EPFO APFC 2023 General Studies · Question 108 of 120

Correct — B, (b) Preparation of books of accounts. The ask is negative — the word 'not' is printed in bold italics in the stem — so three of the four options describe things an audit does and only one describes something it does not. Preparing the books is the one, and the reason is the oldest principle in the subject: an audit is an independent examination of financial information with a view to expressing an opinion on it, and the person who prepares a record cannot independently examine it. Accounting and auditing are two separate functions performed by two separate people. Accounting is the recording, classifying and summarising of transactions and the drawing up of financial statements from them; it is the responsibility of the management of the entity. Auditing begins where accounting ends — the auditor takes the completed records as given, tests them, and reports. If the auditor also wrote the entries, the audit would consist of one person checking their own work, which is what the profession calls a self-review threat and what the law simply forbids. In India the prohibition is statutory and specific. Section 144 of the Companies Act, 2013 lists services an auditor of a company shall not render to that company, to its holding company or to its subsidiary, and the first of them is accounting and book-keeping services; internal audit, design and implementation of financial information systems, actuarial services, investment advisory and investment banking services, outsourced financial services and management services are on the same list. The premise runs through the auditing standards as well: the responsibility of management for the preparation of the financial statements, and for the internal control necessary to make them free from material misstatement, is a precondition of accepting an audit engagement, and the auditor's report expressly distinguishes management's responsibility from the auditor's own. There is a practical point behind the doctrine. The value of an audit to a shareholder, a lender, a tax authority or a provident fund inspector lies entirely in the auditor's independence from the figures. Remove that and the report certifies nothing that the management's own assertion did not already certify. Nothing about an audit changes if the books are badly kept, either: the auditor may then report a qualification or a disclaimer, but the remedy is never for the auditor to write the books up.

• (a)Examination of the system of accounting and internal control — Examining the system of accounting and of internal control is a core audit activity, not something outside the audit. Before testing individual transactions the auditor has to understand how the entity captures and processes them and what controls are supposed to prevent or detect error and fraud, because that understanding determines what can be relied on and what must be tested substantively. The auditing standards require it: the auditor identifies and assesses the risks of material misstatement by obtaining an understanding of the entity and its environment, including its internal control, and designs further audit procedures in response to the risks so assessed. Where controls are strong and are tested and found to work, the extent of substantive testing can be reduced; where they are weak, it must be increased. Note the distinction the option preserves and which makes it correct: the auditor examines and evaluates the system of internal control, but does not design or install it, since designing a financial information system is one of the services section 144 of the Companies Act, 2013 forbids an auditor to render.
• (c)Reporting to the appropriate person/body — Reporting to the appropriate person or body is not merely covered by the audit — it is the audit's entire output and the reason the exercise is commissioned. An audit that examined everything and reported to no one would have no purpose. The report is addressed to whoever appointed the auditor or for whose benefit the audit is conducted: in a company the statutory auditor reports to the members, and the report states whether the financial statements give a true and fair view of the state of affairs and of the profit or loss, whether proper books of account have been kept, and whether the accounts agree with those books. The auditor may also communicate matters to those charged with governance separately, and in specified cases must report suspected fraud to the Central Government. Because the report is the deliverable, its form, its addressee and the circumstances requiring a qualified opinion, an adverse opinion or a disclaimer of opinion are examined at least as often as the field work that precedes it.
• (d)Verification of the authenticity and validity of transactions — Verifying the authenticity and validity of transactions is the substance of audit field work. 'Vouching' is the examination of documentary evidence supporting a transaction recorded in the books — the invoice behind a purchase, the receipt behind a payment, the authorisation behind an unusual item — and it tests whether the entry is genuine, whether it relates to the entity, whether it falls in the right period and whether it was properly authorised. 'Verification' extends the same idea to the existence, ownership, valuation and presentation of assets and liabilities at the balance sheet date. Together they are what most people picture when they picture an audit, and no definition of audit excludes them. The contrast with the keyed option is the one to carry away: the auditor examines the evidence for an entry that somebody else has made, and the moment the auditor makes the entry instead, there is no independent evidence left to examine.

An audit is an independent examination of the financial information of an entity, whether profit oriented or not and irrespective of its size or legal form, carried out with a view to expressing an opinion on that information. Four ideas are packed into that definition and each is examinable. It is independent, so the auditor must be free of any interest that would compromise objectivity, which is why the law disqualifies certain persons from appointment and forbids certain services. It is an examination, so it works on evidence and not on assertion. Its subject is financial information prepared by somebody else, which is why the responsibility for preparing the financial statements rests with management and never with the auditor. And it results in an opinion, not a guarantee — the auditor expresses reasonable assurance that the statements are free from material misstatement, which is a high level of assurance but not an absolute one, because of the inherent limitations of audit: the use of testing rather than complete checking, the possibility of collusion, the judgement involved in accounting estimates and the fact that most audit evidence is persuasive rather than conclusive. The scope of an audit therefore covers understanding the entity and its internal control, assessing the risks of material misstatement, designing and performing procedures in response to those risks — tests of controls, vouching, verification, analytical procedures, external confirmations, physical inspection — evaluating the results, forming an opinion and reporting it. It does not cover writing the books, designing the accounting system, taking management decisions, or guaranteeing that no fraud exists.

