONCEPTS AND
PRINCIPLES OF
AUDIT”
(WEIGHTAGE: 15 – 20 MARKS)

Significant Topics of the Grid
1. Basic Concepts
2. Compliance with Legal
Requirements
3. Fraud Consideration
Reference in ICAP’s Study Text (2018 Edition)
 Level of Assurance (Page # 6)
 Inherent Limitations of Audit (Page # 17)
 Management Responsibility (Page # 5)
 Auditor’s Responsibility (Page # 15)
 Expectation Gap (Page # 255)
 Professional Skepticism (Page # 33)
 Professional Judgment (Page # 16)
 Preconditions for audit (Page # 25)
 Engagement Letter (Page # 26)
Page # 8
Page # 50

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 LO 1.3.2: DESCRIBE OVERALL OBJECTIVES OF THE INDEPENDENT AUDITOR.
LO 1.3.3: DESCRIBE CONCEPTS OF ASSURANCE AND LEVELS OF ASSURANCE…..
LO 1.3.8 DISCUSS THE CONCEPT OF PROFESSIONAL SKEPTICISM.
LO 1.4.1: UNDERSTAND THE RESPONSIBILITY OF MANAGEMENT…..
LO 1.7.1 & 1.7.2 : …. PRECONDITIONS ….

KEY POINTS TO REVISE:

You must be familiar with the following basic concepts:
 Levels of Assurance (Absolute, Reasonable, Limited).
 Inherent Limitations of Audit
 Management Responsibility
 Auditor’s Responsibility
 Expectation Gap.
 Professional Skepticism.
 Preconditions for Audit
o What are preconditions.
o How auditor ensures preconditions are present.
o What if preconditions are not present.
 Contents of Engagement Letter
 Change in terms of engagement letter.
o Circumstances
o Factors to consider
o Course of Action

MODEL QUESTIONS FROM PAST PAPERS FOR REVISION:

FIRST EXAMPLE
In response to an audit engagement letter sent to Roof Limited (RL), Mr. Aziz Aslam, the new chief executive of
RL has requested your firm to provide absolute assurance in the audit report.
Required:
Draft an appropriate reply mentioning any four reasons why the above request cannot be complied with. (05)
(ICAP, CAF 09 Level – Autumn 2017)
(ICAP’s Official Question Bank for CAF 09 – Q. # 53)

SECOND EXAMPLE
Briefly explain with examples, the different levels of assurance that can be provided to an assurance client. (03)
(ICAP, CAF 09 Level – Autumn 2015)
(ICAP’s Official Question Bank for CAF 09 – Q. # 133g)

THIRD EXAMPLE
Briefly highlight the management’s responsibilities relating to the financial statements? (04)
(ICAP, CAF 09 Level – Autumn 2009)
(ICAP’s Official Question Bank for CAF 09 – Q. # 4a)

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 FOURTH EXAMPLE
(a) Explain the term ‘Expectation Gap’ in the context of an audit and give three examples of expectation gap. (04)
(ICAP, CAF 09 Level – Autumn 2015)
(ICAP’s Official Question Bank for CAF 09 – Q. # 133a)

(b) Briefly discuss the concept of ‘Professional skepticism’. (03)

(ICAP, CAF 09 Level – Spring 2016)
(ICAP’s Official Question Bank for CAF 09 – Q. # 109e)

FIFTH EXAMPLE
Strawberry Pakistan Limited (SPL) was incorporated on March 1, 2011. The directors of SPL are in the process
of appointing the first statutory auditor of the company. They have requested your firm to submit a proposal for
the statutory audit assignment. A partner of your firm has asked you to draft the proposal after assessing
whether the preconditions for the audit exist.
Required:
(a) Briefly discuss the term ‘preconditions for an audit’. (02)
(b) What are the steps that you would perform in order to ensure that preconditions for the audit exist? (05)
(c) Discuss whether your firm may or may not accept the assignment if one of the preconditions for the audit is
not present. (08)
(ICAP, CAF 09 Level – Spring 2011)
(ICAP’s Official Question Bank for CAF 09 – Q. # 39)

SIXTH EXAMPLE
List the important matters that are required to be included in an audit engagement letter. (06)
(ICAP, CAF 09 Level – Autumn 2012)
(ICAP’s Official Question Bank for CAF 09 – Q. # 44a)

SEVENTH EXAMPLE
An auditor may agree to a change in the terms of engagement provided there is a reasonable justification for
doing so.
Required:
(a) List the circumstances in which the management may request the auditor to change the terms of an audit
engagement.
(b) What factors should be considered by the auditor before accepting a change in the terms of the engagement?
(c) List the steps that the auditor should consider, if he is unable to agree to a change in the terms of
engagement. (09)
(ICAP, CAF 09 Level – Spring 2012)
(ICAP’s Official Question Bank for CAF 09 – Q. # 43)

(The End of Topic 1)

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 LO1.6.1: …HOW THE FIRST AND SUBSEQUENT AUDITORS ARE APPOINTED
LO1.6.2: … HOW THE FIRST AND SUBSEQUENT AUDITORS ARE REMOVED
LO1.6.3: …QUALIFICATION AND DISQUALIFICATION OF THE AUDITOR

KEY POINTS TO REVISE:

Appointing Authority of Auditor:
Usually, auditor is appointed by Members of the company. However, in exceptional situation
auditor can be appointed by Directors and Commission.

