Accountancy and Auditing Paper II 2026

Q1 (i) Select the best option/answer and fill in the appropriate Box [ ] on the OMR Answer Sheet. (20×1=20)
(ii) Answers given anywhere else, other than OMR Answer Sheet, will not be considered.
1 Management provides detailed explanations for unusually high year-end sales, supported by invoices but not matched by dispatch records. What should the auditor focus on first?
(A) Customer creditworthiness (B) Cutoff testing for revenue (C) Review of sales incentives policy (D) None of these
2 A company uses strong automated controls but bypasses them during system updates, relying solely on manual approvals. The greatest risk arises from:
(A) Unauthorized transactions (B) Data redundancy (C) Excessive documentation (D) None of these
3 A taxpayer depreciates machinery at accelerated rates while claiming repairs as revenue expenses. The tax officer should assess whether:
(A) The business qualifies for minimum tax (B) Expenses result in double deductions (C) Depreciation exceeds threshold limits (D) None of these
4 A trader claims full input tax despite selling a portion of goods at exempt rates. The auditor’s primary adjustment should consider:
(A) No adjustment required (B) Increase in output tax rate (C) Reduction in withholding tax credit (D) Reversal of input tax on exempt supplies
5 A firm’s WACC decreases despite rising interest rates in the economy. This is most likely due to:
(A) Increase in risk-free rate (B) Reduction in business risk premium (C) Higher tax shield from debt (D) None of these
6 Project A has a higher IRR but lower NPV than Project B. The firm should choose B because:
(A) IRR assumes reinvesting cash flows (B) NPV reflects actual value creation (C) IRR ignores discounting (D) None of these
7 A company decentralizes operations but keeps financial decisions centralized. The resulting issue is most likely:
(A) Loss of strategic vision (B) Delayed operational decisions (C) Imbalanced authority-responsibility structure (D) None of these
8 A client’s gross profit margin rises sharply while purchase prices remain unchanged. The most plausible audit concern is:
(A) Capitalization of routine expenses (B) Overstatement of cost of goods sold (C) Overstatement of sales tax refunds (D) Understatement of cost of goods sold
9 A company pays commission to agents but books it as “marketing support.” The primary tax risk is:
(A) Misclassification of final tax (B) Avoidance of withholding liability (C) Incorrect sales tax input claim (D) None of these
10 A portfolio’s beta decreases after diversification, but its standard deviation does not fall significantly. This suggests:
(A) Systematic risk eliminated (B) Market risk increased (C) Unsystematic risk already minimized (D) None of these
11 A multinational transitions to an ERP, but legacy modules still process adjustments during peak periods. Audit logs show inconsistent user IDs creating overrides, some from unusual IP ranges. Which risk dominates?
(A) Weak automated validation (B) Detection risk (C) Fraud risk from unauthorized access (D) None of these
12 A client with declining cash flows capitalizes development costs aggressively while lenders tighten covenants. Best audit response?
(A) Perform sensitivity analysis on assumptions (B) Increase sampling on inventory (C) Recalculate depreciation (D) None of these
13 A consultant spends 160 days in Pakistan but earns foreign income routed through a Pakistani bank. He claims non-resident status. Core issue:
(A) Whether foreign income is Pakistan-source (B) Whether physical presence triggers residency (C) Whether treaties override local rules (D) None of these
14 A textile firm records luxury travel for foreign buyers as “entertainment.” The officer must assess whether:
(A) Section 21 disallows it (B) Depreciation must be recalculated (C) Minimum tax applies instead (D) None of these
15 A manufacturer sells partly to wholesalers and partly to unregistered retailers. CNIC reporting mismatches cause discrepancies. Key concern:
(A) Incorrect apportionment of input tax (B) Ineligible zero-rated claim (C) Excess customs drawback refund (D) None of these
16 A firm with volatile EBIT uses high leverage assuming tax deductibility offsets risk. Falling margins expose fixed interest burdens. Error relates to:
(A) Packing Order Theory (B) Overestimating risk tolerance (C) Misreading MM tax shield (D) None of these
17 A long-term project has low early inflows but a huge terminal value. Management selects a low discount rate to approve it. Flaw:
(A) Ignoring inflation (B) Understating risk-adjusted discount rate (C) Treating cost of capital as payback (D) None of these
18 Payroll testing reveals identical salaries for sequential employee IDs created within days. HR calls them seasonal workers. Auditor should consider:
(A) Labor hour analytics (B) Potential payroll fraud (C) Gratuity confirmation (D) None of these
19 A construction firm subcontracts work involving the supply of material and specialized installation service, treating the entire payment as subject to Final Tax (FTR) under Section 153. The tax officer’s primary task is to assess:
(A) Whether the payment for services must be separated from the payment for supply to apply the correct withholding tax rate and determine the final tax status. (B) Whether the subcontractor is eligible for a tax credit under Section 62. (C) Whether the construction business is eligible for the minimum tax on turnover under Section 113. (D) None of these
20 Management changes costing assumptions mid-year without documentation, affecting product-level margins unevenly. Which assertion is MOST at risk?
(A) Rights & obligations (B) Completeness (C) Both (A) & (B) (D) Accuracy / valuation

ANSWER KEY
1 (B) Cutoff testing for revenue
2 (A) Unauthorized transactions
3 (B) Expenses result in double deductions
4 (D) Reversal of input tax on exempt supplies
5 (C) Higher tax shield from debt
6 (B) NPV reflects actual value creation
7 (C) Imbalanced authority-responsibility structure
8 (D) Understatement of cost of goods sold
9 (B) Avoidance of withholding liability
10 (C) Unsystematic risk already minimized
11 (C) Fraud risk from unauthorized access
12 (A) Perform sensitivity analysis on assumptions
13 (B) Whether physical presence triggers residency
14 (A) Section 21 disallows it
15 (A) Incorrect apportionment of input tax
16 (C) Misreading MM tax shield
17 (B) Understating risk-adjusted discount rate
18 (B) Potential payroll fraud
19 (A) Whether the payment for services must be separated from the payment for supply to apply the correct withholding tax rate and determine the final tax status.
20 (D) Accuracy / valuation

Q No. 2 Explain how the concept of true and fair view guides an auditor when management adopts accounting estimates that are technically permissible under IFRS but appear overly optimistic in light of industry conditions. Support your answer with examples and references to International Federation of Accountants (IFAC) guidelines. (20)

Q No. 3 “Audit risk is not merely a computation; it is a judgment.”
Discuss this statement in the context of inherent risk, control risk, and detection risk, with particular reference to computerized (EDP) environments. (20)

Q No. 4 Provide a critical distinction between the following audit concepts:
(a) Reasonable assurance and absolute assurance
(b) Tests of control and substantive procedures
(c) Misstatement and material misstatement
(d) Management’s responsibility and auditor’s responsibility under the Companies Ordinance, 1984 (20)

Q No. 5 Ms. Sana, an individual taxpayer, has provided the following data for the Tax Year 2024. Analyze her income components and determine her net tax position under the Income Tax Ordinance, 2001.