Advanced Auditing and Professional Ethics - Srinivasa Academy

Final Course (Revised Scheme of Education and Training)

Study Material (Modules 1 to 3)

PAPER 3

Advanced Auditing and Professional Ethics

MODULE – 1

BOARD OF STUDIES THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

© The Institute of Chartered Accountants of India

ii This study material has been prepared by the faculty of the Board of Studies. The objective of the study material is to provide teaching material to the students to enable them to obtain knowledge in the subject. In case students need any clarifications or have any suggestions for further improvement of the material contained herein, they may write to the Director of Studies. All care has been taken to provide interpretations and discussions in a manner useful for the students. However, the study material has not been specifically discussed by the Council of the Institute or any of its Committees and the views expressed herein may not be taken to necessarily represent the views of the Council or any of its Committees. Permission of the Institute is essential for reproduction of any portion of this material.


All rights reserved. No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form, or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior permission, in writing, from the publisher. Edition : August, 2019

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iii

BEFORE WE BEGIN …

Evolving Role of a CA. - Shift Towards Strategic Decision Making

The traditional role of a chartered accountant restricted to accounting and auditing, has now changed substantially and there has been a marked shift towards strategic decision making and entrepreneurial roles that add value beyond traditional financial reporting. The primary factors responsible for the change are the increasing business complexities on account of plethora of laws, borderless economies consequent to giant leap in e-commerce, emergence of new financial instruments, emphasis on corporate social responsibility, significant developments in information technology, to name a few. These factors necessitate an increase in the competence of chartered accountants to take up the role of not merely an accountant or auditor, but a global solution provider. Towards this end, the scheme of education and training is being continuously reviewed so that it is in sync with the requisites of the dynamic global business environment; the competence requirements are being continuously reviewed to enable aspiring chartered accountants to acquire the requisite professional competence to take on new roles.

Skill Requirements at Final Level

Under the Revised Scheme of Education and Training, at the Final Level, you are expected to not only acquire professional knowledge but also the ability to apply such knowledge in problem solving. The process of learning should also help you inculcate the requisite professional skills, i.e., the intellectual skills and communication skills, necessary for achieving the desired professional competence.

Auditing – Core and Practical Subject

Auditing has been conceived of to provide a highly useful technical service to the economy to know performances in financial and other appropriate terms in a reliable manner. It is needless to say that multitudes of significant decisions in the economic society are taken based on the financial information and, therefore, ensuring reliability of such information is an imperative necessity. Audit is a subject that requires a lot of quick and logical application of mind to answer practical problems. It is one of the most practical-oriented subjects in the C.A. curriculum. This paper aims to provide knowledge of generally accepted auditing procedures and of techniques and skills needed to apply them in audit engagements. A good knowledge of the subject would provide a strong foundation to students while pursuing the Chartered Accountancy course. A good understanding of the theoretical concepts, particularly, in the context of auditing standards would make practical training an enriching and enjoying experience. While studying this paper, students are advised to integrate the knowledge acquired in other subjects in a meaningful manner along with practical training. Such learning would only help a student to become a better professional.


iv

Know your syllabus and Study Material

The Study Material of Advanced Auditing and Professional Ethics subject has been designed having regard to the needs of home study and distance learning students. The study material deals with the conceptual theoretical framework in detail. In each chapter, the topic has been covered in a step by step approach. The text has been explained, where appropriate, through illustrations, diagrams, tables, flowcharts, screenshots etc. You should go through the chapter carefully ensuring that you understand the topic and then test your knowledge by attempting question.

The Study Material has been divided into eighteen chapters in line with the syllabus and further bifurcated into three modules for the easy handling and convenience of students. For bare text of Guidance Notes and Auditing Standards, the students are advised to refer the “Auditing Pronouncements” which has been separately published by the Board of Studies. For understanding the coverage of the syllabus, it is important to read the study material along with the Study Guidelines.

Framework of Chapters – Uniform Structure Comprising of Specific Components

Efforts have been made to present each topic of the syllabus in a lucid manner. Care has been taken to present the chapters in a logical sequence to facilitate easy understanding by the students.

Structure of the Study Material

The content for each chapter/unit at the Final level has been structured in the following manner –

S. No.

Components of Each Chapter

About the Component

1. Learning Outcomes Learning outcomes which you need to demonstrate after learning each topic have been detailed in the first page of each chapter/unit. Demonstration of these learning outcomes would help you to achieve the desired level of technical competence.

2. Chapter Overview As the name suggests, this chart/table would give a broad outline of the contents covered in the chapter.

3. Introduction A brief introduction is given at the beginning of each chapter/unit which would help you get a feel of the topic.

4. Content The concepts and provisions of law/standard are explained in student-friendly manner with the aid of Examples/illustrations/diagrams/flow charts. These value additions would help you develop conceptual clarity and get a


v

good grasp of the topic. Diagrams and Flow charts would help you understand the concept/provision in a better manner. Illustrations would help you understand the application of concepts/provisions.

5. Exercise Questions with Answers and MCQs / Test Your Knowledge

Exercising questions and answers alongwith MCQs would help you to apply what you have learnt in problem solving. In effect, it would sharpen your application skills and test your understanding as well as your application of concepts/provisions.

Attention is invited to the Significant Additions/Modifications made in this edition of the Study Material which are given on the next page.

We hope that these student-friendly features in the Study Material makes your learning process more enjoyable, enriches your knowledge and sharpens your application skills.

Happy Reading and Best Wishes!


vi

SIGNIFICANT ADDITIONS/ MODIFICATIONSIN THE REVISED EDITION

Students are advised to refer Multiple Choice Questions (MCQs) inserted at the end of each of the Chapters after Theoretical Questions under heading Test Your Knowledge.

Chapter No.

Chapter Name Section / Sub-Section wherein Additions / Modifications have been done

Page Number

5 Company Audit

Insertion of Example on Section 139(2) Rotation of Auditors

5.15

Insertion of Tabular Presentation explaining Manner and Procedure of Selection and Appointment of Auditors 5.20, 5.21

12 Cost Audit 5.42

14.1 Financial Statements 5.44

14.4 Constitution of National Financial Reporting Authority

5.47


vii

SYLLABUS

PAPER – 3 : ADVANCED AUDITING AND PROFESSIONAL ETHICS

(One paper – Three hours – 100 marks)

Objective:

(a) To acquire the ability to analyse current auditing practices and procedures and apply themin auditing engagements;

(b) To acquire the ability to solve cases relating to audit engagements.

Contents:

1. Auditing Standards, Statements and Guidance Notes: Engagement & Quality ControlStandards, Statements and Guidance Notes on Auditing issued by the ICAI; Elements of System ofQuality Control, Leadership Responsibilities for Quality within the Firm, Acceptance andContinuance of Clients Relationships and Specific Engagements, Engagement Performances, etc.(SQC 1 Quality Control for Firms that Perform Audits and Reviews of Historical FinancialInformation and Other Assurance and Related Services Engagements).

2. Audit Planning, Strategy and Execution: Planning the Flow of Audit Work; Audit Strategy,Audit Plan, Audit Programme and Importance of Supervision; Principal’s Ultimate Responsibility;Extent of Delegation; Control over Quality of Audit Work; Analytical Procedures Prior to Audit aswell as towards finalization; Concept of Principal Auditor and Other Auditor, Acceptance asPrincipal Auditor, Procedures to be Performed by Principal Auditor, Co-ordination between thePrincipal Auditor and Other Auditor (SA 600 Using the Work of Another Auditor); Concept ofInternal Audit Functions and its evaluation, Using the work of the internal audit function, UsingInternal Auditors to Provide Direct Assistance (SA 610 Using the Work of Internal Auditors);Auditor's Expert – Meaning, Need for an Auditor’s Expert, Understanding the Auditor’s Expert,Agreement with the Auditor’s Expert, Adequacy of the Auditor’s Expert’s Work (SA 620 Using theWork of an Auditor’s Expert).

3. Risk Assessment and Internal Control: Evaluation of Internal Control Procedures;Components of Internal Controls; Internal Control and Risk Assessment; Risk-Based Audit- AuditRisk Analysis, General Steps; Internal Audit; Reporting on Internal Control Weaknesses (SA 265Communicating Deficiencies in Internal Control to Those Charged With Governance andManagement); Framework on Reporting of Internal Controls.

4. Special aspects of Auditing in an Automated Environment: Key Features of AutomatedEnvironment, Related Risks and Controls, Standards, Guidelines and Procedures, Using RelevantFrameworks and Best Practices, Understanding and Documenting Automated Environment,


viii Enterprise Risk Management Overview, Assessing IT-Related Risks and Controls, Evaluating Risks and Controls at Entity Level and Process Level, Considerations of Automated Environment at each Phase of Audit Cycle, Using Relevant Analytical Procedures and Tests Using Data Analytics, Key Concepts of Auditing in Real-Time Automated Environments such as E-Commerce, ERP, Core Banking, etc..

5. Audit of Limited Companies: Application of Relevant Provisions under the Companies Act, 2013 relating to Audit and Auditors and Rules made thereunder; Powers/rights, Duties of Auditors; Branch Audit; Significance of True and Fair View; Dividends and Divisible Profits- Financial, Legal, and Policy Considerations; Depreciation; Special Features of Audit of Limited Liability Partnerships (LLPs)- Eligibility for Audit, Appointment of Auditor, Remuneration, etc. Audit Report under the Companies Act, 2013; Reporting under CARO.

6. Audit Reports: Basic Elements of Auditor’s Report; Types of Opinion; Notes on Accounts; Distinction between Notes and Qualifications; Distinction between Audit Reports and Certificates; Communication to Management and those Charged with Governance; Self Review Threats; Drafting of Different Types of Audit Reports.

7. Audit Committee and Corporate Governance: Audit committee; Role of Auditor in Audit Committee and Certification of Compliance of Corporate Governance; Compliances with Laws and Regulations (SA 250 Consideration of Laws and Regulations in an Audit of Financial Statements); Disclosure requirements including those of SEBI; Regulatory requirements of Corporate Governance, Report on Corporate Governance.

8. Audit of Consolidated Financial Statements: Provisions under the Companies Act, 2013 in respect of Accounts of Companies and Rules made thereunder; Audit of Consolidated Financial Statements - Responsibility of Parent Company, Auditor of the Consolidated Financial Statements; Audit Considerations - Permanent Consolidation, Current Period Consolidation; Reporting.

9. Special Features of Audit of Banks, Insurance & Non Banking Financial Companies

10. Audit under Fiscal Laws: Audit under Fiscal Laws, viz, Direct and Indirect Tax Laws including Documentation for Form 3CD etc.

11. Audit of Public Sector Undertakings: Special features, Directions of Comptroller and Auditor General of India; Concept of Propriety Audit; Performance Audit; Comprehensive Audit.

12. Liabilities of Auditors: Professional Negligence; Civil Liabilities; Criminal Liabilities; Liabilities under Different Statutes - for example Income Tax Act, Companies Act.

13. Internal Audit, Management and Operational Audit: Provisions of Internal Audit as per Companies Act, 2013; Scope of Internal Auditing; Relationship between Internal and External Auditor; Basics of Internal Audit Standards issued by the ICAI; Drafting of Internal Audit Report; Management Audit and Operational Audit.


ix 14. Due Diligence, Investigation and Forensic Audit: Due Diligence Review; Audit versus Investigation; Steps for Investigation; Types of Investigation; Procedure, Powers, etc. of Investigator; Types of Fraud, Indicators of Fraud, Follow-up thereof; Forensic Audit- meaning, difference between Statutory Audit and Forensic Audit, Forensic Audit Techniques, Forensic Audit Report etc.

15. Peer Review and Quality Review

16. Professional Ethics: Code of Ethics with special reference to the relevant provisions of the Chartered Accountants Act, 1949 and the Regulations thereunder.

Note:

(i) The specific inclusions/exclusions, in any topic covered in the syllabus, will be effected every year by way of Study Guidelines.

(ii) The provisions of the Companies Act, 1956 which are still in force would form part of the syllabus till the time their corresponding or new provisions of the Companies Act, 2013 are enforced.

(iii) If new legislations/ Engagement and Quality Control Standards /Guidance Notes/Statements are enacted in place of the existing legislations, the syllabus would include the corresponding provisions of such new legislations with effect from a date notified by the Institute. The changes in this regard would also form part of Study Guidelines.


x

CONTENTS

MODULE – 1

Chapter 1: Auditing Standards, Statements and Guidance Notes – An Overview

Chapter 2: Audit Planning, Strategy and Execution

Chapter 3: Risk Assessment and Internal Control

Chapter 4: Special Aspects of Auditing in an Automated Environment

Chapter 5: Audit of Limited Companies

Chapter 6: Audit Reports

MODULE – 2

Chapter 7: Audit Committee and Corporate Governance

Chapter 8: Audit of Consolidated Financial Statements

Chapter 9: Audit of Banks

Chapter 10: Audit of Insurance Companies

Chapter 11: Audit of Non Banking Financial Companies

Chapter 12: Audit under Fiscal Laws

MODULE – 3

Chapter 13: Audit of Public Sector Undertakings

Chapter 14: Liabilities of Auditors

Chapter 15: Internal Audit, Management and Operational Audit

Chapter 16: Due Diligence, Investigation and Forensic Audit

Chapter 17: Peer Review and Quality Review

Chapter 18: Professional Ethics


xi

DETAILED CONTENTS MODULE – 1

CHAPTER-1: AUDITING STANDARDS, STATEMENTS & GUIDANCE NOTES-AN OVERIVEW

LEARNING OUTCOMES ........................................................................................................... 1.1

CHAPTER OVERVIEW ............................................................................................................. 1.1

Contents:

1. Introduction ................................................................................................................. 1.2

2. Historical Retrospect .................................................................................................... 1.2

3. Auditing and Assurance Standards Board-Scope and Functions ................................... 1.3

3.1 Setting up of AASB ......................................................................................... 1.3

3.2 Scope and Functions of AASB ........................................................................ 1.4

3.3 Scope of SAs .................................................................................................. 1.4

3.4 Procedure for Issuing SAs ............................................................................... 1.5

3.5 Compliance with the SAs ................................................................................ 1.5

3.6 Linkage between SAs and Disciplinary Proceedings ........................................ 1.5

4. Framework of Standards and Guidance Notes on Related Services .............................. 1.6

5. Quality Control and Engagement Standards ................................................................. 1.8

5.1 Structure of SAs ........................................................................................... 1.11

6. Guidance Notes ......................................................................................................... 1.11

6.1 Guidance Note on Tax Audit under Section 44AB of the Income-Tax Act ........ 1.11

6.2 Guidance Note on Audit of Internal Financial Controls over

Financial Reporting ....................................................................................... 1.12

7. Guidance Note(s) on Related Services ....................................................................... 1.12

8. Authority Attached to the Documents issued by the Institute/MCA ............................... 1.12

8.1 Statements ................................................................................................... 1.13

8.2 Guidance Notes ............................................................................................ 1.13


xii 8.3 Accounting Standards and Standards on Auditing .......................................... 1.13

8.4 Accounting Standards ................................................................................... 1.14

8.5 Ind AS .......................................................................................................... 1.16

9. SQC 1- Quality Control for Firms that Perform Audits and Reviews of Financial Statement and Other Assurance and Related Services Engagements ......................... 1.19

10. SAs -Brief Overview ................................................................................................... 1.24

10.1 SA 200: Overall Objectives of the Independent Auditor and the Conduct of an Audit in accordance with Standards on Auditing ..................... 1.24

10.2 SA 210: Agreeing the Terms of Audit Engagements ....................................... 1.24

10.3 SA 220: Quality Control for an Audit of Financial Statements ......................... 1.25

10.4 SA 230: Audit Documentation........................................................................ 1.25

10.5 SA 240: The Auditor’s Responsibility Relating to Fraud in an Audit of Financial Statements ........................................................................ 1.25

10.6 SA 250: Consideration of Laws and Regulations in an Audit of Financial Statements .................................................................................... 1.26

10.7 SA 260: Communication with Those Charged with Governance ..................... 1.26

10.8 SA 265: Communicating Deficiencies in Internal Control to Those Charged with Governance and Management ....................................... 1.26

10.9 SA 299: Responsibility of Joint Auditors ........................................................ 1.27

10.10 SA 300: Planning an Audit of Financial Statements ........................................ 1.27

10.11 SA 315: Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment .................................. 1.27

10.12 SA 320: Materiality in Planning and Performing an Audit ............................... 1.27

10.13 SA 330: The Auditor’s Responses to Assessed Risks ................................... 1.28

10.14 SA 402: Audit Considerations Relating to an Entity Using a Service Organisation ..................................................................................... 1.28

10.15 SA 450: Evaluation of Misstatements Identified During the Audit .................... 1.28

10.16 SA 500: Audit Evidence ................................................................................ 1.28

10.17 SA 501: Audit Evidence—Specific Considerations for Selected Items ............. 1.29

10.18 SA 505: External Confirmations ..................................................................... 1.29


xiii 10.19 SA 510: Initial Audit Engagements- Opening Balances ................................. 1.29

10.20 SA 520: Analytical Procedures ...................................................................... 1.30

10.21 SA 530: Audit Sampling ................................................................................ 1.30

10.22 SA 540: Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures ............................................ 1.30

10.23 SA 550: Related Parties ................................................................................ 1.31

10.24 SA 560: Subsequent Events .......................................................................... 1.31

10.25 SA 570 Going Concern ................................................................................. 1.31

10.26 SA 580: Written Representations................................................................... 1.31

10.27 SA 600: Using the Work of Another Auditor ................................................... 1.32

10.28 SA 610: Using the work of Internal Auditors ................................................... 1.33

10.29 SA 620: Using the Work of an Auditor’s Expert .............................................. 1.33

10.30 SA 700: Forming an Opinion and Reporting on Financial Statements ............. 1.33

10.31 SA 701: Communicating Key Audit Matters in the Independent Auditor’s Report ........................................................................ 1.34

10.32 SA 705: Modifications to the Opinion in the Independent Auditor’s Report ...... 1.34

10.33 SA 706: Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report ............................................ 1.34

10.34 SA 710: Comparative Information—Corresponding Figures and Comparative Financial Statements ......................................................... 1.35

10.35 SA 720: The Auditor’s Responsibility Relating to Other Information ................ 1.35

TEST YOUR KNOWLEDGE .................................................................................................... 1.36

CHAPTER-2: AUDIT PLANNING, STRAEGY & EXECUTION



Contents:

1. Commencing an Audit .................................................................................................. 2.2

1.1 Benefits/Advantages of Planning in an Audit of Financial Statements ............... 2.2


xiv 1.2 Nature and Extent of Planning ......................................................................... 2.3

1.3 Planning - A Continuous Process .................................................................... 2.3

1.4 Overall Audit Strategy and Audit Plan - Responsibility of the Auditor ................ 2.4

1.5 Acceptance and Continuance of Client Relationships and Audit engagements .. 2.4

1.6 Contents of an Audit Plan ............................................................................... 2.5

1.7 Changes to Planning Decisions ....................................................................... 2.5

2. Overall Audit Strategy .................................................................................................. 2.6

2.1 Factors while establishing Overall Audit Strategy ............................................. 2.6

2.2 Benefits of Overall Audit Strategy .................................................................... 2.6

2.3 Considerations in Establishing the Overall Audit Strategy ................................ 2.7

2.4 Documenting the Audit Plan ........................................................................... 2.9

2.5 Relationship between the Overall Audit Strategy and the Audit Plan ................. 2.9

3. Audit Programme ....................................................................................................... 2.10

3.1 Formulating an Audit Programme .................................................................. 2.10

3.2 Drawing up the Audit Programme .................................................................. 2.12

4. Audit Execution .......................................................................................................... 2.13

4.1 Execution Planning ....................................................................................... 2.13

4.2 Risk and Control Evaluation .......................................................................... 2.13

4.3 Testing ........................................................................................................ 2.14

4.4 Reporting...................................................................................................... 2.14

4.5 Other Important Considerations ..................................................................... 2.14


CHAPTER-3: RISK ASSESSMENT AND INTERNAL CONTROL



Contents:

1. Introduction ................................................................................................................. 3.2


xv 2. Internal Control System - Nature, Scope, Objectives and Structure ............................... 3.5

2.1 Nature of Internal Control ................................................................................ 3.5

2.2 Scope of Internal Controls ............................................................................... 3.6

2.3 Objectives of Internal Control System .............................................................. 3.6

2.4 Structure of Internal Control ............................................................................ 3.8

3. Components of Internal Controls ................................................................................ 3.10

3.1 Control Environment ..................................................................................... 3.10

3.2 Entity’s Risk Assessment Process ................................................................. 3.11

3.3 Control Activities ........................................................................................... 3.13

3.4 Information System, including the Related Business Processes, Relevant to Financial Reporting, and Communication ................................... 3.14

3.5 Monitoring of Controls ................................................................................... 3.14

4. Review of the system of Internal Controls ................................................................... 3.17

5. Methods of Recording ................................................................................................ 3.19

5.1 Questionnaire ............................................................................................... 3.19

5.2 Check List .................................................................................................... 3.21

5.3 Flow Chart .................................................................................................... 3.22

6. Internal Control and Risk Assessment ........................................................................ 3.29

6.1 Preliminary Assessment of Control Risk ........................................................ 3.31

6.2 Relationship between the Assessments of Inherent and Control Risk: ............ 3.35

6.3 Detection Risk .............................................................................................. 3.35

7. Internal Control Assessment & Evaluation .................................................................. 3.38

8. Reporting to clients on Internal Control Weaknesses .................................................. 3.39

9. Risk Based Audit ....................................................................................................... 3.41

9.1 Audit Risk Analysis ....................................................................................... 3.42

9.2 General Steps in the Conduct of RBA ............................................................ 3.43

10. Frameworks of Internal Control .................................................................................. 3.44

10.1 International Internal Control Frameworks: .................................................... 3.45



xvi CHAPTER 4: SPECIAL ASPECTS OF AUDITING IN AN AUTOMATED ENVIRONMENT



Contents:

1. Key Features of an Automated Environment ................................................................ 4.2

2. Key concepts of Auditing in Real-Time Environment such as E-Commerce, ERP, Core Banking, etc. ............................................................ 4.4

3. Understanding and Documenting Automated Environment ........................................... 4.5

4. Consideration of Automated Environment at each phase of Audit Cycle ........................ 4.6

5. Enterprise Risk Management Overview ........................................................................ 4.7

6. Assessing IT-related Risks and Controls ..................................................................... 4.9

7. Evaluating Risks and Controls at Entity Level and Process Level ................................ 4.12

8. Using relevant Analytical Procedures and Tests using Data Analytics ......................... 4.16

9. Standards, Guidelines and Procedures-using Relevant Frameworks and Best Practices ................................................................................. 4.17

GLOSSARY ............................................................................................................................ 4.19


CHAPTER-5: COMPANY AUDIT



Contents:

1. Appointment of Auditors ............................................................................................... 5.2

1.1 Appointment of First Auditors ......................................................................... 5.3

1.2 Appointment of Subsequent Auditors/Re-appointment of Auditors .................. 5.5

1.3 Filling of a Casual Vacancy ............................................................................ 5.6

2. Eligibility, Qualifications and Disqualifications of an Auditor ......................................... 5.7

3 Rotation of Auditors .................................................................................................. 5.14

3.1 Applicability of section 139(2) Rotation of Auditors ....................................... 5.14


xvii 3.2 Manner of Rotation of Auditors by the

Companies on Expiry of their Term .............................................................. 5.17

4. Provisions relating to Audit Committee ...................................................................... 5.19

4.1 Applicability of section 177 i.e. Constitution of Audit Committee .................... 5.19

4.2 Manner and procedure of selection and appointment of auditors ................... 5.20

5. Auditor’s Remuneration ............................................................................................. 5.21

6. Removal of Auditors .................................................................................................. 5.22

6.1 Removal of Auditor before Expiry of Term .................................................... 5.22

6.2 Appointment of Auditor other than retiring Auditor: ........................................ 5.22

7. Ceiling on Number of Audits ...................................................................................... 5.23

8. Powers/Rights of Auditors ......................................................................................... 5.26

8.1 Powers / Rights of Comptroller and Auditor-General of India ......................... 5.30

9. Duties of Auditors ..................................................................................................... 5.31

10. Joint Audit ................................................................................................................ 5.37

11. Audit of Branch Office Accounts ................................................................................. 5.38

12. Cost Audit ................................................................................................................. 5.39

13. Punishment for non-compliance ............................................................................... 5.42

14. Final Accounts Preparation and Presentation ............................................................ 5.43

14.1 Financial Statements ................................................................................... 5.43

14.2 Consolidated Financial Statement ................................................................ 5.45

14.3 Penalty for contravention ............................................................................. 5.46

14.4 Constitution of National Financial Reporting Authority ................................... 5.47

14.5 Form of the Balance Sheet ............................................................................ 5.50

15. Significance of True and Fair ..................................................................................... 5.52

16. Divisible Profits, Dividends and Reserves .................................................................. 5.54

16.1 Depreciation under Section 123 of the Companies Act, 2013 read with Schedule II to the Companies Act, 2013 ........................................ 5.54

16.2 Law relating to dividends .............................................................................. 5.55


xviii 16.3 Right to dividend, rights shares and bonus shares to be held in

abeyance pending registration of transfer of shares ...................................... 5.61

16.4 Power to close register of members or debenture-holders or other security holders .............................................................................. 5.61

16.5 Interim Dividend ........................................................................................... 5.62

16.6 Payment of dividend and the Income tax Act ................................................ 5.62

16.7 Audit procedure for “Payment of Dividend”: .................................................. 5.63

16.8 Reserves ..................................................................................................... 5.64

16.9 Deferred Taxation ........................................................................................ 5.65

16.10 Non-provision of Tax in the Accounts ........................................................... 5.65

17. Depreciation ............................................................................................................. 5.69

18. Salient features of Limited Liability Partnerships (LLP) Audit ....................................... 5.70

19. Audit Report ............................................................................................................. 5.73

19.1 Reporting Under CARO, 2016 ...................................................................... 5.73

Appendix 1: Comprehensive Case Studies on CARO 2016 .............................................. 5.79

Appendix-2: Key Aspects discussed in Guidance Note on Internal Financial Control over Financial Reporting .............................................................................. 5.88

TEST YOUR KNOWLEDGE ............................................................................................................... 5.91

Schedule III ................................................................................................................................... A1-A47

CHAPTER-6: AUDIT REPORTS



Contents:

1. Introduction ................................................................................................................. 6.2

2. The Auditor’s Report on Financial Statements .............................................................. 6.2

3. SA-700, “Forming an Opinion and Reporting on the Financial Statements” .................... 6.3

3.1 Purpose .......................................................................................................... 6.4

3.2 Basic Elements of the Auditor’s Report ............................................................ 6.4


xix 3.3 Auditor’s Report Prescribed by Law or Regulation ........................................ .6.12

3.4 Auditor’s Report for Audits Conducted in accordance with both Standards on Auditing issued by ICAI and International Standards on Auditing or Auditing Standards of any other jurisdiction .................................. 6.13

4. SA 701, “Communicating Key Audit Matters in the Independent Auditor’s Report” ....... 6.14

4.1 Purpose ........................................................................................................ 6.14

4.2 Scope ........................................................................................................... 6.14

4.3 Determining Key Audit matters ...................................................................... 6.15

4.4 Communicating Key Audit matters: ................................................................ 6.15

5. SA 705, “Modifications to the opinion in the Independent Auditor’s Report” ................. 6.16

5.1 Types of modified opinions ............................................................................ 6.16

5.2 Objective ...................................................................................................... 6.16

5.3 Circumstances when a Modification to the Auditor’s Opinion is required ........ 6.17

5.4 Determining the type of Modification to the Auditor’s Opinion ......................... 6.17

5.5 Consequence of an inability to obtain Sufficient Appropriate Audit Evidence due to a Management-Imposed Limitation after the Auditor has accepted the Engagement ........................................................................................... 6.19

5.6 If the Auditor Decides to Withdraw ................................................................ 6.20

5.7 Other Considerations Relating to an adverse opinion or Disclaimer of opinion 6.20

5.8 Form and Content of the Auditor’s Report when the opinion is modified ......... 6.20

5.9 Communication with those charged with Governance .................................... 6.23

6. SA 706, “Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report” ........................................................ 6.23

6.1 Objective ...................................................................................................... 6.23

6.2 When to give Emphasis of Matter Paragraphs in the Auditor’s Report?........... 6.24

6.3 When the auditor includes an Emphasis of Matter Paragraph in the Auditor’s Report .................................................................................. 6.24

7. Distinction between Notes on Accounts and Qualifications .......................................... 6.25

8. Distinction between Audit Report and Certificate ........................................................ 6.26

9. Communication to Management and those charged with Governance ......................... 6.27


xx 9.1 When all of those charged with Governance are involved

in managing the entity ................................................................................... 6.28

9.2 Matters to be communicated ......................................................................... 6.28

9.3 Planned Scope and Timing of the Audit ......................................................... 6.28

9.4 Significant findings from the Audit ................................................................. 6.29

10. Self Review Threats ................................................................................................... 6.29

10.1 Meaning- Self Review Threats ....................................................................... 6.30

10.2 Safeguards that may eliminate or reduce such threats to an acceptable level fall into two board categories ................................................................ 6.30

11. Reporting Requirements in case of Comparative Information ...................................... 6.30

11.1 Audit Procedures for Comparative Information ............................................... 6.31

11.2 Audit Reporting ............................................................................................. 6.31

12. Illustrative Audit Reports ............................................................................................ 6.34

TEST YOUR KNOWLEDGE ............................................................................................ 6.49


1 AUDITING STANDARDS, STATEMENTS AND GUIDANCE NOTES - AN OVERVIEW

LEARNING OUTCOMES

After studying this chapter, you will be able to: Apply logical, critical and creative thinking to analyse, synthesise and

apply theoretical knowledge, and technical skills to conduct Audit & Assurance as per Engagement and Quality Control Standards.

Determine and apply knowledge of Auditing Standards to your professional practice and/or further study.

Understand the requirements of each Standard to conduct Audit in Accordance with Standards.

Auditing Standards, Statements & Guidance Notes

IFAC - IAASB ICAI - AASB

Engagement and Quality Control

StandardsGuidance Notes Statements

CHAPTER OVERVIEW


1.2 ADVANCED AUDITING AND PROFESSIONAL ETHICS

1. INTRODUCTION The past decade has been one of unprecedented change in the global economy and capital markets. Key aspects of the current business environment include a globalized, highly competitive, expanding economy; explosive growth in the development and use of technology; dramatic increases in new economy service- and technology-based businesses with predominantly intangible assets; unparalleled expansion in the number of public entities; large increases in the number of individuals who directly or indirectly own equity securities; and unprecedented growth in the market value of those securities.

The expanded use of technology in both the operating and financial systems of companies also has significantly affected the audit environment, forcing audit firms to recruit, train and deploy a large number of information technology specialists to support their audit efforts. It also has caused firms to reconsider their audit methods and techniques in an effort to harness technology to improve audit efficiency and effectiveness. In the changing environment, it is obvious that a professional accountant should to adhere to standards and procedures laid down by the professional accountancy bodies of which he is a member while discharging his duties in a responsible manner. In this direction, the role of a professional accounting body is to lay down such standards and procedures with the aim of providing guidance to members. The Institute of Chartered Accountants of India (ICAI) has been formulating auditing and accounting standards for the guidance of its members on its own volition in the larger interests of the society. In this chapter, we provide an overview of auditing standards and guidance notes issued by the Institute from time to time. Though these standards and guidance notes have been dealt at appropriate places, the main purpose is to acquaint and inculcate appreciation on the part of students in a focused manner as to significance of the standards in their day to day auditing activities. Towards the end of the Chapter, the clarification issued by the Council of the Institute is also included, which would go a long way in understanding as well as significance to the mandatory status of “Statements” and “Standards”.

2. HISTORICAL RETROSPECT The Institute, since its inception, has been committed to research in the field of accountancy. As early as in 1955, the Council set up the Research Committee. The Council at that point of time felt the necessity to establish such a Committee to deal with the growing complexities of the problems faced by membership at large and with a view to ensuring the highest of traditions and technical competence in the discharge of the duties by chartered accountants.


1.3 AUDITING STANDARDS, STATEMENTS AND GUIDANCE NOTES - AN OVERVIEW

As back as in 1964, the Council published the “Statement on Auditing Practices” as prepared by the Research Committee not only for the benefit of its members but also for others outside the profession, who might be interested in this subject. It was hoped that this Statement would provide valuable guidance in the performance of audits, particularly of companies. The Council of the Institute fully realised that techniques of accounting and auditing had undergone and were undergoing important changes. Since the members were expected to keep pace with recent developments, this Statement attempted to set out practices which were generally accepted in other countries and which the Council considered desirable in the light of prevailing circumstances in India. The issuance of the Statement on Auditing Practices might be considered as a path break as far as establishing sound auditing practices is concerned.

3. AUDITING AND ASSURANCE STANDARDS BOARD – SCOPE AND FUNCTIONS

The Following are the important points as regards scope and functions of Auditing and Assurance Standards Board –

3.1 Setting up of AASB The International Federation of Accountants (IFAC) came into existence in 1977 and constituted International Auditing Practices Committee (IAPC) to formulate International Auditing Guidelines. These guidelines were later on converted into International Standards on Auditing (ISA). Considering the developments in the field of auditing at international level, the need for issuing Standards and Guidance Notes in tandem with international standards but conforming to national laws, customs, usages and business environments was felt. With this objective, our Institute constituted the Auditing Practices Committee (APC) on September 17, 1982, to spearhead the new framework of Statements on Standard Auditing Practices (SAPs) and Guidance Notes (GNs) inter alia to replace various chapters of the old omnibus Statement on Auditing Practices issued in 1964.

International Auditing and Assurance Standards Board (IAASB): The IFAC Board has established the IAASB to develop and issue, in the public interest and under its own authority, high quality auditing standards for use around the world. The IAASB functions as an independent standard-setting body under the auspices of IFAC.

Auditing and Assurance Standards Board: ICAI is a member of the IFAC and is committed to work towards the implementation of the guidelines issued by the IFAC. ICAI constituted the AASB (erstwhile Auditing Practices Committee) to review the existing auditing practices in India and to develop Engagement and Quality Control Standards (erstwhile Statements on Standard Auditing Practices) so that these may be issued by the Council of the Institute.



In July, 2002, the Auditing Practices Committee has been converted into an Auditing and Assurance Standards Board by the Council of the Institute, to be in line with the international trend. A significant step has been taken aimed at bringing in the desired transparency in the working of the Auditing and Assurance Standards Board, through participation of representatives of various segments of the society and interest groups, such as, regulators, industry and academics. The nomenclature of SAPs had been changed to Auditing and Assurance Standards (AASs). As per the Preface to Standards on Quality Control Auditing Review, other Assurance and Related Services w.e.f. April 1, 2008, the nomenclature of AASs under the authority of the Council are collectively known as the Engagement Standards and Quality Control Standards which include the following:

3.2 Scope and Functions of AASB The main function of the AASB is to review the existing auditing practices in India and to develop Statements on Standards on Auditing (SAs) so that these may be issued by the Council of the Institute. While formulating the SAs, the AASB takes into consideration the ISAs issued by the IAPC, applicable laws, customs, usages and business environment in India. The SAs are issued under the authority of the Council of the Institute. The AASB also issues Guidance Notes on the issues arising from the SAs wherever necessary. The AASB has also been entrusted with the responsibility to review the SAs at periodical intervals.

3.3 Scope of SAs The SAs apply whenever an independent audit is carried out; that is, in the independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size, or legal form (unless specified otherwise) when such an examination is conducted with a view to expressing an opinion. The SAs may also have application, as appropriate, to other related functions of auditors. Any limitation on the applicability of a specific SA is made clear in the introductory paragraph of the SA.

Standards on Auditing (SAs) are applied in the audit of historical financial information.

Standards on Review Engagements(SREs) are applied in the review ofhistorical financial information.

Standards on Assurance Engagements(SAEs) are applied in assuranceengagements, dealing with subjectmatters other than historical financialinformation.

Standards on Related Services (SRSs),are applied to engagements involvingapplication of agreed-upon proceduresto information, compilationengagements, and other relatedservices engagements, as may bespecified by the ICAI.

Standard on Quality Control which containsextensive requirements in relation toestablishment and maintenance of a systemof quality control in the audit firms as wellas even for sole practitioners.



3.4 Procedure for issuing SAs Broadly, the following procedure is adopted for the formulation of SAs:

3.5 Compliance with the SAs While discharging their attest function, it is the duty of the members of the Institute to ensure that the SAs are followed in the audit of financial information covered by their audit reports. If for any reason a member has not been able to perform an audit in accordance with the SAs, his report should draw attention to the material departures therefrom. Auditors are expected to follow SAs in the audits commencing on or after the date specified in the Standard. Further, compliance of SAs are mandatory requirement as per the Companies Act, 2013.

3.6 Linkage between SAs and Disciplinary Proceedings The SAs (as well as other statements on auditing) represent the generally accepted procedure(s) of audit. As such, a member who does not perform his audit in accordance with these statements and fails to disclose the material departures there from, becomes liable to the disciplinary proceedings of the Institute under Clause (9) of Part I of the Second Schedule to the Chartered Accountants Act, 1949 (as amended by the Chartered Accountants (Amendment) Act, 2006), which specifies that a member of the Institute engaged into practice shall be guilty of professional misconduct if he “fails to invite attention to any material departure from the generally accepted procedure of audit applicable to the circumstances”.

1. The AASB determines the broadareas in which the SAs need to beformulated and the priority in regard tothe selection thereof.

2. In the preparation of SAs, the AASB is assisted byStudy Groups constituted to consider specificsubjects. In the formation of Study Groups, provisionis made for participation of a cross-section ofmembers of the Institute.

3. On the basis of the work of the StudyGroups, an exposure draft of the proposedSA is prepared by the Committee andissued for comments by members of theInstitute.

4. After taking into consideration thecomments received, the draft of theproposed SA is finalised by theAASB and submitted to the Councilof the Institute.

5. The Council of the Institute considers the final draft of the proposedSA, and, if necessary, modifies the same in consultation with the AASB.The SA is then issued under the authority of the Council.



4. FRAMEWORK OF STANDARDS AND GUIDANCE NOTES ON RELATED SERVICES

Framework of Standards on Auditing and Guidance Notes on Related Services issued recently distinguishes audits from related services. Related services comprise reviews, agreed-upon procedures and compilations. As illustrated in the diagram below, audits and reviews are designed to enable the auditor to provide high and moderate levels of assurance respectively, such terms being used to indicate their comparative ranking. Engagements to undertake agreed-upon procedures and compilations are not intended to enable the auditor to express assurance.

Auditing _____Related Services_____

Nature of service Audit Review Agreed-upon Procedures

Compilation

Comparative level of assurance provided by the auditor

High, but not absolute assurance

Moderate assurance

No assurance No assurance

Report provided Positive assurance on assertion(s)

Negative assurance on assertion(s)

Factual findings of procedures

Identification of information compiled

Assurance in the above context refers to the auditor's satisfaction as to the reliability of an assertion being made by one party for use by another party. To provide such assurance, the auditor assesses the evidence collected as a result of procedures conducted and expresses a conclusion. The degree of satisfaction achieved and, therefore, the level of assurance which may be provided is determined by the procedures performed and their results.

In an audit engagement, the auditor provides a high, but not absolute, level of assurance (i.e. reasonable level of assurance) that the information subject to audit is free of material misstatement expressed positively in the audit report.

In a review engagement, the auditor provides a moderate level of assurance that the information subject to review is free of material misstatement. This is expressed in the form of negative assurance (also known as limited assurance).

For agreed-upon procedures, auditor simply provides a report of the factual findings, no assurance is expressed. Instead, users of the report draw their own conclusions from the auditor's work. In a



compilation engagement, although the users of the compiled information derive some benefit from the involvement of a member of the Institute, no assurance is expressed in the report. Objective of an audit is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an identified financial reporting framework "give a true and fair view". Absolute assurance in auditing is not attainable as a result of such factors as the need for judgement, the use of test checks, the inherent limitations of any accounting and internal control systems and the fact that most of the evidence available to the auditor is persuasive, rather than conclusive, in nature.

The objective of a review of financial statements is to enable an auditor to state whether, on the basis of procedures which do not provide all the evidence that would be required in an audit, anything has come to the auditor's attention that causes the auditor to believe that the financial statements are not prepared, in all material respects, in accordance with an identified financial reporting framework. While a review involves the application of audit skills and techniques and the gathering of evidence, it does not ordinarily involve on assessment of accounting and internal control systems, tests of records and of responses to inquiries by obtaining corroborating evidence through inspection, observation, confirmation and computation, the auditor attempts to become aware of all significant matters, the procedures of a review make the achievement less likely than in an audit engagement, thus the level of assurance provided in a review report is correspondingly less than that given in an audit report.

In an engagement to perform agreed-upon procedures and auditor is engaged to carry out those procedures of an audit nature to which the auditor and the entity and any appropriate third parties have agreed and to report on factual findings.

The report is restricted to those parties that have agreed to the procedures to be performed since others, unaware of the reasons for the procedures, may misinterpret the results. In a compilation engagement, a member of the Institute is engaged to use accounting expertise as opposed to auditing expertise to collect, classify, and summaries financial information.

The procedures employed are not designed and do not enable the member to express any assurance on the financial information. However, users derive some benefit as a result of the member's involvement because the service has been performed with due professional skill and care. An auditor is associated with financial information when the auditor attaches a report to that information or consents to the use of the auditor's name in a professional connection. If the auditor is not associated in this manner, third parties can assume no responsibility of the auditor.



5. QUALITY CONTROL AND ENGAGEMENT STANDARDSDiagrammatic Representation of the Structure of Standards Under the New Preface

AUDITING STANDARDS - AN OVERVIEW

Auditing and Assurance Standard Board - (AASB)- Scope / Objective STRUCTURE OF

PRONOUNCEMENTS ISSUED BY AASB

FRAMEWORK FOR AUDIT & ASSURANCE & OTHER SERVICES ENGAGEMENTS –

Scope/ Objective/ Definitions/ Requirements

Standard for Quality Control

(SQC 01 - 99)

Standards on Auditing (SA 100-999) - aspects covered in series: Introductory Matters SA100 - 199

General Principles and Responsibilities SA200 - 299 Risk Assessment and Response to Assessed Risk SA300 - 499

Audit Evidence SA500 - 599 Using Work of Others SA600 - 699

Audit Conclusions and Reporting SA700 – 799 Specialised Areas SA800 - 899

Standard on Assurance Engagements

SAE (3000-3699)

Standards on Related Services

SRS- 4000 & 4699

Standards on Review Engagements (SRE 2000 -2699)



The Council of the ICAI has issued following Quality Control and Engagement Standards:

S. No. No. of Standard Title of the Standard 1 SQC 1 Quality Control for Firms that Perform Audits and Reviews of

Historical Financial Information, and Other Assurance and Related Services Engagements

2 SA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing

3 SA 210 Agreeing the Terms of Audit Engagements 4 SA 220 Quality Control for an Audit of Financial Statements 5 SA 230 Audit Documentation 6 SA 240 The Auditor’s responsibilities Relating to Fraud in an Audit of

Financial Statements 7 SA 250 Consideration of Laws and Regulations in an Audit of Financial

Statements 8 SA 260 Communication with Those Charged with Governance 9 SA 265 Communicating Deficiencies in Internal Control to Those Charged

with Governance and Management 10 SA 299 Joint Audit of Financial Statements 11 SA 300 Planning an Audit of Financial Statements 12 SA 315 Identifying and Assessing the Risks of Material Misstatement

through Understanding the Entity and its Environment 13 SA 320 Materiality in Planning and Performing an Audit 14 SA 330 The Auditor’s Responses to Assessed Risks 15 SA 402 Audit Considerations Relating to an Entity Using a Service

Organization 16 SA 450 Evaluation of Misstatements Identified during the Audits 17 SA 500 Audit Evidence 18 SA 501 Audit Evidence - Specific Considerations for Selected Items 19 SA 505 External Confirmations 20 SA 510 Initial Audit Engagements-Opening Balances 21 SA 520 Analytical Procedures 22 SA 530 Audit Sampling 23 SA 540 Auditing Accounting Estimates, Including Fair Value Accounting



Estimates, and Related Disclosures 24 SA 550 Related Parties 25 SA 560 Subsequent Events 26 SA 570 Going Concern 27 SA 580 Written Representations 28 SA 600 Using the Work of Another Auditor 29 SA 610 Using the Work of Internal Auditors 30 SA 620 Using the Work of an Auditor’s Expert 31 SA 700 Forming an Opinion and Reporting on Financial Statements 32 SA 701 Communicating Key Audit Matters in the Independent Auditor’s

Report 33 SA 705 Modifications to the Opinion in the Independent Auditor’s Report 34 SA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in

the Independent Auditor’s Report 35 SA 710 Comparative Information – Corresponding Figures and

Comparative Financial Statements 36 SA 720 The Auditor’s Responsibility in Relation to Other Information 37 SA 800 Special Considerations-Audits of Financial Statements Prepared

in Accordance with Special Purpose Framework 38 SA 805 Special Considerations-Audits of Single Purpose Financial

Statements and Specific Elements, Accounts or Items of a Financial Statement

39 SA 810 Engagements to Report on Summary Financial Statements 40 SRE 2400 Engagements to Review Historical Financial Statements 41 SRE 2410 Review of Interim Financial Information Performed by the

Independent Auditor of the Entity 42 SAE 3400 The Examination of Prospective Financial Information 43 SAE 3402 Assurance Reports on Controls At a Service Organisation 44 SAE 3420 Assurance Engagements to Report on the Compilation of Pro

Forma Financial Information Included in a Prospectus 45 SRS 4400 Engagements to Perform Agreed Upon Procedures Regarding

Financial Information 46 SRS 4410 Compilations Engagements



5.1 Structure of SAs SAs are structured in the particular manner:

• Introduction: It includes the purpose, scope, and subject matter as well as the responsibilities of the auditor and others in that context.

• Objective: It includes the objective of the auditor in the audit area addressed by that particular SA.

• Definitions: For higher understanding of the SAs, pertinent terms are delineated in each SA.

• Requirements: Every objective is shored up by clearly stated requirements. Requirements are always expressed by the phrase “the auditor shall.”

• Application and Other Explanatory Material: The application and other explanatory material explains more exactly what is meant by a requirement or is intended to cover, or includes examples of procedures that can be appropriate under certain circumstances.

(Students may note that the above mentioned Quality Control and Engagement Standards are reproduced in Auditing Pronouncements)

6. GUIDANCE NOTES Various technical committees of the Institute are involved in the task of issuing guidance notes on topics relating to accounting and auditing for guidance of the members. Some of the important topics in auditing on which guidance notes have been issued are discussed below:

6.1 Guidance Note on Tax Audit under Section 44AB of the Income-Tax Act This Guidance Note was first issued by the Taxation Committee in 1985 and was revised from time to time by the Direct Taxes Committee. Refer to Chapter 12 for a detailed discussion.

The clarifications and explanations contained in this Guidance Note are not intended to be exhaustive and the auditors should exercise their professional judgment and experience on various matters on which they are


1.12 ADVANCED AUDITING AND PROFESSIONAL ETHICS required to report under the Order. Further, the Order is also not intended to limit the duties and responsibilities of auditors but only requires a statement to be included in the audit report in respect of the matters specified therein.

Students are advised to refer Chapter 6 Audit Reports and Auditing Pronouncements for details.

6.2 Guidance Note on Audit of Internal Financial Controls over Financial Reporting

To help the members properly understand and perform the various aspects of reporting responsibility related to audits of internal financial controls over financial reporting, the Auditing and Assurance Standards Board of the Institute of Chartered Accountants of India has brought out this Guidance Note on Audit of Internal Financial Controls Over Financial Reporting. The Guidance Note covers aspects such as Scope of reporting on internal financial controls under Companies Act 2013, essential components of internal financial controls, Technical guidance on audit of internal financial controls, Implementation guidance on audit of internal financial controls.

The Companies Act, 2013 has introduced some new requirements relating to audits and reporting by the statutory auditors of companies. One of these requirements is given under Section 143(3)(i) of the Act which requires the statutory auditor to state in his audit report whether the company has adequate internal financial controls system in place and the operating effectiveness of such controls. The section has cast onerous responsibilities on the statutory auditors because reporting on internal financial controls is not covered under the Standards on Auditing issued by the ICAI.

7. GUIDANCE NOTE(S) ON RELATED SERVICES The framework for auditing and related services makes it clear that there can be different layers of assurance depending upon the nature of services being performed by the chartered accountant. Related Services comprise of Review engagements, Agreed upon Procedures and Compilation Engagement. Reviews engagements involve providing moderate assurance (or negative assurance) but other two services, viz., and compilation and agreed upon procedures provide no assurance at all. The Institute has issued guidance notes covering these aspects of related services in a comprehensive manner.

8. AUTHORITY ATTACHED TO THE DOCUMENTS ISSUED BY THE INSTITUTE/MCA

The Institute has, from time to time, issued ‘Statements’ and ‘Guidance Notes’ on a number of matters. With the formation of the Accounting Standards Board and the Auditing and Assurance Standards Board, Accounting Standards and Standards on Auditing have also been issued. The level of authority attached to these documents and the degree of compliance required in respect thereof has been explained by the Institute through its various announcements issued from time to time.



8.1 Statements The ‘statements’ have been issued with a view to securing compliance by members on matters which in the opinion of the council of the institute are critical for the proper discharge of their functions. ‘statements’ therefore are mandatory. Accordingly, while discharging their attest function, it is the duty of the members of the institute-

(a) to examine whether ‘Statements’ relating to accounting matters are complied with in the presentation of financial statements covered by their audit. In the event of any deviation from such ‘Statements’, it is their duty to make adequate disclosures in their audit reports so that the users of financial statements may be aware of such deviations; and

(b) to ensure that the ‘Statements’ relating to auditing matters, are followed in the audit of financial information covered by their audit reports. If, for any reason, a member, has not been able to perform an audit in accordance with such ‘Statements his report should draw attention to the material departures there from.

8.2 Guidance Notes ‘Guidance Notes’ are primarily designed to provide guidance to members on matters which may arise in the course of their professional work and on which they may desire assistance in resolving issues which may pose difficulty. Guidance notes are recommendatory in nature. A member should ordinarily follow recommendations in a guidance note relating to an auditing matter except where he is satisfied that in the circumstances of the case, it may not be necessary to do so. Similarly, while discharging his attest function, a member should examine whether the recommendations in a guidance note relating to an accounting matter have been followed or not. If the same have not been followed, the member should consider whether keeping in view the circumstances of the case, a disclosure in his report is necessary. There are, however a few guidance notes in case of which the Council has specifically stated that they should be considered as mandatory on members while discharging their attest function.

8.3 Accounting Standards and Standards on Auditing The ‘accounting standards’ and ‘Standards on Auditing’ establish standards which have to be complied with to ensure that financial statements are prepared in accordance with generally accepted accounting standards and that auditors carry out their audit in accordance with the generally accepted auditing practices. They become mandatory on the dates specified in the respective document or notified by the council.

There can be situations in which certain matters are covered both by a ‘Statement’ and by an ‘Accounting Standard’/ ‘Standards on Auditing. In such a situation, the ‘Statement’ prevails till the time the relevant ‘Accounting Standard’/ Standards on Auditing becomes mandatory. Once an ‘Accounting Standard’/ ‘Standards on Auditing’ becomes mandatory, the concerned ‘Statement’ or the relevant part thereof automatically stands withdrawn.


1.14 ADVANCED AUDITING AND PROFESSIONAL ETHICS Standards on Auditing (SAs) establish standards, which have to be complied with to ensure that auditors carry out their duties in accordance with the generally accepted auditing practices. They become operative (i.e., mandatory) in respect of audit of all enterprises on the dates specified in the respective SAs or notified by the Council. The duties of the members of the Institute in relation to operative SAs are similar to those in respect of ‘Statements’ relating to auditing matters.

8.4 Accounting Standards Accounting Standards are formulated by the Accounting Standards Board and issued by the Council of the Institute. The Accounting Standards are issued for use in the presentation of ‘general purpose financial statements’ which are issued to the public by such ‘commercial, industrial or business enterprises’ as may be specified by the Institute from time to time and subject to the attest function of its members. They become mandatory on the dates specified in the respective Accounting Standards or notified by the Council in this behalf.

(a) The term ‘General Purpose Financial Statements’ includes balance sheet, statement of profit and loss and other statements and explanatory notes which form part thereof, issued for the use of shareholders/members, creditors, employees and public at large.

(b) The reference to ‘commercial, industrial or business enterprises’ is in the context of the nature of activities carried on by an enterprise rather than with reference to its objects. The Accounting Standards apply in respect of commercial, industrial or business activities of any enterprise, irrespective of whether it is profit oriented or is established for charitable or religious purposes. Accounting Standards will not, however, apply to those activities which are not of commercial, industrial or business nature (e.g. an activity of collecting donations and giving them to flood affected people). The exclusion of an entity from the applicability of the Accounting Standards is permissible only if no part of the activity of entity is commercial, industrial or business in nature. In other words, even if a very small proportion of the activities of an entity is considered to be commercial, industrial or business in nature, then it cannot claim exemption from the application of Accounting Standards. In such a case the Accounting Standards will apply to all its activities including those which are not commercial, industrial or business in nature.

The Companies Act as well as many other statutes require that the financial statements of an enterprise should give a true and fair view of its financial position and working results. This requirement is implicit even in the absence of a specific statutory provision to this effect. However, what constitutes ‘true and fair’ view has not been defined either in the Companies Act or in any other statute. The Accounting Standards (as well as other pronouncements of the Institute on accounting matters) seek to describe the accounting principles and the methods of applying these principles in the preparation and presentation of financial statements so that they give a true and fair view.

The ‘Preface to the Statements of Accounting Standards’ issued by the Institute in 2004 states (paragraphs 6.1 and 6.3):



“6.1 While discharging their attest function, it will be the duty of the members of the Institute to examine whether the Accounting Standard is complied with in the presentation of financial statements covered by their audit. In the event of any deviation from the Accounting Standard, it will be their duty to make adequate disclosures in their reports so that the users of such statements may be aware of financial deviations.”

“6.3 Financial Statements cannot be described as complying with the Accounting Standards unless they comply with all the requirements of each applicable standard.”

Once an Accounting Standard becomes mandatory, the duties of an auditor with respect to such standard are the same as those specified at paragraph 2(a) above.

While discharging their attest function, the members of the Institute may keep the following in mind with regard to mandatory Accounting Standards.

AS 1 - Disclosure of Accounting Policies - In the case of a company, members should qualify their audit reports in case:

(a) accounting policies required to be disclosed under Schedule III or any other provisions of the Companies Act, 2013, have not been disclosed, or

(b) accounts have not been prepared on accrual basis, or

(c) the fundamental accounting assumption of going concern has not been followed and this fact has not been disclosed in the financial statements, or

(d) proper disclosures regarding changes in the accounting policies have not been made.

Where a company has been given a specific exemption regarding any of the matters stated in paragraph 16 above but the fact of such exemption has not been adequately disclosed in the accounts, the member should mention the fact of exemption in his audit report without necessarily making it a subject matter of audit qualification.

If accounting policies have not been disclosed at one place or if certain significant accounting policies have not been disclosed, by a company on the ground that their disclosure is not required under the Companies Act, 2013, the member should disclose the fact in his audit report without necessarily making it a subject matter of audit qualification. Such a disclosure would not constitute a reservation, qualification or adverse remark except where the auditor has specifically made it a subject matter of audit qualification. Accordingly in the case of a company, the Board of Directors need not provide information or explanation with regard to such a disclosure (except where the same constitutes a qualification) in their report under sub-section (3) of Section 134 of the Companies Act, 2013.

In the case of enterprises not governed by the Companies Act, 2013, the member should examine the relevant statute and make suitable qualification in his audit report in case adequate disclosures regarding accounting policies have not been made as per the statutory requirements. Similarly, the member should examine if the fundamental accounting assumptions have been followed in


1.16 ADVANCED AUDITING AND PROFESSIONAL ETHICS preparing the financial statements or not. In appropriate cases, he should consider whether, keeping in view the requirements of the applicable laws, a qualification in his report is necessary. In the event of non-compliance, by enterprises not governed by the Companies Act, 2013, with the disclosure requirements of AS1 in situations where the relevant statute does not require such disclosures to be made, the member should make adequate disclosure in his audit report without necessarily making it a subject matter of audit qualification.

Other Mandatory Accounting Standards - While making a qualification, the auditor should follow the requirements of the ‘Statement on Qualifications in Auditor’s Report’ issued by the Institute. Subject to this, non-compliance with any of the requirements of a mandatory Accounting Standard other than AS 1 by any enterprise should be a subject matter of qualification except that, to the extent that the disclosure requirements in the relevant standard are in addition to the requirements of the Companies Act, 2013, or any other applicable statute, the member should disclose the fact of non - compliance with such disclosure requirements in his audit report without necessarily making it a subject matter of audit qualifications.

Financial Statements Prepared on a Basis other than Accrual - With regard to the fundamental accounting assumption of accrual, the Council of the Institute has made a specific announcement that in respect of individuals/bodies covered by para AS I - Disclosure of Accounting Policies above, the auditor should examine whether the financial statements have been prepared on accrual basis. In cases where the statute governing the enterprise requires the preparation and presentation of financial statements on accrual basis but the financial statements have not been so prepared, the auditor should qualify his report. On the other hand, where there is no statutory requirement for preparation and presentation of financial statements on accrual basis, and the financial statements have been prepared on a basis other than ‘accrual’, the auditor should describe in his audit report, the basis of accounting followed, without necessarily making it a subject matter of a qualification. In such a case the auditor should also examine whether those provisions of the accounting standards which are applicable in the context of basis of accounting followed by the enterprise have been complied with or not and consider making suitable disclosures/qualifications in his audit report accordingly.

8.5 Ind AS Indian Accounting Standards (Ind-AS) are the International Financial Reporting Standards (IFRS) converged standards issued by the Central Government of India under the supervision and control of Accounting Standards Board (ASB) of ICAI and in consultation with National Financial Reporting Authority (NFRA). The Ind AS are named and numbered in the same way as the corresponding International Financial Reporting Standards (IFRS). In July 2014, the Finance Minister of India at that time, Shri Arun Jaitely ji, in his Budget Speech, announced an urgency to converge the existing accounting standards with the International Financial Reporting Standards (IFRS) through adoption of the new Indian Accounting Standards (Ind AS) by the Indian companies from the financial year 2015-16 voluntarily and from the financial year 2016-17 on a mandatory basis.



Pursuant to the above announcement, various steps were taken to facilitate the implementation of IFRS-converged Indian Accounting Standards (Ind AS). Moving in this direction, the Ministry of Corporate Affairs (MCA) had issued the Companies (Indian Accounting Standards) Rules, 2015 vide Notification dated February 16, 2015 covering the revised roadmap of implementation of Ind AS for companies other than Banking companies, Insurance Companies and NBFCs and Indian Accounting Standards (Ind AS). Manner of Making Qualification Disclosure in the Audit Report - In making a qualification/disclosure in the audit report in respect of non-compliance with a Statement, SA, Accounting Standard or Guidance Note, the auditor should consider the materiality of the relevant item. Thus, the auditor need not make qualification/disclosure in respect of items which, in his judgement, are not material. While making a qualification, the auditor should follow the requirements of the ‘Statement on Qualifications in Auditor’s Report’ issued by the Institute. A disclosure, which is not a subject matter of audit qualification, should be made in the auditor’s report in a manner that it is clear to the reader that the disclosure does not constitute an audit qualification. The paragraph containing the auditor’s opinion on true and fair view should not include a reference to the paragraph containing the aforesaid disclosure. Examples of Qualifications/Disclosures in the Audit Report - Given below are some examples which illustrate the manner of making qualification/disclosure in the audit report. It may be clarified that these examples are aimed only at illustrating the manner of making qualifications/disclosures and are not intended in any way to be exhaustive.

Qualifications

(a) Where proper disclosures regarding changes in accounting policies have not been made by a company.

"The statement of profit and loss and balance sheet comply with the accounting standards referred to Section 133 of the Companies Act, 2013, except Accounting Standard (AS) 5, 'Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies', as the company has not disclosed in its accounts the fact of change, from this year, in the method of providing depreciation on plant and machinery from straight-line method to written-down value method, as also the effect of this change. As a result of this change, the net profit for the year, the net block as well as the reserves and surplus are lower by ` …. Each as compared to the position which would have prevailed had this change not been made.

Subject to the above, we report that ……..".

(b) Where a manufacturing company has accounted for interest income on receipt basis and not on time proportion basis.

"The statement of profit and loss and balance sheet comply with the accounting standards referred to in Section 133 of the Companies Act, 2013, except Accounting Standard (AS) 9, 'Revenue Recognitions', as the company has followed the policy of accounting for interest



income on receipt basis rather than on time proportion basis. As a result, the net profit for the year and the current assets are understated by `…… each as compared to the position which would have prevailed if the company had accounted for interest income on time proportion basis.

Subject to the above, we report that ….."

(c) Where an enterprise has capitalised financing costs related to certain fixed assets for periods after such assets were ready to be put to use.

"The statement of profit and loss and balance sheet comply with the accounting standards referred to in Section 133 of the Companies Act, 2013, except Accounting Standard (AS) 16, 'Borrowing Costs', as interest payable on borrowings related to the acquisition of fixed assets has been capitalised for the periods after which the assets were put to use. Consequently, the net profit for the year, the net block of fixed assets and the reserves and surplus have been overstated by `….. each as compared to the position which would have prevailed if the company had complied with the requirements of AS 16.

Subject to the above, we report that ……"

Disclosures (a) Where a company has not disclosed all significant accounting policies and has also

not disclosed the accounting policies at one place.

"The statement of profit and loss and balance sheet comply with the accounting standards referred to in Section 133 of the Companies Act, 2013, except Accounting Standard (AS) 1, 'Disclosure of Accounting Policies', as the company has disclosed those accounting policies the disclosure of which is required by the Companies Act, 2013. Other significant accounting policies, relating to treatment of research and development costs have not been disclosed nor have all the policies been disclosed at one place.

We report that ….."

(b) Where a sole proprietary concern enterprise follows cash basis of accounting.

"It is the policy of the enterprise to prepare its financial statements on the cash receipts and disbursements basis. On this basis revenue and the related assets are recognised when received rather than when earned, and expenses are recognised when paid rather than when the obligation is incurred.

In our opinion, the financial statements give a true and fair view of the assets and liabilities arising from cash transactions of …….. at ……… and of the revenue collected and expenses paid during the year then ended on the cash receipts and disbursements basis as described in Note X."



Applicability of Accounting Standards to Charitable and/or Religious Organisations - The Accounting Standards Board has received a query as to whether the accounting standards formulated by it are applicable to organisations whose objects are charitable or religious. The Board has considered this query and its views in the matter are set forth in the following paragraphs.

The Preface to the Statements of Accounting Standards states:

“The Institute will issue Accounting Standards for use in the presentation of the general purpose financial statements issued to the public by such commercial, industrial or business enterprises as may be specified by the Institute from time to time and subject to the attest function of its members”.

The reference to commercial, industrial or business enterprises in the aforesaid paragraph is in the context of the nature of activities carried on by an enterprise rather than with reference to its objects. It is quite possible that an enterprise has charitable objects but it carries on, either wholly or in part, activities of a commercial, industrial or business nature in furtherance of its objects. The Board believes that Accounting Standards apply in respect of commercial, industrial or business activities of any enterprise, irrespective of whether it is profit oriented or is established for charitable or religious purposes. Accounting Standards will not, however, apply to those activities which are not of a commercial, industrial or business nature. (e.g. an activity of collecting donations and giving them to flood affected people).

It is also clarified that exclusion of an entity from the applicability of the Accounting Standards would be permissible only if no part of the activity of such entity was commercial, industrial or business in nature. For the removal of doubts, it is clarified that even if a very small proportion of the activities of an entity were considered to be commercial, industrial or business in nature, then it could not claim exemption from the application of Accounting Standards. The Accounting standards would apply to all its activities including those which were not commercial, industrial or business in nature.

9. SQC 1 - QUALITY CONTROL FOR FIRMS THAT PERFORM AUDITS AND REVIEWS OF FINANCIAL STATEMENTS, AND OTHER ASSURANCE AND RELATED SERVICES ENGAGEMENTS

It is a mother Standard for all other Standards and is all pervasive Standard in respect of quality control. As the name suggests, the SQC 1 contains extensive requirements in relation to establishment and maintenance of a system of quality control (QC) in the audit firms as well as even for sole practitioners. The important elements of a system of quality control discussed by the Standard include Elements of a System of Quality Control, Leadership Responsibilities for Quality Within the Firm, Ethical Requirements – Independence, Acceptance and Continuation of Client


1.20 ADVANCED AUDITING AND PROFESSIONAL ETHICS Relationships and Specific Engagements, Human Resources - Assignment of Engagement Team, Engagement Performance - Consultation, Differences of Opinion, Engagement Quality Control Review and Documentation of the Engagement Quality Control Review - Engagement Documentation.

Introduction:

Scope This Standard on Quality Control (SQC) deals with A firm’s responsibilities for its system of quality control for Audits

and Reviews of financial statements, and other Assurance and related services engagements and

Consists of policies designed to achieve the objective set out in SQC.

Authority Applicable to all Professional Accountants Firms in respect of audits and reviews of financial statements, and other assurance and related services engagements.

The nature and extent of the policies and procedures will depend on the size and operating characteristics of the firm.

Effective Date

Systems of quality control in compliance with this SQC are required to be established by April 1, 2009

Objective

The objective of the firm is to establish and maintain a system of quality control to provide reasonable assurance that

(a) the firm and its personnel comply with the respective standards and regulatory and legal requirements; and

(b) Reports issued are appropriate in the circumstances.

Definitions

In this SQC the following terms have the meanings attributed below:

Engagement team All personnel performing an engagement, including any experts contracted by the firm in connection with that engagement.

Engagement partner The partner or other person in the firm who is a member of the Institute of Chartered Accountants of India and is in full time practice and is responsible for the engagement and its performance, and for the report that is issued on behalf of the firm, and who, where required, has the appropriate authority from a professional, legal or regulatory body.



Engagement quality control review

A process designed to provide an objective evaluation, before the report is issued, of the significant judgments the engagement team made and the conclusions they reached in formulating the report.

Engagement documentation

The record of work performed, results obtained, and conclusions the practitioner reached (terms such as “working papers” or “work-papers” are sometimes used).

Engagement quality control reviewer

A partner, other person (should be a member of the Institute of Chartered Accountants of India) in the firm, suitably qualified external person, or a team made up of such individuals, with sufficient and appropriate experience and authority to objectively evaluate, before the report is issued, the significant judgments the engagement team made and the conclusions they reached in formulating the report. However, in case the review is done by a team of individuals, such team should be headed by a member of the Institute.

Firm A sole practitioner, partnership or corporation or other entity of professional accountants.

Partner Any individual with authority to bind the firm with respect to the performance of a professional services engagement.

Professional standards Engagement standards, as defined in the AASB’s “Preface to the Standards on Quality Control, Auditing, Review, Other Assurance and Related Services,” and relevant ethical requirements as contained in the Code. TY

Reasonable assurance In the context of this SQC, a high, but not absolute, level of assurance.

Staff Professionals, other than partners, including any experts the firm employs.

Requirements

Complying, with relevant Requirements The Partners and Staff within the firm are responsible for establishing and maintaining the system and applying its requirements properly.

Elements of the System of Quality Control Leadership Responsibilities for

Quality within the Framework Establish Policies & Procedures to Design an internal culture recognising

Quality control. Firm’s chief executive officer or,



managing board of partners to assume ultimate responsibility for Quality Control

Person assigned has sufficient and appropriate experience and ability to adhere the responsibility.

Internal Culture recognising Quality Control includes compliances with Professional

Standards, Legal Compliances and Laws and Regulations.

Relevant Ethical Requirement Establish Policies and procedures designed to provide that the firm and its personnel comply with relevant ethical requirements of. (a) Integrity; (b) Objectivity; (c) Professional competence and due care; (d) Confidentiality; and (e) Professional behaviour.

Independence Establish Policies and procedures designed to maintain independence to Communicate its requirements to the

Management. Identify and evaluate circumstances and

relationships that create threats to independence, and to take appropriate action against them.

Resolutions on Breach of Independence. Written confirmation of compliance with

its policies and procedures on independence from all firm personnel.

Acceptance and Continuance of Client Relationships and Specific Engagements

Establish Policies and procedures for the acceptance/ continuance and withdrawal of client relationships and specific engagements, designed to provide the Firm is Competent to perform the

engagement. Has the capabilities, including time and

resources, ethical values Client integrity is available.



Human Resources & Engagement Performance

Establish Policies and Procedures designed to provide and assign sufficient personnel with the competence, capabilities, and

commitment to perform engagements with professional standards and

to issue reports that are appropriate in the circumstances

Monitoring Establish policies and procedures for Monitoring. Firm’s Quality Control Policies and

Procedures Evaluating, Communicating and

Remedying Identified Deficiencies Complaints and Allegations

Documentation of the System of Quality Control

Establish policies and procedures requiring appropriate documentation for Evidence of the operation of each

element of its system. Retention for a period of time sufficient to

permit those performing monitoring procedures to evaluate the firm’s compliance with its system of quality control, or for a longer period if required by law or regulation.

Complaints and allegations and the responses to them.

Depending upon the size of the firm and number of office and nature and complexity of the firm.

large firms may use electronic databases to document matters such as independence confirmations,

performance evaluations and the results of monitoring inspections. Smaller firms may use more informal methods in the documentation such as manual notes, checklists and forms.



10. SAs-BRIEF OVERVIEW 10.1 SA 200: Overall Objectives of the Independent Auditor and the

Conduct of an Audit in Accordance with Standards on Auditing It establishes the independent auditor’s overall responsibilities when conducting an audit of financial statements in accordance with SAs. Specifically, it sets out the overall objectives of the independent auditor, and explains the nature and scope of an audit designed to enable the independent auditor to meet those objectives. It also explains the scope, authority and structure of the SAs, and includes requirements establishing the general responsibilities of the independent auditor applicable in all audits, including the obligation to comply with the SAs. It has to be adapted as necessary in the circumstances when applied to audits of other historical financial information. This SA requires that the auditor to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error.

The SAs require that the auditor exercise professional judgment and maintain professional skepticism throughout the planning and performance of the audit and, among other things:

• Identify and assess risks of material misstatement, whether due to fraud or error, based on an understanding of the entity and its environment, including the entity’s internal control (further expounded in SA 315 and SA 330).

• Obtain sufficient appropriate audit evidence about whether material misstatements exist, through designing and implementing appropriate responses to the assessed risks (further expounded in SA 500 and SA 501).

• Form an opinion on the financial statements based on conclusions drawn from the audit evidence obtained (further expounded in SA 700, SA 705, SA 706 and SA 720).

This SA is effective for audits of financial statements for periods beginning on or after April 1, 2010.

10.2 SA 210: Agreeing the Terms of Audit Engagements It is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 26, “Terms of Audit Engagements” issued by the Institute in 2003. The revised Standard deals with the auditor’s responsibilities in agreeing the terms of audit engagement with management and, where appropriate, those charged with governance. SA 210 establishes certain preconditions for an audit, responsibility for which rests with management or those charged with governance. SA 210 also deals with the requirements relating to preconditions for an audit, agreement on audit engagement terms, recurring audits, acceptance of a change in the terms of the audit engagement and additional considerations in engagement acceptance. The appendices to revised SA 210 contain the illustrative example of an audit engagement letter and the factors determining the acceptability of general purpose frameworks.




10.3 SA 220: Quality Control for an Audit of Financial Statements SA 220 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 17, “Quality Control for Audit Work” issued by the Institute in 1999. The revised Standard deals with the specific responsibilities of the auditor regarding quality control procedures for an audit of financial statements. It also addresses, where applicable, the responsibilities of the engagement quality control reviewer. Revised SA 220 also deals with the aspects relating to leadership responsibilities for quality on audits, relevant ethical requirements, acceptance and continuance of client relationships and audit engagement, assignment of engagement teams, engagement performance, monitoring and documentation requirements.


10.4 SA 230: Audit Documentation SA 230 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 3, “Documentation” issued by the Institute in 1985. The new Standard deals with the auditor’s responsibility to prepare audit documentation for an audit of financial statements. SA 230 also deals with the requirements of timely preparation of audit documentation, documentation of the audit procedures performed and audit evidence obtained and assembly of the final audit file. SA 230 also outlines about vesting of property of working papers with the Auditor. SQC 1 read with SA 230 spells out two essential principles viz. period of maintaining working papers and assembly of audit file by the auditor.


10.5 SA 240: The Auditor’s Responsibility Relating to Fraud in an Audit of Financial Statements

The Standard adopts a risk-based approach to auditor’s responsibility relating to fraud in an audit of financial statements. It, therefore, explains how the principles enunciated in SA 315, “Identifying and Assessing the Risks of Material Misstatement

Through Understanding the Entity and Its Environment” and SA 330, “The Auditor’s Responses to Assessed Risks” would be applied in case of consideration of fraud in an audit of financial statements.




10.6 SA 250: Consideration of Laws and Regulations in an Audit of Financial Statements

SA 250 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 21, “Considerations of Laws and Regulations in an Audit of Financial Statements” issued by the Institute in 2001. The revised Standard deals with the auditor’s responsibility to consider laws and regulations when performing an audit of financial statements. Revised SA 250 also deals with the effect of laws and regulations, responsibility of management for compliance with laws and regulations, responsibility of the auditor, audit procedures and reporting of identified or suspected non-compliance and documentation requirements.


10.7 SA 260: Communication with Those Charged with Governance This Standard deals with the auditor’s responsibility to communicate with those charged with governance in an audit of financial statements. SA 260 also describes the requirements regarding communication with those charged with governance and regarding matter to be communicated and documentation required. This standard also spells out the distinction between the Management and Those Charged with Governance.

Although this SA applies irrespective of an entity’s governance structure or size, particular considerations apply where all of those charged with governance are involved in managing an entity, and for listed entities. This SA does not establish requirements regarding the auditor’s communication with an entity’s management or owners unless they are also charged with a governance role.


10.8 SA 265: Communicating Deficiencies in Internal Control to Those Charged with Governance and Management

SA 265 is a new Standard on Auditing which deals with the auditor’s responsibility to communicate appropriately to those charged with governance and management deficiencies in internal control that the auditor has identified in an audit of financial statements. SA 265 defines the terms “Deficiency in internal control” and “Significant deficiency in internal control”. This SA also deals with the aspects like determination of whether deficiencies in internal control have been identified, whether it is significant deficiencies in internal control and communicating deficiencies in internal control. This standard somehow supplements the concept of ‘Letter of Weakness.’




10.9 SA 299: Joint Audit of Financial Statements This SA deals with the special considerations in carrying out audit by joint auditors. Accordingly, in addition to the requirements enunciated in this Standard, the joint auditors also need to comply with all the relevant requirements of other applicable Standards on Auditing. This Standard deals with the special considerations in carrying out audit by joint auditors. The objectives of this Standard are to lay down broad principles for the joint auditors in conducting the joint audit, to provide a uniform approach to the process of joint audit, to identify the distinct areas of work and coverage thereof by each joint auditor and to identify individual responsibility and joint responsibility of the joint auditors in relation to audit.

This SA became effective for all audits relating to accounting periods commencing on or after April 1, 2018.

10.10 SA 300: Planning an Audit of Financial Statements This Standard on Auditing (SA) deals with the auditor’s responsibility to plan an audit of financial statements. As per this SA the objective of the auditor is to plan the audit so that it will be performed in an effective manner.


10.11 SA 315: Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment

The Standard deals with the auditor’s responsibility to obtain an understanding of the entity and its environment and using that understanding to identify and assess the risks of material misstatement at the financial statement level and assertion level.


10.12 SA 320: Materiality in Planning and Performing an Audit SA 320 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 13, “Audit Materiality” issued by the Institute in 1997. The revised Standard deals with the auditor’s responsibility to apply the concept of materiality in planning and performing an audit of financial statements. This SA also deals with the requirements of determining materiality and performance materiality when planning the audit, revision as the audit progresses and documentation requirements.




10.13 SA 330: The Auditor’s Responses to Assessed Risks SA 330 is a new Standard on Auditing which deals with the auditor’s responsibility to design and implement responses to the risks of material misstatement identified and assessed by the auditor in accordance with SA 315 at the financial statement level and assertion level. This SA also deals with the aspects relating to overall responses to assessed risks, audit procedures responsive to the assessed risks of material misstatement at the assertion level, adequacy of presentation and disclosure, evaluating the sufficiency and appropriateness of audit evidence and documentation requirements.


10.14 SA 402: Audit Considerations Relating to an Entity Using a Service Organisation

SA 402 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 24, “Audit Considerations Relating to Entities Using Service Organisations” issued by the Institute in 2002. The revised Standard deals with the user auditor’s responsibility to obtain sufficient appropriate audit evidence when a user entity uses the services of one or more service organizations. SA 402 also deals with the aspects like obtaining an understanding of the services provided by a service organisation, including internal control, responding to the assessed risks of material misstatement, Type 1 and Type 2 reports, fraud, non-compliance with laws and regulations and uncorrected misstatements in relation to activities at the service organisation and reporting by the user auditor. This SA is effective for audits of financial statements for periods beginning on or after April 1, 2010.

10.15 SA 450: Evaluation of Misstatements Identified During the Audit SA 450 is a new Standard on Auditing which deals with the auditor’s responsibility to evaluate the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements. SA 450 defines the terms “Misstatement” and “Uncorrected misstatements”. This SA also deals with the aspects like accumulation of identified misstatements, consideration of identified misstatements as the audit progresses, communication and correction of misstatements, evaluating the effect of uncorrected misstatements, written representation and documentation.


10.16 SA 500: Audit Evidence SA 500 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 5, “Audit Evidence” issued by the Institute in 1988. The revised Standard is quite detailed in terms of audit evidence in an audit of financial statements, and deals with the auditor’s responsibility to design and perform audit procedures to obtain sufficient appropriate audit evidence to be able to draw



reasonable conclusions on which to base the auditor’s opinion. This SA also deals with the requirements of obtaining sufficient appropriate audit evidence, how information to be used as audit evidence, how to select items for testing to obtain audit evidence and procedures in case of inconsistency in, or doubts over reliability of, audit evidence.


10.17 SA 501: Audit Evidence—Specific Considerations for Selected Items

SA 501 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 34, “Audit Evidence – Additional Considerations for Specific Items” issued by the Institute in 2005. The revised Standard deals with specific considerations by the auditor in obtaining sufficient appropriate audit evidence in accordance with SA 330, SA 500 (Revised) and other relevant SAs, with respect to certain aspects of inventory, litigation and claims involving the entity, and segment information in an audit of financial statements. Revised SA 501 also deals with the requirements and application of the aspects relating to inventory, litigation and claims and segment information.


10.18 SA 505: External Confirmations SA 505 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 30, “External Confirmations” issued by the Institute in 2003. The revised Standard deals with the auditor’s use of external confirmation procedures to obtain audit evidence in accordance with the requirements of SA 330. Revised SA 505 also deals with the requirements and application of the aspects relating to external confirmation procedures, management’s refusal to allow the auditor to send a confirmation request, results of the external confirmation procedures, negative confirmations and evaluating the evidence obtained.


10.19 SA 510: Initial Audit Engagements- Opening Balances SA 510 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 22, “Initial Engagements- Opening Balances” issued by the Institute in 2001. The revised Standard establishes the principles regarding audit of opening balances in case of initial engagements, i.e., when the financial statements are audited for the first time or when the financial statements for the preceding period were audited by another auditor. This SA also deals with the audit procedures and audit conclusions and reporting requirements in case of initial audit engagements.




10.20 SA 520: Analytical Procedures SA 520 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 14, “Analytical Procedures” issued by the Institute in 1997. The revised Standard deals with the auditor’s use of analytical procedures as substantive procedures (“substantive analytical procedures”), and as procedures near the end of the audit that assist the auditor when forming an overall conclusion on the financial statements.

Revised SA 520 also deals with the requirements and application of the aspects relating to substantive analytical procedures, analytical procedures that assist when forming an overall conclusion and investigating results of analytical procedures.


10.21 SA 530: Audit Sampling SA 530 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 15, “Audit Sampling” issued by the Institute in 1998. The revised Standard applies when the auditor has decided to use audit sampling in performing audit procedures. It also deals with the auditor’s use of statistical and non-statistical sampling when designing and selecting the audit sample, performing tests of controls and tests of details, and evaluating the results from the sample. This SA also deals with the requirements relating to sample design, size and selection of items for testing, performing audit procedures, nature and cause of deviations and misstatements, projecting misstatements and evaluating results of audit sampling. This SA contains four Appendices also.


10.22 SA 540: Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures

SA 540 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 18, “Audit of Accounting Estimates” issued by the Institute in 2000. The revised Standard deals with the auditor’s responsibilities regarding accounting estimates, including fair value accounting estimates, and related disclosures in an audit of financial statements. Specifically, it expands on how SA 315 and SA 330 and other SAs are to be applied in relation to accounting estimates. It also includes requirements and guidance on misstatements of individual accounting estimates, and indicators of possible management bias. Considering the application of Ind AS/ IFRS in times to come and resulting estimates to made, this Standard assumes special significance for the auditors.




10.23 SA 550: Related Parties SA 550 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 23, “Related Parties” issued by the Institute in 2001. The revised Standard deals with the auditor’s responsibilities regarding related party relationship and transactions when performing an audit of financial statements. This standard also deals with the risk assessment procedures and related activities, identification and assessment of the risks of material misstatement associated with related party relationships and transactions, responses to the risks of material misstatement associated with related party relationships and transactions and evaluation of the accounting for and disclosure of identified related party relationships and transactions etc.


10.24 SA 560: Subsequent Events SA 560 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 19, “Subsequent Events” issued by the Institute in 2000. The revised Standard deals with the auditor’s responsibilities relating to subsequent events in an audit of financial statements. SA 560 also deals with the events occurring between the date of the financial statements and the date of the auditor’s report, facts which become known to the auditor after the date of the auditor’s report but before the date the financial statements are issued and facts which become known to the auditor after the financial statements have been issued.


10.25 SA 570 Going Concern The revised Standard is quite detailed in terms of auditor’s responsibility in the audit of financial statements with respect to management’s use of the going concern assumption in the preparation and presentation of the financial statements. SA 570 requires the auditor to inquire of management as to its knowledge of events or conditions beyond the period of management’s assessment that may cast significant doubt on the entity’s ability to continue as a going concern. SA 570 also deals with the requirements of risk assessment procedures and related activities, evaluating management’s assessment, additional procedures, audit conclusions and reporting, use of going concern assumption etc. The standard also discusses the principles when mitigating factors are present vis-à-vis Going Concern of the enterprise.


10.26 SA 580: Written Representations SA 580 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 11, “Representations by Management” issued by the Institute in 1996. The revised Standard is quite


1.32 ADVANCED AUDITING AND PROFESSIONAL ETHICS detailed in terms of the duties and objectives of the auditors regarding the acknowledgement by the management that it is fulfilling its responsibility relating to preparation and presentation of financial statements and internal controls, the various forms of management representations, situations where management representations are unreliable or where the management refuses to provide requested representations.


10.27 SA 600: Using the Work of Another Auditor This SA discusses the procedures to be applied in situations where an independent auditor reporting on the financial statements of an entity, uses the work of an independent auditor with respect to the financial statements of one or more divisions or branches included in the financial statement of the entity. The Statement also discusses the principal auditor's responsibility in relation to his use of the work of other auditor. This Standard becomes operative for all audits relating to accounting periods beginning on or after April 1, 1995.

When the principal auditor uses the work of another auditor, the principal auditor should determine how the work of the other auditor will affect the audit.

The auditor should consider whether the auditor's own participation is sufficient to be able to act as the principal auditor.

When planning to use the work of another auditor, the principal auditor should consider the professional competence of the other auditor in the context of specific assignment if the other auditor is not a member of the Institute of Chartered Accountants of India.

The principal auditor should perform procedures to obtain sufficient appropriate audit evidence, that the work of the other auditor is adequate for the principal auditor's purposes, in the context of the specific assignment.

The principal auditor should consider the significant findings of the other auditor.

There should be sufficient liaison between the principal auditor and the other auditor.

The other auditor, knowing the context in which his work is to be used by the principal auditor, should co-ordinate with the principal auditor.

