Chapter 1

Accounting Fundamentals and Financial Reporting

Lok Sewa Aayog (Public Service Commission) past exam questions

Past questions and answers

2 questions set from this chapter. Most repeated first.

2082 · 1st · 10 marks

Define internal audit and explain how it differs from external audit. Explain the scope of internal audit. 2+3+5=10

Answer

Internal Audit: Definition, Difference from External Audit, and Scope

1. Definition of Internal Audit (2 marks)

Internal audit is an independent, objective assurance and consulting activity conducted within an organisation to examine and evaluate its accounting, financial and operational activities. It is carried out by employees or a separate internal audit department appointed by the management, and it continuously reviews the effectiveness of internal control, risk management and governance so as to help the organisation achieve its objectives.

According to the Institute of Internal Auditors (IIA), "Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organisation's operations."

2. Difference between Internal Audit and External Audit (3 marks)

Basis	Internal Audit	External Audit
Appointment	Appointed by the management/board of the organisation.	Appointed by the shareholders/owners or by a statutory authority.
Objective	To evaluate internal control, detect errors and frauds and suggest improvements.	To express an independent opinion on the true and fair view of financial statements.
Scope	Covers the whole organisation — financial, operational, managerial and compliance matters.	Generally limited to the verification of financial statements and books of accounts.
Independence	An employee of the organisation; independent of the department audited but dependent on management.	Fully independent of the organisation; not an employee of the client.
Period	Continuous (conducted throughout the year).	Periodic (usually once a year, after the close of the accounting period).
Reporting	Reports to the management/board.	Reports to the shareholders or the appointing authority.
Qualification	No fixed statutory qualification; accounting/auditing knowledge is required.	Must hold prescribed qualification (e.g., registered auditor, CA) as required by law.
Legal status	Not compulsory by law in most cases; a management requirement.	Compulsory by law (e.g., Companies Act, 2063 in Nepal).
Remuneration	Paid as salary by the organisation.	Paid as audit fee by the client.

3. Scope of Internal Audit (5 marks)

The scope of internal audit is very wide. It is not limited to financial matters but extends to the entire system of the organisation. The main areas covered are:

(a) Accounting and financial audit: Verification of books of accounts, vouchers, ledgers, bank reconciliation, cash and bank balances, debtors and creditors, and checking whether the financial statements are prepared as per the applicable accounting standards and legal provisions.

(b) Internal control review: Examination of the adequacy and effectiveness of internal control systems — segregation of duties, authorization procedures, physical safeguards and accounting controls — and reporting weaknesses with recommendations.

(c) Compliance audit: Checking whether the organisation complies with the applicable laws, rules, regulations, bylaws, contracts and management policies (e.g., income tax, VAT, labour laws, company law).

(d) Operational/performance audit: Review of the economy, efficiency and effectiveness of operations — purchase, production, sales, inventory, manpower and use of resources — to identify waste, inefficiency and scope for cost reduction.

(e) Risk management and governance: Identification and assessment of risks faced by the organisation and evaluation of the adequacy of risk mitigation measures and the governance structure.

(f) Fraud and irregularity investigation: Detection and investigation of errors, frauds, misappropriations, embezzlement and misuse of authority, and recommending action against those responsible.

(g) Safeguarding of assets: Physical verification of assets such as cash, stock, fixed assets and investments to ensure that assets exist, are properly recorded and are protected from loss or misuse.

(h) Management advisory service: Providing advice to management on improvement of systems, procedures, cost control and decision-making, thereby adding value to the organisation.

(i) Special audit: Conducting special investigations or reviews as directed by the management or the board on specific matters.

Conclusion: In short, internal audit is a continuous, management-appointed review activity covering the whole range of financial and non-financial operations of an organisation. It differs from external audit in appointment, objective, scope, independence and reporting, and its scope extends from verification of accounts to evaluation of internal control, compliance, operational efficiency, risk management and fraud investigation.