Appointing authority depends on whether it is the case of:

1. Appointment of first auditor.
2. Appointment of subsequent auditor.
3. Appointment in case of casual vacancy.
4. Appointment in case of mid-term removal of auditor.

Procedure for appointment of auditor:

 Recommendation of BOD (with consent of proposed auditor, notice to members and
retiring auditor).
 Recommendation by Member (holding 10% shares, with consent of proposed
auditor and 7 days before AGM).
 Right of representation by retiring auditor.
 Passing resolution at AGM.

Qualification & Disqualification of Statutory Auditor:

Qualification:
Audit of a Public Company, or a Private company which is subsidiary of a public company,
or a private company with paid up capital of Rs. 3 million or more, shall be conducted by a
chartered Accountant.

Audit of other companies can be conducted by a chartered Accountant a cost and

management accountant.
Disqualification Criteria:
Following persons shall not be appointed as auditor in a company:
1. If a partner or his spouse or minor child holds any shares in the audit client or any of
its associated company. However, if such a person holds shares at time of
appointment, he can be appointed if he discloses the fact at time of appointment and
dispose shares within 90 days of appointment.
2. If a partner is indebted to the company.
However following are not considered debt in this regard:
a. sum payable to a credit card issuer upto Rs. 1,000,000.
b. sum payable to a utility company unpaid upto 90 days.
3. If a partner is or was an employee (or officer or director) of the company in last 3
years.
4. If a partner is an employee/partner of an employee (or officer or director) of the
company.
5. If a partner’s Spouse is a director in company.
6. If a person is a Body corporate.

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 7. If a partner has given guarantee or security to company for indebtedness of third
person.
8. If a partner or firm has business relationship with the company (directly or
indirectly).
9. If a partner has been convicted by a Court of an offence involving fraud in last 10
years.
10. A partner who is not eligible for appointment as auditor under Code of Ethics
adopted by ICAP and ICMAP.

If a person is disqualified for a company, he is also disqualified for its holding, subsidiaries, and
holding’s other subsidiaries.

Exam Tips
1. All conditions of disqualification apply at time of appointment as well as during term of appointment.
2. Carefully note which relatives are covered in which case of disqualification.
3. Word “Limited” in the name of an organization shows that it is a Company. Similarly, word “Private”
in the name confirms that it is a private company.
4. Make sure you know and correctly apply nature of relationship between individuals (i.e. spouse, child
and others), and between companies (i.e. holding/subsidiary, associated or others).
5. In law, auditor means only sole-proprietor/partners of audit firm, not other employees.
6. Disqualification criteria applies on all partners. If a partner is disqualified, then whole firm is
disqualified.

TYPE OF QUESTIONS:
Theoretical Question:
A theoretical question may be set requiring you to produce the legal provision relating to
appointment, removal or qualification/disqualification of statutory auditor.

Case Study & its Suggested Approach:

You may be given different short situations and requirement will be to comment on
appointment/qualification/independence of statutory auditor in each situation.

EXAMINATION TECHNIQUES:
Decide whether it is a situation of legal requirements or ethical requirements:
 If words like “Companies Act”, “Legal”, “Statutory” are used, apply legal provisions.
 If words like “Code of Ethics”, “Ethical”, “Threats, Safeguards” are used apply ethical
provisions.

If question relates to legal requirements:

1. There may be THREE issues involved in the case:
a. Whether appointment is made by appropriate authority.
b. Whether qualification criteria is complied.
c. Whether disqualification criteria is complied.
2. If appointment is not appropriate on more than one grounds, you will cover BOTH
grounds one by one.
3. Whatever is the case, do not reproduce provision of law; rather state your decision by
directly applying legal provisions to the facts of case. (this is because usually 2 or 3
marks only are allocated to each case of legal provisions in exam question)

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 COMMON ERRORS/WEAKNESSES IDENTIFIED BY EXAMINER:
1. Most students seemed to adopt a casual approach and did not view the situations
from all angles and therefore arrived at incorrect conclusions.
2. As always, many students gave the verdict without reasoning whereas some
produced the correct opinion but gave incorrect reasons.