When the principal auditor concludes, based on his procedures, that the work of the other auditor cannot be used and the principal auditor has not been able to perform sufficient additional procedures regarding the financial information of the component audited by the other auditor, the principal auditor should express a qualified opinion or disclaimer of opinion because there is a limitation on the scope of audit.

When the principal auditor has to base his opinion on the financial information of the entity as a whole relying upon the statements and reports of the other auditors, his report should state clearly



the division of responsibility for the financial information of the entity by indicating the extent to which the financial information of components audited by the other auditors have been included in the financial information of the entity, e.g., the number of divisions/ branches/subsidiaries or other components audited by other auditors.

10.28 SA 610: Using the work of Internal Auditors This SA deals with the external auditor’s responsibilities if using the work of internal auditors. This includes (a) using the work of the internal audit function in obtaining audit evidence and (b) using internal auditors to provide direct assistance under the direction, supervision and review of the external auditor.

Furthermore, the requirements in this SA relating to direct assistance do not apply if the external auditor does not plan to use internal auditors to provide direct assistance.


10.29 SA 620: Using the Work of an Auditor’s Expert SA 620 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 9 “Using the Work of An Expert” issued by the Institute in 1991. The revised Standard deals with the auditor’s responsibilities regarding the use of an individual or organisation’s work in a field of expertise other than accounting or auditing, when that work is used to assist the auditor in obtaining sufficient appropriate audit evidence. Revised SA 620 also deals with the requirements and application of the aspects relating to determining the need for an auditor’s expert, nature, timing and extent of audit procedures, the competence, capabilities and objectivity of the auditor’s expert, obtaining an understanding of the field of expertise of the auditor’s expert, agreement with the auditor’s expert, evaluating the adequacy of the auditor’s expert’s and reference to the auditor’s expert in the auditor’s report. This standard should be read in conjunction with SA 500 because Expert’s opinion also serves as audit evidence in appropriate cases.


10.30 SA 700: Forming an Opinion and Reporting on Financial Statements

The revised Standard deals with the auditor’s responsibilities to form an opinion on the financial statements and the form and content of the auditor’s report issued as a result of an audit of financial statements. Revised SA 700 also deals with the requirements relating to forming an opinion on the financial statements, form of opinion, auditor’s report, supplementary information presented with the financial statements and the application guidance of these aspects. Appendix to revised SA 700 also contains the Illustrative Formats of Auditors’ Reports on Financial Statements.




10.31 SA 701: Communicating Key Audit Matters in the Independent Auditor’s Report

This Standard on Auditing (SA) deals with the auditor’s responsibility to communicate key audit matters in the auditor’s report. It is intended to address both the auditor’s judgment as to what to communicate in the auditor’s report and the form and content of such communication. The purpose of communicating key audit matters is to enhance the communicative value of the auditor’s report by providing greater transparency about the audit that was performed. Communicating key audit matters provides additional information to intended users of the financial statements (“intended users”) to assist them in understanding those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements of the current period. Communicating key audit matters may also assist intended users in understanding the entity and areas of significant management judgment in the audited financial statements.

The communication of key audit matters in the auditor’s report may also provide intended users a basis to further engage with management and those charged with governance about certain matters relating to the entity, the audited financial statements, or the audit that was performed.


10.32 SA 705: Modifications to the Opinion in the Independent Auditor’s Report

This Standard on Auditing (SA) deals with the auditor’s responsibility to issue an appropriate report in circumstances when, in forming an opinion in accordance with SA 700 (Revised), the auditor concludes that a modification to the auditor’s opinion on the financial statements is necessary. The objective of the auditor is to express clearly an appropriately modified opinion on the financial statements that are necessary when:

(a) The auditor concludes, based on the audit evidence obtained, that the financial statements as a whole are not free from material misstatement; or

(b) The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement.


10.33 SA 706: Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report

This Standard on Auditing (SA) deals with additional communication in the auditor’s report when the auditor considers it necessary to draw users’ attention to a matter or matters presented or disclosed in the financial statements that are of such importance that they are fundamental to users’ understanding of the financial statements; or draw users’ attention to any matter or matters other than those presented or disclosed in the financial statements that are relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report.



SA 7011 establishes requirements and provides guidance when the auditor determines key audit matters and communicates them in the auditor’s report. When the auditor includes a Key Audit Matters section in the auditor’s report, this SA addresses the relationship between key audit matters and any additional communication in the auditor’s report in accordance with this SA.


10.34 SA 710: Comparative Information—Corresponding Figures and Comparative Financial Statements

SA 710 is a revised version of the erstwhile Auditing and Assurance Standard (AAS) 25, “Comparatives” issued by the Institute in 2002. The revised Standard deals with the auditor’s responsibilities regarding comparative information in an audit of financial statements. This SA defines the terms ‘Corresponding figures’, ‘Comparative information’ and ‘Comparative financial statements’. Revised SA 710 also deals with the requirements and application of the aspects relating to audit procedures and audit reporting relating to Corresponding Figures and Comparative Financial Statements. Appendix to revised SA 710 contains the ‘Example of Auditors’ Reports’.


10.35 SA 720: The Auditor’s Responsibility Relating to Other Information

This Standard on Auditing (SA) deals with the auditor’s responsibilities relating to other information, whether financial or non-financial information (other than financial statements and the auditor’s report thereon), included in an entity’s annual report. An entity’s annual report may be a single document or a combination of documents that serve the same purpose. This SA requires the auditor to read and consider the other information because other information that is materially inconsistent with the financial statements or the auditor’s knowledge obtained in the audit may indicate that there is a material misstatement of the financial statements or that a material misstatement of the other information exists, either of which may undermine the credibility of the financial statements and the auditor’s report thereon. Such material misstatements may also inappropriately influence the economic decisions of the users for whom the auditor’s report is prepared.


(Note: Till the time Statements, Engagement and Quality Control Standards, Guidance Notes etc. bare document gets updated from Auditing and Assurance Standard Board of ICAI in pursuance of the Companies Act, 2013, students are required to understand the basic nature of the provision and quote the same along with the new corresponding provisions. Further, students may note that the Framework of Standards, Engagement and Quality Control Standards and Guidance Notes on Related Services are reproduced in Auditing Pronouncements)

1 SA 701, Communicating Key Audit Matters in the Independent Auditor’s Report



TEST YOUR KNOWLEDGE Theoretical Questions 1. (a) ABC Company files a law suit against Unlucky Company for ` 5 crores. The Attorney

of Unlucky Company feels that the suit is without merit, so Unlucky Company merely discloses the existence of the law suit in the notes accompanying its financial statements. As an auditor of Unlucky Company, how will you deal with the situation?

(b) T & Co. wants to issue a prospectus, to provide potential investors with information about future expectations of the Company. You are hired by T & Co. to examine the projected financial statements and give report thereon. What things you will consider before accepting the audit engagement and what audit evidence will be obtained for reporting on projected financial statements?

(c) In the course of audit of K Ltd., its auditor Mr. 'N' observed that there was a special audit conducted at the instance of the management on a possible suspicion of a fraud and requested for a copy of the report to enable him to report on the fraud aspects. Despite many reminders it was not provided. In absence of the special audit report, Mr. 'N' insisted that he be provided with at least a written representation in respect of fraud on/by the company. For this request also, the management remained silent. Please guide Mr. 'N'.

(d) During the course of audit of Star Limited the auditor received some of the confirmation of the balances of trade payables outstanding in the balance sheet through external confirmation by negative confirmation request. In the list of trade payables, there are number of trade payables of small balances except one, old outstanding of ` 15 Lacs, of whom, no confirmation on the credit balance received. Comment with respect to Standard of Auditing.

2. (a) Mr. Z who is appointed as auditor of Elite Co. Ltd. wants to use confirmation request as audit evidence during the course of audit. What are the factors to be considered by Mr. Z when designing a confirmation request? Also state the effects of using positive external confirmation request by Mr. Z.

(b) R & M Co. wants to be alert on the possibility of non-compliance with Laws and Regulations during the course of audit of SRS Ltd. R & M Co. seeks your guidance for identifying the indications of non-compliance with Laws and Regulations.

3. KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y and Mr. Z as joint auditors to conduct auditing for the financial year 2018-19. For the valuation of gratuity scheme of the company, Mr. X, Mr. Y and Mr. Z wanted to refer their own known Actuaries. Due to difference of opinion, all the joint auditors consulted their respective Actuaries. Subsequently, major difference was found in the actuary reports. However, Mr. X agreed to



Mr. Y’s actuary report, though, Mr. Z did not. Mr. X contends that Mr. Y’s actuary report shall be considered in audit report due to majority of votes. Now, Mr. Z is in dilemma.

(a) You are required to briefly explain the responsibilities of auditors when they are jointly and severally responsible in respect of audit conducted by them and also guide Mr. Z in such situation.

(b) Explain the responsibility of auditors, in case, report made by Mr. Y’s actuary, later on, found faulty.

4. (a) As an auditor of RST Ltd. Mr. P applied the concept of materiality for the financial statements as a whole. On the basis of obtaining additional information of significant contractual arrangements that draw attention to a particular aspect of a company's business, he wants to re-evaluate the materiality concept. Please, guide him.

(b) When a sub-service organization performs services for a service organization, there are two alternative methods of presenting the description of controls. The service organization determines which method will be used. As a user auditor what information would you obtain about controls at a sub-service organization?

(c) In an initial audit engagement the auditor will have to satisfy about the sufficiency and appropriateness of ‘Opening Balances' to ensure that they free from misstatements, which may materially affect the current financial statements. Lay down the audit procedure, you will follow, when financial statements are audited for the first time. If, after performing the procedure, you are not satisfied about the correctness of 'Opening Balances', what approach you will adopt in drafting your audit report?

5. An auditor of Sagar Ltd. was not able to get the confirmation about the existence and value of certain machineries. However, the management gave him a certificate to prove the existence and value of the machinery as appearing in the books of account. The auditor accepted the same without any further procedure and signed the audit report. Is he right in his approach?

Multiple Choice Questions 1. PMP Ltd is an associate of PMP Inc, a company based in Kuwait. PMP Ltd is listed in India

having its corporate office at Assam. The company’s operations have remained stable over the years and the management is looking to expand the operations for which the management is considering different business ventures.

The company’s auditors issued clean audit report on the audit of the financial statements for the year ended 31 March 2018.

For the financial year ended 31 March 2019, the auditors made some changes in their audit team. While the audit partner remained the same, the field incharge has been replaced as



the field incharge who was engaged in the audit of the financial statements for the year ended 31 March 2018 has left the firm. The audit team has a new person as External Quality Control Reviewer (EQCR) who has specialized knowledge of the industry in which the company is operating. EQCR has been employed with the firm for over 2.5 years and is yet to clear his CA (Chartered Accountancy) final exams. The changes were made on the basis of the consideration that the the firm has enough experience of engagement with this client.

The audit team commenced the work for audit of the year ended 31 March 2019 after detailed planning and it was observed that EQCR had various comments on certain matters which were not accepted by the audit partner. Audit partner had better understanding of the client and after assessing the comments of the EQCR did not find those relevant.

The audit partner without concurrence of the EQCR finalized the audit and issued the audit report.

In the given situation, please advise which one of the following is correct?

(a) The changes in the audit team were not appropriate except for the field incharge who had left the firm. EQCR should have been a member of the Institute of Chartered Accountants of India (ICAI).

(b) The audit partner did the right thing by ignoring the comments of EQCR as he is the final authority to decide on any matter and take decisions. Further EQCR was junior to the audit partner.

(c) The audit partner must discuss each and every comment of EQCR with the client and ensure that a proper disclosure in respect of those points should be made either in the financial statements or the audit report.

(d) EQCR had sufficient and appropriate experience. He should have been given the authority to objectively evaluate various matters, before the report is issued, the significant judgments the engagement team made and the conclusions they reached in formulating the report. By ignoring the comments of the EQCR, audit partner took additional professional responsibility on himself. By considering the comments of EQCR, he could have passed the responsibility to EQCR.

2. VKPL & Associates, a firm of Chartered Accountants, have been operating for the last 5 years having its office in Gurgaon. The firm has staff of around 25 persons with 3 Partners.

The firm has been offering statutory audit, risk advisory and tax services to its various clients. The major work of the firm is for taxation services. The audit partners also discussed that the firm needs to work significantly to improve the quality of the services they offer and that would also help the firm to grown its business. Considering this objective, the firm started training programmes for the staff which were made mandatory to be attended.



During one of the training programmes on quality, a topic was discussed regarding the information that should be obtained by the firm before accepting an engagement with a new client, when deciding whether to continue an existing engagement, and when considering acceptance of a new engagement with an existing client. It was explained that the following points may assist the engagement partner in determining whether the conclusions reached regarding the acceptance and continuance of client relationships and audit engagements are appropriate (as per SA 220):

(i) The integrity of the principal owners, key management and those charged with governance of the entity;

(ii) The qualification of all the employees of the entity;

(iii) Whether the engagement team is competent to perform the audit engagement and has the necessary capabilities, including time and resources;

(iv) The remuneration offered by the entity to its various consultants;

(v) Whether the firm and the engagement team can comply with relevant ethical requirements; and

(vi) Significant matters that have arisen during the current or previous audit engagement, and their implications for continuing the relationship.

We would like to understand from you which of the above mentioned points are relevant for the topic under discussion?

(a) i, ii, iv and v.

(b) ii, iv, v and vi.

(c) iii, iv, v and vi.

(d) i, iii, v and vi.

3. ZOV is a private limited company engaged in the business of mining. The company’s operations are fairly large and its turnover is INR 4,000 crores on an annual basis. Due to the nature of the business and the size of the company, the company has appointed a firm of Chartered Accountants as its statutory auditors who have the relevant experience of the industry in which the company has been operating.

During the course of the audit of the financial statements for the year ended 31 March 2019, the audit team had various observations which resulted in many adjustments in the financial statements of the company and that was also appreciated by the CFO of the company.

At the time of final reviews of the audit team, the audit partner requested working paper on final analytical procedures from the engagement team, however, the engagement team explained that they performed substantive testing procedures which also resulted in some adjustments and the same was incorporated in the final set of financial statements given to



the audit partner for the review and accordingly there was no need to perform final analytical procedures. Audit partner was not convinced with this and requested the engagement team to perform this procedure. Considering that the timeline to conclude the audit was approaching, the audit partner also requested the CFO that the audit team would need some more time to perform final analytical procedures. CFO was very impressed with the engagement team and agreed for the time but he also told the audit partner that work of the team was excellent and hence the audit partner should avoid these additional procedures.

You are requested to give your view in respect of this matter as per SA 520.

(a) The explanation of the audit team was correct. After doing substantive testing which also resulted in audit adjustments, there was no need to perform final analytical procedures.

(b) The suggestion of CFO should have been considered by the audit partner as the CFO was observing the work of the engagement team and hence he could assess that better than the audit partner.

(c) The requirement in view of the audit partner was valid. The conclusions drawn from the results of final analytical procedures are intended to corroborate conclusions formed during the audit of individual components or elements of the financial statements.

(d) The audit team did the right thing by not performing final analytical procedures, however, one additional procedure in that case should have been - obtain the document containing the analysis performed by the client on the financial statements. This document is required to be assembled in the audit file.

4. BDJ Private Ltd was established in 2001 and since then the company’s operations have grown significantly. The company is based in Kanpur and has branch offices outside Kanpur.

The company is engaged in tours and travels business and because of the nature of the business, it has voluminous transactions. The annual turnover of the company is INR 700 crores.

During the audit of the financial statements of the company for the year ended 31 March 2019, the auditors observed wide variation in various details of sales and various expenses as compared to last year. Various balances of trade receivables, loans and advances, statutory liabilities showed significant increase and many balances were found to be non-moving which were aged for more than 3 years.

On the basis of the materiality and planned procedures, the audit team requested the client for testing of various samples for sales, expenses etc. The client observed that the number of samples that the team has requested increased as compared to last year and asked the



team to cut down on the number of samples so that it is the same number of samples which were tested in the previous years.

The audit team did not agree with this and explained various factors which the team had considered for sample selection and the reasons for changes in the samples and also explained the requirements of SA 530 to the client but the client still did not agree.

Now there is a situation of deadlock and you are requested to provide your guidance to resolve this matter.

(a) The argument of the client is not valid. Sample selection is based on certain principles as per SA 530 and that is on the assessment of the audit team. It may change year on year and hence the client should provide the required information to the audit team.

(b) The explanation of the audit team is not valid. Referring SA 530 was not correct in this case. The audit team should have explained their entire approach around risk assessment to the client before starting the fieldwork and should have formally shared that with the client in writing.

(c) In the given situation, the audit team instead of getting into any arguments should cut down the number of samples and should increase their procedures around analytical work. That would resolve the problem.

(d) The audit team should make a formal request in writing for these details from the client and if the client still refuses then they should report this matter to the audit partner. In that case, the auditing standards require audit partner to check some of the documents which may not be provided by the client to the audit team.

5. SKJ Private Ltd is engaged in the business of construction. The company has also got some real estate projects few years back on which it started the work in the last 2 years. The annual turnover of the company is INR 600 crores and profits of INR 40 crores.

The statutory auditors of the company got rotated by another audit firm due to mandatory audit rotation requirements as per the Companies Act 2013.

The new statutory auditors of the company started audit of the financial statements for the year ended 31 March 2019 in May 2019. The audit team also requested the client to provide certain information on the opening balances to perform their audit procedures. Initially the management did not provide any information to the auditors on the opening balances thinking that this is not within the scope of their work, however, after going through the auditing standards, the management agreed and provided the required information.

Later on, the audit team also started requesting information for the period from 1 April 2019 to 31 May 2019. With this requirement, CFO of the company got very upset and angry and set up a meeting with the senior members of the audit team. CFO raised a concern that the



audit team has not been doing the work properly and has been asking for unnecessary information like information on opening balances and then the information for the period after 31 March 2019. The audit partner explained to the CFO that everything requested by the audit team has been as per the auditing standards, however, CFO said that in the earlier years, the previous auditors never asked for such information.

You are requested to give your view in respect of this matter.

(a) The requirement of the auditors for opening balances was valid but for the period after 31 March 2019 is completely wrong as that is out of their scope for the current year’s audit. They can ask for those details during the audit of next year.

(b) The concern of the CFO was valid. He has seen the previous auditors not performing such audit procedures and hence the new audit team should also follow the same approach which was followed by previous auditors as that would lead to efficient in audit.

(c) The audit team should set up a meeting with previous auditors wherein it should be assessed why different approach was followed by the previous auditors. On the basis of that discussion with the previous auditors, next course of action should be decided.

(d) The requirement of the auditors for opening balances as well as for the period after 31 March 2019 is valid. After the requirements of SA 510 and SA 560, audit team is required to perform these procedures.

Answers to Theoretical Questions 1. (a) Existence of Contingent Liability: As per AS 29 "Provisions, Contingent liabilities

and Contingent Assets", a contingent liability is a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise.

Further, future events that may affect the amount required to settle an obligation should be reflected in the amount of a provision where there is sufficient objective evidence that the event will occur.

As per SA 570 “Going Concern”, there are certain examples of events or conditions that, individually or collectively, may cast significant doubt about the going concern assumption. Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that the entity is unlikely to be able to satisfy is one of the example of such event.

When the auditor concludes that the use of the going concern assumption is appropriate in the circumstances but a material uncertainty exists, the auditor shall



determine whether the financial statements adequately describe the principal events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern and management’s plans to deal with these events or conditions; and disclose clearly that there is a material uncertainty related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern and, therefore, that it may be unable to realize its assets and discharge its liabilities in the normal course of business.

In the instant case, ABC Company has filed a law suit against Unlucky Company for ` 5 crores. Though, the attorney of Unlucky Company feels that the suit is without merit so the company merely discloses the existence of law suit in the notes accompanying its financial statements. But the auditor may evaluate the source data on which basis the opinion is formed. If the auditor finds the uncertainty, he may request the management to adjust the sum of ` 5 crore by making provision for expenses as per AS 29. If the management does not accept the request the auditor should qualify the audit report.

(b) Projected Financial Statements: As per SAE 3400, “The Examination of Prospective Financial Information”, the answer is divided into two parts i.e. (i) the things to be considered before accepting the engagement and (ii) audit evidence to be obtained for reporting on projected financial statements.

(i) Acceptance of Engagement: As per SAE 3400, “The Examination of Prospective Financial Information”, before accepting an engagement to examine prospective financial information, the auditor would consider, amongst other things:

(1) the intended use of the information;

(2) whether the information will be for general or limited distribution;

(3) the nature of the assumptions, that is, whether they are best-estimates or hypothetical assumptions;

(4) the elements to be included in the information; and

(5) the period covered by the information.

Further, the auditor should not accept, or should withdraw from, an engagement when the assumptions are clearly unrealistic or when the auditor believes that the prospective financial information will be inappropriate for its intended use.

In accordance with SA 210, “Terms of Audit Engagement”, it is necessary that the auditor and the client should agree on the terms of the engagement.

(ii) Audit evidence to be obtained for Reporting on Projected Financial



Statements: The auditor should document matters, which are important in providing evidence to support his report on examination of prospective financial information, and evidence that such examination was carried out.

The audit evidence in form of working papers will include:

(1) the sources of information,

(2) basis of forecasts,

(3) the assumptions made in arriving the forecasts,

(4) hypothetical assumptions, evidence supporting the assumptions,

(5) management representations regarding the intended use anddistribution of the information, completeness of material assumptions,

(6) management’s acceptance of its responsibility for the information,

(7) audit plan,

(8) the nature, timing and extent of examination procedures performed,and,

(9) in case the auditor expresses a modified opinion or withdraws from theengagement, the reasons forming the basis of such decision.

(c) Auditor’s Responsibilities Relating to Fraud: As per SA 240 on “The Auditor’sResponsibilities Relating to Fraud in an Audit of Financial Statements”, the auditor isresponsible for obtaining reasonable assurance that the financial statements, takenas a whole, are free from material misstatement, whether caused by fraud or error.

As per SA 580 “Written Representations”, if management modifies or does notprovide the requested written representations, it may alert the auditor to thepossibility that one or more significant issues may exist.

In the instant case, the auditor observed that there was a special audit conducted atthe instance of the management on a possible suspicion of fraud. Therefore, theauditor requested for special audit report which was not provided by themanagement despite of many reminders. The auditor also insisted for writtenrepresentation in respect of fraud on/by the company. For this request alsomanagement remained silent.

It may be noted that, if management does not provide one or more of the requestedwritten representations, the auditor shall discuss the matter with management; re-evaluate the integrity of management and evaluate the effect that this may have onthe reliability of representations (oral or written) and audit evidence in general; andtake appropriate actions, including determining the possible effect on the opinion inthe auditor’s report.



Further, as per section 143(12) of the Companies Act, 2013, if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the Central Government (in case amount of fraud is ` 1 crore or above)or Audit Committee or Board in other cases (in case the amount of fraud involved is less than ` 1 crore) within such time and in such manner as may be prescribed.

The auditor is also required to report as per Clause (x) of Paragraph 3 of CARO, 2016, Whether any fraud by the company or any fraud on the company by its officers or employees has been noticed or reported during the year; If yes, the nature and the amount involved is to be indicated.

If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters exceptional circumstances that bring into question the auditor’s ability to continue performing the audit, the auditor shall:

(i) Determine the professional and legal responsibilities applicable in thecircumstances, including whether there is a requirement for the auditor toreport to the person or persons who made the audit appointment or, in somecases, to regulatory authorities;

(ii) Consider whether it is appropriate to withdraw from the engagement, wherewithdrawal from the engagement is legally permitted; and

(iii) If the auditor withdraws:

(1) Discuss with the appropriate level of management and those chargedwith governance, the auditor’s withdrawal from the engagement andthe reasons for the withdrawal; and

(2) Determine whether there is a professional or legal requirement toreport to the person or persons who made the audit appointment or, insome cases, to regulatory authorities, the auditor’s withdrawal from theengagement and the reasons for the withdrawal.

(d) External Confirmation: As per SA 505, “External Confirmation”, NegativeConfirmation is a request that the confirming party respond directly to the auditoronly if the confirming party disagrees with the information provided in the request.Negative confirmations provide less persuasive audit evidence than positiveconfirmations.

The failure to receive a response to a negative confirmation request does notexplicitly indicate receipt by the intended confirming party of the confirmation requestor verification of the accuracy of the information contained in the request.Accordingly, a failure of a confirming party to respond to a negative confirmation



request provides significantly less persuasive audit evidence than does a response to a positive confirmation request. Confirming parties also may be more likely to respond indicating their disagreement with a confirmation request when the information in the request is not in their favor, and less likely to respond otherwise.

In the instant case, the auditor sent the negative confirmation requesting the trade payables having outstanding balances in the balance sheet while doing audit of Star Limited. One of the old outstanding of ` 15 lacs has not sent the confirmation on the credit balance. In case of non response, the auditor may examine subsequent cash disbursements or correspondence from third parties, and other records, such as goods received notes. Further non response for negative confirmation request does not means that there is some misstatement as negative confirmation request itself is to respond to the auditor only if the confirming party disagrees with the information provided in the request.

But, if the auditor identifies factors that give rise to doubts about the reliability of the response to the confirmation request, he shall obtain further audit evidence to resolve those doubts.

2. (a) As per SA 505, “External Confirmation”, factors to be considered when designing confirmation requests include:

(i) The assertions being addressed.

(ii) Specific identified risks of material misstatement, including fraud risks.

(iii) The layout and presentation of the confirmation request.

(iv) Prior experience on the audit or similar engagements.

(v) The method of communication (for example, in paper form, or by electronic or other medium).

(vi) Management’s authorisation or encouragement to the confirming parties to respond to the auditor. Confirming parties may only be willing to respond to a confirmation request containing management’s authorisation.

(vii) The ability of the intended confirming party to confirm or provide the requested information (for example, individual invoice amount versus total balance).

A positive external confirmation request asks the confirming party to reply to the auditor in all cases, either by indicating the confirming party’s agreement with the given information, or by asking the confirming party to provide information. A response to a positive confirmation request ordinarily is expected to provide reliable audit evidence. There is a risk, however, that a confirming party may reply to the confirmation request without verifying that the information is correct. The auditor may



reduce this risk by using positive confirmation requests that do not state the amount (or other information) on the confirmation request, and ask the confirming party to fill in the amount or furnish other information. On the other hand, use of this type of “blank” confirmation request may result in lower response rates because additional effort is required of the confirming parties.

(b) As per SA 250, “Consideration of Laws and Regulations, the auditor shall perform the audit procedures to help identify instances of non-compliance with other laws and regulations that may have a material effect on the financial statements by inquiring of management and, where appropriate, those charged with governance, as to whether the entity is in compliance with such laws and regulations; and Inspecting correspondence, if any, with the relevant licensing or regulatory authorities.

However, when the auditor becomes aware of the existence of, or information about, the following matters, it may also be an indication of non-compliance with laws and regulations:

Investigations by regulatory organisations and government departments or payment of fines or penalties.

Payments for unspecified services or loans to consultants, related parties, employees or government employees.

Sales commissions or agent’s fees that appear excessive in relation to those ordinarily paid by the entity or in its industry or to the services actually received.

Purchasing at prices significantly above or below market price.

Unusual payments in cash, purchases in the form of cashiers’ cheques payable to bearer or transfers to numbered bank accounts.

Unusual payments towards legal and retainership fees.

Unusual transactions with companies registered in tax havens.

Payments for goods or services made other than to the country from which the goods or services originated.

Payments without proper exchange control documentation.

Existence of an information system which fails, whether by design or by accident, to provide an adequate audit trail or sufficient evidence.

Unauthorised transactions or improperly recorded transactions.

Adverse media comment.

3. (a) Difference of Opinion Among Joint Auditors: SA 299 on, “Joint Audit of Financial Statements” deals with the professional responsibilities, which the auditors



undertake in accepting such appointments as joint auditors. In respect of the work divided amongst the joint auditors, each joint auditor is responsible only for the work allocated to him, whether or not he has made a separate report on the work performed by him. On the other hand the joint auditors are jointly and severally responsible in respect of the audit conducted by them as under:

(i) in respect of the audit work which is not divided among the joint auditors and is carried out by all of them;

(ii) in respect of decisions taken by all the joint auditors under audit planning in respect of common audit areas concerning the nature, timing and extent of the audit procedures to be performed by each of the joint auditors;

(iii) in respect of matters which are brought to the notice of the joint auditors by any one of them and on which there is an agreement among the joint auditors;

(iv) for examining that the financial statements of the entity comply with the requirements of the relevant statute;

(v) for ensuring presentation and disclosure of the financial statements as required by the applicable financial reporting framework;

(vi) for ensuring that the audit report complies with the requirements of the relevant statutes, the applicable Standards on Auditing and the other relevant pronouncements issued by ICAI.

(vi) it is the separate and specific responsibility of each joint auditor to study and evaluate the prevailing system of internal control relating to the work allocated to him, the extent of enquiries to be made in the course of his audit;

(vii) the responsibility of obtaining and evaluating information and explanation from the management is generally a joint responsibility of all the auditors;

(viii) each joint auditor is entitled to assure that the other joint auditors have carried out their part of work in accordance with the generally accepted audit procedures and therefore it would not be necessary for joint auditor to review the work performed by other joint auditors.

Where, in the course of the audit, a joint auditor comes across matters which are relevant to the areas of responsibility of other joint auditors and which deserve their attention, or which require disclosure or require discussion with, or application of judgment by other joint auditors, the said joint auditor shall communicate the same to all the other joint auditors in writing prior to the completion of the audit.

Normally, the joint auditors are required to issue common audit report, however, where the joint auditors are in disagreement with regard to the opinion or any matters to be covered by the audit report, they shall express their opinion in a



separate audit report. A joint auditor is not bound by the views of the majority of the joint auditors regarding the opinion or matters to be covered in the audit report and shall express opinion formed by the said joint auditor in separate audit report in case of disagreement. In such circumstances, the audit report(s) issued by the joint auditor(s) shall make a reference to the separate audit report(s) issued by the other joint auditor(s). Further, separate audit report shall also make reference to the audit report issued by other joint auditors. Such reference shall be made under the heading “Other Matter Paragraph” as per Revised SA 706, “Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report”.

In the instant case, there are three auditors, namely, Mr. X, Mr. Y and Mr. Z, jointly appointed as an auditor of KRP Ltd. For the valuation of gratuity scheme of the Company they referred their own known Actuaries. Mr. Z (one of the joint auditor) is not satisfied with the report submitted by Mr. Y’s referred actuary. He is not agreed with the matters to be covered by the report whereas Mr. X agreed with the same.

Hence, as per SA 299, Mr. Z is suggested to express his own opinion through a separate report whereas Mr. X and Mr. Y may provide their joint report for the same.

(b) Using the work of an Auditor’s Expert: As per SA 620 “Using the Work of an Auditor’s Expert”, the expertise of an expert may be required in the actuarial calculation of liabilities associated with insurance contracts or employee benefit plans etc., however, the auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the auditor’s use of the work of an auditor’s expert.

The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes, including the relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other audit evidence as per SA 500.

Further, in view of SA 620, if the expert’s work involves use of significant assumptions and methods, then the relevance and reasonableness of those assumptions and methods must be ensured by the auditor and if the expert’s work involves the use of source data that is significant to that expert’s work, the relevance, completeness, and accuracy of that source data in the circumstances must be verified by the auditor.

In the instant case, Mr. X, Mr. Y and Mr. Z, jointly appointed as an auditor of KRP Ltd., referred their own known Actuaries for valuation of gratuity scheme. Actuaries are an auditor’s expert as per SA 620. Mr. Y’s referred actuary has provided the gratuity valuation report, which later on found faulty. Further, Mr. Z is not agreed with this report therefore he submitted a separate audit report specifically for such gratuity valuation.

In such situation, it was duty of Mr. X, Mr. Y and Mr. Z, before using the gratuity valuation report of Actuary, to ensure the relevance and reasonableness of assumptions and methods used. They were also required to examine the relevance,



completeness and accuracy of source data used for such report before expressing their opinion.

Mr. X and Mr. Y will be held responsible for grossly negligence and using such faulty report without examining the adequacy of expert actuary’s work whereas Mr. Z will not be held liable for the same due to separate opinion expressed by him.

4. (a) Re-evaluation of the Materiality Concept: In the instant case, Mr. P, as an auditor of RST Ltd. has applied the concept of materiality for the financial statements as a whole. But he wants to re-evaluate the materiality concept on the basis of additional information of significant contractual arrangements which draws attention to a particular aspect of the company’s business.

As per SA 320 “Materiality in Planning and Performing an Audit”, while establishing the overall audit strategy, the auditor shall determine materiality for the financial statement as a whole. He should set the benchmark on the basis of which he performs his audit procedure. If, in the specific circumstances of the entity, there is one or more particular classes of transactions, account balances or disclosures for which misstatements of lesser amounts than the materiality for the financial statements as a whole could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements, the auditor shall also determine the materiality level or levels to be applied to those particular classes of transactions, account balances or disclosures.

The auditor shall revise materiality for the financial statements in the event of becoming aware of information during the audit that would have caused the auditor to have determined a different amount (or amounts) initially.

If the auditor concludes a lower materiality for the same, then he should consider the fact that whether it is necessary to revise performance materiality and whether the nature, timing and extent of the further audit procedures remain appropriate.

Thus, Mr. P can re-evaluate the materiality concepts after considering the necessity of such revision.

(b) Controls at a Sub-Service Organisation: In accordance with SA 402 “Audit Considerations relating to an Entity Using a Service Organisation”, a user entity may use a service organisation that in turn uses a sub-service organisation to provide some of the services provided to a user entity that are part of the user entity’s information system relevant to financial reporting. The sub-service organisation may be a separate entity from the service organisation or may be related to the service organisation. A user auditor may need to consider controls at the sub-service organisation. In situations where one or more sub-service organisations are used, the interaction between the activities of the user entity and those of the service organisation is expanded to include the interaction between the user entity, the service organisation and the sub-service organisations. The degree of this interaction, as well as the nature and materiality of the transactions processed by the service organisation and



the sub-service organisations are the most important factors for the user auditor to consider in determining the significance of the service organisation’s and sub-service organisation’s controls to the user entity’s controls. Further, the user auditor shall determine whether a sufficient understanding of the nature and significance of the services provided by the service organisation and their effect on the user entity's internal control relevant to the audit has been obtained to provide a basis for the identification and assessment of risks of material misstatement. If the user auditor is unable to obtain a sufficient understanding from the user entity, the user auditor shall obtain that understanding by application of the following two methods of presenting description of internal controls i.e. (i) Type 1 report; or (ii) Type 2 report. If a service organisation uses a subservice organisation, the service auditor's report may either include or exclude the subservice organisation's relevant control objectives and related controls in the service organisation's description of its system and in the scope of the service auditor's engagement. These two methods of reporting are known as the inclusive method and the carve-out method respectively. In either method, the service organisation includes in its description of controls a description of the functions and nature of the processing performed by the sub-service organisation. If the Type 1 or Type 2 report excludes the control at a subservice organization and the services provided by the subservice organization are relevant to the audit of the user entity’s financial statements, the user auditor is required to apply the requirements of the SA 402 in respect of the subservice organization. The nature and extent of work to be performed by the user auditor regarding the services provided by a subservice organization depend on the nature and significance of those services to the user entity and relevance of those services to the audit.

(c) Audit Procedure for ensuring correctness of Opening Balances: As per SA 510 “Initial Audit Engagements-Opening Balances”, the auditor shall obtain sufficient appropriate audit evidence about whether the opening balances contain misstatements that materially affect the current period’s financial statements by - (i) Determining whether the prior period’s closing balances have been correctly

brought forward to the current period or, when appropriate, any adjustments have been disclosed as prior period items in the current year’s Statement of Profit and Loss;

(ii) Determining whether the opening balances reflect the application of appropriate accounting policies; and

(iii) By evaluating whether audit procedures performed in the current period provide evidence relevant to the opening balances; or performing specific audit procedures to obtain evidence regarding the opening balances.



If the auditor obtains audit evidence that the opening balances contain misstatements that could materially affect the current period’s financial statements, the auditor shall perform such additional audit procedures as are appropriate in the circumstances to determine the effect on the current period’s financial statements. If the auditor concludes that such misstatements exist in the current period’s financial statements, the auditor shall communicate the misstatements with the appropriate level of management and those charged with governance.

Approach for drafting Audit Report: If the auditor concludes that the opening balances contain a misstatement that materially affects the current period’s financial statements and the effect of the misstatement is not properly accounted for or not adequately presented or disclosed, the auditor shall express a qualified opinion or an adverse opinion, as appropriate, in accordance with SA 705 and in case where the auditor is unable to obtain sufficient appropriate audit evidence regarding the opening balances, the auditor shall express a qualified opinion or a disclaimer of opinion, as appropriate, in accordance with SA 705.

5. Validity of Written Representation: The physical verification of fixed assets is the primary responsibility of the management. The auditor, however, is required to examine the verification programme adopted by the management. He must satisfy himself about the existence, ownership and valuation of fixed assets. In the case of Sagar Ltd., the auditor has not been able to verify the existence and value of some machinery despite the verification procedure followed in routine audit. He accepted the certificate given to him by the management without making any further enquiry.

As per SA 580 “Written Representations”, when representation relate to matters which are material to the financial information, then the auditor should seek corroborative audit evidence from other sources inside or outside the entity.

He should evaluate whether such representations are reasonable and consistent with other evidences and should consider whether individuals making such representations can be expected to be well informed on the matter. “Written Representations” cannot be a substitute for other audit evidence that the auditor could reasonably expect to be available.

If the auditor is unable to obtain sufficient appropriate audit evidence that he believes would be available regarding a matter which has or may have a material effect on the financial information, this will constitute a limitation on the scope of his examination even if he has obtained a representation from management on the matter. Therefore, the approach adopted by the auditor is not right.

Answers to Multiple Choice Questions 1. (a) 2. (d) 3. (c) 4. (a) 5. (d)


2

AUDIT PLANNING, STRATEGY & EXECUTION

LEARNING OUTCOMES After studying this chapter, you will be able to: Know factors, benefits and considerations for establishing overall audit

strategy. Understand the nature and extent of planning. Analyse the responsibility of the auditor in audit strategy and audit plan. Understand the process of audit execution.

Audit Strategy

Audit Planning

Audit Execution

CHAPTER OVERVIEW



1. COMMENCING AN AUDIT SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in accordance with Standards on Auditing” states that in order to achieve the overall objectives of the auditor, the auditor shall use the objectives stated in relevant SAs in planning and performing the audit. Without a careful plan, the overall objective of an audit may not be achieved. The audit planning is necessary to conduct an effective audit in an efficient and timely manner.

Image: Audit Planning, Preparation and Execution♣

1.1 Benefits/Advantages of Planning in an Audit of Financial Statements

Planning an audit involves establishing the overall audit strategy for the engagement and developing an audit plan. Adequate planning benefits the audit of financial statements in several ways described hereunder- (i) Attention to Important

♣ Source : Forum Auditorías


http://forumauditorias.org/audits/audit-lifecycle/

AUDIT PLANNING, STRATEGY & EXECUTION 2.3

(ii) Timely resolution of Potential Problems (iii) Proper Organisation and Management of Audit Engagement. (iv) Proper Selection of Engagement Team (v) Direction and Supervision of Engagement Team (vi) Easy Coordination in work done by auditors of components and experts.

1.2 Nature and Extent of Planning So far as the nature of planning is concerned, it would vary according to-

1.3 Planning - A Continuous Process Planning is not a discrete phase of an audit but rather a continual and iterative process. It often begins shortly after (or in connection with) the completion of the previous audit and continues until the completion of the current audit engagement. Planning includes consideration of the timing of certain activities and audit procedures. It also involves Audit Programming.

Planning includes the need to consider such matters as: The analytical procedures to be applied as risk assessment procedures.

Obtaining a general understanding of the legal and regulatory framework applicable to the entity and how the entity is complying with that framework.

The determination of materiality.

The involvement of experts.

The performance of other risk assessment procedures.

(i) Size and Complexity of the Auditee - If the size and complexityof organization of which audit is to be conducted is large, then muchmore planning activities would be required as compared to an entitywhose size and complexity is small.

(ii) Past Experience & Expertise - The key engagement teammembers’ previous experience & expertise also contributes towardsvariation in planning activities.

(iii) Change in Circumstances - Another factor contributingtowards variation in planning activities is change in circumstances.



1.4 Overall Audit Strategy and Audit Plan - Responsibility of the Auditor The auditor may decide to discuss elements of planning with the entity’s management to facilitate the conduct and management of the audit engagement. For example - to coordinate some of the planned audit procedures with the work of the entity's personnel.

Although these discussions often occur but the overall audit strategy and the audit plan remain the auditor's responsibility. When discussing matters about the overall audit strategy or audit plan, care is required in order not to compromise the effectiveness of the audit to be taken to see there is no compromise in the effectiveness of the audit. For Example - discussing the nature and timing of detailed audit procedures with management may compromise the effectiveness of the audit by making the audit procedures too predictable.

The engagement partner and other key members of the engagement team shall be involved in planning the audit. The involvement of the engagement partner and other key members of the engagement team in planning the audit draws on their experience thereby enhancing the effectiveness and efficiency of the planning process.

1.5 Acceptance and Continuance of Client Relationships and Audit Engagements

Acceptance and Continuance of Client Relationships and Audit Engagements are very important preliminary engagement activities. The engagement partner shall be satisfied that appropriate procedures regarding the acceptance and continuance of client relationships and audit engagements have been followed, and shall determine that conclusions reached in this regard are appropriate. The auditor shall undertake the following activities at the beginning of the current audit engagement- (i) Performing procedures required by SA 220, “Quality Control for an Audit of Financial

Statements” regarding the continuance of the client relationship and the specific audit engagement. As per the combined reading of SA 220 and SQC 1, information and procedures such as the following assists the auditor in determining whether the conclusions reached regarding the acceptance and continuance of client relationships and audit engagements are appropriate:

• The integrity of the principal owners, key management and those charged with governance of the entity;

• Whether the engagement team is competent to perform the audit engagement and has the necessary capabilities, expertise, including time and resources;

• Whether the firm and the engagement team can comply with relevant ethical requirements; and

• Significant matters that have arisen during the current or previous audit engagement, and their implications for continuing the relationship.

In case of certain entities, such as, Central/State governments and related government



entities (for example, agencies, boards, commissions), auditors may be appointed in accordance with statutory procedures.

(ii) Evaluating compliance with ethical requirements, including independence, as required by SA 220; and

(iii) Establishing an understanding of the terms of the engagement, as required by SA 210.

1.6 Contents of an Audit Plan The auditor shall develop an audit plan that shall include a description of- (i) The nature, timing and extent of planned risk assessment procedures, as determined under

SA 315 “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment”.

(ii) The nature, timing and extent of planned further audit procedures at the assertion level, as determined under SA 330 “The Auditor’s Responses to Assessed Risks”.

(iii) Other planned audit procedures that are required to be carried out so that the engagement complies with SAs.

The audit plan is more detailed than the overall audit strategy that includes the nature, timing and extent of audit procedures to be performed by engagement team members. Planning for these audit procedures takes place over the course of the audit as the audit plan for the engagement develops. For example, planning of the auditor's risk assessment procedures occurs early in the audit process. However, planning the nature, timing and extent of specific further audit procedures depends on the outcome of those risk assessment procedures. In addition, the auditor may begin the execution of further audit procedures for some classes of transactions, account balances and disclosures before planning all remaining further audit procedures.

1.7 Changes to Planning Decisions The auditor shall update and change the overall audit strategy and the audit plan as necessary during the course of the audit. The auditor may need to modify the overall audit strategy and audit plan due to below mentioned factors-

(iii) the audit evidence

obtained from the results of

audit procedures.

(ii) changes in conditions,

or

(i) result of unexpected

events,


2.6 ADVANCED AUDITING AND PROFESSIONAL ETHICS Further, the auditor would also modify the nature, timing and extent of further audit procedures, based on the revised consideration of assessed risks.

This may be the case when information coming to the auditor differs significantly from the information when he planned the audit procedures. For example, audit evidence obtained through the performance of substantive procedures may contradict the audit evidence obtained through tests of controls. In addition to above, there may be a possibility of change in law notifications, Govt. policies which necessitates updation of overall Audit strategy.

2. OVERALL AUDIT STRATEGY The auditor shall establish an overall audit strategy that sets the scope, timing and direction of the audit, and that guides the development of the audit plan.

2.1 Factors while establishing Overall Audit Strategy Overall audit strategy would involve-

(i) Determination of Characteristics of Audit: Identify the characteristics of the engagement that define its scope.

(ii) Reporting Objectives: Ascertain the reporting objectives of the engagement to plan the timing of the audit and the nature of the communications required.

(iii) Team’s Efforts: Consider the factors that, in the auditor’s professional judgment, are significant in directing the engagement team’s efforts.

(iv) Preliminary Work: Consider the results of preliminary engagement activities and, where applicable, whether knowledge gained on other engagements performed by the engagement partner for the entity is relevant.

(v) Nature, timing and Extent of Resources: Ascertain the nature, timing and extent of resources necessary to perform the engagement.

2.2 Benefits of Overall Audit Strategy The process of establishing the overall audit strategy assists the auditor to determine such matters as-

(i) Employment of Qualitative Resources: The resources to deploy for specific audit areas, such as the use of appropriately experienced team members for high risk areas or the involvement of experts on complex matters.

(ii) Allocation of Quantity of Resources: The amount of resources to allocate to specific audit areas, such as the number of team members assigned to observe the inventory count at material locations, the extent of review of other auditors’ work in the case of group audits, or the audit budget in hours to allocate to high risk areas.



(iii) Timing of Deployment of Resources: When these resources are to be deployed, such as whether at an interim audit stage or at key cut-off dates.

(iv) Management of Resources: How such resources are managed, directed and supervised, such as when team briefing and debriefing meetings are expected to be held, how engagement partner and manager reviews are expected to take place (for example, on-site or off-site), and whether to complete engagement quality control reviews.

2.3 Considerations in Establishing the Overall Audit Strategy Some of the examples of matters that the auditor may consider in establishing the overall audit strategy are given hereunder. Many of these matters will also influence the auditor’s detailed audit plan. All matters are not relevant to every audit engagement and the list is not necessarily complete.

(a) Characteristics of the Engagement (i) The financial reporting framework. (ii) Industry-specific reporting requirements such as reports mandated by industry

regulators. (iii) The expected audit coverage, including the number and locations of components to

be included. (iv) The nature of the control relationships between a parent and its components that

determine how the group is to be consolidated. (v) The extent to which components are audited by other auditors. (vi) The entity’s use of service organizations and how the auditor may obtain evidence

concerning the design or operation of controls performed by them. (vii) The expected use of audit evidence obtained in previous audits, for example, audit

evidence related to risk assessment procedures and tests of controls. (viii) The effect of information technology on the audit procedures. (ix) The availability of client personnel and data.

(b) Reporting Objectives, Timing of the Audit, and Nature of Communications (i) The entity's timetable for reporting. (ii) The organization of meetings with management regarding audit work (Nature, timing

and extent). (iii) The discussion with management regarding type and timing of reports to be issued. (iv) The discussion with management regarding communications on the status of audit

work.



(v) Communication with auditors of components regarding types and timing of reports to be issued.

(vi) The nature and timing of communications among engagement team members. (vii) Whether there are any other expected communications with third parties, including

any statutory or contractual reporting responsibilities arising from the audit. (c) Significant Factors, Preliminary Engagement Activities, and Knowledge Gained on

Other Engagements (i) The determination of materiality in accordance with SA 320. (ii) Preliminary identification of areas where there may be a higher risk of material

misstatement. (iii) The impact of the assessed risk of material misstatement at the overall financial

statement level on direction, supervision and review. (iv) The manner in which engagement team members need to maintain a questioning

mind and to exercise professional skepticism. (v) Results of previous audits including the identified deficiencies and action taken to

address them. (vi) The discussion of matters that may affect the audit with firm personnel responsible

for performing other services to the entity. (vii) Evidence of management’s commitment to the design, implementation and

maintenance of sound internal control. (viii) Volume of transactions which may determine reliance on internal control. (ix) Importance attached to internal control. (x) Significant business developments affecting the entity. (xi) Significant industry developments. (xii) Significant changes in the financial reporting framework, such as changes in

accounting standards. (xiii) Other significant relevant developments, such as changes in the legal environment

affecting the entity.

(d) Nature, Timing and Extent of Resources (i) The selection of the engagement team and the assignment of audit work to the team

members. (ii) Engagement budgeting.



2.4 Documenting the Audit Plan The auditor shall document-

(i) The overall audit strategy;

(ii) The audit plan; and

(iii) Any significant changes made during the audit engagement to the overall audit strategy or the audit plan, and the reasons for such changes as under-

(a) Record of Key Decisions: The documentation of the overall audit strategy is a record of the key decisions considered necessary to properly plan the audit and to communicate significant matters to the engagement team

(b) Record of Nature, Timing and Extent of Risk Assessment Procedures: The documentation of the audit plan is a record of the planned nature, timing and extent of risk assessment procedures and further audit procedures at the assertion level in response to the assessed risks. It also serves as a record of the proper planning of the audit procedures that can be reviewed and approved prior to their performance. The auditor may use standard audit programs and/or audit completion checklists, tailored as needed to reflect the particular engagement circumstances.

(c) Record of reasons for Change in Audit Plans: A record of the significant changes to the overall audit strategy and the audit plan, and resulting changes to the planned nature, timing and extent of audit procedures, explains why the significant changes were made, and the overall strategy and audit plan finally adopted for the audit. It also reflects the appropriate response to the significant changes occurring during the audit.

2.5 Relationship between the Overall Audit Strategy and the Audit Plan

Fig 1: Audit Strategy and the Audit Plan are interrelated.∗

∗ Source : msp-c.com


https://www.google.co.in/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&ved=&url=http%3A%2F%2Fmsp-c.com%2FContent-Kings%2FMarch-2015%2FThe-Business-Value-of-the-Content-Audit-Part-1&bvm=bv.133387755,d.cGc&psig=AFQjCNGLIwQeCuYYpjUf4VyPCBuTSD2FMg&ust=1474534580857692

2.10 ADVANCED AUDITING AND PROFESSIONAL ETHICS The audit strategy is prepared before the audit plan. The audit plan contains more details than the overall audit strategy. Audit strategy and audit plan are inter-related because change in one would result into change in the other. The audit strategy provides the guidelines for developing the audit plan. It establishes the scope and conduct of the audit procedures and thereby works as basis for developing a detailed audit plan. Detailed audit plan would include the nature, timing and extent of the audit procedures so as to obtain sufficient appropriate audit evidence.

CA. Sam has already developed an audit strategy for Hitesh Ltd. While a detailed audit plan is being developed, she decided that materiality levels set earlier need to be increased as weaknesses in the internal controls were highlighted in the internal audit report. Subsequently, a deviation from the audit strategy is felt necessary.

Therefore, Sam would firstly modify the overall strategy and thereafter prepare the audit plan according to the strategy. This shows that the audit strategy and audit plan are closely inter-related as change in one is resulting into change in the other. The overall audit strategy & Audit plan should take into consideration the element of materiality and its relationship with Risks & procedures to be adopted. It is summarized as under:-

High Materiality Detailed Procedures High Risks Low Materiality Test Checks Low Risks

3. AUDIT PROGRAMME An audit programme is commonly prepared to allocate work to team members which may include the list of audit procedures and instructions to be followed by the member. It also estimates the duration for completing an audit task.

3.1 Formulating an Audit Programme: It is very useful for students to know how to plan an audit programme. The programme may contain audit objectives for each area and should have sufficient detail to serve as a set of instructions to the assistants involved in the audit and as a means to control the proper execution of work. It may be emphasised that a clear spelling out of audit objectives for each area is important to link up the procedures with audit objectives and to ensure a purposeful audit.

The important matters which need to be considered in this regard are:

(a) Nature of business in which the organisation is engaged: On his first appointment, the auditor should examine in detail the financial and accounting organisation of the business by visiting the client’s office; by observing different stages through which papers pass before each transaction is authorised and recorded; the record that is kept and the titles of books in which it is kept.

In the case of an industrial concern, he must also visit the factory to acquaint himself with the different processes of manufacture, the quantitative records maintained and the manner in which statistics are compiled in respect of losses in process.



The auditor, therefore, should draw up the programme of audit on a consideration of the technical, financial and accounting set-up of the company.

(b) Overall plan: Overall plan for the audit programme should be drawn up to ensure a systematic approach to the work. If in drawing the audit programme, any divergence from the overall plan becomes necessary, first the overall plan should be modified after due consideration and thereafter only the matter may be taken in the audit programme. The frame provided by the overall plan should be strictly adhered to.

(c) System of internal control and accounting procedures: The existence of a system of internal control ensures that both financial and statistical records are checked continuously; it also unearths errors, both of omission and of commission. The auditor, in framing his opinion on financial statements needs reasonable assurance that transactions are properly authorised and recorded in the accounting records and that transactions have not been omitted. The study and evaluation of internal control helps the auditor to establish the reliance he can place on the internal control in determining the nature, timing and extent of his substantive auditing procedures.

The auditor’s examination of the system of internal control should have three features - review and preliminary evaluation, testing of compliance and evaluation.

(d) Size of the organisation and structure of its management: An increase in the size of the organisation enhances the complexity of the examination of its accounting records specially when it has a number of branches, deals in several products or has a very large turnover.

the reports of the Comptroller and Auditor General on audit of accounts of Public Enterprises show that some of them have a very poor system of internal control. In such

cases, the magnitude of the tasks of the auditor increases considerably.

(e) Information as regards organisation of the business: To plan audit programme, it is necessary that the auditor should obtain from his client information as regards the client’s history and business, purpose and nature of engagement and time schedule for the completion of audit.

(f) Accounting and management policies: The auditor should review the financial statements of the past several years, audited by his predecessors specially those of the immediately preceding previous year. This would reveal to him a great deal of information regarding accounting and management policies which have been followed in the past and whether these have been employed consistently.

(a) Nature of business in which the organisation is

engaged.

(b) Overall plan

prepared for the audit.

(c) System of internal

control and accounting procedures.

(d) Size of the organisation and structure

of its management.

(e) Information regarding the

organisation of business.

(f) Accounting

policies followed by the client.



3.2 Drawing up the audit programme: After the auditor has collected the aforementioned information, he will be in a position to draw up the programme of audit. He can now decide the areas to be covered by audit, also those to be covered in detail and those which should be covered by the applications of the test checks. He will also be able to decide the specific audit procedures which should be applied in each case. These procedures vary widely because of the conditions under which each concern operates, its form of organisation, its nature of business and the condition of its accounts. On this account, it is not practicable to draw up a typical audit programme. When an auditor is appointed to audit the accounts of an entity for the first time, the audit programme should be developed in three stages stated below:

(i) To begin with, a broad outline of the audit programme should be drawn up.

(ii) After the internal and accounting procedures have been reviewed, the details should be filled up on a consideration of the deficiencies in the system of internal control.

(iii) After the detailed checking procedure is over, the extent to which the special procedures need to be applied should be determined, e.g., independent verification of balances of debtors and creditors, physical inspection of fixed assets, personal inspection of various items of stock included in closing inventories and testing their values. At times, special procedures may have to be applied on a consideration of the nature of business e.g. verification of provision for tax liability in case of a shipping company regarding freight booked in different countries or for making a provision for unexpired liability in case of an insurance company, etc.

At each subsequent engagement the programme should be reviewed and, if necessary, modified on account of:

Given below are a few circumstances where in the audit programme would have to be suitably altered: (1) If the audit procedures were designed for a certain volume of turnover and subsequently

the volume have substantially increased. Also, when there have been significant changes in the accounting organisation, procedures and personnel subsequent to the audit procedures.

(i) experience gained during the previous audits;

(ii) important changes that have taken place in the business specially in the system of internal control, accounting procedures or in the structure of management or of the scope of business; and

(iii) evaluation of internal control made for the current year.



(2) Where during the course of an audit, it has been discovered that internal control procedures were not as effective as assumed at the time the audit programme was framed.

(3) Where there has been an extraordinary increase in the amount of book debts or that in the value of stocks as compared to that in the previous year.

(4) When a suspicion is aroused during the course of audit or information has been received that assets of the company have been misappropriated.

It may be noted that the audit plan and related programme should be reconsidered as the audit progresses. Such re-consideration is based on the auditor’s review of internal control, his preliminary evaluation thereof and the result of his compliance and substantive procedures

4. AUDIT EXECUTION Key phases in the audit execution stage are Execution Planning, Risk and Control Evaluation, Testing and Reporting.

Image showing Stages of Audit Execution

4.1 Execution Planning Prior to commencement of an audit engagement, it is important to lay down the roadmap for audit execution to ensure timely and quality audit results. The auditors need to plan their work in order to carry out the audit in an effective, efficient and timely manner. A detailed audit program is prepared laying down the audit objectives, scope and audit approach. The manpower requirement, audit team qualifications, and the time element, etc. are some of the important considerations during execution planning. In order to plan effectively, the auditor may need some more information about the audit area. A preliminary survey would help in gathering the required information.

4.2 Risk and Control Evaluation For each segment of audit, the auditors should conduct a detailed risk and control assessment i.e. list the risks that must be reviewed in that segment, capture for each risk the controls that exist or those that are needed to protect against the risk and show for each control, the work steps required to test the effectiveness of the controls. While making Risk & Control assessment it is necessary to borne in mind Materiality levels as the same is linked with Audit Risks.

(Note: Students may refer Chapter 3 for understanding and evaluation of the Risk and Control for more details)

Execution Planning

Risk and Control

Evaluation, Testing Reporting



4.3 Testing Once a comprehensive understanding is gained of the key risks and the controls to be evaluated in a given audit area, the auditors should test the operating effectiveness of the controls to determine whether controls are operating as designed. There are multiple test methods which can be used to arrive at the conclusions on the effectiveness of the controls

4.4 Reporting SA 700, “Forming an Opinion and Reporting on Financial Statements” establishes standards on the form and content of the auditor’s report issued as a result of an audit performed by an auditor of the financial statements of an entity. The auditor should review and assess the conclusions drawn from the audit evidence obtained as the basis for the expression of an opinion on the financial statements. This review and assessment involves considering whether the financial statements have been prepared in accordance with an acceptable financial reporting framework applicable to the entity under audit. It is also necessary to consider whether the financial statements comply with the relevant statutory requirements such as compliance of Provisions & Enactments of the Company Law, Accounting Standards framed by ICAI, latest Guidelines etc.

The auditor’s report should contain a clear written expression of opinion on the financial statements taken as a whole. A measure of uniformity in the form and content of the auditor’s report is desirable because it helps to promote the reader’s understanding of the auditor’s report and to identify unusual circumstances when they occur. A statute governing the entity or a regulator may require the auditor to include certain matters in the audit report or prescribe the form in which the auditor should issue his report.

(Note: For details Students may refer SA 700 discussed in Chapter 6 of this study material)

4.5 Other Important Considerations In addition to above, there are certain other consideration which auditor is required to take care while executing the audit, which are given below:

4.5.1 SA 600 - USING THE WORK OF ANOTHER AUDITOR “When the auditor delegates work to assistants or uses work performed by other auditors and experts, he will continue to be responsible for forming and expressing his opinion on the financial information. However, he will be entitled to rely on work performed by others, provided he exercises adequate skill and care and is not aware of any reason to believe that he should not have so relied. In the case of any independent statutory appointment to perform the work on which the auditor has to rely in forming his opinion, such as in the case of the work of branch auditors appointed under the Companies Act the auditor’s report should expressly state the fact of such reliance.”

It may be noted that auditor who uses the work performed by other auditors is Principal auditor.



"Principal auditor" means the auditor with responsibility for reporting on the financial information of an entity when that financial information includes the financial information of one or more components audited by another auditor.

"Other auditor" means an auditor, other than the principal auditor, with responsibility for reporting on the financial information of a component which is included in the financial information audited by the principal auditor.

"Component" means a division, branch, subsidiary, joint venture, associated enterprises or other entity whose financial information is included in the financial information audited by the principal auditor.

When the principal auditor uses the work of another auditor, the principal auditor should determine how the work of the other auditor will affect the audit.

The purpose of SA 600 (Using the work of another auditor) is to:

establish standards to be applied in situations where Principal auditor,

uses the work of other auditor with respect to the financial information of one or more components

included in the financial information of the entity.

"Other auditor" responsibile for reporting on the

financial information of a component

which is included in the financial

information audited by the principal

auditor.

When the principal auditor

uses the work of another auditor,

principal auditor to determine how

the work of the other auditor will affect the audit.

"Principal Auditor"

when that financial information includes the

financial information of one or more components

audited by another auditor.

responsibile for reporting on the

financial information of an entity


2.16 ADVANCED AUDITING AND PROFESSIONAL ETHICS This Standard also discusses the principal auditor’s responsibility in relation to his use of the work of the other auditor. In this Standard, the term 'financial information' encompasses 'financial statements'.

SA 600 does not deal with those instances where two or more auditors are appointed as joint auditors nor does it deal with the auditor’s relationship with a predecessor auditor.

I. ACCEPTANCE AS PRINCIPAL AUDITOR

The auditor would consider the following before accepting his work as Principal auditor:

(a) the materiality of the portion of the financial information which the principal auditor audits;

(b) the principal auditor's degree of knowledge regarding the business of the components;

(c) the risk of material misstatements in the financial information of the components audited by the other auditor; and

(d) the performance of additional procedures as set out in this SA regarding the components audited by other auditor resulting in the principal auditor having significant participation in such audit.

II. THE PRINCIPAL AUDITOR’S PROCEDURES

1. Right of Principal auditor to visit and examine books of accounts of a component

In certain situations, the statute governing the entity may confer a right on the principal auditor to visit a component and examine the books of account and other records of the said component, if he thinks it necessary to do so. Where another auditor has been

appointed for the component, the principal auditor would normally be entitled to rely upon the work of such auditor unless there are special circumstances to make it essential for him to visit the component and/or to examine the books of account and other records of the said component.

2. Principal auditor to consider the professional competence of other auditor

When planning to use the work of another auditor, the principal auditor should consider the professional competence of the other auditor in the context of specific assignment if

the other auditor is not a member of the Institute of Chartered Accountants of India.

3. Procedures to be performed by principal auditor when using the work of other auditor

The principal auditor should perform procedures to obtain sufficient appropriate audit evidence, that the work of the other auditor is adequate for the principal auditor's purposes, in the context of the specific assignment. When using the work of another auditor, the principal auditor should ordinarily perform the following procedures:



4. Principal auditor to review – written summary of other auditor’s procedures The principal auditor might discuss with the other auditor the audit procedures applied or review a written summary of the other auditor’s procedures and findings which may be in the form of a completed questionnaire or check-list.

5. The principal auditor should consider the significant findings of the other auditor. The principal auditor may consider it appropriate to discuss with the other auditor and the management of the component, the audit findings or other matters affecting the financial information of the components. He may also decide as to application of supplementary that supplemental tests of the records or the financial statements of the component are if necessary. Such tests may, depending upon the circumstances, be performed by the principal auditor or the other auditor.

6. When other auditor is not a professionally qualified auditor. In certain circumstances, the other auditor may happen to be a person other than a professionally qualified auditor. For instance, where a component is situated in a foreign country and the applicable laws permit a person other than a professionally

qualified auditor to audit the financial statements of such component.

Procedures to be performed by Principal Auditor while using the work of other auditor

(a)advise the other auditor regarding use of his (other auditor) work and report and make sufficient arrangements for co-ordination at

the planning stage of the audit.

The principal auditor would inform the other auditor of

matters such as :

areas requiring special

consideration,

procedures for the identification of inter-component transactions that

may require disclosure and

the time-table for completion of audit;

(b) advise the other auditor of the significant accounting, auditing and reporting requirements and obtain representation as to compliance

with them.

The principal auditor may

also wish to visit the other auditor.

Nature, timing and extent of procedures depend on

circumstances of engagement

& Materiality aspect

Nature, timing and extent of

procedures depend on principal

auditor's knowledge of the

professional competence of the

other auditor.

This knowledge may have been enhanced from the review of the previous audit work of

the other auditor.


2.18 ADVANCED AUDITING AND PROFESSIONAL ETHICS 7. Principal Auditor to document in his working papers – the components whose

financial information audited by other auditors. The principal auditor should also document the procedures performed and the conclusions reached.

The auditor would document the results of discussions with the other auditor and review of the written summary of the other auditor's procedures.

However, the principal auditor need not document the reasons for limiting the procedures in the circumstances where sufficient appropriate audit evidence previously obtained that acceptable quality control policies and procedures are complied with in the conduct of other auditor's practice.

Where the other auditor’s report is other than unmodified, the principal auditor should also document how he has dealt with the qualifications or adverse remarks contained in the other auditor’s report in framing his own report.

III. CO-ORDINATION BETWEEN AUDITORS

There should be sufficient liaison between the principal auditor and the other auditor. For this purpose, the principal auditor may find it necessary to issue written communication(s) to the other auditor. The other auditor, knowing the context in which his work is to be used by the principal auditor, should co-ordinate with the principal auditor-

by bringing to the principal auditor’s immediate attention any significant findings requiring to be dealt with at entity level, adhering to the time-table for audit of the component, etc. He should ensure compliance with the relevant statutory requirements.

Similarly, the principal auditor should advise the other auditor of any matters that come to his attention that he thinks may have an important bearing on the other auditor’s work.

Diagram Showing Coordination Between the Auditors

Sufficient liaison between the principal auditor and

the other auditor.

The other auditor should co-ordinate with the

principal auditor.

The principal auditor should advise the other auditor of any matters having an important

bearing on the other auditor’s work.

The principal auditor may require the other auditor

to answer a detailed questionnaire

The other auditor should respond to such

questionnaire on a timely basis.



IV. REPORTING CONSIDERATIONS

1. Principal auditor to express a qualified opinion or disclaimer of opinion in case of a limitation on the scope of audit.

When the principal auditor concludes, based on his procedures, that the work of the other auditor cannot be used and the principal auditor has not been able to perform sufficient additional procedures regarding the financial information of the component

audited by the other auditor, the principal auditor should express a qualified opinion or disclaimer of opinion because there is a limitation on the scope of audit.

2. If the other auditor issues a Modified Report In all circumstances, if the other auditor issues, or intends to issue, a modified auditor's report, the principal auditor should consider whether the subject of the modification is of such nature and significance, in relation to the financial information of the entity on which

the principal auditor is reporting that it requires a modification of the principal auditor's report.

V. DIVISION OF RESPONSIBILITY

The principal auditor would not be responsible in respect of the work entrusted to the other auditors, except in circumstances which should have aroused his suspicion about the reliability of the work performed by the other auditors.

When the principal auditor has to base his opinion on the financial information of the entity as a whole relying upon the statements and reports of the other auditors, his report should state clearly the division of responsibility for the financial information of the entity by indicating the extent to which the financial information of components audited by the other auditors have been included in the financial information of the entity, e.g., the number of divisions/branches/subsidiaries or other components audited by other auditors. However, if the Principal Auditor notices any material discrepancies the same has to be brought to the knowledge of other Auditor. This should be incorporated in the Audit Report.

4.5.2 SA 610- USING THE WORK OF INTERNAL AUDITORS

I. THE EXTERNAL AUDITOR’S RESPONSIBILITY FOR THE AUDIT The external auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the external auditor’s use of the work of the internal audit function or internal auditors to provide direct assistance on the engagement. Although they may perform audit procedures similar to those performed by the external auditor, neither the internal audit function nor the internal auditors are independent of the entity as is required of the external auditor in an audit of financial statements in accordance with SA 200. SA 610, “Using the work of Internal Auditors”, therefore, defines the conditions that are necessary for the external auditor to be able to use the work of internal auditors. It also defines the necessary work effort to obtain sufficient appropriate evidence that the work of the internal audit function, or internal auditors providing direct assistance, is adequate for the purposes of the audit. The


2.20 ADVANCED AUDITING AND PROFESSIONAL ETHICS requirements are designed to provide a framework for the external auditor’s judgments regarding the use of the work of internal auditors to prevent over or undue use of such work.

Review the Internal Auditor’s Report which helps external auditor in procedural tests and audit planning.

II. SCOPE OF THIS SA This (SA) deals with the external auditor’s responsibilities if using the work of internal auditors. This includes

(a) using the work of the internal audit function in obtaining audit evidence and

(b) using internal auditors to provide direct assistance under the direction, supervision and review of the external auditor.

This SA does not apply if the entity does not have an internal audit function. III. THE OBJECTIVES OF THE EXTERNAL AUDITOR, WHERE THE ENTITY HAS AN

INTERNAL AUDIT FUNCTION

The objectives of the external auditor, where the entity has an internal audit function and the external auditor expects to use the work of the function to modify the nature or timing, or reduce the extent, of audit procedures to be performed directly by the external auditor, or to use internal auditors to provide direct assistance, are:

The external auditor has sole responsibility for the audit

opinion expressed

by the external auditor’s use of the work of the internal audit

function or

internal auditors to provide direct assistance on the

engagement

that responsibility is not reduced

The objectives of the external auditor, where the entity has an internal audit function

To determine whether the work of the internal audit function or direct assistance from internal

auditors can be used,

If using the work of the internal audit function, to determine

whether that work is adequate for purposes of the audit

If using internal auditors to provide direct assistance, to

appropriately direct, supervise and review their work.



Meaning of Internal Audit Function & Direct Assistance–

Internal Audit Function: A function of an entity that performs assurance and consulting activities designed to evaluate and improve the effectiveness of the entity’s governance, risk management and internal control processes.

Direct Assistance: The use of internal auditors to perform audit procedures under the direction, supervision and review of the external auditor.

The objectives and scope of internal audit functions: The objectives and scope of internal audit functions typically include assurance and consulting activities designed to evaluate and improve the effectiveness of the entity’s governance processes, risk management and internal control such as the following:

IV. EVALUATING WHETHER WORK OF THE INTERNAL AUDIT FUNCTION CAN BE USED

FOR PURPOSES OF THE AUDIT

(i) The external auditor shall determine whether the work of the internal audit function can be used for purposes of the audit by evaluating the following: (a) The extent to which the internal audit

function’s organizational status and relevant policies and procedures support the objectivity of the internal auditors;

(b) The level of competence of the internal audit function; and

(c) Whether the internal audit function applies a systematic and disciplined approach, including quality control.

(ii) The external auditor shall not use the work of the internal audit function if the external auditor determines that: (a) The function’s organizational status

and relevant policies and procedures do not adequately support the objectivity of internal auditors;

(b) The function lacks sufficient competence; or

(c) The function does not apply a systematic and disciplined approach, including quality control.

Activities Relating to Governance

The internal audit function mayassess the governance processin its accomplishment ofobjectives on :• ethics and values, performance management and accountability,

• communicating risk and control information.

Activities Relating to Risk Management

• The internal auditfunction may assist theentity by identifying andevaluating significantexposures to risk.•The internal audit function

may perform proceduresto assist the entity in thedetection of fraud.

Activities Relating to Internal Control

• Evaluation of internal control • Examination of financial and

operating information• Review of operating activities. • Review of compliance with

laws and regulations.


2.22 ADVANCED AUDITING AND PROFESSIONAL ETHICS V. DETERMINING THE NATURE AND EXTENT OF WORK OF THE INTERNAL AUDIT

FUNCTION THAT CAN BE USED

1. The external auditor shall consider the nature and scope of the work performed by Internal audit function.

Work of the internal audit function that can be used by the external auditor include the following:

• Testing of the operating effectiveness of controls.

• Substantive procedures involving limited judgment.

• Observations of inventory counts.

• Tracing transactions through the information system relevant to financial reporting.

• Testing of compliance with regulatory requirements.

• In some circumstances, audits or reviews of the financial information of subsidiaries that are not significant components to the group (where this does not conflict with the requirements of SA 600.

2. The external auditor shall make all significant judgments in the audit engagement and, to prevent undue use of the work of the internal audit function, shall plan to use less of the work of the function and perform more of the work directly:

(a) The more judgment is involved in: (i) Planning and performing relevant audit procedures; and (ii) Evaluating the audit evidence gathered;

(b) The higher the assessed risk of material misstatement at the assertion level, with special consideration given to risks identified as significant;

(c) The less the internal audit function’s organizational status and relevant policies and procedures adequately support the objectivity of the internal auditors; and

(d) The lower the level of competence of the internal audit function.

3. Extent of involvement of external auditor: The external auditor shall also evaluate whether, in aggregate, using the work of the internal audit function to the extent planned would still result in the external auditor being sufficiently involved in the audit, given the external auditor’s sole responsibility for the audit opinion expressed.

4. Communicate how the external auditor has planned to use the work of the internal audit function: The external auditor shall, in communicating with those charged with governance, an overview of the planned scope and timing of the audit in accordance with SA 260, communicate how the external auditor has planned to use the work of the internal audit function.



VI. USING THE WORK OF THE INTERNAL AUDIT FUNCTION

1. Discussion and Coordination with the Internal Audit Function: If the external auditor plans to use the work of the internal audit function, the external auditor shall discuss the planned use of its work with the function as a basis for coordinating their respective activities.

2. The external auditor shall read the reports of the internal audit function relating to the work of the function that the external auditor plans to use to obtain an understanding of the nature and extent of audit procedures it performed and the related findings.

3. The external auditor shall perform sufficient audit procedures to determine adequacy of internal audit function for purposes of the audit, including evaluating whether:

(a) The work of the function had been properly planned, performed, supervised, reviewed and documented;

(b) Sufficient appropriate evidence had been obtained to enable the function to draw reasonable conclusions; and

(c) Conclusions reached are appropriate in the circumstances and the reports prepared by the function are consistent with the results of the work performed.

4. The nature and extent of the external auditor’s audit procedures shall be responsive to the external auditor’s evaluation of:

(a) The amount of judgment involved; (b) The assessed risk of material misstatement; (c) The extent to which the internal audit function supports the objectivity of the

internal auditors; and (d) The level of competence of the function.

5. The external auditor shall also evaluate whether the external auditor’s conclusions regarding the internal audit function and the determination of the nature and extent of use of the work of the function for purposes of the audit remain appropriate.

VII. DETERMINING WHETHER INTERNAL AUDITORS CAN BE USED TO PROVIDE DIRECT ASSISTANCE FOR PURPOSES OF THE AUDIT

(a) The external auditor prohibited from obtaining direct assistance from internal auditors.

In case where the external auditor is prohibited by law or regulation from using internal auditors to provide direct assistance, it is relevant for the principal auditors to consider whether the prohibition also extends to component auditors

and, if so, to address this in the communication to the component auditors.


2.24 ADVANCED AUDITING AND PROFESSIONAL ETHICS (b) Using internal auditors to provide direct assistance is not prohibited

(i) Evaluation of the existence and significance of threats to objectivity and the level of competence of the internal auditors.

(ii) Evaluation of the existence and significance of threats shall include inquiry of the internal auditors.

The external auditor’s evaluation of the existence and significance of threats to the internal auditors’ objectivity shall include inquiry of the internal auditors regarding interests and relationships that may create a threat to their objectivity.

Objectivity refers to the ability to perform the proposed work without allowing bias, conflict of interest or undue influence of others to override professional judgments.

In evaluating the existence and significance of threats to the objectivity of an internal auditor, the following factors may be relevant:

The extent to which the internal audit function’s organizational status and relevant policies and procedures support the objectivity of the internal auditors. Family and personal relationships with an individual working in, or responsible for, the aspect of the entity to which the work relates. Association with the division or department in the entity to which the work relates. Significant financial interests in the entity other than remuneration on terms consistent with those applicable to other employees at a similar level of seniority.

The external auditor shall not use an internal auditor to provide direct assistance if:

(a) There are significant threats to the objectivity of the internal auditor; or

(b)The internal auditor lacks sufficient competence to perform the proposed work. As

the function of Internal Auditor is again a concept of evaluation of Internal Control

mechanism it would amount to weaknesses in Internal Control System In case internal Auditor does not apply required test procedures seeing the Material aspects. This would in turn result

in Higher Audit Risks.



Determining the Nature and Extent of Work that Can Be Assigned to Internal Auditors Providing Direct Assistance:

Review of the work performed by internal auditors

The external auditor shall direct, supervise and review the work performed by internal auditors on the engagement in accordance with SA 220. In so doing:

(a) The nature, timing and extent of direction, supervision, and review shall recognize that the internal auditors are not independent of the entity and

(b) The review procedures shall include the external auditor checking back to the underlying audit evidence for some of the work performed by the internal auditors.

The direction, supervision and review by the external auditor shall be sufficient in order for the external auditor to be satisfied that the internal auditors have obtained sufficient appropriate audit evidence to support the conclusions based on that work. [Note: Students are advised to refer SA 610 “Using the work of Internal Auditor” for more details, SA 610 is reproduced in Auditing Pronouncements.]

Illustration

CA. Amboj, a practicing chartered accountant has been appointed as an internal auditor of Textile Ltd. He conducted the physical verification of the inventory at the year-end and handed over the report of such verification to CA. Kishore, the statutory auditor of the Company, for his view and reporting. Can CA. Kishore rely on such report?

Using the Work of Internal Auditor: As per SA 610 “Using the Work of Internal Auditors”,

Nature & Extent of work that can be

assigned to Internal auditors providing Direct Assistance

The E.A. shall consider :

Amount of judgement wrt:Planning & performing

relevant audit procedures

Evaluation of the audit evidence

gathered.

Assessed risk of material misstatement

Evaluation of existence & significance of threats .

The E.A. shall not use internal auditors to

provide direct assistance to

perform procedures :

Making significant judgements in the audit

Relate to higher assessed risks of material misstatement where the judgement required is

more than limited.

Relate to work which is reported to management or TCWG by Internal audit function

Relate to decisions the E.A. makes in accordance with SA .



while determining whether the work of the internal auditors can be used for the purpose of the audit, the external auditor shall evaluate-

(a) The extent to which the internal audit function’s organizational status and relevant policies and procedures support the objectivity of the internal auditors;

(b) The level of competence of the internal audit function; and

(c) Whether the internal audit function applies a systematic and disciplined approach, including quality control.

Further, the external auditor shall not use the work of the internal audit function if the external auditor determines that:

(a) The function’s organizational status and relevant policies and procedures do not adequately support the objectivity of internal auditors;

(b) The function lacks sufficient competence; or

(c) The function does not apply a systematic and disciplined approach, including quality control.

In the instant case, CA. Kishore should ascertain the internal auditor’s scope of verification, area of coverage and method of verification. He should review the report on physical verification taking into consideration these factors. If possible he should also test check few items and he can also observe the procedures performed by the internal auditors.

If the statutory auditor is satisfied about the appropriateness of the verification, he can rely on the report but if he finds that the verification is not in order, he has to decide otherwise. The final responsibility to express opinion on the financial statement remains with the statutory auditor.

4.5.3 SA 620-USING THE WORK OF AN AUDITOR’S EXPERT

I. SCOPE OF SA 620

SA 620 deals with the auditor’s responsibilities regarding the use of work in a field of expertise other than accounting or auditing when that work is used to assist the auditor in obtaining sufficient appropriate audit evidence.

SA-620 does not deal with:

Situations where the engagement team

includes a member with expertise in

specialised area of accounting or

auditing

The auditor’s use of the work of an individual or organisation possessing

expertise in a field other than accounting or auditing, whose work in that field is used by

the entity to assist the entity in preparing the financial statements(a management’s

expert), which is dealt with in SA 500.



Important Definition’s: Auditor’s Expert – An individual or organisation possessing expertise in a field other than accounting or auditing, whose work in that field is used by the auditor to assist the auditor in obtaining sufficient appropriate audit evidence. An auditor’s expert may be either an auditor’s internal expert (who is a partner or staff, including temporary staff, of the auditor’s firm or a network firm), or an auditor’s external expert. Management’s Expert – An individual or organisation possessing expertise in a field other than accounting or auditing, whose work in that field is used by the entity to assist the entity in preparing the financial statements.

II. THE AUDITOR’S RESPONSIBILITY FOR THE AUDIT OPINION

The auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the auditor’s use of the work of an auditor’s expert. Nonetheless, if the auditor using the work of an auditor’s expert, having followed this SA, concludes that the work of that expert is adequate for the auditor’s purposes, the auditor may accept that expert’s findings or conclusions in the expert’s field as appropriate audit evidence.

The objectives of the auditor are: (a) To determine whether to use the work of an auditor’s expert; and (b) If using the work of an auditor’s expert, to determine whether that work is adequate for

the auditor’s purposes.

Expertise in a field other than

accounting or auditing

The valuation of complex financial

instruments, land and buildings, plant and

machinery etc.

The actuarial calculation of

liabilities

The estimation of oil and gas

reserves.

The interpretation of contracts, laws and regulations

The analysis of complex or unusual tax compliance

issues.


2.28 ADVANCED AUDITING AND PROFESSIONAL ETHICS III. DETERMINING THE NEED FOR AN AUDITOR’S EXPERT

An auditor’s expert may be needed to assist the auditor in one or more of the following:

• Obtaining an understanding of the entity and its environment, including its internal control.

• Identifying and assessing the risks of material misstatement.

• Determining and implementing overall responses to assessed risks at the financial statement level.

• Designing and performing further audit procedures to respond to assessed risks at the assertion level, comprising tests of controls or substantive procedures.

• Evaluating the sufficiency and appropriateness of audit evidence obtained in forming an opinion on the financial statements.

Auditor may obtain understanding of other field: An auditor who is not an expert in a relevant field other than accounting or auditing may nevertheless be able to obtain a sufficient understanding of that field to perform the audit without an auditor’s expert. This understanding may be obtained through.

• Experience in auditing entities that require such expertise in the preparation of their financial statements. • Education or professional development in the particular field. This may include formal

courses, or discussion with individuals possessing expertise in the relevant field for the purpose of enhancing the auditor’s own capacity to deal with matters in that field. Such discussion differs from consultation with an auditor’s expert regarding a specific set of circumstances encountered on the engagement where that expert is given all the relevant facts that will enable the expert to provide informed advice about the particular matter. • Discussion with auditors who have performed similar engagements. IV. CONSIDERATIONS WHEN DECIDING WHETHER TO USE AN AUDITOR’S EXPERT

In other cases, however, the auditor may determine that it is necessary, or may choose, to use an auditor’s expert to assist in obtaining sufficient appropriate audit evidence. Considerations when deciding whether to use an auditor’s expert may include: • Whether management has used a management’s expert in preparing the financial

statements.

• The nature and significance of the matter, including its complexity.

• The risks of material misstatement in the matter.

• The expected nature of procedures to respond to identified risks, including the auditor’s knowledge of and experience with the work of experts in relation to such matters; and the availability of alternative sources of audit evidence.



When management has used a management’s expert When management has used a management’s expert in preparing the financial statements, the auditor’s decision on whether to use an auditor’s expert may also be influenced by such factors as:

• The nature, scope and objectives of the management’s expert’s work.

• Whether the management’s expert is employed by the entity, or is a party engaged by it to provide relevant services.

• The extent to which management can exercise control or influence over the work of the management’s expert.

• The management’s expert’s competence and capabilities.

• Whether the management’s expert is subject to technical performance standards or other professional or industry requirements.

• Any controls within the entity over the management’s expert’s work. V. NATURE, TIMING AND EXTENT OF AUDIT PROCEDURES

The nature, timing and extent of the auditor’s procedures will vary depending on the circumstances. In determining the nature, timing and extent of those procedures, the auditor shall consider matters including:

(a) The nature of the matter to which that expert’s work relates;

(b) The risks of material misstatement in the matter to which that expert’s work relates;

(c) The significance of that expert’s work in the context of the audit;

(d) The auditor’s knowledge of and experience with previous work performed by that expert; and

(e) Whether that expert is subject to the auditor’s firm’s quality control policies and procedures.

The following factors may suggest the need for different or more extensive procedures than would otherwise be the case: • The work of the auditor’s expert relates to a significant matter that involves

subjective and complex judgments.

• The auditor has not previously used the work of the auditor’s expert, and has no prior knowledge of that expert’s competence, capabilities and objectivity.

• The auditor’s expert is performing procedures that are integral to the audit, rather than being consulted to provide advice on an individual matter.

• The expert is an auditor’s external expert and is not, therefore, subject to the firm’s quality control policies and procedures.


2.30 ADVANCED AUDITING AND PROFESSIONAL ETHICS VI. THE COMPETENCE, CAPABILITIES AND OBJECTIVITY OF THE AUDITOR’S EXPERT

The auditor shall evaluate whether the auditor’s expert has the necessary competence, capabilities and objectivity for the auditor’s purposes. In the case of an auditor’s external expert, the evaluation of objectivity shall include inquiry regarding interests and relationships that may create a threat to that expert’s objectivity.