This is one of seventeen stems in this booklet whose ask is negative, and on every one of them the word 'not' is set in bold italics — the Commission's own way of warning the candidate that three options will look right because they are right. Where a negative ask is signalled that plainly, the reliable method is to read the four options as four separate true-or-false statements about audit and mark each one before choosing, rather than searching for the option that feels wrong. The subject matter is directly relevant to the post. An Assistant Provident Fund Commissioner inspects employers' records to establish liability for contributions, damages and interest, relies on audited accounts as evidence, and must know precisely what an audit opinion does and does not certify — that it addresses material misstatement rather than every error, that it rests on management's own preparation of the statements, and that an unqualified report is not a warranty against fraud. The accountancy, auditing and insurance block runs through this paper in three stretches, and the auditing items in it stay close to first principles rather than to detailed procedure: what audit is, what sets its scope, who is responsible for what, and what the report says. Learn the definition of audit clause by clause and a large share of those questions answer themselves, because each clause of the definition excludes something that an option set will offer.

• Accounting and auditing are distinct functions. Accounting records, classifies and summarises transactions and produces the financial statements, and is the responsibility of the entity's management. Auditing begins where accounting ends: the auditor independently examines those completed records and expresses an opinion on them, and can no more prepare them than a judge can draft the plaint.
• Section 144 of the Companies Act, 2013 forbids the auditor of a company to render to it, its holding company or its subsidiary a list of services that begins with accounting and book-keeping services and includes internal audit, design and implementation of financial information systems, actuarial services, investment advisory and investment banking services, outsourced financial services and management services.
• The scope of an audit covers understanding the entity and its internal control, assessing the risks of material misstatement, performing tests of controls and substantive procedures including vouching and verification, evaluating the evidence obtained, forming an opinion and reporting it to the appropriate person or body. All three non-keyed options here name one of those activities.
• The auditor examines and evaluates the internal control system but does not design or install it, and expresses reasonable rather than absolute assurance. The inherent limitations of an audit — testing rather than complete checking, the possibility of collusion, judgement in estimates and the persuasive rather than conclusive nature of most evidence — are why the opinion is not a guarantee.
• The statutory auditor of a company reports to the members, stating whether the financial statements give a true and fair view, whether proper books of account as required by law have been kept and whether the accounts agree with the books. The opinion may be unmodified, qualified or adverse, or the auditor may disclaim an opinion where sufficient appropriate evidence cannot be obtained.

• Missing the negative ask. Three of the four options are true statements about audit, so a candidate reading quickly finds an option that is plainly correct and stops. The bold italic 'not' in the stem is the Commission's warning that the correct answer is the false statement.
• Confusing examining internal control with designing it. The auditor must understand and evaluate the system of accounting and internal control, but designing or implementing a financial information system for the audited entity is among the services section 144 of the Companies Act, 2013 prohibits.
• Assuming that because small firms often have the same professional write up the books and audit them, book-keeping is part of audit. It is not; where the same firm does both for a company the statutory prohibition is breached, and the practice survives only outside the company audit framework.
• Believing an audit certifies that the accounts are free of all error or fraud. It expresses reasonable assurance about material misstatement, which is why the report is an opinion and why the inherent limitations of audit are part of the definition rather than an excuse added to it.

Auditing questions in EPFO papers stay at the level of principle and definition, and three shapes recur. The first, used here, lists four activities and asks which is or is not within the scope of audit, testing the boundary between the accountant's function and the auditor's. The second asks who is responsible for what — for preparing the financial statements, for internal control, for detecting fraud, for reporting — where the answer is usually management for the first two and the auditor only for the last. The third names a document or a step and asks what governs it, which is where the engagement letter, the overall audit strategy, the audit plan and the audit programme are distinguished. All three reward learning the standard definition of audit and the standard division of responsibilities rather than procedural detail, and all three are made harder by negative phrasing, so the habit of marking each option true or false before selecting is worth more than speed.

No directly related past PYQ was found.

• practice — not a real PYQ

  Which one of the following services is an auditor of a company prohibited from rendering to that company under section 144 of the Companies Act, 2013?

  • (a)Reporting to the members on the financial statements
  • (b)Internal audit
  • (c)Examining the entity's system of internal control
  • (d)Attending the annual general meeting of the company

  Answer(b) Internal audit — section 144 lists the services an auditor shall not render to the company, its holding company or its subsidiary, and internal audit appears on that list alongside accounting and book-keeping services, design and implementation of financial information systems, actuarial services, investment advisory and investment banking services, outsourced financial services and management services. The other three options are ordinary parts of a statutory auditor's role.

• practice — not a real PYQ

  Which one of the following statements correctly describes the relationship between accounting and auditing?

  • (a)Accounting begins where auditing ends
  • (b)Auditing begins where accounting ends
  • (c)Accounting and auditing are two names for the same process
  • (d)Auditing is the recording of transactions and accounting is their verification

  Answer(b) Auditing begins where accounting ends — accounting records, classifies and summarises transactions and produces the financial statements, a task belonging to the entity's management; the auditor then independently examines those completed records and expresses an opinion on them. The last option reverses the two functions, and the first reverses the sequence, which are the two ways this distinction is usually tested.