MODEL QUESTIONS FROM PAST PAPERS FOR REVISION:

FIRST EXAMPLE
(a) Under the Companies Act, 2017, state the procedure to be followed if the board of directors decides to
recommend the reappointment of existing auditor for the next year. (02)
(b) The board of directors of Alpha Limited intends to re-appoint the existing auditor for the next year. However,
Javed, a shareholder of the company, wants to appoint a different auditor.
Required:
Briefly explain the procedure that Javed should follow. Also state the responsibilities of the board in this regard.
(06)
(ICAP, CAF 09 Level – Spring 2019)

SECOND EXAMPLE
Comment on each of the following situations with reference to the appointment of external auditors in
accordance with the requirements of the Companies Act, 2017:

(a) Farrukh & Co., Chartered Accountants, has received an offer to be appointed as the external auditor of
Ebrahim Gas Company. The firm is indebted to the company as it has not paid the last two months’ bills
amounting to Rs. 4,860.

(b) After seventy days of incorporation, the directors of Rahman Limited (RL) decided to appoint Mr. Shahid as
the company’s statutory auditor. Mr. Shahid was employed by RL before he started his own practice.

(c) The directors of Fazal Limited (FL) have decided to appoint Syed & Company, Chartered Accountants, as
external auditor of the company. One of the partner’s spouse holds 1,000 shares in the subsidiary of FL.

(d) The directors of Najam (Pvt.) Limited having paid-up capital of Rs. 4.5 million have appointed Mr. Dawood to
act as the external auditor of the company. Mr. Dawood has been awarded a diploma in International Financial
Reporting Standards by the Institute of Chartered Accountants of Pakistan and has completed the mandatory
period of training from a leading firm of chartered accountants.

(e) All directors of Hussain Associates (Pvt.) Limited are chartered accountants. The company has recently
received an offer for appointment as the external auditor of Masood (Pvt.) Limited which has a paid-up share
capital of Rs. 1,000,000. (10)
(ICAP, CAF 09 Level – Spring 2010)
(ICAP’s Official Question Bank for CAF 09 – Q. # 25 a-e)

THIRD EXAMPLE
Daud and Company, Chartered Accountants (DC), has received an offer for appointment as auditor of Jamal
Limited (JL). Wife of Daud is a Shareholder and Director in Royal Limited (RL).

Required:
In accordance with the requirements of the Companies Act, 2017, state whether and under what circumstances
DC could accept the audit, under each of the following situations:
(a) JL holds 51% shareholding in RL.
(b) JL is an associated company of RL.
(c) One of the directors in JL also holds 10% shareholding in RL. (02)
(ICAP, CAF 09 Level – Autumn 2016)
(ICAP’s Official Question Bank for CAF 09 – Q. # 32)

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 FOURTH EXAMPLE
Comment on each of the following independent situations in respect of appointment of auditors, with reference
to the applicable rules and regulations:
(a) Guava and Company, Chartered Accountants, have received a request for appointment as auditor of
Orange Bank Limited (OBL). Most of the partners of Guava and Company maintain their accounts with
OBL and are enjoying credit card facilities from them. The maximum outstanding balance on the credit
card facility, due from any partner is Rs. 899,000.
(b) Apricot and Company, Chartered Accountants, have received an offer for appointment as auditor of
Banana Limited. Mr. Pumpkin who is a nominee director of the Government on the Board of Directors of
Banana Limited holds 25% shares in Water Melon Limited. The spouse of a partner also holds shares in
Water Melon Limited.
(c) Mr. Zaheer, a legal practitioner, has received an offer for appointment as external auditor of Lychee
(Private) Limited (LPL). The paid up capital of LPL is Rs. 1,500,000 of which 40% is owned by Blue Black
Limited, a listed company.
(d) Walnut and Company, Chartered Accountants, have received an offer for appointment as external
auditors of Wasim (Private) Limited (WPL), in place of the previous auditors, who were removed before
the completion of their term. You may assume that WPL has completed all the legal formalities before
removing the previous auditors.
(e) Mr. Sadiq has recently joined your firm as a partner. He has served on the Board of Directors of
Strawberry Limited (SL) until 30 June 2009, as a Government nominee. In the Annual General Meeting of
SL held on 31 August 2011, a shareholder has proposed the name of your firm for appointment as the
external auditors for the year ending 30 June 2012. (11)
(ICAP, CAF 09 Level – Autumn 2011)
(ICAP’s Official Question Bank for CAF 09 – Q. # 40)

(The End of Topic 2)

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 LO1.5.4: IDENTIFY THE FRAUD RISK FACTORS IN THE SIMPLE SCENARIO ….
LO1.5.5: IDENTIFY THE CIRCUMSTANCES THAT INDICATE THE POSSIBILITY OF
FRAUD IN THE SIMPLE SCENARIO ….