In case where whether that expert’s work is subject to technical performance standards or other professional or industry requirements, ethical standards and other membership requirements of a professional body or industry association, accreditation standards of a

licensing body, or requirements imposed by law or regulation.

VII. OTHER MATTERS THAT MAY BE RELEVANT INCLUDE • The relevance of the auditor’s expert’s competence to the matter for which that expert’s work

will be used, including any areas of specialty within that expert’s field. A particular actuary may specialise in property and casualty insurance, but have limited expertise regarding pension calculations.

• The auditor’s expert’s competence with respect to relevant accounting and auditing requirements

knowledge of assumptions and methods, including models where applicable, that are consistent with the applicable financial reporting framework.

• Whether unexpected events, changes in conditions, or the audit evidence obtained from the results of audit procedures indicate that it may be necessary to reconsider the initial evaluation of the competence, capabilities and objectivity of the auditor’s expert as the audit progresses.

VIII. EVALUATION OF THE SIGNIFICANCE OF THREATS TO OBJECTIVITY AND NEED FOR SAFEGUARDS

The evaluation of the significance of threats to objectivity and of whether there is a need for safeguards may depend upon the role of the auditor’s expert and the significance of the expert’s work in the context of the audit.

if a proposed auditor’s expert is an individual who has played a significant role in preparing the information that is being audited, that is, if the auditor’s expert is a management’s expert.

Evaluating the objectivity of an auditor’s external expert: When evaluating the objectivity of an auditor’s external expert, it may be relevant to:

(a) Inquire of the entity about any known interests or relationships that the entity has with the auditor’s external expert that may affect that expert’s objectivity.

(b) Discuss with that expert any applicable safeguards, including any professional requirements that apply to that expert; and evaluate whether the safeguards are adequate



to reduce threats to an acceptable level. Interests and relationships that may be relevant to discuss with the auditor’s expert include:

• Financial interests.

• Business and personal relationships.

• Provision of other services by the expert

• In some cases, it may also be appropriate for the auditor to obtain a written representation from the auditor’s external expert about any interests or relationships with the entity of which that expert is aware.

IX. OBTAINING AN UNDERSTANDING OF THE FIELD OF EXPERTISE OF THE AUDITOR’S EXPERT

The auditor shall obtain a sufficient understanding of the field of expertise of the auditor’s expert to enable the auditor to:

(a) Determine the nature, scope and objectives of that expert’s work for the auditor’s purposes; and

(b) Evaluate the adequacy of that work for the auditor’s purposes.

X. AGREEMENT WITH THE AUDITOR’S EXPERT

The auditor shall agree, in writing when appropriate, on the following matters with the auditor’s expert:

(a) The nature, scope and objectives of that expert’s work;

(b) The respective roles and responsibilities of the auditor and that expert;

(c) The nature, timing and extent of communication between the auditor and that expert, including the form of any report to be provided by that expert; and

When the work of the auditor’s expert relates to the auditor’s conclusions regarding a significant risk, both a formal written report at the conclusion of that expert’s work, and oral reports as the work progresses, may be appropriate. Identification of specific partners or staff who will liaise with the auditor’s expert, and procedures for communication between that expert and the entity, assists timely and effective communication, particularly on larger engagements.

(d) The need for the auditor’s expert to observe confidentiality requirements.

It is necessary for the confidentiality provisions of relevant ethical requirements that apply to the auditor also to apply to the auditor’s expert. Additional requirements may be imposed by law or regulation. The entity may also have requested that specific confidentiality provisions be agreed with auditor’s external experts.


2.32 ADVANCED AUDITING AND PROFESSIONAL ETHICS XI. EVALUATING THE ADEQUACY OF THE AUDITOR’S EXPERT’S WORK

The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes, including:

(a) The relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other audit evidence; The Findings and Conclusions of the Auditor’s Expert

Specific procedures to evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes may include:

• Inquiries of the auditor’s expert. • Reviewing the auditor’s expert’s working papers and reports. • Corroborative procedures, such as:

o Observing the auditor’s expert’s work; o Examining published data, such as statistical reports from reputable, authoritative

sources; o Confirming relevant matters with third parties; o Performing detailed analytical procedures to see whether Principles of materiality

aspects considered; and o Re-performing calculations.

• Discussion with another expert with relevant expertise when, for example, the findings or conclusions of the auditor’s expert are not consistent with other audit evidence.

• Discussing the auditor’s expert’s report with management.

(b) If that expert’s work involves use of significant assumptions and methods, the relevance and reasonableness of those assumptions and methods in the circumstances; and Assumptions and Methods: When the auditor’s expert’s work is to evaluate underlying assumptions and methods, including models where applicable, used by management in developing an accounting estimate, the auditor’s procedures are likely to be primarily directed to evaluating whether the auditor’s expert has adequately reviewed those assumptions and methods. When the auditor’s expert’s work is to develop an auditor’s point estimate or an auditor’s range for comparison with management’s point estimate, the auditor’s procedures may be primarily directed to evaluating the assumptions and methods, including models where appropriate, used by the auditor’s expert. SA 540 discusses the assumptions and methods used by management in making accounting estimates, including the use in some cases of highly specialised, entity-developed models. Although that discussion is written in the context of the auditor obtaining sufficient appropriate



audit evidence regarding management’s assumptions and methods, it may also assist the auditor when evaluating an auditor’s expert’s assumptions and methods. When an auditor’s expert’s work involves the use of significant assumptions and methods, factors relevant to the auditor’s evaluation of those assumptions and methods include whether they are: • Generally accepted within the auditor’s expert’s field; • Consistent with the requirements of the applicable financial reporting framework; • Dependent on the use of specialised models; and • Consistent with those of management, and if not, the reason for, and effects of, the

differences.

(c) If that expert’s work involves the use of source data that is significant to that expert’s work, the relevance, completeness, and accuracy of that source data. When an auditor’s expert’s work involves the use of source data that is significant to that expert’s work, procedures such as the following may be used to test that data: • Verifying the origin of the data, including obtaining an understanding of, and where

applicable testing, the internal controls over the data and, where relevant, its transmission to the expert.

• Reviewing the data for completeness and internal consistency.

XII. WHEN WORK OF THE AUDITOR’S EXPERT IS NOT ADEQUATE FOR THE AUDITOR’S PURPOSES

If the auditor determines that the work of the auditor’s expert is not adequate for the auditor’s purposes, the auditor shall: (a) Agree with that expert on the nature and extent of further work to be performed by that

expert; or (b) Perform further audit procedures appropriate to the circumstances.

Inadequate Work : If the auditor concludes that the work of the auditor’s expert is not adequate for the auditor’s purposes and the auditor cannot resolve the matter through the additional audit procedures, which may involve further work being

performed by both the expert and the auditor, or include employing or engaging another expert, it may be necessary to express a modified opinion in the auditor’s report in accordance with SA 705 because the auditor has not obtained sufficient appropriate audit evidence

XIII. REFERENCE TO THE AUDITOR’S EXPERT IN THE AUDITOR’S REPORT

1 The auditor shall not refer to the work of an auditor’s expert in an auditor’s report containing an unmodified opinion unless required by law or regulation to do so. If such reference is



required by law or regulation, the auditor shall indicate in the auditor’s report that the reference does not reduce the auditor’s responsibility for the audit opinion.

In some cases, law or regulation may require a reference to the work of an auditor’s expert, for the purposes of transparency in the public sector.

2 If the auditor makes reference to the work of an auditor’s expert in the auditor’s report because such reference is relevant to an understanding of a modification to the auditor’s opinion, the auditor shall indicate in the auditor’s report that such reference does not reduce the auditor’s responsibility for that opinion.

Illustration

While doing audit, Ram, the Auditor requires reports from experts for the purpose of Audit evidence. What types of reports/opinions he can obtain and to what extent he can rely upon the same?

Using the Work of an Auditor’s Expert: As per SA 620, “Using the Work of an Auditor’s Expert”, during the audit, the auditor may seek to obtain, in conjunction with the client or independently, audit evidence in the form of reports, opinions, valuations and statements of an expert.

While doing audit, Ram, the auditor can obtain the following types of reports, or options or statements of an expert for the purpose of audit evidence:

(i) The valuation of complex financial instruments, land and buildings, plant and machinery, jewelry, works of art, antiques, intangible assets, assets acquired and liabilities assumed in business combinations and assets that may have been impaired.

(ii) The actuarial calculation of liabilities associated with insurance contracts or employee benefit plans.

(iii) The estimation of oil and gas reserves.

(iv) The valuation of environmental liabilities, and site clean-up costs.

(v) The interpretation of contracts, laws and regulations.

(vi) The analysis of complex or unusual tax compliance issues.

When the auditor intends to use the work of an expert, he shall evaluate the adequacy of the auditor’s expert’s work, including the relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other audit evidence; if that expert’s work involves use of significant assumptions and methods, the relevance and reasonableness of those assumptions and methods in the circumstances; and if that expert’s work involves the use of source data that is significant to his work, the relevance, completeness, and accuracy of that source data.

If the auditor determines that the work of the auditor’s expert is not adequate for the auditor’s purposes, he shall agree with that expert on the nature and extent of further work to be performed by that expert; or perform further audit procedures appropriate to the circumstances



4.5.4 SA 540-AUDITING ACCOUNTING ESTIMATES, INCLUDING FAIR VALUE ACCOUNTING ESTIMATES & RELATED DISCLOSURES

I. SCOPE OF THIS SA

This Standard on Auditing (SA) deals with the auditor’s responsibilities regarding accounting estimates, including fair value accounting estimates, and related disclosures in an audit of financial statements. Specifically, it expands on how SA 315 and SA 330 and other relevant SAs are to be applied in relation to accounting estimates. It also includes requirements and guidance on misstatements of individual accounting estimates, and indicators of possible management bias.

II. NATURE OF ACCOUNTING ESTIMATES

Some financial statement items cannot be measured precisely, but can only be estimated. For purposes of this SA, such financial statement items are referred to as accounting estimates.

Because of the uncertainties inherent in business activities, some financial statement items can only be estimated. Further, the specific characteristics of an asset, liability or component of equity, or the basis of or method of measurement prescribed by the financial reporting framework, may give rise to the need to estimate a financial statement item.

Some accounting estimates involve relatively low estimation uncertainty and may give rise to lower risks of material misstatements, o Accounting estimates arising in entities that engage in business activities that are

not complex.

o Accounting estimates that are frequently made and updated because they relate to routine transactions.

o Accounting estimates derived from data that is readily available, such as published interest rate data or exchange-traded prices of securities. Such data may be referred to as

The auditor’s responsibilities

regarding accounting estimates,

including fair value accounting

estimates,

related disclosures in an audit of financial

statements.Scope of SA 540

The information available to management for

making of an accounting estimate varies widely,

which affects the degree of estimation uncertainty.

The degree of estimation uncertainty affects, in

turn, the risks of material misstatement of

accounting estimates.



“observable” in the context of a fair value accounting estimate.

o Fair value accounting estimates where the method of measurement prescribed by the applicable financial reporting framework is simple and applied easily to the asset or liability requiring measurement at fair value.

o Fair value accounting estimates where the model used to measure the accounting estimate is well-known or generally accepted, provided that the assumptions or inputs to the model are observable.

For some accounting estimates, however, there may be relatively high estimation uncertainty, particularly where they are based on significant assumptions, for example:

• Accounting estimates relating to the outcome of litigation.

• Fair value accounting estimates for derivative financial instruments not publicly traded.

• Fair value accounting estimates for which a highly specialised entity-developed model is used or for which there are assumptions or inputs that cannot be observed in the marketplace. Accounting estimates in cases of Wage Revision Agreements wherein negotiations with the Trade Unions is on the way or Government’s sanction is awaited leading to uncertainty.

III. THE DEGREE OF ESTIMATION UNCERTAINTY

1. Not all financial statement items requiring measurement at fair value, involve

estimation uncertainty.

This may be the case for some financial statement items where there is an active and open market that provides readily available and reliable information on the prices at which actual exchanges occur, in which case the existence of published

price quotations ordinarily is the best audit evidence of fair value.

However, estimation uncertainty may exist even when the valuation method and data are well defined. For example, valuation of securities quoted on an active and open market at the listed market price may require adjustment if the holding is significant in relation to the market or is subject to restrictions in marketability. In addition, general economic

The degree of estimation uncertainty varies based on :

the nature of the accounting estimate,

the extent to which there is a generally accepted method

used to make the accounting estimate,

the subjectivity of the assumptions used to make the

accounting estimate



circumstances prevailing at the time, for example, illiquidity in a particular market, may impact estimation uncertainty.

Examples of situations where accounting estimates, other than fair value accounting estimates, may be required include: • Allowance for doubtful accounts. • Inventory obsolescence. • Warranty obligations. • Depreciation method or asset useful life. • Provision against the carrying amount of an investment where there is uncertainty

regarding its recoverability. • Outcome of long term contracts. • Financial Obligations / Costs arising from litigation settlements and judgments. Examples of situations where fair value accounting estimates may be required include: • Complex financial instruments, which are not traded in an active and open market. • Share-based payments. • Property or equipment held for disposal. • Certain assets or liabilities acquired in a business combination, including goodwill and

intangible assets. • Transactions involving the exchange of assets or liabilities between independent

parties without monetary consideration, for example, a non-monetary exchange of plant facilities in different lines of business.

2. Estimation involves judgments: Estimation involves judgments based on information available when the financial statements are prepared. For many accounting estimates, these include making assumptions about matters that are uncertain at the time of estimation. The auditor is not responsible for predicting future conditions, transactions or events that, if known at the time of the audit, might have significantly affected management’s actions or the assumptions used by management.

IV. MANAGEMENT BIAS

Financial reporting frameworks often call for neutrality, that is, freedom from bias. Accounting estimates are imprecise, however, and can be influenced by management judgment. Such judgment may involve unintentional or intentional management bias (for example, as a result of motivation to achieve a desired result).

The susceptibility of an accounting estimate to management bias increases with the subjectivity involved in making it.

Unintentional management bias and the potential for intentional management bias are inherent in subjective decisions that are often required in making an accounting estimate. For continuing


2.38 ADVANCED AUDITING AND PROFESSIONAL ETHICS audits, indicators of possible management bias identified during the audit of the preceding periods influence the planning and risk identification and assessment activities of the auditor in the current period.

Management bias can be difficult to detect at an account level.

It may only be identified when considered in the aggregate of groups of accounting estimates or all accounting estimates, or when observed over a number of accounting periods.

Although some form of management bias is inherent in subjective decisions, in making such judgments there may be no intention by management to mislead the users of financial statements.

Where, however, there is intention to mislead, management bias is fraudulent in nature.

V. THE MEASUREMENT OBJECTIVE OF ACCOUNTING ESTIMATES

The measurement objective of accounting estimates can vary depending on the applicable financial reporting framework and the financial item being reported. The measurement objective for some accounting estimates is to forecast the outcome of one or more transactions, events or conditions giving rise to the need for the accounting estimate. For other accounting estimates, including many fair value accounting estimates, the measurement objective is different, and is expressed in terms of the value of a current transaction or financial statement item based on conditions prevalent at the measurement date, such as estimated market price for a particular type of asset or liability.

For example, the applicable financial reporting framework may require fair value measurement based on an assumed hypothetical current transaction between knowledgeable, willing parties (sometimes referred to as “marketplace participants” or equivalent) in an arm’s length transaction, rather than the settlement of a transaction at some past or future date.

A difference between the outcome of an accounting estimate and the amount originally recognised or disclosed in the financial statements does not necessarily represent a misstatement of the financial statements. This is particularly the case for fair value accounting estimates, as any observed outcome is invariably affected by events or conditions subsequent to the date at which the measurement is estimated for purposes of the financial statements.

VI. OBJECTIVE OF SA 540

The objective of the auditor is to obtain sufficient appropriate audit evidence whether in the context of the applicable financial reporting framework:

(a) accounting estimates, including fair value accounting estimates, in the financial statements, whether recognised or disclosed, are reasonable; and

(b) related disclosures in the financial statements are adequate.



Important Definition: Accounting estimate – An approximation of a monetary amount in the absence of a precise means of measurement. This term is used for an amount measured at fair value where there is estimation uncertainty, as well as for other amounts that require estimation. Where this SA addresses only accounting estimates involving measurement at fair value, the term “fair value accounting estimates” is used. Auditor’s point estimate or auditor’s range – The amount, or range of amounts, respectively, derived from audit evidence for use in evaluating management’s point estimate Management bias – A lack of neutrality by management in the preparation and presentation of information. Management’s point estimate – The amount selected by management for recognition or disclosure in the financial statements as an accounting estimate. Estimation uncertainty – The susceptibility of an accounting estimate and related disclosures to an inherent lack of precision in its measurement. Outcome of an accounting estimate –The actual monetary amount which results from the resolution of the underlying transaction(s), event(s) or condition(s) addressed by the accounting estimate. VII. AUDITOR’S RESPONSIBILITY /AUDIT PROCEDURES

1. Risk Assessment Procedures and Related Activities for Accounting Estimates: When performing risk assessment procedures and related activities to obtain an understanding of the entity and its environment, including the entity’s internal control, as required by SA 315, the auditor shall obtain an understanding of the following in order to provide a basis for the identification and assessment of the risks of material misstatement for accounting estimates:

(a) The requirements of the applicable financial reporting framework relevant to accounting estimates, including related disclosures.

(b) How management identifies those transactions, events and conditions that may give rise to the need for accounting estimates to be recognised or disclosed in the financial statements. In obtaining this understanding, the auditor shall make inquiries of management about changes in circumstances that may give rise to new, or the need to revise existing, accounting estimates. As the assessment of accounting estimates affects the ultimate decision in forming an opinion much care has to be taken in this regard. It is highly important as the Auditors conclusion is on the above basis.

2. Obtaining an Understanding of How Management Identifies the Need for Accounting Estimates: In preparing the financial statements, management has the responsibility to determine whether a transaction, event or condition gives rise to the need to make an accounting estimate, and that all necessary accounting estimates have been recognised,



measured and disclosed in the financial statements in accordance with the applicable financial reporting framework.

The auditor’s understanding of the entity and its environment obtained during the performance of risk assessment procedures, together with other audit evidence obtained during the course of the audit, assist the auditor in identifying circumstances, or changes in circumstances, that may give rise to the need for an accounting estimate.

Inquiries of management about changes in circumstances may include, for example, inquiries about whether:

• The entity has engaged in new types of transactions that may give rise to accounting estimates.

• Terms of transactions that gave rise to accounting estimates have changed.

• Accounting policies relating to accounting estimates have changed, as a result of changes to the requirements of the applicable financial reporting framework or otherwise.

• Regulatory or other changes outside the control of management have occurred that may require management to revise, or make new, accounting estimates.

• New conditions or events have occurred that may give rise to the need for new or revised accounting estimates.

During the audit, the auditor may identify transactions, events and conditions that give rise to the need for accounting estimates that management failed to identify. SA 315 deals with circumstances where the auditor identifies risks of material misstatement that management failed to identify, including determining whether there is a significant deficiency in internal control with regard to the entity’s risk assessment processes.

3. How management makes the accounting estimates: How management makes the accounting estimates, and an understanding of the data on which they are based, including:

(i) The method, including where applicable the model, used in making the accounting estimate;

(ii) Relevant controls;

(iii) Whether management has used an expert;

(iv) The assumptions underlying the accounting estimates;

(v) Whether there has been or ought to have been a change from the prior period in the methods for making the accounting estimates, and if so, why; and

(vi) Whether and, if so, how management has assessed the effect of estimation uncertainty.



The auditor shall review the outcome of accounting estimates included in the prior period financial statements, or, where applicable, their subsequent re-estimation for the purpose of the current period. The nature and extent of the auditor’s review takes account of the nature of the accounting estimates, and whether the information obtained from the review would be relevant to identifying and assessing risks of material misstatement of accounting estimates made in the current period financial statements. However, the review is not intended to call into question the judgments made in the prior periods that were based on information available at that time.

4. Estimation Uncertainty: For accounting estimates that give rise to significant risks, in addition to other substantive procedures performed to meet the requirements of SA 330, the auditor shall evaluate the following:

(a) How management has considered alternative assumptions or outcomes, and why it has rejected them, or how management has otherwise addressed estimation uncertainty in making the accounting estimate.

(b) Whether the significant assumptions used by management are reasonable.

(c) Where relevant to the reasonableness of the significant assumptions used by management or the appropriate application of the applicable financial reporting framework, management’s intent to carry out specific courses of action and its ability to do so.

If, in the auditor’s judgment, management has not adequately addressed the effects of estimation uncertainty on the accounting estimates that give rise to significant risks, the auditor shall, if considered necessary, develop a range with which to evaluate the reasonableness of the accounting estimate.

Recognition and Measurement Criteria: For accounting estimates that give rise to significant risks, the auditor shall obtain sufficient appropriate audit evidence whether the following are in accordance with the requirements of the applicable financial reporting framework:

(a) management’s decision to recognise, or to not recognise, the accounting estimates in the financial statements; and

(b) the selected measurement basis for the accounting estimates.

I. Identifying and Assessing the Risks of Material Misstatements: (a) In identifying and assessing the risks of material misstatement as required by

SA 315, the auditor shall evaluate the degree of estimation uncertainty associated with accounting estimates.

(b) The auditor shall determine whether, in the auditor’s judgment, any of those accounting estimate that have been identified as having high estimation uncertainty give rise to significant risk.



II. Responses to the Assessed Risks of Material Misstatement: (a) Based on assessed risk of material misstatement the auditor, shall determine:

• Whether management has appropriately applied the applicable financial reporting framework relevant to the accounting estimate; and.

• Whether the methods for making the accounting estimates are appropriate and have been applied consistently

• If changes are there the in accounting estimates or in the method making those from prior period are appropriate in circumstances present.

(b) In response to the assessed risk of material misstatement the auditor shall undertake one or more of the following, taking in account the nature of the accounting estimates. • Determine whether events occurring up to the date of the auditor’s report

provide sufficient audit evidence regarding the accounting estimate. • Test checks the data used by the management for making accounting

estimate. • The auditor shall also evaluate whether the method used for measurement

is appropriate in the circumstances and assumptions made by the management are reasonable in the light of the measurement objective of the applicable financial reporting. This can be achieved by

• Testing the extent to which data on which accounting estimate is based is accurate, complete and relevant and whether the accounting estimate has been properly determined using such data and management assumptions.

• Considering the source, relevance and reliability of external data. • Recalculating the accounting estimate and reviewing information about an

accounting estimate for internal consistency. • Test checks the effectiveness of the controls over the estimates used by the

management together with appropriate substantive procedure. (c) While determining the matters identified or in responding to the assessed risks of

material misstatement, the auditor shall consider whether specialized skills or knowledge in relation to one or more aspects of the accounting estimates are required in order to obtain sufficient appropriate audit evidence.

5. Evaluating the Reasonableness of the Accounting Estimates, and Determining Misstatements: The auditor shall evaluate, based on the audit evidence, whether the accounting estimates in the financial statements are either reasonable in the context of the applicable financial reporting framework, or are misstated.



VIII. AUDIT REPORTING & DISCLOSURE:

Disclosures Related to Accounting Estimates

The auditor shall obtain sufficient appropriate audit evidence about whether the disclosures in the financial statements related to accounting estimates are in accordance with the requirements of the applicable financial reporting framework.

For accounting estimates that give rise to significant risks, the auditor shall also evaluate the adequacy of the disclosure of their estimation uncertainty in the financial statements in the context of the applicable financial reporting framework

(a) The presentation of financial statement in accordance with the applicable financial reporting framework includes adequate disclosure of material matters. These disclosures may include, • The assumptions used. • The method of estimation used,

including any applicable model. • The basis for the selection of the

estimation. • Any changes in the method of

estimation from prior period and its subsequent effect.

• The sources and implication of estimation uncertainty.

(b) In relation to accounting estimate having significant risk, even where the disclosures are in accordance with the applicable financial reporting framework, the auditor may conclude that the disclosure of estimation uncertainty is inadequate in light of the circumstances and facts involved.

Written Representations: The auditor shall obtain written representations from management and, where appropriate, those charged with governance whether they believe significant assumptions used in making accounting estimates are reasonable.

Documentation of Accounting Estimates

The audit documentation shall include: (a) The basis for the auditor’s conclusions about the reasonableness of accounting

estimates and their disclosure that give rise to significant risks; and (b) Indicators of possible management bias, if any.



4.5.5 CONTROL OF QUALITY OF AUDIT WORK

As per SA 220 “Quality Control for an Audit of Financial Statements” Quality control systems, policies and procedures are the responsibility of the audit firm. Under SQC 1, the firm has an obligation to establish and maintain a system of quality control to provide it with reasonable assurance that:

(a) The firm and its personnel comply with professional standards and regulatory and legal requirements; and

SA 540-Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures

Management's Responsibility-

Follow an unbiased

approach in preparing for accountingestimates

To make appropriate

disclosure in FS about the

assertion andestimates made.

Auditor's Responsibility/Audit

Procedure

Perform risk assessment

procedure andrelated activites

Identify and assess the risk of

materialmisstatements

Response to the assessed risk of

materialmisstatements

Evaluate the reasonableness of

accountingestimates

Audit Reporting

Adequate disclosure of

material matter, such as

the assumptions and method ofestimates used

basis of selectionof estimates

any change in the method of estimates as compared to

prior period

the source and implication of

estimation uncertainty

If significant risk exist even after adequate disclosure the auditor

may conclude that the disclosure of estimation uncertainty is

inadequate in light of the circumstances and facts

involved.

Scope : Auditor's Responsibility regarding

use of accounting estimates by management



(b) The reports issued by the firm or engagement partners are appropriate in the circumstances.

Within the context of the firm’s system of quality control, engagement teams have a responsibility to implement quality control procedures that are applicable to the audit engagement and provide the firm with relevant information to enable the functioning of that part of the firm’s system of quality control relating to independence.

Engagement teams are entitled to rely on the firm’s system of quality control, unless information provided by the firm or other parties suggests otherwise.

The objective of the auditor is to implement quality control procedures at the engagement level that provide the auditor with reasonable assurance that:

(a) The audit complies with professional standards and regulatory and legal requirements; and

(b) The auditor’s report issued is appropriate in the circumstances.

(Students may refer SA 220 for more details)

4.5.6 ANALYTICAL PROCEDURES PRIOR TO AUDIT AS WELL AS TOWARDS FINALIZATION

I. WHEN DESIGNING AND PERFORMING SUBSTANTIVE ANALYTICAL PROCEDURES

As per SA 520, “Analytical Procedures” the auditor shall:

(a) Determine the suitability of particular substantive analytical procedures for given assertions, taking account of the assessed risks of material misstatement and tests of details, if any, for these assertions;

(b) Evaluate the reliability of data from which the auditor’s expectation of recorded amounts or ratios is developed, taking account of source, comparability, and nature and relevance of information available, and controls over preparation;

(c) Develop an expectation of recorded amounts or ratios and evaluate whether the expectation is sufficiently precise to identify a misstatement that, individually or when aggregated with other misstatements, may cause the financial statements to be materially misstated; and

(d) Determine the amount of any difference of recorded amounts from expected values that is acceptable without further investigation as required.

II. ANALYTICAL PROCEDURES THAT ASSIST WHEN FORMING AN OVERALL CONCLUSION

The auditor shall design and perform analytical procedures near the end of the audit that assist the auditor when forming an overall conclusion as to whether the financial statements are consistent with the auditor’s understanding of the entity.


2.46 ADVANCED AUDITING AND PROFESSIONAL ETHICS The conclusions drawn from the results of analytical procedures designed and performed in accordance with above are intended to verify conclusions formed during the audit of individual components or elements of the financial statements. This assists the auditor to draw reasonable conclusions on which to base the auditor’s opinion.

The results of such analytical procedures may identify a previously unrecognised risk of material misstatement. In such circumstances, SA 315 requires the auditor to revise the auditor’s assessment of the risks of material misstatement and modify the further planned audit procedures accordingly.

The analytical procedures performed in accordance with above may be similar to those that would be used as risk assessment procedures.

III. INVESTIGATING RESULTS OF ANALYTICAL PROCEDURES

If analytical procedures performed in accordance with this SA 520 identify fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount, the auditor shall investigate such differences by:

(a) Inquiring of management and obtaining appropriate audit evidence relevant to management’s responses; and

(b) Performing other audit procedures as necessary in the circumstances: The need to perform other audit procedures may arise when, for example, management is unable to provide an explanation, or the explanation, together with the audit evidence obtained relevant to management’s response, is not considered adequate.

Note: Students are also advised to refer: 1 Audit Strategy, Audit Planning & Audit Program discussed in Chapter-2 of CA Intermediate

course study material. (covering SA 300)

2. Audit Documentation & Audit Evidence discussed in Chapter-3 of CA Intermediate course study material. (covering SA 230, SA 500, SA 580, SA 501, SA 505, SA 510, SA 550, SA 560 & SA 570)

3. Fraud & Responsibilities of Auditor discussed in Chapter-5 of CA Intermediate course study material. (covering SA 240)

4. Audit Sampling discussed in Chapter-7 of CA Intermediate course study material. (covering SA 530)

5. Analytical Procedures as discussed in Chapter-8 of CA Intermediate course study material. (covering SA 520)

6. SA 250, SA 260, SA 320, SA 330, SA 402, SA 450 & also above mentioned SA’s, produced in Auditing Pronouncements of CA Final Course for detailed discussion.

7. SA 315 Identifying and Assessing the Risk of Material Misstatements through understanding the Entity and its Environment.



TEST YOUR KNOWLEDGE Theoretical Questions 1. While auditing Z Ltd., you observe certain material financial statement assertions have been

based on estimates made by the management. As the auditor how do you minimize the risk of material misstatements?

2. KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y and Mr. Z as joint auditors to conduct auditing for the financial year 2018-19. For the valuation of gratuity scheme of the company, Mr. X, Mr. Y and Mr. Z wanted to refer their own known Actuaries. Due to difference of opinion, all the joint auditors consulted their respective Actuaries. Subsequently, major difference was found in the actuary reports. However, Mr. X agreed to Mr. Y’s actuary report, though, Mr. Z did not. Mr. X contends that Mr. Y’s actuary report shall be considered in audit report due to majority of votes. Now, Mr. Z is in dilemma. Explain the responsibility of auditors, in case, report made by Mr. Y’s actuary, later on, found faulty.

3. A & Co. was appointed as auditor of Great Airways Ltd. As the audit partner what factors shall be considered in the development of overall audit plan?

4. As an auditor of garment manufacturing company for the last five years, you have observed that new venture of online shopping has been added by the company during current year. What factors would be considered by you in formulating the audit strategy of the company?

Multiple Choice Questions: 1. AK & Co, a firm of Chartered Accountants, have been operating for the last 6 years. Due to

the quality of service offered by the firm, it has made its name and is quite renowned especially in Southern India where its head office is located. The firm has a staff size of 240 including graduates, Chartered Accountants, Management Consultants, Company Secretaries and lawyers.

The firm has 3 branches other than head office at Bangalore, Chennai and Pune.

The firm has got many clients for statutory audit over the period and ensures that to maintain the quality of work, proper planning is done by each team before starting any engagement.

One of the engagement team, picked up for statutory audit of Sun Private Ltd, was involved in the process of planning of audit for the financial year ended 31 March, 2019.

The audit for the financial year ended 31 March, 2018 was conducted by a different engagement team. However, the engagement team of Sun Private Ltd for the current year has got the industry experience.


2.48 ADVANCED AUDITING AND PROFESSIONAL ETHICS The audit team is confused during the planning work and would like to have your views on

following points. Please advise by answering one of them.

(a) The engagement team should consult the previous year’s engagement team during the course of their planning.

(b) The engagement team should be independent and hence cannot consult the previous year’s engagement team during the course of their planning.

(c) The engagement team needs to maintain confidentiality and hence cannot consult the previous year’s engagement team during the course of their planning.

(d) Only the Partner who is going to sign the audit report may consult the previous year’s audit team.

2. Kshitij Private Ltd is a company based out of Kochi having operations primarily in Europe. Because of the nature of the operations of the company, it is required to prepare its financial statements as per International Standards for reporting to the local regulatory authorities over there.

Since the business is based in Europe, the audit team is also required to visit the locations wherever the company has offices and is accordingly required to perform certain audit procedures over there.

During the audit of this company for the financial year ended 31 March, 2019, the auditors, who had planned their work appropriately and had a large team for conducting the audit, were facing lot of challenges at various stages.

They were also required to revisit their materiality level during the course of the work.

However, at the time of final reviews when this was discussed with the Audit Partner (Audit Incharge), he was not convinced with the approach of the audit team wherein they reassessed their plans continuously resulting in waste of time.

In this situation, please advise which one of the following would be correct.

(a) Audit Partner being the senior most team member is right and same thing should be considered by audit team by documenting it in the audit file.

(b) Audit Partner’s view is not correct as the audit team did the right thing.

(c) Audit Partner was correct, however, during the course of an audit which required visits at various locations it was mandatory.

(d) Audit Partner’s view is not correct because the materiality was revised by the audit team which is a big thing and same should have been considered by the audit partner.



3. RJ Private Limited having its office at Bangalore and operations spread across Southern India, had a discussion with its statutory auditors regarding the audit plan and the timelines.

In the past years, there have been significant delays in completion of audit work and the management wanted that for the current year, audit should get completed on time. For doing this, the audit team suggested that the information for the purpose of audit should be ready on time and only then the timelines as agreed can be achieved.

On the basis of the discussions with the client & the auditors and internal discussions amongst the audit team members, a detailed audit programme was prepared by the audit team for the current year’s audit. But the audit team discussed that they will not document this audit programme till the completion of the audit work because at various stages, the work may require changes. If the audit team documents the audit programme then it would create problems later on at the time of assembly of the audit file wherein the audit team would have to show the changes made by them in the audit programme during the course of the audit.

You are required to share your views in respect of this understanding and approach of the auditor.

(a) The decision of audit team regarding not documenting the audit programme is very good as this would avoid unnecessary problems of documentation of changes made in the audit programme at the time of assembly of file.

(b) Instead of considering the audit programme, the audit team could have prepared a checklist. In case of a checklist, such problem will not arise. Because in case of a checklist if any changes are made then the final checklist can be kept in the file along with old working checklist used during the audit.

(c) The approach of the audit team not to document audit programme is not correct. The audit team needs to document it properly at the time of planning stage itself and any changes made after that should also be documented with explanations.

(d) The decision of audit team not to document the audit programme is not correct. Their concern that the changes may arise in the audit programme is valid, however, to take care of that the audit team can take approval from the ICAI later on when those changes will be made. The audit team will have to document the changes and the approval note of the ICAI.

4. KJ Private Ltd has a business of pharmaceuticals and has an annual turnover of INR 1,500 crores. During the last few years, considering the environment in which the company operates, its profit have reduced and are still reducing. Hence the management has been looking at various ways to cut the costs.

AD & Associates are the statutory auditors of the company and RM & Associates are the internal auditors of the company.


2.50 ADVANCED AUDITING AND PROFESSIONAL ETHICS Initially the company did not want to appoint any internal auditors to save costs, however, at

insistence of the statutory auditors, the company appointed the internal auditors.

During the course of the statutory audit for the financial year ended 31 March, 2019, the statutory auditors requested for the detailed working papers of the internal auditors which the internal auditors refused. However, the statutory auditors told the management if the same are not provided then they would qualify their report.

In this situation, please advise which of the following would be correct.

(a) The statutory auditors should review the detailed working papers but they cannot qualify their report on this ground.

(b) The statutory auditors may review the detailed working papers and even after that they may qualify their report.

(c) The statutory auditors are not required to go to the extent of review of detailed working papers of internal auditors.

(d) The statutory auditors may review the detailed working papers of internal auditors but for that purpose they would require prior approval of the ICAI.

5. RIM Private Ltd is engaged in the business of manufacturing of steel having annual turnover of INR 10,000 crores. The company is very capital intensive and has its plants at two locations – Mohali and Hosur.

During the year ended 31 March, 2019, the company carried out a detailed physical verification of its property, plant and equipment and also reassessed their useful lives by engaging a consultant. The consultant submitted its report to the management on 21 April, 2019.

The statutory auditors of the company started their audit work from May 2019 and when this information was given to them regarding the physical verification and the reassessment of the useful lives of property, plant and equipment, the auditors told the management that the consultant should have submitted its report to the auditors also independently. Further, in the absence of this direct communication of the report of the consultant to the auditors, the audit team would have to review the work of the consultant which is not efficient but it cannot be avoided now.

Management did not agree with both the points of the auditors that the consultant should have shared report with the auditors directly and that the auditors need to review the work of the consultant. The management would like to have your views on this matter. (a) The view of the management seems to be correct because there is no such

requirement that any consultant of the company should share his report directly with the auditor. Also when the consultant has already submitted a detailed report, no further review is required on that.



(b) Both the management and auditors are not correct. The auditor is not supposed to receive the report directly. Further, the auditor needs to review the work of the consultant irrespective of the fact whether he received the report directly or not.

(c) The auditor’s requirements are reasonable because he carries duty in respect of audit of financial statements and by not getting report directly from the consultant he would not know whether it belongs to that consultant or not. And now only because of this lack of proper communication the auditor would have to review the work of the consultant.

(d) Both management and auditors should find a solution to this problem. The management may request the consultant to send the report to the auditor directly now. On the basis of the same, the auditor can avoid unnecessary procedure related to review of report of the consultant.

Answers to Theoretical Questions 1. As per SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting

Estimates, and Related Disclosures”, the auditor shall obtain an understanding of the following in order to provide a basis for the identification and assessment of the risks of material misstatements for accounting estimates: (i) The requirements of the applicable financial reporting framework relevant to the

accounting estimates, including related disclosures. (ii) How Management identifies those transactions, events and conditions that may give

rise to the need for accounting estimates to be recognised or disclosed, in the financial statements. In obtaining this understanding, the auditor shall make inquiries of management about changes in circumstances that may give rise to new, or the need to revise existing, accounting estimates.

(iii) The estimation making process adopted by the management including- (1) The method, including where applicable the model, used in making the

accounting estimates. (2) Relevant controls. (3) Whether management has used an expert? (4) The assumption underlying the accounting estimates. (5) Whether there has been or ought to have been a change from the prior period

in the methods for making the accounting estimates, and if so, why; and (6) Whether and, if so, how the management has assessed the effect of

estimation uncertainty. 2. Using the work of an Auditor’s Expert: As per SA 620 “Using the Work of an Auditor’s

Expert”, the expertise of an expert may be required in the actuarial calculation of liabilities associated with insurance contracts or employee benefit plans etc., however, the auditor



has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the auditor’s use of the work of an auditor’s expert.

The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes, including the relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other audit evidence as per SA 500.

Further, in view of SA 620, if the expert’s work involves use of significant assumptions and methods, then the relevance and reasonableness of those assumptions and methods must be ensured by the auditor and if the expert’s work involves the use of source data that is significant to that expert’s work, the relevance, completeness, and accuracy of that source data in the circumstances must be verified by the auditor.

In the instant case, Mr. X, Mr. Y and Mr. Z, jointly appointed as an auditor of KRP Ltd., referred their own known Actuaries for valuation of gratuity scheme. Actuaries are an auditor’s expert as per SA 620. Mr. Y’s referred actuary has provided the gratuity valuation report, which later on found faulty. Further, Mr. Z is not agreed with this report therefore he submitted a separate audit report specifically for such gratuity valuation.

In such situation, it was duty of Mr. X, Mr. Y and Mr. Z, before using the gratuity valuation report of Actuary, to ensure the relevance and reasonableness of assumptions and methods used. They were also required to examine the relevance, completeness and accuracy of source data used for such report before expressing their opinion.

Mr. X and Mr. Y will be held responsible for grossly negligence and using such faulty report without examining the adequacy of expert actuary’s work whereas Mr. Z will not be held liable for the same due to separate opinion expressed by him.

3. Development of an overall plan - Overall plan is basically intended to provide direction for audit work programming and includes the determination of timing, manpower development and co-ordination of work with the client, other auditors and other experts. The auditor should consider the following matters in developing his overall plan for the expected scope and conduct of the audit:

(i) Terms of his engagement and any statutory responsibilities.

(ii) Nature and timing of reports or other communications.

(iii) Applicable Legal or Statutory requirements.

(iv) Accounting policies adopted by the clients and changes, if any, in those policies.

(v) The effects of new accounting and auditing pronouncement on the audit.

(vi) Identification of significant audit areas.

(vii) Setting of materiality levels for the audit purpose.



(viii) Conditions requiring special attention such as the possibility of material error or fraud or involvement of parties in whom directors or persons who are substantial owners of the entity are interested and with whom transactions are likely.

(ix) Degree of reliance to be placed on the accounting system and internal control.

(x) Possible rotation of emphasis on specific audit areas.

(xi) Nature and extent of audit evidence to be obtained.

(xii) Work of the internal auditors and the extent of reliance on their work, if any in the audit.

(xiii) Involvement of other auditors in the audit of subsidiaries or branches of the client and involvement of experts.

(xiv) Allocation of works to be undertaken between joint auditors and the procedures for its control and review.

(xv) Establishing and coordinating staffing requirements.

4. Formulation of Audit Strategy: While formulating the audit strategy for a company, following factors may be considered -

General Factors: Refer Para 2.1.

Specific Factors for Online Shopping:

The auditor shall also obtain an understanding of the information system including the related business processes due to new venture of online shopping in the following areas: (i) The classes of transactions in the entity’s operations that are significant to the

financial statements; (ii) The procedures, within both information technology (IT) and manual systems, by

which those transactions are initiated, recorded, processed, corrected as necessary, transferred to the general ledger and reported in the financial statements;

(iii) The related accounting records, supporting information and specific accounts in the financial statements that are used to initiate, record, process and report transactions; this includes the correction of incorrect information and how information is transferred to the general ledger. The records may be in either manual or electronic form;

(iv) How the information system captures events and conditions, other than transactions, that are significant to the financial statements;

(v) Controls surrounding journal entries, including non-standard journal entries used to record non-recurring, unusual transactions or adjustments.

Answers to Multiple Choice Questions 1. (a) 2. (b) 3. (c) 4. (c) 5. (b)


3

RISK ASSESSMENT AND INTERNAL CONTROL LEARNING OUTCOMES

After studying this chapter, you will be able to: Know the Internal Control System-Nature, Scope, Objective and

Structure. Identify the components of Internal Control. Learn to review of the systems of Internal Control. Understand the concept of Risk Based Audit, Internal Control and Risk

Assessment. Gain knowledge of reporting to clients on Internal Control weaknesses. Know the framework of Reporting of Internal Control



1. INTRODUCTION It is the risk that the auditor may fail to express an appropriate opinion in an audit assignment. An auditor may consider audit risk both at overall level as well as at the level of individual account balances or classes of transactions. This means that at overall level the auditor applies their professional judgement to determine the extent of risk which he considers to be an acceptable level. At account balance level, audit risk refers to the risk that error in monetary terms exists beyond a tolerable error limit in the account balances or class of transaction which

the auditor fails to defect. Fig.: Internal Control and Risk Assessment∗

∗ Source : SlideShare

RISK ASSESSMEN

T AND INTERNAL CONTROL

Internal Control

System -Nature, Scope,

Objective and Structure Components

of Internal Control

Review of the System of

Internal Controls

Methods of Recording

Internal Control and

Risk Assessment

Framework on Reporting of

Internal Controls

Reporting to clients on Internal Control

Weaknesses

CHAPTER OVERVIEW


http://www.slideshare.net/RishabNahata2/final-presentation-internal-controls-60162900

RISK ASSESSMENT AND INTERNAL CONTROL 3.3

AUDIT RISK means the risk that the auditor gives an inappropriate audit opinion when the financial statement are materially misstated. SA 315 establishes requirements and provides guidance on identifying and assessing the risks of material misstatement at the financial statement and assertion levels.

Audit risk is a function of the risks of material misstatement and detection risk

Risk of material misstatement may be defined as the risk that the financial statements are materially misstated prior to audit. This consists of two components, described as follows at the assertion level:(A) Inherent risk—The susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls. (B) Control risk—The risk that a misstatement that could occur in an assertion about a class of transaction, account balance or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control. (C) Detection Risk: The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements.

Audit Risk = Risk of Material Misstatement x Detection Risk------(1) Risk of Material Misstatement= Inherent Risk x Control Risk------(2)From (1) and (2), we arrive at- Audit Risk = Inherent Risk x Control Risk x Detection Risk

Assessment of Risks - Matter of Professional Judgement

The Internal Control structure in an organization is referred to as the policies and procedures established by the entity to provide reasonable assurance that the objectives are achieved. The control structure in an organization basically has the following components:

1. Control Environment - Control environment covers the effect of various factors like management attitude, awareness and actions for establishing, enhancing or mitigating the effectiveness of specific policies and procedures.

2. Accounting System - Accounting system means the series of task and records of an entity by

Control Environment

Accounting System

Control Procedure

Control Environment

Accounting SystemAccounting SystemAccounting System

Control Procedure

Accounting SystemAccounting SystemAccounting SystemAccounting SystemAccounting SystemAccounting SystemAccounting System



which transactions are processed for maintaining financial records. Such system identifies, assemble, analyze, calculate, classify, record, summarize and report transactions and other events.

3. Control Procedure - Policies and procedures means those policies and procedures in addition to the control environment and accounting systems which the management has established to achieve the entity’s specific objectives.

In this regard, the management is responsible for maintaining an adequate accounting system incorporating various internal controls to the extent that they are appropriate to the size and nature of the business. There should be reasonable assurance for the auditor that the accounting system is adequate and that all the accounting information required to be recorded has in fact been recorded.

Internal controls normally contribute to such assurance. The auditor should gain an understanding of the accounting system and related internal controls and should study and evaluate the operation of those internal controls upon which he wishes to rely in determining the nature, timing and extent of other audit procedures. Where the auditor concludes that he can rely on certain internal controls, he could reduce his substantive procedures which otherwise may be required and may also differ as to the nature and timing.

Specific Requirement under SA 315 - “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment” deals with the auditor’s responsibility to identify and assess the risks of material misstatement in the financial statements, through understanding the entity and its environment, including the entity’s internal control.

SA 315 defines the system of internal control as the process designed, implemented and maintained by those charged with governance, management and other personnel to provide reasonable assurance about the achievement of an entity’s objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations, safeguarding of assets, and compliance with applicable laws and regulations.

SA 315 further states that the auditor should identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels, through understanding the entity and its environment, including the entity’s internal control, thereby providing a basis for designing and implementing responses to the assessed risks of material misstatement. This will help the auditor to reduce the risk of material misstatement to an acceptably low level.



2. INTERNAL CONTROL SYSTEM - NATURE, SCOPE, OBJECTIVES AND STRUCTURE

Internal controls are a system consisting of specific policies and procedures designed to provide management with reasonable assurance that the goals and objectives it believes important to the entity will be met.

"Internal Control System" means all the policies and procedures (internal controls) adopted by the management of an entity to assist in achieving management's objective of ensuring, as far as practicable, the orderly and efficient conduct of its business, including adherence

to management policies, the safeguarding of assets, the prevention and detection of fraud and error, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information.

To state whether a set of financial statements presents a true and fair view, it is essential to benchmark and check the financial statements for compliance with the framework. The Accounting Standards specified under the Companies Act, 1956 (which are deemed to be applicable as per Section 133 of the 2013 Act, read with Rule 7 of Companies (Accounts) Rules, 2014) is one of the criteria constituting the financial reporting framework on which companies prepare and present their financial statements under the Act and against which the auditors evaluate if the financial statements present a true and fair view of the state of affairs and the results of operations of the company in an audit of the financial statements carried out under the Act. The following are the Nature, Scope, Objectives and Structure of an Internal Control Audit:

2.1 Nature of Internal Control A set of internally generated policies and procedures adopted by the management of an enterprise is a prerequisite for an organisations efficient and effective performance. It is thus, a primary responsibility of every management to create and maintain an adequate system of internal control appropriate to the size and nature of the business entity. SA 315 defines the system of internal control as the process designed, implemented and maintained by those charged with governance, management and other personnel to provide reasonable assurance about the achievement of an entity’s objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations, safeguarding of assets, and compliance with applicable laws and regulations.

Internal control is a process/set of processes designed to facilitate and support the achievement of business objectives. Any system of internal control is based on a consideration of significant risks in operations, compliance and financial reporting. Objectives such as improving business effectiveness are included, as are compliance and reporting objectives.



2.2 Scope of Internal Controls The scope of internal controls extends beyond mere accounting controls and includes all administrative controls concerned with the decision - making process leading to managements authorization of transaction, such controls include, production method, time and motion study, pricing policies, quality control, work standard, budgetary control, policy appraisal, quantitative controls etc. In an independent financial audit, the auditor is primarily concerned with those policies and procedures having a bearing on the assertions underlying the financial statements. These comprise primarily controls relating to safeguarding of assets, prevention and detection of fraud and error, accuracy and completeness of accounting records and timely preparation of reliable financial information. Administrative controls, on the other hand, have only a remote relationship with financial records and the auditor may evaluate only those administrative controls which have a bearing on the reliability of the financial records.

The fundamental therefore is that effective internal control is a process effected by people that supports the organization in several ways, enabling it to provide reasonable assurance regarding risk and to assist in the achievement of objectives.

Fundamental to a system of internal control is that it is integral to the activities of the company, and not something practiced in isolation.

2.3 Objectives of Internal Control System The objectives of internal control systems are determined by the management, after considering the nature of business, scale operations, the extent of professionalism of the management etc.

INTE

RNAL

CON

TROL

SYS

TEM:

Facilitates the effectiveness and efficiency of operations.

Helps ensure the reliability of internal and external financial reporting.

Assists compliance with laws and regulations.

Helps safeguarding the assets of the entity.



The objectives of internal controls relating to the accounting system are:

(i) Transactions are executed through general or specific management authorization.

(ii) All transactions are promptly recorded in an appropriate manner to permit the preparation of financial information and to maintain accountability of assets.

(iii) Assets and records are safeguarded from unauthorized access, use or disposition.

(iv) Assets are verified at reasonable intervals and appropriate action is taken with regard to the discrepancies.

Precisely, the control objectives ensure that the transactions processed are complete, valid and accurate. The basic accounting control objectives which are sought to be achieved by any accounting control system are:

If the response to all the above answer is positive, the auditor would be justified in limiting his account balance tests considerably.

In case of excellent companies it may also be possible to rely on account balance with minimum of external tests, such as direct confirmation, management representation etc. Where in a system a particular control is found to be deficient, audit attention can be focused on the areas where basic accounting control objectives are not being adhered to.

In case, if it found that sales transactions are not being properly valued in accordance with the price list determined by the management, the auditor would have to perform extensive searching tests on sales invoices to assure himself that the recoverable amounts are correctly posted. He may also want to expand his

confirmation request at the year end to cover a large majority of trade receivables. 2.3.1 Limitations of Internal Control - Internal control, no matter how effective, can provide an entity with only reasonable assurance and not absolute assurance about achieving the entity’s operational, financial reporting and compliance objectives.

Ensure all transactions are

Recorded Real Properly Valued

Recorded Timely Properly

Posted

Properly Classified

and Disclosed

Properly Summarized.



Internal control systems are subject to certain inherent limitations, such as:

Management's consideration that the cost of an internal control does not exceed the expected benefits to be derived.

The fact that most internal controls do not tend to be directed at transactions of unusual nature. The potential for human error, such as, due to carelessness, distraction, mistakes of judgement and misunderstanding of instructions.

The possibility of circumvention of internal controls through collusion with employees or with parties outside the entity.

The possibility that a person responsible for exercising an internal control could abuse that responsibility, for example, a member of management overriding an internal control.

Manipulations by management with respect to transactions or estimates and judgements required in the preparation of financial statements.

2.4 Structure of Internal Control In order to achieve the objectives of internal controls, it is necessary to establish adequate control policies and procedures. Most of these policies and procedures cover:

2.4.1 Segregation of duties - Transaction processing are allocated to different persons in such a manner that no one person can carry through the completion of a transaction from start to finish or the work of one person is made complimentary to the work of another person. The purpose is to minimize the occurrence of fraud and errors and to detect them on a timely basis, when they take place. The following functions are segregated -

(a) authorization of transactions;

(b) execution of transactions;

(c) physical custody of related assets; and

(d) maintenance of records and documents, while allocating duties, the considerations of cost and efficacy should be kept in mind as there is a tendency to stretch the allocation of tasks involved in a job to more persons than what is required resulting in cumbersome procedures, over elaboration of records and unduly high cost of administration.

Apart from segregation of duties, periodic rotation of duties of personnel is also desirable. The rotation of duties seeks to ensure that if a fraud and error is committed by a person, it does not remain undetected for long. It also ensures that a person cannot develop vested interest by holding a position for to long. Rotation of duties also ensures that each employee keeps his work up to date. This also makes an employee to be careful because he is aware that his performed tasks will be reviewed by others when duties are rotated.

2.4.2 Authorization of Transaction - Delegation of authority to different levels and to particular persons are required to establish by the management for controlling the execution of transaction


RISK ASSESSMENT AND INTERNAL CONTROL 3.9 in accordance with prescribed conditions. Authorization may be general or it may be specific with reference to a single transaction. It is necessary to establish procedures which provide assurance that authorizations are issued by persons acting within the scope of their authority, and that the transactions conform to the terms of the authorizations. This objective can be achieved by making independent comparison of transaction document with general or specific authorizations, as the case may be. 2.4.3 Adequacy of Records and Documents - Accounting controls should ensure that - (i) Transactions are executed in accordance with management’s general or specific

authorization. (ii) Transactions and other events are promptly recorded at correct amounts. (iii) Transactions should be classified in appropriate accounts and in the appropriate period

to which it relates. (iv) Transaction should be recorded in a manner so as to facilitate preparation of financial

statements in accordance with applicable accounting standards, other accounting policies and practices and relevant statutory requirements.

(v) Recording of transaction should facilitate maintaining accountability for assets. (vi) Assets and records are required to be protected from unauthorized access, use or

disposition. (vii) Records of assets such as sufficient description of the assets (to facilitate identification)

its location should also be maintained so that the assets could be physically verified periodically.

For prompt, accurate, complete and appropriate recording of accounting transaction, several procedures are often established by the management. The assurance that transactions have been properly recorded can also be obtained through a comparison of records with an independent source of information which provides an indication of the execution of the relevant transactions.

2.4.4 Accountability and Safeguarding of Assets - The process of accountability of assets commences from acquisitions of assets its use and final disposal. Safeguarding of assets requires appropriate maintenance of records, their periodic reconciliation with the related assets. Assets like cash, inventories, investment scrips require frequent physical verification with book records. The frequency of reconciliation would differ for different assets depending upon their nature and amount. Assets which are considered sensitive or susceptible to error need to be reconcile more frequently than others. For proper safeguarding of assets, only authorized personnel should be given access to such asset. This not only means physical access but also exercising control over processing of documents relating to authorization for use and disposal of assets. It is essential to have effective controls over physical custody of cash, inventories, investments and other fixed assets. In some cases, as per requirement, special procedures regarding physical custody of assets may have to be designed by the management.



2.4.5 Independent Checks - Independent verification of the control systems, designed and implemented by the management, involves periodic or regular review by independent persons to ascertain whether the control procedures are operating effectively or not. Such process may be carried out by specially assigned staff under the banner of external audit.

3. COMPONENTS OF INTERNAL CONTROLS In general, a system of internal control to be considered adequate should include the following five components:

(i) Control environment;

(ii) Entity’s Risk assessment Process;

(iii) Control activities;

(iv) Information system and communication;

(v) Monitoring of Controls

3.1 Control Environment The control environment encompasses the following elements:

(a) Communication and enforcement of integrity and ethical values: The effectiveness of controls cannot rise above the integrity and ethical values of the people who create, administer, and monitor them. Integrity and ethical behavior are the product of the entity’s ethical and behavioral standards, how they are communicated, and how they are reinforced in practice. The enforcement of integrity and ethical values includes, for example, management actions to eliminate or mitigate incentives or temptations that might prompt personnel to engage in dishonest, illegal, or unethical acts. The communication of entity policies on integrity and ethical values may include the communication of behavioral standards to personnel through policy statements and codes of conduct and by example.

(b) Commitment to competence: Competence is the knowledge and skills necessary to accomplish tasks that define the individual’s job.

Components of Internal Control

Control environment

Entity’s risk assessment

processControl

activitiesInformation system and

communicationMonitoring of

controls


RISK ASSESSMENT AND INTERNAL CONTROL 3.11 (c) Participation by those charged with governance: An entity’s control consciousness is

influenced significantly by those charged with governance. The importance of the responsibilities of those charged with governance is recognised in codes of practice and other laws and regulations or guidance produced for the benefit of those charged with governance. Other responsibilities of those charged with governance include oversight of the design and effective operation of whistle blower procedures and the process for reviewing the effectiveness of the entity’s internal control.

(d) Management’s philosophy and operating style: Management’s philosophy and operating style encompass a broad range of characteristics. For example, management’s attitudes and actions toward financial reporting may manifest themselves through conservative or aggressive selection from available alternative accounting principles, or conscientiousness and conservatism with which accounting estimates are developed.

(e) Organisational structure: Establishing a relevant organizational structure includes considering key areas of authority and responsibility and appropriate lines of reporting. The appropriateness of an entity’s organisational structure depends, in part, on its size and the nature of its activities.

(f) Assignment of authority and responsibility: The assignment of authority and responsibility may include policies relating to appropriate business practices, knowledge and experience of key personnel, and resources provided for carrying out duties. In addition, it may include policies and communications directed at ensuring that all personnel understand the entity’s objectives, know how their individual actions interrelate and contribute to those objectives, and recognize how and for what they will be held accountable.

(g) Human resource policies and practices: Human resource policies and practices often demonstrate important matters in relation to the control consciousness of an entity. For example, standards for recruiting the most qualified individuals – with emphasis on educational background, prior work experience, past accomplishments, and evidence of integrity and ethical behaviour – demonstrate an entity’s commitment to competent and trustworthy people. Training policies that communicate prospective roles and responsibilities and include practices such as training schools and seminars illustrate expected levels of performance and behaviour. Promotions driven by periodic performance appraisals demonstrate the entity’s commitment to the advancement of qualified personnel to higher levels of responsibility.

3.2 Entity’s Risk Assessment Process For financial reporting purposes, the entity’s risk assessment process includes how management identifies business risks relevant to the preparation of financial statements in accordance with the entity’s applicable financial reporting framework, estimates their significance, assesses the likelihood of their occurrence, and decides upon actions to respond to and manage them and the



results thereof. For example, the entity’s risk assessment process may address how the entity considers the possibility of unrecorded transactions or identifies and analyses significant estimates recorded in the financial statements.

Risks relevant to reliable financial reporting include external and internal events, transactions or circumstances that may occur and adversely affect an entity’s ability to initiate, record, process, and report financial data consistent with the assertions of management in the financial statements. Management may initiate plans, programs, or actions to address specific risks or it may decide to accept a risk because of cost or other considerations.

Risks can arise or change due to circumstances such as the following: (a) Changes in operating environment. Changes in the regulatory or operating

environment can result in changes in competitive pressures and significantly different risks.

(b) New personnel. New personnel may have a different focus on or understanding of internal control.

(c) New or revamped information systems. Significant and rapid changes in information systems can change the risk relating to internal control.

(d) Rapid growth. Significant and rapid expansion of operations can strain controls and increase the risk of a breakdown in controls.

(e) New technology. Incorporating new technologies into production processes or information systems may change the risk associated with internal control.

(f) New business models, products, or activities. Entering into business areas or transactions with which an entity has little experience may introduce new risks associated with internal control.

(g) Corporate restructurings. Restructurings may be accompanied by staff reductions and changes in supervision and segregation of duties that may change the risk associated with internal control.

(h) Expanded foreign operations. The expansion or acquisition of foreign operations carries new and often unique risks that may affect internal control, for example, additional or changed risks from foreign currency transactions.

(i) New accounting pronouncements. Adoption of new accounting principles or changing accounting principles may affect risks in preparing financial statements.



3.3 Control Activities Generally, control activities that may be relevant to an audit may be categorised as policies and procedures that pertain to the following:

(a) Performance reviews: These control activities include reviews and analyses of actual performance versus budgets, forecasts, and prior period performance; relating different sets of data – operating or financial – to one another, together with analyses of the relationships and investigative and corrective actions; comparing internal data with external sources of information; and review of functional or activity performance.

(b) Information processing: The two broad groupings of information systems control activities are application controls, which apply to the processing of individual applications, and general IT-controls, which are policies and procedures that relate to many applications and support the effective functioning of application controls by helping to ensure the continued proper operation of information systems. Examples of application controls include checking the arithmetical accuracy of records, maintaining and reviewing accounts and trial balances, automated controls such as edit checks of input data and numerical sequence checks, and manual follow-up of exception reports. Examples of general IT-controls are program change controls, controls that restrict access to programs or data, controls over the implementation of new releases of packaged software applications, and controls over system software that restrict access to or monitor the use of system utilities that could change financial data or records without leaving an audit trail.

(c) Physical controls: Controls that encompass:

The physical security of assets, including adequate safeguards such as secured facilities over access to assets and records.

The authorisation for access to computer programs and data files.

The periodic counting and comparison with amounts shown on control records (for example, comparing the results of cash, security and inventory counts with accounting records). The extent to which physical controls intended to prevent theft of assets are relevant to the reliability of financial statement preparation, and therefore the audit, depends on circumstances such as when assets are highly susceptible to misappropriation.

(d) Segregation of duties: Assigning different people the responsibilities of authorising transactions, recording transactions, and maintaining custody of assets. Segregation of duties is intended to reduce the opportunities to allow any person to be in a position to both perpetrate and conceal errors or fraud in the normal course of the person’s duties.

Certain control activities may depend on the existence of appropriate higher level policies established by management or those charged with governance. For example, authorisation controls may be delegated under established guidelines, such as, investment criteria set by



those charged with governance; alternatively, non-routine transactions such as, major acquisitions or divestments may require specific high level approval, including in some cases that of shareholders.

3.4 Information System, Including the Related Business Processes, Relevant to Financial Reporting, and Communication

An information system consists of infrastructure (physical and hardware components), software, people, procedures, and data. Many information systems make extensive use of information technology (IT).

The information system relevant to financial reporting objectives, which includes the financial reporting system, encompasses methods and records that: (a) Identify and record all valid transactions.

(b) Describe on a timely basis the transactions in sufficient detail to permit proper classification of transactions for financial reporting.

(c) Measure the value of transactions in a manner that permits recording their proper monetary value in the financial statements.

(d) Determine the time period in which transactions occurred to permit recording of transactions in the proper accounting period.

(e) Present properly the transactions and related disclosures in the financial statements.

The quality of system-generated information affects management’s ability to make appropriate decisions in managing and controlling the entity’s activities and to prepare reliable financial reports.

Communication, which involves providing an understanding of individual roles and responsibilities pertaining to internal control over financial reporting, may take such forms as policy manuals, accounting and financial reporting manuals, and memoranda. Communication also can be made electronically, orally, and through the actions of management.

3.5 Monitoring of Controls An important management responsibility is to establish and maintain internal control on an ongoing basis. Management’s monitoring of controls includes considering whether they are operating as intended and that they are modified as appropriate for changes in conditions. Monitoring of controls may include activities such as, management’s review of whether bank reconciliations are being prepared on a timely basis, internal auditors’ evaluation of sales personnel’s compliance with the entity’s policies on terms of sales contracts, and a legal department’s oversight of compliance with the entity’s ethical or business practice policies. Monitoring is done also to ensure


RISK ASSESSMENT AND INTERNAL CONTROL 3.15 that controls continue to operate effectively over time. For example, if the timeliness and accuracy of bank reconciliations are not monitored, personnel are likely to stop preparing them.

Internal auditors or personnel performing similar functions may contribute to the monitoring of an entity’s controls through separate evaluations. Ordinarily, they regularly provide information about the functioning of internal control, focusing considerable attention on evaluating the effectiveness of internal control, and communicate information about strengths and deficiencies in internal control and recommendations for improving internal control.

Monitoring activities may include using information from communications from external parties that may indicate problems or highlight areas in need of improvement. Customers implicitly corroborate billing data by paying their invoices or complaining about their charges. In addition, regulators may communicate with the entity concerning matters that affect the functioning of internal control, for example, communications concerning examinations by bank regulatory agencies. Also, management may consider communications relating to internal control from external auditors in performing monitoring activities.

The overall systems of internal control comprises of Administrative Control and Accounting Controls, Internal Checks and Internal Audit are important constituents of Accounting Controls.

1. Internal Check System - Internal check system implies organization of the overall system of book-keeping and arrangement of Staff duties in such a way that no one person can carry through a transaction and record every aspect thereof. It is a part of overall control system and operates basically as a built-in-device as far as organization and job-allocation aspects of the controls are concerned.

The system provides existence of checks on the day to day transactions which operate continuously as part of the routine system whereby the work of each person is either proved independently or is made complimentary to the work of another.

The following are the objectives of the internal check system:

(i) To detect error and frauds with ease.

(ii) To avoid and minimize the possibility of commission of errors and fraud by any staff.

(iii) To increase the efficiency of the staff working within the organization.

(iv) To locate the responsibility area or the stages where actual fraud and error occurs.

(v) To protect the integrity of the business by ensuring that accounts are always subject to proper scrutiny and check.

(vi) To prevent and avoid the misappropriation or embezzlement of cash and falsification of accounts.



The effectiveness of an efficient system of internal check depends on the following considerations- (i) Clarity of Responsibility - The responsibility of different persons engaged in various

operations of business transactions should be properly identified. A well integrated organizational chart depicting the names of responsible persons associated with specific functions may help to fix up responsibility.

(ii) Division of Work - The segregation of work should be made in such a manner that the free flow of work is not interrupted and also helps to determine that the work of one person is complementary to the other. Then, it is suggested that rotation of different employees through various components of job should be effectively implemented.

(iii) Standardization - The entire process of accounting should be standardized by creating suitable policies commensurate with the nature of the business, so as to strengthen the system of internal check.

(iv) Appraisal - Periodic review should be made of the chain of operations and work flow. Such process may be carried out by preparing an audit flow chart.

The general condition pertaining to the internal check system may be summarized as under: (i) no single person should have complete control over any important aspect of the

business operation. Every employee’s action should come under the review of another person.

(ii) Staff duties should be rotated from time to time so that members do not perform the same function for a considerable length of time.

(iii) Every member of the staff should be encouraged to go on leave at least once a year. (iv) Persons having physical custody of assets must not be permitted to have access to the

books of accounts. (v) There should exist an accounting control in respect of each class of assets, in addition,

there should be periodical inspection so as to establish their physical condition. (vi) Mechanical devices should be used, where ever practicable to prevent loss or

misappropriation of cash. (vii) Budgetary control should be exercised and wide deviations observed should be

reconciled. (viii) For inventory taking, at the close of the year, trading activities should, if possible be

suspended, and it should be done by staff belonging to several sections of the organization.

(ix) The financial and administrative powers should be distributed very judiciously among different officers and the manner in which those are actually exercised should be reviewed periodically.

(x) Procedures should be laid down for periodical verification and testing of different sections of accounting records to ensure that they are accurate.


RISK ASSESSMENT AND INTERNAL CONTROL 3.17 The scope of statutory audit is limited by both time and cost. Therefore, it is increasingly being recognized that for an audit to be effective especially in case of large organization, the existence of a system of internal check is essential.

2. Internal Audit - Internal audit may be defined as, an independent appraisal function established within an organization to examine and evaluate its activities as a service to the organization. The scope of the internal audit is determined by the management. Internal auditing includes a series of processes and techniques through which an organizations own employees ascertain for the management, by means of on-the-job observation, whether established management controls are adequate, and are effectively maintained; records and reports financial, accounting and otherwise reflect actual operation and results accurately and properly; each division, department or other units are carrying out the plans, policies and procedures for which they are responsible. Note: For a detailed discussion on internal audit refer to Chapter 15.

4. REVIEW OF THE SYSTEM OF INTERNAL CONTROLS The control environment sets the tone of an organization, influencing the control consciousness of its people. The control environment includes the governance and management functions and the attitudes, awareness, and actions of those charged with governance and management concerning the entity’s internal control and its importance in the entity.

Evaluating the design of a control involves considering whether the control, individually or in combination with other controls, is capable of effectively preventing, or detecting and correcting, material misstatements. Implementation of a control means that the control exists and that the entity is using it. There is little point in assessing the implementation of a control that is not effective, and so the design of a control is considered first. An improperly designed control may represent a material weakness or significant deficiency in the entity’s internal control.

An entity’s system of internal control contains manual elements and often contains automated elements. The use of manual or automated elements in internal control also affects the manner in which transactions are initiated, recorded, processed, and reported. An entity’s mix of manual and automated elements in internal control varies with the nature and complexity of the entity’s use of information technology.

Manual elements in internal control may be more suitable where judgment and discretion are required such as for the following circumstances:

Large, unusual or non-recurring transactions.

Circumstances where errors are difficult to define, anticipate or predict.

In changing circumstances that require a control response outside the scope of an existing automated control.



In monitoring the effectiveness of automated controls.

The extent and nature of the risks to internal control vary depending on the nature and characteristics of the entity’s information system. The entity responds to the risks arising from the use of IT or from use of manual elements in internal control by establishing effective controls in light of the characteristics of the entity’s information system.

The review of the internal control system enables the auditor -

(i) to formulate his opinion as to the reliance he may place on the system itself i.e. whether the system is such as would enable the management to produce a true and fair set of financial statements; and

(ii) to locate the areas of weakness in the system so that the audit programme and the nature, timing and extent of substantive and compliance audit procedures can be adjusted to meet the situation. For example, if the auditor is not satisfied with the control system as regards trade receivable, he may decide to have a wider coverage for confirmation of trade receivables’ balances. Normally, investments and cash are physically verified at the end of the period and this routine is known to the client and his employees. In case the auditor comes across a weakness in the control either he may provide in the programme for a surprise cash count or investment verification on a day preceding or succeeding the routine verification. In such a case, a surprise check will be more useful if it is undertaken after the routine verification is over. Similarly, if he is of the view that because of weak controls the possibility of wrong billing to customers exists, be may extend the programme for comparison of the invoices with the forwarding notes and for checking of the extensions and castings of the invoices.

Deciding the point of time appropriate for undertaking the review of the internal controls is a matter for individual judgement of the auditor. This decision can be taken on a consideration of the size and complexity of the client’s operations. If the auditor, because of his continuing relationship with his client, is already aware of the features and efficacy of internal controls, he may just review the changes that have taken place in the intervening period because of changes in the operations of the client. However, a comprehensive review in such cases must be made at an interval of, say, 3 years. Ordinarily, the review of internal controls should be undertaken as a distinct phase of audit before finalisation of the audit programme. However, if the size of operations is rather small, the review can be undertaken in conjunction with other audit procedures and the programmes can be adjusted for any extension or elimination of checking.

When the auditor finds inadequacies or weaknesses in the internal control system, he should advise his client about such inadequacies and weaknesses and the consequences that may follow. It should be the duty of the auditor to see, in the course of his audit, how far the inadequacies and weaknesses have been removed. He will take this into account in preparing his audit report. It is a useful practice to note the following after each function, set out in the audit programme -


RISK ASSESSMENT AND INTERNAL CONTROL 3.19 (a) Any change in the system of internal control from that record in the appropriate section of

the internal control questionnaire.

(b) Any further weakness noted in the internal control.

(c) Any instance where the prescribed system or procedure has not been followed.

These should be considered in deciding whether any further modification in the audit programme is called for. Also, these should be communicated to the client and confirmation should be sought as regards changes in the system.

The review of internal control consists mainly of enquiries of personnel at various organisational levels within the enterprise together with reference to documentation such as procedures, manuals, job description and flow-charts, to gain knowledge about the controls which the auditor has identified as significant to his audit. The auditor may trace a few transactions through the accounting system to assist in understanding that system and it is related to internal controls. The auditor’s preliminary evaluation of internal controls should be made on the assumption that the controls operate generally as described and that they function effectively throughout the period of intended reliance. The purpose of the preliminary evaluation is to identify the particular controls on which the auditor still intends to rely and to test through compliance procedures. Different techniques are used to record information relating to an internal control system. Selection of a particular technique is a matter for the auditor’s judgement.

5. METHODS OF RECORDING The following are the methods of recording:

5.1 Questionnaire Because of the widespread experience that auditors possess about the business operations in general and the knowledge about the appropriate control, most of the auditing firms have developed their own standardised internal control questionnaire on a generally applicable basis. In developing the standard questionnaire, endeavour is made to make it as wide as possible so that all situations, generally found, are included therein but all of these may not be applicable in a particular case. A questionnaire is a set of questions framed in an organised manner, about each functional area, which has as purpose the evaluation of the effectiveness of control and detection of its weakness if any. A questionnaire usually consists of several separate sections devoted to areas such as purchases, sales, trade receivables, trade payables, wages, etc. The questionnaire is intended to be filled by the company executives who are in charge of the various areas. However, this poses some practical difficulties. The questionnaire is to travel from executives and, therefore, it may take a pretty long time to be filled; also the questions may not be readily intelligible to busy executives and there is a possibility of the questionnaire being misplaced while travelling from one table to another. Having regard to these difficulties, it is now almost an accepted practice that the auditor (or his representative) arranges meetings with the executives



concerned and gets the answers filled by each executive. Sometimes, the auditor himself may be required to fill the answers. In such a case, he should ensure that the concerned executive has initiated the answers as a token of his agreement therewith.

Questions are so framed as generally to dispense with the requirement of a detailed answer to each question. For this purpose, often one general question is broken down into a number of questions and sub-questions to enable the executive to provide a just ‘Yes’, ‘No’ or ‘Not applicable’ form of reply. Questions are also framed in such a manner that generally a “No” answer will effect weakness in the control system. This requires giving a positive power to the question, keeping in view what the proper control should be. Consider the question ‘Are all receipts recorded promptly and deposited in bank daily? If the answer to this is ‘Yes’, it fits with the plan of good internal control. But if it is ‘No’ it indicates weakness in the system in as much as the moneys received may not be recorded and may be defalcated because the cashier has continued control over the amount for an uncertain period. However, this should not be taken as an unbreakable rule. Questions may be framed also when a ‘Yes’ answer would indicate weakness. The only thing that should be borne in mind is that the scheme of questions should be consistent, sequential, logical, and if possible corroborative. Wherever it is necessary, slightly detailed answers also may be asked for to bring clarity to the matter.

In the use of standardized internal control questionnaire, certain basic assumptions about elements of good control are taken into account. These are - (i) Certain procedures in general used by most business concerns are essential in

achieving reliable internal control. This is a time-tested assumption. Deposit into bank of the entire receipts of a day or daily balancing of the cash book and ledgers or periodic reconciliation with the control accounts are examples of widely used practices which are considered good internal control practices. Besides, basic operations giving rise to these practices exist in all businesses irrespective of their nature.

(ii) Organisations are such that permit an extensive division of duties and responsibilities. The larger the organisation, the greater is the scope of such division.

(iii) Employees concerned with accounting function are not assigned any custodial function.

(iv) No single person is thrust with the responsibility of completing a transaction all by himself.

(v) There should always be evidence to identify the person who has done the work whether involving authorisation, implementation or checking.

(vi) The work performed by each one is expected to come under review of another in the usual course of routine.

(vii) There is proper documentation and recording of the transactions. The questionnaire serves the purpose of a record so far as the auditor is concerned about the state of internal control as given to him officially. A question naturally arises as to whether it is necessary to issue questionnaire for every year of the auditor’s engagement.


RISK ASSESSMENT AND INTERNAL CONTROL 3.21 For the first year of engagements issue of questionnaire is necessary.

For subsequent years, the auditor, instead of issuing a questionnaire again, may request the client to confirm whether any change in the nature and scope of business has taken place that necessitated a corresponding change in the control system, or whether, even without a change in the nature and scope of business, the control system has undergone a change.

If there has been a change, the auditor should take note of its and enter appropriate comments on the relevant part of the questionnaire. However, it would be a good practice in the case of continuing engagements to issue a questionnaire irrespective of any change, say, every third year. This will obviate unnecessary trouble of filling the answers every time and to that extent the client’s and the auditor’s own time will be saved. The rationale for issuance of a questionnaire every three years, in the case of even no change, lies in altering the client as regards unnoticed and unspectacular changes that might have taken place during the intervening period; also this will make the client more control-conscious. Questionnaires can be prepared for various aspects of the internal control system.

5.2 Check List It is a series of instructions or questions on internal control which the auditor must follow or answer. When a particular instruction is carried out, the auditor initials the space opposite the instruction. If it is in the form of a question, the answer generally ‘Yes’, ‘No’ or ‘Not Applicable’ is entered opposite the question. A check list is more in the nature of a reminder to the auditor about the matters to be checked for testing the internal control system. While a questionnaire is basically a set of questions put to the client, a check list which may be in a form of instructions, questions or just points to be checked may be meant for the auditor’s own staff it is a set of instructions or points; it may be meant for the client if it is in the form of questions. The question form of check list may even be meant for the auditor’s own staff.

Questions in the check list may be formed in the following manner (this is an illustrative set of questions to be answered by the audit staff).

Have you checked that the cashier - (i) is not responsible for opening the incoming mails; (ii) does not authorise any of the ledgers; (iii) does not authorise any expenditure or receipt; (iv) does not sign cheques; (v) takes his annual leave regularly; (vi) inks and balances the cash book everyday; (vii) verifies physical cash balance with the book figure daily at the end of the day; (viii) prepares monthly bank reconciliation statement;



(ix) holds no other funds or investment; (x) holds no unnecessary balance in hand; (xi) does not pay money without looking into compliance with proper procedure and due

authorisation; and (xii) has tendered proper security or has executed a fidelity bond? When the check list is in question form, it is hardly different from a questionnaire. However, generally questionnaire is a popular medium for the evaluation of the internal control system.

The basic distinction between internal control questionnaire and check list are as under:

1. The ICQ incorporates a large number of detailed questions but the check list generally contains questions relating to the main control objective with the area under review.

2. ICQ, the weaknesses are highlighted by the ‘Yes’ while in the check list, it is indicated by ‘No’.

3. The significance of ‘No’ in an ICQ does indicate a weakness but the significance of that weakness is not revealed automatically. However, in the check list, a specific statement is required where an apparent weakness may prove to be material in relation to the accounts as a whole.

5.3 Flow chart The flow charting technique can also be resorted to for evaluation of the internal control system. It is a graphic presentation of internal controls in the organisation and is normally drawn up to show the controls in each section or sub-section. As distinct from a narrative form, it provides the most concise and comprehensive way for reviewing the internal controls and the evaluator’s findings. In a flow chart, narratives, though cannot perhaps be totally banished are reduced to the minimum and by that process, it can successfully bring the whole control structure, specially the essential parts thereof, in a condensed but wholly meaningful manner. It gives a bird’s eye view of the system and is drawn up as a result of the auditor’s review thereof. It should, however, not be understood that details are not reflected in a flow chart. Every detail relevant from the control point of view and the details about how an operation is performed can be included in the flow chart. Essentially a flow chart is a diagram full with lines and symbols and, if judicious use of them can be made, it is probably the most effective way of presenting the state of internal controls in the client’s organisation.

A properly drawn up flow chart can provide a neat visual picture of the whole activities of the section or department involving flow of documents and activities. More specifically it can show -

(i) at what point a document is raised internally or received from external sources;

(ii) the number of copies in which a document is raised or received;

(iii) the intermediate stages set sequentially through which the document and the activity pass;


RISK ASSESSMENT AND INTERNAL CONTROL 3.23 (iv) distribution of the documents to various sections, department or operations;

(v) checking authorisation and matching at relevant stages;

(vi) filing of the documents; and

(vii) final disposal by sending out or destruction.

As a matter of fact a very sound knowledge of internal control requirements is imperative for, adopting flow-charting technique for evaluation of internal controls; also it demands a highly analytical mind to be able to see clearly the inter division of a job and the appropriate control at relevant points.

It has been stated earlier that flow charts should be made section-wise or department-wise. The suggestion has been made to ensure readability and intelligibility of the flow charts.

Drawing of a flow chart - A flow chart is normally a horizontal one in which documents and activities are shown to flow horizontally from section to section and the concerned sections are shown as the vertical column heads; in appropriate cases an individual also may be shown as the vertical column head. Care should be taken to see that the first column head is devoted to the section or the individual wherefrom a transaction originates and the placements of other column heads should be in the order of the actual flow of the transaction.

It has been started earlier that a flow chart is a symbolic representation the flow of activity and related documents through the section from origin to conclusion. These can be sales, purchases, wages, production, etc. Each one of the main functions is to be linked with related functions for making a complete course. Purchase is to be linked with trade payables and payments; sales with trade receivables and collections. By this process, a flow chart will become self contained, complete and meaningful for evaluation of internal controls.



Generally, a questionnaire is also enclosed with a flow chart, incorporating questions, the answers to which are to be looked into from the flow chart. This is an evaluation of the control system through the process of flow charting. The internal control questionnaire contains questions; answers are available in the flow chart and they will reveal weakness, if any, in the system. In fact, the questionnaire is a guide for the study of a control system through flow charts.

We may examine the flow charting techniques for evaluation of internal controls on the sales and trade receivables function. Let us assume that these are - 1. Order receiving function. 2. Dispatch function. 3. Billing function. 4. Accounting in the trade receivables’ ledger. 5. Main accounting functions. 6. Inventory recording function. All these functions are carried out in distinct sections. As regards the Order Receiving Section, let us further assume that the section receives orders:

(i) through mail;

(ii) by telephone; and

(iii) through the company’s salesmen.

Basing the receipts of orders of customers, the section raises internal “Sales advices”. These sales advices are consecutively numbered (by reference to the last number on the order book) and entered in the order book with the consecutive number, date, the party and other relevant details. The orders received from customers are temporarily filed in the alphabetical order. The sales advices are prepared in sets of four with a noting for the customer’s sales-tax status. All the four copies are sent to the dispatch section. The dispatch section, after dispatch of the goods, sends back to the Order receiving Section the last copy of the sales advice after entering thereon the date of dispatch and the quantity despatched. Upon receipt of the last copy, the Order receiving Section enters the date of dispatch and the quantity despatched in the order book. If the quantity despatched is fulfillment of the quantity ordered, the last copy of the sales invoices is annexed to customer’s order and filed in the customer’s file. If, however, the order is only partly executed, the copy of the sales advice is kept in a temporary file in numerical order. Periodically this file is checked to determine the unfulfilled orders and, if inventory is then available, the Section again initiates fresh sales advices in respect of the unfulfilled part and all the processes, as in the case of original, are repeated. The last copy of the original set is annexed to the customer’s order and kept in the customer’s file.

The salesmen use the same advice form as is being used by the order receiving section.


RISK ASSESSMENT AND INTERNAL CONTROL 3.25 For the purpose of drawing a flow chart to incorporate the above narration it is useful to know - 1. the point for originating the flow of transaction. 2. the documents, internal and external, and the flow of the transaction, number of copies,

distribution flow and the details. 3. the books, if any, maintained and the details recorded there in and the source or sources for

the details. 4. that there exists an alternative possibility. The flow chart for the above may be as under -

CHART 1

We can extend the activity flow now to the dispatch section which is the logical second stage of operation. The work and procedure content of the dispatch section is assumed to be as follows:

After the receipt of the sales advices in sets of four, the dispatch section arranges dispatch of materials and put the date of dispatch and the quantities despatched; the head of the Section initials the advices. The last copy of the advice is sent back to the Order Receiving Section. The first copy is sent as a packing slip with the goods, the second copy goes to the Billing Department and the third copy accompanies the goods when delivered to the buyer and, obtaining the buyer’s acknowledgement of the receipt of the goods therein, is received back and filed date-wise. In case of goods not directly delivered to the buyers, i.e., when the goods are sent either by rail, road or water transport, the copy constitutes the basis for raising the relevant forwarding note on the basis of which R.R. etc., can be prepared.



The flow chart for the dispatch section may be as follows -

CHART 2 This flow is taken to the Billing Section. The Section generally accumulates the second copy of the Sales Advice for two or three days and prepares sales invoices in sets of four. The pricing of the sales invoice is done by reference to the company’s current price list or the catalogue. The number of the sales advice is entered on the corresponding invoice which is pre-numbered, also, the number of the invoice is recorded on the copy of the sales advice which is then filed alphabetically. The first copy of the invoice is sent to the customer while the second, third and fourth copies are respectively sent to the trade receivables ledger clerk, the Inventory Section and the Accounts Section. The Billing Section also is responsible for raising credit notes on the basis of documents received. Credit notes are also prepared in sets of four and are distributed in exactly the same way as invoices. The inventories of invoice and the credit note forms remain in the Billing Section.