Answer checked by Claude Haiku · Oct 21, 2026

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2082 · 1st · 10 marks

Why is bank reconciliation statement prepared? Give reasons for disagreement between cash book and pass book. 4+6=10

Answer

Bank Reconciliation Statement — Purpose and Causes of Disagreement

1. Reasons for preparing a Bank Reconciliation Statement (4 marks)

A bank reconciliation statement (BRS) is a statement prepared on a particular date to reconcile the difference between the balance shown by the cash book (bank column) and the balance shown by the bank pass book (bank statement). It is prepared for the following reasons:

To identify the causes of difference: It traces out the exact reasons why the two balances do not agree, such as cheques issued but not presented, cheques deposited but not collected, bank charges, interest allowed, etc.
To verify the accuracy of both records: It checks whether the entries made in the cash book and those made by the bank are correct and complete. Errors committed by either the firm or the bank are detected through it.
To ascertain the true bank balance: It determines the correct balance of cash at bank as on a particular date, which is needed for preparing the trial balance and final accounts.
To prevent and detect frauds: Regular reconciliation helps detect unauthorized withdrawals, wrong credits, or manipulation by employees handling cash and bank transactions.
To ensure timely correction of errors: Once the discrepancies are located, necessary adjustments (entries) can be passed in the cash book or the matter can be taken up with the bank.
To maintain effective control over cash resources: It enables management to know the actual position of funds available and to plan payments accordingly.

2. Reasons for disagreement between Cash Book and Pass Book (6 marks)

The cash book is maintained by the business, while the pass book is maintained by the bank. The two balances generally differ due to the following reasons:

(A) Cheques issued but not yet presented for payment When a cheque is issued, it is immediately recorded as a payment in the cash book, but the bank debits the account only when the cheque is presented. Until then, the pass book shows a higher balance than the cash book. Similarly, cheques issued but not presented at all cause a difference.

(B) Cheques deposited/paid into bank but not yet collected or credited When cheques are deposited into the bank, they are recorded as receipts in the cash book at once. But the bank credits the account only after collection. Until collection, the pass book shows a lower balance. Cheques dishonoured also cause a difference, as the bank debits them back.

(C) Amount directly deposited into bank by customers Amounts deposited directly by debtors, tenants, or other parties into the bank account are not known to the business and hence not recorded in the cash book. The pass book shows a higher balance.

(D) Amount directly paid by the bank on standing instructions The bank may make payments such as insurance premium, loan instalments, rent, or subscriptions on the customer's standing instructions. These are recorded only in the pass book and not in the cash book.

(E) Bank charges, commission, and incidental charges The bank deducts charges for its services (cheque book issue, collection charges, etc.) which are recorded only in the pass book. The cash book balance therefore appears higher.

(F) Interest allowed by the bank Interest on the credit balance is credited by the bank directly. It is not entered in the cash book until intimation is received, causing the pass book balance to be higher.

(G) Interest and charges on overdraft When there is an overdraft, the bank charges interest and other expenses, which increase the overdraft in the pass book but are not recorded in the cash book.

(H) Direct payment by the bank (honouring bills/cheques) The bank may honour a bill of exchange or a cheque drawn on the customer's account under instructions. Such payments appear only in the pass book.

(I) Errors committed by the business (in the cash book)

Cheques deposited but not recorded in the cash book.
Cheques issued but recorded twice.
Wrong amount recorded in the cash book.
Omission of bank charges or interest in the cash book.

(J) Errors committed by the bank (in the pass book)

Cheques deposited credited to another account.
Cheques issued debited to another account.
Wrong amount debited or credited.
Omission to credit a cheque deposited or to debit a cheque issued.

(K) Cheques deposited into bank but not recorded in the cash book Sometimes cheques are sent directly to the bank for collection without being entered in the cash book, causing a difference.

(L) Bills discounted with the bank When a bill receivable is discounted with the bank and the bank credits the amount after deducting discount, the cash book may not have recorded it, causing a difference. If the bill is dishonoured, the bank debits the amount, again causing a difference.

Conclusion

Thus, the bank reconciliation statement is a very useful control device. It not only explains the difference between the cash book and pass book balances but also helps in locating errors and frauds, ascertaining the true bank balance, and keeping the bank records up to date.