KEY POINTS TO REVISE:

Distinction between Error and Fraud:
Misstatements in the financial statements can arise from either fraud or error.
 Error: an unintentional misstatement in financial statements.
 Fraud: An intentional act by one or more individuals involving the use of deception
to obtain an unjust or illegal advantage.

Types of Fraud:
There are two types of fraud i.e.
 Misappropriation of Assets (e.g. Embezzling receipts, Stealing assets)
 Fraudulent Financial Reporting. (e.g. Recording fictitious journal entries,
Inappropriately changing estimates, Altering records, Concealing facts)

Auditor’s Responsibility:
1. To perform risk assessment procedures to identify risk of fraud.
2. Respond to risk of fraud.
3. Maintain professional skepticism throughout the audit

TYPE OF QUESTIONS:
Theoretical Question:
Theoretical question may require to describe techniques of misappropriate of assets and
fraudulent financial reporting, risk assessment procedures, fraud risk factors, and response
to risks of fraud including management override of controls.

Case Study:
In exam, you may be given a question (either a long descriptive question or question
divided into different short situations), and you may be required to identify risks of fraud
from given information.

EXAMINATION TECHNIQUES:
Read and understand the following lists given in topic of fraud:
1. “Techniques of management override of control”,
2. “Fraud Risk Factors”, and
3. “Circumstances that indicate possibility of fraud in F/S”.

Search if any of the above risks is mentioned in the question.

COMMON ERRORS/WEAKNESSES IDENTIFIED BY EXAMINER:

It was also noted in a number of instances that even though the students were able to
identify the relevant fraud risk factors, they did not properly explain why there was a risk
or what affect the risk had.

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 For example, some candidates identified the demand by management for early completion
of the audit as a risk; however, they did not explain that there was a risk because
requirement for early completion could limit the ability of the auditor to carry out a
thorough audit and may distract him from his responsibilities.

MODEL QUESTIONS FROM PAST PAPERS FOR REVISION:

FIRST EXAMPLE
You are the Audit Manager on the audit of Al-Salam Pakistan Limited (ASPL) for the year ended June 30, 2010.
ASPL is engaged in the manufacture of a wide range of plastic products. While reviewing the initial work
performed by the audit team, the following matters have come to your notice:

(i) The quantity of material scrapped during the year is materially different from the quantity of scrap sold. The
company’s records show nil balance both at the beginning and at the close of the year. No reconciliation for the
difference has been provided by the company.

(ii) Sales for the year have increased by 7% over the previous year. However, it has been noted that sales in the
last two weeks of June 2010 have been exceptionally high and represent 15% of the annual sales.
The audit working papers carry the following observations in respect of the above:
 70% of the sales in the last two weeks of June were made to two new customers whose credit
assessment has not been formally documented;
 a significant portion of the goods sold to the above referred customers were returned in the first week
of July 2010; and
 management bonuses are linked to the operating performance of the company.

(iii) During the year, ASPL purchased a machine for Rs. 25 million. The payment voucher is duly supported by
the invoice from the supplier. However, the fixed assets schedule provided by the client shows the amount
capitalized as Rs. 2.5 million. Depreciation has been charged on this amount. The difference of Rs. 22.5 million is
appearing in the Bank Reconciliation Statement.

Required:
Analyze each of the above situations and assess whether it represents a fraud or an error. (06)
(ICAP, CAF 09 Level – Autumn 2010)
(ICAP’s Official Question Bank for CAF 09 – Q. # 26a)

SECOND EXAMPLE
Green Limited (GL) is a listed company engaged in the manufacturing of garments and apparels. During the audit
planning meeting for the year ending 31 March 2018, the Chief Financial Officer of GL has provided the following
information:

(i) GL was previously exporting all its production under the brand name of ‘Wearables’. However, it has been
facing the issue of decline in export orders and therefore has decided to start focusing on the local market.
Accordingly, it has made an agreement with BL, according to which GL’s products would be sold to BL who
would market them through BL’s retail outlets spread throughout Pakistan. A director of GL holds major
shareholding in BL.

(ii) Two of the directors of GL holding 16% and 13% shares in GL have informed the Board that they intend to
sell their entire shareholding in GL in order to concentrate on some of their other businesses.

(iii) While discussing some of the internal control deficiencies in the payroll processing department, which were
raised in the previous year’s management letter, the CFO has informed that the matter has been referred to the
internal audit department but is pending because of the illness of the Chief Internal Auditor.

Required:
(a) Identify fraud risk factors in the above scenario. (04)
(b) Describe what actions an auditor should take on identifying a fraud risk factor. (05)
(ICAP, CAF 09 Level – Spring 2018)
(ICAP’s Official Question Bank for CAF 09 – Q. # 57)
(The End of Topic 3)