RISK ASSESSMENT AND INTERNAL CONTROL 3.27 The Flow Chart for this Section is given below - CHART 3

Now, in the order of the flow of activities, more sectional flow charts can be prepared to cover the activities in the Accounts Section and the Inventory Section and they together, when sequentially assembled, will constitute the complete flow chart for the sales transactions and trade receivables recordings.

(These flow charts have been prepared on the basis of the approach and the symbols used in the book “Analytical Auditing” by Skinner and Anderson. Students who desire to study the subject of preparation of flow charts further may refer to Chapter 4 of that book.)



It is now left for us to see how these flow charts reveal the state of internal control. A close look into flow charts will show the following:

(i) The advices are sent by salesmen; though prepared on the same sales advice form as is prepared in the section, there is no check that all the advices sent by salesmen have been received. This may entail loss of business because of non-receipt of sales advice. (Refer to the flow chart for the Order Receiving Section).

(ii) The raising of sales advises on the basis of telephonic orders, irrespective of the party’s standing and record of performance is risky from the business point of view. (Refer to the flow chart for the Order Receiving Section).

(iii) There is no system of prior credit sanction to the parties; in consequence, there may be dispatch of goods to bad credit risks. (Refer to the flow chart for the Dispatch Section).

(iv) There is no check that all the second copies of the sales advices sent by the Dispatch Section have been received by the Billing Section. The possibility of dispatch not being, billed exists, (Refer to the flow chart for the Dispatch as well as the Billing Section.

(v) There is no check in respect of pricing, extension and addition on the invoice or the credit notes. This may result in loss of revenue for wrong pricing or wrong calculation. (Refer to the flow chart for Billing Section).

(vi) It is not clear whether the supporting documents are adequate for authorising the issue of credit notes where there is a need for a greater caution. (Refer to the flow chart for Billing Section).

So far we have seen the points of weaknesses that are evident from these flow charts. For a clearer understanding of the flow chart as a medium for evaluating internal controls, the following further points may be useful:

(a) There exists proper numerical control over orders booked (except the case for the salesmen’s orders).

(b) There is a permanent and continuous record of the orders booked in the form of order book.

(c) There is a definite basis for raising sales advices.

(d) The order book record is always kept complete by entering the information about the execution of the order and this keeps the information about the pending orders ready at any moment.

(e) Partly executed orders are reviewed from time to time so that as soon as goods are available, the same may be despatched to customers.

(f) The customer’s purchase order and the related sales advice are matched and kept together in the customer’s file.


RISK ASSESSMENT AND INTERNAL CONTROL 3.29 (g) The sales advices are initialed by the Dispatch Section head as token of his having satisfied

himself about the correctness of the entries as regards the quantity despatched and the date of dispatch.

(h) Record of actual direct delivery is maintained through the copy of the sales advice bearing the customer’s, acknowledgement of his having received the goods. Similarly, the record of out station deliveries is kept in the copy of the forwarding note annexed to the sales advice copy.

(i) Documents have as many copies as are necessary for ensuring proper flow and proper control. There is neither wastage through unnecessary copies nor any hold up because of inadequacy of copies.

(j) There are supporting documents for raising invoices and credit notes.

(k) The distribution of invoices and credit notes is such as would enable the recording of billing at the relevant centres independent of each other.

(l) There is control over the number of invoices and credit notes by pre-numbering.

Thus, by flow charting, an auditor can very clearly see the inter-relationships of the activities and flows and how they are integrated from stage to stage. However, the auditor has to be careful about the readability and intelligibility of the chart. Identification of all individual functions in a section is also highly relevant for preparation of the flow chart. The smaller the segment, the better is the possibility of quick comprehension. Naturally, the auditor should try to see each section as the natural assembly of distinct and identified components.

6. INTERNAL CONTROL AND RISK ASSESSMENT The auditor should obtain an understanding of the control environment sufficient to assess management's attitudes, awareness and actions regarding internal controls and their importance in the entity. Such an understanding would also help the auditor to make a preliminary assessment of the adequacy of the accounting and internal control systems as a basis for the preparation of the financial statements, and of the likely nature, timing and extent of audit procedures.

The auditor should obtain an understanding of the control procedures sufficient to develop the audit plan. In obtaining this understanding, the auditor would consider knowledge about the presence or absence of control procedures obtained from the understanding of the control environment and accounting system in determining whether any additional understanding of control procedures is necessary. Because control procedures are integrated with the control environment and the accounting system, as the auditor obtains an understanding of the control environment and the accounting system, some knowledge about control procedures is also likely to be obtained, for example, in obtaining an understanding of the accounting system pertaining to cash, the auditor ordinarily becomes aware of whether bank accounts are reconciled regularly.



Ordinarily, development of the overall audit plan does not require an understanding of control procedures for every financial statement assertion in each account balance and transaction class.

Fig.: Risks of Material Mis-statement∗

An auditor’s judgement as to what is sufficient and appropriate audit evidence is affected by the degree of risk of mis-statement. Audit risk is the risk that an auditor may give an inappropriate opinion on financial information which is materially misstated.

As per SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing”, the risks of material misstatement at the assertion level consist of two components: inherent risk and control risk. Inherent risk and control risk are the entity’s risks; they exist independently of the audit of the financial statements. The nature of each of these types of risk and their interrelationship is discussed below:

(i) Inherent risk: It is the susceptibility of an account balance or class of transactions to misstatement that could be material either individually or, when aggregated with misstatements in other balances or classes, assuming that there were no related internal controls. External circumstances giving rise to business risks may also influence inherent risk. For example, technological developments might make a particular product obsolete, thereby causing inventory to be more susceptible to overstatement.

(ii) Control Risk: It is the risk that a misstatement that could occur in an assertion about a class of transaction, account balance or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control. It is a function of the effectiveness of the design, implementation and maintenance of internal control by management to address identified risks that threaten the achievement of the entity’s objectives relevant to preparation of the entity’s financial statements.

∗ Source : Source : cjess1 audit class pln - WordPress.com


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RISK ASSESSMENT AND INTERNAL CONTROL 3.31 The SAs do not ordinarily refer to inherent risk and control risk separately, but rather to a

combined assessment of the “risks of material misstatement”. However, the auditor may make separate or combined assessments of inherent and control risk depending on preferred audit techniques or methodologies and practical considerations.

(iii) Detection Risk: It is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not detect a misstatement that exists and that could be material, either individually or when aggregated with other misstatements. Detection risk relates to the nature, timing, and extent of the auditor’s procedures that are determined by the auditor to reduce audit risk to an acceptably low level. It is therefore a function of the effectiveness of an audit procedure and of its application by the auditor.

Fig.: Audit Risk∗

The inherent and control risks are functions of the entity’s business and its environment and the nature of the account balances or classes of transactions, regardless of whether an audit is conducted. Even though inherent and control risks cannot be controlled by the auditor, the auditor can assess them and design his substantive procedures to produce on acceptable level of detection risk, thereby reducing audit risk to an acceptably low level.

6.1 Preliminary Assessment of Control Risk After obtaining an understanding of the accounting system and internal control system, the auditor should make a preliminary assessment of control risk, at the assertion level, for each material account balance or class of transactions.

∗ Source: cplusglobal - WordPress.com


https://www.google.co.in/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&ved=0ahUKEwjWtc_Eh-TPAhUIrY8KHZ3QAdEQjB0IBg&url=https%3A%2F%2Fcplusglobal.wordpress.com%2F2014%2F04%2F15%2Faudit-risk-model%2F&psig=AFQjCNHiaMexKDacg_lB9u1-ZhReK--Zpw&ust=1476869316343297


The preliminary assessment of control risk is the process of evaluating the likely effectiveness of an entity's accounting and internal control systems in preventing or detecting and correcting material misstatements. The preliminary assessment of control risk is based on the assumption that the controls operate generally as described and that they operate effectively throughout the period of intended reliance. There will always be some control risk because of the inherent limitations of any accounting and internal control system.

The auditor ordinarily assesses control risk at a high level for some or all assertions when:

(a) the entity's accounting and internal control systems are not effective; or

(b) evaluating the effectiveness of the entity's accounting and internal control systems would not be efficient.

In the above circumstances, the auditor would obtain sufficient appropriate audit evidence from substantive procedures and from any audit work carried out in the preparation of financial statements.

The preliminary assessment of control risk for a financial statement assertion should be high unless the auditor:

(a) is able to identify internal controls relevant to the assertion which are likely to prevent or detect and correct a material misstatement; and

(b) plans to perform tests of control to support the assessment.

Documentation of Understanding and Assessment of Control Risk - The auditor should document in the audit working papers:

(a) the understanding obtained of the entity's accounting and internal control systems; and

(b) the assessment of control risk.

When control risk is assessed at less than high, the auditor would also document the basis for the conclusions.

Different techniques may be used to document information relating to accounting and internal control systems. Selection of a particular technique is a matter for the auditor's judgement.

Tests of Control - Tests of control are performed to obtain audit evidence about the effectiveness of the:

(a) design of the accounting and internal control systems, that is, whether they are suitably designed to prevent or detect and correct material misstatements; and

(b) operation of the internal controls throughout the period.


RISK ASSESSMENT AND INTERNAL CONTROL 3.33 Tests of control include tests of elements of the control environment where strengths in the control environment are used by auditors to reduce control risk.

Some of the procedures performed to obtain the understanding of the accounting and internal control systems may not have been specifically planned as tests of control but may provide audit evidence about the effectiveness of the design and operation of internal controls relevant to certain assertions and, consequently, serve as tests of control. For example, in obtaining the understanding of the accounting and internal control systems pertaining to cash, the auditor may have obtained audit evidence about the effectiveness of the bank reconciliation process through inquiry and observation.

When the auditor concludes that procedures performed to obtain the understanding of the accounting and internal control systems also provide audit evidence about the suitability of design and operating effectiveness of policies and procedures relevant to a particular financial statement assertion, the auditor may use that audit evidence, provided it is sufficient to support a control risk assessment at less than a high level.

Tests of control may include:

♦ Inspection of documents supporting transactions and other events to gain audit evidence that internal controls have operated properly, for example, verifying that a transaction has been authorised.

♦ Inquiries about, and observation of, internal controls which leave no audit trail, for example, determining who actually performs each function and not merely who is supposed to perform it.

♦ Re-performance of internal controls, for example, reconciliation of bank accounts, to ensure they were correctly performed by the entity.

♦ Testing of internal control operating on specific computerised applications or over the overall information technology function, for example, access or program change controls.

The auditor should obtain audit evidence through tests of control to support any assessment of control risk which is less than high. The lower the assessment of control risk, the more evidence the auditor should obtain that accounting and internal control systems are suitably designed and operating effectively.

When obtaining audit evidence about the effective operation of internal controls, the auditor considers :

how they were applied,

the consistency with which they were applied during the period and

by whom they were applied.



The concept of effective operation recognises that some deviations may have occurred. Deviations from prescribed controls may be caused by such factors as changes in key personnel, significant seasonal fluctuations in volume of transactions and human error. When deviations are detected the auditor makes specific inquiries regarding these matters, particularly, the timing of staff changes in key internal control functions. The auditor then ensures that the tests of control appropriately cover such a period of change or fluctuation.

Based on the results of the tests of control, the auditor should evaluate whether the internal controls are designed and operating as contemplated in the preliminary assessment of control risk. The evaluation of deviations may result in the auditor concluding that the assessed level of control risk needs to be revised. In such cases, the auditor would modify the nature, timing and extent of planned substantive procedures.

Quality and Timeliness of Audit Evidence

Certain types of audit evidence obtained by the auditor are more reliable than others. Ordinarily, the auditor's observation provides more reliable audit evidence than merely making inquiries, for example, the auditor might obtain audit evidence about the proper segregation of duties by observing the individual who applies a control procedure or by making inquiries of appropriate personnel. However, audit evidence obtained by some tests of control, such as observation, pertains only to the point in time at which the procedure was applied. The auditor may decide, therefore, to supplement these procedures with other tests of control capable of providing audit evidence about other periods of time.

In determining the appropriate audit evidence to support a conclusion about control risk, the auditor may consider the audit evidence obtained in prior audits. In a continuing engagement, the auditor will be aware of the accounting and internal control systems through work carried out previously but will need to update the knowledge gained and consider the need to obtain further audit evidence of any changes in control. Before relying on procedures performed in prior audits, the auditor should obtain audit evidence which supports this reliance. The auditor would obtain audit evidence as to the nature, timing and extent of any changes in the entity's accounting and internal control systems since such procedures were performed and assess their impact on the auditor's intended reliance. The longer the time elapsed since the performance of such procedures the less assurance that may result.

The auditor should consider whether the internal controls were in use throughout the period. If substantially different controls were used at different times during the period, the auditor would consider each separately. A breakdown in internal controls for a specific portion of the period requires separate consideration of the nature, timing and extent of the audit procedures to be applied to the transactions and other events of that period.

The auditor may decide to perform some tests of control during an interim visit in advance of the period end. However, the auditor cannot rely on the results of such tests without considering the need to obtain further audit evidence relating to the remainder of the period.



Factors to be considered include:

♦ The results of the interim tests.

♦ The length of the remaining period.

♦ Whether any changes have occurred in the accounting and internal control systems during the remaining period.

♦ The nature and amount of the transactions and other events and the balances involved.

♦ The control environment, especially supervisory controls.

♦ The nature, timing and extent of substantive procedures which the auditor plans to carry out.

Final Assessment of Control Risk

Before the conclusion of the audit, based on the results of substantive procedures and other audit evidence obtained by the auditor, the auditor should consider whether the assessment of control risk is confirmed. In case of deviations from the prescribed accounting and internal control systems, the auditor would make specific inquiries to consider their implications. Where, on the basis of such inquiries, the auditor concludes that the deviations are such that the preliminary assessment of control risk is not supported, he would amend the same unless the audit evidence obtained from other tests of control supports that assessment. Where the auditor concludes that the assessed level of control risk needs to be revised, he would modify the nature, timing and extent of his planned substantive procedures.

6.2 Relationship between the Assessments of Inherent and Control Risk

Management often reacts to inherent risk situations by designing accounting and internal control systems to prevent or detect and correct misstatements and therefore, in many cases, inherent risk and control risk are highly interrelated. In such situations, if the auditor attempts to assess inherent and control risks separately, there is a possibility of inappropriate risk assessment. As a result, audit risk may be more appropriately determined in such situations by making a combined assessment.

6.3 Detection Risk The level of detection risk relates directly to the auditor's substantive procedures. The auditor's control risk assessment, together with the inherent risk assessment, influences the nature, timing and extent of substantive procedures to be performed to reduce detection risk, and therefore audit risk, to an acceptably low level.



Some detection risk would always be present even if an auditor was to examine 100 percent of the account balances or class of transactions because, for example, most audit evidence is persuasive rather than conclusive.

The auditor should consider the assessed levels of inherent and control risks in determining the nature, timing and extent of substantive procedures required to reduce audit risk to an acceptably low level. In this regard the auditor would consider:

(a) the nature of substantive procedures, for example, using tests directed toward independent parties outside the entity rather than tests directed toward parties or documentation within the entity, or using tests of details for a particular audit objective in addition to analytical procedures;

(b) the timing of substantive procedures, for example, performing them at period end rather than at an earlier date; and

(c) the extent of substantive procedures, for example, using a larger sample size.

There is an inverse relationship between detection risk and the combined level of inherent and control risks. For example, when inherent and control risks are high, acceptable detection risk needs to be low to reduce audit risk to an acceptably low level. On the other hand, when inherent and control risks are low, an auditor can accept a higher detection risk and still reduce audit risk to an acceptably low level.

While tests of control and substantive procedures are distinguishable as to their purpose, the results of either type of procedure may contribute to the purpose of the other. Misstatements discovered in conducting substantive procedures may cause the auditor to modify the previous assessment of control risk.

The assessed levels of inherent and control risks cannot be sufficiently low to eliminate the need for the auditor to perform any substantive procedures. Regardless of the assessed levels of inherent and control risks, the auditor should perform some substantive procedures for material account balances and classes of transactions.

The auditor's assessment of the components of audit risk may change during the course of an audit, for example, information may come to the auditor's attention when performing substantive procedures that differs significantly from the information on which the auditor originally assessed inherent and control risks. In such cases, the auditor would modify the planned substantive procedures based on a revision of the assessed levels of inherent and control risks.

The higher the assessment of inherent and control risks, the more audit evidence the auditor should obtain from the performance of substantive procedures. When both inherent and control risks are assessed as high, the auditor needs to consider whether substantive procedures can provide sufficient appropriate audit evidence to reduce detection risk, and therefore audit risk, to an acceptably low level. When the auditor determines that detection risk regarding a financial statement assertion for a material account balance or class of transactions cannot be reduced to


RISK ASSESSMENT AND INTERNAL CONTROL 3.37 an acceptable level, the auditor should express a qualified opinion or a disclaimer of opinion as may be appropriate. Mathematically Audit Risk (AR) can be expressed as a product of Inherent Risk (IR), Control Risk (CR) and Detection Risk (DR), i.e. AR = IR x CR x DR It should be noted that: 1. The combined level of Inherent Risk and Control Risk is inversely related with Detection

Risk, and

2. Audit Materiality is also inversely related with audit risk.

The relationship between different components of audit risks is given in the following table: Auditors’ assessment of control risk

High Medium Low

Auditors’ assessment of inherent risk

High Lowest Lower Medium

Medium Lower Medium Higher

Low Medium Higher Highest

The shaded areas in this table relate to detection risk.

Y Co. Ltd. has five entertainment centers to provide recreational facilities for public especially for children and youngsters at 5 different locations in the peripheral of 200 kilometers. Collections are made in cash. Specify the adequate system towards

collection of money.

Control System over Selling and Collection of Tickets: In order to achieve proper internal control over the sale of tickets and its collection by the Y Co. Ltd., following system should be adopted -

(i) Printing of tickets: Serially numbered pre-printed tickets should be used and designed in such a way that any type of ticket used cannot be duplicated by others in order to avoid forgery. Serial numbers should not be repeated during a reasonable period, say a month or year depending on the turnover. The separate series of the serial should be used for such denomination.

(ii) Ticket sales: The sale of tickets should take place from the Central ticket office at each of the 5 centres, preferably through machines. There should be proper control over the keys of the machines.

(iii) Daily cash reconciliation: Cash collection at each office and machine should be reconciled with the number of tickets sold. Serial number of tickets for each entertainment activity/denomination will facilitate the reconciliation.



(iv) Daily banking: Each day’s collection should be deposited in the bank on next working day of the bank. Till that time, the cash should be in the custody of properly authorized person preferably in joint custody for which the daily cash in hand report should be signed by the authorized persons.

(v) Entrance ticket: Entrance tickets should be cancelled at the entrance gate when public enters the centre.

(vi) Advance booking: If advance booking of facility is made available, the system should ensure that all advance booked tickets are paid for.

(vii) Discounts and free pass: The discount policy of the Y Co. Ltd. should be such that the concessional rates, say, for group booking should be properly authorized and signed forms for such authorization should be preserved.

(viii) Surprise checks: Internal audit system should carry out periodic surprise checks for cash counts, daily banking, reconciliation and stock of unsold tickets etc.

7. INTERNAL CONTROL ASSESSMENT & EVALUATION The quality & effectiveness of internal controls is directly dependent on the Organisational environment. The tone at the top (the Board & Executive Management) & the credibility of the

message on internal controls from top plays an important role in establishing strong control environment. Following are some of the key components to assess & evaluate the controls environment:

Standard Operating Procedures (SOPs): A well defined set of SOPs helps define role, responsibilities, process & controls & thus helps clearly communicate the operating controls to all

touch points of a process. The controls are likely to be clearly understood & consistently applied even during employee turnover

1. Enterprise Risk Management: An organization which has robust process to identify & mitigate risks across the enterprise & its periodical review will assist in early identification of gaps & taking effective control measures. In such organizations, surprises of failures in controls is likely to be few.

2. Segregation of Job Responsibilities: A key element of control is that multiple activities in a transaction/decision should not be concentrated with one individual. Segregation of duties is an important element of control such that no two commercial activities should be conducted by the same person.



a buyer should not be involved in receiving of materials or passing of bills. Similarly bank reconciliation should be prepared by a person other than the one who maintains bank book.

3. Job Rotation in Sensitive Areas: Any job carried out by the same person over a long period of time is likely to lead to complacency & possible misuse in sensitive areas. It is therefore important that in key commercial functions, the job rotation is regularly followed to avoid degeneration of controls. For example if the same buyer continues to conduct purchase function for long period, it is likely that he gets into comfort zone with existing vendors & hence does not exercise adequate controls in terms of vendor development, competitive quotes etc.

4. Delegation of Financial Powers Document: As the organization grows, it needs to delegate the financial & other powers to their employees. A clearly defined document on delegation of powers allows controls to be clearly operated without being dependent on individuals.

5. Information Technology based Controls: With the advent of computers & enterprise resource planning (ERP) systems, it is much easier to embed controls through the system instead of being human dependent. The failure rate for IT embedded controls is likely to be low, is likely to have better audit trail & is thus easier to monitor. For example at the stage of customer invoicing, application of correct rates in invoices or credit control can all be exercised directly through IT system improving control environment.

8. REPORTING TO CLIENTS ON INTERNAL CONTROL WEAKNESSES

During the course of audit work, the audit may notice material weaknesses in the internal control system. Material weaknesses are defined as absence of adequate controls on flow of transactions that increases the possibility of errors and frauds in the financial statements of the entity.

In case, if monthly age-wise analysis of trade receivables is not performed then it may result in inadequate provisioning of bad debts for the fiscal year under audit.

The auditor should communicate such material weaknesses to the management or the audit committee, if any, on a timely basis. This communication should be, preferably, in writing through a letter of weakness or management letter. Important points with regard to such a letter are as follows:

(a) The letter lists down the area of weaknesses in the system and offers suggestions for improvement.

(b) It should clearly indicate that it discusses only weaknesses which have come to the attention of the auditor as a result of his audit and that his examination has not been designed to determine the adequacy of internal control for management.



(c) This letter serves as a valuable reference document for management for the purpose of revising the system and insisting on its strict implementation.

(d) The letter may also serve to minimize legal liability in the event of a major defalcation or other loss resulting from a weakness in internal control.

It should be appreciated that by writing a letter to the management about the weaknesses in the system, the auditor is not absolved from his duty to report the shortcomings in the accounts by way of qualification where the defects have not been corrected to the auditor’s satisfaction weighing the materiality of weaknesses and their impact, if considered necessary.

The practice of the issue of letter of weaknesses has a great merit in relieving the auditor from liability in case serious frauds or losses have occurred, which probably would not have taken place had the client taken due note of the auditor’s points in the letter of weakness. In the case Re S.P. Catterson & Ltd. (1937, 81, Act L.R. 62), the auditor was acquitted of the charge of negligence for employee’s fraud in view of the fact that he had already informed the client about the unsatisfactory state in the specific areas of accounts and had suggested improvements which were not acted upon by the management.

The Council of ICAI has issued SA 265 on “Communicating Deficiencies in Internal Control to Those Charged with Governance and Management” in this regard. This Standard on Auditing (SA) deals with the auditor’s responsibility to communicate appropriately to those charged with governance and management deficiencies in internal control that the auditor has identified in an audit of financial statements. This SA does not impose additional responsibilities on the auditor regarding obtaining an understanding of internal control and designing and performing tests of controls over and above the requirements of SA 315 and SA 330.

The objective of the auditor is to communicate appropriately to those charged with governance and management deficiencies in internal control that the auditor has identified during the audit and that, in the auditor’s professional judgment, are of sufficient importance to merit their respective attentions.

The auditor shall determine whether, on the basis of the audit work performed, the auditor has identified one or more deficiencies in internal control.

If the auditor has identified one or more deficiencies in internal control, the auditor shall determine, on the basis of the audit work performed, whether, individually or in combination, they constitute significant deficiencies.


RISK ASSESSMENT AND INTERNAL CONTROL 3.41 The auditor shall communicate in writing significant deficiencies in internal control identified during the audit to those charged with governance on a timely basis.

The auditor shall include in the written communication of significant deficiencies in internal control:

(a) A description of the deficiencies and an explanation of their potential effects; and

(b) Sufficient information to enable those charged with governance and management to understand the context of the communication. In particular, the auditor shall explain that:

(i) The purpose of the audit was for the auditor to express an opinion on the financial statements;

(ii) The audit included consideration of internal control relevant to the preparation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of internal control; and

(iii) The matters being reported are limited to those deficiencies that the auditor has identified during the audit and that the auditor has concluded are of sufficient importance to merit being reported to those charged with governance.

9. RISK-BASED AUDIT Audit should be risk-based or focused on areas of greatest risk to the achievement of the audited entity’s objectives. Risk-based audit (RBA) is an approach to audit that analyzes audit risks, sets materiality thresholds based on audit risk analysis and develops audit programmes that allocate a larger portion of audit resources to high-risk areas.

The auditor shall also communicate to management at an appropriate level of responsibility on a timely basis: (a) In writing, significant deficiencies in internal control that the auditor has

communicated or intends to communicate to those charged with governance, unless it would be inappropriate to communicate directly to management in the circumstances; and

(b) Other deficiencies in internal control identified during the audit that have not been communicated to management by other parties and that, in the auditor’s professional judgment, are of sufficient importance to merit management’s attention.



The auditor does not normally need to perform specific audit procedures on all areas of audit. He only needs to design audit programmes and procedures on areas earlier identified as major risks that could result in the financial statements being materially misstated. RBA is an essential element of financial audit- both in the attest audit of the financial statements and in the audit of financial systems and transactions including evaluation of internal controls. It focuses primarily on the identification and assessment of the financial statement misstatement risks and provides a framework to reduce the impact to the financial statement of these identified risks to an acceptable level before rendering an opinion on the financial statements. It also provides indicators of risks as a basis of opportunity for improvement of auditee risk management and control processes. This affords an opportunity to the auditee to improve its operations from recommendations on risks that do not have a current impact on the financial statements but impact the audited entity’s operational strategies and performance over the longer term.

In the context of performance audit, it is the risk to delivery of an activity or scheme or programme of the entity with economy, efficiency and effectiveness. Awareness of areas that puts the programme or resources at risk from the point of view of economy, efficiency and effectiveness helps focus audit attention on them. The risk analysis provides a framework for assurance in performance auditing.

9.1 Audit Risk Analysis The auditor should perform an analysis of the audit risks that impact on the auditee before undertaking specific audit procedures. Risk assessment is a subjective process. It is part of the professional judgment of the auditor and of the particular circumstances. It is the risk that the auditor may unknowingly fail to appropriately modify his opinion on financial statements that are materially misstated.

Audit risks are brought about by error and fraud:

♦ Error is an unintentional mistake resulting from omission, as when legitimate transactions and/or balances are excluded from the financial statements; or by commission, as when erroneous transactions and/or balances are included in the financial statements.

♦ Fraud is an intentional misstatement in the accounting records or supporting documents from which the financial statements are prepared. It is intended to deceive financial statement users or to conceal misappropriations.

The auditor has the responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements, whether caused by error or fraud.

An error risk may arise from an error in principle, estimate, critical information processing, financial reporting process or disclosure.


RISK ASSESSMENT AND INTERNAL CONTROL 3.43 Fraud risk involves manipulation, falsification of accounting records, or misrepresentation in the financial statements of events, transactions or other significant information, or misapplication of accounting principles or misappropriation of funds.

9.2 General Steps in the Conduct of RBA RBA consists of four main phases starting with the identification and prioritization of risks, to the determination of residual risk, reduction of residual risk to acceptable level and the reporting to auditee of audit results. These are achieved through the following:

Step 1 Understand auditee operations to identify and prioritize risks: Understanding auditee operations involves processes for reviewing and understanding the audited organization’s risk management processes for its strategies, framework of operations, operational performance and information process framework, in order to identify and prioritize the error and fraud risks that impact the audit of financial statements. The environment in which the auditee operates, the information required to monitor changes in the environment, and the process or activities integral to the audited entity’s success in meeting its objectives are the key factors to an understanding of agency risks. Likewise, a performance review of the audited entity’s delivery of service by comparing expectations against actual results may also aid in understanding agency operations.

Step 2 Assess auditee management strategies and controls to determine residual audit risk: Assessment of management risk strategies and controls is the determination as to how controls within the auditee are designed. The role of internal audit in promoting a sound accounting system and internal control is recognized, thus the SAI should evaluate the effectiveness of internal audit to determine the extent to which reliance can be placed upon it in the conduct of substantive tests.

Step 3 Manage residual risk to reduce it to acceptable level: Management of residual risk requires the design and execution of a risk reduction approach that is efficient and effective to bring down residual audit risk to an acceptable level. This includes the design and execution of necessary audit procedures and substantive testing to obtain evidence in support of transactions and balances. More resources should be allocated to areas of high audit risks, which were earlier known through the analytical procedures undertaken.

Step 4 Inform auditee of audit results through appropriate report: The results of audit shall be communicated by the auditor to the audited entity. The auditor must immediately communicate to

Understand auditee

operations to identify and

prioritize risks

Assess auditee management strategies and

controls to determine

residual audit risk

Manage residual risk to

reduce it to acceptable

level

Inform auditee of audit results

through appropriate

report



the auditee reportable conditions that have been observed even before completion of the audit, such as weaknesses in the internal control system, deficiencies in the design and operation of internal controls that affect the organization’s ability to record, process, summarize and report financial data.

10. FRAMEWORKS OF INTERNAL CONTROL Corporate internal controls are part of governance mechanisms of every organisation and, whether a company adopts a global internal control framework or develops its own, management should always be guided by the need to safeguard business value. There are a number of global internal control frameworks that provide guidance to entities for developing and establishing their internal control systems.

Control should be built and established within the processes through which the company pursues its objectives. It follows that, rather than developing separate risk reporting systems, it would be more appropriate to build early warning mechanisms into existing management information systems. The board of directors or those charged with governance need to consider whether they have enough timely, relevant and reliable reports on progress against business objectives and significant risks.

Objective: Internal control is fundamental to the successful operation and day-to-day running of a business and it assists the company in achieving its business objectives. It is wider in scope and encompasses all controls incorporated into the strategic, governance and management process, covering the company’s entire range of activities and operations, and not limited to those directly related to financial operations and reporting. There are many internal control frameworks. The objective of this chapter is to give an overview of the common international frameworks.

Guidance Note on Audit of Internal Financial Controls Over Financial Reporting: ICAI has issued a Guidance Note on Audit of Internal Financial Controls Over Financial Reporting which covers aspects such as Scope of reporting on internal financial controls under Companies Act 2013, essential components of internal controls, Technical guidance on audit of Internal Financial Controls, Implementation guidance on audit of Internal Financial Controls. The Guidance Note states as below: “To state whether a set of financial statements presents a true and fair view, it is essential to benchmark and check the financial statements for compliance with the financial reporting framework. The Accounting Standards specified under the Companies Act, 1956 (which are deemed to be applicable as per Section 133 of the 2013 Act, read with Rule 7 of Companies (Accounts) Rules, 2014) is one of the criteria constituting the financial reporting framework based on which companies prepare and present their financial statements and against which the auditors evaluate if the financial statements present a true and fair view of the state of affairs and operations of the company in an audit of the financial statements carried out under the Companies Act, 2013.


RISK ASSESSMENT AND INTERNAL CONTROL 3.45 Similarly, a benchmark internal control system, based on suitable criteria, is essential to enable the management and auditors to assess and state adequacy of and compliance with the system of internal control. In the Indian context, students are advised to refer Appendix 1 “Internal Control Components” of SA 315, “Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and its Environment” provides the necessary criteria for internal financial controls over financial reporting for companies.

10.1 International Internal Control Frameworks An overview of different internal control frameworks followed internationally are given below:

A. Internal Control - Integrated Framework issued by Committee of the Sponsoring Organisations of the Treadway Commission (COSO Framework).

COSO’s Internal Control – Integrated Framework was introduced in 1992 as guidance on how to establish better controls so companies can achieve their objectives. COSO categorizes entity-level objectives into operations, financial reporting, and compliance. The framework includes more than 20 basic principles representing the fundamental concepts associated with its five components: control environment, risk assessment, control activities, information and communication, and monitoring. Some of the principles include key elements for compliance, such as integrity and ethical values, authorities and responsibilities, policies and procedures, and reporting deficiencies.

However, the Framework clarifies the requirements for effective internal control. This was largely done through the articulation of the 17 principles, which are relevant to every entity and must be present and functioning in order to have an effective system of internal control. Here are the tiles of the 17 internal control principles by internal control component as presented in COSO’s framework:

Control Environment Risk Assessment

Control Activities

Information and Communication

Monitoring

Demonstrates commitment to integrity and ethical values

Exercises oversight responsibility

Establishes structure, authority, and responsibility

Demonstrates commitment to competence

Enforces accountability

Specifies suitable objectives

Identifies and analyses risk

Assesses fraud risk

Identifies and analyses significant change

Selects and develops control activities

Selects and develops general controls over technology

Deploys through policies and procedures

Uses relevant information

Communicates internally

Communicates externally

Conducts ongoing and/or separate evaluations

Evaluates and communicate deficiencies



The COSO Framework is designed to be used by organizations to assess the effectiveness of the system of internal control to achieve objectives as determined by management. The Framework lists three categories of objectives as below:

• Operations Objectives – related to the effectiveness and efficiency of the entity’s operations, including operational and financial performance goals, and safeguarding assets against loss.

• Reporting Objectives – related to internal and external financial and non-financial reporting to stakeholders, which would encompass reliability, timeliness, transparency, or other terms as established by regulators, standard setters, or the entity’s policies.

• Compliance objectives – In the Framework, the compliance objective was described as “relating to the entity’s compliance with applicable laws and regulations.” The Framework considers the increased demands and complexities in laws, regulations, and accounting standards.

Limitations of Internal Control: The Framework acknowledges that there are limitations related to a system of internal control. For example, certain events or conditions are beyond an organization’s control, and no system of internal control will always do what it was designed to do. Controls are performed by people and are subject to human error, uncertainties inherent in judgment, management override, and their circumvention due to collusion. An effective system of internal control recognizes their inherent limitations and addresses ways to minimize these risks by the design, implementation, and conduct of the system of internal control. However, an effective system will not eliminate these risks. An effective system of internal control provides reasonable assurance, not absolute assurance, that the entity will achieve its defined operating, reporting, and compliance objectives.

B. Guidance on Assessing Control published by the Canadian Institute of Chartered Accountants (CoCo)

CoCo was introduced in 1992 with the objective of improving organizational performance and decision-making with better controls, risk management, and corporate governance.

The Criteria of Control (CoCo) framework was developed by the Canadian Institute of Chartered Accountants with the objective of improving organisational performance and decision making with better controls, risk management, and corporate goverance. In 1995, Guidance on Control was produced and described the CoCo framework and defining controls. The framework includes 20 criteria for effective control in four areas of an organization: purpose (direction), commitment (identity and values), capability (competence), and monitoring and learning (evolution).

The framework emphasizes that control involves the entire organization but begins on an individual level, with the employee.

The CoCo framework outlines criteria for effective control in the following four areas:

• Purpose

• Commitment


RISK ASSESSMENT AND INTERNAL CONTROL 3.47 • Capability

• Monitoring and Learning

In order to assess whether controls exist and are operating effectively, each criterion would be examined to identify the controls that are in place to address them.

C. Control Objectives for Information and Related Technology (COBIT)

COBIT stands for Control Objectives for Information and Related Technology. It is a framework created by the ISACA (Information Systems Audit and Control Association) for IT governance and management. COBIT has 34 high-level processes that cover 210 control objectives categorized in four domains: planning and organization, acquisition and implementation, delivery and support, and monitoring and evaluation. It is designed as a supportive tool for managers and allows bridging the crucial gap between technical issues, business risks and control requirements.

Business managers are equipped with a model to deliver value to the organization and practice better risk management practices associated with the IT processes. It is a control model that guarantees the integrity of the information system. Today, COBIT is used globally by all managers who are responsible for the IT business processes. It is a thoroughly recognized guideline that can be applied to any organization across industries. Overall, COBIT ensures quality, control and reliability of information systems in organization, which is also the most important aspect of every modern business.

This framework guides an organization on how to use IT resources (i.e., applications, information, infrastructure, and people) to manage IT domains, processes, and activities to respond to business requirements, which include compliance, effectiveness, efficiency, confidentiality, integrity, availability, and reliability. Well-governed IT practices can assist businesses in complying with laws, regulations, and contractual arrangements.

D. Internal Control: Guidance for Directors on the Combined Code, published by the Institute of Chartered Accountants in England & Wales (known as the Turnbull Report)

When the Combined Code of the Committee on Corporate Governance (the Code) was published, the Institute of Chartered Accountants in England & Wales agreed with the London Stock Exchange that it would provide guidance to assist listed companies to implement the requirements in the Code relating to internal control. The key principles of the Code are enunciated as below:

• The board should maintain a sound system of internal control to safeguard shareholders’ investment and the company’s assets.

• The directors should, at least annually, conduct a review of the effectiveness of the group’s system of internal control and should report to shareholders that they have done so. The review should cover all controls, including financial, operational and compliance controls and risk management.

• Companies which do not have an internal audit function should from time to time review the need for one.



The guidance requires directors to exercise judgement in reviewing how the company has implemented the requirements of the Code relating to internal control and reporting to shareholders thereon. The guidance is based on the adoption by a company’s board of a risk-based approach to establishing a sound system of internal control and reviewing its effectiveness. This should be incorporated by the company within its normal management and governance processes. It should not be treated as a separate exercise undertaken to meet regulatory requirements

E. Sarbanes-Oxley Section 404

SOX Section 404 (Sarbanes-Oxley Act Section 404) mandates that all publicly-traded companies must establish internal controls and procedures for financial reporting and must document, test and maintain those controls and procedures to ensure their effectiveness. The purpose of SOX is to reduce the possibilities of corporate fraud by increasing the stringency of procedures and requirements for financial reporting. The Sarbanes Oxley Act, signed into law in 2002, has revamped federal regulations pertaining to publicly traded companies’ corporate governance and reporting obligations. The PCAOB followed with AS 2, which was approved by the SEC in June 2004. AS 2 was replaced in May 2007 by AS 5.

The SEC rules and PCAOB standard require that:

• Management perform a formal assessment of its controls over financial reporting including tests that confirm the design and operating effectiveness of the controls.

• Management include in its annual report an assessment of ICFR.

• The external auditors provide two opinions as part of a single integrated audit of the company:

- An independent opinion on the effectiveness of the system of ICFR.

- The traditional opinion on the financial statements.

There are a number of different definitions of the term internal control. For the purposes of Section 404, the great majority of companies and all the CPA firms use the definition in COSO’s Internal Control — Integrated Framework. The COSO framework has made it easier for management to see what’s covered and here gaps may exist in their SOX 404 compliance program.

Management needs to determine whether the system of internal control in effect as of the date of the assessment provides reasonable assurance that material errors, in either interim or annual financial statements, will be prevented or detected.

The rules issued by Securities and Exchange Commission require a company’s annual report to include an internal control report of management that contains:

- A statement of management’s responsibility for establishing and maintaining adequate internal control over financial reporting for the company.


RISK ASSESSMENT AND INTERNAL CONTROL 3.49 - A statement identifying the framework used by management to conduct the required

evaluation of the effectiveness of the company’s internal control over financial reporting.

- Management’s assessment of the effectiveness of the company’s internal control over financial reporting as of the end of the company’s most recent fiscal year, including a statement as to whether or not the company’s internal control over financial reporting is effective. The assessment must include disclosure of any “material weaknesses” in the company’s internal control over financial reporting identified by management. Management is not permitted to conclude that the company’s internal control over financial reporting is effective if there are one or more material weaknesses in the company’s internal control over financial reporting. A statement that the registered public accounting firm that audited the financial statements included in the annual report has issued an attestation report on management’s assessment of the registrant’s internal control over financial reporting.

The final rules also require a company to file, as part of the company’s annual report, the attestation report of the registered public accounting firm that audited the company’s financial statements.

TEST YOUR KNOWLEDGE Theoretical Questions 1. Briefly describe the various stages of a Risk Assessment process.

2. What are the components of an internal control framework?

3. During the course of his audit, the auditor noticed material weaknesses in the internal control system and he wishes to communicate the same to the management. You are required to elucidate the important points the auditor should keep in the mind while drafting the letter of weaknesses in internal control system.

4. Explain briefly the Flow Chart technique for evaluation of the Internal Control system.

5. What are the General Steps in the conduct of Risk based audit?

Multiple Choice Questions: 1. Raj Private Limited is engaged in the business of retail and has its retail outlets

concentrated towards Northern India. Currently, the company has 59 outlets and the plan of the management is to take this to at least 100 over the next 2 years.

The company is audited by Raj & Associates, a firm of Chartered Accountants, who have been operating for over 20 years, however, they don’t have much experience in the retail sector. Because of this fact the audit team decided to plan efficiently for the audit of the financial statements of the company for the year ended 31 March 2019, being their first year of audit.



During the course of risk assessment by the auditors, it was discussed that the company is operating in an industry where the operations are not very complicated and mostly the processes are known to all. Considering the same they decided that assessment of inherent risk should not be done for this company as that would be inefficient. However, the auditors will take due care of the control risks. The same assessment was deliberated upon and after lot of discussions it was finalized like this.

In the given situation, please advise which one of the following would be correct.

(a) The assessment of audit team is correct.

(b) The assessment of audit team is wrong considering the fact that this is a private company wherein such assessment is not possible.

(c) The assessment of audit team is wrong for this company.

(d) The assessment of audit team is correct considering the fact that this has been thoroughly discussed.

2. Kshitij Private Ltd is a company based out of Noida having operations in India and Dubai. The company’s operations in Dubai have increase over the last 2 years and the management is earning very good profits.

Because of the profits, the management also planned that they should now focus on strengthening of internal controls of the company and for that purpose they have discussed with the statutory auditors to carry out the audit for the financial year ended 31 March 2019 very rigorously.

The report on internal financial controls is also applicable to the company and hence the auditors during the course of their work asked for Risk-control matrices from the company. During the year ended 31 March 2018, Risk-control matrix was not available with the company and was prepared in a draft manner and the same was shared with the audit team during that year and the auditors completed their work on the basis of that.

However, for the year ended 31 March 2019, the auditors would like to have robust documentation and are not ready to accept the same Risk-control matrices.

In the given situation, please suggest what should be the course of action.

(a) The request of audit team is correct and the management should provide that.

(b) The requirement of audit team is not justified considering the fact that last year same documentation was used by them.

(c) The requirement of audit team is not justified considering the fact that it’s a private company and auditor anyways is required to perform rigorous audit procedures.



(d) In case of a private company on which internal financial controls report is required, the auditor is not allowed to take any Risk-control matrix from the management. Seems to be an ethical issue.

3. SK Private Limited is a medium-sized company having operations in Jharkhand. The company manufactures some parts and sells that to various dealers on ex-works basis. The financial statements of the company are prepared as per Ind AS and internal financial controls report is also applicable on the same.

During the course of audit of the financial statements for the year ended 31 March 2019, the management of the company had a detailed discussion with the auditors for audit planning.

Further it was also decided that any observations of the auditors should also be discussed with the management before conclusion by the audit team which was not done in the past years.

Considering this, the auditors started the risk assessment and requested the management to share their documentation for the same on which the management said that they don’t have any risks and if the auditors come across any such thing they can discuss that with the management.

But the auditors were not convinced with the view of the management and the same thing has happened in the past years as well.

You are required to provide your inputs to resolve this matter.

(a) The requirement of the audit team is not correct.

(b) The view of the management is correct because of the applicability of Ind AS.

(c) The view of the management is correct because of the applicability of internal financial controls reporting.

(d) The view of the management is not correct.

4. AJ Private Ltd is in the business of telecom and have significant operations across India predominantly in Northern India.

The statutory auditors of the company have been continuing for the last 3 years and have been issuing clean report.

For the financial year ended 31 March 2019, the statutory auditors commenced their work in March 2019 as per discussions with the management and with a plan to complete the audit by first week of May 2019.

The audit team concluded the work as per the agreed timelines and the financial statements and audit report were signed on 5 May 2019 along with the engagement letter for the financial year ended 31 March 2019.



In the given situation, please advise which of the following would be correct.

(a) The engagement letter should have been signed before commencing the audit work.

(b) The engagement letter should have been signed at least a day before signing the audit report.

(c) The engagement letter should have been signed at least a day before signing the financial statements.

(d) The engagement letter is optional in case of a private company and hence can be signed anytime.

5. RIM Private Ltd is engaged in the business of manufacturing of water bottles and is experiencing significant increase in turnover year on year. It is a subsidiary of RIM Gmbh, based out of Germany.

During the financial year ended 31 March 2019, the company carried out a detailed physical verification of its inventory and property, plant and equipment.

During the year, various other activities were carried out to increase efficiency in operations and reductions of costs.

The statutory auditors of the company started their audit work from April 2019 and requested for a documentation on changes in processes and activities during the year as well as any resultant impact of the same on management controls.

The management of the company told the auditors that all such documentation is maintained by the parent company as this is a closely held private company and even though internal financial controls reporting is applicable on this company, the parent company is taking due care of each and every process.

The auditors did not agree with the views of the management. Please advise both the management and the auditors.

(a) The auditors should look for documentation as per Sarbanes Oxley in this case.

(b) The auditors are correct in this case and the management should provide the required documentation.

(c) The auditors are correct in this case and the management should provide the required documentation. However, in case the parent company is covered by Sarbanes Oxley then it can be ignored by the auditors.

(d) The management is correct.



Answers to Theoretical Questions 1. Risk Assessment is one of the most critical components of Enterprise Risk Management.

The risk assessment process involves considerations for qualitative and quantitativefactors, definition of key performance and risk indicators, risk appetite, risk scores, scalesand maps, use of data & metrics and benchmarking. The various stages in a RiskAssessment process are as follows:

• Define Business Objectives and Goals;

• Identify events that affect achievement of business objectives;

• Assess likelihood and impact;

• Respond and mitigate risks;

• Assess residual risk.

2. There are five components of an internal control framework. They are as follows:

• Control Environment;

• Risk Assessment;

• Information & Communication;

• Monitoring;

• Control Activities.

3. Important Points to be kept in Mind While Drafting Letter of Weakness: As per SA 265,“Communicating Deficiencies in Internal Control to Those who Charged with Governanceand Management”, the auditor shall include in the written communication of significantdeficiencies in internal control -

(i) A description of the deficiencies and an explanation of their potential effects; and

(ii) Sufficient information to enable those charged with governance and management tounderstand the context of the communication.

In other words, the auditor should communicate material weaknesses to the management or the audit committee, if any, on a timely basis. This communication should be, preferably, in writing through a letter of weakness or management letter. Important points with regard to such a letter are as follows-

(1) The letter lists down the area of weaknesses in the system and offers suggestionsfor improvement.



(2) It should clearly indicate that it discusses only weaknesses which have come to the attention of the auditor as a result of his audit and that his examination has not been designed to determine the adequacy of internal control for management.

(3) This letter serves as a valuable reference document for management for the purpose of revising the system and insisting on its strict implementation.

(4) The letter may also serve to minimize legal liability in the event of a major defalcation or other loss resulting from a weakness in internal control.

4. Refer Para 5.3

5. Refer Para 9.2.

Answers to Multiple Choice Questions 1. (c) 2. (a) 3. (d) 4. (a) 5. (b)


4

SPECIAL ASPECTS OF AUDITING IN AN AUTOMATED ENVIRONMENT

LEARNING OUTCOMES

After studying this chapter, you will be able to: Understand the key features of an automated environment and key

concepts of auditing in real-time automated environment such as e-commerce, ERP, core banking.

Learn how to document the understanding of an automated environment. Know how to perform an evaluation of risks and controls at entity level and

process level. Gain the knowledge of how to assess IT-related risks and controls that

exist in an automated environment. Gain an overview of enterprise risk management. Learn about relevant analytical procedures and tests using data analytics. Understand the available standards, guidelines and procedures,

frameworks and best practices that are relevant to an automated environment.

Know the considerations of automated environment at each phase of audit cycle.



1. KEY FEATURES OF AN AUTOMATED ENVIRONMENT An automated environment is an ecosystem that combines people, processes and technology within an overall business environment. Typically, the automated environment is driven by computer based systems which are also known as information technology (IT) systems or information systems (IS). There are several types of applications that could exist in a business depending on several factors including the nature, size, location of a business. Business applications can be broadly categorised as follows:

Category of Business Applications Example of Category

Packaged software (also called off-the-shelf applications) used by micro and small business.

For example, Tally, QuickBooks.

Over

view

Key features of an Automated Environment

Real Time Environment viz., E Commerce, ERP, Core

Banking etc.

Standarads, Guidelines and Procedures towards it

Evaluating Risk and Controls at Entity Level and

Process Level

Assessing IT Related Risk and Controls

General IT Controls

Application Controls

IT Dependent ControlsEnterprise Risk Management

Analytical Procedures and Test using Data Analytics

CHAPTER OVERVIEW


SPECIAL ASPECTS OF AUDITING IN AN AUTOMATED ENVIRONMENT 4.3

Small ERPs used in small to medium business.

For example, Tally ERP, SAP Business One, Focus ERP.

ERP applications used in medium to large companies.

For example, SAP R/3, Oracle R12 Enterprise Business Suite.

The applications described above form one layer of the overall automated environment. The other layers are made up of the technology infrastructure and the physical & environmental aspect including:

• Databases - Oracle 12g, MS-SQL Server;

• Operating systems - Windows, Unix, Linux;

• Storage devices - disks, tapes, network storage;

• Network devices - switches, routers and firewalls;

• Networks - local area networks, wide area networks, virtual private networks, etc.;

• Physical and environmental – access to IT facilities, CCTVs, temperature control, firefighting equipment, etc.

The illustration below shows the various layers of an automated environment:

It is also likely that some automated environments could have more than one application being used.

Physical & Environmental

Networks (LAN/WAN/VPN)

SAP R/3 Application

Unix Operating System

Oracle 12g Database



In a hotel there could be one application for front desk & reservations, another application for restaurant & kitchen orders, a guest billing system, and an accounting system. In large multinational companies, specifically in the financial services, the

number of applications could be hundreds and even thousands of applications.

2. KEY CONCEPTS OF AUDITING IN REAL-TIME ENVIRONMENT SUCH AS E-COMMERCE, ERP, CORE BANKING, ETC.

A real-time environment is a type of automated environment in which business operations and transactions are initiated, processed and recorded immediately as they happen without delay.

In a bank that is using core banking system a customer account balance is instantly updated when the customer withdraws cash from an ATM. If there is a time delay in updating the customer account, there is a risk that the customer may initiate another

transaction through internet or mobile banking channel and this could result in withdrawing more than account balance. Similarly, when a customer makes an online order on a shopping e-commerce portal using credit card, the credit limit of the customer will be reduced immediately.

A real-time environment has several critical IT components that enable anytime, anywhere transactions to take place. They include:

To facilitate transactions in real-time, it is essential to have the systems, networks and applications available during all times. Any failure even in one component could render the real-time system unavailable and could result in a loss of revenue.

If an e-commerce portal that normally processes a several hundred of orders per day goes down for an hour due to a malware attack on one of the webservers hosting the portal, the

revenue loss could be significant.

Real Time Environment: IT

Components

Applications.

For example, ERP applications SAP, Oracle R12, Core

banking applications.

Middleware.

For example, Webservers like

Apache, ATM switches.

Networks.

For example, Wide Area Networks,

Internet hosting.

Hardware.

For example, Data centers, Backup

and Storage devices, Power

supply.



Most real-time systems and environments are accessible through public domain and internet and hence, they are more likely to be vulnerable to network and cyber-attacks including denial of service, distributed denial of service.

Hence, it is critical for a company that operates in a real-time environment to constantly monitor all the IT components to identify and resolve issues and failures. Understanding of the automated environment, the risks and controls that should be considered and audit approach will be covered in the following sections of this chapter.

3. UNDERSTANDING AND DOCUMENTING AUTOMATED ENVIRONMENT

Understanding of the automated environment of a company is required as per SA 315. The auditor’s understanding of the automated environment should include the following:

• The applications that are being used by the company;

• Details of the IT infrastructure components for each of the application;

• The organisation structure and governance;

• The policies, procedures and processes followed;

• IT risks and controls.

The auditor is required to document the understanding of a company’s automated environment as per SA 230.

The illustration below is an example of how an auditor can document details of an automated environment:

Application Used for Database Operating System

Network Storage

SAP R/3 Financial Accounting

Oracle 12g HP-UX LAN, WAN NAS

REVS Front Desk, Guest Reservations

MS-SQL Server 2008

Windows 2012 Server

In-house developed

Server Internal HDD

KOTS Restaurant and Kitchen Orders

MS-SQL Server 2008

Windows 2012 Server

In-house developed

Server Internal HDD

BILLSYS Billing Oracle 11i Windows 2008 Server

Packaged Software

Server Internal HDD



The illustration below is an example of an IT organization:

4. CONSIDERATION OF AUTOMATED ENVIRONMENT AT EACH PHASE OF AUDIT CYCLE

In a controls-based audit, the audit approach can be classified into three broad phases comprising of planning, execution, and completion. In this approach, the considerations of automated environment will be relevant at every phase as given below: • during risk assessment, the auditor should consider risk arising from the use of IT systems at

the company;

• when obtaining an understanding of the business process and performing walkthroughs the use of IT systems and applications should be considered;

• while assessing the entity level controls the aspects related to IT governance need to be understood and reviewed;

• pervasive controls including segregation of duties, general IT controls and applications should be considered and reviewed;

• during testing phase, the results of general IT controls would impact the nature, timing and extent of testing;

• when testing of reports and information produced by the entity (IPE) generated through IT systems and applications;

• at completion stage, evaluation of control deficiencies may require using data analytics and CAATs.

Board of Directors

IT Director/CIO

Manager (Applications)

Application Support Team

In-House Development

Team

Manager (IT Infrastructure)

Network Administrator

Database Administrator

System Administrator

Manager (IT Facilities)

Hardware Engineer

Helpdesk

IT Vendor Management

Team



5. ENTERPRISE RISK MANAGEMENT OVERVIEW Businesses today operate in a dynamic environment. The volatility, unpredictability and pace of changes that exist in the business environment today is far greater than in the past. Some of the reasons for this dynamic environment include globalisation, use of technology, new regulatory requirements, etc. Because of this dynamic environment the associated risks to business have also increased and companies have a need to continuously manage risks.

Risk Assessment

• Identify significant accounts and disclosures.

• Qualitative and Quantitative considerations.

• Relevant Financial Statement Assertions (FSA).

• Identify likely sources of misstatement.

• Consider risk arising from use of IT systems.

Understand and Evaluate

• Document understanding of business processes using Flowcharts / Narratives.

• Prepare Risk and Control Matrices (RCM).

• Understand design of controls by performing walkthrough of end-to-end process.

• Process wide considerations for Entity Level Controls, Segregation of Duties.

• IT General Controls, Application Controls.

Test for Operating

Effectiveness

• Assess Nature, Timing and Extent (NTE) of controls testing.

• Assess reliability of source data; completeness of population.

• Testing of key reports and spreadsheets.

• Sample testing. • Consider

competence and independence of staff /team performing controls testing.

Reporting

• Evaluate Control Deficiencies.

• Significant deficiencies, Material weaknesses.

• Remediation of control weaknesses.

• Internal Controls Memo (ICM) or Management Letter.

• Auditor’s report.

Planning Execution Completion



Examples of risks include:

• Market Risks;

• Regulatory & Compliance Risks;

• Technology & Security Risks;

• Financial Reporting Risks;

• Operational Risks;

• Credit Risk;

• Business Partner Risk;

• Product or Project Risk;

• Environmental Risks.

Risk is the possibility that something could go wrong. In other words, Risk is the possibility that an event will happen which prevents a company from achieving business objectives. Risk Management is a combination of process, people, tools and techniques through which companies identify, assess, respond, mitigate and monitor risks. Enterprise Risk Management is a formal program or framework that is implemented across an enterprise or company for enabling risk management.

Globally, companies in several countries are required by law to have a formal enterprise risk management program. In India, the Companies Act, 2013 requires the board report to include a statement indicating development and implementation of a risk management policy for the company including identification therein of elements of risk, if any, which in the opinion of the board may threaten the existence of the company. The existence of an appropriate system of internal financial control does not by itself provide an assurance to the board of directors that the company has developed and implemented an appropriate risk management policy. While the law makes the Board of directors responsible, an Enterprise Risk Management program of a company is implemented by the board of directors, top management and employees across all levels.

The internal control framework of a company is not separate, though it is an integral part of an Enterprise Risk Management program. The scope of an Enterprise Risk Management program is much broader than an internal control framework and encompasses both internal and external factors that are relevant to business strategy, governance, business process and transaction and activity level. The focus of an internal control framework is primarily around financial reporting, operations and compliance risks associated with an account balance, business process, transaction and activity level, which form a sub-set of the overall enterprise risks.

One of the most common framework that is suitable for implementing an effective enterprise risk management is the COSO Enterprise Risk Management – Integrated Framework developed by the Committee of Sponsoring Organisations (COSO) in 2004 and subsequently updated in 2016 to address the changes in business environment.



One of the most critical component of Enterprise Risk Management is the Risk Assessment process. The risk assessment process involves considerations for: • qualitative and quantitative factors; • definition of key performance and risk indicators; • risk appetite; • risk scores, scales and maps; • use of data & metrics; • benchmarking. A typical risk assessment process would be as given below:

Apart from COSO framework, another relevant and widely available framework is the ISO 31000 Risk Management standard published by the International Organization for Standardization. The ISO 31000:2009, published in 2009, provides a set of principles and guidelines and risk assessment techniques for implementing a risk management framework in a company.

6. ASSESSING IT-RELATED RISKS AND CONTROLS The auditing standards SA 315 and SA 330 require an auditor to understand, assess and respond to the risks within a company, including those risks that pertain to the use of IT systems and applications in an automated environment. When assessing IT risks in the automated environment, the auditor should consider the following:

• Entity level aspects of risks that are related to the governance, organisation and management of IT.

Has management established an IT Security Policy (Control Environment), communicated the policy to all employees and provided relevant training (Information & Communication)?

How does management monitor adherence to the established policies (Monitoring)?

• Risks in the IT processes and procedures being followed.

Are unauthorised changes to IT systems applications prevented and detected in a timely manner?

Is user access to systems commensurate with roles and responsibilities of the user?

Define business objectives and goals

Identify events that affect

achievement of business objectives

Assess likelihood and

impactRespond and mitigate risks

Assess residual risk



• IT risks at each layer of the automated environment.

Are direct data changes to database prevented, are strong passwords used in the operating system?

As systems evolve and version updates happen so will new risks emerge. For example, as systems these days are highly interconnected and accessible through public networks like the internet, cyber risks are an emerging threat.

The controls that are put in place to mitigate the IT risks and to maintain the confidentiality, integrity, availability and security of data are as follows:

• General IT Controls;

• Application Controls;

• IT-Dependent Controls.

The illustration below is a sample representation of the various components of an automated environment and where the different types of IT controls fit into the overall environment:

General IT Controls: “General IT controls are policies and procedures that relate to many applications and support the effective functioning of application controls. They apply to mainframe, miniframe, and end-user environment. General IT-controls that maintain the integrity of information and security of data commonly include controls over the following:” (SA 315)

• Data center and network operations;

• Program change;

• Access security;

• Application system acquisition, development, and maintenance (Business Applications).



These are IT controls generally implemented to mitigate the IT specific risks and applied commonly across multiple IT systems, applications and business processes. Hence, General IT controls are known as “pervasive” controls or “indirect” controls.

The illustration below is an overview of the Control Objectives and activities for each area of General IT Controls:

Application Controls: Application controls include both automated or manual controls that operate at a business process level. Automated Application controls are embedded into IT applications viz., ERPs and help in ensuring the completeness, accuracy and integrity of data in those systems. Examples of automated applications include edit checks and validation of input data, sequence number checks, user limit checks, reasonableness checks, mandatory data fields. IT dependent controls: IT dependent controls are basically manual controls that make use of some form of data or information or report produced from IT systems and applications. In this case, even though the control is performed manually, the design and effectiveness of such controls depend on the reliability of source data.



Due to the inherent dependency on IT, the effectiveness and reliability of Automated application controls and IT dependent controls require the General IT Controls to be effective.

General IT Controls vs. Application Controls

• These two categories of control over IT systems are interrelated.

• The relationship between the application controls and the General IT Controls is such that General IT Controls are needed to support the functioning of application controls, and both are needed to ensure complete and accurate information processing through IT systems.

7. EVALUATING RISKS AND CONTROLS AT ENTITY LEVEL AND PROCESS LEVEL

Entity Level Risks and Controls: The controls that operate across a company at all levels i.e., from board and top management to the department and transaction level are known as entity level controls or ELCs. The characteristics of ELCs include the following:

• Entity Level controls are known as pervasive controls since they operate across all organisation levels.

• ELCs are part of a company’s overall internal control framework and relate to the internal control components other than control activities.

• Entity level controls are subjective by nature and hence require application of more professional judgement in their evaluation and testing.

There are direct entity level controls and indirect entity level controls.

(i) Direct ELCs operate at a level higher than business activity or transaction level such as a business process or sub-process level, account balance level, at a sufficient level of precision, to prevent, detect or correct a misstatement in a timely manner.

Examples include: • Business performance reviews;

• Monitoring of effectiveness of controls activities by Internal Audit function; (ii) Indirect ELCs do not relate to any specific business process, transaction or account balance

and hence, cannot prevent or detect misstatements. However, they contribute indirectly to the effective operation of direct ELC and other control activities.



Examples include: • Company code of conduct and ethics policies;

• Human resource policies;

• Employee job roles & responsibilities.

As per these examples, a company that has established policies and procedures, hires people with good background, promotes a culture of fairness and follows ethical practices, is less likely to see the occurrence of a fraud being committed in the company.

From the perspective of an ERP environment, the internal control component that is more relevant is the Information & Communication component.

As part of understanding and evaluation of the Information & Communication component the auditor is required to obtain an understanding of:

• how business processes operate;

• the relevant information systems used in the processing of business transactions and activities;

• the risks and controls pertaining to the information systems and underlying infrastructure;

• reliability of information generated from systems.

While Information & Communication is more relevant to the use of information systems in a company, in large and complex ERP environments it is very likely that the other components of internal controls viz., Control Environment, Risk Assessment and Monitoring will also be relevant.

Auditors are required to understand, evaluate and validate the entity level controls as a part of an audit engagement. The results of testing entity level controls could have an impact on the nature, timing and extent of other audit procedures including testing of controls. For example, when the entity level controls at a company are effective, the auditor may consider reducing the number of samples in the test of controls and where the auditor finds the entity level controls ineffective, the auditor may consider to increase the rigour of testing by increasing sample sizes. In small and less complex companies, the entity level controls may not formally defined or documented. In such situations, the auditor should design audit procedures accordingly to obtain evidence of the existence and effectiveness of entity level controls.

The following example shows how the auditor performs an understanding and evaluation of the whistle-blower policy in a company: • Does the company have a whistle-blower policy?

• Is this policy documented and approved?

• Has the whistle-blower policy been communicated to all the employees?

• Are employees aware of this policy and understand its purpose and their obligations?



• Has the company taken measures viz., training, to make the employees understand the contents and purpose of the policy?

• Does the company monitor effectiveness of the policy from time-to-time?

• How does the company deal with deviations and non-compliance?

Process Level Risks and Controls: In an audit of financial statements the auditor determines the significant account balances and disclosures. Auditing standards (SA 315) require the auditor to understand the business process that makes up an account balance or financial statement line item (FSLI). A business process is a sequence of activities that take place from the initiation of a transaction, recording it, approving, posting accounting entries and reporting. A business process is typically made up of sub-process - a logical grouping of related activities.

Domestic Sales account balance in the financial statements is an example of an FSLI. The Domestic Sales account balance represents all the sales transactions that were processed during an accounting period. The illustration below shows the business process, sub-process and activities for the Domestic Sales Process - also known as Revenue or OTC (Order to Cash) Process.

Understanding the business process helps the auditor in identification of risks and controls within each process, sub-process and activity. The auditor should document this understanding of the company’s business process and flow of transactions in the audit file in accordance with SA 230.

Domestic Sales Account

Receive Order Request

Credit Control Check

Obtain Price

Check with Customer File

Create Sale Order

Pick items

Packaging

Create Delivery Note

Shipping

Generate billing due list

Create Invoice

Verify Invoice

Receive Customer Payments

Match to Invoice

Accounting Entries

Update Inventory

Accounting Entries

Track Open Invoices

Order Processing Delivery Invoicing Receipts



Given below is an example of documentation using flowcharts for one of the sub-process in Domestic Sales process:



8. USING RELEVANT ANALYTICAL PROCEDURES AND TESTS USING DATA ANALYTICS

In an automated environment, the data stored and processed in systems can be used to get various insights into the way business operates. This data can be useful for preparation of management information system (MIS) reports and electronic dashboards that give a high-level snapshot of business performance. Generating and preparing meaningful information from raw system data using processes, tools, and techniques is known as Data Analytics.

The data analytics methods used in an audit are known as Computer Assisted Auditing Techniques or CAATs. When auditing in an automated environment, auditors can apply the concepts of data analytics for several aspects of an audit including the following:

• preliminary analytics;

• risk assessment;

• control testing;

• non-standard journal analysis;

• evaluation of deficiencies;

• fraud risk assessment.

There are several steps that should be followed to achieve success with CAATs and any of the supporting tools. A suggested approach to benefit from the use of CAATs is given in the illustration below:

The illustration below is an example of a data analytics dashboard from which an auditor can see a high-level view of the transaction patterns in terms of percentage, volume, distribution and type of transaction. Based on this information the auditor can design appropriate procedures for audit.

Understand Business

Environment including IT

Define the Objectives and

Criteria

Identify Source and Format of

DataExtract Data

Verify the Completeness

and Accuracy of Extracted Data

Apply Criteria on Data Obtained

Validate and Confirm Results

Report and Document Results and Conclusions

[SA 230]



9. STANDARDS, GUIDELINES AND PROCEDURES - USING RELEVANT FRAMEWORKS AND BEST PRACTICES

When auditing in an automated environment the auditor should be aware, adhere to and be guided by the various standards, guidelines and procedures that may be relevant to both audit and the automated environment. Given below are some of the common standards and guidelines that are relevant in this context include:

Standards on Auditing issued by the Institute of Chartered Accountants of India, are required to be followed for an audit of financial statements.

Section 143 of Companies Act 2013 requires statutory auditors to provide an Independent Opinion on the Design and Operating Effectiveness of Internal Financial Controls Over Financial Reporting (IFC-FR) of the company as at Balance Sheet date. For this purpose, the Guidance Note on Audit of Internal Financial Controls Over Financial Reporting issued by the Institute of Chartered Accountants of India, provides the framework, guidelines and procedures for an audit of financial statements.

Sarbanes Oxley Act of 2002, commonly known as SOX, is a requirement in America. Section 404 of this act requires public listed companies to implement, assess and ensure



effectiveness of internal controls over financial reporting and auditors independent opinion on the design and operating effectiveness of internal controls over financial reporting (ICFR) – which is similar to the requirements of IFC-FR for Indian companies. Similar legal and statutory requirements over internal controls exist in several other countries including Japan, China, European Countries, etc.

ISO 27001:2013 is the Information Security Management System (ISMS) standard issued by the International Organization for Standardization (ISO). This standard provides the framework, guidelines and procedures for implementing information security and related controls in a company. For example, this standard covers password security, application security, physical security, backup and recovery, that are relevant when auditing in an automated environment.

ITIL (Information Technology Infrastructure Library) and ISO 20000 provide a set of best practice processes and procedures for IT service management in a company. For example, change management, incident management, problem management, IT operations, IT asset management are some of the areas that could be relevant to audit.

The Payment Card Industry – Data Security Standard or PCI-DSS, is the most widely adopted information security standard for the payment cards industry. Any company that is involved in the storage, retrieval, transmission or handling of credit card/debit card information are required to implement the security controls in accordance with this standard.

The American Institute of Certified Public Accountants has published a framework under the Statements on Standards for Attest Engagements (SSAE) No.16 for reporting on controls at a service organisation that include

SOC 1 for reporting on controls at a service organization relevant to user entities’ internal control over financial reporting (ICFR).

SOC 2 and SOC 3 for reporting on controls at a service organization relevant to security, availability, processing integrity, confidentiality or privacy i.e., controls other than ICFR.

While SOC 1 and SOC 2 are restricted use reports, SOC 3 is general use report.

Control Objectives for Information and Related Technologies (CoBIT) is best practice IT Governance and Management framework published by Information Systems Audit and Control Association. CoBIT provides the required tools, resources and guidelines that are relevant to IT governance, risk, compliance and information security.

The Cybersecurity Framework (CSF) published by the National Institute of Standards and Technology is one of the most popular framework for improving critical infrastructure cybersecurity. This framework provides a set of standards and best practices for companies to manage cybersecurity risks.



GLOSSARY ERP Enterprise Resource Planning IT Information Technology IS Information System ATM Automated Teller Machine SA Standards on Auditing CIO Chief Information Officer CISO Chief Information Security Officer ELC Entity Level Controls FSLI Financial Statement Line Item GITC General Information Technology Controls IPE Information Produced by Entity FSA Financial Statement Assertion RCM Risk & Control Matrix NTE Nature, Timing & Extent ICM Internal Controls Memorandum SOD Segregation of Duties ERM Enterprise Risk Management COSO Committee of Sponsoring Organisations CAATS Computer Assisted Auditing Techniques ACL Audit Command Language (CAAT Tool) ISO International Organization for Standardization IFC-FR Internal Financial Controls over Financial Reporting ICFR Internal Controls over Financial Reporting SOX Sarbanes Oxley Act of 2002 PCI - DSS Payment Card Industry - Data Security Standard ITIL Information Technology Infrastructure Library COBIT Control Objectives for Information and Related Technologies SOC Service Organisation Controls SSAE Statement on Standards for Attest Engagements



TEST YOUR KNOWLEDGE Theoretical Questions 1. Briefly describe the various stages of a Risk Assessment process.

2. What are the components of an internal control framework?

3. Describe application controls and give three examples of automated application controls.

Multiple Choice Questions 1. KPL Private Limited is a large software company based out of Hyderabad. The annual

turnover of the company is INR 2,100 crores. The company sells software and is also involved in the implementation of those softwares for its clients.

The major chunk of the revenue though comes from sale of software only. The company works on a completely paper-less office and accordingly, most of the documents are available in soft copy.

During the financial year ended 31 March 2019, the auditors during the course of their audit obtained various audit evidences some of which were in hard copy but mostly in soft copy.

On conclusion of the audit, the auditors are in a dilemma whether to maintain their documentation entirely in hard copy or soft copy or can it be mixed of both.

After consultations with various persons, the auditors stood that the documentation for this company, being operated in fully automated environment should be in soft copy only.

Please advise whether this understanding is correct.

(a) This is a matter of documentation of audit evidence for a client working in fully automated environment and hence it should be in soft copy only.

(b) As per the requirements of auditing standards, this documentation can be in a mix of both soft and hard copy.

(c) Since the client is operating in a fully automated environment, it would be important to check with them because all this documentation has come from the client only.

(d) As per the requirements of auditing standards, documentation is not required in case of a client working in automated environment because everything is automated and can be accessed easily at any point of time.

2. KJ Private Ltd is engaged in the business of e-commerce wherein most of the operations are automated. The company has SAP at its ERP package and is planning to upgrade the SAP version.



Currently, the version of SAP being used is fine but the higher version would lead to increased efficiencies and hence the company is considering this plan which will also involve a huge outlay.

KPP & Associates, were appointed as the statutory auditors of this company for the year ended 31 March 2019 and the statutory audit firm has been working in this industry for long but most of the work which the firm did was more of risk advisory or internal audit.

For the first time, this audit will be conducted and that’s why the audit team started obtaining understanding of the operations of the company which included understanding of the SAP system of the company.

However, the management of the company was not comfortable with this approach of the audit team particularly because audit team was spending good time on understanding of the IT systems of the company.

The management suggested that the auditors should limit their understanding and should perform audit procedures rather than getting into business/ operations.

But the auditors have a different view on this matter and because of which work has got stuck.

In the given situation, please suggest what should be the course of action.

(a) The approach of audit team to obtain detailed understanding of the company before starting with the audit procedures is absolutely fine. If the auditors don’t understand the systems properly the audit procedures may not be appropriate.

(b) The management’s concern regarding the approach of the auditors seems reasonable. The auditors are spending time on understanding of the systems/ business and not performing their audit procedures.

(c) This being a private company and that too into the business of e-commerce, the auditors should have knowledge about the operations of the company through their understanding of the industry and hence should not get into this process of obtaining detailed understanding at the client place.

(d) The audit team could have planned their work differently. They should involve IT experts who would have knowledge of the systems of the company and hence lot of time can be saved. Further in case of such type of industry, involvement of IT experts is anyways required mandatorily as per the legal requirements.

3. AR Private Limited is a medium-sized company engaged in the business of trading of electronic equipments. The company has various warehouses where all of these equipments are kept and has an inventory levels of generally 2-3 months.

The internal environment of the company is driven by various processes some of them are manual and some automated. Accordingly, the management has also set up various controls both manual and automated and is comfortable with their design and operating effectiveness.



During the course of audit of the financial statements for the year ended 31 March 2019, the auditors raised various queries regarding various processes where the controls were operating effectively. This was because of the fact that auditor was considering either only manual controls or only automated controls in a process.

As per the auditor, the management should have adopted the same approach and hence he would like to increase the substantive audit procedures because they had a view that as per the current approach of the management, controls should be considered as ineffective irrespective of the fact that the testing which the audit team had performed resulted in the controls being effective.

Currently, the concern was regarding the approach on which management was also stuck on their point.

You are required to provide your inputs to resolve this matter.

(a) The approach of the management doesn’t seem to be correct because of the nature of the operations of the company. The current approach which the management has followed can be accepted only in case of manufacturing industry.

(b) The management should have discussed their approach with the auditors before appointing them. The Companies Act 2013 provide specific guidance on these matters wherein the management of the company can follow such approach by taking pre-approval from their auditors and in such a case, the report of the auditors is always clean.

(c) The approach of the management is completely fine. The auditors need to correct their understanding of the internal controls and the application of internal controls. A process can not be limited to have either only manual control or automated control.

(d) Considering the size of the company, such matters should be ignored by the auditors. Even if the approach of the management is not correct, it would not have any impact on the work of the auditors because all such matters get resolved at the time when auditors perform final analytical procedures.

4. AJ Private Ltd is in the business of construction and infrastructure having an annual turnover of INR 1,100 crores. The operations of the company are run efficiently driven by the well laid out policies and procedures. The processes of the company are very strong and are well documented and properly communicated to its employees, as required.

The management had also done a detailed risk assessment in the earlier years and currently the risk management system of the company is considered to be very effective. The internal controls include both automated and manual.



During the course of the audit of the financial statements of the company for the financial year ended 31 March 2019, the statutory auditors did their risk assessment and also reviewed the general IT controls which were found to be effective.

Considering the same, one of the senior audit team members asked the team to start performing the substantive audit procedures taking the approach that controls are effective.

However, the audit team did not find this approach correct and discussed that they should also check the effectiveness of other manual and automated controls by testing them and then move on to substantive testing.

The audit team recently had a training on the internal controls and hence their understanding was different from the audit senior.

This led to a conflicting situation between the audit senior and remaining audit team.

In the given situation, please advise which of the following would be correct.

(a) The audit senior is correct because general IT controls were found to be effective and hence no further work may be required on controls.

(b) The view of the audit team looks fine because without testing of internal controls covering all types of controls (manual and automated), those controls can not be said to be operating effectively.

(c) The audit senior seems reasonable in his approach because general IT controls were found to be effective. However, it would be more appropriate to also test application controls before concluding on the effectiveness of the controls.

(d) The argument of the audit team looks better because every audit requires significant time to be spent on testing of internal controls and by only covering general IT controls, it would be difficult to justify this requirement later on in the audit file.

5. RIM Private Ltd is engaged in the business of manufacturing of cranes and other construction equipments. The nature of the operations are such that purchases are quite significant even though the sales may or may not be very significant, in terms of number of transactions during the year.

The company’s statutory auditors, have also obtained certain audit tools to help the audit team on various audit procedures to bring efficiency in various audits.

During the course of the audit of the financial statements for the financial year ended 31 March 2019, the auditors used those audit tools (also known as computed assisted audit techniques) for sampling procedures and data analytics.

The outcome of the tools resulted in some analysis and requirements which the audit team requested from the client. However, the client refused to provide any such information



because as per the client all these tools were those of the auditor and any outcome of the same needs to be handled by themselves instead of asking the management.

The auditors have suggested that such an attitude of non-cooperation would not help the either party and would defeat the objective of the audit. The management of the company is, however, ready to provide any other information to the auditors.

In this situation, please advise both the management and the auditors.

(a) Since the management is ready to provide any other information, the auditor should obtain this information as well by not disclosing the management that it is outcome of any audit tool.

(b) The view of the management is correct because audit tools are there to support the auditors and not to lead to increased work for the management.

(c) The auditors are correct because by using audit tools they are performing their audit procedures.

(d) The auditors should ignore all these tools and plan their audit procedures accordingly.

Answers to Theoretical Questions 1. Risk Assessment is one of the most critical components of Enterprise Risk Management. The

risk assessment process involves considerations for qualitative and quantitative factors, definition of key performance and risk indicators, risk appetite, risk scores, scales and maps, use of data & metrics and benchmarking. The various stages in a Risk Assessment process are as follows:

• Define Business Objectives and Goals;

• Identify events that affect achievement of business objectives;

• Assess likelihood and impact;

• Respond and mitigate risks;

• Assess residual risk.

2. There are five components of an internal control framework. They are as follows:

• Control Environment;

• Risk Assessment;

• Information & Communication;

• Monitoring;

• Control Activities.



3. Application Controls are automated or manual controls that operate at a business process level. Automated Application controls are embedded into IT applications viz., ERPs and help in ensuring the completeness, accuracy and integrity of data in those systems. Examples of automated applications include:

• Edit checks and validation of input data;

• Sequence number checks;

• User limit checks;

• Reasonableness checks;

• Mandatory data fields.

Answers to Multiple Choice Questions 1. (b) 2. (a) 3. (c) 4. (b) 5. (c)


5

COMPANY AUDIT

LEARNING OUTCOMES

After studying this chapter, you will be able to: Know the procedures of appointment, reappointment, filling up of the

casual vacancies and removal of auditor. Understand qualification, disqualification, powers and duties of an auditor. Gain the knowledge of the provisions relating to rotation of an auditor. Analyse the significance of true and fair view, reporting requirements

under the Companies Act, 2013 including reporting under CARO, 2016. Learn the salient features of audit of limited liability partnership.



The Companies Act 2013 is an Act of the Parliament of India which regulates incorporation of a company, responsibilities of a company, directors, and dissolution of a company. It is a rule based Act. The Companies Act, 2013 is divided into 29 chapters containing 470 sections as against 658 Sections in the Companies Act, 1956 and has 7 schedules. Sections 138 to 148 of the Companies Act, 2013 (hereinafter referred to as the Act unless otherwise mentioned) deal with provisions relating to audit of companies. Therefore, it is quite important to understand these provisions very carefully. You may also study sections 128 to 137 relating to “Accounts” of companies for better understanding of the subject.

1. APPOINTMENT OF AUDITORSSection 139 of the Companies Act, 2013 contains provisions regarding Appointment of Auditors. Discussion on appointment of auditors may be grouped under two broad headings-

Sections w.r.t. Company Audit

138. Internal Audit.

139. Appointment of auditors.

140. Removal, resignation of auditor and giving of special notice.

141. Eligibility, qualifications and disqualifications of auditors.

142. Remuneration of auditors.

143. Powers and duties of auditors and auditing standards.

144. Auditor not to render certain services.

145. Auditors to sign audit reports, etc.

146. Auditors to attend general meeting.

147. Punishment for contravention.

148. Central Government to specify audit of items of cost in respect of certaincompanies.

Appointment of First Auditors. Appointment of Subsequent Auditors

CHAPTER OVERVIEW


https://en.wikipedia.org/wiki/Parliament_of_India

COMPANY AUDIT5 . 5.3

1.1 Appointment of First Auditors 1.1.1 Appointment of First Auditors in the case of a company, other than a Government Company: As per Section 139(6), the first auditor of a company, other than a Government company, shall be appointed by the Board of Directors within 30 days from the date of registration of the company and the auditor so appointed shall hold office until the conclusion of the first AGM.

Appointment of Auditors (Section 139)

First Auditor

Other than Government Company [Section

139(6)]

Appointment by BOD -within 30 days from

DOR

in case of failure:Members in EGM within

90 days.

Hold the office till the conclusion of the first

AGM

Goverment Company defined u/s 2 (45) [Section 139(7)]

Appointment by C&AG within 60 days from the

DOR

in case of failureBOD within 30 days

in case of failureMembers in EGM within

60 days

Hold the office till the conclusion of the first

AGM

Subsequent Auditor

Other than Government Company [Section

139(1)]

Appointment by Members in AGM

Hold the office from 1st AGM to 6th AGM

subject to fulfilment of certain conditions

Goverment Company defined u/s 2 (45) [Section 139(5)]

Appointment by C& AG within 180 days from

the commencement of year

Hold the office till the conclusion of AGM


5.4 ADVANCED AUDITING AND PROFESSIONAL ETHICS In the case of failure of the Board to appoint the auditor, it shall inform the members of the company.

The members of the company shall within 90 days at an extraordinary general meeting appoint the auditor. Appointed auditor shall hold office till the conclusion of the first annual general meeting.

Managing Director of PQR Ltd. himself wants to appoint Shri Ganpati, a practicing Chartered Accountant, as first auditor of the company. Comment on the proposed action of the Managing Director. Please advise.

Provisions and Explanation: Section 139(6) of the Companies Act, 2013 lays down that “the first auditor or auditors of a company shall be appointed by the Board of directors within 30 days from the date of registration of the company”. In the instant case, the proposed appointment of ShriGanpati, a practicing Chartered Accountant as first auditors by the Managing Director of PQR Ltd by himself is in violation of Section 139(6) of the Companies Act, 2013, which requires the Board of Directors to appoint the first auditor of the company.

Conclusion: In view of the above, the Managing Director of PQR Ltd cannot appoint the first auditor of the company.

1.1.2 Appointment of First Auditors in the case of Government Company: Section 139(7) provides that in the case of a Government company or any other company owned or controlled, directly or indirectly, by the Central Government, or by any State Government, or Governments, or partly by the Central Government and partly by one or more State Governments, the first auditor shall be appointed by the Comptroller and Auditor-General of India within 60 days from the date of registration of the company.

In case the Comptroller and Auditor-General of India does not appoint such auditor within the above said period, the Board of Directors of the company shall appoint such auditor within the next 30 days. Further, in the case of failure of the Board to appoint such auditor within next 30 days, it shall inform the members of the company who shall appoint such auditor within 60 days at an extraordinary general meeting. Auditors shall hold office till the conclusion of the first annual general meeting.

“Government Company” is a company in which not less than 51% of the paid-up share capital is held by the Central Government or by any State Government or Governments or partly by the Central Government and partly by one or more State Governments, and includes a company which is a subsidiary company of such a Government company.

The first auditor of Healthy Wealthy Ltd., a Government company, was appointed by the Board of Directors.

Provisions and Explanation: Section 139(6) of the Companies Act, 2013 (the Act) lays down that “the first auditor or auditors of a company shall be appointed by the Board of directors within 30 days from the date of registration of the company”. Thus, the first auditor of a company can be appointed by the Board of Directors within 30 days from the date of registration of the



company. However, in the case of a Government Company, the appointment of first auditor is governed by the provisions of Section 139(7) of the Companies Act, 2013 which states that in the case of a Government company, the first auditor shall be appointed by the Comptroller and Auditor-General of India within 60 days from the date of registration of the company. Hence in the case of Healthy Wealthy Ltd., being a government company, the first auditors shall be appointed by the Comptroller and Auditor General of India.

Conclusion: Thus, the appointment of first auditors made by the Board of Directors of Healthy Wealthy Ltd. is null and void.

1.2 Appointment of Subsequent Auditors/Re-appointment of Auditors 1.2.1 Appointment of subsequent auditors in case of Non Government Companies: Section139(1) of the Companies Act, 2013 provides that every company shall, at the first annual general meeting appoint an individual or a firm as an auditor who shall hold office from the conclusion of that meeting till the conclusion of its sixth annual general meeting and thereafter till the conclusion of every sixth meeting.

The following points need to be noted in this regard-

(i) Before such appointment is made, the written consent of the auditor to such appointment, and a certificate from him or it that the appointment, if made, shall be in accordance with the conditions as may be prescribed, shall be obtained from the auditor.

(ii) The certificate shall also indicate whether the auditor satisfies the criteria provided in section 141.

(iii) The company shall inform the auditor concerned of his or its appointment, and also file a notice of such appointment with the Registrar within 15 days of the meeting in which the auditor is appointed.

1.2.2 Appointment of subsequent auditors in case of Government Companies: As per Section 139(5), in the case of a Government company or any other company owned or controlled, directly or indirectly, by the Central Government, or by any State Government or Governments, or partly by the Central Government and partly by one or more State Governments, the Comptroller and Auditor-General of India shall, in respect of a financial year, appoint an auditor duly qualified to be appointed as an auditor of companies under this Act, within a period of 180 days from the commencement of the financial year, who shall hold office till the conclusion of the annual general meeting.



1.3 Filling of a Casual Vacancy As per Section 139(8), any casual vacancy in the office of an auditor shall –

(i) In the case of a company other than a company whose accounts are subject to audit by an auditor appointed by the Comptroller and Auditor-General of India, be filled by the Board of Directors within 30 days.

If such casual vacancy is as a result of the resignation of an auditor, such appointment shall also be approved by the company at a general meeting convened within three months of the recommendation of the Board and he shall hold the office till the conclusion of the next annual general meeting.

(ii) In the case of a company whose accounts are subject to audit by an auditor appointed by the Comptroller and Auditor-General of India, be filled by the Comptroller and Auditor-General of India within 30 days.

It may be noted that in case the Comptroller and Auditor-General of India does not fill the vacancy within the said period the Board of Directors shall fill the vacancy within next 30 days.

1.3.1 Casual Vacancy by Resignation: As per section 140(2), the auditor who has resigned from the company shall file within a period of 30 days from the date of resignation, a statement in the prescribed Form ADT–3 (as per Rule 8 of CAAR) with the company and the Registrar, and in case of the companies referred to in section 139(5) i.e. Government company, the auditor shall also file such statement with the Comptroller and Auditor-General of India, indicating the reasons and other facts as may be relevant with regard to his resignation. In case of failure, the auditor shall be liable to a penalty which shall not be less than fifty thousand rupees or the remuneration of the auditor, whichever is less, and in case of continuing failure, with further penalty of five hundred

Fillin

g of

casu

al va

canc

y { u

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9 (8)

}

Other Companies

To be filled by BOD within 30 days

In case of resignation, appointment by BOD should be approved by Co.

at GM

Govt Companies

To be filled by C&AG within 30 days

In case of failure BOD shall fill within 30 days


COMPANY AUDIT5 . 5.7 rupees for each day after the first during which such failure continues, subject to a maximum of five lakh rupees as per section 140(3).

Other Important Provisions Regarding Appointment of Auditors 1. A retiring auditor may be re-appointed at an annual general meeting, if-

(a) he is not disqualified for re-appointment;

(b) he has not given the company a notice in writing of his unwillingness to be re-appointed; and

(c) a special resolution has not been passed at that meeting appointing some other auditor or providing expressly that he shall not be re-appointed.

2. Where at any annual general meeting, no auditor is appointed or re-appointed, the existing auditor shall continue to be the auditor of the company.

2. ELIGIBILITY, QUALIFICATIONS AND DISQUALIFICATIONS OF AN AUDITOR

The provisions relating to eligibility, qualifications and disqualifications of an auditor are governed by section 141 of the Companies Act, 2013 (hereinafter referred as the Act).

ELIGIBILITY AND QUALIFICATION OF AUDITOR :

A person shall be eligible for appointment as an auditor of a company only if he is a Chartered Accountant. It may be noted that a firm whereof majority of partners practising in India are qualified for appointment as aforesaid may be appointed by its firm name to be auditor of a company. Where a firm including a limited liability partnership (LLP) is appointed as an auditor of a company, partners who are Chartered Accountants shall be authorised to act and sign on behalf of the firm DISQUALIFICATIONS OF AN AUDITOR: Under sub-section (3) of section 141 along with Rule 10 of the Companies (Audit and Auditors) Rules, 2014 following persons shall not be eligible for appointment as an auditor of a company- (a) a body corporate other than a limited liability partnership registered under the Limited Liability

Partnership Act, 2008; (b) an officer or employee of the company; According to Section 2(59) of the Companies Act, 2013, the term ‘Officer’ includes:

(i) Director (ii) Manager



(iii) Key Managerial personnel (iv) Shadow Directors.

1. G, a CA in practice is director in RST Ltd. On combined reading of Section 141(3)(b) and Section 2(59), it may be concluded that CA. G would be disqualified to be appointed as an auditor of RST Ltd.

2. G, a CA in practice is director in Zed Ltd., holding company of RST Ltd. On combined reading of Section 141(3)(b) and Section 2(59), it may be concluded that CA. G would be disqualified to be appointed as an auditor of Zed Ltd. but would not be disqualified in case of RST Ltd.

(c) a person who is a partner, or who is in the employment, of an officer or employee of the company;

This sub-section disqualifies the below mentioned persons from being appointed as auditor of a company:

(i) partner of an officer of the company;

(ii) employee of an officer of the company;

(iii) partner of an employee of the company;

(iv) employee of an employee of the company.

(d) a person who, or his relative or partner -

(i) is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.

It may be noted that the relative may hold security or interest in the company of face value not exceeding rupees one lakh.

It may also be noted that the condition of rupees one lakh shall, wherever relevant, be also applicable in the case of a company not having share capital or other securities:

Students may also note that in the event of acquiring any security or interest by a relative, above the threshold prescribed, the corrective action to maintain the limits as specified above shall be taken by the auditor within 60 days of such acquisition or interest.

The following points may be noted in this regard

(i) The value of shares of ` 1,00,000 that can be hold by relative is the face value not the market value.

(ii) The limit of ` 1,00,000 would be applicable where the securities are held by the relative of an auditor and not where the securities are held by an auditor himself or his partner. In case of an auditor or his partner, holding securities of even small value shall lead to a disqualification.



(iii) Grace period of 60 days for corrective action shall apply only in respect of securities held by relatives. This would not apply to auditor or his partner.

(iv) Limit of ` 1,00,000 and grace period of 60 days would be applicable where securities are held in the company only.

Section 2(77) of the Companies Act, 2013 defines the term “relative” to mean anyone who is related to another as:

(i) members of a Hindu Undivided Family;

(ii) husband and wife; or

(iii) one person is related to the other in such manner as may be prescribed.

Rule 4 of the Companies (Specification of Definitions Details) Rules, 2014 prescribes the list of relatives as per Section 2(77). As per the said rule, a person shall be deemed to be relative of another if he or she is related to another in the below mentioned manner-

Father (including step- father), Mother (including step-mother), Son (including step- son), Son’s wife, Daughter, Daughter’s husband, Brother (including step- brother), Sister (including step- sister).

Ex 1: “Mr. A”, a practicing Chartered Accountant, is holding securities of “XYZ Ltd.” having face value of ` 900/-. Whether Mr. A is qualified for appointment as an Auditor of “XYZ Ltd.”?

As per section 141(3)(d)(i), a person is disqualified to be appointed as an auditor if he, or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.

In the present case, Mr. A. is holding security of ` 900 in the XYZ Ltd, therefore he is not eligible for appointment as an auditor of “XYZ Ltd”.

Ex 2: “Mr. P” is a practicing Chartered Accountant and “Mr. Q”, the relative of “Mr. P”, is holding securities of “ABC Ltd.” having face value of ` 90,000/-. Whether “Mr. P” is Qualified for being appointed as an auditor of “ABC Ltd.”?

As per section 141(3)(d)(i), a person is disqualified to be appointed as an auditor if he, or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company. Further as per proviso to this Section, the relative of the person may hold the securities or interest in the company of face value not exceeding of ` 1,00,000.

In the present case, Mr. Q. (relative of Mr. P), is having securities of ` 90,000 face Value in ABC Ltd., which is as per requirement of proviso to section



141(3)(d)(i). Therefore, Mr. P will not be disqualified to be appointed as an auditor of ABC Ltd.

Ex 3: “M/s BC & Co.” is an Audit Firm having partners “Mr. B” and “Mr. C”, and “Mr. A” the relative of “Mr. C”, is holding securities of “MWF Ltd.” having face value of ` 1,01,000/-. Whether “M/s BC & Co.” is qualified for being appointed as an auditor of “MWF Ltd.”?

As per section 141(3)(d)(i), a person is disqualified to be appointed as an auditor if he, or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company: Further as per proviso to this Section, the relative of the person may hold the securities or interest in the company of face value not exceeding of ` 1,00,000.

In the instant case, M/s BC & Co, will be disqualified for appointment as an auditor of MWF Ltd as the relative of Mr. C (i.e. partner of M/s BC & Co.), is holding the securities in MWF Ltd which is exceeding the limit mentioned in proviso to section 141(3)(d)(i).

Ex 4: M/s RM & Co. is an audit firm having partners CA. R and CA. M. The firm has been offered the appointment as an auditor of Enn Ltd. for the Financial Year 2018-19. Mr. Bee, the relative of CA. R, is holding 5,000 shares (face value of ` 10 each) in Enn Ltd. having market value of ̀ 1,50,000. Whether M/s RM & Co. is disqualified to be appointed as auditors of Enn Ltd.?

As per section 141(3)(d)(i), a person shall not be eligible for appointment as an auditor of a company, who, or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company. However, as per proviso to this section, the relative of the person may hold the securities or interest in the company of face value not exceeding of ` 1,00,000.

In the instant case, M/s RM & Co. is an audit firm having partners CA. R and CA. M. Mr. Bee is a relative of CA. R and he is holding shares of Enn Ltd. of face value of ` 50,000 only (5,000 shares x ` 10 per share).

Therefore, M/s RM & Co. is not disqualified for appointment as an auditors of Enn Ltd. as the relative of CA. R (i.e. partner of M/s RM & Co.) is holding the securities in Enn Ltd. which is within the limit mentioned in proviso to section 141(3)(d)(i) of the Companies Act, 2013.

(ii) is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of rupees five lakh; or

(iii) has given a guarantee or provided any security in connection with the indebtedness of any third person to the Company or its Subsidiary, or its Holding or Associate Company or a Subsidiary of such Holding Company, in excess of one lakh rupees.


COMPANY AUDIT5 . 5.11 Disqualification due to indebtedness.

1. Direct Indebtedness A person shall be disqualified to be appointed as auditor if he or his relative or his

partner is indebted in excess of ` 5 Lakhs to - (i) the company; or (ii) its subsidiary; or (iii) its holding company; or (iv) its associate company; or (v) a subsidiary of such holding company.

2. Indirect Indebtedness A person shall be disqualified to be appointed as auditor if he or his relative or his partner has given a guarantee or provided any security in connection with the indebtedness of any third person in excess of ` 1 lakh to - (i) the company; or (ii) its subsidiary; or (iii) its holding company; or (iv) its associate company; or (v) a subsidiary of such holding company.

(e) a person or a firm who, whether directly or indirectly has business relationship with the Company, or its Subsidiary, or its Holding or Associate Company or Subsidiary of such holding company or associate company, of such nature as may be prescribed; Students may note that for the purpose of clause (e) above, the term “business relationship” shall be construed as any transaction entered into for a commercial purpose, except - (i) commercial transactions which are in the nature of professional services permitted to

be rendered by an auditor or audit firm under the Act and the Chartered Accountants Act, 1949 and the rules or the regulations made under those Acts;

(ii) commercial transactions which are in the ordinary course of business of the company at arm’s length price - like sale of products or services to the auditor, as customer, in the ordinary course of business, by companies engaged in the business of telecommunications, airlines, hospitals, hotels and such other similar businesses.

(f) a person whose relative is a Director or is in the employment of the Company as a director or key Managerial Personnel;

(g) a person who is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies other than one



person companies, dormant companies, small companies and private companies having paid-up share capital less than ` 100 crore;

(h) a person who has been convicted by a Court of an offence involving fraud and a period of ten years has not elapsed from the date of such conviction;

(i) a person who, directly or indirectly, renders any service referred to in section 144 to the company or its holding company or its subsidiary company. Section 144 of the Companies Act, 2013 prescribes certain services not to be rendered by the auditor. An auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company), namely: (i) accounting and book keeping services; (ii) internal audit; (iii) design and implementation of any financial information system; (iv) actuarial services; (v) investment advisory services; (vi) investment banking services; (vii) rendering of outsourced financial services; (viii) management services; and (ix) any other kind of services as may be prescribed.

Certain services not to be rendered by the Auditor as per section 144 of the Companies Act 2013.

Accounting and book keeping services; Internal audit;

Design and implementation of any financial information system;

Actuarial services; Investment advisory services;

Investment banking services;

Rendering of outsourced financial services;

Management services; and

Any other kind of services as may be prescribed.



It may be noted that an auditor or audit firm who or which has been performing any non audit services on or before the commencement of this Act shall comply with the provisions of this section before the closure of the first financial year after the date of such commencement.

Further, in case of auditor being an individual, either himself or through his relative or any other person connected or associated with such individual or through any other entity, whatsoever, in which such individual has significant influence or control, or whose name or trade mark or brand is used by such individual, shall be termed as rendering of services directly or indirectly by the auditor; and in case of auditor being a firm, either itself or through any of its partners or through its parent, subsidiary or associate entity or through any other entity, whatsoever, in which the firm or any partner of the firm has significant influence or control, or whose name or trade mark or brand is used by the firm or any of its partners, shall be termed as rendering of services directly or indirectly by the auditor.

CA. P is providing the services of Design and implementation of any financial information system to C Ltd. Later on, he was also offered to be appointed as an auditor of the company for the current financial year. Advise.

Section 141(3)(i) of the Companies Act, 2013 disqualifies a person for appointment as an auditor of a company who is engaged as on the date of appointment in consulting and specialized services as provided in section 144. Section 144 of the Companies Act, 2013 prescribes certain services not to be rendered by the auditor which includes investment banking services.

Therefore, CA. P is advised not to accept the assignment of auditing as the service he rendering is specifically notified in the list of services not to be rendered by him as per section 141(3)(i) read with section 144 of the Companies Act, 2013.

(4) Where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in sub-section (3) after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

CASE STUDY

Mr. A, a Chartered Accountant has been appointed as an auditor of Laxman Ltd. In the Annual General Meeting of the company held in September, 2018, which assignment he accepted. Subsequently in January, 2019 he joined Mr. B, another Chartered Accountant, who is the Manager Finance of Laxman Ltd., as partner.

Provisions and Explanation: Section 141(3)(c) of the Companies Act, 2013 prescribes that any person who is a partner or in employment of an officer or employee of the company will be disqualified to act as an auditor of a company. Sub-section (4) of Section 141 provides that an auditor who becomes subject, after his appointment, to any of the disqualifications specified in sub-sections (3) of Section 141, he shall be deemed to have vacated his office as an auditor.


5.14 ADVANCED AUDITING AND PROFESSIONAL ETHICS Conclusion: In the present case, Mr. A, an auditor of Laxman Ltd., joined as partner with Mr. B, who is Manager Finance of Laxman Limited. The given situation has attracted sub-section (3)(c) of Section 141 and, therefore, he shall be deemed to have vacated office of the auditor of Laxman Limited.

3 ROTATION OF AUDITORS 3.1 Applicability of section 139(2) Rotation of Auditors As per rules prescribed in Companies (Audit and Auditors) Rules, 2014, for applicability of section 139(2) the class of companies shall mean the following classes of companies:-

(a) all unlisted public companies having paid up share capital of rupees ten crore or more;

(b) all private limited companies having paid up share capital of rupees fifty crore or more;

(c) all companies having paid up share capital of below threshold limit mentioned in (a) and (b) above, but having public borrowings from financial institutions, banks or public deposits of rupees fifty crores or more.

Rano Ltd. is a private limited Company, having paid up share capital of rupees 48 crore but having public borrowing from nationalized banks and financial institutions of rupees 42 crore, manner of rotation of auditor will not be applicable.

As per Section 139(2), no listed company or a company belonging to such class or classes of companies as mentioned above, shall appoint or re-appoint-

(a) an individual as auditor for more than one term of five consecutive years; and

Class of Companies for Rotation of Auditor↓

including Listed Companies +

excluding OPC (One Person Company) and Small Companies

All unlisted public companies having

paid up share capital ≥` 10 crore

All private limited companies having

paid up share capital ≥` 50 crore

All companies having paid up share capital of below

threshold limit mentioned, but

having public borrowings from financial institutions, banks or public deposits ≥

` 50 crore



PRTK Ltd. is a listed company engaged in the business of textiles. The company has appointed Rahuul & Co. as its statutory auditor in its AGM dated 29th September, 2018. Rahuul & Co. will hold office of auditor from the

conclusion of this meeting upto conclusion of sixth AGM i.e. AGM to be held in the year 2023. Now as per sub-section (2), Rahuul & Co. shall not be re-appointed as auditor in PRTK Ltd. for further term of five years i.e. he cannot be appointed as auditor upto year 2028.

(b) an audit firm as auditor for more than two terms of five consecutive years. Provided that -

(i) an individual auditor who has completed his term under clause (a) shall not be eligible for re-appointment as auditor in the same company for five years from the completion of his term;

(ii) an audit firm which has completed its term under clause (b), shall not be eligible for re-appointment as auditor in the same company for five years from the completion of such term.

Jolly Ltd., a listed company, appointed M/s Polly & Co., a Chartered Accountant firm, as the statutory auditor in its AGM held at the end of September, 2018 for 11 years. Here, the appointment of M/s Polly & Co. is not valid as the appointment can be made only for one term of five consecutive years and then another one more term of five

consecutive years. It can’t be appointed for two terms in one AGM only. Further, a cooling period of five years from the completion of term is required i.e. the firm can’t be re-appointed for further 5 years after completion of two terms of five consecutive years.

The following points merit consideration in this regard-

1. As on the date of appointment, no audit firm having a common partner or partners to the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be appointed as auditor of the same company for a period of five years.

M/s XYZ & Co., is an audit firm having partner Mrs. X, Mr. Y and Mr. Z, whose tenure has expired in the company immediately preceding the financial year, M/s ABZ& Co., is another audit firm in which Mr. Z is a common partner, will also be

disqualified for the same company along with M/S XYZ & Co. for the period of five years.

2. Every company, existing on or before the commencement of this Act which is required to comply with provisions of this sub-section, shall comply with the requirements of this sub-section within a period which shall not be later than the date of the first annual general meeting of the company held, within the period specified under sub-section (1) of section 96, after three years from the date of commencement of this Act.

Example 1: Mr. Raj, a Chartered Accountant, is an individual auditor of Binaca Limited for last 5 years as on March, 2013 (i.e. existing on or before the date of Commencement of Companies Act, 2013), here a break in the term for a continuous period of five years will not be considered as fulfilling the requirement of rotation. Thus, Mr. Raj can continue the audit of



Binaca Ltd. upto the first annual general meeting to be held after three years from the date of commencement of the Act due to transitional effect.

Example 2:M/s Raj Associates, a Chartered Accountants Audit Firm, is doing audit of Binaca Limited for last 11 years as on March, 2013 (i.e. existing on or before the date of Commencement of Companies Act, 2013), here a break in the term for a continuous period of two terms of five consecutive years will not be considered as fulfilling the requirement of rotation. Thus, M/s Raj Associates can continue the audit of Binaca Ltd. upto the first annual general meeting to be held after three years from the date of commencement of the Act due to transitional effect.

Students may interlink the above example with Illustrative table explaining rotation in case of individual auditor as well as audit firm which has been given after the 3.2 i.e. Manner of rotation of Auditors by the Companies on Expiry of their Term.*

The ICAI made a clarification dated 30.09.2016 on the difference in requirements relating to auditor’s rotation under SQC 1 vis-à-vis Companies Act, 2013.

In case of audits of listed entities, SQC 1 requires rotation of engagement partner after a pre-defined period normally not more than seven years. Now, since SQC 1 is applicable from April 1, 2009, the provisions regarding the rotation of engagement partner would be due from April 1, 2016 as per the SQC 1 during the transition phase.

Further, the Companies Act, 2013 is also applicable from April 1, 2014 and the existing companies which is required to comply with provisions of this sub-section, shall comply with the requirements of this auditor’s rotation provisions within 3 years from the date of commencement of this Act. Therefore, the provisions regarding auditor’s rotation would be due from April 1, 2017 as per the Companies Act, 2013 during the transition phase

Hence, there is a difference of 1 year in the compliance of auditor’s rotation provision between SQC 1 vis-à-vis the Companies Act, 2013 during the transition phase of implementation of the Companies Act, 2013.

Thus, the Council of the ICAI decided to provide relaxation in the requirement of rotation of engagement partner given in SQC 1 for the transition phase (i.e. for the financial year 2016-17).

3. It has also been provided that right of the company to remove an auditor or the right of the auditor to resign from such office of the company shall not be prejudiced.

4. Subject to the provisions of this Act, members of a company may resolve to provide that-

(a) in the audit firm appointed by it, the auditing partner and his team shall be rotated at such intervals as may be resolved by members; or



(b) the audit shall be conducted by more than one auditor.

5. The Central Government may, by rules, prescribe the manner in which the companies shall rotate their auditors.

3.2 Manner of Rotation of Auditors by the Companies on Expiry of their Term

Rule 6 of the Companies (Audit and Auditors) Rules, 2014 prescribes the manner of rotation of auditors on expiry of their term which is given below:

(1) The Audit Committee shall recommend to the Board, the name of an individual auditor or of an audit firm who may replace the incumbent auditor on expiry of the term of such incumbent.

(2) Where a company is required to constitute an Audit Committee, the Board shall consider the recommendation of such committee, and in other cases, the Board shall itself consider the matter of rotation of auditors and make its recommendation for appointment of the next auditor by the members in annual general meeting.

(3) For the purpose of the rotation of auditors-

(i) in case of an auditor (whether an individual or audit firm), the period for which the individual or the firm has held office as auditor prior to the commencement of the Act shall be taken into account for calculating the period of five consecutive years or ten consecutive years, as the case may be.

(ii) the incoming auditor or audit firm shall not be eligible if such auditor or audit firm is associated with the outgoing auditor or audit firm under the same network of audit firms.

Explanation I - For the purposes of these rules the term “same network” includes the firms operating or functioning, hitherto or in future, under the same brand name, trade name or common control.

Explanation II - For the purpose of rotation of auditors,-

(a) a break in the term for a continuous period of five years shall be considered as fulfilling the requirement of rotation;

(b) if a partner, who is in charge of an audit firm and also certifies the financial statements of the company, retires from the said firm and joins another firm of Chartered Accountants, such other firm shall also be ineligible to be appointed for a period of five years.



*Illustration explaining rotation in case of individual auditor Number of consecutive years for which an individual auditor has been functioning as auditor in the same company [in the first AGM held after the commencement of provisions of section 139(2)]

Maximum number of consecutive years for which he may be appointed in the same company (including transitional period)

Aggregate period which the auditor would complete in the same company in view of column I and II

I II III 5 Years (or more than 5 years) 3 years 8 years or more 4 years 3 years 7 years 3 years 3 years 6 years 2 years 3 years 5 years 1 year 4 years 5 years

Note:

1. Individual auditor shall include other individuals or firms whose name or trade mark or brand is used by such individual, if any.

2. Consecutive years shall mean all the preceding financial years for which the individual auditor has been the auditor until there has been a break by five years or more.

*Illustration explaining rotation in case of audit firm

Number of consecutive years for which an audit firm has been functioning as auditor in the same company [in the first AGM held after the commencement of provisions of section 139(2)]

Maximum number of consecutive years for which the firm may be appointed in the same company (including transitional period)

Aggregate period which the firm would complete in the same company in view of column I and II

I II III 10 Years (or more than 10years) 3 years 13 years or more 9 years 3 years 12 years 8 years 3 years 11 years 7 years 3 years 10 years 6 year 4 years 10 years 5 years 5 years 10 years 4 years 6 years 10 years 3 year 7 years 10 years 2 years 8 years 10 years 1 years 9 years 10 years



Note:

1. Audit Firm shall include other firms whose name or trade mark or brand is used by the firm or any of its partners.

2. Consecutive years shall mean all the preceding financial years for which the firm has been the auditor until there has been a break by five years or more.

(4) Where a company has appointed two or more individuals or firms or a combination thereof as joint auditors, the company may follow the rotation of auditors in such a manner that both or all of the joint auditors, as the case may be, do not complete their term in the same year.

4. PROVISIONS RELATING TO AUDIT COMMITTEE 4.1 Applicability of section 177 i.e. Constitution of Audit Committee Where a company is required to constitute an Audit Committee under section 177, all appointments, including the filling of a casual vacancy of an auditor under this section shall be made after taking into account the recommendations of such committee.

Diagram showing class of companies to constitute Audit Committee It is important to know that in addition to listed companies, following classes of companies shall constitute an Audit Committee -

(i) all public companies with a paid up capital of ten crore rupees or more;

(ii) all public companies having turnover of one hundred crore rupees or more;

(iii) all public companies, having in aggregate, outstanding loans or borrowings or debentures or deposits exceeding fifty crore rupees or more.

• all public companies with a paid up capital ≥ ` 10 crore

• all public companies having turnover ≥ ` 100 crore

• all public companies, having in aggregate, outstanding

loans or borrowings or debentures or deposits > ` 50

crore

Class of Companies to constitute Audit

Committee [including Listed Companies]


5.20 ADVANCED AUDITING AND PROFESSIONAL ETHICS Explanation- The paid up share capital or turnover or outstanding loans, or borrowings or debentures or deposits, as the case may be, as existing on the date of last audited Financial Statements shall be taken into account for the purposes of this rule.

XYZ Ltd., a public company having paid up capital of ` 9 crore but having turnover of ` 150 crore, will be required to constitute an Audit Committee under section 177 because the requirement for constitution of Audit Committee arises if the company falls into any

of the prescribed condition.

4.2 Manner and Procedure of Selection and Appointment of Auditors Rule 3 of CAAR 2014 prescribes the following manner and procedure of selection and appointment of auditors: (1) In case of a company that is required to constitute an Audit Committee under section 177,

the committee, and, in cases where such a committee is not required to be constituted, the Board, shall take into consideration the qualifications and experience of the individual or the firm proposed to be considered for appointment as auditor and whether such qualifications and experience are commensurate with the size and requirements of the company. It may be noted that while considering the appointment, the Audit Committee or the Board, as the case may be, shall have regard to any order or pending proceeding relating to professional matters of conduct against the proposed auditor before the Institute of Chartered Accountants of India or any competent authority or any Court.

(2) The Audit Committee or the Board, as the case may be, may call for such other information from the proposed auditor as it may deem fit.

(3) Subject to the provisions of sub-rule (1), where a company is required to constitute the Audit Committee, the committee shall recommend the name of an individual or a firm as auditor to the Board for consideration and in other cases, the Board shall consider and recommend an individual or a firm as auditor to the members in the annual general meeting for appointment.

Categories of Companies

Competent Authority

Common Responsibility of the Competent Authority

A company which is required to constitute an Audit Committee under section 177

Audit Committee

(i) The competent authority shall take into consideration the qualifications and experience of the individual or the firm proposed to be considered for appointment as auditor and whether such qualifications and experience are commensurate with the size and requirements of the company. (ii) It shall have regard to any order or pending proceeding relating to professional matters of conduct against the proposed auditor before the Institute of Chartered Accountants of India or any competent authority or any Court. (iii) It may call for such other information from the proposed auditor as it may deem fit.

A Company which is not required to constitute an Audit Committee under section 177

Board of Directors



Categories of Companies Competent Authority Specific Responsibility of the Competent Authority

A company which is required to constitute an Audit Committee under section 177

Audit Committee The committee shall recommend the name of an individual or a firm as auditor to the Board for consideration.

A Company which is not required to constitute an Audit Committee under section 177

Board of Directors The Board shall consider and recommend an individual or a firm as auditor to the members in the AGM for appointment.

(4) If the Board agrees with the recommendation of the Audit Committee, it shall further recommend the appointment of an individual or a firm as auditor to the members in the annual general meeting.

(5) If the Board disagrees with the recommendation of the Audit Committee, it shall refer back the recommendation to the committee for reconsideration citing reasons for such disagreement.

(6) If the Audit Committee, after considering the reasons given by the Board, decides not to reconsider its original recommendation, the Board shall record reasons for its disagreement with the committee and send its own recommendation for consideration of the members in the annual general meeting; and if the Board agrees with the recommendations of the Audit Committee, it shall place the matter for consideration by members in the annual general meeting.

(7) The auditor appointed in the annual general meeting shall hold office from the conclusion of that meeting till the conclusion of the sixth annual general meeting, with the meeting wherein such appointment has been made being counted as the first meeting.

5. AUDITOR’S REMUNERATION As per section 142 of the Act, the remuneration of the auditor of a company shall be fixed in its general meeting or in such manner as may be determined therein. However, board may fix remuneration of the first auditor appointed by it. Further, the remuneration, in addition to the fee payable to an auditor, include the expenses, if any, incurred by the auditor in connection with the audit of the company and any facility extended to him but does not include any remuneration paid to him for any other service rendered by him at the request of the company. Therefore, it has been clarified that the remuneration to Auditor shall also include any facility provided to him.



6. REMOVAL OF AUDITORS 6.1 Removal of Auditor before Expiry of Term According to Section 140(1), the auditor appointed under section 139 may be removed from his office before the expiry of his term only by a special resolution of the company, after obtaining the previous approval of the Central Government in that behalf as per Rule 7 of CAAR, 2014:

(1) The application to the Central Government for removal of auditor shall be made in Form ADT-2 and shall be accompanied with fees as provided for this purpose under the Companies (Registration Offices and Fees) Rules, 2014.

(2) The application shall be made to the Central Government within 30 days of the resolution.

(3) The company shall hold the general meeting within 60 days of receipt of approval of the Central Government for passing the special resolution.

It is important to note that before taking any action for removal before expiry of terms, the auditor concerned shall be given a reasonable opportunity of being heard.

Direction by Tribunal in case auditor acted in a fraudulent manner: As per sub-section (5) of the section 140, the Tribunal either suo motu or on an application made to it by the Central Government or by any person concerned, if it is satisfied that the auditor of a company has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers, it may, by order, direct the company to change its auditors.

However, if the application is made by the Central Government and the Tribunal is satisfied that any change of the auditor is required, it shall within fifteen days of receipt of such application, make an order that he shall not function as an auditor and the Central Government may appoint another auditor in his place.

It may be noted that an auditor, whether individual or firm, against whom final order has been passed by the Tribunal under this section shall not be eligible to be appointed as an auditor of any company for a period of five years from the date of passing of the order and the auditor shall also be liable for action under section 447.

It is hereby clarified that the case of a firm, the liability shall be of the firm and that of every partner or partners who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its director or officers.

6.2 Appointment of Auditor other than retiring Auditor: Section 140 lays down procedure to appoint an auditor other than retiring auditor who was removed:

1. Special notice shall be required for a resolution at an annual general meeting appointing as auditor a person other than a retiring auditor, or providing expressly that a retiring auditor shall not be re-appointed, except where the retiring auditor has completed a consecutive



tenure of five years or as the case may be, ten years, as provided under sub-section (2) of section 139.

2. On receipt of notice of such a resolution, the company shall forthwith send a copy thereof to the retiring auditor.

3. Where notice is given of such a resolution and the retiring auditor makes with respect thereto representation in writing to the company (not exceeding a reasonable length) and requests its notification to members of the company, the company shall, unless the representation is received by it too late for it to do so,

(a) in any notice of the resolution given to members of the company, state the fact of the representation having been made; and

(b) send a copy of the representation to every member of the company to whom notice of the meeting is sent, whether before or after the receipt of the representation by the company. and if a copy of the representation is not sent as aforesaid because it was received too late or because of the company's default, the auditor may (without prejudice to his right to be heard orally) require that the representation shall be read out at the meeting -

Students may note that if a copy of representation is not sent as aforesaid, a copy thereof shall be filed with the Registrar.

If the Tribunal is satisfied on an application either of the company or of any other aggrieved person that the rights conferred by this sub-section are being abused by the auditor, then, the copy of the representation may not be sent and the representation need not be read out at the meeting.

7. CEILING ON NUMBER OF AUDITS It has been mentioned earlier that before appointment is given to any auditor, the company must obtain a certificate from him to the effect that the appointment, if made, will not result in an excess holding of company audit by the auditor concerned over the limit laid down in section 141(3)(g) of the Companies Act, 2013 which prescribes that a person shall not be eligible for appointment as an auditor if he is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies other than one person companies, dormant companies, small companies and private companies having paid-up share capital less than ` 100 crore private company (which has not committed a default in filing its financial statements under section 137 of the said Act or annual return under section 92 of the said Act with the Registrar).

In the case of a firm of auditors, it has been further provided that ‘specified number of companies’ shall be construed as the number of companies specified for every partner of the firm who is not in full time employment elsewhere.


5.24 ADVANCED AUDITING AND PROFESSIONAL ETHICS As per section 141(3)(g), this limit of 20 company audits is per person. In the case of an audit firm having 3 partners, the overall ceiling will be 3 × 20 = 60 company audits. Sometimes, a Chartered Accountant is a partner in a number of auditing firms. In such a case, all the firms in which he is partner or proprietor will be together entitled to 20 company audits on his account. Subject to the overall ceiling of company audits, how they allocate the 20 audits between themselves is their affairs.

CASE STUDY “ABC & Co.” is an Audit Firm having partners “Mr. A”, “Mr. B” and “Mr. C”, Chartered Accountants. “Mr. A”, “Mr. B” and “Mr. C” are holding appointment as an Auditor in 4, 6 and 10 Companies respectively. (i) Provide the maximum number of Audits remaining in the name of “ABC & Co.”

(ii) Provide the maximum number of Audits remaining in the name of individual partner i.e. Mr. A, Mr. B and Mr. C.

(iii) Can ABC & Co. accept the appointment as an auditor in 60 private companies having paid-up share capital less than ` 100 crore which has not committed default in filing its financial statements under section 137 or annual return under section 92 of the Companies Act with the Registrar, 2 small companies and 1 dormant company?

(iv) Would your answer be different, if out of those 60 private companies, 45 companies are having paid-up share capital of ` 110 crore each?

Fact of the Case: In the instant case, Mr. A is holding appointment in 4 companies, whereas Mr. B is having appointment in 6 Companies and Mr. C is having appointment in 10 Companies. In aggregate all three partners are having 20 audits. Provisions and Explanations: As per section 141(3)(g) of the Companies Act, 2013, a person shall not be eligible for appointment as an auditor if he is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies other than one person companies, dormant companies, small companies and private companies having paid-up share capital less than ` 100 crore (private company which has not committed a default in filing its financial statements under section 137 of the said Act or annual return under section 92 of the said Act with the Registrar). As per section 141(3)(g), this limit of 20 company audits is per person. In the case of an audit firm having 3 partners, the overall ceiling will be 3 × 20 = 60 company audits. Sometimes, a Chartered Accountant is a partner in a number of auditing firms. In such a case, all the firms in which he is partner or proprietor will be together entitled to 20 company audits on his account.

Conclusion:

(i) Therefore, ABC & Co. can hold appointment as an auditor of 40 more companies:

Total Number of Audits available to the Firm = 20*3 = 60



Number of Audits already taken by all the partners

In their individual capacity = 4+6+10 = 20

Remaining number of Audits available to the Firm = 40

(ii) With reference to above provisions an auditor can hold more appointment as auditor = ceiling limit as per section 141(3)(g)- already holding appointments as an auditor. Hence (1) Mr. A can hold: 20 - 4 = 16 more audits. (2) Mr. B can hold 20-6 = 14 more audits and (3) Mr. C can hold 20-10 = 10 more audits.

(iii) In view of above discussed provisions, ABC & Co. can hold appointment as an auditor in all the 60 private companies having paid-up share capital less than ` 100 crore (private company which has not committed a default in filing its financial statements under section 137 of the said Act or annual return under section 92 of the said Act with the Registrar), 2 small companies and 1 dormant company as these are excluded from the ceiling limit of company audits given under section 141(3)(g) of the Companies Act, 2013.

(iv) As per fact of the case, ABC & Co. is already having 20 company audits and they can also accept 40 more company audits. In addition they can also conduct the audit of one person companies, small companies, dormant companies and private companies having paid up share capital less than ` 100 crores(private company which has not committed a default in filing its financial statements under section 137 of the said Act or annual return under section 92 of the said Act with the Registrar).. In the given case, out of the 60 private companies ABC & Co. is offered, 45 companies having paid-up share capital of ` 110 crore each.

Therefore, ABC & Co. can also accept the appointment as an auditor for 2 small companies, 1 dormant company, 15 private companies having paid-up share capital less than ` 100 crore (private company which has not committed a default in filing its financial statements under section 137 of the said Act or annual return under section 92 of the said Act with the Registrar.”) and 40 private companies having paid-up share capital of ` 110 crore each in addition to above 20 company audits already holding.

Council General Guidelines, 2008 (Chapter VIII): In exercise of the powers conferred by clause (ii) of Part II of the Second Schedule to the Chartered Accountants Act, 1949, the Council of the Institute of Chartered Accountants of India hereby specifies that a member of the Institute in practice shall be deemed to be guilty of professional misconduct, if he holds at any time appointment of more than the “specified number of audit assignments of the companies under Section 224 and / or Section 226 of the Companies Act, 1956 (Section 141(3)(g) of the Companies Act, 2013).

It may be noted that in the case of a firm of Chartered Accountants in practice, the specified number of audit assignments shall be construed as the specified number of audit assignments for every partner of the firm.


5.26 ADVANCED AUDITING AND PROFESSIONAL ETHICS It may also be noted that where any partner of the firm of Chartered Accountants in practice is also a partner of any other firm or firms of Chartered Accountants in practice, the number of audit assignments which may be taken for all the firms together in relation to such partner shall not exceed the specified number of audit assignments in the aggregate.

It is further provided that where any partner of a firm or firms of Chartered Accountants in practice accepts one or more audit assignments in his individual capacity, or in the name of his proprietary firm, the total number of such assignment which may be accepted by all firms in relation to such Chartered Accountant and by him shall not exceed the specified number of audit assignments in the aggregate.

1. In computing the specified number of audit assignments.

(a) the number of such assignments, which he or any partner of his firm has accepted whether singly or in combination with any other Chartered Accountant in practice or firm of such Chartered Accountants, shall be taken into account.

(b) the number of partners of a firm on the date of acceptance of audit assignment shall be taken into account.

(c) a Chartered Accountant in full time employment elsewhere shall not be taken into account.

2. A Chartered Accountant in practice as well as firm of Chartered Accountants in practice shall maintain a record of the audit assignments accepted by him or by the firm of Chartered Accountants, or by any of the partner of the firm in his individual name or as a partner of any other firm as far as possible, in the prescribed manner.

Ceiling on Tax Audit Assignments: The specified number of tax audit assignments that an auditor, as an individual or as a partner of a firm, can accept is 60 numbers. ICAI has notified that a Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he accepts in a financial year, more than the specified number of tax audit assignments u/s 44AB of the Income Tax Act, 1961.

8. POWERS/RIGHTS OF AUDITORS The auditor has following powers/rights while conducting an audit:

(a) Right of access to books, etc.– Section 143(1) of the Act provides that the auditor of a company, at all times, shall have a right of access to the books of account and vouchers of the company, whether kept at the registered office of the company or at any other place and he is entitled to require from the officers of the company such information and explanation as he may consider necessary for the performance of his duties as auditor.



It may be noted that according to section 2(59) of the Act, the term ‘officer’ includes any director, manager or key managerial personnel or any person in accordance with whose directions or instructions the Board of Directors or any one or more of the directors is or are accustomed to act.

The phrase ‘books, accounts and vouchers’ includes all books which have any bearing, or are likely to have any bearing on the accounts, whether these be the usual financial books or the statutory or statistical books; memoranda books, e.g., inventory books, costing records and the like may also be inspected by the auditor. Similarly the term ‘voucher’ includes all or any of the correspondence which may in any way serve to vouch for the accuracy of the accounts. Thus, the right of access is not restricted to books of account alone and it is for the auditor to determine what record or document is necessary for the purpose of the audit.

The right of access is not limited to those books and records maintained at the registered or head office so that in the case of a company with branches, the right also extends to the branch records, if the auditor considers it necessary to have access thereto as per section143(8).

Further, the auditor of a company which is a holding company shall also have the right of access to the records of all its subsidiaries and associate companies in so far as it relates to the consolidation of its financial statements with that of its subsidiaries and associate companies.

Case Study

While conducting the audit of a limited company for the year ended 31st March, 2019, the auditor wanted to refer to the Minute Books. The Board of Directors refused to show the Minute Books to the auditor.

Provisions and Explanation: Section 143 of the Companies Act, 2013 grants powers to the auditor that every auditor has a right of access, at all times, to the books and account including all statutory records such as minute books, fixed assets register, etc. of the company for conducting the audit. In order to verify actions of the company and to vouch and verify some of the transactions of the company, it is necessary for the auditor to refer to the decisions of the shareholders and/or the directors of the company.

It is, therefore, essential for the auditor to refer to the Minute Books. In the absence of the Minute Books, the auditor may not be able to vouch/verify certain transactions of the company.

Conclusion: In case the directors have refused to produce the Minute Books, the auditor may consider extending the audit procedure as also consider qualifying his report in any appropriate manner.


5.28 ADVANCED AUDITING AND PROFESSIONAL ETHICS (b) Right to obtain information and explanation from officers- This right of the auditor to

obtain from the officers of the company such information and explanations as he may think necessary for the performance of his duties as auditor is a wide and important power. In the absence of such power, the auditor would not be able to obtain details of amount collected by the directors, etc. from any other company, firm or person as well as of any benefits in kind derived by the directors from the company, which may not be known from an examination of the books. It is for the auditor to decide the matters in respect of which information and explanations are required by him. When the auditor is not provided the information required by him or is denied access to books, etc., his only remedy would be to report to the members that he could not obtain all the information and explanations he had required or considered necessary for the performance of his duties as auditors.

(c) Right to receive notices and to attend general meeting– The auditors of a company are entitled to attend any general meeting of the company (the right is not restricted to those at which the accounts audited by them are to be discussed); also to receive all the notices and other communications relating to the general meetings, which members are entitled to receive and to be heard at any general meeting in any part of the business of the meeting which concerns them as auditors.

Section 146 of the Companies Act, 2013 discusses right as well as duty of the auditor. According to the section 146: “all notices of, and other communications relating to, any general meeting shall be forwarded to the auditor of the company, and the auditor shall, unless otherwise exempted by the company, attend either by himself or through his authorised representative, who shall also be qualified to be an auditor, any general meeting and shall have right to be heard at such meeting on any part of the business which concerns him as the auditor.”

Thus, it is right of the auditor to receive notices and other communications relating to any general meeting and to be heard at such meeting, relating to the matter of his concern, however, it is duty of the auditor to attend the same or through his authorised representative unless otherwise exempted.


COMPANY AUDIT5 . 5.29 (d) Right to report to the members of the company on the accounts examined by him- The

auditor shall make a report to the members of the company on the accounts examined by him and on every financial statements which are required by or under this Act to be laid before the company in general meeting and the report shall after taking into account the provisions of this Act, the accounting and auditing standards and matters which are required to be included in the audit report under the provisions of this Act or any rules made there under or under any order made under this section and to the best of his information and knowledge, the said accounts, financial statements give a true and fair view of the state of the company’s affairs as at the end of its financial year and profit or loss and cash flow for the year and such other matters as may be prescribed.

(e) Right to Lien- In terms of the general principles of law, any person having the lawful possession of somebody else’s property, on which he has worked, may retain the property for non-payment of his dues on account of the work done on the property. On this premise, auditor can exercise lien on books and documents placed at his possession by the client for non-payment of fees, for work done on the books and documents. The Institute of Chartered Accountants in England and Wales has expressed a similar view on the following conditions:

(i) Documents retained must belong to the client who owes the money.

(ii) Documents must have come into possession of the auditor on the authority of the client. They must not have been received through irregular or illegal means. In case of a company client, they must be received on the authority of the Board of Directors.

(iii) The auditor can retain the documents only if he has done work on the documents assigned to him.

(iv) Such of the documents can be retained which are connected with the work on which fees have not been paid.

Under section 128 of the Act, books of account of a company must be kept at the registered office. These provisions ordinarily make it impracticable for the auditor to have possession of the books and documents. The company provides reasonable facility to auditor for inspection of the books of account by directors and others authorised to inspect under the Act. Taking an overall view of the matter, it seems that though legally, auditor may exercise right of lien in cases of companies, it is mostly impracticable for legal and practicable constraints. His working papers being his own property, the question of lien, on them does not arise.



SA 230 issued by ICAI on Audit Documentation (explanatory text, A- 25), “Standard on Quality Control (SQC) 1, “Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements”, issued by the Institute, provides that, unless otherwise specified by law or regulation, audit documentation is the property of the auditor. He may at his discretion, make portions of, or extracts from, audit documentation available to clients, provided such disclosure does not undermine the validity of the work performed, or, in the case of assurance engagements, the independence of the auditor or of his personnel.”

8.1 Powers / Rights of Comptroller and Auditor-General of India Section 143(5) of the Act states that, in the case of a Government company or any other company owned or controlled, directly or indirectly, by the Central Government, or by any State Government or Governments, or partly by the Central Government and partly by one or more State Governments, the comptroller and Auditor-General of India shall appoint the auditor under sub-section (5) or sub-section (7) of section 139 i.e. appointment of First Auditor or Subsequent Auditor (discuss in the beginning of the chapter) and direct such auditor the manner in which the accounts of the company are required to be audited and thereupon the auditor so appointed shall submit a copy of the audit report to the Comptroller and Auditor-General of India which, among other things, include the directions, if any, issued by the Comptroller and Auditor-General of India, the action taken thereon and its impact on the accounts and financial statement of the company.

The Comptroller and Auditor-General of India shall within 60 days from the date of receipt of the audit report have a right to,

(a) conduct a supplementary audit under section 143(6)(a), of the financial statement of the company by such person or persons as he may authorize in this behalf; and for the purposes of such audit, require information or additional information to be furnished to any person or persons, so authorised, on such matters, by such person or persons, and in such form, as the Comptroller and Auditor-General of India may direct; and

(b) comment upon or supplement such audit report under section 143(6)(b). It may be noted that any comments given by the Comptroller and Auditor-General of India upon, or supplement to, the audit report shall be sent by the company to every person entitled to copies of audited financial statements under sub-section (1) of section 136 i.e. every member of the company, to every trustee for the debenture-holder of any debentures issued by the company, and to all persons other than such member or trustee, being the person so entitled and also be placed before the annual general meeting of the company at the same time and in the same manner as the audit report.

Test Audit under section 143(7): Further, without prejudice to the provisions relating to audit and auditor, the Comptroller and Auditor- General of India may, in case of any company covered under sub-section (5) or sub-section (7) of section 139, if he considers necessary, by an order, cause test


COMPANY AUDIT5 . 5.31 audit to be conducted of the accounts of such company and the provisions of section 19A of the Comptroller and Auditor-General's (Duties, Powers and Conditions of Service) Act, 1971, shall apply to the report of such test audit.

9. DUTIES OF AUDITORS Sections 143 of the Companies Act, 2013 specifies the duties of an auditor of a company in a quite comprehensive manner. It is noteworthy that scope of duties of an auditor has generally been extending over all these years.

1. Duty of Auditor to Inquire on certain matters: It is the duty of auditor to inquire into the following matters-

(a) whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are prejudicial to the interests of the company or its members;

(b) whether transactions of the company which are represented merely by book entries are prejudicial to the interests of the company;

(c) where the company not being an investment company or a banking company, whether so much of the assets of the company as consist of shares, debentures and other securities have been sold at a price less than that at which they were purchased by the company;

(d) whether loans and advances made by the company have been shown as deposits;

(e) whether personal expenses have been charged to revenue account;

(f) where it is stated in the books and documents of the company that any shares have been allotted for cash, whether cash has actually been received in respect of such allotment, and if no cash has actually been so received, whether the position as stated in the account books and the balance sheet is correct, regular and not misleading.

The opinion of the Research Committee of the Institute of Chartered Accountants of India on section 143(1) is reproduced below:

“The auditor is not required to report on the matters specified in sub-section (1) unless he has any special comments to make on any of the items referred to therein. If he is satisfied as a result of the inquiries, he has no further duty to report that he is so satisfied. In such a case, the content of the Auditor’s Report will remain exactly the same as the auditor has to inquire and apply his mind to the information elicited by the enquiry, in deciding whether or not any reference needs to be made in his report. In our opinion, it is in this light that the auditor has to consider his duties under section 143(1).”


5.32 ADVANCED AUDITING AND PROFESSIONAL ETHICS Therefore, it could be said that the auditor should make a report to the members in case he finds answer to any of these matters in adverse.

2. Duty to Sign the Audit Report: As per section 145 of the Companies Act, 2013, the person appointed as an auditor of the company shall sign the auditor's report or sign or certify any other document of the company, in accordance with the provisions of sub-section (2) of section 141 and the qualifications, observations or comments on financial transactions or matters, which have any adverse effect on the functioning of the company mentioned in the auditors’ report shall be read before the company in general meeting and shall be open to inspection by any member of the company.

3. Duty to comply with Auditing Standards: As per sub-section (9) of section 143 of the Companies Act, 2013, every auditor shall comply with the auditing standards. Further as per sub-section 10 of section 143 of the Act, the Central Government may prescribe the standards of auditing or any addendum thereto, as recommended by the Institute of Chartered Accountants of India, constituted under section 3 of the Chartered Accountants Act, 1949, in consultation with and after examination of the recommendations made by the National Financial Reporting Authority. Students may note that until any auditing standards are notified, any standard, or standards of auditing specified by the Institute of Chartered Accountants of India shall be deemed to be the auditing standards.

4. Duty to audit report: As per sub-section (3) of section 143, the auditor’s report shall also state–

(a) whether he has sought and obtained all the information and explanations which to the best of his knowledge and belief were necessary for the purpose of his audit and if not, the details thereof and the effect of such information on the financial statements;

(b) whether, in his opinion, proper books of account as required by law have been kept by the company so far as appears from his examination of those books and proper returns adequate for the purposes of his audit have been received from branches not visited by him;

(c) whether the report on the accounts of any branch office of the company audited under sub-section (8) by a person other than the company’s auditors has been sent to him under the proviso to that sub-section and the manner in which he has dealt with it in preparing his report;

(d) whether the company’s balance sheet and profit and loss account dealt with in the report are in agreement with the books of account and returns;

(e) whether, in his opinion, the financial statements comply with the accounting standards;

(f) the observations or comments of the auditors on financial transactions or matters which have any adverse effect on the functioning of the company;


COMPANY AUDIT5 . 5.33 (g) whether any director is disqualified from being appointed as a director under sub-section (2)

of the section 164;

(h) any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters connected therewith;

(i) whether the company has adequate internal financial controls with reference to financial statements in place and the operating effectiveness of such controls;

(Note: Clause (i) of Sub-Section (3) of Section143 shall not apply to a private company:-(i) which is a one person company or a small company; or (ii) which has turnover less than rupees fifty crores as per latest audited financial statement and which has aggregate borrowings from banks or financial institutions or anybody corporate at any point of time during the financial year less than rupees twenty five crore)

(j) such other matters as may be prescribed. Rule 11 of the Companies (Audit and Auditors) Rules, 2014 prescribes the other matters to be included in auditor’s report. The auditor’s report shall also include their views and comments on the following matters, namely:-

(i) whether the company has disclosed the impact, if any, of pending litigations on its financial position in its financial statement;

(ii) whether the company has made provision, as required under any law or accounting standards, for material foreseeable losses, if any, on long term contracts including derivative contracts;

(iii) whether there has been any delay in transferring amounts, required to be transferred, to the Investor Education and Protection Fund by the company.

Note: Students may refer Guidance note on Reporting under section 143(3)(f) and (h) of the Companies Act, 2013 for better understanding.]

5. Duty to report on frauds:

A. Reporting to the Central Government-As per sub-section (12) of section 143 of the Companies Act, 2013, if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed.

In this regard, Rule 13 of the Companies (Audit and Auditors) Rules, 2014 has been prescribed. Sub-rule (1) of the Rule 13 states that if an auditor of a company, in the course of the performance of his duties as statutory auditor, has reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of ` 1 crore or above, is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the Central Government.


http://ebook.mca.gov.in/notificationdetail.aspx?acturl=6CoJDC4uKVUR7C9Fl4rZdatyDbeJTqg3tUG/+pSc45zEULgLoqvnPOvytbvjFyqbwE32urTTdrYZFScR/DnGEA==

5.34 ADVANCED AUDITING AND PROFESSIONAL ETHICS The manner of reporting the matter to the Central Government is as follows:

(a) the auditor shall report the matter to the Board or the Audit Committee, as the case may be, immediately but not later than 2 days of his knowledge of the fraud, seeking their reply or observations within 45 days;

(b) on receipt of such reply or observations, the auditor shall forward his report and the reply or observations of the Board or the Audit Committee along with his comments (on such reply or observations of the Board or the Audit Committee) to the Central Government within 15 days from the date of receipt of such reply or observations;

(c) in case the auditor fails to get any reply or observations from the Board or the Audit Committee within the stipulated period of 45 days, he shall forward his report to the Central Government along with a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he has not received any reply or observations;

(d) the report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by Registered Post with Acknowledgement Due or by Speed Post followed by an e-mail in confirmation of the same;

(e) the report shall be on the letter-head of the auditor containing postal address, e-mail address and contact telephone number or mobile number and be signed by the auditor with his seal and shall indicate his Membership Number; and

(f) the report shall be in the form of a statement as specified in Form ADT-4.

B. Reporting to the Audit Committee or Board- Sub-section (12) of section 143 of the Companies Act, 2013 further prescribes that in case of a fraud involving lesser than the specified amount [i.e. less than ` 1 crore], the auditor shall report the matter to the audit committee constituted under section 177 or to the Board in other cases within such time and in such manner as may be prescribed.

In this regard, sub-rule (3) of Rule 13 of the Companies (Audit and Auditors) Rules, 2014 states that in case of a fraud involving lesser than the amount specified in sub-rule (1) [i.e. less than ` 1 crore], the auditor shall report the matter to Audit Committee constituted under section 177 or to the Board immediately but not later than 2 days of his knowledge of the fraud and he shall report the matter specifying the following:

(a) Nature of Fraud with description;

(b) Approximate amount involved; and

(c) Parties involved.

C. Disclosure in the Board's Report: Sub-section (12) of section 143 of the Companies Act, 2013 furthermore prescribes that the companies, whose auditors have reported frauds under this sub-section (12) to the audit committee or the Board, but not reported to the Central Government, shall disclose the details about such frauds in the Board's report in such manner as may be prescribed.


COMPANY AUDIT5 . 5.35 In this regard, sub-rule (4) of Rule 13 of the Companies (Audit and Auditors) Rules, 2014 states that the company is required to disclose in the Board’s Report the following details of each of the fraud reported to the Audit Committee or the Board under sub-rule (3) during the year:

(a) Nature of Fraud with description; (b) Approximate Amount involved;

(c) Parties involved, if remedial action not taken; and

(d) Remedial actions taken.

Sub-section (13) of section 143 of the Companies Act, 2013 safeguards the act of fraud reporting by the auditor if it is done in good faith. It states that no duty to which an auditor of a company may be subject to shall be regarded as having been contravened by reason of his reporting the matter above if it is done in good faith.

It is very important to note that the provisions regarding fraud reporting shall also apply, mutatis mutandis, to a cost auditor and a secretarial auditor during the performance of his duties under section 148 and section 204 respectively. If any auditor, cost accountant or company secretary in

Fraud Reporting[Section 143(12) of Companies Act, 2013 & Rule 13 of CAAR, 2014]

Fraud involving amount of less than ` 1 crore

Auditor to Report Board/Audit Committee

Within 2 days of knowledge of fraud,

Report the following matters:

(a) Nature of Fraud with description;(b) Approximate

amount involved; and(c) Parties involved.

Company bound to disclose certain

specified details in Board's Report as:(a) Nature of Fraud with description; (b) Approximate

amount involved; (c) Parties involved, if

remedial action not taken; and

(d) Remedial actions taken.

Fraud involving amount of ` 1 crore or above

Auditor to Report Central Governmentin following manner:

Within 2 days of knowledge of fraud,

Report to Board/Audit Committee

Reply/observations received within stipulated time

ForwardReport+Reply/

observations+Commentsto CG

within 15 days of receipt of such reply/observations

Reply/observations notreceived within stipulated

time

ForwardReport+Note

containing details of report for which

failed to receive any reply/observations

to CG

Seeking reply within 45 days


5.36 ADVANCED AUDITING AND PROFESSIONAL ETHICS practice do not comply with the provisions of sub-section (12) of section 143, he shall be punishable with fine which shall not be less than one lakh rupees but which may extend to twenty-five lakh rupees.

The auditor is also required to report under clause (x) of paragraph 3 of Companies (Auditor’s Report) Order, 2016 [CARO, 2016], whether any fraud by the company or any fraud on the Company by its officers or employees has been noticed or reported during the year. If yes, the nature and the amount involved is to be indicated.

The Auditing and Assurance Standards Board of the ICAI has issued the Guidance Note on Reporting on Fraud under Section 143(12) of the Companies Act, 2013 to provide guidance to the members on this new reporting requirement.

The definition of fraud as per SA 240 and the explanation of fraud as per Section 447 of the 2013 Act are similar, except that under section 447, fraud includes ‘acts with an intent to injure the interests of the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss.’ However, an auditor may not be able to detect acts that have intent to injure the interests of the company or cause wrongful gain or wrongful loss, unless the financial effects of such acts are reflected in the books of account/financial statements of the company. For example,

(i) an auditor may not be able to detect if an employee is receiving pay-offs for favoring a specific vendor, which is a fraudulent act, since such pay-offs would not be recorded in the books of account of the company;

(ii) if the password of a key managerial personnel is stolen and misused to access confidential/restricted information, the effect of the same may not be determinable by the management or by the auditor;

Therefore, the auditor shall consider the requirements of the SAs, insofar as it relates to the risk of fraud, including the definition of fraud as stated in SA 240, in planning and performing his audit procedures in an audit of financial statements to address the risk of material misstatement due to fraud.

[Note: Students may refer Guidance note on Reporting on Fraud under Section 143(12) of the Companies Act, 2013 for detailed knowledge.]

Example: The head accountant of a company entered fake invoices of credit purchases in the books of account aggregate of ` 50 lakh and cleared all the payments to such bogus creditor. Here, the auditor of the company is required to report the fraudulent activity to the Board or Audit Committee (as the case may be) within 2 days of his knowledge of fraud. Further, the company is also required to disclose the same in Board’s Report.

It may be noted that the auditor need not to report the central government as the amount of fraud involved is less than ` 1 crore, however, reporting under CARO, 2016 is required.


COMPANY AUDIT5 . 5.37 6. Duty to report on any other matter specified by Central Government: The Central Government may, in consultation with the National Financial Reporting Authority (NFRA), by general or special order, direct, in respect of such class or description of companies, as may be specified in the order, that the auditor's report shall also include a statement on such matters as may be specified therein.

As per the notification dated 29.03.2016, till the time NFRA is constituted, the Central Government may hold consultation required under this sub-section with the Committee chaired by an officer of the rank of Joint Secretary or equivalent in the MCA and the Committee shall have the representatives from the ICAI and Industry Chambers and also special invitees from the National Advisory Committee on Accounting Standards (NACAS) and the office of the C&AG. However, by virtue of notification dated 21st March 2018, in exercise of the powers conferred by sub-section (3) of section 1 of the Companies Act, 2013 (18 of 2013), the Central Government hereby appoints the 21st March, 2018 as the date on which the provisions of subsections (3) and (11) of section 132 of the said Act shall come into force.

[Note: Students are required to refer Para 14.4 Constitution of National Financial Reporting Authority for detailed understanding of the topic]

7. Duties and powers of the company’s auditor with reference to the audit of the branch and the branch auditor are discussed separately in this chapter.

8. Duty to state the reason for qualification or negative report: As per sub-section (4) of section 143, where any of the matters required to be included in the audit report is answered in the negative or with a qualification, the report shall state the reasons there for.

10. JOINT AUDIT

The practice of appointing Chartered Accountants as joint auditors is quite widespread in big companies and corporations. Joint audit basically implies pooling together the resources and expertise of more than one firm of auditors to render an expert job in a given time period which may be difficult to accomplish acting individually. It essentially involves sharing of the total work.

[Note: Student may refer SA 299 “Joint Audit of Financial Statements” reproduced in “Auditing Pronouncements” for comprehensive knowledge.]



11. AUDIT OF BRANCH OFFICE ACCOUNTS As per section 128(1) of the Companies Act, 2013, every company shall prepare and keep at its registered office books of account and other relevant books and papers and financial statement for every financial year which give a true and fair view of the state of the affairs of the company, including that of its branch office or offices, if any, and explain the transactions effected both at the registered office and its branches and such books shall be kept on accrual basis and according to the double entry system of accounting. It may be noted that all or any of the books of account aforesaid and other relevant papers may be kept at such other place in India as the Board of Directors may decide and where such a decision is taken, the company shall, within 7 days thereof, file with the Registrar a notice in writing giving the full address of that other place. Students may also note that the company may keep such books of account or other relevant papers in electronic mode in such manner as may be prescribed. Sub-section (2) provides that where a company has a branch office in India or outside India, it shall be deemed to have complied with the provisions of sub-section (1), if proper books of account relating to the transactions effected at the branch office are kept at that office and proper summarised returns periodically are sent by the branch office to the company at its registered office or the other place referred in (1). Further, sub-section (8) of section 143 of the Companies Act, 2013, prescribes the duties and powers of the company’s auditor with reference to the audit of the branch and the branch auditor. Where a company has a branch office, the accounts of that office shall be audited either by the auditor appointed for the company (herein referred to as the company's auditor) under this Act or by any other person qualified for appointment as an auditor of the company under this Act and appointed as such under section 139, or where the branch office is situated in a country outside India, the accounts of the branch office shall be audited either by the company's auditor or by an accountant or by any other person duly qualified to act as an auditor of the accounts of the branch office in accordance with the laws of that country and the duties and powers of the company' s auditor with reference to the audit of the branch and the branch auditor, if any, shall be such as may be prescribed. It may be noted that the branch auditor shall prepare a report on the accounts of the branch examined by him and send it to the auditor of the company who shall deal with it in his report in such manner as he considers necessary. Further as per Rule 12 of the Companies (Audit and Auditors) Rules, 2014, the branch auditor shall submit his report to the company’s auditor and reporting of fraud by the auditor shall also extend to such branch auditor to the extent it relates to the concerned branch. Using the Work of another Auditor: When the accounts of the branch are audited by a person other than the company’s auditor, there is need for a clear understanding of the role of such auditor and the company’s auditor in relation to the audit of the accounts of the branch and the audit of the company as a whole; also, there is great necessity for a proper rapport between these two auditors for the purpose of an effective audit. In recognition of these needs, the Council of the Institute of


COMPANY AUDIT5 . 5.39 Chartered Accountants of India has dealt with these issues in SA 600, “Using the Work of another Auditor”. It makes clear that in certain situations, the statute governing the entity may confer a right on the principal auditor to visit a component and examine the books of account and other records of the said component, if he thinks it necessary to do so. Where another auditor has been appointed for the component, the principal auditor would normally be entitled to rely upon the work of such auditor unless there are special circumstances to make it essential for him to visit the component and/or to examine the books of account and other records of the said component. Further, it requires that the principal auditor should perform procedures to obtain sufficient appropriate audit evidence, that the work of the other auditor is adequate for the principal auditor's purposes, in the context of the specific assignment. When using the work of another auditor, the principal auditor should ordinarily perform the following procedures: (a) advise the other auditor of the use that is to be made of the other auditor's work and report

and make sufficient arrangements for co-ordination of their efforts at the planning stage of the audit. The principal auditor would inform the other auditor of matters such as areas requiring special consideration, procedures for the identification of inter-component transactions that may require disclosure and the time-table for completion of audit; and

(b) advise the other auditor of the significant accounting, auditing and reporting requirements and obtain representation as to compliance with them.

The principal auditor might discuss with the other auditor the audit procedures applied or review a written summary of the other auditor’s procedures and findings which may be in the form of a completed questionnaire or check-list. The principal auditor may also wish to visit the other auditor. The nature, timing and extent of procedures will depend on the circumstances of the engagement and the principal auditor's knowledge of the professional competence of the other auditor. This knowledge may have been enhanced from the review of the previous audit work of the other auditor.

12. COST AUDIT It is an audit process for verifying the cost of manufacture or production of any article, on the basis of accounts as regards utilisation of material or labour or other items of costs, maintained by the company.

Cost Audit: Cost Audit is covered by Section 148 of the Companies Act, 2013. The audit conducted under this section shall be in addition to the audit conducted under section 143.

As per section 148, the Central Government may by order specify audit of items of cost in respect of certain companies.

Further, the Central Government may, by order, in respect of such class of companies engaged in the production of such goods or providing such services as may be prescribed, direct that particulars relating to the utilisation of material or labour or to other items of cost as may be prescribed shall also be included in the books of account kept by that class of companies.


5.40 ADVANCED AUDITING AND PROFESSIONAL ETHICS It may be noted that the Central Government shall, before issuing such order in respect of any class of companies regulated under a special Act, consult the regulatory body constituted or established under such special Act.

In this regard, the Central Government has notified the Companies (Cost Records and Audit) Rules, 2014 which prescribes the classes of companies required to include cost records in their books of account, applicability of cost audit, maintenance of records etc.

As per Rule 5 of the Companies (cost records and audit) Rules, 2014, every company under these rules including all units and branches thereof, shall, in respect of each of its financial year is required to maintain cost records in prescribed Form CRA-1. The cost records shall be maintained on regular basis in such manner as to facilitate calculation of per unit cost of production or cost of operations, cost of sales and margin for each of its products and activities for every financial year on monthly or quarterly or half-yearly or annual basis.

Additionally, as per clause (vi) to Paragraph 3 of the CARO, 2016, the auditor has to report whether maintenance of cost records has been specified by the Central Government under section 148(1) of the Companies Act, 2013 and whether such accounts and records have been so made and maintained.

Rule 6 of the Companies (Cost Records and Audit) Rules, 2014 requires the companies prescribed under the said Rules to appoint an Auditor within 180 days of the commencement of every financial year. However, before such appointment is made, the written consent of the cost auditor to such appointment and a certificate from him or it shall be obtained. Every referred company shall inform the cost auditor concerned of his or its appointment as such and file a notice of such appointment with the Central Government within a period of 30 days of the Board meeting in which such appointment is made or within a period of 180 days of the commencement of the financial year, whichever is earlier, through electronic mode, in FormCRA-2, along with the fee as specified in Companies (Registration Offices and Fees) Rules, 2014.

The cost auditor appointed as such shall continue in such capacity till the expiry of 180 days from the closure of the financial year or till he submits the cost audit report, for the financial year for which he has been appointed.

The cost auditor shall submit the cost audit report along with his or its reservations or qualifications or observations or suggestions, if any, in FormCRA-3. He shall forward his duly signed report to the Board of Directors of the company within a period of 180 days from the closure of the financial year to which the report relates and the Board of Directors shall consider and examine such report particularly any reservation or qualification contained therein.

Duty to report on fraud: The provisions of sub-section (12) of section 143 of the Companies Act, 2013 and the relevant rules on duty to report on fraud shall apply mutatis mutandis to a cost auditor during performance of his functions under section 148 of the Act and these rules.


COMPANY AUDIT5 . 5.41 Cost Audit Rules not to apply in certain cases: The requirement for cost audit under these rules shall not be applicable to a company which is covered under rule 3, and,

(i) whose revenue from exports, in foreign exchange, exceeds seventy five per cent of its total revenue; or

(ii) which is operating from a special economic zone.

(iii) which is engaged in generation of electricity for captive consumption through Captive Generating Plant.

If the Central Government is of the opinion, that it is necessary to do so, it may, by order, direct that the audit of cost records of class of companies, which are covered under sub-section (1) and which have a net worth of such amount as may be prescribed or a turnover of such amount as may be prescribed, shall be conducted in the manner specified in the order.

Who can be cost auditor: The audit shall be conducted by a Cost Accountant who shall be appointed by the Board of such remuneration as may be determined by the members in such manner as may be prescribed.

Students may note that no person appointed under section 139 as an auditor of the company shall be appointed for conducting the audit of cost records.

It may also be noted that the auditor conducting the cost audit shall comply with the cost auditing standards ("cost auditing standards" mean such standards as are issued by the Institute of Cost Accountants of India, constituted under the Cost Accountants Act, 1959, with the approval of the Central Government).

Appointment and Remuneration of Cost Auditor: As per rule 14 of the Companies (Audit and Auditors) Rules, 2014,

(a) in the case of companies which are required to constitute an audit committee-

(i) the Board shall appoint an individual, who is a cost accountant, or a firm of cost accountants in practice, as cost auditor on the recommendations of the Audit committee, which shall also recommend remuneration for such cost auditor;

(ii) the remuneration recommended by the Audit Committee under (i) shall be considered and approved by the Board of Directors and ratified subsequently by the shareholders;

(b) in the case of other companies which are not required to constitute an audit committee, the Board shall appoint an individual who is a cost accountant or a firm of cost accountants in practice as cost auditor and the remuneration of such cost auditor shall be ratified by shareholders subsequently.

Qualification, disqualification, rights, duties and obligations of Cost Auditor: The qualifications, disqualifications, rights, duties and obligations applicable to auditors under this Chapter shall, so far as may be applicable, apply to a cost auditor appointed under this section and


5.42 ADVANCED AUDITING AND PROFESSIONAL ETHICS it shall be the duty of the company to give all assistance and facilities to the cost auditor appointed under this section for auditing the cost records of the company.

It may be noted that the report on the audit of cost records shall be submitted by the cost accountant to the Board of Directors of the company.

Submission of Cost Audit Report: A company shall within 30 days from the date of receipt of a copy of the cost audit report prepared (in pursuance of a direction issued by Central Government) furnish the Central Government with such report along with full information and explanation on every reservation or qualification contained therein, in Form CRA-4 in Extensible Business Reporting Language (XBRL) format in the manner as specified in the Companies (Filing of Documents and Forms in Extensible Business Reporting language) Rules, 2015 along with fees specified in the Companies (Registration Offices and Fees) Rules, 2014. It has been provided that the Companies which have got extension of time of holding Annual General Meeting under section 96 (1) of the Companies Act, 2013, may file Form CRA-4 within resultant extended period of filing financial statements under section 137 of the Companies Act, 2013. If, after considering the cost audit report referred to under this section and the, information and explanation furnished by the company as above, the Central Government is of the opinion, that any further information or explanation is necessary, it may call for such further information and explanation and the company shall furnish the same within such time as may be specified by that Government.

Penal Provisions in case of default: If any default is made in complying with the provisions of this section,

(a) the company and every officer of the company who is in default shall be punishable in the manner as provided in sub-section (1) of section 147. (Section 147 is discussed separately in this Chapter);

(b) the cost auditor of the company who is in default shall be punishable in the manner as provided in sub-sections (2) to (4) of section 147. (Section 147 is discussed separately in this Chapter).

13. PUNISHMENT FOR NON-COMPLIANCE Section 147 of the Companies Act, 2013 prescribes following punishments for contravention:

(1) If any of the provisions of sections 139 to 146 (both inclusive) is contravened, the company shall be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than ten thousand rupees but which may extend to one lakh rupees, or with both.


COMPANY AUDIT5 . 5.43 (2) If an auditor of a company contravenes any of the provisions of section 139 section 143,

section 144 or section 145, the auditor shall be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees or four times the remuneration of the auditor, whichever is less.

It may be noted that if an auditor has contravened such provisions knowingly or willfully with the intention to deceive the company or its shareholders or creditors or tax authorities, he shall be punishable with imprisonment for a term which may extend to one year and with fine which shall not be less than fifty thousand rupees but which may extend to twenty-five lakh rupees or eight times the remuneration of the auditor, whichever is less.

(3) Where an auditor has been convicted under sub-section (2), he shall be liable to:-

(i) refund the remuneration received by him to the company;

(ii) and pay for damages to the company statutory bodies or authorities or to members or the creditors of the Company for loss arising out of incorrect or misleading statements of particulars made in his audit report.

(4) The Central Government shall, by notification, specify any statutory body or authority of an officer for ensuring prompt payment of damages to the company or the persons under clause (ii) of sub-section (3) and such body, authority or officer shall after payment of damages the such company or persons file a report with the Central Government in respect of making such damages in such manner as may be specified in the said notification.

(5) Where, in case of audit of a company being conducted by an audit firm, it is proved that the partner or partners of the audit firm has or have acted in a fraudulent manner or abetted or colluded in an fraud by, or in relation to or by, the company or its directors or officers, the liability, whether civil criminal as provided in this Act or in any other law for the time being in force, for such act shall be the partner or partners concerned of the audit firm and of the firm jointly and severally. However, in case of criminal liability of an audit firm, in respect of liability other than fine, the concerned partner or partners, who acted in a fraudulent manner or abetted or, as the case may be, colluded in any fraud shall only be liable.

14. FINAL ACCOUNTS PREPARATION AND PRESENTATION 14.1 Financial Statements Statutory Requirements –Central Government to prescribe accounting standards. Section 133 of the Companies Act, 2013 The Central Government may prescribe the standards of accounting or any addendum thereto, as recommended by the Institute of Chartered Accountants of India (ICAI), constituted under section 3 of the Chartered Accountants Act, 1949, in consultation with and after examination of the recommendations made by the National Financial Reporting Authority (NFRA).


5.44 ADVANCED AUDITING AND PROFESSIONAL ETHICS In exercise of the powers conferred under sub-sections (2) and (4) of section 132, the Central Government made the National Financial Reporting Authority Rules, 2018 (NFRA Rules). As per NFRA rules, NFRA shall have power to monitor and enforce compliance with accounting standards and auditing standards, oversee the quality of service under sub-section (2) of section 132 or undertake investigation under sub-section (4) of such section of the auditors of the prescribed class of companies and bodies corporate. The Central Government has also notified Companies (Indian Accounting Standards) Rules, 2015 dated 16.02.2015 in exercise of the powers conferred by section 133. The said rules list the Indian Accounting Standards (Ind AS) and the class of companies required to comply with the Ind AS while preparation of their financial statements.

Section 129(1) of the Companies Act, 2013, governs the requirements to be satisfied by financial statements. The provisions thereunder, however, are not applicable to an insurance or banking company or a company engaged in the generation or supply of electricity or to any other class of companies for which a form of financial statement has been specified in or under the Act governing such class of companies. The provisions that companies, other than those aforementioned, should comply with are:

(a) That financial statement shall, give a true and fair view of the state of affairs of the company or companies as at the end of financial year, comply with the accounting standards notified under section 133 and be in such form or forms specified in Schedule III to the Companies Act, 2013. Vide notification dated October 11, 2018, the Central Government made few amendments in Schedule III of the Companies Act, 2013 regarding the disclosures required to be made in the financial statements.

(b) That the items contained in such financial statements shall be in accordance with the accounting standards.

By virtue of notification dated February 23, 2018, the Central Government has exempted the companies engaged in defence production to the extent of application of relevant Accounting Standard on segment reporting.

Similarly as per MCA notification dated February 5, 2018, the provision of deferred tax asset/ liability as per Ind AS 12 or Accounting Standard 22 shall not apply, for seven years w.e.f. 1st April, 2014, to Government Company which is a public financial institution under sub-clause (iv) of clause (72) of section 2 of the Companies Act, 2013; is a Non-Banking Financial Company registered with the Reserve Bank of India under section 45-IA of the Reserve bank of India Act, 1934; and is engaged in the business of infrastructure finance leasing with not less than seventy five per cent of its total revenue being generated from such business with Government companies or other entities owned or controlled by Government.

Section 129(2) of the Act, requires the Board of Directors of the company to lay before every annual general meeting (AGM) the financial statements for the financial year.


COMPANY AUDIT5 . 5.45 Re-opening of accounts on Court’s or Tribunal’s orders: Section 130 of the Companies Act, 2013 states that a company shall not re-open its books of account and not recast its financial statements, unless an application in this regard is made by the Central Government, the Income-tax authorities, the Securities and Exchange Board of India (SEBI), any other statutory regulatory body or authority or any person concerned and an order is made by a court of competent jurisdiction or the Tribunal to the effect that—

(i) the relevant earlier accounts were prepared in a fraudulent manner; or

(ii) the affairs of the company were mismanaged during the relevant period, casting a doubt on the reliability of financial statements.

The Order for reopening of accounts not to be made beyond eight financial years immediately preceding the current financial year unless and until Government has, under Section 128(5), issued a direction for keeping books of account longer than 8 years, reopening of accounts can be made for such longer period.

However, a notice shall be given by the Court or Tribunal in this regard and shall take into consideration the representations, if any.

Voluntary revision of financial statements or Board’s report: Section 131 of the Companies Act, 2013 states that if it appears to the directors of a company that—

(a) the financial statement of the company; or

(b) the report of the Board,

do not comply with the provisions of section 129 (Financial statement) or section 134 (Financial statement, Board’s report, etc.) they may prepare revised financial statement or a revised report in respect of any of the three preceding financial years after obtaining approval of the Tribunal on an application made by the company in such form and manner as may be prescribed and a copy of the order passed by the Tribunal shall be filed with the Registrar.

14.2 Consolidated Financial Statement Section 129(3) of the Act has now made the consolidation of financial statement mandatory. It states that where a company has one or more subsidiaries, it shall, in addition to the financial statements provided above (i.e. standalone financial statement), prepare a consolidated financial statement of the company and of all the subsidiaries in the same form and manner as that of its own which shall also be laid before the annual general meeting of the company along with the laying of its financial statement under section 129 (2) above.

The consolidation of financial statements of the company shall be made in accordance with the provisions of Schedule III of the Act and the applicable accounting standards. And in case of a company covered under sub-section (3) of section 129 which is not required to prepare consolidated financial statements under the Accounting Standards, it shall be sufficient if the company complies with provisions on consolidated financial statements provided in Schedule III of the Act.


5.46 ADVANCED AUDITING AND PROFESSIONAL ETHICS The provisions of the Act applicable to the preparation, adoption and audit of the financial statements of a holding company shall, mutatis mutandis, apply to the consolidated financial statements referred to in section 129(3).Explanation - For the purposes of this sub-section, the word “subsidiary” shall include associate company and joint venture.

If the company has only associate companies, then also it will be required to prepare consolidated financial statement.

Exemptions from preparation of CFS: As per Companies (Accounts) Amendment Rules, 2016, preparation of CFS by a company is not required if it meets the following conditions:

(i) it is a wholly-owned subsidiary, or is a partially-owned subsidiary of another company and all its other members, including those not otherwise entitled to vote, having been intimated in writing and for which the proof of delivery of such intimation is available with the company, do not object to the company not presenting consolidated financial statements;

(ii) it is a company whose securities are not listed or are not in the process of listing on any stock exchange, whether in or outside India; and

(iii) its ultimate or any intermediate holding company files consolidated financial statements with the Registrar which are in compliance with the applicable Accounting Standards.

For detailed content on Audit of Consolidated Financial Statements students are required to refer Chapter 8 given in Module 2.

Where the financial statements of the company do not comply with the accounting standards, such companies shall disclose in its financial statements, the following, namely:

(a) the deviation from the accounting standards;

(b) the reasons for such deviation; and

(c) the financial effect, if any, arising due to such deviation.

The Central Government may, on its own or on an application by a class or classes of companies, by notification, exempt any class or classes of the companies from complying with any of the requirements of this section or the rules, if it is considered necessary to grant such exemption in the public interest and such exemption may be granted either conditionally or unconditionally.

14.3 Penalty for contravention If a company contravenes the provisions of this section:

(a) the managing director, the whole-time director in charge of finance, the Chief Financial Officer or any other person charged by the Board with the duty of complying with the requirements of this section shall be punishable with imprisonment for a term which may extend to one year or with fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees, or with both, and


COMPANY AUDIT5 . 5.47 (b) in the absence of any of the officers mentioned above, all the directors shall be punishable

with imprisonment for a term which may extend to one year or with fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees, or with both.

[Explanation- For the purpose of section 129, except where the context otherwise requires, any reference to the financial statement shall include any notes annexed to or forming part of such financial statement, giving information required to be given and allowed to be given in the form of such notes under the Act.]

14.4 Constitution of National Financial Reporting Authority According to Section 132 of the Act, the Central Government may, by notification, constitute a National Financial Reporting Authority (NFRA) to provide for matters relating to accounting and auditing standards for adoption by companies or class of companies under the Act.

As per Section 132 (2) of the Companies Act 2013, notwithstanding anything contained in any other law for the time being in force, the NFRA shall—

(a) make recommendations to the Central Government on the formulation and laying down of accounting and auditing policies and standards for adoption by companies or class of companies or their auditors, as the case may be;

(b) monitor and enforce the compliance with accounting standards and auditing standards in such manner as may be prescribed;

(c) oversee the quality of service of the professions associated with ensuring compliance with such standards, and suggest measures required for improvement in quality of service and such other related matters as may be prescribed; and

(d) perform such other functions relating to clauses (a), (b) and (c) as may be prescribed.

In exercise of the powers conferred under sub-sections (2) and (4) of section 132, the Central Government made the National Financial Reporting Authority Rules, 2018 (NFRA Rules) (MCA Notification dated 13 November 2018).

As per NFRA rules, NFRA shall have power to monitor and enforce compliance with accounting standards and auditing standards, oversee the quality of service under sub-section (2) of section 132 or undertake investigation under sub-section (4) of such section of the auditors of the following class of companies and bodies corporate:

(a) companies whose securities are listed on any stock exchange in India or outside India;

(b) unlisted public companies having paid-up capital of not less than rupees five hundred crores or having annual turnover of not less than rupees one thousand crores or having, in aggregate, outstanding loans, debentures and deposits of not less than rupees five hundred crores as on the 31st March of immediately preceding financial year;


5.48 ADVANCED AUDITING AND PROFESSIONAL ETHICS (c) insurance companies, banking companies, companies engaged in the generation or

supply of electricity, companies governed by any special Act for the time being in force or bodies corporate incorporated by an Act in accordance with clauses (b), (c), (d), (e) and (f) of section 1 (4) of the Companies Act, 2013;

(d) any body corporate or company or person, or any class of bodies corporate or companies or persons, on a reference made to the NFRA by the Central Government in public interest; and

(e) a body corporate incorporated or registered outside India, which is a subsidiary or associate company of any company or body corporate incorporated or registered in India as referred to in clauses (a) to (d) above, if the income or net-worth of such subsidiary or associate company exceeds 20% of the consolidated income or consolidated net-worth of such company or the body corporate, as the case may be, referred to in clauses (a) to (d) above.

Every existing body corporate other than a company governed by these rules, shall inform the NFRA within 30 days of the commencement of NFRA rules, in Form NFRA-1, the particulars of the auditor as on the date of commencement of these rules.

Every body corporate, other than a company as defined in clause (20) of section 2 of the Act, formed in India and governed under NFRA Rules shall, within 15 days of appointment of an auditor under sub-section (1) of section 139, inform the NFRA in Form NFRA-1, the particulars of the auditor appointed by such body corporate. Provided that a body corporate governed under clause (e) of sub-rule (1) of NFRA Rules shall provide details of appointment of its auditor in Form NFRA-1.

A company or a body corporate other than a company governed under NFRA Rules shall continue to be governed by the NFRA for a period of 3 years after it ceases to be listed or its paid-up capital or turnover or aggregate of loans, debentures and deposits falls below the limit stated therein (i.e. mentioned in points (a) to (e) above).

Every auditor referred to in Rule 3 shall file a return with the NFRA on or before 30th April every year in such form as may be specified by the Central Government.

Recommending accounting standards (AS) and auditing standards (SA) - For the purpose of recommending AS or SA for approval by the Central Government, the NFRA -

(a) shall receive recommendations from the ICAI on proposals for new AS or SA or for amendments to existing AS or SA;

(b) may seek additional information from the ICAI on the recommendations received under clause (a), if required.



The NFRA shall consider the recommendations and additional information in such manner as it deems fit before making recommendations to the Central Government.

Monitoring and Enforcing Compliance with Auditing Standards -

(1) For the purpose of monitoring and enforcing compliance with auditing standards under the Act by a company or a body corporate governed under rule 3, the NFRA may:

(a) review working papers (including audit plan and other audit documents) and communications related to the audit;

(b) evaluate the sufficiency of the quality control system of the auditor and the manner of documentation of the system by the auditor; and

(c) perform such other testing of the audit, supervisory, and quality control procedures of the auditor as may be considered necessary or appropriate.

(2) The NFRA may require an auditor to report on its governance practices and internal processes designed to promote audit quality, protect its reputation and reduce risks including risk of failure of the auditor and may take such action on the report as may be necessary.

(3) The NFRA may seek additional information or may require the personal presence of the auditor for seeking additional information or explanation in connection with the conduct of an audit.

(4) The NFRA shall perform its monitoring and enforcement activities through its officers or experts with sufficient experience in audit of the relevant industry.

(5) The NFRA shall publish its findings relating to non-compliances on its website and in such other manner as it considers fit, unless it has reasons not to do so in the public interest and it records the reasons in writing.

(6) The NFRA shall not publish proprietary or confidential information, unless it has reasons to do so in the public interest and it records the reasons in writing.

(7) The NFRA may send a separate report containing proprietary or confidential information to the Central Government for its information.

(8) Where the NFRA finds or has reason to believe that any law or professional or other standard has or may have been violated by an auditor, it may decide on the further course of investigation or enforcement action through its concerned Division.

Overseeing the quality of service and suggesting measures for improvement

(1) On the basis of its review, the NFRA may direct an auditor to take measures for improvement of audit quality including changes in their audit processes, quality control, and audit reports and specify a detailed plan with time-limits.


5.50 ADVANCED AUDITING AND PROFESSIONAL ETHICS (2) It shall be the duty of the auditor to make the required improvements and send a report

to the NFRA explaining how it has complied with the directions made by the NFRA.

(3) The NFRA shall monitor the improvements made by the auditor and take such action as it deems fit depending on the progress made by the auditor.

(4) The NFRA may refer cases with regard to overseeing the quality of service of auditors of companies or bodies corporate referred to in rule 3 to the Quality Review Board constituted under the Chartered Accountants Act, 1949 (38 of 1949) or call for any report or information in respect of such auditors or companies or bodies corporate from such Board as it may deem appropriate.

(5) The NFRA may take the assistance of experts for its oversight and monitoring activities.

Punishment in case of non-compliance - If a company or any officer of a company or an auditor or any other person contravenes any of the provisions of NFRA Rules, the company and every officer of the company who is in default or the auditor or such other person shall be punishable as per the provisions of section 450 of the Act.

Financial reporting advocacy and education - The NFRA shall take suitable measures for the promotion of awareness and significance of AS, SA, auditors’ responsibilities, audit quality and such other matters through education, training, seminars, workshops, conferences and publicity.

14.5 Form of the Balance Sheet Only vertical format of balance sheet and statement of profit and loss is prescribed under Schedule III to the Companies Act, 2013. Only vertical format is allowed and hence becomes compulsory. There is no option to prepare balance sheet and statement of profit and loss in horizontal format (‘T Form’).

Schedule III to the Companies Act, 2013 –

The Schedule III to the Companies Act, 2013 applies to all the companies (except to the companies as referred to in the second proviso to section 129(1) of the Companies Act, 2013) uniformly for the financial statements to be prepared.

The companies excused in the second proviso to section 129(1) of the Companies Act, 2013, are:

(a) an insurance company; or

(b) banking company; or

(c) a company engaged in the generation or supply of electricity; or

(d) any other class of companies for which a form of financial statement has been specified in or under the Act governing such class of companies.



Some of the features of Schedule III are as under:

(i) The disclosure requirements specified in the Schedule are in addition to and not in substitution of the disclosure requirements specified in the Accounting Standards prescribed under the Companies Act, 2013. For the purpose of the Schedule, the terms used therein shall be as per the applicable Accounting Standards.

(ii) The Schedule does not recognize presenting information in Schedules. Instead it requires presenting the information in details through notes to account.

(iii) Each item on the face of the Balance Sheet and Statement of Profit and Loss shall be cross-referenced to any related information in the notes to accounts.

(iv) The corresponding amount for the immediately preceding year for all the items shown in the financial statement including notes shall also be given [excluding the cases where first financial statement are prepared by the company (after its incorporation)].

The Schedule III to the Companies Act, 2013 has been divided into two divisions:

Division I deals with those financial statements which are required to comply with the Companies (Accounting Standards) Rules, 2006; and

Division II deals with those financial statements which are drawn up in compliance with the Companies (Indian Accounting Standards) Rules, 2015.

Division I has been divided as follows:

Part I contains the form in which the Balance Sheet of a company should be drawn up, and states the general instructions as regardsthe presentation of different assets and liabilities.

Part II contains the form and states the general instructions as regard the preparation and presentation of information in the Statement of Profit and Loss.

General instructions for preparation of Consolidated Financial Statements have also been provided in Schedule III where a company is required to prepare Consolidated Financial Statements.

Division II has been divided as follows:

Part I contains the form in which the Balance Sheet of a company required to comply with Ind AS and states the general instructions as regard to preparation of Balance Sheet.

Part II contains the form and states the general instructions as regard to preparation of Statement of Profit and Loss.

PART III contains general instructions for preparation of Consolidated Financial Statements. [Notes: (i)The Ministry of Corporate Affairs (MCA) vide notification dated October 11, 2018 introduced Division III under Schedule III of the Companies Act, 2013, wherein a format for


5.52 ADVANCED AUDITING AND PROFESSIONAL ETHICS preparation of financial statements by NBFCs complying with Ind- AS has been prescribed which is discussed in Chapter 11 Audit of Non-Banking Financial Corporations. (ii)Students are required to refer Appendix annexed at the end of this Chapter for detailed understanding of Schedule III to the Companies Act, 2013].

15. SIGNIFICANCE OF TRUE AND FAIR The concept of true and fair is a fundamental concept in auditing. The phrase “true and fair” in the auditor’s report signifies that the auditor is required to express his opinion as to whether the state of affairs and the results of the entity as ascertained by him in the course of his audit are truly and fairly represented in the accounts under audit. This requires that the auditor should examine the accounts with a view to verify that all assets, liabilities, income and expenses are stated as amounts which are in accordance with accounting principles and policies which are relevant and no material amount, item or transaction has been omitted. The importance of the concept of true and fair view can also be understood and appreciated from the fact that sections 128, 129 and 143 of the Companies Act, 2013 also discuss this concept in relation to books of accounts, financial statements and reporting on financial statements respectively. Place of keeping books of accounts - Section 128(1) of the Companies Act, 2013 provides that every company shall prepare and keep at its registered office books of account and other relevant books and papers and financial statement for every financial year which give a true and fair view of the state of the affairs of the company, including that of its branch office or offices, if any. The company shall be in a position to explain the transactions effected both at the registered office and its branches. Such books of accounts shall be kept on accrual basis and according to the double entry system of accounting. Section 129(1) of the Companies Act, 2013 provides that the financial statements shall give a true and fair view of the state of affairs of the company or companies, comply with the accounting standards notified under section 133 of the Companies Act, 2013, and shall be in the form or forms as may be provided for different class or classes of companies in Schedule III to the Act. The term “financial statement” shall include any notes annexed to or forming part of such financial statement, giving information required to be given and allowed to be given in the form of such notes under the said Act.

Further, according to section 143(2) of the Act, the auditor is required to make a report to the members of the company indicating that, to the best of his information and knowledge, the financial statements give a true and fair view of the state of the company’s affairs as at the end of its financial year and profit or loss and cash flow for the year and such other matters as may be prescribed.

SA 700 “Forming an Opinion and Reporting on Financial Statements”, requires the auditor to form an opinion on the financial statements based on an evaluation of the conclusions drawn from the audit evidence obtained; and express clearly that opinion through a written report that also describes the basis for the opinion. The auditor is required to express his opinion on the financial statements that it gives a true and fair view in conformity with the accounting principles generally accepted in


COMPANY AUDIT5 . 5.53 India (a) in the case of the Balance Sheet, of the state of affairs of the Company as at March 31, 20XX; (b) in the case of the Statement of Profit and Loss, of the profit/ loss for the year ended on that date; and (c) in the case of the Cash Flow Statement, of the cash flows for the year ended on that date.

In the context of audit of a company, the accounts of a company shall be deemed as not disclosing a true and fair view, if they do not disclose any matters which are required to be disclosed by virtue of provisions of Schedule III to that Act, or by virtue of a notification or an order of the Central Government modifying the disclosure requirements. Therefore, the auditor will have to see that the accounts are drawn up in conformity with the provisions of Schedule III of the Companies Act, 2013 and whether they contain all the matters required to be disclosed therein. In case of companies which are governed by special Acts, the auditor should see whether the disclosure requirements of the governing Act are complied with.

It must be noted that the disclosure requirements laid down by the law are the minimum requirements.If certain information is vital for showing a true and fair view, the accounts should disclose it even though there may not be a specific legal provision to do so. Thus, what constitutes a ‘true and fair’ view is a matter of an auditor’s judgment in the particular circumstances of a case. In more specific terms, to ensure true and fair view, an auditor has to see:

(i) that the assets are neither undervalued or overvalued, according to the applicable accounting principles,

(ii) no material asset is omitted;

(iii) the charge, if any, on assets are disclosed;

(iv) material liabilities should not be omitted;

(v) the statement of profit and loss discloses all the matters required to be disclosed by Part II of Schedule III

(vi) the balance sheet has been prepared in accordance with Part I of Schedule III;

(vii) accounting policies have been followed consistently; and

(viii) all unusual, exceptional or non-recurring items have been disclosed separately.

In this context, it is noteworthy that the Council of the ICAI while issuing a clarification regarding authority attached to documents issued by the ICAI also observed that, the Companies Act, as well as many other statutes require that the financial statements of an enterprise should give a true and fair view of its financial position and working results. This requirement is implicit even in the absence of a specific statutory provision to this effect. However, what constitutes ‘true and fair’ view has not been defined either in the Companies Act, 2013 or in any other statute. The pronouncements of the ICAI seek to describe the accounting principles and the methods of applying these principles in the preparation and presentation of financial statements so that they give a true and fair view. The pronouncements issued by the ICAI include various statements, standards and guidance notes.



16. DIVISIBLE PROFITS, DIVIDENDS AND RESERVES Profit is the central theme for almost all business activities. Decision about the future of the business, i.e., whether to close down, expand or modify largely depend on the trend of profits or losses; investors’ interest in a business is also dependent upon the yield that they get. For all these, determination of correct profit is obviously important and, no wonder, it is a matter to which accountants attach great importance.

The auditor must necessarily have regard to generally accepted accounting practices, legal provisions and judicial pronouncements in carrying out his duties. Should more profit be distributed than is permissible, because of a wrong process of computation, it may be treated as paying a dividend out of capital which is legally not permissible unless the company is being wound up. Apart from legal consequences, the management of the business would be depleting capital of the company which may have dangerous results.

Reserves can be created only when there is profit. Some reserves can also be utilised to pay dividends. Apart from the specific law governing creation and maintenance of reserves in certain cases, the articles of association of companies generally contain provisions in this respect. In addition, accepted accounting practices suggest situations, where, even in the absence of any specific law, reserves should be maintained. Despite the existence of accounting principles, judicial rulings and legal requirements controversy in these respects cannot be considered to have come to an end. For example, though professional bodies as well as law have tried to distinguish revenue reserves from capital reserves, still there is large scope of disagreement on whether capital reserves are distributable. It is imperative that there should be a clear idea about profit, distributable profit, dividend and reserves. The auditor should, within the broad framework of available guidelines, exercise his own judgement in each case.

A special note in this connection should be taken for depreciation and valuation of stocks, the two major elements influencing the correct determination of profit or loss. These two are related to the valuation of assets of the business which directly and significantly affect the figure of profit or loss.

One should be aware of the various possibilities in this regard.

16.1 Depreciation under Section 123 of the Companies Act, 2013 read with Schedule II to the Companies Act, 2013

Section 123 of the Act, provides that the dividend shall be declared or paid by a company for any financial year out of the profits of the company for that year arrived at after providing for depreciation in a manner prescribed under Schedule II “Useful lives to compute Depreciation”, to the Companies Act, 2013.

The useful life or residual value of any specific asset as notified for accounting purpose by a Regulatory Authority constituted under an Act of Parliament or by the Central Government intend to


COMPANY AUDIT5 . 5.55 be applied in calculating the depreciation to be provided for such asset irrespective of the requirements of Schedule II.

The Schedule II to the Companies Act, 2013 needs disclosure in the financial statements about the depreciation method used and the useful lives of the assets for computing depreciation, if they are different from the life specified in the Schedule II.

16.2 Law relating to dividends – The Companies Act, 2013 lays down the law relating to distribution of profits by making certain provisions under Section 123. Accordingly, dividend cannot be declared or paid by a company for any financial year except:

(a) out of profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of Section 123(2), or

(b) out of the profits of the company for any previous financial year or years arrived at after providing for depreciation in the manner aforementioned and remaining undistributed, or

(c) out of the balances of profit mentioned in (a) and (b) above; or

(d) out of money provided by the Central Government or a State Government for the payment of dividend by the company pursuant to the guarantee given by that Government.

Dividends out of current profits- Transfer to Reserves is optional –The first proviso to Section 123(1) of the Act provides that a company may, before the declaration of any dividend in any financial year, transfer such percentage of its profit for that financial year as it may consider appropriate to the reserves of the company irrespective of the size of the declared dividend.

Dividends out of past profits -The second proviso to Section 123(1) of the Companies Act, 2013 read with the Companies (Declaration and Payment of Dividend) Rules, 2014 provides that in the event of inadequacy or absence of profits in any year, dividend may be declared by a company for that year out of surplus subject to the fulfillment of prescribed conditions.

No dividend from Reserves other than Free Reserves-It is further provided under third proviso to Section 123(1) of the Companies Act, 2013 that no dividend shall be declared or paid by a company from its reserves other than free reserves.

Dividends includes Interim dividend-As per Section 2(35) of the Companies Act, 2013, dividend has been defined to include any interim dividend also.

Dividend policy and related financial considerations -Normally an auditor, in the discharge of his duties is not concerned with the policy about dividends. He is merely concerned with the legality and actual payment of the dividend. The basis of legality is provided by the Companies Act, 2013 and the related Articles of Association. However, sometimes auditors are consulted in the matter of


5.56 ADVANCED AUDITING AND PROFESSIONAL ETHICS deciding upon the quantum of dividend that can be distributed by a company. Apart from this, Chartered Accountants as such also act as consultants to various companies on a number of matters, including dividend. The basic decision about the dividend is that of the management; the shareholders do not have the authority to enhance the sum proposed by the directors unless the articles allow such a procedure. On the other hand, the management, because of its very thorough and intimate knowledge of the financial state of affairs of the company and of the business environment, is considered to be the best equipped to deal with the matter.

Dividend is a phenomenon involved with the question of financial management of the company, rationality or feelings of the shareholders and other allied factors; it is therefore very difficult to lay down any definite policy in this regard. However, as a guiding rule a broad frame of policy has often been adopted by companies for guidance in deciding each year the quantum of dividend having regard to the specific situations faced by the company in the concerned year or situations that are in offing. In deciding upon a policy of dividend the financial considerations generally get the place of prominence, though the aspects of shareholders’ aspirations are also taken into consideration. A balance is generally struck to bring about compromise and adjustment between these without unduly impairing the financial state of the company. In this context, it should be appreciated that the amount of the profit available as dividend has competing claimants. It is a source of finance so far as the company is concerned. This can often be very profitably employed to finance expansion or diversification or for setting right the adverse working capital or liquidity position.

As a general proposition, the following are determinants of dividend policy:

1. Nature of earnings.

2. Re-investment alternative.

3. Dividends and liquidity.

4. Dividends and working capital.

5. Dividends and new capital requirements.

6. Dividends and market value of shares.

7. Tax brackets of shareholders.

8. Stability of dividend.

Payment of Dividends (1) Dividends once declared become the liability of the company and must be paid within 30 days

from the date of declaration. Any failure to do so attracts a penalty for the various persons associated with the management [Section 127].

(2) Payment of dividend on any share should be made only to the registered shareholder of such share or to his order or to his banker. Dividends are not payable except in cash; or by cheque



or warrant; or in any electronic mode to the shareholder entitled to the payment of the dividend.

But the profits or reserves can be capitalised for purpose of issuing fully paid-up bonus shares subject to the guidelines issued by the SEBI also they may be applied for paying up any amount for the time being unpaid on any share held by the members of the company.

(3) A company may, if so authorised by its articles, pay dividends in proportion to the amount paid-up on each share in accordance with Section 51.

(4) The Board may deduct from any dividend payable to any member all sums of money, if any, presently payable by him to the company on account of calls or otherwise in relation to the shares of the company [Table F of Schedule I to the Companies Act, 2013].

Deposit of amount of Dividend in separate bank account - The amount of the dividend, including interim dividend, should be deposited in a scheduled bank in a separate account within 5 days from the date of declaration of such dividend.

As per Section 123(6) of the Act, a company which fails to comply with the provisions of section 73 (manners to be followed while inviting, accepting or renewing deposits under the new Companies Act, 2013 from the public), and section 74 (manners to be followed for repayment of deposits etc. before the commencement of this Companies Act, 2013) shall not, so long as such failure continues, declare any dividend on its equity shares.

Punishment for failure to distribute dividends - According to Section 127 of the Companies Act, 2013, where a dividend has been declared by a company but has not been paid or the warrant in respect thereof has not been posted, within 30 days from the date of declaration to any shareholder entitled to the payment of the dividend, following shall be punishable:

(i) every director of the company, if he is knowingly a party to the default, be punishable with imprisonment which may extend to 2 years and with fine which shall not be less than one thousand rupees for every day during which such default continues and,

(ii) the company shall be liable to pay simple interest at the rate of 18% per annum during the period for which such default continues.

Proviso to Section 127 of the Act provides that no offence under this section shall be deemed to have been committed:-

(a) where the dividend could not be paid by reason of the operation of any law;

(b) where a shareholder has given directions to the company regarding the payment of the dividend and those directions cannot be complied with and the same has been communicated to him;

(c) where there is a dispute regarding the right to receive the dividend;


5.58 ADVANCED AUDITING AND PROFESSIONAL ETHICS (d) where the dividend has been lawfully adjusted by the company against any sum due to it from

the shareholder; or

(e) where, for any other reason, the failure to pay the dividend or to post the warrant within the period under this section was not due to any default on the part of the company.

Unpaid Dividend Account [Section 124]- Section 124 of the Act provides that dividend declared which remains unpaid or unclaimed within 30 days from the date of declaration of such dividend shall be transferred by the company to a special account called “Unpaid Dividend Account” opened in any scheduled bank. Such transfer shall be made within 7 days from the date of expiry of the said period of 30 days. In case of any default in transferring the amount unpaid/ unclaimed dividend to the Unpaid Dividend Account, the company shall pay interest at the rate of 12% per annum on the amount not transferred. The interest accrue on such amount shall endure to the benefit of the members of the company in proportion to the amount remaining unpaid to them.

Any person claiming to be entitled to any of the money transferred to the Unpaid Dividend Account of the company may apply to the company for the payment of the money claimed.

Obligation to place details of transfer to Unpaid Dividend Account on website- The company is required to prepare a statement containing the names, their last known addresses and the unpaid dividend to be paid to each person within a period of 90 days of making any transfer of an amount to the Unpaid Dividend Account and place it on the website of the company, if any, and also on any other website approved by the Central Government for this purpose, in such form, manner and other particulars as may be prescribed.

Unpaid or unclaimed amount of Unpaid Dividend Account- Any money transferred to Unpaid Dividend Account remains unpaid or unclaimed for a period of 7 years from the date of such transfer shall be transferred by the company along with interest accrued, if any, thereon to the Investor Education and Protection Fund.

The company shall send a statement of the details of such transfer to the authority in the Form DIV 5 which administers the said fund and that authority shall issue a receipt to the company an evidence of such transfer.

All shares in respect of which unpaid or unclaimed dividend has been transferred shall also be transferred by the company in the name of Investor Education and Protection Fund along with a statement containing such details as may be prescribed. Any claimant of shares transferred shall be entitled to claim the transfer of shares from Investor Education and Protection Fund in accordance with such procedure and on submission of such documents as may be prescribed.

Sub-section (7) of Section 124 of the Act provides that the company shall be punishable with fine which shall not be less than five lakh rupees but which may be extend to twenty-five lakh rupees. Every officer of the company who is in default shall be punishable with fine which shall not be less than one lakh rupees but which may be extend to five lakh rupees.


COMPANY AUDIT5 . 5.59 Establishment of Investor Education and Protection Fund [Section 125] (1) The Central Government shall establish a fund to becalled the Investor Education and

Protection Fund (hereafter in this section referred to as the “Fund”).

(2) There shall be credited to the Fund the following amounts, namely:

(a) the amount given by the Central Government by way of grants after due appropriation made by Parliament by law in this behalf for being utilised for the purposes of the Fund;

(b) donations given to the Fund by the Central Government, State Governments, companies or any other institution for the purposes of the Fund;

(c) the amount in the Unpaid Dividend Account of companies transferred to the Fund under sub-section (5) of section 124 of the Companies Act, 2013;

(d) the amount in the general revenue account of the Central Government which had been transferred to that account under sub-section (5) of section 205A of the Companies Act, 1956, as it stood immediately before the commencement of the Companies (Amendment) Act, 1999, and remaining unpaid or unclaimed on the commencement of this Act;

(e) the amount lying in the Investor Education and Protection Fund under section 205C of the Companies Act, 1956;

(f) the interest or other income received out of investments made from the Fund;

(g) the amount received under sub-section (4) of section 38;

(h) the application money received by companies for allotment of any securities and due for refund;

(i) matured deposits with companies other than banking companies;

(j) matured debentures with companies;

(k) interest accrued on the amounts referred to in clauses (h) to (j);

(l) sale proceeds of fractional shares arising out of issuance of bonus shares, merger and amalgamation for seven or more years;

(m) redemption amount of preference shares remaining unpaid or unclaimed for seven or more years; and

(n) such other amount as may be prescribed.

It is provided that no such amounts referred to in clauses (h) to (j) shall form part of the Fund unless such amounts have remained unclaimed and unpaid for a period of seven years from the date they became due for payment.


5.60 ADVANCED AUDITING AND PROFESSIONAL ETHICS (3) The Fund shall be utilised for the following purposes in accordance with such rules as may

be prescribed:-

(a) the refund in respect of unclaimed dividends, matured deposits, matured debentures, the application money due for refund and interest thereon;

(b) promotion of investors’ education, awareness and protection;

(c) distribution of any disgorged amount among eligible and identifiable applicants for shares or debentures, shareholders, debenture-holders or depositors who have suffered losses due to wrong actions by any person, in accordance with the orders made by the Court which had ordered disgorgement;

(d) reimbursement of legal expenses incurred in pursuing class action suits under sections 37 and 245 by members, debenture-holders or depositors as may be sanctioned by the Tribunal; and

(e) any other purpose incidental thereto.

It is provided that the person whose amounts referred to in clauses (a) to (d) of sub-section (2) of section 205C of the Companies Act, 1956, transferred to Investor Education and Protection Fund, after the expiry of the period of seven years as per provisions of the Companies Act, 1956, shall be entitled to get refund out of the Fund in respect of such claims in accordance with rules made under this section.

Explanation- The disgorged amount refers to the amount received through disgorgement or disposal of securities.

(4) Any person claiming to be entitled to the amount referred in section 125(2) may apply to the authority constituted under section 125(5) for the payment of the money claimed.

(5) The Central Government shall constitute, by notification, an authority for administration of the fund consisting of a chairperson and such other members, not exceeding seven and a chief executive officer, as the Central Government may appoint.

(6) The manner of administration of the Fund, appointment of chairperson, members and chief executive officer, holding of meetings of the authority shall be in accordance with such rules as may be prescribed.

(7) The Central Government may provide to the authority such offices, officers, employees and other resources in accordance with such rules as may be prescribed.

(8) The authority shall administer the Fund and maintain separate accounts and other relevant records in relation to the Fund in such form as may be prescribed after consultation with the C&AG of India.

(9) It shall be competent for the authority constituted under sub-section (5) to spend money out of the Fund for carrying out the objects specified in sub-section (3) of 125.


COMPANY AUDIT5 . 5.61 The accounts of the Investor Education and Protection Fund is required to be audited by the C&AG of India at such interval as may be specified by him and such audited accounts together with the audit report thereon shall be forwarded annually by the authority to the Central Government.

The authority is required to prepare in such form and at such time for each financial year as may be prescribed its annual report giving a full account of its activities during the financial year and forward a copy thereof to the Central Government. The Central Government shall cause the annual report and the audit report given by the C&AG of India to be laid before each House of Parliament.

16.3 Right to dividend, rights shares and bonus shares to be held in abeyance pending registration of transfer of shares

As per section 126 of the Act, payment of dividend and allotment of bonus and right shares to the transferee to be held in abeyance till the title to shares is decided. This section requires that where any instrument of transfer of shares has been delivered to the company for registration and the transfer of such shares has not been registered by the company, it shall transfer the dividend in relation to such shares to the special account referred to in section 124 i.e. Unpaid Dividend Account unless the company is authorised by the registered holder of such shares in writing to pay such dividend to the transferee specified in such instrument of transfer. Further, the company shall also keep in abeyance in relation to such shares, any offer of right shares and any issue of fully paid up bonus shares.

16.4 Power to close register of members or debenture-holders or other security holders

As per section 91 of the Act, a company may close the register of members or the register of debenture-holders or the register of other security holders for any period or periods not exceeding in the aggregate 45 days in each year, but not exceeding 30 days at any one time, subject to giving of previous notice of at least 7 days or such lesser period as may be specified by Securities and Exchange Board for listed companies or the companies which intend to get their securities listed, in such manner as may be prescribed.

The auditor may take the following steps to ensure that the dividend has been paid only out of profits:

(a) Check whether dividend was declared out of profits arrived at after providing for depreciation as per Section 123(2).

(b) Check whether:

(i) the depreciation was provided according to provisions of Schedule II to the Companies Act, 2013.

(ii) a board resolution recommending dividend was passed.

(iii) the dividend was declared only in the annual general meeting.



(iv) no dividend declared in general meeting exceeds the amount recommended by the Board.

(v) amount paid or credited as paid on a share in advance of calls is not treated for the purpose of this regulation as paid on the share.

(vi) register of members was closed as per the provisions of section 91 of the Companies Act, 2013.

(vii) dividend has been paid in the prescribed manner within 30 days of time to the registered holder or to their order (Section 127).

(viii) Amount of dividend deposited in a separate bank account within 5 days from the date of declaration of dividend.

(ix) intimation sent to stock exchange, in case of listed company.

(x) there were any complaints regarding non-payment or delay in payment of dividend? If, so, whether corrective action was taken.

16.5 Interim Dividend The definition of term dividend has been modified to include interim dividend also. Interim dividend stands at par with the final dividend. Therefore, all aforesaid requirements applicable in case of final dividend would also apply to interim dividend.

The Board of Directors of a company may declare interim dividend during the financial year out of the surplus in the Statement of profit and loss and out of profits of the financial year in which such interim dividend is sought to be declared. Further, if in a case, the company has incurred loss during the current financial year up to the end of the quarter immediately preceding the date of declaration of interim dividend, such interim dividend shall not be declared at a rate higher than the average dividends declared by the company during the immediately preceding 3 financial years.

16.6 Payment of dividend and the Income tax Act Payment of dividends by a company though basically governed by the provisions of the Companies Act, has to reckon with a number of provisions contained in the Income tax Act, having direct or indirect relevance to the determination of the amount of dividend. The Companies Act, 2013 has prescribed the sources from which dividend may be declared/ paid in Section 123. In particular it requires provision for depreciation, setting off of past losses etc. It also provides for the circumstances under which dividend can be paid out of past profits. The manner of payment of the dividend is also provided for in the Companies Act. It may be mentioned that any deviation from these provisions will render the dividend illegal. The payment of dividend is a corporate phenomenon based on accounting, financial and legal considerations. The accounting and legal considerations are highly related. In determining the accounting profit, as indicated above a number of provisions from the Income tax Act have got to be considered. For example, distributable profit of a company gets conditioned by the requirements to create and retain reserves e.g. investment allowance


COMPANY AUDIT5 . 5.63 reserves. It may be pointed out that any departure from the provisions of the Income tax Act will not make the payment of dividend illegal but may increase the tax liability of the company.

16.7 Audit Procedure for “Payment of Dividend” The auditor should obtain appropriate audit evidence as regard to audit of payment of dividends. The procedures include:

(a) Check whether dividend was declared out of profits arrived at after providing for depreciation as per Section 123(2).

(b) Check whether:

(i) the depreciation was provided according to provisions of Schedule II to the Companies Act, 2013.

(ii) a board resolution recommending dividend was passed.

(iii) the dividend was declared only in the AGM.

(iv) thedividend declared in the general meeting does not exceed the amount recommended by the Board.

(v) register of members was closed as per the provisions of section 91 of the Companies Act, 2013.

(vi) dividend has been paid in the prescribed manner within 30 days of time to the registered holder or to their order (Section 127).

(vii) Amount of dividend deposited in a separate bank account within 5 days from the date of declaration of dividend.

(viii) intimation sent to stock exchange, in case of listed company.

(ix) were there any complaints regarding non-payment or delay in payment of dividend? If, so, whether corrective action was taken.

(c) Examine that the accounting and disclosure procedures have been complied with related to the declaration and payment of dividend like depreciation has been provided before declaration, disclosure has been made by way of notes to the accounts etc.

(d) Inspect that the dividend has been paid only out of “free reserves” i.e. the reserves which, as per the latest audited balance sheet of a company, are available for distribution as dividend except- any amount representing unrealized gains, notional gains or revaluation of assets, whether shown as a reserve or otherwise, or any change in carrying amount of an asset or of a liability recognized in equity, including surplus in statement of profit and loss on measurement of the asset or the liability at fair value, as laid down under third proviso to Section 123(1) read with Section 2(43) of the Act.


5.64 ADVANCED AUDITING AND PROFESSIONAL ETHICS (e) If dividend has been paid out of accumulated profits, earned by it in previous years and

transferred to the reserves, in case of inadequacy or absence of profits in any financial years, verify that the rules related to such distribution has been complied i.e. the maximum amount allowable to be distributed as a dividend in case of inadequate or no profit as required by second proviso to Section 123(1) of the Act.

(f) Check the procedures that have been followed for the payment of unclaimed dividend out of unpaid dividend account.

(g) Verify that, if any money transferred to Unpaid Dividend Account has remained unpaid or unclaimed for a period of 7 years from the date of such transfer then, whether it has been transferred by the company along with interest accrued, if any, thereon to the Investor Education and Protection Fund established under section 125(1) of the Act and a statement regarding such transfer has also been sent to the authority which administers such fund.

(h) In case the company has outsourced the activity to the Service Organisation, check that all the compliances with laws, regulations, accounting and disclosure related to the dividends have been made appropriately.

16.8 Reserves The term “reserves” is not defined in Companies Act, 2013. But the term “free reserves” has been defined under section 2(43) of the Act as means such reserves which, as per the latest audited balance sheet of a company, are available for distribution as dividend except- any amount representing unrealized gains, notional gains or revaluation of assets, whether shown as a reserve or otherwise, or any change in carrying amount of an asset or of a liability recognized in equity, including surplus in statement of profit and loss on measurement of the asset or the liability at fair value. Further, as per the relevant extract of the Schedule III to the Companies Act, 2013, “Reserve” has been classified as capital reserve, capital redemption reserve, securities premium reserve, debenture redemption reserve, revaluation reserve, share options outstanding account and other reserves. The Guidance Note on Terms used in Financial Statements issued by the Institute of Chartered Accountants of India defines Reserves as the portion of earnings, receipts or other surplus of an enterprise (whether capital or revenue) appropriated by the management for a general or a specific purpose other than a provision for depreciation or diminution in the value of assets of for a known liability. The reserves are primarily of two types: (a) Capital Reserves and (b) Revenue Reserves.

Such a distinction is essential for disclosing in the balance sheet the amount by which the equity of the shareholders has increased with the accumulation of undistributed profits.

The distribution is carried further by segregating the reserve which is made up of fortuitous gains, unconnected with business activity (e.g., appreciation in values of fixed assets, receipts on account of share premiums), from those appropriated out of profits for credit to revenue reserve; the first is described as a capital reserve and the second merely as a reserve. The Companies Act does not


COMPANY AUDIT5 . 5.65 specify the categories of accretions to the shareholders funds which are to be credited to the Capital Reserve, except indirectly by providing that the amounts, which in the opinion of directors cannot be distributed as a dividend through the Statement of Profit and Loss are to be credited to such a reserve. The language of the provision appears to suggest that directors are vested with an unrestricted right to decide which of the amounts to be credited to the Capital Reserve subject only to provisions of the Act as regards certain funds not being available for distribution as dividend. But, it is not so, for they cannot violate the accepted principles of accountancy which determine whether or not an item of income is capital or revenue. It may also be remembered that an appropriation once made can be revoked.

The following are examples of amounts retained in the business that are credited to one reserve account or another:

(1) Securities Premium Reserve (Capital Reserve).

(2) Capital Redemption Reserve created in pursuance of provision contained in Section 55 of the Companies Act, 2013 (Capital Reserve).

(3) Debenture Redemption Reserve created in pursuance of provision contained in Section 71 of the Companies Act, 2013 (Capital Reserve).

(4) Profit on reissue of forfeited share (Capital Reserve).

(5) Free Reserve available for distribution of dividend (Revenue Reserve).

Attention of the students is drawn to the provisions of Section 123 of the Companies Act, 2013, discussed earlier, about restrictions in the utilisation of past profit kept in reserves for dividend purposes.

16.9 Deferred Taxation It is a common experience that the profit or loss as per the Statement of Profit and Loss will be different from the income ultimately assessed to income tax. It is also generally different from the income shown in the tax-return submitted to ‘tax authorities’. Consequently the taxation liability that is provided for in the accounts does not bear any direct relationship to the profit disclosed and readers of such account are left to guess the reasons. For instance, income tax should be treated on the same footing as is done in case of other expenses i.e., accounted for on accrual basis. From a management point of view income tax is an item of expense rather than an appropriation of pre-tax profit. AS-22 on “Accounting for Taxes on Income” or Ind AS 12 now requires that tax should be treated as an expense. Students are advised to go relevant accounting standard for comprehensive understanding.

16.10 Non-provision of tax in the accounts The Council of the Institute of Chartered Accountants of India has taken note of the fact that there is a practice prevalent whereby companies do not make provision for tax even when such a liability is anticipated. It has expressed the view that on an overall consideration of the relevant provisions


5.66 ADVANCED AUDITING AND PROFESSIONAL ETHICS of law, non-provision for tax (where a liability is anticipated) would amount to contravention of the provisions of Sections 128 and 129 of the Companies Act, 2013. Accordingly, it is necessary for the auditor to qualify his report and such qualification should bring out the manner in which the accounts do not disclose a “true and fair” view of the state of affairs of the company and the profit or loss of the company. An example of the manner in which the report on the balance sheet and the Statement of Profit and Loss may be qualified in this respect is given below:

“The company has not provided for taxation in respect of its profits and the estimated aggregate amount of taxation not so provided for is ` ............ including ` ............. for the Year ended on ..............To the extent of such non-provision for the year, the profits of the Company for the financial year under report have been overstated and to the extent of such aggregate non provision, the reserves of the company appearing in the said balance sheet have been over-stated and the current liabilities and provisions appearing in the said balance sheet have been understated”.

As per Section 134 of the Companies Act, 2013:

(1) The financial statement, including consolidated financial statement, if any, shall be approved by the Board of Directors before they are signed on behalf of the Board by the chairperson of the company where he is authorized by the Board or by two directors out of which one shall be managing director, if any, and the Chief Executive Officer, the Chief Financial Officer and the company secretary of the company, wherever they are appointed, or in the case of One Person Company, only by one director, for submission to the auditor for his report thereon.

(2) The auditors’ report shall be attached to every financial statement.

(3) There shall be attached to statements laid before a company in general meeting, a report by its Board of Directors, which shall include—

(a) the web address, if any, where annual return referred to in sub-section (3) of section 92 has been placed;

(b) number of meetings of the Board;

(c) Directors’ Responsibility Statement;

(ca) details in respect of frauds reported by auditors under sub-section (12) of section 143 other than those which are reportable to the Central Government;

(d) a statement on declaration given by independent directors under sub-section (6) of section 149;

(e) in case of a company covered under sub-section (1) of section 178, company’s policy on directors’ appointment and remuneration including criteria for determining qualifications, positive attributes, independence of a director and other matters provided under sub-section (3) of section 178;



(f) explanations or comments by the Board on every qualification, reservation or adverse remark or disclaimer made—

(i) by the auditor in his report; and

(ii) by the company secretary in practice in his secretarial audit report;

(g) particulars of loans, guarantees or investments under section 186;

(h) particulars of contracts or arrangements with related parties referred to in sub-section (1) of section 188 in the prescribed form;

(i) the state of the company’s affairs;

(j) the amounts, if any, which it proposes to carry to any reserves;

k) the amount, if any, which it recommends should be paid by way of dividend;

(l) material changes and commitments, if any, affecting the financial position of the company which have occurred between the end of the financial year of the company to which the financial statements relate and the date of the report;

(m) the conservation of energy, technology absorption, foreign exchange earnings and outgo, in such manner as may be prescribed;

(n) a statement indicating development and implementation of a risk management policy for the company including identification therein of elements of risk, if any, which in the opinion of the Board may threaten the existence of the company;

(o) the details about the policy developed and implemented by the company on corporate social responsibility initiatives taken during the year;

(p) in case of a listed company and every other public company having such paid-up share capital as may be prescribed, a statement indicating the manner in which formal annual evaluation of the performance of the Board, its Committees and of individual directors has been made;

(q) such other matters as may be prescribed.

Provided that where disclosures referred to in this sub-section have been included in the financial statements, such disclosures shall be referred to instead of being repeated in the Board's report.

Provided further that where the policy referred to in clause (e) or clause (o) is made available on company's website, if any, it shall be sufficient compliance of the requirements under such clauses if the salient features of the policy and any change therein are specified in brief in the Board's report and the web-address is indicated therein at which the complete policy is available.

(3A) The Central Government may prescribe an abridged Board's report, for the purpose of compliance with this section by One Person Company or small company.



(4) The report of the Board of Directors to be attached to the financial statement under this section shall, in case of a One Person Company, mean a report containing explanations or comments by the Board on every qualification, reservation or adverse remark or disclaimer made by the auditor in his report. (5) The Directors’ Responsibility Statement referred to in clause (c) of sub-section (3) shall state that—

(a) in the preparation of the annual accounts, the applicable accounting standards had been followed along with proper explanation relating to material departures;

(b) the directors had selected such accounting policies and applied them consistently and made judgments and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the company at the end of the financial year and of the profit and loss of the company for that period;

(c) the directors had taken proper and sufficient care for the maintenance of adequate accounting records in accordance with the provisions of this Act for safeguarding the assets of the company and for preventing and detecting fraud and other irregularities;

(d) the directors had prepared the annual accounts on a going concern basis; and

(e) the directors, in the case of a listed company, had laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively.

Explanation.—For the purposes of this clause, the term “internal financial controls” means the policies and procedures adopted by the company for ensuring the orderly and efficient conduct of its business, including adherence to company’s policies, the safeguarding of its assets, the prevention and detection of frauds and errors, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information;

(f) the directors had devised proper systems to ensure compliance with the provisions of all applicable laws and that such systems were adequate and operating effectively.

(6) The Board’s report and any annexures thereto under sub-section (3) shall be signed by its chairperson of the company if he is authorised by the Board and where he is not so authorised, shall be signed by at least two directors, one of whom shall be a managing director, or by the director where there is one director. (7) A signed copy of every financial statement, including consolidated financial statement, if any, shall be issued, circulated or published along with a copy each of— (a) any notes annexed to or forming part of such financial statement; (b) the auditor’s report; and



(c) the Board’s report referred to in sub-section (3). (8) If a company contravenes the provisions of this section, the company shall be punishable with fine which shall not be less than fifty thousand rupees but which may extend to twenty-five lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to three years or with fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees, or with both.

17. DEPRECIATION Section 123 prohibits a company from declaring dividend out of its profits before providing for depreciation in the manner laid down in the section.

Section 123 provides that the dividend shall be declared or paid by a company for any financial year out of the profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of Schedule II “Useful lives to compute Depreciation”, to the Companies Act, 2013.

Schedule II to the Act, provides that useful life of an asset shall not ordinarily be different from the useful life specified in Part ‘C’ to the said Schedule and the residual value of an asset shall not be more than 5% of the original cost of the asset. If a company does not use the useful life or residual value of the asset as provided in the Schedule II, then justification for the difference shall be disclosed in its financial statement.

Where during any financial year, any addition has been made to any asset, or where any asset has been sold, discarded, demolished or destroyed, the depreciation on such asset shall be calculated on a pro rata basis from the date of such addition, or as the case may be, upto the date on which such asset has been sold, discarded, demolished or destroyed.

If an asset is used for any time during the year for double shift, the depreciation will increase by 50% for that period and in case of the triple shift the depreciation shall be calculated on the basis of 100% for that period.

The useful life or residual value of any specific asset as notified for accounting purpose by a Regulatory Authority constituted under an Act of Parliament or by the Central Government shall be applied in calculating the depreciation to be provided for such asset irrespective of the requirements of Schedule II.

The Schedule II to the Companies Act, 2013 needs disclosure in the financial statements about the depreciation method used and the useful lives of the assets for computing depreciation, if they are different from the life specified in the Schedule II.

Schedule III “General Considerations for preparation of Balance Sheet and Statement of Profit and Loss of a Company”, to the Companies Act, 2013, requires separate disclosure of depreciation charged and impairment losses/reversals along with a reconciliation of the gross and net carrying amounts of each class of assets at the beginning and end of the reporting period showing additions, disposals, acquisitions through business combinations and other adjustments.


5.70 ADVANCED AUDITING AND PROFESSIONAL ETHICS Section 123(1) of the Companies Act, 2013 also prescribes that if a company has not provided for depreciation for any previous financial year it shall, before declaring, or paying dividend, provide for such depreciation:

(a) either out of the profits of that financial year, or

(b) out of the profits of any other previous financial year or years.

The implication of this provision is that if, for example, the profits of a company for the year ending 31st March, 2014 are proposed to be distributed, and it is found that due to inadequacy of profits no provision for depreciation had been made for the year ended 31st March, 2013 it would be necessary to make provisions in respect of the depreciation, for the year ended 31st March, 2013 as well as 2014 and only the balance of the profits for the year 31st March, 2014 would be available for distribution as a dividend.

Ascertainment of depreciation for computing net profits for the purpose of managerial remuneration: Under Section 197(1) of the Companies Act, 2013, depreciation calculated in the manner specified in Section 198 of the Companies Act, 2013 must be deducted for arriving at the amount of net profits, on which remuneration payable to managerial personnel is to be calculated.

18. SALIENT FEATURES OF LIMITED LIABILITY PARTNERSHIPS (LLP) AUDIT

An LLP shall be under obligation to maintain annual accounts reflecting true and fair view of its state of affairs. A “Statement of Accounts and Solvency” in prescribed form shall be filed by every LLP with the Registrar every year.

The accounts of every LLP shall be audited in accordance with Rule 24 of LLP Rules 2009. Such rules, inter-alia, provide that any LLP, whose turnover does not exceed, in any financial year, forty lakh rupees, or whose contribution does not exceed twenty five lakh rupees, is not required to get its accounts audited. However, if the partners of such limited liability partnership decide to get the accounts of such LLP audited, the accounts shall be audited only in accordance with such rule.

No mandatory insurance has been proposed in the Act. It would be difficult to assess insurance requirements of different types and sizes of LLPs. This would depend upon the nature of commercial risk attached with work or assignment handled by each. Applying common insurance requirements across a class of LLPs would result in increasing their costs of operation. Therefore, the underlying


COMPANY AUDIT5 . 5.71 concern as to the credit worthiness of the LLP in the event of a contractual default is being addressed through statutory provisions for solvency declaration, disclosure of financial information and audit.

Every LLP would be required to file annual return in Form 11 with ROC within 60 days of closer of financial year. The annual return will be available for public inspection on payment of prescribed fees to Registrar.

Every LLP is also required to submit Statement of Account and Solvency in Form 8 which shall be filed within a period of 30 days from the end of 6 months of the financial year to which the Statement of Account and Solvency relates.

Registrar would have power to obtain such information which he may consider necessary for the purposes of carrying out the provisions of the Act, from any designated partner, partner or employee of the LLP. He would also have power to summon any designated partner, partner or employee of any LLP before him for any such purpose, in case the information has not been furnished to him or in case the Registrar is not satisfied with the information furnished to him.

The following documents/information will be available for inspection by any person:- • Incorporation document, • Names of partners and changes, if any, made therein, • Statement of Account and Solvency • Annual Return The fees for such inspection of an LLP is Rs 50/- and fees for certified copy or extract of any document u/s 36 shall Rs. 5/- per page.

The provisions of the Act require LLPs to file the documents like Statement of Account and Solvency (SAS) and Annual Return (AR) and notices in respect of changes among partners etc. within the time specifically indicated in relevant provisions. The Act contains provisions for allowing LLPs to file such documents after their due dates on payment of additional fees. It has been provided that in case LLPs file relevant documents after their due dates with additional fees upto 300 days, no action for prosecution will be taken against them. In case there is delay of 300 days or more, the LLPs will be required to pay normal filing fees, additional fee and shall also be liable to be prosecuted.

The Act also contains provisions for compounding of offences which are punishable with fine only.

Appointment of Auditor: The auditor may be appointed by the designated partners of the LLP –

1. At any time for the first financial year but before the end of first financial year,

2. At least thirty days prior to the end of each financial year (other than the first financial year),

3. To fill the causal vacancy in the office of auditor,

4. To fill the casual vacancy caused by removal of auditor.

The partners may appoint the auditors if the designated partners have failed to appoint them.


5.72 ADVANCED AUDITING AND PROFESSIONAL ETHICS LLP’s are required to maintain books of accounts which shall contain-

1. Particulars of all sums of money received and expended by the LLP and the matters in respect of which the receipt and expenditure takes place,

2. A record of the assets and liabilities of the LLP,

3. Statements of costs of goods purchased, inventories, work-in-progress, finished goods and costs of goods sold,

4. Any other particulars which the partners may decide. Advantages / Purpose / Need of Audit

1. Auditing the accounts of a LLP helps in detecting errors & frauds & verification of financial statements.

2. Disputes, if any between any partners in the matter of accounts can be settled with the help of audited accounts.

3. Banks & financial institutions lend money to the firms only on the basis of audited accounts.

4. Periodical visits & suggestions by the auditor will be helpful in improving the management of the LLP.

5. For settling accounts between partners at the time of admission, death, retirement, insolvency, insanity, etc audited accounts are accepted by those concerned who have dealings with the LLP.

Auditor’s Duty Regarding Audit of LLP

1. The auditor should get definite instructions in writing as to the work to be performed by him.

2. The auditor should mention-

a) Whether the records of the firm appear to be correct & reliable.

b) Whether he was able to obtain all information & explanation necessary for his work.

c) Whether any restriction was imposed upon him.

3. The auditor should read the LLP agreement & note the following provisions-

a) Nature of the business of the LLP.

b) Amount of capital contributed by each partner.

c) Interest – in respect of additional capital contributed.

d) Duration of partnership.

e) Drawings allowed to the partners.

f) Salaries, commission etc payable to partners.



g) Borrowing powers of the LLP.

h) Rights & duties of partners.

i) Method of settlement of accounts between partners at the time of admission, retirement, admission etc.

j) Any loans advanced by the partners.

k) Profit sharing ratio.

4. If partners maintain minute book he shall refer it for any resolution passed regarding the accounts.

(Source: LLP Rules 2009 and http://www.mca.gov.in/MinistryV2/disclosureauditandfilingrequirements.html)http://www.mca.gov.in/MinistryV2/llpefiling.html

19. AUDIT REPORT Auditor’s Report - An audit report should be clear, specific and complete, in order that anyone who reads it may know clearly about the company. An auditor who gives the shareholders “the means of information” in respect of company’s financial position, does so, at his peril and runs the serious risk of being held judicially to have failed to discharge his duty (Lindley L.J in Re London and General Bank).

The auditor should review and assess the conclusions drawn from the audit evidence obtained as the basis for the expression of an opinion on the financial statements. This review and assessment involves considering whether the financial statements have been prepared in accordance with an acceptable financial reporting framework applicable to the entity under audit. It is also necessary to consider whether the financial statements comply with the relevant statutory requirements.

The auditor’s report should contain a clear written expression of opinion on the financial statements taken as a whole.

(Students may refer Chapter 6 on Audit Report for detailed reporting requirements as prescribed under Standards on Auditing).

19.1 Reporting Under CARO, 2016 In exercise of the powers conferred by section 143(11) of the Companies Act, 2013, the Central Government, after consultation with the Institute of Chartered Accountants of India, has issued the Companies (Auditor’s Report) Order, 2016, (CARO, 2016) dated 29th March, 2016.

1. Applicability of the Order: The CARO, 2016 is an additional reporting requirement. The order applies to every company including a foreign company as defined in clause (42) of section 2 of the Companies Act, 2O13. However, the Order specifically exempts the following classes of companies:


http://www.mca.gov.in/MinistryV2/disclosureauditandfilingrequirements.html


(i) a banking company as defined in clause (c) of section 5 of the Banking Regulation

Act, 1949 (10 of 1949);

(ii) an insurance company as defined under the Insurance Act,1938 (4 of 1938);

(iii) a company licensed to operate under section 8 of the Companies Act;

(iv) a One Person Company as defined under clause (62) of section 2 of the Companies Act and a small company as defined under clause (85) of section 2 of the Companies Act; and

(v) a private limited company, not being a subsidiary or holding company of a public company, having a paid up capital and reserves and surplus not more than rupees one crore as on the balance sheet date and which does not have total borrowings exceeding rupees one crore from any bank or financial institution at any point of time during the financial year and which does not have a total revenue as disclosed in Scheduled III to the Companies Act, 2013 (including revenue from discontinuing operations) exceeding rupees ten crore during the financial year as per the financial statements.

2. Auditor's report to contain matters specified in paragraphs 3 and 4 - Every report made by the auditor under section 143 of the Companies Act, 2013 on the accounts of every company audited by him, to which this Order applies, for the financial year, shall in addition, contain the matters specified in paragraphs 3 and 4, as may be applicable.

Banking company

Insurance company

Company licensed to

operate under section 8 of the Companies Act

One Person Company

Small company as per the

Companies Act

Private limited company subject to

fulfilment of specified

conditions

Exempted Classes of Companies



It may be noted that the Order shall not apply to the auditor’s report on consolidated financial statements.

3. Matters to be included in the auditor's report - The auditor's report on the accounts of a company to which this Order applies shall include a statement on the following matters, namely:-

(i) (a) whether the company is maintaining proper records showing full particulars, including quantitative details and situation of fixed assets;

(b) whether these fixed assets have been physically verified by the management at reasonable intervals; whether any material discrepancies were noticed on such verification and if so, whether the same have been properly dealt with in the books of account;

(c) whether the title deeds of immovable properties are held in the name of the company. If not, provide the details thereof;

(ii) whether physical verification of inventory has been conducted at reasonable intervals by the management and whether any material discrepancies were noticed and if so, whether they have been properly dealt with in the books of account;

(iii) whether the company has granted any loans, secured or unsecured to companies, firms, Limited Liability Partnerships or other parties covered in the register maintained under section 189 of the Companies Act, 2013. If so,

(a) whether the terms and conditions of the grant of such loans are not prejudicial to the company’s interest;

(b) whether the schedule of repayment of principal and payment of interest has been stipulated and whether the repayments or receipts are regular;

(c) if the amount is overdue, state the total amount overdue for more than ninety days, and whether reasonable steps have been taken by the company for recovery of the principal and interest;

(iv) in respect of loans, investments, guarantees, and security whether provisions of section 185 and 186 of the Companies Act, 2013 have been complied with. If not, provide the details thereof.

(v) in case, the company has accepted deposits, whether the directives issued by the Reserve Bank of India and the provisions of sections 73 to 76 or any other relevant provisions of the Companies Act, 2013 and the rules framed there under, where applicable, have been complied with? If not, the nature of such contraventions be stated; If an order has been passed by Company Law Board or National Company Law Tribunal or Reserve Bank of India or any court or any other tribunal, whether the same has been complied with or not?



(vi) whether maintenance of cost records has been specified by the Central Government under section 148(1) of the Companies Act, 2013 and whether such accounts and records have been so made and maintained.

(vii) (a) whether the company is regular in depositing undisputed statutory dues including provident fund, employees' state insurance, income-tax, sales-tax,Goods and Services Tax (with effect from July 1, 2017), service tax, duty of customs, duty of excise, value added tax, cess and any other statutory dues to the appropriate authorities and if not, the extent of the arrears of outstanding statutory dues as on the last day of the financial year concerned for a period of more than six months from the date they became payable, shall be indicated;

(b) where dues of income tax or sales tax or service tax or duty of customs or duty of excise or value added tax have not been deposited on account of any dispute, then the amounts involved and the forum where dispute is pending shall be mentioned. (A mere representation to the concerned Department shall not be treated as a dispute).

(viii) whether the company has defaulted in repayment of loans or borrowing to a financial institution, bank, Government or dues to debenture holders? If yes, the period and the amount of default to be reported (in case of defaults to banks, financial institutions, and Government, lender wise details to be provided).

(ix) whether moneys raised by way of initial public offer or further public offer (including debt instruments) and term loans were applied for the purposes for which those are raised. If not, the details together with delays or default and subsequent rectification, if any, as may be applicable, be reported;

(x) whether any fraud by the company or any fraud on the Company by its officers or employees has been noticed or reported during the year; If yes, the nature and the amount involved is to be indicated;

(xi) whether managerial remuneration has been paid or provided in accordance with the requisite approvals mandated by the provisions of section 197 read with Schedule V to the Companies Act? If not, state the amount involved and steps taken by the company for securing refund of the same;

(xii) whether the Nidhi Company has complied with the Net Owned Funds to Deposits in the ratio of 1: 20 to meet out the liability and whether the Nidhi Company is maintaining ten per cent unencumbered term deposits as specified in the Nidhi Rules, 2014 to meet out the liability;

(xiii) whether all transactions with the related parties are in compliance with sections 177 and 188 of Companies Act, 2013 where applicable and the details have been disclosed in the Financial Statements etc., as required by the applicable accounting standards;



(xiv) whether the company has made any preferential allotment or private placement of shares or fully or partly convertible debentures during the year under review and if so, as to whether the requirement of section 42 of the Companies Act, 2013 have been complied with and the amount raised have been used for the purposes for which the funds were raised. If not, provide the details in respect of the amount involved and nature of non-compliance;

(xv) whether the company has entered into any non-cash transactions with directors or persons connected with him and if so, whether the provisions of section 192 of Companies Act, 2013 have been complied with;

(xvi) whether the company is required to be registered under section 45-IA of the Reserve Bank of India Act, 1934 and if so, whether the registration has been obtained.

Examples-

1. ABC Pvt. Ltd. is a holding company of XYZ ltd. Whether CARO is applicable to ABC Pvt. Ltd.?

CARO 2016 will be applicable to a private limited company which is holding company of a public company. Therefore, CARO shall be applicable to ABC Pvt. Ltd.

2. Physical verification of only 30% (in value) of items of inventory has been conducted by the company. The balance 70% will be conducted in next year due to lack of time and resources.

Reporting for Physical Verification of Inventory: clause (ii) of Para 3 of CARO, 2016 requires the auditor to state in his report whether physical verification of inventory has been conducted at reasonable interval by the management. What constitutes “reasonable intervals” depends on circumstances of each case. The periodicity of the physical verification of inventories depends upon the nature of inventories, their location and the feasibility of conducting a physical verification. The management of a company normally determines the periodicity of the physical verification of inventories considering these factors. Normally, wherever practicable, all the items of inventories should be verified by the management of the company at least once in a year. The auditor in order to satisfy himself about verification at reasonable intervals should examine the adequacy of evidence and records of verification.

In the given case, the above requirement of CARO, 2016 has not been fulfilled as such and the auditor should point out the specific areas where he believes the procedure of inventory verification is not reasonable. He may consider the impact on financial statement and report accordingly.

3. K Ltd. took a term loan from a nationalized bank in 2014 for ` 200 lakhs repayable in five equal instalments of ` 40 lakhs from 31st March, 2015 onwards. It repaid the loans due in 2015 & 2016, but defaulted in 2017, 2018 & 2019. As the auditor of K



Ltd, what is your responsibility assuming that company has sought reschedulement of loan?

Reporting for Default in Repayment of Dues: As per clause (viii) of Para 3 of CARO, 2016, the auditor of a company has to report whether the Company has defaulted in repayment of its dues to a financial institution or bank or debentures holders and if yes, the period and amount of default to be reported.

In this case, K Ltd. has defaulted in repayment of dues for three years. Application for rescheduling will not change the default position. Hence the auditor shall report in his CARO report that the Company has defaulted in its repayment of dues to the bank to the extent of ` 120 lakhs and evaluate its consequential impact on the audit report as well.

4. LM Ltd. had obtained a term loan of ` 300 lakhs from a bank for the construction of a factory. Since there was a delay in the construction activities, the said funds were temporarily invested in short term deposits.

Term loan invested in short term deposits: As per clause (ix) of Para 3 of CARO, 2016, an auditor need to state in his report that whether the term loans were applied for the purpose for which the loans were obtained.

In the present case, the term loan obtained by LM Ltd. have not been put to use for construction activities and temporarily invested the same in short term deposit.

Here, the auditor should report the fact in his report that pending utilization of the term loan for construction of a factory, the funds were temporarily used for the purpose other than the purpose for which the loan was sanctioned as per clause (ix) of Para 3 of CARO, 2016.

5. For the purpose of assessing applicability of CARO, what kind of loansneedto be considered?

Borrowings from banks or financial institutions can be long term or short term and are normally in the form of term loans, demand loans, export credits, cash credits, overdraft facilities, bills purchased or discounted. Outstanding balances of such borrowings should be considered as borrowing outstanding for the purpose of computing the limit of rupees one crore. Non-fund based credit facilities, to the extent such facilities have devolved and have been converted into fund-based credit facilities, should also be considered as outstanding borrowings. The figures of outstanding borrowing would also include the amount of bank guarantees issued by the company where such guarantee(s) has (have) been invoked and encashed or where, say, a letter of credit has been devolved on the company. In case of term loans, interest accrued and due is considered as a borrowing whereas interest accrued but not due is not considered as a borrowing. Further, in case the company enjoys a facility, say, a cash credit facility, whose balance



is fluctuating in nature, the Order would apply to the company in case on any day during the financial year concerned, the amount outstanding in the cash credit facility exceeds Rs. one crore as per books of the company along with other borrowings.

6. Whether CARO is Applicable to the auditor of consolidated financial statement?

Order shall not apply to the auditor’s report on consolidated financial statements.

7. What documents constitute title deed?

Following documents mainly constitute title deeds of the immovable property:-

(i) Registered sale deed / transfer deed / conveyance deed, etc. of land, land & building together, etc. purchased, allotted, transferred by any person including any government, government authority / body / agency/ corporation, etc. to the company.

(ii) In case of leasehold land and land & buildings together, covered under the head fixed assets, the lease agreement duly registered with the appropriate authority.

8. Should the auditor examine the cost record in detail while reporting under CARO?

CARO does not require a detailed examination of Cost Records. The Auditor should, therefore, conduct a general review of Cost Records to ensure that the records as prescribed are made and maintained. The word "made" applies in respect of Cost Accounts, and the word "maintained" applies in respect of Cost Records relating to Materials, Labour, Overheads, etc.

4. Reasons to be stated for unfavourable or qualified answers-

(a) Where, in the auditor's report, the answer to any of the questions referred to in paragraph 3 is unfavourable or qualified, the auditor's report shall also state the basis for such unfavourable or qualified answer, as the case may be.

(b) Where the auditor is unable to express any opinion on any specified matter, his report shall indicate such fact together with the reasons as to why it is not possible for him to give his opinion on the same.

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APPENDIX 1

Questions on CARO 2016 1. Whether the Nidhi Company has complied with the Net Owned Funds to Deposits in the ratio

of 1:20 to meet out the liability and whether the Nidhi Company is maintaining ten per cent unencumbered term deposits as specified in the Nidhi Rules, 2014 to meet out the liability? [Paragraph 3(xii)]


5.80 ADVANCED AUDITING AND PROFESSIONAL ETHICS Ans.Relevant Provisions

(a) This clause requires the auditor to report whether, in the case of a Nidhi Company, net-owned funds to deposit liability ratio is more than 1:20 and the Nidhi Company is maintaining ten per cent unencumbered term deposits as specified in the Nidhi Rules 2014 to meet out the liability.

(b) Section 406(1) of the Act defines “Nidhi” to mean a company which has been incorporated as a Nidhi with the object of cultivating the habit of thrift and savings amongst its members, receiving deposits from, and lending to, its members only, for their mutual benefit, and which complies with such rules as are prescribed by the Central Government for regulation of such class of companies.

(c) It may be noted that MCA on 31st March 2014, vide its Notification No. GSR 258(E) notified the ‘Nidhi Rules 2014’, which came into force on the first day of April 2014. These Rules apply to Nidhicompany incorporated as a Nidhi pursuant to the provisions of Section 406 of the Act and also to the Nidhi companies declared under sub-section (1) of section 620A of the Companies Act 1956.

Audit Procedures and Reporting

(d) It may be noted that Rule 5(1) prescribes the requirements for minimum number of members, net owned fund etc. As per Rule 5(1) every Nidhi shall, within a period of one year from the commencement of these rules, ensure that it has— (i) not less than two hundred members; (ii) net owned funds of ten lakh rupees or more; (iii) unencumbered term deposits of not less than ten per cent of the outstanding deposits as specified in Rule 14; and (iv) ratio of net owned funds to deposits of not more than 1:20. The auditor should note that as such a Nidhi Company can accept deposits not exceeding twenty times of its net owned funds as per last audited balance sheet. Furthermore, as per Rule 14, every Nidhi is to invest and continue to keep invested, in encumbered term deposits with a Scheduled commercial bank (other than a co-operative bank or a regional rural bank), or post office deposits in its own name an amount which shall not be less than ten per cent of the deposits outstanding at the close of business on the last working day of the second preceding month, which needs to be examined.

(e) As per Rule 3(d), Net Owned Funds are defined as the aggregate of paid up equity share capital and free reserves as reduced by accumulated losses and intangible assets appearing in the last audited balance sheet: Provided that, the amount representing the proceeds of issue of preference shares, shall not be included for calculating Net Owned Funds.

(f) A Nidhi company can accept fixed deposits, recurring deposits accounts and savings deposits from its members in accordance with the directions notified by the Central Government. The aggregate of such deposits is referred to as “deposit liability”.


COMPANY AUDIT5 . 5.81 (g) The auditor should ask the management to provide the computation of the deposit liability

and net owned funds on the basis of the requirements contained herein above. This would enable him to verify that the ratio of deposit liability to net owned funds is in accordance with the requirements prescribed in this regard. The auditor should verify the ratio using the figures of net owned funds and deposit liability computed in accordance with what is stated above. The comments of the auditor should be based upon such a statement provided by the management and verification of the same by the auditor.

(h) The auditor may report, incorporating the following as at the balance sheet date:- (i) In case of shortfall in the ratio of net owned funds to the deposits, report the amount of shortfall and state the actual ratio of net owned funds to the deposits. (ii) In case of shortfall with regard to the minimum amount of 10% as unencumbered term deposits, as specified in Nidhi Rules 2014, report the amount thereof.

2. Whether any fraud by the company or any fraud on the company by its officers or employees has been noticed or reported during the year; If yes, the nature and the amount involved is to be indicated? [Paragraph 3(x)]

Ans.Relevant Provisions

(a) This clause requires the auditor to report whether any fraud by the company or any fraud on the company by its officers or employees has been noticed or reported during the year. If yes, the auditor is required to state the amount involved and the nature of fraud. The clause does not require the auditor to discover such frauds. The scope of auditor’s inquiry under this clause is restricted to frauds ‘noticed or reported’ during the year. The use of the words “noticed or reported” indicates that the management of the company should have the knowledge about the frauds by the company or on the company by its Officer and employees that have occurred during the period covered by the auditor’s report. It may be noted that this clause of the Order, by requiring the auditor to report whether any fraud by the company or on the company by its Officer or employees has been noticed or reported, does not relieve the auditor from his responsibility to consider fraud and error in an audit of financial statements. In other words, irrespective of the auditor’s comments under this clause, the auditor is also required to comply with the requirements of Standard on Auditing (SA) 240, “The Auditor’s Responsibility Relating to Fraud in an Audit of Financial Statements”. In this context, the auditor should also have regard to the Guidance Note on Reporting on Fraud under Section 143(12) of the Companies Act, 2013, issued by ICAI.

(b) The term "fraud" refers to an intentional act by one or more individuals among management, those charged with governance, employees, involving the use of deception to obtain an unjust or illegal advantage. Although fraud is a broad legal concept, the auditor is concerned with fraudulent acts that cause a material misstatement in the financial statements. Misstatement of the financial statements may not be the objective of some frauds. Auditors do not make legal determinations of whether fraud has actually occurred. Fraud involving one or more members of management or those charged with governance is referred to as "management



fraud"; fraud involving only employees including officers of the entity is referred to as "employee fraud". In either case, there may be collusion with third parties outside the entity. In fact, generally speaking, the “management fraud” can be construed as “fraud by the company”.

(c) Two types of intentional misstatements are relevant to the auditor's consideration of fraud - misstatements resulting from fraudulent financial reporting and misstatements resulting from misappropriation of assets.

(d) Fraudulent financial reporting involves intentional misstatements or omissions of amounts or disclosures in financial statements to deceive financial statement users. Fraudulent financial reporting may involve: (i) Deception such as manipulation, falsification, or alteration of accounting records or supporting documents from which the financial statements are prepared. (ii) Misrepresentation in, or intentional omission from, the financial statements of events, transactions or other significant information. (iii) Intentional misapplication of accounting principles relating to measurement, recognition, classification, presentation, or disclosure.

(e) Misappropriation of assets involves the theft of an entity's assets. Misappropriation of assets can be accomplished in a variety of ways (including embezzling receipts, stealing physical or intangible assets, or causing an entity to pay for goods and services not received); it is often accompanied by false or misleading records or documents in order to conceal the fact that the assets are missing.

(f) Fraudulent financial reporting may be committed by the company because management is under pressure, from sources outside or inside the entity, to achieve an expected (and perhaps unrealistic) earnings target particularly when the consequences to management of failing to meet financial goals can be significant. The auditor must appreciate that a perceived opportunity for fraudulent financial reporting or misappropriation of assets may exist when an individual believes internal control could be circumvented, for example, because the individual is in a position of trust or has knowledge of specific weaknesses in the internal control system.


(g) While planning the audit, the auditor should discuss with other members of the audit team, the susceptibility of the company to material misstatements in the financial statements resulting from fraud. While planning, the auditor should also make inquiries of management to determine whether management is aware of any known fraud or suspected fraud that the company is investigating.

(h) The auditor should examine the reports of the internal auditor with a view to ascertain whether any fraud has been reported or noticed by the management. The auditor should examine the minutes of the audit committee meetings/ board meetings to ascertain whether any instance of fraud pertaining to the company has been reported and actions taken thereon. The auditor



should enquire from the management about any frauds on the company that it has noticed or that have been reported to it. The auditor should also discuss the matter with other employees including officers of the company.

(i) The auditor should obtain written representations from management that: (i) it acknowledges its responsibility for the implementation and operation of accounting and internal control systems that are designed to prevent and detect fraud and error; (ii) it believes the effects of those uncorrected misstatements in financial statements, aggregated by the auditor during the audit are immaterial, both individually and in the aggregate, to the financial statements taken as a whole. A summary of such items should be included in or attached to the written representation; (iii) it has disclosed to the auditor all significant facts relating to any frauds or suspected frauds known to management that may have affected the entity; and (iv) it has disclosed to the auditor the results of its assessment of the risk that the financial statements may be materially misstated as a result of fraud.

(j) Because management is responsible for adjusting the financial statements to correct material misstatements, it is important that the auditor obtains written representation from management that any uncorrected misstatements resulting from fraud are, in management's opinion, immaterial, both individually and in the aggregate. Such representations are not a substitute for obtaining sufficient appropriate audit evidence. In some circumstances, management may not believe that some of the uncorrected financial statement misstatements aggregated by the auditor during the audit are misstatements. For that reason, management may want to add to their written representation words such as, "We do not agree that items constitute misstatements because [description of reasons]."

(k) The auditor should consider if any fraud has been reported by them during the year under section 143(12) of the Act and if so whether that same would be reported under this Clause. It may be mentioned here that section 143(12) of the Act requires the auditor has reasons to believe that a fraud is being committed or has been committed by an employee or officer. In such a case the auditor needs to report to the Central Government or the Audit Committee. However, this Clause will include only the reported frauds and not suspected fraud.

(l) Where the auditor notices that any fraud by the company or on the company by its officers or employees has been noticed by or reported during the year, the auditor should, apart from reporting the existence of fraud, also required to report, the nature of fraud and amount involved. For reporting under this clause, the auditor may consider the following: (i) This clause requires all frauds noticed or reported during the year shall be reported indicating the nature and amount involved. As specified the fraud by the company or on the company by its officers or employees are only covered. (ii) Of the frauds covered under section 143(12) of the Act, only noticed frauds shall be included here and not the suspected frauds. (iii) While reporting under this clause with regard to the nature and the amount involved of the frauds noticed or reported, the auditor may also consider the principles of materiality outlined in Standards on Auditing.


5.84 ADVANCED AUDITING AND PROFESSIONAL ETHICS 3. Whether the company has entered into any non-cash transactions with directors or persons

connected with him and if so, whether the provisions of section 192 of Companies Act, 2013 have been complied with? [Paragraph 3(xv)]

Ans. Relevant Provisions:

(a) Section 192 of the Act deals with restriction on non-cash transactions involving directors or persons connected with them. The section prohibits the company from entering into following types of arrangements unless it meets the conditions laid out in the said section:

i. An arrangement by which a director of the company or its holding, subsidiary or associate company or a person connected with such director acquires or is to acquire assets for consideration other than cash, from the company.

ii. An arrangement by which the company acquires or is to acquire assets for consideration other than cash, from such director or person so connected.

(b) Arrangements, as discussed herein above, can only be entered by the company on fulfillment of the conditions laid out in Section 192 of the Act which are as under:

i. The company should have obtained prior approval for such arrangement through a resolution of the company in general meeting.

ii. In case the concerned director or the person connected therewith, is also a director of its holding company, a similar approval should have been obtained by the holding company through a resolution at its general meeting.

(c) The reporting requirements under this clause are in two parts. The first part requires the auditor to report on whether the company has entered into any non-cash transactions with the directors or any persons connected with such director/s. The second part of the clause requires the auditor to report whether the provisions of section 192 of the Act have been complied with. Therefore, the second part of the clause becomes reportable only if the answer to the first part is in affirmative.

(d) In other words, such transactions involving change in the assets or liabilities of a company but not involving “cash” or cash equivalents” as defined under Accounting Standard (AS) 3, “Cash Flow Statement” may be construed as non-cash transactions. At this point, it may be appropriate to also refer to the definition and discussion on “non-cash transactions” & “cash and cash equivalents”, as given in AS 3.

(e) There may be a situation where the acquisition of the asset takes place in one year and the corresponding liability is created in the financial statements, the corresponding settlement in the following year. The said transaction will not be considered as non-cash transaction. Further, mergers under Court schemes would be entered into subject to requisite approvals of Court etc., would not be considered non-cash transactions.


COMPANY AUDIT5 . 5.85 (f) The term “person connected with the director” has not been defined in the Act, or the Rules

thereunder. Instead, the term “to any other person in whom the director is interested” is defined in the Explanation to sub section

(1) of section 185 of the Act, which is reproduced as under and may be used as the reference point for reporting under this clause.

“(a) any director of the lending company, or of a company which is its holding company or any partner or relative of any such director;

(b) any firm in which any such director or relative is a partner;

(c) any private company of which any such director is a director or member;

(d) any body corporate at a general meeting of which not less than twenty-five per cent. of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or (e) any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.”

(g) Section 2(77) of the Companies Act, 2013 read with Rule 4 of the Companies (Specification of Definition Details) Rules, 2014 defines the term “relative”. As per the aforesaid section 2(77), “Relative, with reference to any person, means anyone who is related to another, if –

(i) they are members of a Hindu Undivided Family;

(ii) they are husband and wife; or

(iii) one person is related to the other in such manner as may be prescribed” As per Rule 4 of the Companies (Specification of Definition Details) Rules, 2014, a person shall be deemed to be the relative of another, if he or she is related to another in the following manner, namely –

(i) Father, including step father

(ii) Mother, including step mother

(iii) Son, including step son

(iv) Son’s wife

(v) Daughter

(vi) Daughter’s husband

(vii) Brother, including step brother

(viii) Sister, including step sister


5.86 ADVANCED AUDITING AND PROFESSIONAL ETHICS (h) The term “acquire” simply means to come into possession of something. A thing that cannot

be sold cannot be acquired. Thus, an acquisition would necessarily involve existence of two parties and a transfer of rights and/or obligations in a thing. In the context of section 192 of the Act, this transfer is between the company and the director and/or a person connected with a director. Such “director” is not restricted to being a director of the concerned company, but extends to director of a holding company, subsidiary or associate of the company under question.

(i) As provided in section 192, the acquisition by/from the company has to be that of an “asset”. Further, the term assets should be construed to have the same meaning as described in the Framework for Preparation and Presentation of Financial Statements, issued by the Institute of Chartered Accountants of India. The auditor would need to evaluate whether the subject matter of acquisition by/ from the company satisfies the characteristic of an “asset”.


(j) For reporting on the first leg of the reporting clause, the starting point of the auditor’s procedures could be obtaining a management representation as to whether the company has undertaken any non-cash transactions with the directors or persons connected with the directors, as envisaged in section 192(1) of the Act. The auditor would need to corroborate the management representation with sufficient appropriate audit evidence. A scrutiny of the following books of account, records and documents could provide source of such audit evidence to the auditor as to the existence of such non cash transactions as well as persons connected with the Directors:

Persons connected with Director Acquisition by/ From Company Form No. MBP 1, Notice of Interest by Director, filed pursuant to the Companies (Meetings of Board and Its Powers) Rules, 2014 [Ref: Sec 184(1) and Rule 9(1)]

Form No. MBP 2, Register of Loans, Guarantee, Security and Acquisition Made by the Company, filed pursuant to the Companies (Meetings of Board and Its Powers) Rules, 2014 [Ref: Sec 186(9) and Rule 12(1)]

Form No. MBP 4, Register of Contracts with Related Party and Contracts and Bodies etc. in which Directors are Interested, filed pursuant to the Companies (Meetings of Board and Its Powers) Rules, 2014 [Ref: Sec 189(1) and Rule 16(1)]

Movements in the Fixed Asset Register Minutes book of the General Meeting and

Meetings of Directors Report on Annual General Meeting pursuant to

Companies (Management and Administration) Rules, 2014 {Ref Sec 121(1) and Rule 31(2)}


COMPANY AUDIT5 . 5.87 (k) The above documents and records would provide evidence of any such non-cash transactions

that have actually taken place. The language of section 192(1) also uses the term “is to acquire” in the context of such transactions, indicating the existence of intention to acquire. The management may be requested to provide details of its intention to enter into transactions covered under section 192, after the date of the financial statements under audit. The minutes of the meetings of the Board of Directors and the Audit Committee may provide evidence of such intention. Besides, a scrutiny of the information for subsequent period as contained in the aforesaid records and documents may provide corroborative audit evidence of such intention having existed as at the date of the auditor’s report.

(l) Where the company has entered into/is to enter into any non-cash transactions as discussed above, the auditor would make a report to that effect under this clause. The second leg of the clause requires the auditor to report whether the company has complied with the provisions of section 192 in this regard. Section 192(1) and (2) envisage the following compliances in respect of such transactions:

(i) The company should have obtained a prior approval for such arrangement by a resolution in the General Meeting.

(ii) If the concerned Director or connected person is a director of the company’s holding company, the latter too should have obtained a similar prior approval for the arrangement by a resolution at its General Meeting.

(iii) Notice for approval of the resolution should contain details of the arrangement along with the value of assets involved duly calculated by a registered valuer. The auditor should check compliance with Section 192(2) and verify the notice of the General Meeting that it includes particulars of arrangement along with the value of the assets involved such arrangements. The said value should be calculated by the register valuer.

(m) In case where the concerned director/connected person is also a director of the holding company, the auditor would need to check whether the holding company has complied with the requirements. For this purpose, the auditor would need to obtain a management representation letter from the holding company through the management of the auditee company.

Suggested paragraph on reporting:

According to the information and explanations given to us, the company has entered into non-cash transactions with one of the directors/ person connected with the director during the year, by the acquisition of assets by assuming directly related liabilities, which in our opinion is covered under the provisions of Section 192 of the Act, and for which approval has not yet been obtained in a general meeting of the Company.


5.88 ADVANCED AUDITING AND PROFESSIONAL ETHICS ***************************************************************************************************************

APPENDIX 2 Key Aspects discussed in Guidance Note on Internal Financial Control over Financial Reporting

1. What is Internal Financial Control (IFC)? (Sec 134)

As per Section 134 of the Companies Act 2013, the term Internal Financial Controls means the policies and procedures adopted by the company for ensuring:

• Orderly and efficient conduct of its business, including adherence to Company’s policies,

• Safeguarding of its assets,

• Prevention and detection of frauds and errors,

• Accuracy and completeness of the accounting records, and

• Timely preparation of reliable financial information.

2. What is Internal Controls over financial Reporting (ICFR)?

As per Guidance Note issued by ICAI on Guidance Note on Audit of Internal Financial Controls Over Financial Reporting (September, 2015), “Internal Financial Controls Over Financial Reporting (ICFR) shall mean:

“A Process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles”. A Company’s internal financial control over financial reporting includes those policies and procedures that:

i. pertain to the maintenance of the records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;

ii. provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statement in accordance with generally accepted accounting principles, and those receipts and expenditures of the company are being made only in accordance with authorizations of management and director of the company; and

iii. provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effects of the financial statements.

3. Which provision of the Companies Act requires IFC Reporting?

Section 134:



In the case of a listed company, the Directors’ Responsibility states that directors, have laid down IFC to be followed by the company and that such controls are adequate and operating effectively.

Section 134:

In the case of a listed company, the Board of Directors are required to confirm about the adequacy and operating effectiveness of Internal Financial Controls. .However as per Rule 8(5) of Companies (Accounts) Rules, Board of Directors report to state the details in respect of adequacy of IFC with reference to the financial statements.

Section 143:

The auditor’s report should also state whether the company has adequate IFC system in place and the operating effectiveness of such controls.

Section 177:

Audit committee may call for comments of auditors about internal control systems before their submission to the Board and may also discuss any related issues with the internal and statutory auditors and the management of the company.

Schedule IV

The independent directors should satisfy themselves on the integrity of financial information and ensure that financial controls and systems of risk management are robust and defensible.

Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 –

The director’s report should contain details in respect of adequacy of internal financial controls with reference to the financial reporting.

4. To whom does this apply?

The guidance note clarifies that reporting on ICFR by auditors will be applicable to both listed and unlisted companies, including small and one person companies. This is in line with the requirements of section 143(3)(i) of the Companies Act, 2013.

Furthermore, it states that auditors will have to report on ICFR in respect of both stand alone and consolidated financial statements.

(Note: Clause (i) of Sub-Section (3) of Section143 shall not apply to a private company:-(i) which is a one person company or a small company; or (ii) which has turnover less than rupees fifty crores as per latest audited financial statement and which has aggregate borrowings from banks or financial institutions or anybody corporate at any point of time during the financial year less than rupees twenty five crore)


http://ebook.mca.gov.in/notificationdetail.aspx?acturl=6CoJDC4uKVUR7C9Fl4rZdatyDbeJTqg3tUG/+pSc45zEULgLoqvnPOvytbvjFyqbwE32urTTdrYZFScR/DnGEA==


5. When does this apply and for financial statements of which period?

The guidance note clarifies that auditors will have to report whether a company has an adequate ICFR system in place and whether the same was operating effectively as at the balance sheet date. In practice, this will mean that when forming its audit opinion on ICFR, the auditor will surely test transactions during the financial year and not just as at the balance sheet date, though the extent of testing at or near the balance sheet date may be higher. If control issues or deficiencies are identified during the interim period and are remediated before the balance sheet date, then the auditor may still be able to express an unqualified opinion on the ICFR.

6. What is extent of reporting?

The auditor needs to obtain reasonable assurance to state whether an adequate internal financial controls system was maintained and whether such internal financial controls system operated effectively in the company in all material respects with respect to financial reporting only. The auditor’s opinion, therefore,does not assure, for example, the future viability of the entity nor the efficiency or effectiveness with which management has conducted the affairs of the entity.



TEST YOUR KNOWLEDGE Theoretical Questions 1. (a) The Balance Sheet of G Ltd. as at 31st March, 19 is as under. Comment on the presentation

in terms of Schedule III.

Heading Note No.

31st March, 19 31st March, 18

Equity & Liabilities Share Capital 1 XXX XXX Reserves & Surplus 2 0 0 Employee stock option outstanding 3 XXX XXX Share application money refundable 4 XXX XXX Non-Current Liabilities XXX XXX Deferred tax liability (Arising from Indian Income Tax)

5 XXX XXX

Current Liabilities Trade Payables 6 XXX XXX Total XXXX XXXX Assets Non-Current Assets Fixed Assets-Tangible 7 XXX XXX CWIP (including capital advances) 8 XXX XXX Current Assets Trade Receivables 9 XXX XXX Deferred Tax Asset (Arising from

Indian Income Tax) 10 XXX XXX

Debit balance of Statement of Profit and Loss

XXX XXX

Total XXXX XXXX

(b) Z Ltd. changed its employee remuneration policy from 1st April, 2018 to provide for 12% contribution to provident fund on leave encashment also. As per the leave encashment policy, the employees can either utilize or encash it. As at 31st March, 19, the company obtained an actuarial valuation for leave encashment liability. However, it did not provide for 12% PF contribution on it. The auditor of the company wants it to be provided but the management replied that as and when the employees availed leave encashment, the provident fund contribution was made. The company



further contends that this is the correct treatment as it is not sure whether the employees will avail leave encashment or utilize it. Comment.

(c) K Ltd. had 5 subsidiaries as at 31st March, 2019 and the investments in-subsidiaries are considered as long term and valued at cost. Two of the subsidiaries had their net worth eroded as at 31st March 19 and the prospects of their recovery are very bleak and the other three subsidiaries are doing exceptionally well. The company did not provide for the decline in the value of investments in two subsidiaries because the overall investment portfolio in subsidiaries did not suffer any decline as the other three subsidiaries are doing exceptionally well. Comment.

(d) While adopting the accounts for the year, the Board of Directors of Sunrise Ltd. decided to consider the Interim Dividend declared @15% as final dividend and did not consider transfer of Profit to reserves.

2. MG Pvt. Ltd. seeks your advice while preparing the financial statements i.e. the general instructions to be followed while preparing Balance Sheet under Companies Act, 2013 in respect of current assets and liabilities.

3. As an auditor, how would you deal with the following situations:

(a) Ram and Hanuman Associates, Chartered Accountants in practice, have been appointed as Statutory Auditor of Krishna Ltd. for the accounting year 2018-2019. Mr. Hanuman, a partner of Ram and Hanuman Associates, holds 100 equity shares of Shiva Ltd., a subsidiary company of Krishna Ltd.

(b) Nick Ltd. is a subsidiary of Ajanta Ltd., whose 20% shares have been held by Central Government, 25% by Uttar Pradesh Government and 10% by Madhya Pradesh Government. Nick Ltd. appointed Mr. Prem as its statutory auditor.

(c) Contravene Ltd. appointed CA Innocent as an auditor for the company for the current financial year. Further the company offered him the services of actuarial, investment advisory and investment banking which was also approved by the Board of Directors.

(d) Mr. Amar, a Chartered Accountant, bought a car financed at ` 7,00,000 by Chaudhary Finance Ltd., which is a holding company of Charan Ltd. and Das Ltd. He has been the statutory auditor of Das Ltd. and continues to be even after taking the loan.

4. (a) Astha Pvt. Ltd. has fully paid capital of ` 140 lakhs. During the year, the company had borrowed ` 15 lakhs each from a bank and a financial institution. It had the turnover (Net of GST ` 50 lakhs which is credited to a separate account) of ` 475 lakhs. Will Companies (Auditor’s Report) Order, 2016 be applicable to Astha Pvt. Ltd.?

(b) Under CARO, 2016, as a statutory auditor, how would you report on the following:

(i) A term loan was obtained from a bank for ` 80 lakhs for acquiring R&D equipment, out of which ` 15 lakh was used to buy a car for use of the



concerned director who was looking at the R&D activities.

(ii) Physical verification of only 40% of items of inventory has been conducted bythe company. The balance 60% will be conducted in next year due to lack oftime and resources.

5. T Pvt. Ltd.’s paid up capital & reserves are less than ` 50 lakhs and it has no outstandingloan exceeding ` 25 lakhs from any bank or financial institution. Its sales are ` 6 croresbefore deducting trade discount ` 10 lakhs and sales returns ` 95 lakhs. The servicesrendered by the company amounted to ` 10 lakhs. The company contends that reportingunder Companies Auditor’s Reports Order (CARO) is not applicable. Discuss.

Multiple Choice Questions 1. Re-opening of accounts on Court’s or Tribunal’s orders: Section 130 of the Companies

Act, 2013 states that a company shall not re-open its books of account and not recast its financial statements, unless an application in this regard is made by the Central Government, the Income-tax authorities, the Securities and Exchange Board of India (SEBI), any other statutory regulatory body or authority or any person concerned and an order is made by a court of competent jurisdiction or the Tribunal to the effect thatJain Ltd. has an annual turnover of ` 350 crores and has been into losses for the last 2 years. The operations of the company are good. Due to some technology changes, the company started facing competition and hence started incurring losses. The company plans to revive in the next 1-2 years with the improvements in its processes. During the year ended 31 March, 2019, the management of the company came across certain transactions relating to the financial year ended 31 March 2018 which were erroneously missed to be accounted for. This would result into losses and hence the management is considering to take this to the right financial year and for that purpose to re-open its accounts for the financial year ended 31 March 2018. Please advise.

a. The position of the management is correct.

b. The action of the management is correct, however, the reason behind reopening the accounts of last year does not seem to be correct.

c. The action of the management would have been correct had it been advised by the auditors of the company and for the same management should have taken approval from SEBI.

d. The action of the management is not correct.

2. Rimmi Ltd. was set up initially as a private limited company. Subsequently, it got converted into a public company. The company’s management has plans of expansion but the business was not growing in an organic manner. Therefore, the management decided to acquire the competitors. During the financial year ended 31 March, 2019, the company acquired two



companies in India and France in September, 2018 and January, 2019 respectively. The company controls both of these companies as per the criterias laid down in the Companies Act 2013 as well as the applicable accounting standards.

The management started discussions with the auditors regarding the audit wherein it was also pointed out by the auditors that the management should also prepare consolidated financial statements (CFS), if they want. Management needs your advise on the same.

a. Management must prepare the CFS as per the requirements of the Companies Act,2013.

b. Management has a choice not to prepare CFS but should go for that considering thatits true performance and financial position can then be demonstrated.

c. Management could have prepared CFS if the acquired companies would havecompleted at least one year post acquisition.

d. Management must prepare CFS but it should include only the company acquired inIndia.

3. K Pvt Ltd. has been providing marketing support services to its parent company based out ofIreland. The company’s operations are not large and have remained stable over the last fewyears. Recently the parent company was acquired by another company and the new investorwanted to reassess whether the company in India should continue or should be shut downconsidering the legal compliances. It was advised to the new investor that the companyshould be converted into LLP. In December 2018, the new management decided that theywould get the company converted into LLP and also discussed that matter with their statutoryauditors. The management is expecting that the LLP conversion would get completed byFebruary 2019 and wants that the auditors should audit the financial statements of the LLPat the year end because conversion is only an administrative process and hence it would notimpact their work.

a. The management would need to get the financial statements audited from new auditorappointed by CAG in case of LLP.

b. The management would need to appoint new auditor and the new auditor can auditLLP at year end in one go – both for the period it was a company and then when itbecame LLP.

c. The auditor of the company should audit the company before its conversion and thenthe new auditor for LLP would audit LLP separately.

d. The auditor of the company should audit the company before its conversion and thenthe new auditor for LLP would audit LLP separately. But this is a choice available tothe auditor.



4. AJ Private Ltd. was incorporated on 21 March, 2018 and has limited operations. However, the capital induction in the company was huge because it would be capital intensive. The company is in the process to set up a plant in Karnataka which should be completed by 31 May, 2019. The company’s management prepared its financial statements for the year ended 31 March, 2019. The auditors were also called to start the work in April 2019. The auditors would be able to complete their work by 31 May, 2019 and accordingly would issue their audit report by 1st week of June, 2019 as per the plan agreed with the management. The auditors have some observations related to preparations of financial statements which are not in compliance with Schedule III and most importantly the point related to capitalization of the plant as Property, Plant and Equipment in the financial statements for the year ended 31 March, 2019. Please suggest which of the following statements would be correct.

a. The compliance of Schedule III shall start from 1 April 2019 for this company as per Companies Accounts (Amendment) Rules 2016.

b. The compliance of Schedule III shall start from first financial period, however, some exemptions would be applicable as per Companies Accounts Rules 2014.

c. There should be full compliance of Schedule III and plant should be kept as CWIP as per Schedule III.

d. There should be full compliance of Schedule III and plant should be shown as PPE as per Schedule III.

5. SHRD Private Ltd is engaged in the business of software and consultancy. The company has an annual turnover of ` 2,000 crores but its profit margins are not very good as compared to the industry standards. For the financial year ended 31 March 2019, the company proposed appointment of its statutory auditors at its general meeting, however, the remuneration was not finalized. The statutory auditors completed the engagement formalities including the engagement letter between the company and the auditors and it was decided that the engagement letter be signed without fee i.e. with the clause that the fee to be mutually decided. Please provide your views on this.

a. Such engagement letter is not valid.

b. Engagement letter with such arrangement is valid.

c. Engagement letter should specify the fee of last year, if applicable, if the fee for the current year is not yet finalized at the time of signing of the engagement letter.

d. Engagement letter should specify 10% increase in the fee as compared to last year as per the norms of the ICAI, in case the fee is not finalized at the time of signing of the engagement letter.



Answers to Theoretical Questions 1. (a) Following Errors are noticed in presentation as per Schedule III:

(i) Share Capital and Reserve & Surplus are to be reflected under the heading “Shareholders’ funds”, which is not shown while preparing the balance sheet. Although it is a part of Equity and Liabilities yet it must be shown under head “shareholders’ funds”. The heading “Shareholders’ funds” is missing in the balance sheet given in the question.

(ii) Reserve & Surplus is showing zero balance, which is not correct in the given case. Debit balance of statement of Profit & Loss should be shown as a negative figure under the head ‘Surplus’. The balance of ‘Reserves and Surplus’, after adjusting negative balance of surplus shall be shown under the head ‘Reserves and Surplus’ even if the resulting figure is in the negative.

(iii) Schedule III requires that Employee Stock Option outstanding should be disclosed under the heading “Reserves and Surplus”.

(iv) Share application money refundable shall be shown under the sub-heading “Other Current Liabilities”. As this is refundable and not pending for allotment, hence it is not a part of equity.

(v) Deferred Tax Liability has been correctly shown under Non-Current Liabilities. ButDeferred tax assets and deferred tax liabilities, both, cannot be shown in balance sheet because only the net balance of Deferred Tax Liability or Asset is to be shown if the enterprise has a legally enforceable right to set off assets against liabilities representing current tax; and it relates to the same governing tax laws.

(vi) Under the main heading of Non-Current Assets, Property, Plant and Equipment are further classified as under:

(a) Tangible assets

(b) Intangible assets

(c) Capital work in Progress

(d) Intangible assets under development.

Keeping in view the above, the CWIP shall be shown under Property, Plant and Equipment as Capital Work in Progress. The amount of Capital advances included in CWIP shall be disclosed under the sub-heading “Long term loans and advances” under the heading Non-Current Assets.

Subsequent to the notification of Ministry of Corporate Affairs dated October 11, 2018 under Section 467(1) of the Companies Act, 2013, the



words “Fixed assets” shall be substituted with the words “Property, Plant and Equipment”.

(e) Deferred Tax Asset shall be shown under Non-Current Asset. It should be the net balance of Deferred Tax Asset after adjusting the balance of deferred tax liability if the enterprise has a legally enforceable right to set off assets against liabilities representing current tax; and it relates to the same governing tax laws.

(f) Subsequent to the notification of Ministry of Corporate Affairs dated October 11, 2018 under Section 467(1) of the Companies Act, 2013, Trade Payables should be disclosed as follows:-

(A) total outstanding dues of micro enterprises and small enterprises; and

(B) total outstanding dues of creditors other than micro enterprises and small enterprises.”

(b) As per Para 11 of AS-15 on “Employee Benefits”, issued by the Institute of Chartered Accountants of India, an enterprise should recognize the expected cost of short-term employee benefits in the form of compensated absences in the case of accumulating compensated absences, when the employees render service that increases their entitlement to future compensated absences.

Since the company obtained actuarial valuation for leave encashment, it is obvious that the compensated absences are accumulating in nature. An enterprise should measure the expected cost of accumulating compensated absences as the additional amount that the enterprise expects to pay as a result of the unused entitlement that has accumulated at the balance sheet date.

Here, Z Ltd. will accumulate the amount of leave encashment benefits as it is the liability of the company to provide 12% PF on amount of leave encashment. Hence the contention of the auditor is correct that full provision should be provided by the company.

(c) As per AS-13 “Accounting for Investments” issued by the Institute of Chartered Accountants of India, long-term investments are usually of individual importance to the investing enterprise. The carrying amount of long-term investments is therefore determined on an individual investment basis. Investments classified as long term investments should be carried in the financial statements at cost. However, provision for diminution shall be made to recognize a decline, other than temporary, in the value of the investments, such reduction being determined and made for each investment individually.



Keeping in view the above, K Ltd. should provide for the decline in the value of investments in two subsidiaries despite the fact that the overall investment portfolio in subsidiaries did not suffer any decline.

(d) Declaration of Interim Dividend: Section 123(3) of the Companies Act, 2013 provides that the Board of Directors of a company may declare interim dividend during any financial year out of the surplus in the Statement of Profit and Loss and out of profits of the financial year in which such interim dividend is sought to be declared. The amount of dividend including interim dividend should be deposited in a separate bank account within five days from the declaration of such dividend for the compliance of Section 123(4) of the said Act.

Based on Section 2(35) of the Act, it can be said that since interim dividend is also a dividend, companies should provide for depreciation as required by Section 123 before declaration of interim dividend. However, the first proviso to Section 123(1) provides that a company may, before the declaration of any dividend in any financial year, transfer such percentage of its profit for that financial year as it may consider appropriate to the reserves of the company irrespective of the size of the declared dividend i.e. the company is not mandatorily required to transfer the profit to the reserves, it is an option available to the company to transfer such percentage.

In the instant case, the Board has decided to pay interim dividend @15% of the paid-up capital. Assuming that the company has complied with the depreciation requirement, the interim dividend can be declared without transferring such percentage of its profits to the reserves of the company.

2. General Instructions for Preparation of Balance Sheet:

(i) General Instruction in respect of Current Assets: An asset shall be classified as current when it satisfies any of the following criteria-

(1) it is expected to be realized in, or is intended for sale or consumption in, the company’s normal operating cycle;

(2) it is held primarily for the purpose of being traded;

(3) it is expected to be realized within twelve months after the reporting date; or

(4) it is cash or cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting date.

(ii) General Instruction in respect of Current Liabilities: A liability shall be classified as current when it satisfies any of the following criteria-

(1) it is expected to be settled in the company’s normal operating cycle;

(2) it is held primarily for the purpose of being traded;



(3) it is due to be settled within twelve months after the reporting date; or

(4) the company does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting date. Terms of a liability that could, at the option of the counterparty, result in its settlement by the issue of equity instruments do not affect its classification.

3. (a) Auditor Holding Securities of a Company: As per sub-section (3)(d)(i) of Section 141 of the Companies Act, 2013 along with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, a person shall not be eligible for appointment as an auditor of a company, who, or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company. Provided that the relative may hold security or interest in the company of face value not exceeding rupees one lakh.

Also, as per sub-section (4) of Section 141 of the Companies Act, 2013, where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in sub-section (3) after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

In the present case, Mr. Hanuman, Chartered Accountant, a partner of M/s Ram and Hanuman Associates, holds 100 equity shares of Shiva Ltd. which is a subsidiary of Krishna Ltd. Therefore, the firm, M/s Ram and Hanuman Associates would be disqualified to be appointed as statutory auditor of Krishna Ltd., as per section 141(3)(d)(i), which is the holding company of Shiva Ltd., because Mr. Hanuman, one of the partners, is holding equity shares of its subsidiary.

(b) According to Section 139(7) of the Companies Act, 2013, the auditors of a government company shall be appointed or re-appointed by the Comptroller and Auditor General of India(C&AG). As per section 2(45), a Government company is defined as any company in which not less than 51% of the paid-up share capital is held by the Central Government or by any State Government or Governments or partly by the Central Government and partly by one or more State Governments and includes a company which is a subsidiary of a Government Company as thus defined.

In the given case, Ajanta Ltd is a government company as its 20% shares have been held by Central Government, 25% by U.P. State Government and 10% by M.P. State Government. Total 55% shares have been held by Central and State governments, therefore, it is a Government company.

Nick Ltd. is a subsidiary company of Ajanta Ltd. Hence, Nick Ltd. is covered in the definition of a government company. Therefore, auditor of Nick Ltd. can be appointed only by C&AG.



Consequently, appointment of Mr. Prem is invalid and he should not give acceptance to the Directors of Nick Ltd.

(c) Services not to be Rendered by the Auditor: Section 144 of the Companies Act, 2013 prescribes certain services not to be rendered by the auditor. An auditor appointed under the Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company), namely:

(i) accounting and book keeping services;

(ii) internal audit;

(iii) design and implementation of any financial information system;

(iv) actuarial services;

(v) investment advisory services;

(vi) investment banking services;

(vii) rendering of outsourced financial services;

(viii) management services; and

(ix) any other kind of services as may be prescribed.

Further section 141(3)(i) of the Companies Act, 2013 also disqualifies a person for appointment as an auditor of a company who is engaged as on the date of appointment in consulting and specialized services as provided in section 144.

In the given case, CA Innocent was appointed as an auditor of Contravene Ltd. He was offered additional services of actuarial, investment advisory and investment banking which was also approved by the Board of Directors. The auditor is advised not to accept the services as these services are specifically notified in the services not to be rendered by him as an auditor as per section 144 of the Act.

(d) According to section 141(3)(d)(ii) of the Companies Act, 2013, a person is not eligible for appointment as auditor of any company, if he is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of rupees five lakh.

In the given case, Mr. Amar is disqualified to act as an auditor under section 141(3)(d)(ii) as he is indebted to Chaudhary Finance Ltd. for more than ` 5,00,000. Also, according to section 141(3)(d)(ii), he cannot act as an auditor of any subsidiary of Chaudhary Finance Ltd. i.e. he is also disqualified to work in Charan Ltd. & Das Ltd.



Therefore, he has to vacate his office in Das Ltd. even though it is a subsidiary of Chaudhary Finance Ltd.

Hence audit work performed by Mr. Amar as an auditor is invalid, he should vacate his office immediately and Das Ltd. should appoint another auditor for the company.

4. (a) Applicability of CARO, 2016: The CARO, 2016 specifically exempts a private limited company, not being a subsidiary or holding company of a public company, having a paid up capital and reserves and surplus not more than rupees one crore as on the balance sheet date and which does not have total borrowings exceeding rupees one crore from any bank or financial institution at any point of time during the financial year and which does not have a total revenue as disclosed in Scheduled III to the Companies Act, 2013 (including revenue from discontinuing operations) exceeding rupees ten crore during the financial year as per the financial statements.

In the case of Astha Pvt. Ltd., it has outstanding loan of ` 30 lakhs (` 15 lakhs + ` 15 lakhs) collectively from bank and financial institution which is less than ` 1 crore rupees and turnover is ` 475 lakhs i.e. also less than ` 10crores and not exceeding the limit. However,it has paid capital of ` 140 lakhs i.e. more than ` 1 crore.

Thus, considering its paid up capital which is exceeding the prescribed limit for exemption, CARO, 2016 will be applicable to Astha Pvt. Ltd.

(b) Reporting under CARO, 2016

(i) Utilisation of Term Loans: According to clause (ix) of Para 3 of CARO, 2016, the auditor is required to report “whether moneys raised by way of initial public offer orfurther public offer (including debt instruments) and term loans were applied for the purposes for which those are raised. If not, the details together with delays or default and subsequent rectification, if any, as may be applicable”.

The auditor should examine the terms and conditions of the term loan with the actual utilisation of the loans. If the auditor finds that the fund has not been utilized for the purpose for which they were obtained, the report should state the fact.

In the instant case, term loan taken for the purpose of R&D equipment has been utilized for the purchase of car which has no relation with R&D equipment.

Therefore, car though used for R&D Director cannot be considered as R&D equipment. The auditor should state the fact in his report as per Paragraph 3 clause ix of the CARO 2016, that out of the term loan taken for R&D equipment, ` 15 lakhs was not utilised for the purpose of acquiring R&D equipment.



(ii) Physical Verification of Inventory: Clause (ii) of Para 3 of CARO, 2016 requires the auditor to report on whether physical verification of inventory has been conducted at reasonable intervals by the management. Physical verification of inventory is the responsibility of the management which should normally verify all material items at least once in a year and more often in appropriate cases. The auditor in order to satisfy himself about verification at reasonable intervals should examine the adequacy of evidence and record of verification.

In the given case, the above requirement of CARO, 2016 has not been fulfilled as such and the auditor should point out the specific areas where he believes the procedure of inventory verification is not reasonable. He may consider the impact on financial statement and report accordingly.

5. Applicability of CARO, 2016: The CARO, 2016 specifically exempts a private limited company, not being a subsidiary or holding company of a public company, having a paid up capital and reserves and surplus not more than rupees one crore as on the balance sheet date and which does not have total borrowings exceeding rupees one crore from any bank or financial institution at any point of time during the financial year and which does not have a total revenue as disclosed in Scheduled III to the Companies Act, 2013 (including revenue from discontinuing operations) exceeding rupees ten crore during the financial year as per the financial statements.

In the given case, paid up capital and reserves of T Pvt. Ltd. are less than ` 1 crore and has no loan outstanding exceeding ` one crore from any bank or financial institution.

Further, its total revenue as disclosed in Scheduled III to the Companies Act, 2013 (including revenue from discontinuing operations) is not exceeding rupees ten crore during the financial year as per the financial statements.

Thus CARO 2016 will not be applicable to T Pvt. Ltd.

Answers to Multiple Choice Questions 1. (d) 2. (a) 3. (c) 4. (c) 5. (b)


o

SCHEDULE III TO THE COMPANIES ACT, 2013

Division I Financial Statements for a company whose Financial Statements are required

to comply with the Companies (Accounting Standards) Rules, 2006

GENERAL INSTURCTION FOR PREPARATION OF BALANCE SHEET AND STATEMENT OF

PROFIT AND LOSS OF A COMPANY

1. Where compliance with the requirements of the Act including Accounting Standards as

applicable to the companies require any change in treatment or disclosure including addition,

amendment, substitution or deletion in the head/sub-head or any changes inter se, in the

financial statements or statements forming part thereof, the same shall be made and the

requirements of this Schedule shall stand modified accordingly.

2. The disclosure requirements specified in this Schedule are in addition to and not in

substitution of the disclosure requirements specified in the Accounting Standards prescribed

under the Companies Act, 2013. Additional disclosures specified in the Accounting Standards

shall be made in the notes to accounts or by way of additional statement unless required to

be disclosed on the face of the Financial Statements. Similarly, all other disclosures as

required by the Companies Act shall be made in the notes to accounts in addition to the

requirements set out in this Schedule.

3. (i) Notes to accounts shall contain information in addition to that presented in the Financial

Statements and shall provide where required (a) narrative descriptions or dis -

aggregations of items recognized in those statements and (b) information about items

that do not qualify for recognition in those statements.

(ii) Each item on the face of the Balance Sheet and Statement of Profit and Loss shall be

cross-referenced to any related information in the notes to accounts. In preparing the

Financial Statements including the notes to accounts, a balance shall be maintained

between providing excessive detail that may not assist users of financial statements and

not providing important information as a result of too much aggregation.

Annexure


A.2 ADVANCED AUDITING AND PROFESSIONAL ETHICS

4. (i) Depending upon the turnover of the company, the figures appearing in the Financial

Statements may be rounded off as given below:

Turnover Rounding off

(a) less than one hundred crore

rupees

to the nearest hundreds, thousands, lakhs

or millions, or decimals thereof

(b) one hundred crore rupees or

more

to the nearest, lakhs, millions or crores, or

decimals thereof.

(ii) Once a unit of measurement is used, it should be used uniformly in the Financial

Statements.

5. Except in the case of the first Financial Statements laid before the Company (after its

incorporation) the corresponding amounts (comparatives) for the immediately preceding

reporting period for all items shown in the Financial Statements including notes shall also be

given.

6. For the purpose of this Schedule, the terms used herein shall be as per the applicable

Accounting Standards.

Note: This part of Schedule sets out the minimum requirements for disclosure on the face of the

Balance Sheet, and the Statement of Profit and Loss (hereinafter referred to as “Financial

Statements” for the purpose of this Schedule) and Notes. Line items, sub-line items and sub-totals

shall be presented as an addition or substitution on the face of the Financial Statements when

such presentation is relevant to an understanding of the company’s financial position or

performance or to cater to industry/sector-specific disclosure requirements or when required for

compliance with the amendments to the Companies Act or under the Accounting Standards.

PART I – BALANCE SHEET

Name of the Company…………………….

Balance Sheet as at………………………

(Rupees in…………)

Particulars Note

No.

Figures as

at the end

of current

reporting

period

Figures as

at the end

of previous

reporting

period

1 2 3 4

EQUITY AND LIABILITIES

1.

Shareholders' funds

a

Share capital

b

Reserves and Surplus


SCHEDULE III : DIVISION I A.3

c

Money received against share warrants

2.

Share application money pending

allotment

3.

Non-current liabilities

a

Long-term borrowings

b

Deferred tax liabilities (Net)

c

Other long term liabilities

d

Long-term provisions

4.

Current liabilities

a

Short-term borrowings

b

Trade Payables

(A) total outstanding dues of micro

enterprises and small enterprises; and

(B) total outstanding dues of creditors other

than micro enterprises and small enterprises.

c

Other current liabilities

d

Short-term provisions

Total

ASSETS

1

Non-current assets

a

Property, Plant and Equipment

i Tangible assets

ii Intangible assets

iii Capital Work-in-progress

iv Intangible assets under development

b

Non-current investments

c

Deferred tax assets (Net)

d

Long-term loans and advances

e

Other non-current assets



2

Current assets

a

Current investments

b

Inventories

c

Trade receivables

d

Cash and cash equivalents

e

Short-term loans and advances

f

Other current assets

Total

See accompanying notes to Financial Statements.

Notes

GENERAL INSTRUCTIONS FOR PREPARATION OF BALANCE SHEET

1. An asset shall be classified as current when it satisfies any of the following criteria:

(a) it is expected to be realized in, or is intended for sale or consumption in, the company’s

normal operating cycle;

(b) it is held primarily for the purpose of being traded;

(c) it is expected to be realized within twelve months after the reporting date; or

(d) it is cash or cash equivalent unless it is restricted from being exchanged or used to

settle a liability for at least twelve months after the reporting date.

All other assets shall be classified as non-current.

2. An operating cycle is the time between the acquisition of assets for processing and their

realization in cash or cash equivalents. Where the normal operating cycle cannot be

identified, it is assumed to have a duration of 12 months.

3. A liability shall be classified as current when it satisfies any of the following criteria :

(a) it is expected to be settled in the company’s normal operating cycle;

(b) it is held primarily for the purpose of being traded;

(c) it is due to be settled within twelve months after the reporting date; or

(d) the company does not have an unconditional right to defer settlement of the liability for

at least twelve months after the reporting date. Terms of a liability that could, at the

option of the counterparty, result in its settlement by the issue of equity instruments do

not affect its classification.

All other liabilities shall be classified as non-current.



4. A receivable shall be classified as a ‘trade receivable’ if it is in respect of the amount due on

account of goods sold or services rendered in the normal course of business.

5. A payable shall be classified as a ‘trade payable’ if it is in respect of the amount due on

account of goods purchased or services received in the normal course of business.

6. A company shall disclose the following in the notes to accounts:

A. Share Capital

For each class of share capital (different classes of preference shares to be trea ted

separately):

(a) the number and amount of shares authorized;

(b) the number of shares issued, subscribed and fully paid, and subscribed but not fully paid;

(c) par value per share;

(d) a reconciliation of the number of shares outstanding at the beginning and at the end of

the reporting period;

(e) the rights, preferences and restrictions attaching to each class of shares including

restrictions on the distribution of dividends and the repayment of capital;

(f) shares in respect of each class in the company held by its holding company or its

ultimate holding company including shares held by or by subsidiaries or associates of

the holding company or the ultimate holding company in aggregate;

(g) shares in the company held by each shareholder holding more than 5 percent shares

specifying the number of shares held;

(h) shares reserved for issue under options and contracts/commitments for the sale of

shares/disinvestment, including the terms and amounts;

(i) for the period of five years immediately preceding the date as at which the Balance

Sheet is prepared:

(A) Aggregate number and class of shares allotted as fully paid up pursuant to

contract(s) without payment being received in cash.

(B) Aggregate number and class of shares allotted as fully paid up by way of bonus

shares.

(C) Aggregate number and class of shares bought back.

(j) terms of any securities convertible into equity/preference shares issued along with the

earliest date of conversion in descending order starting from the farthest such date.

(k) calls unpaid (showing aggregate value of calls unpaid by directors and officers)

(l) forfeited shares (amount originally paid up)



B. Reserves and Surplus

(i) Reserves and Surplus shall be classified as:

(a) Capital Reserves;

(b) Capital Redemption Reserve;

(c) Securities Premium;

(d) Debenture Redemption Reserve;

(e) Revaluation Reserve;

(f) Share Options Outstanding Account;

(g) Other Reserves – (specify the nature and purpose of each reserve and the amount

in respect thereof);

(h) Surplus i.e. balance in Statement of Profit & Loss disclosing allocations and

appropriations such as dividend, bonus shares and transfer to/from reserves etc.

(Additions and deductions since last balance sheet to be shown under each of the

specified heads)

(ii) A reserve specifically represented by earmarked investments shall be termed as a

‘fund’.

(iii) Debit balance of statement of profit and loss shall be shown as a negative figure under

the head ‘Surplus’. Similarly, the balance of ‘Reserves and Surplus’, af ter adjusting

negative balance of surplus, if any, shall be shown under the head ‘Reserves and

Surplus’ even if the resulting figure is in the negative.

C. Long-Term Borrowings

(i) Long-term borrowings shall be classified as:

(a) Bonds/debentures.

(b) Term loans

(A) From banks.

(B) From other parties

(c) Deferred payment liabilities.

(d) Deposits.

(e) Loans and advances from related parties.

(f) Long term maturities of finance lease obligations

(g) Other loans and advances (specify nature).



(ii) Borrowings shall further be sub-classified as secured and unsecured. Nature of security

shall be specified separately in each case.

(iii) Where loans have been guaranteed by directors or others, the aggregate amount of

such loans under each head shall be disclosed.

(iv) Bonds/debentures (along with the rate of interest and particulars of redemption or

conversion, as the case may be) shall be stated in descending order of maturity or

conversion, starting from farthest redemption or conversion date, as the case may be.

Where bonds/debentures are redeemable by instalments, the date of maturity for this

purpose must be reckoned as the date on which the first instalment becomes due.

(v) Particulars of any redeemed bonds/ debentures which the company has power to

reissue shall be disclosed.

(vi) Terms of repayment of term loans and other loans shall be stated.

(vii) Period and amount of continuing default as on the balance sheet date in repayment of

loans and interest, shall be specified separately in each case.

D. Other Long Term Liabilities

Other Long-term Liabilities shall be classified as:

(a) Trade payables

(b) Others

E. Long-term provisions

The amounts shall be classified as:

(a) Provision for employee benefits.

(b) Others (specify nature).

F. Short-term borrowings

(i) Short-term borrowings shall be classified as:

(a) Loans repayable on demand

(A) From banks

(B) From other parties

(b) Loans and advances from related parties.

(c) Deposits.

(d) Other loans and advances (specify nature).



(ii) Borrowings shall further be sub-classified as secured and unsecured. Nature of security

shall be specified separately in each case.

(iii) Where loans have been guaranteed by directors or others, the aggregate amount of

such loans under each head shall be disclosed.

(iv) Period and amount of default as on the balance sheet date in repayment of loans and

interest shall be specified separately in each case.

FA. Trade Payables

The following details relating to Micro, Small and Medium Enterprises shall be disclosed in

the notes:

(a) the principal amount and the interest due thereon (to be shown separately) remaining

unpaid to any supplier at the end of each accounting year;

(b) the amount of interest paid by the buyer in terms of section 16 of the Micro, Small and

Medium Enterprises Development Act, 2006, along with the amount of the payment

made to the supplier beyond the appointed day during each accounting year;

(c) the amount of interest due and payable for the period of delay in making payment (which

have been paid but beyond the appointed day during the year) but without adding the

interest specified under the Micro, Small and Medium Enterprises Development Act,

2006;

(d) the amount of interest accrued and remaining unpaid at the end of each accounting

year; and

(e) the amount of further interest remaining due and payable even in the succeeding years,

until such date when the interest dues above are actually paid to the small enterprise,

for the purpose of disallowance of a deductible expenditure under section 23 of the

Micro, Small and Medium Enterprises Development Act, 2006.

Explanation The terms 'appointed day', 'buyer', 'enterprise', 'micro enterprise', 'small

enterprise' and 'supplier', shall have the same meaning assigned to those under clauses (b),

(d), (e), (h), (m) and (n) respectively of section 2 of the Micro, Small and Medium Enterprises

Development Act, 2006.

G. Other current liabilities


(a) Current maturities of long-term debt;

(b) Current maturities of finance lease obligations;

(c) Interest accrued but not due on borrowings;

(d) Interest accrued and due on borrowings;



(e) Income received in advance;

(f) Unpaid dividends

(g) Application money received for allotment of securities and due for refund and interest

accrued thereon. Share application money includes advances towards allotment of

share capital. The terms and conditions including the number of shares proposed to be

issued, the amount of premium, if any, and the period before which shares shall be

allotted shall be disclosed. It shall also be disclosed whether the company has sufficient

authorized capital to cover the share capital amount resulting from allotment of shares

out of such share application money. Further, the period for which the share app lication

money has been pending beyond the period for allotment as mentioned in the document

inviting application for shares along with the reason for such share application money

being pending shall be disclosed. Share application money not exceeding the issued

capital and to the extent not refundable shall be shown under the head Equity and share

application money to the extent refundable i.e., the amount in excess of subscription or

in case the requirements of minimum subscription are not met, shall be separately

shown under ‘Other current liabilities’

(h) Unpaid matured deposits and interest accrued thereon

(i) Unpaid matured debentures and interest accrued thereon

(j) Other payables (specify nature);

H. Short-term provisions


(a) Provision for employee benefits.


I. Tangible assets

(i) Classification shall be given as:

(a) Land.

(b) Buildings.

(c) Plant and Equipment.

(d) Furniture and Fixtures.

(e) Vehicles.

(f) Office equipment.

(g) Others (specify nature).

(ii) Assets under lease shall be separately specified under each class of asset.



(iii) A reconciliation of the gross and net carrying amounts of each class of assets at the

beginning and end of the reporting period showing additions, disposals, acquisitions

through business combinations and other adjustments and the related depreciation and

impairment losses/reversals shall be disclosed separately.

(iv) Where sums have been written off on a reduction of capital or revaluation of a ssets or

where sums have been added on revaluation of assets, every balance sheet subsequent

to date of such write-off, or addition shall show the reduced or increased figures as

applicable and shall by way of a note also show the amount of the reduction o r increase

as applicable together with the date thereof for the first five years subsequent to the

date of such reduction or increase.

J. Intangible assets


(a) Goodwill.

(b) Brands /trademarks.

(c) Computer software.

(d) Mastheads and publishing titles.

(e) Mining rights.

(f) Copyrights, and patents and other intellectual property rights, services and

operating rights.

(g) Recipes, formulae, models, designs and prototypes.

(h) Licenses and franchise.

(i) Others (specify nature).

(ii) A reconciliation of the gross and net carrying amounts of each class of assets at the


through business combinations and other adjustments and the re lated amortization and

impairment losses/reversals shall be disclosed separately.

(iii) Where sums have been written off on a reduction of capital or revaluation of assets or

where sums have been added on revaluation of assets, every balance sheet subsequent

to date of such write-off, or addition shall show the reduced or increased figures as

applicable and shall by way of a note also show the amount of the reduction or increase

as applicable together with the date thereof for the first five years subseque nt to the

date of such reduction or increase.



K. Non-current investments

(i) Non-current investments shall be classified as trade investments and other investments

and further classified as:

(a) Investment property;

(b) Investments in Equity Instruments;

(c) Investments in preference shares

(d) Investments in Government or trust securities;

(e) Investments in debentures or bonds;

(f) Investments in Mutual Funds;

(g) Investments in partnership firms

(h) Other non-current investments (specify nature)

Under each classification, details shall be given of names of the bodies corporate

[indicating separately whether such bodies are (i) subsidiaries, (ii) associates, (iii) joint

ventures, or (iv) controlled special purpose entities] in whom investments have been

made and the nature and extent of the investment so made in each such body corporate

(showing separately investments which are partly-paid). In regard to investments in the

capital of partnership firms, the names of the firms (with the names of all t heir partners,

total capital and the shares of each partner) shall be given.

(ii) Investments carried at other than at cost should be separately stated specifying the

basis for valuation thereof.

(iii) The following shall also be disclosed:

(a) Aggregate amount of quoted investments and market value thereof;

(b) Aggregate amount of unquoted investments;

(c) Aggregate provision for diminution in value of investments.

L. Long-term loans and advances

(i) Long-term loans and advances shall be classified as:

(a) Capital Advances;

(b) Security Deposits;

(c) Loans and advances to related parties (giving details thereof);

(d) Other loans and advances (specify nature).

(ii) The above shall also be separately sub-classified as:

(a) Secured, considered good;



(b) Unsecured, considered good;

(c) Doubtful.

(iii) Allowance for bad and doubtful loans and advances shall be disclosed under the

relevant heads separately.

(iv) Loans and advances due by directors or other officers of the company or any of them

either severally or jointly with any other persons or amounts due by firms or private

companies respectively in which any director is a partner or a director or a member

should be separately stated.

M. Other non-current assets

Other non-current assets shall be classified as:

(i) Long Term Trade Receivables (including trade receivables on deferred credit terms);

(ii) Others (specify nature)

(iii) Long term Trade Receivables, shall be sub-classified as:

(a) (A) Secured, considered good;

(B) Unsecured considered good;

(C) Doubtful

(b) Allowance for bad and doubtful debts shall be disclosed under the relevant heads

separately.

(c) Debts due by directors or other officers of the company or any of them either

severally or jointly with any other person or debts due by firms or private



N. Current Investments

(i) Current investments shall be classified as:

(a) Investments in Equity Instruments;

(b) Investment in Preference Shares

(c) Investments in government or trust securities;

(d) Investments in debentures or bonds;

(e) Investments in Mutual Funds;

(f) Investments in partnership firms

(g) Other investments (specify nature).




[indicating separately whether such bodies are (i) subsidiaries, (ii) associates, (iii) joint

ventures, or (iv) controlled special purpose entities] in whom investments have been

made and the nature and extent of the investment so made in each such body corporate

(showing separately investments which are partly-paid). In regard to investments in the

capital of partnership firms, the names of the firms (with the names of all t heir partners,

total capital and the shares of each partner) shall be given.

(ii) The following shall also be disclosed:

(a) The basis of valuation of individual investments

(b) Aggregate amount of quoted investments and market value thereof;

(c) Aggregate amount of unquoted investments;

(d) Aggregate provision made for diminution in value of investments.

O. Inventories

(i) Inventories shall be classified as:

(a) Raw materials;

(b) Work-in-progress;

(c) Finished goods;

(d) Stock-in-trade (in respect of goods acquired for trading);

(e) Stores and spares;

(f) Loose tools;


(ii) Goods-in-transit shall be disclosed under the relevant sub-head of inventories.

(iii) Mode of valuation shall be stated.

P. Trade Receivables

(i) Aggregate amount of Trade Receivables outstanding for a period exceeding six months

from the Date they are due for payment should be separately stated.

(ii) Trade receivables shall be sub-classified as:


(b) Unsecured considered good;

(c) Doubtful.



(iii) Allowance for bad and doubtful debts shall be disclosed under the relevant heads

separately.

(iv) Debts due by directors or other officers of the company or any of them either severally

or jointly with any other person or debts due by firms or private companies respectively

in which any director is a partner or a director or a member should be separately stated.

Q. Cash and cash equivalents

(i) Cash and cash equivalents shall be classified as:

(a) Balances with banks;

(b) Cheques, drafts on hand;

(c) Cash on hand;

(d) Others (specify nature).

(ii) Earmarked balances with banks (for example, for unpaid dividend) shall be separately

stated.

(iii) Balances with banks to the extent held as margin money or security against the

borrowings, guarantees, other commitments shall be disclosed separately.

(iv) Repatriation restrictions, if any, in respect of cash and bank balances shall be

separately stated.

(v) Bank deposits with more than 12 months maturity shall be disclosed separately.

R. Short-term loans and advances

(i) Short-term loans and advances shall be classified as:

(a) Loans and advances to related parties (giving details thereof);


(ii) The above shall also be sub-classified as:


(b) Unsecured, considered good;

(c) Doubtful.

(iii) Allowance for bad and doubtful loans and advances shall be disclosed under the


(iv) Loans and advances due by directors or other officers of the company or any of them

either severally or jointly with any other person or amounts due by firms or private

companies respectively in which any director is a partner or a director or a member shall

be separately stated.

S. Other current assets (specify nature).

This is an all-inclusive heading, which incorporates current assets that do not fit into any

other asset categories.



T. Contingent liabilities and commitments (to the extent not provided for)

(i) Contingent liabilities shall be classified as:

(a) Claims against the company not acknowledged as debt;

(b) Guarantees;

(c) Other money for which the company is contingently liable

(ii) Commitments shall be classified as:

(a) Estimated amount of contracts remaining to be executed on capital account and

not provided for;

(b) Uncalled liability on shares and other investments partly paid

(c) Other commitments (specify nature).

U. The amount of dividends proposed to be distributed to equity and preference shareholders for

the period and the related amount per share shall be disclosed separately. Arrears of fixed

cumulative dividends on preference shares shall also be disclosed separately.

V. Where in respect of an issue of securities made for a specific purpose, the whole or part of

the amount has not been used for the specific purpose at the balance sheet date, there shall

be indicated by way of note how such unutilized amounts have been used or invested.

W. If, in the opinion of the Board, any of the assets other than property, plant and equipment and

non-current investments do not have a value on realization in the ordinary course of business

at least equal to the amount at which they are stated, the fact that the Board is of that

opinion, shall be stated.

PART II – STATEMENT OF PROFIT AND LOSS

Name of the Company…………………….

Profit and loss statement for the year ended ………………………

(Rupees in…………)

Particulars Note

No.

Figures for the

current

reporting

period

Figures for

the previous

reporting

period

1 2 3 4

I. Revenue from operations xxx xxx

II. Other income xxx xxx

III. Total Revenue (I + II) xxx xxx

IV. Expenses:

Cost of materials consumed

xxx

xxx

xxx

xxx



Purchases of Stock-in-Trade

Changes in inventories of finished goods

work-in-progress

and Stock-in-Trade

Employee benefits expense

Finance costs

Depreciation and amortization expense

Other expenses

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

xxx

Total expenses xxx xxx

V. Profit before exceptional and extraordinary

items and tax (III-IV)

xxx xxx

VI. Exceptional items xxx xxx

VII. Profit before extraordinary items and tax (V -

VI)

xxx xxx

VIII. Extraordinary Items xxx xxx

IX. Profit before tax (VII- VIII) xxx xxx

X Tax expense:

(1) Current tax

(2) Deferred tax

xxx

xxx

xxx

xxx

xxx

xxx

XI Profit (Loss) for the period from continuing

operations (VII-VIII)

xxx Xxx

XII Profit/(loss) from discontinuing operations xxx Xxx

XIII Tax expense of discontinuing operations xxx Xxx

XIV Profit/(loss) from Discontinuing operations

(after tax) (XII-XIII)

xxx Xxx

XV Profit (Loss) for the period (XI + XIV) xxx xxx

XVI

Earnings per equity share:

(1) Basic

(2) Diluted

xxx

xxx

xxx

xxx

See accompanying notes to the financial statements.

GENERAL INSTRUCTIONS FOR PREPARATION OF STATEMENT OF PROFIT AND LOSS

1. The provisions of this Part shall apply to the income and expenditure account referred to in

sub-clause (ii) of Clause (40) of Section 2 in like manner as they apply to a statement of profit

and loss.



2. (A) In respect of a company other than a finance company revenue from operations shall

disclose separately in the notes revenue from

(a) Sale of products;

(b) Sale of services;

(c) Other operating revenues;

Less:

(d) Excise duty.

(B) In respect of a finance company, revenue from operations shall include revenue from

(a) Interest; and

(b) Other financial services

Revenue under each of the above heads shall be disclosed separately by way of notes to

accounts to the extent applicable.

3. Finance Costs

Finance costs shall be classified as:

(a) Interest expense;

(b) Other borrowing costs;

(c) Applicable net gain/loss on foreign currency transactions and translation.

4. Other income

Other income shall be classified as:

(a) Interest Income (in case of a company other than a finance company);

(b) Dividend Income;

(c) Net gain/loss on sale of investments

(d) Other non-operating income (net of expenses directly attributable to such income).

5. Additional Information

A Company shall disclose by way of notes additional information regarding aggregate

expenditure and income on the following items:

(i) (a) Employee Benefits Expense [showing separately (i) salaries and wages, (ii)

contribution to provident and other funds, (iii) expense on Employee Stock Option

Scheme (ESOP) and Employee Stock Purchase Plan (ESPP), (iv) staff welfare

expenses].



(b) Depreciation and amortization expense;

(c) Any item of income or expenditure which exceeds one per cent of the revenue from

operations or ` 1,00,000, whichever is higher;

(d) Interest Income;

(e) Interest Expense;

(f) Dividend Income;

(g) Net gain/ loss on sale of investments;

(h) Adjustments to the carrying amount of investments;

(i) Net gain or loss on foreign currency transaction and translation (other than

considered as finance cost);

(j) Payments to the auditor as

(a) auditor,

(b) for taxation matters,

(c) for company law matters,

(d) for management services,

(e) for other services,

(f) for reimbursement of expenses;

(k) In case of companies covered u/s 135, amount of expenditure incurred on

corporate social responsibility activities.

(l) Details of items of exceptional and extraordinary nature;

(m) Prior period items;

(ii) (a) In the case of manufacturing companies,

(1) Raw materials under broad heads.

(2) goods purchased under broad heads.

(b) In the case of trading companies, purchases in respect of goods traded in by the

company under broad heads.

(c) In the case of companies rendering or supplying services, gross income derived

from services rendered or supplied under broad heads.

(d) In the case of a company, which falls under more than one of the categories

mentioned in (a), (b) and (c) above, it shall be sufficient compliance with the



requirements herein if purchases, sales and consumption of raw material and the

gross income from services rendered is shown under broad heads.

(e) In the case of other companies, gross income derived under broad heads.

(iii) In the case of all concerns having works in progress, works-in-progress under broad

heads.

(iv) (a) The aggregate, if material, of any amounts set aside or proposed to be set aside,

to reserve, but not including provisions made to meet any specific liability,

contingency or commitment known to exist at the date as to which the balance-

sheet is made up.

(b) The aggregate, if material, of any amounts withdrawn from such reserves.

(v) (a) The aggregate, if material, of the amounts set aside to provisions made for meeting

specific liabilities, contingencies or commitments.

(b) The aggregate, if material, of the amounts withdrawn from such provisions, as no

longer required.

(vi) Expenditure incurred on each of the following items, separately for each item: -

(a) Consumption of stores and spare parts.

(b) Power and fuel.

(c) Rent.

(d) Repairs to buildings.

(e) Repairs to machinery.

(f) Insurance.

(g) Rates and taxes, excluding, taxes on income.

(h) Miscellaneous expenses,

(vii) (a) Dividends from subsidiary companies.

(b) Provisions for losses of subsidiary companies.

(viii) The profit and loss account shall also contain by way of a note the following information,

namely:

(a) Value of imports calculated on C.I.F basis by the company during the financial year

in respect of –

I. Raw materials;



II. Components and spare parts;

III. Capital goods;

(b) Expenditure in foreign currency during the financial year on account of royalty,

know-how, professional and consultation fees, interest, and other matters;

(c) Total value if all imported raw materials, spare parts and components consumed

during the financial year and the total value of all indigenous raw materials, spare

parts and components similarly consumed and the percentage of each to the total

consumption;

(d) The amount remitted during the year in foreign currencies on account of dividends

with a specific mention of the total number of non-resident shareholders, the total

number of shares held by them on which the dividends were due and the year to

which the dividends related;

(e) Earnings in foreign exchange classified under the following heads, namely:

I. Export of goods calculated on F.O.B. basis;

II. Royalty, know-how, professional and consultation fees;

III. Interest and dividend;

IV. Other income, indicating the nature thereof

Note: Broad heads shall be decided taking into account the concept of materiality and

presentation of true and fair view of financial statements.

GENERAL INSTRUCTIONS FOR THE PREPARATION OF CONSOLIDATED FINANCIAL

STATEMENTS

1. Where a company is required to prepare Consolidated Financial Statements, i.e.,

consolidated balance sheet and consolidated statement of profit and loss, the company shall

mutatis mutandis follow the requirements of this Schedule as applicable to a company in the

preparation of balance sheet and statement of profit and loss. In addition, the consolidated

financial statements shall disclose the information as per the requirements specified i n the

applicable Accounting Standards including the following:

(i) Profit or loss attributable to “minority interest” and to owners of the parent in the

statement of profit and loss shall be presented as allocation for the period.

(ii) “Minority interests” in the balance sheet within equity shall be presented separately from

the equity of the owners of the parent.



2. In Consolidated Financial Statements, the following shall be disclosed by way of additional

information:

Name of the entity in the Net Assets, i.e., total assets minus total liabilities

Share in profit or loss

As % of consolidated net

assets

Amount

As % of consolidated profit or loss

Amount

1 2 3 4 5

Parent Subsidiaries Indian

1.

2.

3.

Foreign

1.

2.

3.

Minority Interests in all subsidiaries Associates (Investment as per the equity method)

Indian

1.

2.

3.

Foreign

1.

2.

3.



Joint Ventures (as per proportionate consolidation/investment as per the equity method)

Indian

1.

2.

3.

Foreign

1.

2.

3.

TOTAL

3. All subsidiaries, associates and joint ventures (whether Indian or foreign) will be covered

under consolidated financial statements.

4. An entity shall disclose the list of subsidiaries or associates or joint ventures which have not

been consolidated in the consolidated financial statements along with the reasons of not

consolidating.


SCHEDULE III : DIVISON II A.23

Division II

Financial Statements for a company whose financial statements are drawn up in compliance of the Companies (Indian Accounting Standards) Rules, 2015.

GENERAL INSTRUCTIONS FOR PREPARATION OF FINANCIAL STATMENT OF A COMPANY

REQUIRED TO COMPLY WITH Ind AS

1. Every company to which Indian Accounting Standards apply, shall prepare its financial

statements in accordance with this Schedule or with such modification as may be required

under certain circumstances.

2. Where compliance with the requirements of the Act including Indian Accounting Standards

(except the option of presenting assets and liabilities in the order of liquidity as provided by

the relevant Ind AS) as applicable to the companies require any change in treatment or

disclosure including addition, amendment substitution or deletion in the head or sub-head or

any changes inter se, in the financial statements or statements forming part thereof, the same

shall be made and the requirements under this Schedule shall stand modified accordingly.

3. The disclosure requirements specified in this Schedule are in addition to and not in

substitution of the disclosure requirements specified in the Indian Accounting Standards.

Additional disclosures specified in the Indian Accounting Standards shall be made in the

Notes or by way of additional statement or statements unless required to be disclosed on the

face of the Financial Statements. Similarly, all other disclosures as required by the

Companies Act, 2013 shall be made in the Notes in addition to the requirements set out in

this Schedule.

4. (i) Notes shall contain information in addition to that presented in the Financial Statements

and shall provide where required-

(a) narrative description or disaggregation of items recognised in those statements;

and

(b) information about items that do not qualify for recognition in those statements.

(ii) Each item on the face of the Balance Sheet, Statement of Changes in Equity and

Statement of Profit and Loss shall be cross-referenced to any related information in the

Notes. In preparing the Financial Statements including the Notes, a balance shall be

maintained between providing excessive detail that may not assist users of Financial

Statements and not providing important information as a result of too much aggregation.



5. Depending upon the turnover of the company, the figures appearing in the Financial

Statements shall be rounded off as below:

Turnover Rounding off

(i) less than one hundred crore rupees To the nearest hundreds, thousands,

lakhs or millions, or decimals thereof

(li) one hundred crore rupees or more To the nearest, lakhs, millions or crores,

or decimals thereof.

Once a unit of measurement is used, it should be used uniformly in the Financial Statements.

6. Financial Statements shall contain the corresponding amounts (comparatives) for the

immediately preceding reporting period for all i tems shown in the Financial Statement

including Notes except in the case of first Financial Statements laid before the company after

incorporation.

7. Financial Statements shall disclose all 'material' items, i,e, the items if they could. individually

or collectively, influence the economic decisions that users make on the basis of the financial

statements. Materiality depends on the size or nature of the item or a combination of both, to

be judged in the particular circumstances.

8. For the purpose of this Schedule, the terms used herein shall have the same meanings

assigned to them in Indian Accounting Standards.

9. Where any Act or Regulation requires specific disclosure to be made in the standalone

financial statement of a company, the said disclosure shall be made in addition to those

required under this Schedule.

Note: This Schedule sets out the minimum requirements for disclosure on the face of the Financial

Statements, i.e, Balance Sheet, Statement of Changes in Equity for the period, the Statement of

profit and Loss for the period (The term 'Statement of Profit and Loss' has the same meaning as

Profit and Loss Account) and Notes. Cash flow statement shall be prepared, where applicable, in

accordance with the requirement of the relevant Indian Accounting Standard.

Line items, sub-line items and sub-totals shall be presented as an addition or substitution on the

face of the Financial Statements when such presentation is relevant to an understanding of the

company's financial position or performance to cater to industry or sector-specific disclosure

requirements or when required for compliance with the amendments to the Companies Act, 2013

or under the Indian Accounting Standards.


SCHEDULE III : DIVISION II A.25

PART I -BALANCE SHEET

Name of the Company....................

Balance Sheet as at ......................

(Rupees in.........)

Particulars Note No.

Figures as at the end of current reporting

period

Figures as at the end of the

previous reporting

period

1 2 3 4

(1) ASSETS

Non-current assets

(a) Property, Plant and Equipment

(b) Capital work-in-progress

(c) lnvestment Property

(d) Goodwill

(e) Other Intangible assets

(f) Intangible assets under development

(g) Biological Assets other than bearer plants

(h) Financial Assets

(i) Investments

(ii) Trade receivables

(iii) Loans

(i) Deferred tax assets (net)

(j) Other non-current assets

(2) Current assets

(a) Inventories

(b) Financial Assets

(i) Investments

(ii) Trade receivables

(iii) Cash and cash equivalents

(iv) Bank balances other than (iii) above

(v) Loans

(vi) Others (to be specified)



(c) Current Tax Assets (Net)

(d) Other current assets

Total Assets

EQUITY AND LIABILITIES

Equity

(a) Equity Share capital

(b) Other Equity

(1) LIABILITIES

Non-current liabilities

(a) Financial Liabilities

(i) Borrowings

(ii) Trade Payables:


(B) total outstanding dues of creditors other than micro enterprises and small enterprises.

(iii) Other financial liabilities (other than those specified in item (b), to be specified)

(b) Provisions

(c) Deferred tax liabilities (Net)

(d) Other non-current liabilities

(2) Current liabilities

(a) Financial Liabilities

(i) Borrowings

(ii) Trade payables:


(B) total outstanding dues of creditors other than micro enterprises and small enterprises

(iii) Other financial liabilities (other than those specified in item (c)

(b) Other current liabilities



(c) Provisions

(d) Current Tax Liabilities (Net)

Total Equity and Liabilities

see accompanying notes to the financial statements

STATEMENT OF CHANGES IN EQUITY

Name of the Company..............

Statement of Changes in Equity for the period ended ............

A. Equity Share Capital

Balance at the

beginning of the

reporting period

Changes in equity share

capital during the year

Balance at the end of the

reporting period


B.

Oth

er

Eq

uit

y

Sh

are

a

pp

lica

tion

o

n m

on

ey

pe

nd

ing

a

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en

t

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uity

co

mp

on

en

t o

f co

mp

ou

nd

fin

an

cia

l in

stru

me

nt

Re

serv

e a

nd

Su

rplu

s D

eb

t In

stru

me

nt

thro

ug

h o

the

r C

om

pre

he

nsi

ve

Inco

me

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uity

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stru

me

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ug

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om

pre

he

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ve

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com

e

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ect

ive

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sh F

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esig

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all

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he N

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ADVANCED AUDITING AND ASSURANCE A 28


A29 SCHEDULE III : DIVISION I A.29

GENERAL INSTRUCTIONS FOR PREPARATION OF BALANCE SHEET

1. An entity shall classify an asset as current when-

(a) it expects to realise the asset, or intends to sell or consume it, in its normal operating

cycle;

(b) it holds the asset primarily for the purpose of trading;

(c) it expects to realise the asset within twelve months after the reporting period; or

(d) the asset is cash or a cash equivalent unless the asset is restricted from being

exchanged or used to settle a liability for at least twelve months after the reporting

period.

An entity shall classify all other assets as non-current.

2. The operating cycle of an entity is the time between the acquisition of assets for processing

and their realisation in cash or cash equivalents, When the entity's normal operating cycle is

not clearly identifiable, it is assumed to be twelve months.

3. An entity shall classify a liability as current when-

(a) it expects to settle the liability in its normal operating cycle;

(b) it holds the liability primarily for the purpose of trading;

(c) the liability is due to be settled within twelve months after the reporting period; or

(d) it does not have an unconditional right to defer settlement of the liability for at least

twelve months after the reporting period. Terms of a liability that could, at the option of

the counterparty, result in it settlement by the issue of equity instruments do not affect

its classification.

An entity shall classify all other liabilities as non-current.

4. A receivable shall be classified as a 'trade receivable' if it is in respect of the amount due on

account of goods sold or services rendered in the normal course of business.

5. A payable shall be classified as a 'trade payable' if it is in respect of the amount due on

account of goods purchased or services received in the normal course of business.

6. A company shall disclose the following in the Notes:

A Non-Current Assets

l. Property. Plant and Equipment :


(a) Land



(b) Buildings

(c) Plant and Equipment

(d) Furniture and Fixtures

(e) Vehicles

(f) Office equipment

(g) Bearer Plants

(h) Others (specify nature)

(ii) Assets under lease shall be separately specified under each class of

assets

(iii) A reconciliation of the gross and net carrying amounts of each class of

assets at the beginning and end of the reporting period showing

additions, disposals, acquisitions through business combinations and

other adjustments and the related depreciation and impairment losses or

reversals shall be disclosed separately.

ll. Investment Property:

A reconciliation of the gross and net carrying amounts of each class of property at the


through business combinations and other adjustments and the related depreciation and

impairment losses or reversals shall be disclosed separately.

III. Goodwill:

A reconciliation of the gross and net carrying amount of goodwill at the beginning and

end of the reporting period showing additions, impairments, disposals and other

adjustments.

IV. Other Intangible assets


(a) Brands or trademarks

(b) Computer software

(c) Mastheads and publishing titles

(d) Mining rights

(e) Copyright, patents, other intellectual property rights, services and operating rights

(f) Recipes, formulae, models, designs and prototypes

(g) Licenses and franchises

(h) Others (specify nature)



(ii) A reconciliation of the gross and net carrying amounts of each class of assets at

the beginning and end of the reporting period showing additions, disposals,

acquisitions through business combinations and other adjustments and the related

amortization and impairment losses or reversals shall be disclosed separately.

V. Biological Assets other than bearer plants:

A reconciliation of the carrying amounts of each class of assets at the beginning and

end of the reporting period showing additions, disposals, acquisitions through business

combinations and other adjustments shall be disclosed separately.

VI. Investment

(i) Investments shall be classified as:

(a) Investments in Equity Instruments;

(b) Investments in Preference Shares;

(c) Investments in Government or trust securities;



(f) Investments in partnership firms; or

(g) Other investments (specify nature)


that are-

(i) subsidiaries,

(ii) associates,

(iii) joint ventures, or

(iv) structured entities,

in whom investments have been made and the nature and extent of the investment

so made in each such body corporate (showing separately investments which are

partly-paid). lnvestment in partnership firms alongwith names of the firms, their

partners, total capital and the shares of each partner shall be disclosed separately.

(ii) The following shall also be disclosed:

(a) Aggregate amount of quoted investment and market value thereof:

(b) Aggregate amount of unquoted investment: and

(c) Aggregate amount of impairment in value of investment.



VII. Trade Receivables:

(i) Trade receivables shall be sub-classified as;

(a) Trade Receivables considered good - Secured;

(b) Trade Receivables considered good - Unsecured;

(c) Trade Receivables which have significant increase in Credit Risk; and

(d) Trade Receivables - credit impaired

(ii) Allowance for bad and doubtful debts shall be disclosed under the relvant heads

separately.

(iii) Debts due by directors or other officers of the company or any of them either

severally or jointly with any other person or debts due by firms or private



VIII. Loans;

(i) Loans shall be classified as-

(a) Security Deposits;

(b) Loans to related parties (giving details thereof); and

(c) Other loans (specify nature).

(ii) Loans Receivables shall be sub-classified as:

(a) Loans Receivables considered good - Secured;

(b) Loans Receivables considered good - Unsecured;

(c) Loans Receivables which have significant increase in Credit Risk; and

(d) Loans Receivables - credit impaired;

The above shall also be separately sub-classified as-


(b) Unsecured, considered good; and

(c) Doubtful. Allowance for bad and doubtful loans shall be disclosed under the


(iv) Loans due by directors or other officers of the company or any of them either

severally or jointly with any other persons or amounts due by firms or private





IX. Bank deposits with more than 12 months maturity shall be disclosed under 'Other

financial assets';

X. Other non-current asset: Other non-current assets shall be classified as-

(i) Capital Advances; and

(ii) Advances other than capital advances;

(1) Advances other than capital advances shall be classified as:


(b) Advances to related parties (giving details thereof; and

(c) Other advances (specify nature).

(2) Advances to directors or other officers of the company or any of them either

severally or jointly with any other persons or advances to firms or private

companies respectively in which any director is a partner or a director or a

member should be separately stated, ln case advances are of the nature of a

financial asset as per relevant Ind AS, these are to be disclosed under other

financial assets separately.

(iii) Others (specify nature).

B. Current Assets

I. Inventories:

(i) Inventories shall be classified as-

(a) Raw materials;

(b) Work in-progress;

(c) Finished goods;

(d) Stock-in-trade (in respect of goods acquired for trading);

(e) stores and spares;

(f) Loose tools; and


(ii) Goods-in-transit shall be disclosed under the relevant sub-head of inventories.

(iii) Mode of valuation shall be stated.

II. Investment;

(i) Investments shall be classified as-

(a) Investments in Equity lnstruments;



(b) lnvestment in Preference Shares;

(c) lnvestment in government or trust securities;



(f) lnvestment in partnership firms; and

(g) Other investments (specify nature).


that are-

(i) subsidiaries,

(ii) associates,

(iii) joint ventures, or

(iv) structured entities,

in whom investments have been made and the nature and extent of the investment

so made in each such body corporate (showing separately investments which are

partly-paid)

(ii) The following shall also be disclosed

(a) Aggregate amount of quoted investments and market value thereof;

(b) Aggregate amount of unquoted investments;

(c) Aggregate amount of impairment in value of investments,

III. Trade Receivables

(i) Trade receivables shall be sub-classified as:

(a) Trade Receivables considered good - Secured;

(b) Trade Receivables considered good - Unsecured;

(c) Trade Receivables which have significant increase in Credit Risk; and

(d) Trade Receivables - credit impaired.

(ii) Allowance for bad and doubtful debts shall be disclosed under the relevant heads

separately.

(iii) Debts due by directors or other officers of the company or any of them either

severally or jointly with any other person or debts due by firms or. private





IV. Cash and cash equivalents:

Cash and cash equivalents shall be classified as-

a. Balances with Banks (of the nature of cash and cash equivalents);

b. Cheques, drafts on hand;

c. Cash on hand; and

d. Others (specify nature).

V. Loans:

(i) Loans shall be classified as:

(a) Security deposits;

(b) Loans to related parties (giving details thereof); and

(c) others (specify nature).

(ii) Loans Receivables shall be sub-classified as:

(a) Loans Receivables considered good - Secured;

(b) Loans Receivables considered good - Unsecured;

(c) Loans Receivables which have significant increase in Credit Risk; and

(d) Loans Receivables - credit impaired.

(iii) Allowance for bad and doubtful loansshall be disclosed under the relevant heads

separately.

(iv) Loans due by directors or other officers of the company or any of them either

severally or jointly with any other person or amounts due by firms or private


shall be separately stated.

VI. Other current assets (specify nature): This is an all-inclusive heading, which

incorporates current assets that do not fit into any other asset categories. Other

current assets shall be classified as-

(i) Advances other than capital advances

(1) Advances other than capital advances shall be classified as:


(b) Advances to related parties (giving details thereof);

(c) Other advances (specify nature)

(2) Advances to directors or other officers of the company or any of them either

severally or jointly with any other persons or advances to firms or private



companies respectively in which any director is a partner or a director or a

member should be separately stated.

(a) Earmarked balances with banks (for example for unpaid dividend) shall

be separately stated.

(b) Balances with banks to the extent held as margin money or security

against the borrowings, guarantees, other commitments shall be

disclosed separately.

(c) Repatriation restrictions, if any, in respect of cash and bank balances

shall be separately stated.

D. Equity

I. Equity Share Capital: For each class of equity share capital:

(a) the number and amount of shares authorised;

(b) the number of shares issued, subscribed and fully paid, and subscribed but not

fully paid;

(c) par value per Share;

(d) a reconciliation of the number of shares outstanding at the beginning and at the

end of the period;

(e) the rights, preferences and restrictions attaching to each class of shares including

restrictions on the distribution of dividends and the repayment of capital;

(f) shares in respect of each class in the company held by its holding company or its

ultimate holding company including shares held by subsidiaries or associates of the

holding company or the ultimate holding company in aggregate;

(g) shares in the company held by each shareholder holding more than five per cent.

shares specifying the number of shares held;

(h) shares reserved for issue under options and contracts or commitments for the sale

of shares or disinvestment, including the terms and amounts;

(i) for the period of five years immediately preceding the date at which the Balance

Sheet is prepared

• aggregate number and class of shares allotted as fully paid up pursuant to

contract without payment being received in cash;

• aggregate number and class of shares allotted as fully paid up by way of

bonus shares; and

• aggregate number and class of shares bought back;



(j) terms of any securities convertible into equity shares issued along with the earliest

date of conversion in descending order starting from the farthest such date;

(k) calls unpaid (showing aggregate value of calls unpaid by directors and officers);

(l) forfeited shares (amount originally paid up).

II. Other Equity:

(i) Other Reserves' shall be classified in the notes as-

(a) Capital Redemption Reserve;

(b) Debenture Redemption Reserve;

(c) Share Options Outstanding Account; and

(d) others- (specify the nature and purpose of each reserve and the amount in

respect thereof);

(Additions and deductions since last balance sheet to be shown under each of the

specified heads)

(ii) Retained Earnings represents surplus i.e. balance of the relevant column in the

Statement of Changes in Equity;

(iii) A reserve specifically represented by earmarked investments shall disclose the fact

that it is so represented;

(iv) Debit balance of Statement of Profit and Loss shal l be shown as a negative figure

under the head 'retained earnings'. Similarly, the balance of 'Other Equity', after

adjusting negative balance of retained earnings, if any, shall be shown under the

head 'Other Equity' even if the resulting figure is in the negative; and

(v) Under the sub-head 'Other Equity', disclosure shall be made for the nature and

amount of each item.

E. Non-Current Liabilities

I. Borrowings:

(i) borrowings shall be classified as-

(a) Bonds or debentures

(b) Term loans

(I) from banks

(lI) from other Parties

(c) Deferred payment liabilities



(d) Deposits.

(e) Loans from related parties

(f) Long term maturities of finance lease obligations

(g) Liability component of compound financial instruments

(h) Other loans (specify nature);

(ii) borrowings shall further be sub-classified as secured and unsecured. Nature of

security shall be specified separately in each case.

(iii) where loans have been guaranteed by directors or others, the aggregate amount of

such loans under each head shall be disclosed;

(iv) bonds or debentures (along with the rate of interest, and particulars of redemption

or conversion, as the case may be) shall be stated in descending order of maturity

or conversion, starting from farthest redemption or conversion date, as the case

may be, where bonds/debentures are redeemable by installments, the date of

maturity for this purpose must be reckoned as the date on which the first

installment becomes due;

(v) particulars of any redeemed bonds or debentures which the company has power to

reissue shall be disclosed;

(vi) terms of repayment of term loans and other loans shall be stated; and

(vii) period and amount of default as on the balance sheet date in repayment of

borrowings and interest shall be specified separately in each case.

III. Provisions: The amounts shall be classified as-

(a) Provision for employee benefits; and


IV. Other non-current liabilities;

(a) Advances; and


F. Current Liabilities

I. Borrowings:

(i) Borrowings shall be classified as-

(a) Loans repayable on demand

(I) from banks



(II) from other parties

(b) Loans from related parties

(c) Deposits

(d) Other loans (specify nature);

(ii) borrowings shall further be sub-classified as secured and unsecured. Nature of

security shall be specified separately in each case;

(iii) where loans have been guaranteed by directors or others, the aggregate amount of

such loans under each head shall be disclosed;

(iv) period and amount of default as on the balance sheet date in repayment of

borrowings and interest, shall be specified separately in each case.

II. Other Financial Liabilities: Other Financial liabilities shall be classified as-

(a) Current maturities of long-term debt;

(b) Current maturities of finance lease obligations;

(c) Interest accrued;

(d) Unpaid dividends;

(e) Application money received for allotment of securities to the extent refundable and

interest accrued thereon;

(f) Unpaid matured deposits and interest accrued thereon;

(g) Unpaid matured debentures and interest accrued thereon; and

(h) Others (specify nature).

'Long term debt is a borrowing having a period of more than twelve months at the time

of origination

III. Other current liabilities:

The amounts shall be classified as-

(a) revenue received in advance;

(b) other advances (specify nature); and

(c) others (specify nature);

IV. Provisions: The amounts shall be classified as-

(i) provision for employee benefits; and

(ii) others (specify nature)



FA. Trade Payables

The following details relating to micro, small and medium enterprises shall be disclosed in the

notes:-

(a) the principal amount and the interest due thereon (to be shown separately) remaining

unpaid to any supplier at the end of each accounting year;

(b) the amount of interest paid by the buyer in terms of section 16 of the Micro, Small and

Medium Enterprises Development Act, 2006 (27 of 2006), along with the amount of the

payment made to the supplier beyond the appointed day dur ing each accounting year;

(c) the amount of interest due and payable for the period of delay in making payment (which

has been paid but beyond the appointed day during the year) but without adding the

interest specified under the Micro, Small and Medium Enterprises Development Act,

2006;

(d) the amount of interest accrued and remaining unpaid at the end of each accounting

year; and 3

(e) the amount of further interest remaining due and payable even in the succeeding years,

until such date when the interest dues above are actually paid to the small enterprise,

for the purpose of disallowance of a deductible expenditure under section 23 of t he

Micro, Small and Medium Enterprises Development Act, 2006.

Explanation.- The terms ‘appointed day’, ‘buyer’, ‘enterprise’, ‘micro enterprise’, ‘small

enterprise’ and ‘supplier’, shall have the same meaning as assigned to them under clauses

(b), (d), (e), (h), (m) and (n) respectively of section 2 of the Micro, Small and Medium

Enterprises Development Act, 2006.

G. The presentation of liabilities associated with group of assets classified as held for sale and

non-current assets classified as held for sale shall be in accordance with the relevant Indian

Accounting Standards (Ind ASs)

H. Contingent Liabilities and Commitments:

(to the extent not provided for)

(i) Contingent Liabilities shall be classified as-

(a) claims against the company not acknowledged as debt;

(b) guarantees excluding financial guarantees; and

(c) other money for which the company is contingently liable.



(ii) Commitments shall be classified as-

(a) estimated amount of contracts remaining to be executed on capital account and not

provided for;

(b) uncalled liability on shares and other investments partly paid; and

(c) other commitments (specify nature).

I. The amount of dividends proposed to be distributed to equity and preference shareholders for

the period and title related amount per share shall be disclosed separately. Arrears of fixed

cumulative dividends on irredeemable preference shares shall also be disclosed separately.

J. Where in respect of an issue of securities made for a specific purpose the whole or part of

amount has not been used for the specific purpose at the Balance sheet date, there shall be

indicated by way of note how such unutilised amounts have been used or invested.

7. When a company applies an accounting policy retrospectively or makes a restatement of

items in the financial statements or when it reclassifies items in its financial statements, the

company shall attach to the Balance Sheet, a "Balance Sheet" as at the beginning of the

earliest comparative period presented.

8. Share application money pending allotment shall be classified into equity or liability in

accordance with relevant Indian Accounting Standards. share application money to the extent

not refundable shall be shown under the head Equity and share application money to the

extent refundable shall be separately shown under 'Other financial liabilities'.

9. Preference shares including premium received on issue, shall be classified and presented as

'Equity' or 'Liability' in accordance with the requirements of the relevant Indian Accounting

Standards. Accordingly, the disclosure and presentation requirements in that regard

applicable to the relevant class of equity or liability shall be applicable mutatis mutandis to the

preference shares. For instance, plain vanilla redeemable preference shares shall be

classified and presented under 'non-current liabilities' as 'borrowings' and the disclosure

requirements in this regard applicable to such borrowings shall be applicable mutatis

mutandis to redeemable preference shares.

10. Compound financial instruments such as convertible debentures, where split into equity and

liability components, as per the requirements of the relevant Indian Accounting Standards,

shall be classified and presented under the relevant heads in 'Equity' and 'Liabili ties'

11. Regulatory Deferral Account Balances shall be presented in the Balance Sheet in accordance

with the relevant Indian Accounting Standards.



PART II - STATEMENT OF PROFIT AND LOSS

Name of the Company.........................

Statement of Profit and Loss for the period ended................

Particulars Note

No.

Figures as at

the end of

current

reporting

period

Figures for the

previous

reporting

period

I Revenue from operations

II Other Income

III Total Income (l + Il)

IV EXPENSES

Cost of materials consumed

Purchases of Stock-in-Trade

Changes in inventories of finished

goods, Stock-in -Trade and work-in-

progress

Employee benefits expense

Finance costs

Depreciation and amortization

expenses

Other expenses

Total expenses (lV)

V Profit/(loss) before exceptional items

and tax (I-IV)

VI Exceptional Items

VII Profit/ (loss) before exceptions items

and tax(V-VI)

VIII Tax expense:

(1) Current tax

(2) Deferred tax

IX Profit (Loss) for the period from

continuing operations (VlI - VlII)

X Profit/(loss) from discontinued

operations



XI Tax expenses of discontinued

operations

XII Profit/(loss) from Discontinued

operations (after tax) (X-XI)

XIII Profit/(loss) for the period (IX+XII)

XIV Other Comprehensive Income

A. (i) Items that will not be

reclassified to profit or

loss

(ii) Income tax relating to

items that will not be


loss

B. (i) Items that will be


loss

(ii) lncome tax relating to

items that will be


loss

XV Total Comprehensive Income for the

period (XIII+XIV) Comprising Profit

(Loss) and Other comprehensive

Income for the period)

XVI Earnings per equity share (for

continuing operation):

(1) Basic

(2) Diluted

XVII Earnings per equity share (for

discontinued operation):

(1) Basic

(2) Diluted

XVIII Earning per equity share (for

discontinued & continuing operation)

(1) Basic

(2) Diluted

see accompanying notes to the financial statements



GENERAL INSTRUCTIONS FOR PREPARING OF STATEMENT OF PROFIT AND LOSS

1. The provisions of this Part shall apply to the income and expenditure account, in like manner

as they apply to a Statement of Profit and Loss,

2. The Statement of Profit and Loss shall include:

(1) Profit of loss for the Period;

(2) Other Comprehensive Income for the period

The sum of (1) and (2) above is “Total Comprehensive Income"

3. Revenue from operations shall disclose separately in the notes

(a) sale of products (including Excise Duty);

(b) sale of services; and

(c) other operating revenues.

4. Finance Costs: Finance costs shall be classified as-

(a) interest;

(b) dividend on redeemable preference shares;

(c) exchange differences regarded as an adjustment to borrowing costs; and

(d) other borrowing costs (specify nature).

5. Other income: other income shall be classified as-

(a) interest Income;

(b) dividend Income; and

(c) other non-operating income (net of expenses directly attributable to such income)

6. Other Comprehensive Income shall be classified into-

(A) Items that will not be reclassified to profit or loss

(i) Changes in revaluation surplus;

(ii) Re-measurements of the defined benefit plans;

(iii) Equity Instruments through Other Comprehensive Income;

(iv) Fair value changes relating to own credit risk of financial liabilities designated at

fair value through profit or loss;

(v) Share of Other Comprehensive Income in Associates and Joint Ventures, to the

extent not to be classified into profit or loss; and

(v) Share of Other Comprehensive Income in Associates and Joint Ventures, to the

extent not to be classified into profit or loss; and

(vi) Others (specify nature).



(B) Items that will be reclassified to profit or loss;

(i) Exchange differences in translating the financial statements of a foreign operation;

(ii) Debt instruments through Other Comprehensive Income;

(iii) The effective portion of gains and loss on hedging instruments in a cash flow

hedge;

(iv) Share of other comprehensive income in Associates and Joint Ventures, to the

extent to be classified into profit or loss; and

(v) Others (specify nature)

7. Additional Information: A Company shall disclose by way of notes, additional information

regarding aggregate expenditure and income on the following items:

(a) employee Benefits expense (showing separately (i) salaries and wages, (ii) contribution

to provident and other funds, (iii) share based payments to employees, (iv) staff welfare

expenses).

(b) depreciation and amortisation expense;

(c) any item of income or expenditure which exceeds one per cent of the revenue from

operations or ` 10,00,000, whichever is higher, in addition to the consideration of

'materiality ‘as specified in clause 7 of the General Instructions for Preparation of

Financial Statements of a Company;

(d) interest Income;

(e) interest Expense

(f) dividend income;

(g) net gain or loss on sale of investments;

(h) net gain or loss on foreign currency transaction and translation (other than considered

as finance cost);

(i) payments to the auditor as (a) auditor, (b) for taxation matters, (c) for company law

matters, (d) for other services, (e) for reimbursement of expenses;

(j) in case of companies covered under section 135, amount of expenditure incurred on

corporate social responsibility activities; and

(k) details of items of exceptional nature;

8. Changes in Regulatory Deferral Account Balances shall be presented in the Statement of

Profit and Loss in accordance with the relevant Indian Accounting Standards



PART III - GENERAL INSRUCTIONS FOR THE PREPARATION OF CONSOLIDATED

FINANCIAL STATEMENTS

1. Where a company is required to prepare Consolidated Financial Statements, i.e,,

consolidated balance sheet, consolidated statement of changes in equity and consolidated

statement of profit and loss, the company shall mutatis mutandis follow the requ irements of

this Schedule as applicable to a company in the preparation of balance sheet, statement of

changes in equity and statement of profit and loss .ln addition, the consolidated financial

statements shall disclose the information as per the requirements specified in the applicable

Indian Accounting Standards notified under the Companies (lndian Accounting Standards)

Rules 2015, including the following, namely:

(i) Profit or loss attributable to 'non-controlling interest ‘and to ‘owners of the parent' in the

statement of profit and loss shall be presented as allocation for the period Further, 'total

comprehensive income for the period attributable to 'non-controlling interest' and to

'owners of the parent shall be presented in the statement of profit and loss as allocation

for the period. The aforesaid disclosures for 'total comprehensive income shall also be

made in the statement of changes in equity. In addition to the disclosure requirements

in the Indian Accounting Standards, the aforesaid disclosures shall also be made in

respect of 'other comprehensive Income

(ii) 'Non-controlling interests' in the Balance Sheet and in the Statement of Changes in

Equity, within equity, shall be presented separately from the equity of the 'owners of the

parent'.

(iii) Investments accounted for using the equity method.

2. In Consolidated Financial Statement, the following shall be disclosed by the way of additional

information

Name of the entity in the

Group

Net Asset i.e. total assets minus total

liabilities

Share in profit or loss

Share in other comprehensive

income

Share in total comprehensive

income

As % of consolidat

ed net assets

Amount As % of consolid

ated profit or

loss

Amount As % of consolidate

d other comprehen

sive income

Amount

As % of total

comprehensive

income

Amount

Parent

Subsidiaries Indian

1.

2.

3.



Foreign

1.

2.

3.

Non-Controlling Interest in all subsidiaries

Associates (Investment as per the equity method)

Indian

1.

2.

3.

Foreign

1.

2.

3.

Joint Venture (Investment as per the equity method)

Indian

1.

2.

3.

Foreign

1.

2.

3.

Total

3. All subsidiaries, associates and joint venture (whether Indian or Foreign) will be covered

under consolidated financial statement.

4. An entity shall disclose the list of subsidiaries or associates or joint venture which have been

consolidated in the consolidated financial statement along with the reason of not

consolidating.


6

AUDIT REPORTS LEARNING OUTCOMES

After studying this chapter, you will be able to: Understand the meaning and Different types of Audit Reports as per

Standards of Auditing. Identify the different aspects of Reporting as per Standards of Auditing. Determine and apply knowledge of Reporting for further study and

Professional Practice.

Audit Report

Meaning Types of Audit Report

Elements of Audit Reports

Audit Report formats

CHAPTER OVERVIEW



1. INTRODUCTION

Assuming you are an auditor and have concluded the audit field work, your next step will be issuance of the audit report. An audit report is very important medium of communication i.e. auditor’s expert views on the financial statements and it has a significant bearing on the credibility of such statements. By expressing views in the report, the auditor takes upon himself a great responsibility because a large number of stakeholders are likely to place reliance on the financial statements. Therefore, the auditor is necessarily required to be careful, vigilant, and objective in the matter of preparation of his report. The auditor should endeavor to keep his report as much simpler as possible but off course complying with the applicable reporting requirements and as much as the circumstances may permit.

2. THE AUDITOR’S REPORT ON FINANCIAL STATEMENTS The SA 700 series is purely dedicated to the auditor report to be issued by the auditor. There are following SAs which you need to be aware of:

Particulars Head Purpose Effective Date SA-700 (Revised)

Forming an Opinion and Reporting on Financial Statements

• Forming opinion on the financial statements.

• Form and content of the audit report.

1st April 2017

SA-701 (newly introduced)

Communicating Key Audit Matters in the Independent Auditor’s Report

• To enhance the communicative value of the auditor’s report by providing greater transparency about the audit that was performed.

• To assist the user in

1st April 2017


AUDIT REPORTS 6.3

understanding those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements of the current period.

SA-705 (Revised)

Modifications to the Opinion in the Independent Auditor’s Report

• To issue an appropriate audit report when the auditor considers the modification in an audit report is necessary.

• To deal with the revised form and content when the modification of the opinion take place.

1st April 2017

SA-706 (Revised)

Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report

To draw user’s attention to a matter or matters:- • Presented or disclosed in the

financial statements and which is fundamental for the understanding of the user, or

• Not presented or disclosed in • the financial statement and

which is relevant for the understanding of the user.

1st April 2017

3. SA-700, “FORMING AN OPINION AND REPORTING ON THE FINANCIAL STATEMENTS”

It deals with the auditor’s responsibility to form an opinion on the financial statements. It also deals with the form and content of the auditor’s report issued as a result of an audit of financial statements.

Objective: As per SA 700 the objectives of the auditor are: (a) To form an opinion on the financial statements based on an evaluation of the conclusions drawn from the audit evidence obtained; and

(b) To express clearly that opinion through a written report.



3.1 Purpose The requirements of this SA are aimed at addressing an appropriate balance between the need for consistency and comparability in auditor reporting globally and the need to increase the value of auditor reporting by making the information provided in the auditor’s report more relevant to users. This SA promotes consistency in the auditor’s report, but recognizes the need for flexibility to accommodate particular circumstances of individual jurisdictions. Consistency in the auditor’s report, when the audit has been conducted in accordance with SAs, promotes credibility in the global marketplace by making more readily identifiable those audits that have been conducted in accordance with globally recognized standards. It also helps to promote the user’s understanding and to identify unusual circumstances when they occur.

Image: Understanding Audit report, Forms and contents of Audit Report∗

3.2 Basic Elements of the Auditor’s Report As per SA 700 “Forming an opinion and reporting on financial statements”, the auditor’s report includes the following basic elements, which ordinarily includes in case of Auditors’ Report for Audits Conducted in Accordance with Standards on Auditing:

∗ Source : accountlearning.com

Date of Audit ReportPlace of Signature

Signature of the AuditorLocation of the description of the auditor’s responsibilities

Other Reporting ResponsibilitiesOther Reporting ResponsibilitiesAuditor’s Responsibility

Management’s Responsibility for Financial StatementBasis of the opinion

OpinionAddressee

Title


AUDIT REPORTS 6.5 1. Title: The auditor’s report shall have a title that clearly indicates that it is the report of an

independent auditor.

“Independent Auditor’s Report,” distinguishes the independent auditor’s report from reports issued by others.

2. Addressee: The auditor’s report shall be addressed as required by the circumstances of the engagement.

The report could be addressed to the Members of the Company in case of general purpose (statutory) financial statements and to the Board of Directors in case of special purpose financial statements.

3. Auditor’s Opinion: The first section of the auditor’s report shall include the auditor’s opinion, and shall have the heading “Opinion.”

The Opinion section of the auditor’s report shall also: (a) Identify the entity whose financial statements have been audited; (b) State that the financial statements have been audited; (c) Identify the title of each statement comprising the financial statements; (d) Refer to the notes, including the summary of significant accounting policies; and (e) Specify the date of, or period covered by, each financial statement comprising the

financial statements.

When expressing an unmodified opinion on financial statements prepared in accordance with a fair presentation framework, the auditor’s opinion shall, unless otherwise required by law or regulation, use one of the following phrases, which are regarded as being equivalent:

(i) In our opinion, the accompanying financial statements present fairly, in all material respects, […] in accordance with [the applicable financial reporting framework]; or

(ii) In our opinion, the accompanying financial statements give a true and fair view of […] in accordance with [the applicable financial reporting framework].

When expressing an unmodified opinion on financial statements prepared in accordance with a compliance framework, the auditor’s opinion shall be that the accompanying financial statements are prepared, in all material respects, in accordance with [the applicable financial reporting framework].

If the reference to the applicable financial reporting framework in the auditor’s opinion is not to Accounting Standards, the auditor’s opinion shall identify the origin of such other framework.

4. Basis for Opinion: The auditor’s report shall include a section, directly following the Opinion section, with the heading “Basis for Opinion”, that:



(a) States that the audit was conducted in accordance with Standards on Auditing; (b) Refers to the section of the auditor’s report that describes the auditor’s

responsibilities under the SAs; (c) Includes a statement that the auditor is independent of the entity in accordance with

the relevant ethical requirements relating to the audit, and has fulfilled the auditor’s other ethical responsibilities in accordance with these requirements. The statement shall refer to the Code of Ethics issued by ICAI

(d) States whether the auditor believes that the audit evidence the auditor has obtained is sufficient and appropriate to provide a basis for the auditor’s opinion.

5. Going Concern: Where applicable, the auditor shall report in accordance with SA 570.

6. Key Audit Matters: For audits of complete sets of general purpose financial statements of listed entities, the auditor shall communicate key audit matters in the auditor’s report in accordance with SA 701.

When the auditor is otherwise required by law or regulation or decides to communicate key audit matters in the auditor’s report, the auditor shall do so in accordance with SA 701.

7. Responsibilities for the Financial Statements: The auditor’s report shall include a section with a heading “Responsibilities of Management for the Financial Statements.” The auditor’s report shall use the term that is appropriate in the context of the legal framework applicable to the entity and need not refer specifically to “management”. In some entities, the appropriate reference may be to those charged with governance.

This section of the auditor’s report shall also identify those responsible for the oversight of

the financial reporting process, when those responsible for such oversight are different from those who fulfill the responsibilities described in next paragraph. In this case, the heading of this section shall also refer to “Those Charged with Governance” or such term that is appropriate in the context of the legal framework applicable to entity.

When the financial statements are prepared in accordance with a fair presentation framework, the description of responsibilities for the financial statements in the auditor’s report shall refer to “the preparation and fair presentation of these financial statements” or

This section of the auditor’s report shall describe management’s responsibility for:

(a) Preparing the financial statements inaccordance with the applicable financialreporting framework, and for such internal controlas management determines is necessary toenable the preparation of financial statementsthat are free from material misstatement,whether due to fraud or error; and

(b) Assessing the entity’s ability to continue as agoing concern and whether the use of the goingconcern basis of accounting is appropriate aswell as disclosing, if applicable, matters relatingto going concern. The explanation ofmanagement’s responsibility for this assessmentshall include a description of when the use of thegoing concern basis of accounting is appropriate.


AUDIT REPORTS 6.7

“the preparation of financial statements that give a true and fair view,” as appropriate in the circumstances.

8. Auditor’s Responsibilities for the Audit of the Financial Statements: The auditors report shall include a section with the heading “Auditor’s Responsibilities for the Audit of the Financial Statements.”

(I) This section of the auditor’s report shall:

(a) State that the objectives of the auditor are to: (i) Obtain reasonable assurance about whether the financial statements

as a whole are free from material misstatement, whether due to fraud or error; and

(ii) Issue an auditor’s report that includes the auditor’s opinion. (b) State that reasonable assurance is a high level of assurance, but is not a

guarantee that an audit conducted in accordance with SAs will always detect a material misstatement when it exists; and

(c) State that misstatements can arise from fraud or error, and either: (i) Describe that they are considered material if, individually or in the

aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements; or

(ii) Provide a definition or description of materiality in accordance with the applicable financial reporting framework.

(II) The Auditor’s Responsibilities for the Audit of the Financial Statements section of the auditor’s report shall further:

Audi

tor’s

Res

pons

ibilit

ies in

Aud

it of

FS

To exercises professional judgment and maintains professional skepticism throughout the audit as per SAs;

To describe an audit by stating

that the auditor’s responsibilities

are:

To identify and assess the risks of material misstatement of the FS

To obtain an understanding of internal control relevant for audit

to design audit procedures

To evaluate the appropriateness of:

accounting policies used

reasonableness of accounting

estimatesrelated

disclosures made by management.

To conclude on the appropriateness of management’s

use of the going concern basis

to evaluate the overall presentation, structure and content of the financial

statements

To describe the auditor’s

responsibilities in a group audit

engagement as per SA 600.



(a) State that, as part of an audit in accordance with SAs, the auditor exercises professional judgment and maintains professional skepticism throughout the audit; and

(b) Describe an audit by stating that the auditor’s responsibilities are:

(i) To identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error; to design and perform audit procedures responsive to those risks; and to obtain audit evidence that is sufficient and appropriate to provide a basis for the auditor’s opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.

(ii) To obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. In circumstances when the auditor also has a responsibility to express an opinion on the effectiveness of internal control in conjunction with the audit of the financial statements, the auditor shall omit the phrase that the auditor’s consideration of internal control is not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control.

(iii) To evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management.

(iv) To conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. If the auditor concludes that a material uncertainty exists, the auditor is required to draw attention in the auditor’s report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify the opinion. The auditor’s conclusions are based on the audit evidence obtained up to the date of the auditor’s report. However, future events or conditions may cause an entity to cease to continue as a going concern.

(v) When the financial statements are prepared in accordance with a fair presentation framework, to evaluate the overall presentation, structure and content of the financial statements, including the


AUDIT REPORTS 6.9

disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation.

(c) When SA 600, “Using the Work of Another Auditor”, applies, further describe the auditor’s responsibilities in a group audit engagement by stating, the division of responsibility for the financial information of the entity by indicating the extent to which the financial information of components is audited by the other auditors have been included in the financial information of the entity, e.g., the number of divisions/branches/subsidiaries or other components audited by other auditors

(III) The Auditor’s Responsibilities for the Audit of the Financial Statements section of the auditor’s report also shall:

(a) State that the auditor communicates with those charged with governance regarding, among other matters:

the planned scope and timing of the audit and

significant audit findings,

including any significant deficiencies in internal control that the auditor identifies during the audit;

(b) State that the auditor provides those charged with governance with a statement that the auditor has:

complied with relevant ethical requirements regarding independence and

communicate with them all relationships and

other matters that may reasonably be thought to bear on the auditor’s independence, and where applicable, related safeguards; and

(c) For audits of financial statements of all such entities for which key audit matters are communicated in accordance with SA 701, state that, from the matters communicated with those charged with governance, the auditor determines those matters that were of most significance in the audit of the financial statements of the current period and are therefore the key audit matters.

In accordance with the requirements of SA 701, the auditor describes these matters in the auditor’s report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, the auditor determines that a matter should not be communicated in the auditor’s report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication.


6.10 ADVANCED AUDITING AND PROFESSIONAL ETHICS 9. Location of the description of the auditor’s responsibilities for the audit of the

financial statements: The description of the auditor’s responsibilities for the audit of the financial statements required by this SA shall be included:

When the auditor refers to a description of the auditor’s responsibilities on a website of an

appropriate authority, the auditor shall determine that such description addresses, and is not inconsistent with, the requirements of this SA.

10. Other Reporting Responsibilities:

(a) If the auditor addresses other reporting responsibilities in the auditor’s report on the financial statements that are in addition to the auditor’s responsibilities under the SAs, these other reporting responsibilities shall be addressed in a separate section in the auditor’s report with a heading titled “Report on Other Legal and Regulatory Requirements” or otherwise as appropriate to the content of the section, unless these other reporting responsibilities address the same topics as those presented under the reporting responsibilities required by the SAs in which case the other reporting responsibilities may be presented in the same section as the related report elements required by the SAs.

(b) If other reporting responsibilities are presented in the same section as the related report elements required by the SAs, the auditor’s report shall clearly differentiate the other reporting responsibilities from the reporting that is required by the SAs.

(c) If the auditor’s report contains a separate section that addresses other reporting responsibilities, the requirements of this SA shall be included under a section with a heading “Report on the Audit of the Financial Statements.” The “Report on Other Legal and Regulatory Requirements” shall follow the “Report on the Audit of the Financial Statements.”

11. Signature of the Auditor: The auditor’s report shall be signed. The report is signed by the auditor (i.e. the engagement partner) in his personal name. Where the firm is appointed as the auditor, the report is signed in the personal name of the auditor and in the name of the

(a) Within the body of the auditor’s report;

(b) Within an appendix to the auditor’s report, in

which case the auditor’s report shall include a

reference to the location of the appendix; or

(c) By a specific reference within the auditor’s report to the location of such a

description on a website of an appropriate authority, where law, regulation or the auditing standards expressly permit the

auditor to do so.


AUDIT REPORTS 6.11

audit firm. The partner/proprietor signing the audit report also needs to mention the membership number assigned by the Institute of Chartered Accountants of India. They also include the registration number of the firm, wherever applicable, as allotted by ICAI, in the audit reports signed by them.

The report is to be signed by the maker of the report. Normally, a chartered accountant in practice signs the report in the name he is registered as a practitioner. If he is an individual, it may be his individual name or the firm name of which he is the sole proprietor. For those members in practise as a partnership firm, it is usual for them to sign in the firm name. Under Section 145 read with Section 141(2) of the Companies Act, 2013, only the person appointed as an auditor of the company or, where a firm is so appointed, only the partner in the firm who is a chartered accountant, may sign the auditor’s report or sign or authenticate any other document of the company required by law to be signed or authenticated by the auditor.

It is obvious that the person appointed makes the report; otherwise the very essence of the appointment of a particular man or firm will be lost. In a profession, the particular skill and reputation of the practitioner counts considerably and if anybody else is allowed to make the report on behalf of the person appointed, then this confidence in the person will cease to be a factor. This has other implications also from the point of view of professional responsibility; it will create an unusual legal situation. It also has implications from the standpoint of the practitioner. If in respect of appointments held by him, the reports are made by others, gradually the goodwill of the practitioner will end and the clients may shift to the person actually making the report.

If A, B and C were in practice as ABC & Co. Chartered Accountants, any of A or B or C could sign as “ABC & Co.” in his own hand. But now in view of the objection raised by the Department of Company Affairs to this practice, the Council of the Institute in the SA 700 “The Auditor’s Report on Financial Statements” has recommended to the members who are in practice in partnership, that signature on or authentication of the auditor’s report or any other document required to be signed or authenticated by the auditor should be made in the following manner.

For ABC and Co. Chartered Accountants

Firm Registration Number Signature

(Name of the Member Signing the Audit Report) (Designation {Partner/Proprietor})

In addition to the provisions of the Companies Act, 2013 referred to above, Clause (12) of Part I of the First Schedule to the Chartered Accountants Act, 1949 provides that a chartered accountant in practice shall be deemed to be guilty of professional misconduct if



he allows a person, not being a member of the Institute or a member not being his partner, to sign on his behalf or on behalf of his firm, any balance sheet, profit and loss account, report or financial statements. The provision is intended to safeguard the professional purity by excluding non-chartered accountants from signing the aforesaid documents. By excluding chartered accountants who are not partners, it seeks to keep the line of professional responsibility clear. Partners are mutual agents and therefore, allowing a partner to sign does not interfere with the clarity of responsibility.

12. Place of Signature: The auditor’s report shall name specific location, which is ordinarily the city where the audit report is signed.

13. Date of the Auditor’s Report: The auditor’s report shall be dated no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence on which to base the auditor’s opinion on the financial statements, including evidence that:

3.3 Auditor’s Report Prescribed by Law or Regulation If the auditor is required by law or regulation applicable to the entity to use a specific layout, or wording of the auditor’s report, the auditor’s report shall refer to Standards on Auditing only if the auditor’s report includes, at a minimum, each of the following elements:

(1) A title.

(2) An addressee, as required by the circumstances of the engagement.

(3) An Opinion section containing an expression of opinion on the financial statements and a reference to the applicable financial reporting framework used to prepare the financial statements.

(4) An identification of the entity’s financial statements that have been audited.

(5) A statement that the auditor is independent of the entity in accordance with the relevant ethical requirements relating to the audit, and has fulfilled the auditor’s other ethical responsibilities in accordance with these requirements. The statement shall refer to the Code of Ethics issued by ICAI.

All the statements that comprise the financial statements,

including the related notes, have been prepared; and

Those with the recognized authority have asserted that they

have taken responsibility for those financial statements.


AUDIT REPORTS 6.13 (6) Where applicable, a section that addresses, and is not inconsistent with, the reporting

requirements of SA 570.

(7) Where applicable, a Basis for Qualified (or Adverse) Opinion section that addresses, and is not inconsistent with, the reporting requirements of SA 570 (Revised).

(8) Where applicable, a section that includes the information required by SA 701, or additional information about the audit that is prescribed by law or regulation and that addresses, and is not inconsistent with, the reporting requirements in that SA 701.

(9) A description of management’s responsibilities for the preparation of the financial statements and an identification of those responsible for the oversight of the financial reporting process that addresses, and is not inconsistent with, the requirements.

(10) A reference to Standards on Auditing and the law or regulation, and a description of the auditor’s responsibilities for an audit of the financial statements that addresses, and is not inconsistent with, the requirements.

(11) The auditor’s signature.

(12) The Place of signature

(13) The date of the auditor’s report.

3.4 Auditor’s Report for Audits Conducted in Accordance with Both Standards on Auditing Issued by ICAI and International Standards on Auditing or Auditing Standards of Any Other Jurisdiction:

An auditor may be required to conduct an audit in accordance with, in addition to the Standards on Auditing issued by ICAI, the International Standards on Auditing or auditing standards of any other jurisdiction. If this is the case, the auditor’s report may refer to Standards on Auditing in addition to the International Standards on Auditing or auditing standards of such other jurisdiction, but the auditor shall do so only if:

(a) There is no conflict between the requirements in the ISAs or such auditing standards of other jurisdiction and those in SAs that would lead the auditor:

(i) to form a different opinion, or

(ii) not to include an Emphasis of Matter paragraph or Other Matter paragraph that,

in the particular circumstances, is required by SAs; and

(b) The auditor’s report includes, at a minimum, each of the elements set out in Auditor’s Report Prescribed by Law or Regulation discussed above when the auditor uses the layout or wording specified by the Standards on Auditing. However, reference to “law or regulation” in above paragraph shall be read as reference to the Standards on Auditing. The auditor’s report shall thereby identify such Standards on Auditing.


6.14 ADVANCED AUDITING AND PROFESSIONAL ETHICS When the auditor’s report refers to both the ISAs or the auditing standards of a specific

jurisdiction and the Standards on Auditing issued by ICAI, the auditor’s report shall clearly identify the same including the jurisdiction of origin of the other auditing standards.

Supplementary Information Presented with the Financial Statements:

4. SA 701, “COMMUNICATING KEY AUDIT MATTERS IN THE INDEPENDENT AUDITOR’S REPORT”

This SA 701 provide guidance regarding communication of Key Audit Matters. Key Audit matter are those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements of the current period. Key audit matters are selected from matters communicated with those charged with governance.

4.1 Purpose The purpose of communicating key audit matters is to enhance the communicative value of the auditor’s report by providing greater transparency about the audit that was performed. Communicating key audit matters provides additional information to intended users of the financial statements (“intended users”) to assist them in understanding those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements of the current period. Communicating key audit matters may also assist intended users in understanding the entity and areas of significant management judgment in the audited financial statements.

4.2 Scope Communicating key audit matters in the auditor’s report is in the context of the auditor having formed an opinion on the financial statements as a whole. Communicating key audit matters in the auditor’s report is not:

(a) A substitute for disclosures in the financial statements that the applicable financial reporting framework requires management to make, or that are otherwise

If supplementary information that is not required by the applicable financial reporting framework is presented with the audited financial statements, the auditor shall evaluate:

whether, in the auditor’s professionaljudgment, supplementary information isnevertheless an integral part of thefinancial statements due to its nature orhow it is presented. When it is an integralpart of the financial statements, thesupplementary information shall becovered by the auditor’s opinion.

whether such supplementary information is presentedin a way that sufficiently and clearly differentiates itfrom the audited financial statements. If this is not thecase, then the auditor shall ask management to changehow the unaudited supplementary information ispresented. If management refuses to do so, the auditorshall identify the unaudited supplementary informationand explain in the auditor’s report that suchsupplementary information has not been audited.


AUDIT REPORTS 6.15

necessary to achieve fair presentation;

(b) A substitute for the auditor expressing a modified opinion when required by the circumstances of a specific audit engagement in accordance with SA 705 (Revised);

(c) A substitute for reporting in accordance with SA 570 (Revised) when a material uncertainty exists relating to events or conditions that may cast significant doubt on an entity’s ability to continue as a going concern; or

(d) A separate opinion on individual matters.

This SA applies to audits of complete sets of general purpose financial statements of listed entities and circumstances when the auditor otherwise decides to communicate key audit matters in the auditor’s report.

This SA also applies when the auditor is required by law or regulation to communicate key audit matters in the auditor’s report. However, SA 705 (Revised) prohibits the auditor from communicating key audit matters when the auditor disclaims an opinion on the financial statements, unless such reporting is required by law or regulation.

4.3 Determining Key Audit Matters The auditor shall determine, from the matters communicated with those charged with governance, those matters that required significant auditor attention in performing the audit. In making this determination, the auditor shall take into account the following:

(a) Areas of higher assessed risk of material misstatement, or significant risks identified in accordance with SA 315

(b) Significant auditor judgments relating to areas in the financial statements that involved significant management judgment, including accounting estimates that have been identified as having high estimation uncertainty.

(c) The effect on the audit of significant events or transactions that occurred during the period.

4.4 Communicating Key Audit Matters The introductory language in this section of the auditor’s report shall state that:

(a) Key audit matters are those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements [of the current period]; and.

(b) These matters were addressed in the context of the audit of the financial statements as a whole, and in forming the auditor’s opinion thereon, and the auditor does not provide a separate opinion on these matters.


6.16 ADVANCED AUDITING AND PROFESSIONAL ETHICS Illustration The following illustrates the presentation in the auditor’s report if the auditor has determined there are no key audit matters to communicate: Key Audit Matters [Except for the matter described in the Basis for Qualified (Adverse) Opinion section or Material Uncertainty Related to Going Concern section,] We have determined that there are no [other] key audit matters to communicate in our report.]

5. SA 705, “MODIFICATIONS TO THE OPINION IN THE INDEPENDENT AUDITOR’S REPORT”

Modified Opinions: SA 705 deals with the auditor’s responsibility to issue an appropriate report in circumstances when, in forming an opinion in accordance with SA 700 (Revised), the auditor concludes that a modification to the auditor’s opinion on the financial statements is necessary.

The succinct requirements of this SA 705 are given below-

5.1 Types of Modified Opinions:

The decision regarding which type of modified opinion is appropriate depends upon:

(a) The nature of the matter giving rise to the modification, that is, whether the financial statements are materially misstated or, in the case of an inability to obtain sufficient appropriate audit evidence, may be materially misstated; and

(b) The auditor’s judgment about the pervasiveness of the effects or possible effects of the matter on the financial statements.

5.2 Objective The objective of the auditor is to express clearly an appropriately modified opinion on the financial statements that is necessary when:

(a) The auditor concludes, based on the audit evidence obtained, that the financial statements as a whole are not free from material misstatement; or

Types of Modified Opinions as per SA 705:

(i) Qualified Opinion

(ii) Adverse Opinion

(iii) Disclaimer of Opinion


AUDIT REPORTS 6.17 (b) The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the

financial statements as a whole are free from material misstatement.

5.3 Circumstances When a Modification to the Auditor’s Opinion is Required:

The auditor shall modify the opinion in the auditor’s report when:

The auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are not free from material misstatement; or

The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement.

5.4 Determining the Type of Modification to the Auditor’s Opinion:5.4.1 Qualified Opinion: The auditor shall express a qualified opinion when:

(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or

(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive.

Illustrative Audit Opinion:

“The Company’s has been unable to re-negotiate or obtain replacement financing. This situation indicates the existence of a material uncertainty that may cast significant doubt

on the Company’s ability to continue as a going concern and therefore, the Company may be unable to realize its assets and discharge its liabilities in the normal course of business. The financial statements (and notes thereto) do not fully disclose this fact.” You are required to identify the type of opinion and draft the same.

In view of circumstances mentioned in SA 705, the auditor should give Qualified Opinion in above case. Draft qualified opinion is given as under;

Qualified Opinion

In our opinion, except for the incomplete disclosure of the information referred to in the Basis for Qualified Opinion paragraph, the financial statements give the information required by the Companies Act, 2013, in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India:

(a) in the case of the Balance Sheet, of the state of affairs of the company as at March 31, 20X1;


6.18 ADVANCED AUDITING AND PROFESSIONAL ETHICS (b) in the case of the Profit and Loss Account, of the profit/ loss for the year ended on that

date; and

(c) in the case of the cash flow statement, of the cash flows for the year ended on that date.

5.4.2 Adverse Opinion: The auditor shall express an adverse opinion when the auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are both material and pervasive to the financial statements.

CASE STUDY

“The Company’s financing arrangements expired and the amount outstanding was payable on March 31, 20X0. The Company has been unable to re-negotiate or obtain replacement financing and is considering filing for bankruptcy. These events indicate a material uncertainty that may cast significant doubt on the Company’s ability to continue as a going concern and therefore it may be unable to realize its assets and discharge its liabilities in the normal course of business. The financial statements (and notes thereto) do not disclose this fact.” You are required to identify the type of opinion and draft the same.

In view of circumstances mentioned in SA 705, the auditor should give Adverse Opinion in above case. Draft qualified opinion is given as under;

Adverse Opinion

In our opinion, because of the omission of the information mentioned in the Basis for Adverse Opinion paragraph, the financial statements do not give the information required by the Companies Act, 2013, in the manner so required and also, do not give a true and fair view in conformity with the accounting principles generally accepted in India:

(a) in the case of the Balance Sheet, of the state of affairs of the company as at March 31, 20X0; and

(b) in the case of the Profit and Loss Account, of the profit/loss for the year ended on that date; and

(c) in the case of the cash flow statement, of the cash flows for the year ended on that date.

5.4.3 Disclaimer of Opinion: The auditor shall disclaim an opinion when the auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, and the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive. The auditor shall disclaim an opinion when, in extremely rare circumstances involving multiple uncertainties, the auditor concludes that, notwithstanding having obtained sufficient appropriate audit evidence regarding each of the individual uncertainties, it is not possible to form an opinion on the financial statements due to the potential interaction of the uncertainties and their possible cumulative effect on the financial statements.


AUDIT REPORTS 6.19

Draft Disclaimer of Opinion

We were engaged to audit the financial statements of ABC & Associates (“the entity”), which comprise the balance sheet as at March 31, 20XX, the statement of Profit and Loss, (the

statement of changes in equity)1 and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.

We do not express an opinion on the accompanying financial statements of the entity. Because of the significance of the matters described in the Basis for Disclaimer of Opinion section of our report, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion on these financial statements.

5.5 Consequence of an Inability to Obtain Sufficient Appropriate Audit Evidence Due to a Management-Imposed Limitation after the Auditor Has Accepted the Engagement

If, after accepting the engagement, the auditor becomes aware that management has imposed a limitation on the scope of the audit that the auditor considers likely to result in the need to express a qualified opinion or to disclaim an opinion on the financial statements, the auditor shall request that management remove the limitation.

If management refuses to remove the limitation, the auditor shall communicate the matter to those charged with governance, unless all of those charged with governance are involved in managing the entity, and determine whether it is possible to perform alternative procedures to obtain sufficient appropriate audit evidence.

If the auditor is unable to obtain sufficient appropriate audit evidence, the auditor shall determine the implications as follows:

(a) If the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive, the auditor shall qualify the opinion; or

(b) If the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive so that a qualification of the opinion would be inadequate to communicate the gravity of the situation, the auditor shall:

(i) Withdraw from the audit, where practicable and possible under applicable law or regulation; or

(ii) If withdrawal from the audit before issuing the auditor’s report is not practicable or possible, disclaim an opinion on the financial statements.

1 Where applicable.



5.6 If the auditor decides to withdraw When the auditor decides to withdraw before withdrawing, the auditor shall communicate to those charged with governance any matters regarding misstatements identified during the audit that would have given rise to a modification of the opinion.

5.7 Other Considerations Relating to an Adverse Opinion or Disclaimer of Opinion

When the auditor considers it necessary to express an adverse opinion or disclaim an opinion on the financial statements as a whole, the auditor’s report shall not also include an unmodified opinion with respect to the same financial reporting framework on a single financial statement or one or more specific elements, accounts or items of a financial statement. To include such an unmodified opinion in the same report in these circumstances would contradict the auditor’s adverse opinion or disclaimer of opinion on the financial statements as a whole.

5.8 Form and Content of the Auditor’s Report When the Opinion is Modified

When the auditor modifies the audit opinion, the auditor shall use the heading “Qualified Opinion,” “Adverse Opinion,” or “Disclaimer of Opinion,” as appropriate, for the Opinion section.

What special consideration are required for expressing Qualified Opinion?

When the auditor expresses a qualified opinion due to a material misstatement in the financial statements, the auditor shall state that, in the auditor’s opinion, except for the effects of the matter(s) described in the Basis for Qualified Opinion section:

(a) When reporting in accordance with a fair presentation framework, the accompanying financial statements present fairly, in all material respects (or give a true and fair view of) […] in accordance with [the applicable financial reporting framework]; or

(b) When reporting in accordance with a compliance framework, the accompanying financial statements have been prepared, in all material respects, in accordance with [the applicable financial reporting framework].

When the modification arises from an inability to obtain sufficient appropriate audit evidence, the auditor shall use the corresponding phrase “except for the possible effects of the matter(s) ...” for the modified opinion.

What special consideration needed for expressing Adverse Opinion?

When the auditor expresses an adverse opinion, the auditor shall state that, in the auditor’s opinion, because of the significance of the matter(s) described in the Basis for Adverse Opinion section:


AUDIT REPORTS 6.21 (a) When reporting in accordance with a fair presentation framework, the accompanying

financial statements do not present fairly (or give a true and fair view of) […] in accordance with [the applicable financial reporting framework]; or

(b) When reporting in accordance with a compliance framework, the accompanying financial statements have not been prepared, in all material respects, in accordance with [the applicable financial reporting framework].

What special consideration is required for expressing Disclaimer of Opinion?

When the auditor disclaims an opinion due to an inability to obtain sufficient appropriate audit evidence, the auditor shall:

(a) State that the auditor does not express an opinion on the accompanying financial statements;

(b) State that, because of the significance of the matter(s) described in the Basis for Disclaimer of Opinion section, the auditor has not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion on the financial statements; and

(c) Amend the statement required in SA 700 (Revised), which indicates that the financial statements have been audited, to state that the auditor was engaged to audit the financial statements.

Unless required by law or regulation, when the auditor disclaims an opinion on the financial statements, the auditor’s report shall not include a Key Audit Matters section in accordance with SA 701.

What is the Basis for Modification of Opinion (Qualified/Disclaimer /Adverse)?

When the auditor modifies (Qualification/ Disclaimer/ Adverse) the opinion as above on the financial statements, the auditor shall, in addition to the specific elements required by SA 700 (Revised):

(a) Amend the heading “Basis for Opinion” to “Basis for Qualified Opinion,” “Basis for Adverse Opinion,” or “Basis for Disclaimer of Opinion,” as appropriate; and

(b) Within this section, include a description of the matter giving rise to the modification.

If there is a material misstatement of the financial statements that relates to specific amounts in the financial statements (including quantitative disclosures in the notes to the financial statements), the auditor shall include in the Basis for Opinion section, a description and quantification of the financial effects of the misstatement, unless impracticable. If it is not practicable to quantify the financial effects, the auditor shall so state in this section.


6.22 ADVANCED AUDITING AND PROFESSIONAL ETHICS If there is a material misstatement of the financial statements that relates to narrative disclosures, the auditor shall include in the Basis for Opinion section an explanation of how the disclosures are misstated.

If there is a material misstatement of the financial statements that relates to the non- disclosure of information required to be disclosed, the auditor shall:

(a) Discuss the non-disclosure with those charged with governance;

(b) Describe in the Basis for Opinion section the nature of the omitted information; and

(c) Unless prohibited by law or regulation, include the omitted disclosures, provided it is practicable to do so and the auditor has obtained sufficient appropriate audit evidence about the omitted information.

If the modification results from an inability to obtain sufficient appropriate audit evidence, the auditor shall include in the Basis for Opinion section the reasons for that inability.

When the auditor expresses a qualified or adverse opinion, the auditor shall amend the statement about whether the audit evidence obtained is sufficient and appropriate to provide a basis for the auditor’s opinion to include the word “qualified” or “adverse”, as appropriate.

When the auditor disclaims an opinion on the financial statements, the auditor’s report shall not include following elements required under SA 700

(a) A reference to the section of the auditor’s report where the auditor’s responsibilities are described; and

(b) A statement about whether the audit evidence obtained is sufficient and appropriate to provide a basis for the auditor’s opinion.

Even if the auditor has expressed an adverse opinion or disclaimed an opinion on the financial statements, the auditor shall describe in the Basis for Opinion section the reasons for any other matters of which the auditor is aware that would have required a modification to the opinion, and the effects thereof.

How Auditor should give description of Auditor’s Responsibilities for the Audit of the Financial Statements When the Auditor Disclaims an Opinion on the Financial Statements?

When the auditor disclaims an opinion on the financial statements due to an inability to obtain sufficient appropriate audit evidence, the auditor shall amend the description of the auditor’s responsibilities required by SA 700 (Revised) to include only the following:

(a) A statement that the auditor’s responsibility is to conduct an audit of the entity’s financial statements in accordance with Standards on Auditing and to issue an auditor’s report;


AUDIT REPORTS 6.23 (b) A statement that, however, because of the matter(s) described in the Basis for Disclaimer of

Opinion section, the auditor was not able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion on the financial statements; and

(c) The statement about auditor independence and other ethical responsibilities required in SA 700.

5.9 Communication with Those Charged with Governance When the auditor expects to modify the opinion in the auditor’s report, the auditor shall communicate with those charged with governance the circumstances that led to the expected modification and the wording of the modification.

Nature of Matter Giving Rise to the Modification:

Auditor’s judgment about the Pervasiveness of the Effects or Possible Effects on the Financial

Statements

Material but not pervasive

Material and pervasive

Financial Statements are materially misstated

Qualified Opinion Adverse Opinion

Inability to obtain Sufficient appropriate audit evidence

Qualified Opinion Disclaimer of Opinion

6 SA 706, “EMPHASIS OF MATTER PARAGRAPHS AND OTHER MATTER PARAGRAPHS IN THE INDEPENDENT AUDITOR’S REPORT”

6.1 Objective The objective of the auditor, having formed an opinion on the financial statements, is to draw users’ attention, when in the auditor’s judgment it is necessary to do so, by way of clear additional communication in the auditor’s report, to:

(a) A matter, although appropriately presented or disclosed in the financial statements, that is of such importance that it is fundamental to users’ understanding of the financial statements; or

(b) As appropriate, any other matter that is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report.

Emphasis of Matter paragraph – A paragraph included in the auditor’s report that refers to a matter appropriately presented or disclosed in the financial statements that, in the auditor’s


6.24 ADVANCED AUDITING AND PROFESSIONAL ETHICS judgment, is of such importance that it is fundamental to users’ understanding of the financial statements.

Other Matter paragraph – A paragraph included in the auditor’s report that refers to a matter other than those presented or disclosed in the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report.

6.2 When to give emphasis of Matter Paragraphs in the Auditor’s Report?

If the auditor considers it necessary to draw users’ attention to a matter presented or disclosed in the financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of the financial statements, the auditor shall include an Emphasis of Matter paragraph in the auditor’s report provided:

(a) The auditor would not be required to modify the opinion in accordance with SA 705 (Revised) as a result of the matter; and

(b) When SA 701 applies, the matter has not been determined to be a key audit matter to be communicated in the auditor’s report.

These circumstances may include: • When a financial reporting framework prescribed by law or regulation

would be unacceptable but for the fact that it is prescribed by law or regulation.

• To alert users that the financial statements are prepared in accordance with a special purpose framework.

• When facts become known to the auditor after the date of the auditor’s report and the auditor provides a new or amended auditor’s report (i.e., subsequent events).

6.3 When the auditor includes an Emphasis of Matter paragraph in the auditor’s report, the auditor shall:

(a) Include the paragraph within a separate section of the auditor’s report with an appropriate heading that includes the term “Emphasis of Matter”;

(b) Include in the paragraph a clear reference to the matter being emphasized and to where relevant disclosures that fully describe the matter can be found in the financial statements. The paragraph shall refer only to information presented or disclosed in the financial statements; and

(c) Indicate that the auditor’s opinion is not modified in respect of the matter emphasized.


AUDIT REPORTS 6.25

When to issue other Matter Paragraphs in the Auditor’s Report?

If the auditor considers it necessary to communicate a matter other than those that are presented or disclosed in the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report, the auditor shall include an Other Matter paragraph in the auditor’s report, provided:

(a) This is not prohibited by law or regulation; and

(b) When SA 701 applies, the matter has not been determined to be a key audit matter to be communicated in the auditor’s report.

When the auditor includes an Other Matter paragraph in the auditor’s report, the auditor shall include the paragraph within a separate section with the heading “Other Matter,” or otherappropriate heading.

Circumstances where the auditor may consider it necessary to include an Emphasis of Matter paragraph are:

• An uncertainty relating to the future outcome of exceptional litigation or regulatory action.

• A significant subsequent event that occurs between the date of the financialstatements and the date of the auditor’s report.

• Early application (where permitted) of a new accounting standard that has a materialeffect on the financial statements.

• A major catastrophe that has had, or continues to have, a significant effect on theentity’s financial position.

Is there any duty to communicate with Those Charged with Governance?

If the auditor expects to include an Emphasis of Matter or an Other Matter paragraph in the auditor’s report, the auditor shall communicate with those charged with governance regarding this expectation and the wording of this paragraph.

Note: Students are advised to refer Illustration of Emphasis of Matter Para is given in appendix at the end of the Chapter.

7. DISTINCTION BETWEEN NOTES ON ACCOUNTS AND QUALIFICATIONS

As a general practice, the management would normally prefer to explain their view point and assessment on all matters involving difference of opinion between them and the auditors by way of notes in the financial statements, for better understanding of the facts of the matters by users of financial statements. Such notes represents management’s stand on the matter while the auditor records his disagreement on the matters by way of qualifications in the auditor’s report.


6.26 ADVANCED AUDITING AND PROFESSIONAL ETHICS Students should note that client and auditor are two separate independent parties and in real life situations, at times, the client management may insist upon the auditor for not modifying his audit opinion considering the management has disclosed full facts and assessment of the matter through notes on the financial statements. However, the auditor needs to exercise his professional judgement and assess if the disclosure alone would suffice or in case, he also needs to modify his audit report by either inserting a qualification or Emphasis of matter.

Once auditor concludes that modification of his report in relation to the specific matter under question, is warranted, he may choose to refer to the specific note given by the management and thereafter, continue explaining more facts and his assessment on the matter including quantification and impact on the various financial statements captions, to the extent possible.

The Auditor must express the nature of qualification, in a clear and unambiguous manner. Where the Auditor answers any of the statutory affirmations in the negative or with a qualification, his report shall state the reasons for such answer. All qualifications should be contained in the Auditor’s Report.

Where the company has committed an irregularity resulting in a breach of law, the Auditor should bring the same to the notice of the shareholders by properly qualifying his report. A quantified opinion should be expressed as “except for” for the effects of the matter to which qualification related. It would not be appropriate to use phrases such as “with the foregoing explanation” or “subject to” in the opinion paragraph as these are not sufficiently clear or forceful.

Notes – Report Relationship – Where notes of a qualificatory nature appear in the accounts, the Auditors should state all qualifications independently in their report so that the user can assess the significance of these qualifications. A reference to the notes to Accounts in the Auditors’ Report does not automatically become a qualification.

Note : Students are advised to refer examples/illustrative formats given at the end of the Chapter for better understanding of the differences.

8. DISTINCTION BETWEEN AUDIT REPORT AND CERTIFICATE

The term ‘report’ is used where an expression of opinion is involved. The term ‘certificate’ is preferable where the auditor comments on or verifies facts such as a verification of investment by inspection or the checking of ballot papers on a poll in a company meeting. Under the Companies Act, 2013, a number of situations are there where an auditor is required to issue a certificate rather than a report, like under Section 66 of the Companies Act, 2013, an auditor is required to file a certificate in the tribunal where company is proposing for the reduction of capital. However, the report under Section 143 of the Companies Act, 2013, is an opinion based report and is not a certificate.


AUDIT REPORTS 6.27 Some situations where Audit Reports and Certificates are required is given below -

(1) Under the Payment of Bonus Act, 1965, a chartered accountant may be required to issue a ‘report’ on the computation of bonus payable. The report may be as under:

“We have reviewed the figures in the above computation in comparison with the books and records produced to us, the audit of which has already been completed by us and report that subject to the notes given on face of the computation in our opinion, and to the best of our knowledge and belief and according to the information and explanation given to us, the above computation is in due accordance therewith and has been made on a basis reasonably consistent with the provisions of the Payment of Bonus Act, 1965.”

Place: For X & Co.

Date: Chartered Accountants (2) Auditor’s Report in accordance with Regulation 54 of the SEBI (Mutual Fund)

Regulations, 1993. (i) All Mutual funds shall be required to get their accounts audited in terms of a provision to

that effect in their trust deeds. The Auditor’s Report shall form a part of the Annual Report. It should accompany the Abridged Balance Sheet and Revenue Account. The auditor shall report to the Board of Trustees and not to the unit holders.

(ii) The auditor shall state whether: 1. He has obtained all information and explanations which, to the best of his

knowledge and belief, were necessary for the purpose of his audit. 2. The Balance Sheet and the Revenue Account are in agreement with the

books of account of the fund. (iii) The auditor shall give his opinion as to whether:

1. The Balance Sheet gives a true and fair view of the scheme wise state of affairs’ of the fund as at the balance sheet date, and

2. The Revenue Account gives a true and fair view of the scheme wise surplus/deficit of the fund for the year/period ended at the balance sheet date.

9. COMMUNICATION TO MANAGEMENT AND THOSE CHARGED WITH GOVERNANCE

As per SA 260 Communication with Those Charged with Governance, it is auditor’s responsibility to communicate with those charged with governance in an audit of financial statements irrespective of an entity’s governance structure or size, particular considerations apply where all of those charged with governance are involved in managing an entity, and for listed entities.



The objectives of the auditor are To communicate clearly with those charged with governance the responsibilities of the auditor in relation to the financial statement audit, and an overview of the planned scope and timing of the audit; To obtain from those charged with governance information relevant to the audit; To provide those charged with governance with timely observations arising from the audit that are significant and relevant to their responsibility to oversee the financial reporting process; and To promote effective two-way communication between the auditor and those charged with governance.

The auditor shall determine the appropriate person(s) within the entity’s governance structure with whom to communicate. If the auditor communicates with a subgroup of those charged with governance, for example, an audit committee, or an individual, the auditor shall determine whether the auditor also needs to communicate with the governing body.

9.1 When All of Those Charged with Governance Are Involved in Managing the Entity

In some cases, all of those charged with governance are involved in managing the entity, for example, a small business where a single owner manages the entity and no one else has a governance role. In these cases, if matters required by this SA are communicated with person(s) with management responsibilities, and those person(s) also have governance responsibilities, the matters need not be communicated again with those same person(s) in their governance role. These matters are noted in paragraph 16(c). The auditor shall nonetheless be satisfied that communication with person(s) with management responsibilities adequately informs all of those with whom the auditor would otherwise communicate in their governance capacity. (Ref: Para. A8)

9.2 Matters to Be Communicated The auditor shall communicate with those charged with governance the responsibilities of the auditor in relation to the financial statement audit, including that:

(a) The auditor is responsible for forming and expressing an opinion on the financial statements that have been prepared by management with the oversight of those charged with governance; and

(b) The audit of the financial statements does not relieve management or those charged with governance of their responsibilities.

9.3 Planned Scope and Timing of the Audit The auditor shall communicate with those charged with governance an overview of the planned scope and timing of the audit, which includes communicating about the significant risks identified by the auditor.


AUDIT REPORTS 6.29

9.4 Significant Findings from the Audit The auditor shall communicate with those charged with governance:

(a) The auditor’s views about significant qualitative aspects of the entity’s accounting practices, including accounting policies, accounting estimates and financial statement disclosures. When applicable, the auditor shall explain to those charged with governance why the auditor considers a significant accounting practice, that is acceptable under the applicable financial reporting framework, not to be most appropriate to the particular circumstances of the entity;

(b) Significant difficulties, if any, encountered during the audit;

(c) Unless all of those charged with governance are involved in managing the entity:

i. Significant matters arising during the audit that were discussed, or subject to correspondence, with management; and

ii. Written representations the auditor is requesting;

(d) Circumstances that affect the form and content of the auditor’s report, if any; and

(e) Any other significant matters arising during the audit that, in the auditor’s professional judgment, are relevant to the oversight of the financial reporting process.

10. SELF REVIEW THREATS Compliance with the fundamental principles may potentially be threatened by a broad range of circumstances. Many threats fall into the following categories:

Self-interest threats, which

may occur as a result of the

financial or other interests of a professional

accountant or of a relative*;

Self-review threats, which

may occur when a previous

judgement needs to be re-

evaluated by the professional accountant

responsible for that judgement;

Advocacy threats, which

may occur when a professional

accountant promotes a position or

opinion to the point that

subsequent objectivity may

be compromised;

Familiarity threats, which

may occur when, because of a relationship, a professional accountant

becomes too sympathetic to the interests of

others; and

Intimidation threats, which

may occur when a professional

accountant may be deterred from acting objectively by threats, actual

or perceived.


6.30 ADVANCED AUDITING AND PROFESSIONAL ETHICS The nature and significance of the threats may differ depending on whether they arise in relation to the provision of services to a financial statement audit client*, a non- financial statement audit assurance client* or a non-assurance client.

10.1 Meaning- Self Review Threats Self-review threats, which occur when during a review of any judgement or conclusion reached in a previous audit or non-audit engagement, or when a member of the audit team was previously a director or senior employee of the client. Instances where such threats come into play are

(i) when an auditor having recently been a director or senior officer of the company, and

(ii) when auditors perform services that are themselves subject matters of audit. Circumstances that may create self-review threats include, but are not limited to:

The discovery of a significant error during a re-evaluation of the work of the professional accountant in public practice.

Reporting on the operation of financial systems after being involved in their design or implementation.

Having prepared the original data used to generate records that are the subject matter of the engagement.

A member of the assurance team* being, or having recently been, a director or officer* of that client.

A member of the assurance team being, or having recently been, employed by the client in a position to exert direct and significant influence over the subject matter of the engagement.

Performing a service for a client that directly affects the subject matter of the assurance engagement.

10.2 Safeguards that may eliminate or reduce such threats to an acceptable level fall into two broad categories:

11. REPORTING REQUIREMENTS IN CASE OF COMPARATIVE INFORMATION

SA 710 Comparative Information-Corresponding Figures and Comparative Financial Statements deals with auditor’s responsibility regarding comparative information in an audit of financial

Safeguard in the work environment.

Safeguard created by the profession, legislation or

regulation; and


AUDIT REPORTS 6.31 statement. There are two different broad approaches to the auditor’s responsibilities in respect of comparative information: Corresponding figures and Comparative financial statement.

The essential audit reporting differences between the approaches are:

(a) For corresponding figures, the auditor’s opinion on the financial statements refers to the current period only; whereas

(b) For comparative financial statements, the auditor’s opinion refers to each period for which financial statements are presented.

The objectives of the auditor are to obtain sufficient appropriate audit evidence about whether the comparative information included in the financial statements has been presented, in all material respects, in accordance with the requirements for comparative information in the applicable financial reporting framework; and to report in accordance with the auditor’s reporting responsibilities.

11.1 Audit Procedures for Comparative Information: (a) Perform Specific audit Procedure: For determining that the financial statement contains

appropriately classified comparative information, the auditor should:

• Ensure that comparative information agrees with the amount and other disclosure presented in the prior period.

• The accounting policies applied are consistent with those applied in current period.

• If there have been any changes in the application of accounting policies than they are properly disclosed and presented.

(b) Evaluating the impact on financial statement: If the auditor becomes aware of any possible misstatement in the comparative information, then:

• He should perform the necessary audit procedures to obtain sufficient audit evidence.

• If the auditor had audited the prior period’s financial statement than he should follow the relevant requirements of SA 560.

(c) Written Representation: As required by SA 580, the auditor should also request written representation. He should also obtain a specific written representation regarding any prior period item that is disclosed in current year’s financial statement.

11.2 Audit Reporting: (a) With Reference to Corresponding Figures: When corresponding figures are

presented, the auditor’s opinion shall not refer to the corresponding figures except in the following circumstances:



• If the auditor’s report of the previous period contains other than an unqualified opinion.

• If the auditor is of the opinion, and he has sufficient evidence in this regard, that a material misstatement exists in the financial statement of prior period, which was not addressed earlier.

If the prior period financial statement are not audited, than he should obtain sufficient audit evidence that the opening balance does not contain any material misstatement. (b) With Reference to Comparative Financial Statement: When comparative financial

statement are presented - • The auditor’s opinion shall refer to each period for which the financial statements

are presented. • When reporting on current period’s audit, if the auditor’s opinion on such prior

period financial statement differs from the opinion previously issued on such financial statement, the auditor shall disclose the substantive reason for the different opinion in other matter paragraph in his report.

• If the auditor concludes that a material misstatement is present in the previously audited figures of financial statement, he should report it to the appropriate level of the management and request that the predecessor auditor be informed. If then the prior years statements are amended with new report by the predecessor auditor, then the auditor shall report only on the current period.

(c) Reporting treatment common to both (for corresponding figures and comparative information): (i) If the financial statement of the prior period were audited by a predecessor

auditor, the auditor (is permitted by law or regulation to refer to the predecessor audit report – on case of corresponding figures and decides to do so) shall state in his audit report: • That the financial statement of the prior period were audited by a

predecessor auditor; • The type of the opinion expressed by the predecessor auditor; • The date of that audit report.

(ii) If the prior period financial statement were not audited than he shall report the same in other matter paragraph in his audit report that the corresponding/comparative figures are unaudited. However, the disclosure does not relieve him from his responsibility of obtaining sufficient appropriate audit evidence that the opening balances do not contain misstatements that materially affect the current period’s financial statements.

(Note: Students are advised to refer Series of SA 700 on Audit Reporting and Conclusion for better understanding)


AUDIT REPORTS 6.33

SA 710 Comparative Information & Corresponding Figures

Audit Procedure

Assess the consistency of accounting policies used

Check Comparative figures with amount and disclosure in

prior period

Determine that FS Contains appropraitely classified comparative information

Evaluate the impact of possible misstatement in

comparative information on FS

Obtain Written representation

Audit Reporting

1. With Reference to corresponding figures, auditor

opinion should refer in his opinion only when

a) if previous AR is other than unqualified

b) Prior period misstatement not

addressed

c) if prior period FS unaudited

2. With Reference to comparative figures

a) the auditor's opinion shall refer to each period

for which FS are presented and on which

audit opinion is expressed

b) Difference in opinion on previously issued FS

c) if previous FS audited by some other auditor,

mention the same in AR

d) If prior period FS unaudited, mention the

same in the AR



12. ILLUSTRATIVE AUDIT REPORTS Example 1- Illustration of Emphasis of Matter Para

INDEPENDENT AUDITOR’S REPORT

To the Members of ABC Company Limited

Report on the Audit of the Standalone Financial Statements Opinion We have audited the standalone financial statements of ABC Company Limited (“the Company”), which comprise the balance sheet as at March 31, 20X1, and the statement of Profit & Loss, (statement of changes in equity) and the statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies and other explanatory information (in which are included the Returns for the year ended on that date audited by the branch auditors of the Company’s branches located at (location of branches))13.

In our opinion, and to the best of our information and according to the explanations given to us the aforesaid financial statements, give a true and fair view, in conformity with the accounting principles generally accepted in India, of the state of affairs of the Company as at March 31st, 2XXX and profit/loss, (changes in equity) and its cash flows for the year ended on that date. Basis for Opinion We conducted our audit in accordance with Standards on Auditing (SAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements as per the ICAI’s Code of Ethics and the provisions of the Companies Act, 2013, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Emphasis of Matter We draw attention to Note X of the financial statements, which describes the effects of a fire in the Company’s production facilities. Our opinion is not modified in respect of this matter. Key Audit Matters Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the financial statements of the current period. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters.

[Description of each key audit matter in accordance with SA 701.]


AUDIT REPORTS 6.35 Other Matter

The financial statements of ABC Company for the year ended March 31, 20X0, were audited by another auditor who expressed an unmodified opinion on those statements on March 31, 20X1.

Responsibilities of Management and Those Charged with Governance for the Financial Statements

[Reporting in accordance with SA 700 (Revised) – see Illustration 1 in SA 700 (Revised) given in Auditing Pronouncement.]

Auditor’s Responsibilities for the Audit of the Financial Statements

[Reporting in accordance with SA 700 (Revised) – see Illustration 1 in SA 700 (Revised).]

Report on Other Legal and Regulatory Requirements

[Reporting in accordance with SA 700 (Revised) – see Illustration 1 in SA 700 (Revised).]

For XYZ & Co Chartered Accountants

(Firm’s Registration No.)

Signature

(Name of the Member Signing the Audit Report)

(Designation)

Example 2- Illustration of Emphasis of Matter in a situation when the business of one of the Indian branch office of an existing foreign company- ABC Limited is being transferred by way of slump sale to another newly incorporated subsidiary company in India- XYZ Private Limited

Relevant Note given by the management in the financial statements of India Branch Office of ABC Limited

"During the year, ABC Limited (‘the Company’) has incorporated a private limited company ('XYZ Private Limited') in India for the purpose of furtherance of the Company’s objectives and has entered into a Business Transfer Agreement dated October 5, 2016 with XYZ Private Limited for transfer of all assets and liabilities alongwith the business of India Branch Office to XYZ Private Limited on going concern basis effective April 01, 2016. Further, the Reserve Bank of India (RBI) vide letter No. …………………. dated December 22, 2016 has also granted approval for transfer of assets and liabilities and business of India Branch Office to XYZ Private Limited.


6.36 ADVANCED AUDITING AND PROFESSIONAL ETHICS ABC Limited has confirmed that it shall provide continuing financial and operational support to its Branch Office in India for its operations during the transitional period and loss incurred post the date of transfer of business to XYZ Private Limited, if any, shall be borne by ABC Limited

The current year financial statements of India Branch Office have been prepared on the basis that the Branch Office does not continue to be a going concern and all its assets are carried in the books of accounts at the values likely to be recovered at the time of closure of operations, to the extent ascertainable at the time of preparation of these financial statements". INDEPENDENT AUDITOR’S REPORT To the Members of India Branch Office of ABC Limited

Report on the Audit of the Standalone Financial Statements

Opinion

We have audited the standalone financial statements of India Branch Office of ABC Limited (“the Company”), which comprise the balance sheet as at March 31, 20X1, and the statement of Profit & Loss, (statement of changes in equity) and the statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies and other explanatory information.

In our opinion, and to the best of our information and according to the explanations given to us the aforesaid financial statements, give a true and fair view, in conformity with the accounting principles generally accepted in India, of the state of affairs of the India Branch Office of the Company as at March 31st, 2XXX and profit/loss, (changes in equity) and its cash flows for the year ended on that date. Basis for Opinion

We conducted our audit in accordance with Standards on Auditing (SAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements as per the ICAI’s Code of Ethics and the provisions of the Companies Act, 2013, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Emphasis of Matter

We draw attention to Note XX regarding India Branch Office management’s intention to close the operations of the Branch Office subject to regulatory approvals. Accordingly, the financial statements have been prepared on the basis that the India Branch Office does not continue to be a going concern and provisions have been made in the books of account for the losses arising or likely to arise on account of closure of operations including the losses on the realizability of current assets. Our opinion is not modified in respect of this matter.


AUDIT REPORTS 6.37 Example 3- Qualified Opinion

Relevant Notes given by the management in the financial statements of ABC Limited (a) During the year, the management circulated request for confirmation to key vendors of

maintenance expenses and has written-back the liabilities recorded in earlier years of ` 2 crores that have not been claimed by these vendors and have also not been responded to management’s request for confirmation. The management is confident that the balances are no longer payable and that no further adjustments are required to the financial statements in this regard.

(b) During the year, the management has undertaken detailed assessment regarding advances of `____ paid to certain project managers including `____ paid during earlier years. The Company has incurred expenses on account of travel expense at various sites in cash and has closing balance of `1.75 crores against which management has obtained confirmation from respective project managers for balances aggregating ` 0.65 crores and has provided balance amount of `1.1 crores as provision for doubtful advances. The management is confident that the expenditure incurred is towards business operations of the Company and that no further adjustments are required to the financial statements in this regard.

Report on the Audit of the Standalone Financial Statements

Qualified Opinion

We have audited the standalone financial statements of ABC Limited (“the Company”), which comprise the balance sheet as at March 31, 20X1, and the statement of Profit & Loss, (statement of changes in equity) and the statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies and other explanatory information.

In our opinion, and to the best of our information and according to the explanations given to us the aforesaid financial statements, subject to the matters discussed in Basis for Qualified Opinion paragraph below, the consequential impact, if any, whereof is not quantifiable, give a true and fair view, in conformity with the accounting principles generally accepted in India, of the state of affairs of the Company as at March 31st, 2XXX and profit/loss, (changes in equity) and its cash flows for the year ended on that date.

Basis for Qualified Opinion

(a) As stated in Note XX of the financial statements, the management has during the year circulated request for confirmation to key vendors of maintenance expenses and written-back the liabilities recorded in earlier years of ` 2 crores considering that these balances have not been claimed by these vendors and they have also not responded to management request for confirmation. In the absence of balance confirmation of these vendors, we are unable to comment upon such write back of `2 crores and any further adjustments that may be required to the financial statement in this regard.


6.38 ADVANCED AUDITING AND PROFESSIONAL ETHICS (b) Attention is invited to Note____ which explains management assessment regarding

advances of `____ paid to certain project managers including `____ paid during earlier years. The Company has incurred expenses on account of travel at various sites in cash and has closing balance of `1,75 crores against which management has obtained confirmation from respective project managers for balances aggregating ` 0.65 crores and has provided balance amount of `1.1 crores as provision for doubtful advances. Further, for such transactions, the Company has not complied with provision for deduction of taxes at source.

We strongly recommend that management should undertake these transactions through banking channels and in the absence of any confirmations, we are unable to confirm the completeness of expenses as at year- end and consequential adjustment required to closing tax liabilities and interest thereupon, if any.

We conducted our audit in accordance with Standards on Auditing (SAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements as per the ICAI’s Code of Ethics and the provisions of the Companies Act, 2013, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion, except for the matters, discussed above.

Note: Students are advised to refer Illustrations of Independent Auditor’s Reports on Financial Statements given in SA 700. Illustration 1: An auditor’s report on financial statements of a listed entity prepared in accordance with a fair presentation framework

Illustration 2: An auditor’s report on consolidated financial statements of a listed company prepared in accordance with a fair presentation framework

Illustration 3 – Auditor’s Report on Financial Statements of an Unlisted Company Prepared in Accordance with a Fair Presentation Framework

Illustration 4 – Auditor’s Report on Financial Statements of a Non Corporate Entity Prepared in Accordance with a Fair Presentation Framework

Illustration – Auditor’s Report on Financial Statements of Non Corporate Entity Prepared in Accordance with a General Purpose Compliance Framework

For purposes of this illustrative auditor’s report, the following circumstances are assumed:

• Audit of a complete set of financial statements of an entity, other than a listed company under the Companies Act 2013, required by law or regulation. The audit is not a group audit (i.e., SA 600 does not apply).


AUDIT REPORTS 6.39 • The financial statements are prepared by management of the entity in accordance with the

Financial Reporting Framework (XYZ Laws) of Jurisdiction X (that is, a financial reporting framework, encompassing law or regulation, designed to meet the common financial information needs of a wide range of users, but which is not a fair presentation framework).

• The terms of the audit engagement reflect the description of management’s responsibility for the financial statements in SA 210.

• The auditor has concluded an unmodified (i.e., “clean”) opinion is appropriate based on the audit evidence obtained.

• The relevant ethical requirements that apply to the audit are those of the jurisdiction.

• Based on the audit evidence obtained, the auditor has concluded that a material uncertainty does not exist related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern in accordance with SA 570 (Revised).

• The auditor is not required, and has otherwise not decided, to communicate key audit matters in accordance with SA 701.

• Those responsible for oversight of the financial statements differ from those responsible for the preparation of the financial statements.

• The auditor has no other reporting responsibilities required under local law.

Opinion

We have audited the financial statements of ABC & Associates (the entity), which comprise the balance sheet as at March 31, 20X1, and the Profit and Loss Account (and the cash flow statement)2 for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.

In our opinion, the accompanying financial statements of the entity are prepared, in all material respects, in accordance with XYZ Laws.

Basis for Opinion

We conducted our audit in accordance with Standards on Auditing (SAs). Our responsibilities under those Standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the entity in accordance with the ethical requirements that are relevant to our audit of the financial statements, and we have fulfilled our other responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

2 Where applicable.


6.40 ADVANCED AUDITING AND PROFESSIONAL ETHICS Responsibilities of Management and Those Charged with Governance for the Financial Statements3

Management is responsible for the preparation of the financial statements in accordance with XYZ Law and for such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the financial statements, management is responsible for assessing the entity’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the entity or to cease operations, or has no realistic alternative but to do so.

Those charged with governance are responsible for overseeing the entity’s financial reporting process.


Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with SAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.

Paragraph 40(b) of this SA explains that the shaded material below can be located in an Appendix to the auditor’s report. Paragraph 40(c) explains that when law, regulation or national auditing standards expressly permit, reference can be made to a website of an appropriate authority that contains the description of the auditor’s responsibilities, rather than including this material in the auditor’s report, provided that the description on the website addresses, and is not inconsistent with, the description of the auditor’s responsibilities below.

As part of an audit in accordance with SAs, we exercise professional judgment and maintain professional skepticism throughout the audit. We also:

• Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.

• Obtain an understanding of internal control relevant to the audit in order to design audit

3 Or other terms that are appropriate in the context of the legal framework of the particular entity.


AUDIT REPORTS 6.41

procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control.4

Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management.

• Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the entity to cease to continue as a going concern.

We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.

Illustration – Qualified Opinion due to a Material Misstatement of the Financial Statements


• Audit of a complete set of financial statements of a listed company (registered under the Companies Act, 2013) using a fair presentation framework.

• The financial statements are prepared by management of the entity in accordance with the Accounting Standards prescribed under section 133 of the Companies Act, 2013 (a general purpose framework).

• The terms of the audit engagement reflect the description of management’s responsibility for the financial statements in SA 210.5

• Inventories are misstated. The misstatement is deemed to be material but not pervasive to the financial statements (i.e., a qualified opinion is appropriate).

• The relevant ethical requirements that apply to the audit are the ICAI’s Code of Ethics and the provisions of the Companies Act, 2013.


4 This sentence would be modified, as appropriate, in circumstances when the auditor also has responsibility to issue an opinion on the effectiveness of internal control in conjunction with the audit of the financial statements. 5 SA 210, Agreeing the Terms of Audit Engagements


6.42 ADVANCED AUDITING AND PROFESSIONAL ETHICS • Key audit matters have been communicated in accordance with SA 701.


• In addition to the audit of the financial statements, the auditor has other reporting responsibilities required under the Companies Act, 2013.

Report on the Audit of the Standalone Financial Statements6

Qualified Opinion

We have audited the standalone financial statements of ABC Company Limited (“the Company”), which comprise the balance sheet as at March 31, 20XX, and the statement of Profit and Loss, (statement of changes in equity)7 and the statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies and other explanatory information (in which are included the Returns for the year ended on that date audited by the branch auditors of the Company’s branches located at (location of branches))8.

In our opinion and to the best of our information and according to the explanations given to us, except for the effects of the matter described in the Basis for Qualified Opinion section of our report, the aforesaid financial statements give a true and fair view in conformity with the accounting principles generally accepted in India, of the state of affairs of the Company as at March 31st, 2XXX and profit/loss, (changes in equity) and its cash flows for the year ended on that date.


The Company’s inventories are carried in the Balance Sheet at ` XXX. Management has not stated the inventories at the lower of cost and net realizable value but has stated them solely at cost, which constitutes a departure from the Accounting Standards prescribed under section 133 of the Companies Act, 2013. The Company’s records indicate that, had management stated the inventories at the lower of cost and net realizable value, an amount of ` xxx would have been required to write the inventories down to their net realizable value. Accordingly, cost of sales would have been increased by ` xxx, and income tax, net income and shareholders’ funds would have been reduced by ` xxx, ` xxx and ` xxx, respectively.

We conducted our audit in accordance with Standards on Auditing (SAs) specified under section 143(10) of the Companies Act, 2013. Our responsibilities under those Standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the Code of Ethics issued by the Institute of Chartered Accountants of India together with the ethical requirements that are relevant 6 The sub-title “Report on the Audit of the Standalone Financial Statements” is unnecessary in circumstances when the second sub-title “Report on Other Legal and Regulatory Requirements” is not applicable. 7 As may be applicable. 8 As may be applicable.


AUDIT REPORTS 6.43 to our audit of the financial statements under the provisions of the Companies Act, 2013 and we have fulfilled our other ethical responsibilities in accordance with these requirements and the ICAI’s Code of Ethics. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion.

Note : Students are advised to refer Illustrations of Auditor’s Reports with Modifications to the Opinion given in SA 705. • Illustration 2: An auditor’s report containing an adverse opinion due to a material

misstatement of the consolidated financial statements. • Illustration 3: An auditor’s report containing a qualified opinion due to the auditor’s inability

to obtain sufficient appropriate audit evidence regarding a foreign associate. • Illustration 4: An auditor’s report containing a disclaimer of opinion due to the auditor’s

inability to obtain sufficient appropriate audit evidence about a single element of the consolidated financial statements.

Illustration – Disclaimer of Opinion due to the Auditor’s Inability to Obtain Sufficient Appropriate Audit Evidence about Multiple Elements of the Financial Statements For purposes of this illustrative auditor’s report, the following circumstances are assumed: • Audit of a complete set of financial statements of an entity other than a company

incorporated under the Companies Act, 2013, using a fair presentation framework. The audit is not a group audit (i.e., SA 600, does not apply).

• The financial statements are prepared by management of the entity in accordance with the Accounting Standards issued by the Institute of Chartered Accountants of India (a general purpose framework).


• The auditor was unable to obtain sufficient appropriate audit evidence about multiple elements of the financial statements, that is, the auditor was also unable to obtain audit evidence about the entity’s inventories and accounts receivable. The possible effects of this inability to obtain sufficient appropriate audit evidence are deemed to be both material and pervasive to the financial statements.

• The relevant ethical requirements that apply to the audit are ICAI’s Code of Ethics and applicable law/regulation


• A more limited description of the auditor’s responsibilities section is required.

• In addition to the audit of the financial statements, the auditor has other reporting responsibilities required under relevant law/ regulation.


6.44 ADVANCED AUDITING AND PROFESSIONAL ETHICS Report on the Audit of the Financial Statements9 Disclaimer of Opinion

We were engaged to audit the financial statements of ABC & Associates (“the entity”), which comprise the balance sheet as at March 31, 20XX, the statement of Profit and Loss, (the statement of changes in equity)10 and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.

We do not express an opinion on the accompanying financial statements of the entity. Because of the significance of the matters described in the Basis for Disclaimer of Opinion section of our report, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion on these financial statements. Basis for Disclaimer of Opinion We were not appointed as auditors of the Company until after March 31, 20X1 and thus did not observe the counting of physical inventories at the beginning and end of the year. We were unable to satisfy ourselves by alternative means concerning the inventory quantities held at March 31, 20X0 and 20X1, which are stated in the Balance Sheets at ` xxx and ` xxx, respectively. In addition, the introduction of a new computerized accounts receivable system in September 20X1 resulted in numerous errors in accounts receivable. As of the date of our report, management was still in the process of rectifying the system deficiencies and correcting the errors. We were unable to confirm or verify by alternative means accounts receivable included in the Balance Sheet at a total amount of ` xxx as at March 31, 20X1. As a result of these matters, we were unable to determine whether any adjustments might have been found necessary in respect of recorded or unrecorded inventories and accounts receivable, and the elements making up the statement of Profit and Loss (and statement of cash flows)11.


Our responsibility is to conduct an audit of the entity’s financial statements in accordance with Standards on Auditing and to issue an auditor’s report. However, because of the matters described in the Basis for Disclaimer of Opinion section of our report, we were not able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion on these financial statements.

We are independent of the entity in accordance with the ethical requirements in accordance with the requirements of the Code of Ethics issued by ICAI and the ethical requirements as prescribed under the laws and regulations applicable to the entity.

9 The sub-title “Report on the Audit of the Financial Statements” is unnecessary in circumstances when the second sub-title “Report on Other Legal and Regulatory Requirements” is not applicable. 10 Where applicable. 11 Where applicable.


AUDIT REPORTS 6.45

Illustration of an Auditor’s Report that Includes a Key Audit Matters Section, an Emphasis of Matter Paragraph, and an Other Matter Paragraph


• Audit of a complete set of financial statements of a listed company (registered under the companies Act, 2013) using a fair presentation framework.



• The auditor has concluded an unmodified (i.e., “clean”) opinion is appropriate based on the audit evidence obtained.

• The relevant ethical requirements that apply to the audit are those of the ICAI’s Code of Ethics and the provisions of the Companies Act, 2013.


• Between the date of the financial statements and the date of the auditor’s report, there was a fire in the entity’s production facilities, which was disclosed by the entity as a subsequent event. In the auditor’s judgment, the matter is of such importance that it is fundamental to users’ understanding of the financial statements. The matter did not require significant auditor attention in the audit of the financial statements in the current period.

• Key audit matters have been communicated in accordance with SA 701.

• Corresponding figures are presented, and the prior period’s financial statements were audited by a predecessor auditor. The auditor is not prohibited by law or regulation from referring to the predecessor auditor’s report on the corresponding figures and has decided to do so.




6.46 ADVANCED AUDITING AND PROFESSIONAL ETHICS Report on the Audit of the Standalone Financial Statements12

Opinion We have audited the standalone financial statements of ABC Company Limited (“the Company”), which comprise the balance sheet as at March 31, 20X1, and the statement of Profit & Loss, (statement of changes in equity) and the statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies and other explanatory information (in which are included the Returns for the year ended on that date audited by the branch auditors of the Company’s branches located at (location of branches))13. In our opinion, and to the best of our information and according to the explanations given to us the aforesaid financial statements, give a true and fair view, in conformity with the accounting principles generally accepted in India, of the state of affairs of the Company as at March 31st, 2XXX and profit/loss, (changes in equity) and its cash flows for the year ended on that date. Basis for Opinion We conducted our audit in accordance with Standards on Auditing (SAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements as per the ICAI’s Code of Ethics and the provisions of the Companies Act, 2013, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Emphasis of Matter14 We draw attention to Note X of the financial statements, which describes the effects of a fire in the Company’s production facilities. Our opinion is not modified in respect of this matter.

Illustration of an Auditor’s Report Containing a Qualified Opinion Due to a Departure from the Applicable Financial Reporting Framework and that Includes an Emphasis of Matter Paragraph


• Audit of a complete set of financial statements of an company other than a listed company (registered under the Companies Act, 2013) using a fair presentation framework..


12 1 The sub-title “Report on the Audit of the Standalone Financial Statements” is unnecessary in circumstances when the second sub-title “Report on Other Legal and Regulatory Requirements” is not applicable. 13 As may be applicable 14 As noted in paragraph A16, an Emphasis of Matter paragraph may be presented either directly before or after the Key Audit Matters section based on the auditor’s judgment as to the relative significance of the information included in the Emphasis of Matter paragraph.


AUDIT REPORTS 6.47 • The terms of the audit engagement reflect the description of management’s responsibility

for the financial statements in SA 210.

• A departure from the applicable financial reporting framework resulted in a qualified opinion.

• The relevant ethical requirements that apply to the audit are the ICAI’s Code of Ethics and the provisions of the Companies Act, 2013.


• Between the date of the financial statements and the date of the auditor’s report, there was a fire in the entity’s production facilities, which was disclosed by the entity as a subsequent event. In the auditor’s judgment, the matter is of such importance that it is fundamental to users’ understanding of the financial statements. The matter did not require significant auditor attention in the audit of the financial statements in the current period.

• The auditor is not required, and has otherwise not decided, to communicate key audit matters in accordance with SA 701.



Report on the Audit of the Standalone Financial Statements15

Qualified Opinion

We have audited the standalone financial statements of ABC Limited (“the Company”), which comprise the balance sheet as at March 31, 20X1, and the statement of Profit and Loss, (statement of changes in equity) and the statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies and other explanatory information (in which are included the Returns for the year ended on that date audited by the branch auditors of the Company’s branches located at (location of branches))2. In our opinion and to the best of our information and according to the explanations given to us, except for the effects of the matter described in the Basis for Qualified Opinion section of our report, the aforesaid financial statements present fairly, in all material respects, or give a true and fair view in conformity with the accounting principles generally accepted in India of the state of affairs of the Company as at March 31st, 2XXX and profit/loss, (changes in equity) and its cash flows for the year ended on that date.

15 The sub-title “Report on the Audit of the Standalone Financial Statements” is unnecessary in circumstances when the second sub-title “Report on Other Legal and Regulatory Requirements” is not applicable.




The Company’s short-term marketable securities are carried in the statement of financial position at xxx. Management has not marked these securities to market but has instead stated them at cost, which constitutes a departure from the Accounting Standards prescribed in section 133 of the Companies Act, 2013. The Company’s records indicate that had management marked the marketable securities to market, the Company would have recognized an unrealized loss of `xxx in the statement of comprehensive income for the year. The carrying amount of the securities in the statement of financial position would have been reduced by the same amount at March 31, 20X1, and income tax, net income and shareholders’ equity would have been reduced by `xxx, `xxx and `xxx, respectively.

We conducted our audit in accordance with Standards on Auditing (SAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements under the provisions of the Companies Act, 2013, and we have fulfilled our other ethical responsibilities in accordance with these requirements and the ICAI’s Code of Ethics. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion.

Emphasis of Matter – Effects of a Fire

We draw attention to Note X of the financial statements, which describes the effects of a fire in the Company’s production facilities. Our opinion is not modified in respect of this matter.

Note: Students may refer remaining paras of Audit Report like Key Audit Matters para etc., from the illustrative format given above.


AUDIT REPORTS 6.49

TEST YOUR KNOWLEDGE Theoretical Questions 1. Under the applicable Standards on Auditing, in what circumstances does the report of the

statutory auditor require modifications? What are the types of modifications possible to the said report?

2. Write a short note on Emphasis of matter paragraph in Audit Reports.

3. Write a short note on Certificate for Special Purpose vs. Audit Report.

4. Compare and explain the following:

(i) Reporting to Shareholders vs. Reporting to those Charged with Governance

(ii) Audit Qualification vs. Emphasis of Matter.

Multiple Choice Questions 1. KPI Ltd is a joint venture of KPI Inc, a company based in US, and OPQ Ltd, a company

based in Japan (hereinafter referred to as ‘JV partners’). KPI Ltd was registered in India and is operating as a marketing support company for KPI Inc. All the costs of KPI Ltd are incurred in India and entire revenue of KPI Inc is generated in USD. The entire funding requirements of KPI Ltd are taken care of by the JV partners. Since KPI Ltd is based in India, hence it is also required to get its financial statements audited.

The company appointed new auditors for the audit of the financial statements for the year ended 31 March 2019 after doing all appointment formalities wherein auditors also confirmed their eligibility for appointment including independence.

The statutory auditors have completed their audit and did not come up any significant observations. Management of KPI Ltd was also very pleased with the working style of the auditors.

When the auditors issued their final audit report, the management observed that the auditors did not state anything related to their compliance in respect of ethical requirements regarding independence etc. Further, the audit report was also silent on the requirement related to auditor’s communication with those charged with governance in respect of matters related to planned scope & timing of audit and any significant findings.

The management requested that the auditors should revisit their report and should include these points in their report, however, as per the auditors all these communications were already completed by them and hence they were not required to form part of the audit report.


6.50 ADVANCED AUDITING AND PROFESSIONAL ETHICS On the basis of above mentioned facts, please suggest which of the following should be

correct.

(a) The auditing standards do not require the auditors to comment on the points which the management is requesting i.e. ethical requirements or matters related to planned scope & timing of audit or any significant findings etc. However, if the auditor wants to include that on the basis of his agreed terms with the management, he may do so.

(b) The auditing standards require the auditors to comment on the points which the management is requesting i.e. ethical requirements or matters related to planned scope & timing of audit or any significant findings etc. Hence, the auditors should issue rectified report.

(c) The ethical requirements are already completed by the auditors at the time of appointment itself. Since the audit is completed, there is no need to comment on the planned scope & timing of audit. Since there are no significant findings so this communication is also not possible. Hence, the auditors need not revisit their report.

(d) The ethical requirements are already completed by the auditors at the time of appointment itself and there are no significant findings, hence, there is no need to comment on these points. However, the auditors should state that they communicate with those charged with governance regarding the planned scope & timing of audit. Therefore, the auditors should revisit their report.

2. LMN & Co LLP is a large firm of Chartered Accountants having its offices based in Delhi, Pune, Chandigarh and Bangalore.

The firm has staff of around 300 with 28 Partners. The firm has also created various departments for various services that it offers – statutory audit, risk advisory, mergers & acquisitions, indirect tax and direct tax, where dedicated teams are working who are specialized in those fields. The firm is also considering to create departments on the basis of industry sectors so that the staff can become specialized into specific industries as the same would help in the objective of the firm i.e. to offer best quality service to its various clients.

Statutory audit department of the firm has 13 partners across various offices in India out of which 6 are based in Delhi office.

The audit team of one of the prestigious clients, KSH Ltd, has concluded that audit where audit partner was AD Jain. As per the agreed timelines, the financial statements and the audit report were planned to be signed on 30 June, 2019, however, on 29 June, 2019, AD Jain was required to move out of India due to some exigency and would be back to India after a month’s time. He was also not accessible during this period.


AUDIT REPORTS 6.51 The management of KSH Ltd discussed the matter with another partner of the audit firm, SK

Gupta, who eventually signed the audit report on 30 June, 2019 even though he was not part of the audit team which was involved in the fieldwork.

We would like to understand your views in respect of this matter.

(a) The management in such a case should have waited for AD Jain to come back and then get the report signed. The audit report in this case would be considered to be invalid.

(b) SK Gupta signed the audit report considering the client was prestigious for the firm which was unethical.

(c) Signing of the audit report as per the agreed timelines by SK Gupta was fine as he was also the audit partner of the firm.

(d) Signing of audit report by any other person interferes with the concept of clarity of responsibility.

3. RBJ Ltd is a listed company engaged in the business of software and is one of the largest company operating in this sector in India. The company’s annual turnover is INR 40,000 crores with profits of INR 5,000 crores. Due to the nature of the business and the size of the company, the operations of the company are spread out in India as well as outside India.

Outside India, the company is focusing more on US and European markets and the company has been able to establish its good reputation in these markets as well.

During the course of the audit, the audit team spends significant time on audit of revenue – be it planning, execution or conclusion. The audit team for this engagement is generally very big i.e. a team of approx. 70-80 members. The company’s contracts with its various customers are quite complicated and different. The efforts towards audit of revenue also involve significant involvement of senior members of the audit team including the audit partner.

After completion of audit for the year ended 31 March 2019, the audit partner was discussing significant matters with the management wherein he also communicated to the management that he plans to include revenue recognition as key audit matter in his audit report. The management was quite surprised to understand this from the auditor and did not agree with revenue recognition to be shown as key audit matter in the audit report. As per the management, the auditors didn’t have any modification and such a matter getting reported as key audit matter would not go down well with various stakeholders and would significantly impact the financial positions of the company in the market. The auditors were not able to convince the management in respect of this point and there was a difference of opinion.

You are requested to give your view in respect of this matter.



(a) The concern of the management is valid. For such a large sized company, such type of matter getting reported as key audit matter is not appropriate.

(b) The assessment of the auditor is valid. Such a matter qualifies to be a key audit matter and hence should be reported accordingly by the auditor in his audit report.

(c) Reporting revenue as key audit matter when the auditor does not have observation in that area leading to any modification in his report, would not be appropriate.

(d) This being the first year of reporting of key audit matters, the auditor should take a soft stand and should avoid reporting such controversial matters in his report.

4. BDJ Ltd is engaged in the business of providing management consultancy services and have been in operation for the last 15 years. The company’s financial reporting process is very good and its statutory auditors always issued clean report on the audit of the financial statements of the company. The auditors were required to be rotated due to mandatory audit rotation requirement of the Companies Act 2013.

RNJ & Associates, a firm of Chartered Accountants, was appointed as the new auditor of the company for a term of 5 years and have to start their first audit for the financial year ended 31 March 2019.

The auditors had a detailed and clear discussion with the management that they will perform their audit procedures in respect of opening balances along with the audit procedures for the financial year ended 31 March 2019.

Management agreed with that and the audit was completed as per the plan.

The auditors did not have any significant observations and hence they communicated to the management that their report will be clean. Management was quite happy with this and also requested the auditors to share draft report before issuing the final report.

In the draft audit report, all the particulars were fine except ‘other matters paragraph’ wherein the auditors gave a reference that the financial statements for the comparative year ended 31 March 2018 was audited by another auditor. Management asked the audit team to remove this paragraph as the auditors had performed all the audit procedures on opening balances also. But the auditors did not agree with the management.

Please advise the auditor or the management whoever is incorrect with the right guidance.

(a) The contention of the management is valid. After performing all the audit procedures, an auditor should not pass on the responsibility to another auditor by including such references in his audit report.

(b) Any auditor has two options, either to perform audit procedures on opening balances or given such reference of another auditor in his report. An auditor can not mix up the things like this auditor has done. It is completely unprofessional.


AUDIT REPORTS 6.53

(c) In the given situation even if the auditor wants to give such reference, the management and the auditor should have taken approval from the previous auditor at the time of appointment of new auditor. In this case, it cannot be done.

(d) The report of the auditor is absolutely correct and is in line with the auditing standards. An auditor is required to include such reference in his report as per the requirements of the auditing standard.

5. SKJ Private Ltd has an annual turnover of INR 200 crores and profits of INR 25 crores. The company is engaged in the business of textiles and has fairly stable operations over the years. There has not been much growth in the company in the last few years despite the attempts of the management. Currently the management is more focused towards cost cutting and has been considering all the options to achieve that objective.

The statutory auditors of the company have been auditing the financial statements for the last 3 years and have issued clean reports over these years.

During the financial year ended 31 March 2019, management got a large project from a new customer which resulted in significant increase in the turnover of the company. However, the profitability of the company did not improve much because the margins in the contract were not high.

The statutory auditors during the course of their audit of financial statements for the year ended 31 March 2019 (their fourth year of audit) did not agree with the revenue recognition criteria followed by the company. Since the matter was significant, lot of discussions/ debates happened between the auditor and the management. But it was finally agreed that the auditors would qualify their audit report.

Auditors wanted that the management should explain this matter in detail in the notes to accounts to the financial statement over which the auditors are qualifying the audit report. However, the management had a different view. Management said that if the auditor is qualifying his report then why should the management also highlight that matter in the financial statement and hence refused to include any note for the same.

Because of this conflict, audit is not getting concluded. You are requested to give your view in respect of this matter so that the matter gets concluded.

(a) In the given situation, if the management does not agree to give a note in the financial statements then the auditor should not hold the audit report. However, in such a case, the auditor would need to give disclaimer of opinion in his report instead of qualification.

(b) The argument of the management seems correct. Auditor cannot do both the things i.e. to qualify and then also get that highlighted in the financial statements. That note would not be beneficial for the users of the financial statements.



(c) In case of such matters related to revenue recognition, it is always better to give detailed explanation in the notes to accounts to the financial statements. If the explanation is satisfactory then the auditor should also consider giving emphasis of matter instead of qualification.

(d) The requirement of the auditor is beneficial for the company because by giving an explanation of the matter, on which auditor has given a qualification, in the notes to accounts, the management would be able to explain their perspective/ point of view to the users of the financial statements. In that case, auditor while giving the qualification can give reference to the notes to accounts otherwise the entire matter would form part of the audit report. However, the auditor should not hold his report if the management does not want to give any explanation in the notes to accounts.

6. While conducting the current year audit of Finco Ltd, the auditor obtains audit evidence that a material misstatement exists in the prior period financial statements. This misstatement was related to recognition of research and development expenditure. The provisions of Ind AS 38 Intangible Assets relating to capitalisation of development expenditure was not applied properly. On this, unmodified opinion had been previously issued. The current auditor verified that the misstatement had not been dealt with as required under Ind AS 8 Accounting Policies, Changes in Accounting Estimates and Errors. Accordingly, the current auditor will:

(a) Express an unmodified opinion in the auditor’s report on the current period financial statements since it was related to the prior year.

(b) Express a qualified opinion in the auditor’s report on the current period financial statements, modified with respect to the corresponding figures included therein.

(c) Express a qualified or an adverse opinion in the auditor’s report on the current period financial statements modified with respect to the corresponding figures included therein.

(d) Express an adverse opinion in the auditor’s report on the current period financial statements, modified with respect to the corresponding figures included therein.

Answers to Theoretical Questions 1. Refer Para 5.

2. Refer Para 6.

3. Certificate for Special Purpose vs. Audit Report: A certificate is a written confirmation of the accuracy of the facts stated therein and does not involve any estimate or opinion. The term ‘certificate’ is, therefore, used where the auditor verifies the accuracy of facts. An auditor may thus, certify the circulation figures of a newspaper or the value of imports or exports of a company. An auditor’s certificate represents that he has verified certain figures


AUDIT REPORTS 6.55

and is in a position to vouch safe their accuracy as per his examination of documents and books of account. A report, on the other hand, is a formal statement usually made after an enquiry, examination or review of specified matters under report and includes the reporting auditor’s opinion thereon. Thus, when a reporting auditor issues a certificate, he is responsible for the factual accuracy of what is stated therein. On the other hand, when a reporting auditor gives a report, he is responsible for ensuring that the report is based on factual data, that his opinion is in due accordance with facts, and that it is arrived at by the application of due care and skill. The ‘report’ involves expression of opinion which may differ from one professional to another. There is no question of exactitude in case of a report since the information contained therein is based on estimates and involves judgement element.

4. (i) Reporting to Shareholders vs. Reporting to those Charged with Governance: REPORT

Reporting to Shareholders Reporting to those Charged with Governance

• Section 143 of the Companies Act, 2013 deals with the provisions relating to reporting to Shareholders. Thus, it is a Statutory Audit Report which is addressed to the members.

• Standard on Auditing 260 deals with the provisions relating to reporting to those Charged with Governance.

• Statutory Audit Report is on true and fair view and as per prescribed Format.

• It is a reporting on matters those charged with governance like scope of audit, audit procedures, audit modifications, etc.

• Statutory Audit Reports are in public domain.

• Reporting to those Charged with Governance is an internal document i.e. private report.

(ii) Audit Qualification vs. Emphasis of Matter: REPORT

Audit Qualification Emphasis of Matter • Standard on Auditing 705

“Modifications to the Opinion in the Independent Auditor’s Report”, deals with the provisions relating to Audit Qualification.

• Standard on Auditing 706 “Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report” deals with the provisions relating to Emphasis of Matter.

• Audit Qualifications are also known as “subject to report” or “except that report”.

• Emphasis of Matter is a paragraph which is included in auditor’s report to draw users’ attention to important matter(s) which are already disclosed



in Financial Statements and are fundamental to users’ for understanding of Financial Statements.

• Audit Qualifications are given when auditor is having reservations on some of the items out of the financial statements as a whole i.e. Auditor’s Judgment about the Pervasiveness of the Effects or Possible Effects on the Financial Statements relating to if the impact of material misstatements is not pervasive on the financial statements but is present at some levels of the financial statements, qualified report is issued.

• Emphasis of Matter is a paragraph which is issued when there is a uncertainty relating to future outcome of exceptional litigation, regulatory action, etc.; or there is early application (where permitted) of a new accounting standard that has a pervasive effect on the financial statements in advance of its effective date.

Answers to Multiple Choice Questions 1. (b) 2. (c) 3. (b) 4. (d) 5. (d) 6. (c)


Advanced Auditing and Professional Ethics - Srinivasa Academy

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